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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 17, 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 October 22, 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 September 17, 2004
and May 28, 2004 (unaudited).............................. 2
Consolidated statements of operations for the
sixteen weeks ended September 17, 2004 and
September 19, 2003 (unaudited)............................ 3
Consolidated statements of stockholders' equity
and comprehensive income for the sixteen weeks
ended September 17, 2004 and the fiscal year
ended May 28, 2004 (unaudited)............................ 4
Consolidated statements of cash flows for the
sixteen weeks ended September 17, 2004 and
September 19, 2003 (unaudited)............................ 5
Notes to unaudited consolidated financial statements........ 6
Item 2. Management's discussion and analysis of financial
condition and results of operations.......................11
Item 3. Quantitative and qualitative disclosures about market risk..24
Item 4. Controls and procedures.....................................25
Part II. Other Information....................................................26
Item 4. Submission of matters to a vote of security holders.........26
Item 6. Exhibits and reports on Form 8-K............................26
Signatures....................................................................27
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)
September 17, May 28,
2004 2004
------------ ------------
Assets
Current assets:
Cash and cash equivalents........................... $ 69,975 $ 58,898
Receivables, net.................................... 32,410 28,727
Prepaid expenses and supplies....................... 8,984 7,357
Deferred income taxes............................... 15,534 14,132
Assets held for sale................................ 2,957 5,826
------------ ------------
Total current assets............................ 129,860 114,940
Property and equipment, net........................... 678,574 692,162
Deferred income taxes................................. 15,414 15,075
Goodwill.............................................. 42,565 42,565
Deferred financing costs.............................. 17,476 18,673
Other assets.......................................... 21,949 21,079
------------ ------------
$ 905,838 $ 904,494
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts..................................... $ 5,480 $ 6,042
Accounts payable.................................... 9,422 8,840
Current portion of long-term debt................... 7,240 7,169
Accrued expenses and other liabilities.............. 113,958 124,261
------------ ------------
Total current liabilities....................... 136,100 146,312
Long-term debt........................................ 480,376 481,610
Noncurrent self-insurance liabilities................. 34,930 33,046
Deferred income taxes................................. 263 --
Other noncurrent liabilities.......................... 97,220 93,664
------------ ------------
Total liabilities............................... 748,889 754,632
------------ ------------
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........... 197 197
Additional paid-in capital.......................... 26,800 26,800
Notes receivable from stockholders.................. (1,865) (1,933)
Retained earnings................................... 132,092 124,997
Accumulated other comprehensive loss................ (275) (199)
------------ ------------
Total stockholders' equity...................... 156,949 149,862
------------ ------------
$ 905,838 $ 904,494
============ ============
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)
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Revenues, net.......................................... $ 266,379 $ 255,707
------------ ------------
Operating expenses:
Salaries, wages and benefits......................... 148,808 143,689
Depreciation and amortization........................ 17,765 18,230
Rent................................................. 17,638 16,585
Provision for doubtful accounts...................... 2,623 1,800
Other................................................ 59,601 62,690
------------ ------------
Total operating expenses......................... 246,435 242,994
------------ ------------
Operating income................................... 19,944 12,713
Investment income...................................... 159 72
Interest expense....................................... (11,032) (12,963)
Gain on minority investment............................ 2,052 --
Dividend income........................................ 667 --
Loss on the early extinguishment of debt............... -- (3,669)
------------ ------------
Income (loss) before income taxes and
discontinued operations............................ 11,790 (3,847)
Income tax (expense) benefit........................... (4,827) 1,522
------------ ------------
Income (loss) before discontinued operations......... 6,963 (2,325)
Discontinued operations, net of income taxes of
$92 and $451, respectively........................... 132 (688)
------------ ------------
Net income (loss).................................. $ 7,095 $ (3,013)
============ ============
Basic net income (loss) per share:
Income (loss) before discontinuedoperations.......... $ 0.35 $ (0.12)
Discontinued operations, net......................... 0.01 (0.03)
------------ ------------
Net income (loss).................................. $ 0.36 $ (0.15)
============ ============
Diluted net income (loss) per share:
Income (loss) before discontinued operations......... $ 0.34 $ (0.12)
Discontinued operations, net......................... 0.01 (0.03)
------------ ------------
Net income (loss) ................................. $ 0.35 $ (0.15)
============ ============
Weighted average common shares outstanding:
Basic.............................................. 19,722 19,684
Diluted............................................ 20,076 19,684
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 30, 2003................... 19,661 $ 197 $ 25,909 $ (1,085) $ 110,297 $ (159) $ 135,159
Comprehensive income:
Net income.............................. -- -- -- -- 14,700 -- 14,700
Cumulative translation adjustment....... -- -- -- -- -- 159 159
Mark-to-market adjustment on interest
rate cap agreement................... -- -- -- -- -- (199) (199)
----------
Total comprehensive income.......... 14,660
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 May 28, 2004............... 19,722 197 26,800 (1,933) 124,997 (199) 149,862
Comprehensive income:
Net income.............................. -- -- -- -- 7,095 -- 7,095
Mark-to-market adjustment on interest
rate cap agreement, net of tax........ -- -- -- -- -- (76) (76)
----------
Total comprehensive income.......... 7,019
Proceeds from collection of stockholders'
notes receivable........................ -- -- -- 68 -- -- 68
-------- -------- ---------- ------------ -------------- ------------- ----------
Balance at September 17, 2004......... 19,722 $ 197 $ 26,800 $ (1,865) $ 132,092 $ (275) $ 156,949
======== ======== ========== ============ ============== ============= ==========
See accompanying notes to unaudited consolidated financial statements.
