Document/Exhibit Description Pages Size
1: 10-K Annual Report 74 377K
2: EX-10.A Revolving Credit Agreement 109 453K
12: EX-10.AA Lease Agreement 59 232K
3: EX-10.B Guarantee 15 52K
13: EX-10.BB Form of Letter Re Fy04 Management Bonus 2 17K
4: EX-10.C Pledge Agreement 22 85K
5: EX-10.D Material Contract -- security_agreement 39 126K
6: EX-10.E Material Contract -- formof_mortgage 29 78K
7: EX-10.J 2002 Stock Purchase and Option Plan 9 39K
8: EX-10.N Form of Term Note 2 14K
9: EX-10.W Material Contract -- loan_agreement 104 433K
10: EX-10.X First Amendment to Loan Agreement 6 20K
11: EX-10.Y Management Agreement 28 120K
14: EX-21 Subsidiaries 1 7K
15: EX-23 Consent of Experts or Counsel -- auditors_consent 1 8K
16: EX-31.A Certification of CEO 2 12K
17: EX-31.B Certification of CFO 2 12K
18: EX-32.A Section 1350 Certification of CEO 1 9K
19: EX-32.B Section 1350 Certification of CFO 1 9K
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
FORM 10-K
-------------------
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-42137
KINDERCARE LEARNING CENTERS, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-0941966
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
650 NE Holladay Street, Suite 1400
Portland, OR 97232
(Address of principal executive offices)
(503) 872-1300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the voting common stock held by
non-affiliates of the registrant (assuming for purposes of this calculation, but
without conceding, that all executive officers and directors are "affiliates")
at December 13, 2002 (the last business day of the most recently completed
second fiscal quarter) was $9,520,017, based on the market price at the close of
business on December 13, 2002, as quoted on the OTC Bulletin Board.
The number of shares of the registrant's common stock, $.01 par value per
share, outstanding at August 22, 2003 was 19,696,797.
Documents Incorporated by Reference
Selected portions of the registrant's 2003 proxy statement for its 2003
Annual Meeting of Shareholders, to be filed within 120 days of May 30, 2003, are
incorporated by reference into Part III of this Form 10-K to the extent
identified herein.
================================================================================
KinderCare Learning Centers, Inc. and Subsidiaries
Index
Part I.........................................................................1
Item 1. Business....................................................1
Item 2. Properties.................................................15
Item 3. Legal Proceedings..........................................17
Item 4. Submission of Matters to a Vote of Security Holders........17
Item 4(a). Executive Officers of the Registrant.......................17
Part II.......................................................................19
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters................................19
Item 6. Selected Historical Consolidated Financial and
Other Data.................................................22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................25
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk................................................40
Item 8. Financial Statements and Supplementary Data................42
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................67
Item 9A. Disclosure Controls and Procedures.........................67
Part III......................................................................68
Item 10. Directors and Executive Officers of the Registrant.........68
Item 11. Executive Compensation.....................................68
Item 12. Security Ownership of Certain Beneficial Owners and
Related Stockholder Matters................................68
Item 13. Certain Relationships and Related Transactions.............68
Item 14. Principal Accounting Fees and Services.....................68
Part IV.......................................................................69
Item 15. Exhibits and Financial Statement Schedules and
Reports on Form 8-K........................................69
Signatures....................................................................72
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PART I
ITEM 1. BUSINESS
Forward-Looking Statements
We have made statements in this report that constitute forward-looking
statements as that term is defined in the federal securities laws. These
forward-looking statements concern our operations, economic performance and
financial condition and include statements regarding: opportunities for growth;
the number of early childhood education and care centers expected to be added in
future years; the profitability of newly opened centers; capital expenditure
levels; the ability to refinance or incur additional indebtedness; strategic
acquisitions, investments, alliances and other transactions; changes in
operating systems and policies and their intended results; our expectations and
goals for increasing center revenue and improving our operational efficiencies;
changes in the regulatory environment; the potential benefit of tax incentives
for child care programs; our projected cash flow; and our marketing efforts to
sell and lease back centers. The forward-looking statements are subject to
various known and unknown risks, uncertainties and other factors. When we use
words such as "believes," "expects," "anticipates," "plans," "estimates" or
similar expressions, we are making forward-looking statements.
Although we believe that our forward-looking statements are based on
reasonable assumptions, our expected results may not be achieved. Actual results
may differ materially from our expectations. Important factors that could cause
actual results to differ from expectations include, among others:
o the effects of general economic conditions;
o competitive conditions in the child care and early education
industries;
o various factors affecting occupancy levels, including, but not limited
to, the reduction in or changes to the general labor force that would
reduce the need for child care services;
o the availability of a qualified labor pool, the impact of labor
organization efforts and the impact of government regulations
concerning labor and employment issues;
o federal and state regulations regarding changes in child care
assistance programs, welfare reform, transportation safety, minimum
wages and licensing standards;
o the loss of government funding for child care assistance programs;
o our inability to successfully execute our growth strategy;
o the availability of financing or additional capital;
o 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 make us unable 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;
1
o our inability to obtain insurance at the same levels, or at costs
comparable to those incurred historically;
o the effects of potential environmental contamination existing on any
real property owned or leased by us; and
o other risk factors that are discussed in this report and, from time to
time, in our other Securities and Exchange Commission reports and
filings.
We caution you that these risks may not be exhaustive. We operate in a
continually changing business environment and new risks emerge from time to
time.
You should not rely upon forward-looking statements except as statements of
our present intentions and of our present expectations that may or may not
occur. You should read these cautionary statements as being applicable to all
forward-looking statements wherever they appear. We assume no obligation to
update or revise the forward-looking statements or to update the reasons why
actual results could differ from those projected in the forward-looking
statements.
Overview
KinderCare is the largest for-profit provider of early childhood education
and care in the United States in terms of the number of centers and licensed
capacity. At August 22, 2003, we served approximately 116,000 children and their
families at 1,259 child care centers. At our child care centers, we provide
educational services to infants and children up to twelve years of age. However,
the majority of the children are from six weeks to five years old. The total
licensed capacity at our centers was approximately 167,000 at August 22, 2003.
We operate child care centers under two brands as follows:
o KinderCare - At August 22, 2003, we operated 1,189 KinderCare centers.
The brand was established in 1969 and operates centers in 39 states,
as well as two centers located in the United Kingdom.
o Mulberry - We operated 70 Mulberry centers at August 22, 2003, which
are located primarily in the northeast region of the United States and
southern California. In addition, we had seven service contracts to
operate before- and after-school programs.
Within each brand, we operate two types of centers: community centers and
employer-sponsored centers. The vast majority are community centers. Our
employer-sponsored centers partner with companies to provide on-site or
near-site education and child care for the families of their employees.
We offer a reading and literacy program, for a fee, in selected centers.
This program enhances the educational services offered to children four years
and older attending our centers. During fiscal year 2003, 960 of our centers
offered this reading and literacy program. In fiscal year 2004, we expect to
begin offering the Spanish version of a language enrichment program, also on a
supplemental fee basis.
Our centers are open year round. The hours vary by location, although
Monday through Friday from 6:30 a.m. to 6:00 p.m. is typical. Children are
usually enrolled on a weekly basis for either full- or half-day sessions. Hourly
enrollment is permitted where capacity allows. Tuition rates vary for children
of different ages and by location. See "Tuition."
2
Center-based child care continues to be our primary business. However, we
also own and operate a distance learning company serving teenagers and young
adults. Our subsidiary, KC Distance Learning, Inc., is based in Bloomsburg,
Pennsylvania and operates two business units as follows:
o Keystone National High School, an accredited high school distance
learning program, which provides courses delivered in either online or
correspondence formats, and
o Learning and Evaluation Center, which provides subject extension or
make-up and extra credit courses to high school students.
KC Distance Learning sells and/or delivers its high school curriculum over
the kcdistancelearning.com, keystonehighschool.com and creditmakeup.com
websites. The information on our websites is not incorporated by reference in
this report.
We hold 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., a charter school management company.
We are a Delaware corporation organized on November 14, 1986. Our principal
executive offices are located at 650 N.E. Holladay Street, Suite 1400, Portland,
Oregon 97232. Our telephone number is (503) 872-1300. Our website addresses
include kindercare.com, kindercareatwork.com, mulberrychildcare.com,
kcdistancelearning.com, keystonehighschool.com and creditmakeup.com. 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
websites is not incorporated by reference in this report.
Business Strategy
We are pursuing a business strategy containing the following key elements:
Provide High Quality Educational Programs. We have developed high quality
proprietary curricula of age-specific learning programs based on the latest
educational research. All of our educational programs are designed to respond to
the needs of the children and parents we serve and to prepare children for
success in school and in life. We provide curriculum-specific training for our
staff to enable effective delivery of our programs. Periodically, we revise our
educational programs to take advantage of the latest developments in early
childhood education.