4
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Cash flows from operations:
Net income (loss)..................................... $ 7,095 $ (3,013)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation...................................... 17,620 18,890
Amortization of deferred gain on sale-leasebacks.. (1,668) (873)
Amortization of deferred financing costs.......... 1,217 4,040
Provision for doubtful accounts................... 2,686 1,901
Gain on minority investment....................... (2,052) --
Gain on sales and disposals of property and
equipment....................................... (685) (50)
Deferred tax (benefit) expense.................... (1,478) 1,848
Changes in operating assets and liabilities:
Increase in receivables......................... (6,368) (5,609)
Increase in prepaid expenses and supplies....... (1,627) (654)
Decrease (increase) in other assets............. 787 (1,586)
Decrease in accounts payable, accrued
expenses and other current and noncurrent
liabilities................................... (9,439) (8,019)
Other, net........................................ (76) (30)
------------ ------------
Net cash provided by operating activities........... 6,012 6,845
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment................... (13,659) (16,478)
Purchases of property and equipment previously
included in the synthetic lease facility........... -- (97,851)
Proceeds from sales of property and equipment......... 18,572 16,290
Increase in restricted cash........................... (716) (2,897)
Proceeds from (issuance of) notes receivable.......... 2,673 (759)
------------ ------------
Net cash provided by (used in) investing activities. 6,870 (101,695)
------------ ------------
Cash flows from financing activities:
Proceeds from long-term borrowings.................... -- 327,000
Payments on long-term borrowings...................... (1,163) (213,681)
Deferred financing costs related to refinanced debt... -- (16,890)
Payments on capital leases............................ (148) (241)
Proceeds from issuance of common stock................ -- 76
Proceeds from stockholders' notes receivable.......... 68 145
Repurchase of common stock............................ -- (198)
Bank overdrafts....................................... (562) (566)
------------ ------------
Net cash (used in) provided by financing activities. (1,805) 95,645
------------ ------------
Increase in cash and cash equivalents............. 11,077 795
Cash and cash equivalents at the beginning
of the period....................................... 58,898 18,066
------------ ------------
Cash and cash equivalents at the end of the period.... $ 69,975 $ 18,861
============ ============
Supplemental cash flow information:
Interest paid..................................... $ 12,751 $ 16,612
Income taxes paid, net............................ 6,312 1,927
Non-cash financial activities:
Issuance of notes receivable to stockholders........ $ -- $ 714
See accompanying notes to unaudited consolidated financial statements.
5
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
1. Nature of Business
KinderCare Learning Centers, Inc., referred to as KinderCare, is the
leading for-profit provider of early childhood education and care in the United
States. At September 17, 2004, we served approximately 115,000 children and
their families at 1,228 child care centers. At our child care centers, education
and care services are provided 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 164,000
at September 17, 2004.
We operate early childhood education and care centers under two brands as
follows:
o KinderCare - At September 17, 2004, we operated 1,158 KinderCare
centers. The brand was established in 1969 and operates centers in 39
states.
o Mulberry - We operated 70 Mulberry centers at September 17, 2004,
which are located primarily in the northeast region of the United
States and southern California.
We also partner with companies to provide on- or near-site care to help
employers attract and retain employees. Included in the 1,228 centers at
September 17, 2004 were 44 KinderCare at Work Centers. Additionally, we had
eleven service contracts to operate before- and after-school programs. In
addition to our center-based child care operations, we own and operate a
distance learning company serving teenagers and young adults. Our subsidiary, KC
Distance Learning, Inc., offers an accredited high school program delivered in
either online or correspondence format. We have made a minority investment 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.
Fiscal Year. References to fiscal year 2005 and fiscal year 2004 are to the
53 weeks ended June 3, 2005, and to the 52 weeks ended May 28, 2004. Our fiscal
year ends on the Friday closest to May 31. The first quarter is comprised of 16
weeks and ended on September 17, 2004 in fiscal year 2005 and September 19, 2003
in fiscal year 2004. The second, third and fourth quarters are each comprised of
12 weeks.