Operate Accredited Centers. Although not mandated by any regulatory
authority, we pursue accreditation of our centers by the National Association
for the Education of Young Children, referred to as NAEYC. NAEYC is a national
organization that has established comprehensive criteria for providing quality
early childhood education and care. The accreditation process strengthens the
quality of the centers by motivating the teaching staff and enhancing their
understanding of developmentally appropriate early childhood practices. At
August 22, 2003, we had 485 accredited centers and approximately 300 centers
actively pursuing accreditation.
Increase Existing Center Revenue. We have ongoing initiatives to increase
center revenue by:
o Sharing best practices
o Providing incentives for center directors
o Using targeted marketing
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o Recruiting, retaining and training qualified staff
o Maintaining competitive tuition pricing
We have supported these initiatives by: (i) requiring management to visit
centers and providing an automated way to collect best practices and assess
quality; (ii) focusing our bonus program to reward center directors for
enrollment growth, in addition to overall operating profit performance; (iii)
driving local marketing efforts including direct mail solicitation, telephone
directory and internet yellow pages and customer referrals; (iv) focusing on
recruiting and retaining high quality center personnel; and (v) implementing
market specific rate increases in centers where the quality of our services,
demand and other market conditions support such increases. See "Tuition."
Improve Operational Efficiencies. Strong overhead controls are expected to
help us to contain costs. We focus on center-level economics, which makes each
center director accountable for center expenditures. For example, we developed a
labor tool to assist center directors in managing labor hours relative to
attendance levels at their centers. We believe this focus has a positive effect
on cost control at the centers.
Pursue Strategic Partnerships. Our market position makes us an attractive
strategic partner for companies with compatible products and services, and our
large, nationwide customer base gives us a valuable distribution network for
such products and services. Our market position also gives us the ability to
spread the costs of programs and services over a large number of centers. We
believe that strategic partnerships strengthen our reputation as a child care
provider and enrich the experiences of children enrolled at our centers.
In some markets, we face competition from the public school sector with
respect to preschool and before- and after-school programs. We would like to
partner with the public schools to provide these services or enhancement
programs through management and/or licensing agreements.
Continue to Open and Acquire Centers. We plan to expand by opening 25 to 30
new centers per year. We target locations where we believe the market for
center-based child care will support tuition rates higher than the current
average rates. There continues to be opportunities to locate centers in many
attractive markets across the United States. Also, we believe that many of our
competitors have recently reduced or eliminated spending on new development.
The following is a summary of our center opening activity over the past
five years:
[Download Table]
Fiscal Year Ended
-------------------------------------------
May 30, May 31, June 1, June 2, May 28,
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Number of centers,
beginning of fiscal year........ 1,264 1,242 1,169 1,160 1,147
------- ------- ------- ------- -------
Openings.......................... 28 35 44 35 39
Acquisitions...................... -- -- 75 13 --
Centers closed or sold............ (28) (13) (46) (39) (26)
------- ------- ------- ------- -------
Net centers
additions/(closings)............ -- 22 73 9 13
------- ------- ------- ------- -------
Number of centers, end of
fiscal year..................... 1,264 1,264 1,242 1,169 1,160
======= ======= ======= ======= =======
We have opened five new centers from the end of fiscal year 2003 to August
22, 2003.
4
Due to the changing demographics of today's workforce and the prevalence of
dual career families, a growing number of companies are providing child care
benefits in the form of subsidies or availability. We attempt to meet this need
by partnering with companies to provide on-site or near-site child care to
attract and retain employees. We intend to pursue growth in this area through
expanded relationships with our existing customers, as well as expansion of our
customer base through internal growth, selective acquisitions and strategic
alliances.
We also plan to continue making selective acquisitions of existing
high-quality centers. Our strong market position enhances the opportunities to
capitalize on consolidation of the highly fragmented child care segment of the
education industry.
Manage Asset Portfolio. At August 22, 2003, we owned 769, or 61.1%, of our
1,259 centers. Those centers have an approximate net book value of $608.9
million, which includes land, building and equipment costs. In July 2003 we
completed a refinancing of a portion of our debt that included a $300.0 million
mortgage loan secured by first mortgages or deeds of trust on 475 of our owned
centers. We also mortgaged another 119 of our owned centers as collateral for
our new revolving credit facility. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations, Liquidity and Capital
Resources." These 594 centers are included in our 769 owned centers and have an
approximate net book value of $397.5 million.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We continue to manage the
operations of any centers sold in such transactions. During fiscal year 2003, we
had completed sales totaling $88.8 million and another $12.6 million from the
end of fiscal year 2003 to August 22, 2003. We are currently in the process of
negotiating another $42.9 million of sales. We believe this has been an
effective way to monetize our real estate assets and reduce leverage. We expect
this effort to continue, assuming the market for such transactions remains
favorable.
We also routinely analyze the profitability of our existing centers. If a
center continues to under perform, exit strategies are employed in an attempt to
minimize the resulting financial liability. An effort is made to time center
closures to minimize the negative impact on affected families.
Pursue Strategic Acquisitions. We plan to continue to evaluate acquisition
opportunities of companies in the education industry that offer educational
content and services to children, teenagers and adults. These opportunities
would complement our center based educational and distance learning services.
Educational Programs
We have developed a series of educational programs, including five separate
proprietary age-specific curricula. Our educational programs recognize the
importance of using high quality, research-based curriculum materials designed
to create a rich and nurturing learning environment for children. The programs
are revised on a rotating basis to take advantage of the latest research in
child development.
Our educational programs and materials are designed to respond to the needs
of our children, parents and families and to prepare children for success in
school and in life. Specifically, we focus on the development of the whole
child: physically, socially, emotionally, cognitively and linguistically.
Training. We provide curriculum-specific training for teachers and
caregivers to assist them in effectively delivering our programs. Each
curriculum is designed to provide teachers with the necessary materials and
enhancements to enable effective delivery based on the resources and needs of
the local
5
community. We emphasize selection of staff who are caring adults responsive to
the needs of children. We strive to give each teacher the opportunity, training
and resources to effectively implement the best in developmentally and age
appropriate practice. Opportunities for professional growth are available
through company-wide training such as the Certificate of Excellence Program. We
also make available more advanced training opportunities, including tuition
reimbursement for employment-related college courses or course work in obtaining
a Child Development Associate credential.
Infant and Toddler Curricula. Our infant and toddler program, Welcome to
Learning(R), is designed for children ages six weeks to two years. The infant
component, for children from six weeks to 15 months, is based on building
relationships with the child and the family and focuses on providing a safe and
nurturing environment. The toddler component lets children from 12 to 24 months
feel free to explore and discover the world around them.
Two-Year-Old Curriculum. Our Early Learning Curriculum focuses on using the
latest research in brain development to provide learning experiences for
children during one of their most critical developmental stages. This curriculum
provides children with opportunities to explore and discover the world around
them with both daily and long-term extended activities and projects. The Early
Learning Curriculum is offered for children from 24 to 36 months.
Preschool Curricula. We have two preschool programs designed for children
three to five years of age. Both programs use research-based goals and
objectives as their framework to provide a high quality learning experience for
children. We also offer a reading and literacy program as a program enhancement.
This program is available, for a fee, in selected centers. In fiscal 2004, we
expect to begin offering the Spanish version of a language enrichment program,
on the same supplemental fee basis.
The Preschool Readiness Curriculum focuses on three-year-olds. Monthly
themes are divided into two-week units to allow children extended time for
in-depth exploration and discovery. Curriculum activities emphasize emerging
readiness skills in reading and language development. Specially designed
LetterBooks are used to introduce children to phonics and letter and word
recognition. Discovery areas support children's learning of basic math and
science concepts, computer awareness, creative arts, blocks, cooking and
homeliving.
The Preschool at KinderCare curriculum focuses on four-year-olds. It
teaches children to enjoy learning through hands-on involvement and stimulating
activities. Monthly themes are divided into one-week units providing a
comprehensive array of activities relevant to the lives of older preschoolers.
Curriculum materials build pre-reading, writing and language skills. Discovery
areas provide opportunities for exploration and choice based on children's
interests.
Kindergarten Curriculum. For five-year-olds, we offer the Kindergarten at
KinderCare ... Journey to Discovery(R) program. Children learn through play,
hands-on exploration, activities and experiences that are real world and sensory
in nature. This curriculum emphasizes reading development, beginning math
concepts and those skills necessary to give children the confidence to succeed
in school. Our kindergarten is offered in approximately two-thirds of our child
care centers and meets state requirements for instructional curriculum prior to
first grade.
School-Age Curriculum. Our KC Imagination Highway(R) program is a
project-based curriculum designed for children ages six to twelve. The program
includes a number of challenging activities and projects designed to stimulate
the imagination of elementary school-age children through researching,
designing, building, decorating and presenting. This program meets the needs of
parents looking for content rich after-school experiences that keep school-age
children interested and involved.