2. Summary of Significant Accounting Policies
Basis of Presentation. The unaudited consolidated financial statements
include the financial statements of KinderCare and our subsidiaries, all of
which are wholly owned. All significant intercompany balances and transactions
have been eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial
statements reflect the adjustments, all of which are of a normal recurring
nature, necessary to present fairly our financial position at September 17, 2004
and our results of operations and cash flows for the sixteen weeks ended
September 17, 2004 and September 19, 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 the annual consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K for the fiscal year
ended May 28, 2004.
6
Restricted Cash. At September 17, 2004 and May 28, 2004 restricted cash of
$2.2 million and $1.4 million, respectively, was included in other assets in our
unaudited consolidated balance sheets. The restricted cash related primarily to
capital expenditure requirements under our $300.0 million mortgage loan.
Property and Equipment, net. Our $300.0 million mortgage loan is secured by
first mortgages or deeds of trust on 475 of our owned centers. In addition, we
mortgaged another 119 of our owned centers to secure the debt under our
revolving credit facility. At September 17, 2004 and May 28, 2004, the net book
value of $388.2 million and $392.6 million, respectively, for these 594 centers
was included in property and equipment in our unaudited consolidated balance
sheets.
Revenue Recognition. The recognition of our net revenues meets the
following criteria: the existence of an arrangement through an enrollment
agreement, the rendering of childcare services, an age specific tuition rate
and/or 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 revenue is primarily comprised of
supplemental fees from tutoring programs and field trips. Tuition, 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 average enrollment period, not to exceed twelve months.
Comprehensive Income (Loss). Comprehensive income (loss) included the
following, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Net income (loss)...................... $ 7,095 $ (3,013)
Mark-to-market adjustment on interest
rate cap agreement, net of tax....... (76) --
Cumulative translation adjustment...... -- (30)
------------ ------------
Comprehensive income (loss).......... $ 7,019 $ (3,043)
============ ============
We determined that our interest rate cap agreement, which was purchased in
connection with our mortgage loan in July 2003, is a cash flow hedge, which is
a derivative that is based on future cash flows attributed to a particular risk,
such a interest rate changes on variable rate debt. During the first quarter of
fiscal year 2005, a mark-to-market adjustment of $0.3 million was recorded,
which reduced the value of the interest rate cap agreement and resulted in a
comprehensive loss of $0.1 million, net of tax. Due to the sale of our
subsidiary in the United Kingdom in the fourth quarter of our fiscal year 2004
we no longer record a cumulative translation adjustment.
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.
7
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:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Reported net income (loss)............ $ 7,095 $ (3,013)
Compensation costs for stock option
plans, net of taxes................. (301) (290)
------------ ------------
Pro forma net income (loss)....... $ 6,794 $ (3,303)
============ ============
Pro forma basic net income (loss)
per share:
Reported basic net income (loss)
per share......................... $ 0.36 $ (0.15)
Compensation costs for stock option
plans, net of taxes............... (0.02) (0.02)
------------ ------------
Pro forma basic net income
(loss) per share.............. $ 0.34 $ (0.17)
============ ============
Pro forma diluted net income (loss)
per share:
Reported diluted net income (loss)
per share......................... $ 0.35 $ (0.15)
Compensation costs for stock option
plans, net of taxes............... (0.02) (0.02)
------------ ------------
Pro forma diluted net income
(loss) per share.............. $ 0.33 $ (0.17)
============ ============
A summary of the weighted average fair values was as follows:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Weighted average fair value of
options granted during the period,
using the Black-Scholes option
pricing model....................... $ -- $ 8.43
Assumptions used to estimate the
present value of options at the
grant date:
Volatility........................ -- 48.2%
Risk-free rate of return.......... -- 3.7%
Dividend yield.................... -- 0.0%
Number of years to exercise
options......................... -- 7
There were no options granted during the first quarter of fiscal year 2005.
8
Discontinued Operations. Discontinued operations included the operating
results for centers closed since fiscal year 2002. A summary of discontinued
operations was as follows, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Revenues, net......................... $ 293 $ 5,596
Operating expenses.................... 69 6,735
------------ ------------
Operating income (loss)............. 224 (1,139)
Income tax (expense) benefit.......... (92) 451
------------ ------------
Discontinued operations,
net of tax........................ $ 132 $ (688)
============ ============
Operating expenses related to discontinued operations included the
following, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Impairment recoveries................. $ 391 $ --
Gain on closed center sales........... 673 --
During the sixteen weeks ended September 17, 2004, $0.4 million of
impairment charges recognized during fiscal year 2004 for closed centers were
recovered as a result of higher than expected proceeds on the sale of three
centers that had been held for sale. Of the center closures since fiscal year
2002, ten were held for sale at September 17, 2004 and 16 were held for sale at
May 28, 2004. As a result, $3.0 million and $5.7 million of property and
equipment was classified as current in the unaudited consolidated balance sheets
at September 17, 2004 and May 28, 2004, respectively. During the first quarter
of fiscal year 2005, six centers previously classified as held for sale were
sold.
Net Income (Loss) per Share. The difference between basic and diluted net
income (loss) per share was a result of the dilutive effect of options, which
are considered potential common shares. A summary of the weighted average common
shares was as follows, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Basic weighted average common
shares outstanding.................. 19,722 19,684
Dilutive effect of options............ 354 --
------------ ------------
Diluted weighted average common
shares outstanding.................. 20,076 19,684
============ ============
Shares excluded from potential shares
due to their anti-dilutive effect... 1,182 2,671
============ ============
There was no dilutive effect of stock options in the first quarter of
fiscal year 2004 due to the recognition of a net loss.
9
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 center closures since fiscal year
2002, we have conformed amounts previously reported in our Report on Form 10-Q
for the quarterly period ended September 19, 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:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Land.................................. $ 160,678 $ 161,575
Buildings and leasehold improvements.. 635,687 636,104
Equipment............................. 199,212 196,146
Construction in progress.............. 8,550 13,173
------------ ------------
1,004,127 1,006,998
Accumulated depreciation and
amortization........................ (325,553) (314,837)
------------ ------------
$ 678,574 $ 692,161
============ ============
4. Commitments and Contingencies
We are presently, and are from time to time, subject to claims and
litigation arising in the ordinary course of business. We believe that none of
the claims or litigation of which we are aware will materially affect our
consolidated financial statements, although assurance cannot be given with
respect to the ultimate outcome of any such actions.
5. Registration Statements
In April 2004, we filed registration statements with the Securities and
Exchange Commission for a proposed initial public offering of Income Deposit
Securities ("IDSs"), a separate proposed offering of senior subordinated notes
and a proposed recapitalization pursuant to which our existing stockholders
would receive in exchange for their common stock, cash and either IDSs or shares
of new class B common stock. The proposed offerings and recapitalization are
referred to as "the IDS Transactions." An IDS is a unit containing one share of
new class A common stock of KinderCare and a fixed principal amount of senior
subordinated notes of KinderCare. The senior subordinated notes to be sold in
the separate offering will be identical to those senior subordinated notes
included in the IDSs. The completion of the proposed offerings and
recapitalization is subject to a number of conditions, including the approval of
the recapitalization by the holders of a majority of our outstanding existing
common stock. We plan to use the net proceeds of the proposed offerings,
together with available cash, to refinance certain outstanding indebtedness and
to finance the cash portion of the cash to be paid to holders of our existing
common stock in the proposed recapitalization. The registration statements are
currently under review by the Securities and Exchange Commission. There is no
guarantee that the IDS Transactions will be consummated in whole or in part, and
we may elect at any time and for any reason not to proceed with the IDS
Transactions or to change any of the proposed terms of the IDS Transactions. As
of September 17, 2004, we had capitalized $2.7 million in costs associated with
the IDS Transactions.
10
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 16 weeks ended September 17, 2004 as "the
first quarter of fiscal year 2005" and the 16 weeks ended September 19, 2003 as
"the first quarter of fiscal year 2004." Our first fiscal quarter is comprised
of 16 weeks, while the remaining quarters are each comprised of 12 weeks.
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 September 17, 2004, licensed
capacity at our centers was approximately 164,000 and we served approximately
115,000 children and their families at 1,228 child care centers. We distinguish
ourselves by providing high quality educational programs, a professional,
well-trained staff and clean, safe and attractive 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.
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 primarily from the tuition we charge for
attendance by children at our centers. Our tuition rates and net revenues can be
significantly impacted by enrollment levels and factors affecting the enrollment
mix at our centers. These factors include (i) enrollment levels by geographic
location because we can command higher tuition rates in certain geographic
areas; (ii) the age mix of children enrolled because our tuition rates depend on
the age of the child and are generally higher for younger children; (iii) the
mix between full- and part-time attendance because we charge a premium rate for
part-time enrollment and (iv) the level of participation in discount programs.
Recently, net revenue growth has primarily resulted from increased tuition
charges and expanded programs at existing centers and to a lesser extent due to
the addition of new centers through internal development and acquisitions.
Tuition charges from our child care centers represent the majority of our
net revenues. We collect tuition on a weekly basis, in advance. The majority of
our tuition is paid by individual families. Approximately 20% of our net revenue
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.
11
Over the past several years, we have pursued a strategy of increasing our
net revenues through enhanced center yield management. We have done so by
balancing an increase in tuition rates and a gradual decline in occupancy at our
centers. In addition, we have expanded our fee-based service offerings, which
include tutorial programs in the areas of literacy, reading, foreign language
and mathematics. Revenues from our fee-based offerings were $2.2 million and
$1.5 million in the first quarters of fiscal year 2005 and 2004, respectively.
Our comparable center net revenues grew moderately from fiscal year 2001 to
fiscal year 2003 and were relatively flat during fiscal year 2004. During the
first quarters of fiscal year 2005 and 2004 our comparable center net revenue
grew 2.6% and 0.3%, respectively. A center is included in comparable center net
revenues when it has been open and operated by us for at least one 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 from our distance learning
services.
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 period. However, we may adjust individual
classroom 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 and corporate management. Our focus on pricing at the
classroom level within our centers has enabled us to improve comparable center
net revenue growth without losing occupancy in centers where the quality of our
services, demand and other market conditions support such increases. 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 command
premium tuition rates.
We calculate an average weekly tuition rate 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.
The average weekly tuition rate has risen primarily due to the annual
tuition rate increases we have instituted as well as the classroom 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, as a result of the higher care requirements of younger children,
and the lowest pricing is charged in our school-age offerings. 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, participation levels within discount programs
and the opening of new centers in markets that support rates at levels higher
than our company average. The average tuition rate is also affected by regional
concentrations, which may represent markets with significantly different tuition
levels.
Occupancy is a measure of the utilization of center capacity. We calculate
occupancy as the FTE attendance divided by the sum of the centers' licensed
capacity during the related time period. Our licensed capacity has remained
relatively flat for the past three fiscal years. Typically, our new centers open
with lower occupancy than our pre-existing center base. We have experienced
declines in our occupancy levels in recent years. 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.
12
In addition to our tuition charges, we record revenues from fees and other
income. 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. We offer tutorial 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. Our child care
centers earn other miscellaneous revenue from various sources, including
management fees related to certain employer-sponsored contracts. In addition to
our child care operations, our subsidiary, KC Distance Learning, sells high
school level courses via online and correspondence formats and provides related
instructional services directly to private students, as well as to cyber and
traditional schools and school districts.
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.
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:
Sixteen Weeks Fiscal Year Ended
Ended ----------------------------
September 17, May 28, May 30, May 31,
2004 2004 2003 2002
------------- -------- -------- --------
Number of centers at the beginning of
the period............................... 1,240 1,264 1,264 1,242
Openings................................... 2 16 28 35
Acquisitions............................... -- 1 -- --
Closures................................... (14) (41) (28) (13)
------------- -------- -------- --------
Number of centers at the end of
the period............................. 1,228 1,240 1,264 1,264
============= ======== ======== ========
Total center licensed capacity at the
end of the period...................... 164,000 166,000 167,000 166,000
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 center base gives us the
ability to leverage the costs of programs and services, such as curriculum
development, training programs and other management processes.
Labor related costs are the largest component of operating expenses. We
have been successful in managing our labor productivity without adversely
impacting the quality of services within our centers. Other costs incurred at
the center level include insurance, janitorial, utilities, food, maintenance,
transportation, marketing and bad debt. While we generally have seen gradual
rises in our expenses, historically our largest increase has been in insurance
expense, as a result of higher premium and claims costs, particularly with
respect to workers compensation. During the first quarter of fiscal year 2005,
we experienced a reduction in projected claims costs, however, we anticipate
that premium and claims costs will continue to reflect market forces, which are
beyond our control.
13
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 new 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 to the
unaudited consolidated financial statements included in this report. 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
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 through an enrollment
agreement, the rendering of child care services, an age specific tuition rate
and/or 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 an appropriate
allowance. At September 17, 2004 and May 28, 2004, our allowance for doubtful
accounts, as a percentage of accounts receivable, was 13.0%. 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 typically 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. Impairment may not be appropriate under
certain circumstances, such as: (1) a new or maturing center, (2) recent center
director turnover or (3) an unusual, non-recurring expense impacting the cash
flow projection. Conversely, we will impair a center, regardless of mitigating
factors, when the center is placed on a closure list assuming that the center's
undiscounted cash flows are less than the net book value for a leased center or
the projected proceeds for the sale of an owned center are less than the net
book value. We also evaluate construction projects and internal use software and
programming development projects for impairment. If there is evidence that
development will not be completed, we will impair the project.
14
To the extent impairment has occurred, the loss will be measured as the
excess of the estimated 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:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Impairment charges included in
depreciation expense................. $ 779 $ 577
Impairment charges (recoveries)
included in discontinued operations.. (391) --
------------ ------------
Total impairment charges........... $ 388 $ 577
============ ============
Investments. Investments as to which 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 first quarter of fiscal year 2005,
we sold a minority investment, which resulted a gain of $2.1 million. Also,
during the first quarter of fiscal year 2005, we received a $0.7 million
dividend payment from a minority investment accounted for under the cost method,
which we recognized as dividend income.
Self-insurance obligations. We self-insure a portion of our workers'
compensation, general liability, 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 $56.9
million and $54.1 million at September 17, 2004 and May 28, 2004, respectively.
Our internal estimates are reviewed periodically by a third party actuary. While
we believe that the amounts accrued for these obligations are sufficient, any
significant increase in the number of claims and/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. During the first quarter of
fiscal year 2005, our effective tax rate increased to 40.9% compared to 39.6% in
the same period last year due the suspension of the Work Opportunity Tax Credit
("WOTC") on December 31, 2003. Subsequent to September 17, 2004 the WOTC was
reinstated and allows for a retroactive credit from January 1, 2004 to the date
of enactment, October 4, 2004. We will record an adjustment in our second
quarter of fiscal year 2005.
15
First Quarter of Fiscal Year 2005 compared to First Quarter of Fiscal Year 2004
The following table shows the comparative operating results of KinderCare,
in thousands, except the average weekly tuition rate:
Sixteen Weeks Sixteen Weeks Change
Ended Percent Ended Percent Amount
September 17, of September 19, of Increase/
2004 Revenues 2003 Revenues (Decrease)
------------- ---------- ------------- ---------- ----------
Revenues, net.............................. $ 266,379 100.0% $ 255,707 100.0% $ 10,672
------------- ---------- ------------- ---------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense......................... 137,717 51.7 133,136 52.1 4,581
Field and corporate expense............ 11,091 4.2 10,553 4.1 538
------------- ---------- ------------- ---------- ----------
Total salaries, wages and benefits... 148,808 55.9 143,689 56.2 5,119
Depreciation and amortization............ 17,765 6.7 18,230 7.1 (465)
Rent..................................... 17,638 6.6 16,585 6.5 1,053
Other.................................... 62,224 23.4 64,490 25.2 (2,266)
------------- ---------- ------------- ---------- ----------
Total operating expenses............... 246,435 92.5 242,994 95.0 3,441
------------- ---------- ------------- ---------- ----------
Operating income..................... $ 19,944 7.5% $ 12,713 5.0% $ 7,231
============= ========== ============= ========== ==========
Average weekly tuition rate................ $ 158.17 $ 150.88 $ 7.29
Occupancy.................................. 58.9% 59.5% (0.6)
Comparable center net revenue growth....... 2.6% 0.3%
Revenues, net. Net revenues increased $10.7 million, or 4.2%, from the same
period last year to $266.4 million in the first quarter of fiscal year 2005. The
increase was due to a higher average weekly tuition rate, offset by reduced
occupancy, as well as additional net revenues generated by the newly opened
centers. Comparable center net revenues increased $6.9 million, or 2.6%.
The average weekly tuition rate increased $7.29, or 4.8%, to $158.17 in the
first quarter of fiscal year 2005 due primarily to tuition increases. Occupancy
declined to 58.9% from 59.5% 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 the recent declines include reduced or
flat government funding for child care assistance programs, increased
unemployment rates and job losses and the general economic downturn.
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $5.1 million, or 3.6%, from the same period last year to $148.8
million. Total salaries, wages and benefits expense as a percentage of net
revenues was 55.9% for the first quarter of fiscal year 2005 compared to 56.2%
for the first quarter of fiscal year 2004.
Expenses for salaries, wages and benefits directly associated with the
centers was $137.7 million, an increase of $4.6 million from the same period
last year. The increase was primarily due to overall higher wage rates, offset
by improved labor productivity and a reduction in medical insurance costs. While
we have experienced recent reductions in medical insurance costs, we anticipate
that premium and claim costs will continue to reflect market forces that are
beyond our control. At the center level, salaries, wages and benefits expense as
a percentage of net revenues declined to 51.7% from 52.1% for the same period
last year due primarily to improved labor productivity and a reduction in
medical insurance costs.
16
Depreciation and amortization. Depreciation and amortization expense
decreased $0.5 million from the same period last year to $17.8 million.
Significant changes in depreciation expense included the impact of 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:
Impairment charges....................................... $ 203
Impact of centers sold in the sale-leaseback program..... (628)
Other.................................................... (40)
--------
Decrease in depreciation and amortization expense...... $ (465)
========
Impairment charges of $0.8 million and $0.6 million in the first quarters
of fiscal year 2005 and 2004, respectively, related to under-performing centers
and certain undeveloped properties and internal use programming development
projects.
Rent. Rent expense increased $1.1 million in the first quarter of fiscal
year 2005 compared to the same period last year. The most significant reason for
the change in rent expense was the sale-leaseback program. See "Liquidity and
Capital Resources." The changes were as follows, in thousands:
Impact of centers leased under the sale-leaseback
program................................................ $ 2,193
Amortization of deferred gains on sale-leaseback
transactions........................................... (780)
Other.................................................... (360)
--------
Increase in rent expense............................... $ 1,053
========
Other operating expenses. Other operating expenses include costs directly
associated with the centers, such as insurance, janitorial, utilities, food,
property taxes and licenses, maintenance and marketing costs, as well as
expenses related to field management and corporate administration. Other
operating expenses decreased $2.3 million in the first quarter of fiscal year
2005 compared to the same period last year. Other operating expenses as a
percentage of net revenues decreased to 23.4% from 25.2% for the same period
last year primarily as a result of cost controls and reduced insurance costs.
Interest expense. Interest expense was $11.0 million compared to $13.0
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 in the first quarter of fiscal year 2004, as discussed
below, was 7.0% and 6.8% for the first quarters of fiscal year 2005 and 2004,
respectively. The increase in the weighted average interest rate in the first
quarter of fiscal year 2005 was due primarily to an increase in the average
interest rate on our CMBS Loan, which bears interest at a per annum rate equal
to LIBOR plus 2.25% and comprises the most significant portion of our debt.
Gain on minority investment. During the first quarter of fiscal year 2005,
we sold our interest in a minority investment and settled all obligations due
from such company for $3.6 million, which resulted in a gain of $2.1 million.
Dividend income. During the first quarter of fiscal year 2005 we received a
dividend payment of $0.7 million from a minority investment accounted for under
the cost method.
17
Loss on the early extinguishment of debt. As a result of our debt
refinancing in July 2003 and the acquisition of $52.0 million of our 9.5% senior
subordinated notes in the first quarter of fiscal year 2004, we recognized a
loss on the early extinguishment of debt of $3.7 million in such quarter. These
costs included the write-off of deferred financing costs of $2.9 million
associated with the debt that was repaid and the incurrence of premium costs of
$0.8 million in connection with the acquisition of a portion of our 9.5% senior
subordinated notes.
Income tax (expense) benefit. Income tax expense was $4.8 million, or 40.9%
of pretax income, in the first quarter of fiscal year 2005. In the first quarter
of fiscal year 2004, the income tax benefit was $1.5 million, or 39.6% of pretax
income. Income tax (expense) benefit was computed by applying estimated
effective income tax rates to the income or loss before income taxes. The income
tax rate 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 first quarter of fiscal year 2005 was due
primarily to the suspension of the WOTC on December 31, 2003. On October 4,
2004, the WOTC was reinstated and allows for a retroactive credit from January
1, 2004 to October 4, 2004. We will record an adjustment in our second quarter
of fiscal year 2005.
Discontinued operations. We recognized income of $0.1 million and a loss of
$0.7 million on discontinued operations in the first quarters of fiscal year
2005 and 2004, respectively, which represents the operating results, net of tax,
for all periods presented for centers closed since fiscal year 2002.
Discontinued operations included the following, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Revenues, net........................... $ 293 $ 5,596
------------ ------------
Operating expenses:
Salaries, wages and benefits.......... 291 3,715
Depreciation.......................... (145) 664
Rent.................................. 48 495
Provision for doubtful accounts....... 63 101
Other................................. (188) 1,760
------------ ------------
Total operating expenses............ 69 6,735
Operating income (loss) .............. 224 (1,139)
Income tax (expense) benefit............ (92) 451
------------ ------------
Discontinued operations, net of tax... $ 132 $ (688)
============ ============
Depreciation expense for the sixteen weeks ended September 17, 2004
included $0.4 million of impairment recoveries. These recoveries were the result
of higher than expected proceeds received on the sale of three centers that were
held for sale. Other operating expenses for the sixteen weeks ended September
17, 2004 included $0.7 million of gains on centers previously classified as held
for sale.
Liquidity and Capital Resources
Cash Flows and Liquidity Sources
Our principal liquidity requirements are for new center development and
debt service. 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.
18
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. At September 17, 2004, there were no
borrowings outstanding under our revolving credit facility. We had outstanding
letters of credit totaling $58.1 million. Our availability under our revolving
credit facility was $66.9 million.
Our credit facility contains certain customary covenants and other credit
requirements. We are required to meet or exceed certain leverage and interest
and lease expense coverage ratios. We were in compliance with our covenants at
September 17, 2004. Our most restrictive covenant is the limitation on dividend
payments. We are currently prohibited from paying dividends, as our consolidated
total debt to consolidated EBITDA ratio, as defined in the credit agreement, was
greater than 3.0 to 1.0, at 4.1 to 1.0.
Our consolidated net cash provided by operating activities for the sixteen
weeks ended September 17, 2004 decreased $0.8 million to $6.0 million compared
to $6.8 million in the same period last year. The decrease was due to higher
year-end bonus incentive payments in the first quarter of fiscal year 2005
compared to the same period last year, offset, in part, by cost controls. Cash
and cash equivalents totaled $70.0 million at September 17, 2004, compared to
$58.9 million at May 28, 2004.
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. 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 accounting principals generally accepted in the United
States of America ("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:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Net income (loss)...................... $ 7,095 $ (3,013)
Interest expense, net.................. 10,873 16,560
Income tax expense (benefit)........... 4,827 (1,522)
Depreciation and amortization.......... 17,765 18,230
Discontinued operations:
Income tax expense (benefit)......... 92 (451)
Depreciation......................... (145) 664
------------ ------------
EBITDA............................. $ 40,507 $ 30,468
============ ============
EBITDA - percentage of net revenues.... 15.2% 11.9%
Interest expense, net includes the $3.7 million loss on the early
extinguishment of debt for the sixteen weeks ended September 19, 2003.
19
A reconciliation of EBITDA to net cash provided by operating activities was
as follows, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
Net cash provided by operating activities...... $ 6,012 $ 6,845
Income tax expense (benefit)................... 4,827 (1,522)
Deferred income tax benefit (expense).......... 1,478 (1,848)
Interest expense, net.......................... 10,873 16,560
Effect of discontinued operations on
interest and taxes........................... 92 (451)
Change in operating assets and liabilities..... 17,617 10,927
Other non-cash items........................... (392) (43)
------------ ------------
EBITDA....................................... $ 40,507 $ 30,468
============ ============
During the sixteen weeks ended September 17, 2004, EBITDA increased $10.0
million, or 32.9%, from the same period last year. The increase was due
primarily to higher tuition rates, cost controls and a gain on the sale of a
minority investment, offset by increased rent expense due primarily to our
sale-leaseback program.
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 any
centers that are sold in such transactions. The sales were summarized as
follows, in thousands, except for the number of centers:
Sixteen Weeks Fiscal Year Ended
Ended -------------------------------------
September 17, May 28, May 30, May 31,
2004 2004 2003 2002
------------- ----------- ----------- -----------
Number of centers.................. 6 41 41 5
Net proceeds from completed sales.. $ 14,673 $ 89,292 $ 89,558 $ 9,259
Deferred gains..................... 4,990 28,348 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 September 17, 2004 and May 28, 2004, other
noncurrent liabilities on the consolidated balance sheet included deferred gains
on sale-leaseback transactions of $68.5 million and $64.8 million, respectively.
Subsequent to September 17, 2004, we closed $1.6 million in sales, which
included one center, and are currently in the process of negotiating another
$50.4 million of sales related to 20 centers. It is possible that we will be
unable to complete some or all of these transactions currently in process. 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.
20
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. No
assurance can be given that such sources of capital will be sufficient. If we
experience a lack of working capital, 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 substantially
reduced our capital expenditures 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.
During the first quarter of fiscal year 2005, there have been no material
changes, outside of the ordinary course of business, to the contractual
obligations and commercial commitments specified in the table of contractual
obligations and commercial commitments included in the section "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
our Fiscal 2004 Annual Report on Form 10-K for the year ended May 28, 2004.
Capital Expenditures
During the sixteen weeks ended September 17, 2004 and September 19, 2003,
we opened two and eight new centers, respectively. We expect to open 15 to 20
new centers in fiscal year 2005 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 $2.9 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.
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Capital expenditures included the following, in thousands:
Sixteen Weeks Ended
---------------------------
September 17, September 19,
2004 2003
------------ ------------
New center development.................. $ 7,139 $ 9,035
Refurbishment of existing facilities.... 3,188 3,898
Equipment purchases..................... 2,510 2,913
Information systems purchases........... 822 632
------------ ------------
$ 13,659 $ 16,478
============ ============
Capital expenditures for the sixteen weeks ended September 19, 2003 do not
include $97.9 million spent to purchase the 44 centers previously included in
the synthetic lease facility
Capital expenditure limits under our credit facility for fiscal year 2005
are $115.0 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 55.9%
of net revenues for the sixteen weeks ended September 17, 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.
Forward-Looking Statements
Some of the statements under "Business," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
report may include forward-looking statements which reflect our current views
with respect to future events and financial performance. 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.
22
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
services 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 federal food program 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 our operating results, cash flow or our financial
position;
o our ability to adequately maintain 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 the 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 inability to integrate acquisitions;
o our inability to successfully defend against or counter negative
publicity associated with claims involving alleged incidents at our
centers;
o our inability to obtain insurance at the same levels, or at costs
comparable to those incurred historically;
o the effects of potential environmental contamination existing on any
real property owned or leased by us;
23
o the effects of audits by tax authorities, which if determined
favorably or adversely, could have a material effect on our cash flow
and result of operations;
o the loss of any of our key management employees; 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 assume 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 area of interest 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 $179.4 million at September 17, 2004.
We also have no cash flow exposure on certain industrial revenue bonds
aggregating $3.6 million at September 17, 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 no borrowings
outstanding under our credit facility at September 17, 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 September 17, 2004, would
have resulted in interest expense changing by less than $0.1 million in both of
the first quarters of fiscal 2005 and 2004.
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 $0.9 million and $0.7 million in the sixteen weeks
ended September 17, 2004 and September 19, 2003, 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 $0.2 million in both of the first quarters of fiscal 2005 and
2004.
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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 appropriately accumulated and communicated to our management,
including our CEO and CFO, to allow timely decisions regarding
required disclosure.
Internal Control Over Financial Reporting. There have been no significant
changes in our internal controls over financial reporting that occurred during
our first quarter ended September 17, 2004 that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting. We continue to evaluate our internal control systems and procedures
through documentation and testing. In the course of our ongoing evaluation we
have identified certain deficiencies that we are remediating. These matters have
been communicated to our Audit Committee.
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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:
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 August 25, 2004 for fiscal 2004 earnings
released on August 23, 2004.
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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 October 27, 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)
27