6
Summer Curriculum. We offer a summer program called Summer ExplorationsSM
to elementary school-agers. This program is a fun-filled, academic-based
curriculum of 10 weekly themes selected from the following 15 topics:
o Abracadabra o Cartooning o Rap, Rhythm & Rock
o Act It Out o Crazy Creations o Science Mania
o American Pride o Foodle For Your Noodle o Tournament of Games
o At Head of the Class o Mega Machines o Up, Up, & Away
o Can You Dig It o Outer Space o Wild, Wild Wilderness
Accreditation. We continue to stress the importance of offering high
quality programs and services to children and families. At August 22, 2003, we
had 485 centers accredited by NAEYC. See "Business Strategy, Operate Accredited
Centers."
Tuition
We determine tuition charges based upon a number of factors, including the
age of the child, full- or part-time attendance, location and competition.
Tuition is generally collected on a weekly basis, in advance. Tuition rates are
typically adjusted company-wide each year to coincide with the back-to-school
period. However, we may adjust individual center rates at any time based on
competitive position, occupancy levels and consumer demand. Our focus on
center-level economics has enabled us to better implement market specific
increases in rates without losing occupancy in centers where the quality of our
services, demand and other market conditions support such increases. Our
weighted average weekly tuition rate was as follows:
o Twelve weeks ended August 22, 2003 $151.63
o Fiscal year 2003 $144.45
o Fiscal year 2002 $137.72
o Fiscal year 2001 $129.34
See "Item 6. Selected Historical Consolidated Financial and Other Data,
Note (g)" for a description of average weekly tuition rate.
Seasonality
New enrollments are generally highest during the traditional fall "back to
school" period and after the calendar year-end holidays. Enrollment generally
decreases 5% to 10% during the summer months and calendar year-end holidays.
Marketing, Advertising and Promotions
We conduct our marketing efforts through various promotional activities and
customer referral programs. Additionally, we utilize targeted direct mail,
telephone and internet yellow pages advertising, access to informative and
user-friendly websites and newspaper and magazine advertisements. We continually
evaluate the effectiveness of our marketing efforts and attempt to use the most
cost-effective means of advertising. Currently, interested customers can call
toll-free or access our internet websites,
7
kindercare.com and mulberrychildcare.com, to locate their nearest center or
obtain information. The information on our websites is not incorporated by
reference in this report.
We have focused on center-specific marketing opportunities such as (1)
choosing sites that are convenient for customers in order to encourage drive-by
identification, (2) renovating our existing centers to enhance their curb appeal
and (3) upgrading the signage at our centers to a uniform standard to enhance
customer recognition of our centers.
Our local marketing programs include periodic extended evening hours and a
five o'clock snack that is provided to the children as they are picked up by
their parents. We also sponsor a referral program under which parents receive
tuition credits for every new customer referral that leads to a new enrollment.
We hold parent orientation meetings in the fall at which center directors and
staff explain our educational programs, as well as policies and procedures. We
also periodically hold open house events and have established parent forums to
involve parents in center activities and events. We offer these programs and
events in an effort to retain current customers.
Our new center pre-opening marketing effort includes direct mail and
newspaper support, as well as local public relations support. Every new center
hosts a grand opening, an open house and provides individualized center tours
where parents and children can talk with staff, visit classrooms and play with
educational toys and computers.
Employer-Sponsored Child Care Services
Through KinderCare At Work(R), we offer a more flexible format for our
services by individually evaluating the needs of each sponsoring company to find
the appropriate format to fit its needs for on-site or near-site employee child
care. Our current relationships with employers include centers owned or leased
by us and various forms of management contracts. The management contracts
generally provide for a three- to five-year initial period with renewal options
ranging from two to five years. Our compensation under existing agreements is
generally based on a fixed fee with annual escalations. KinderCare At Work(R)
can also assist organizations in one or more aspects of implementing a child
care related benefit, including needs assessments, financial analysis,
architectural design and development plans. KinderCare At Work's(R) website
address is kindercareatwork.com. The information on our websites is not
incorporated by reference into this report.
At August 22, 2003, we operated 44 on-site/near-site employer-sponsored
early childhood education and care centers for 40 different employers, including
Universal Orlando Resort, Saturn Corporation, LEGO Systems, Inc., Oregon State
University and several other businesses, universities and hospitals. Of the 44
employer-sponsored centers, 39 were owned or leased by us and five were operated
under management contracts.
We also offer back-up child care, a program that utilizes our existing
centers to provide back-up child care services to the employees of subscribed
employers. Current clients include Universal Orlando Resort, Prudential
Financial, US Cellular and KPMG.
Site Selection for New Centers
We seek to identify attractive new sites for our centers in large,
metropolitan markets and smaller, growth markets that meet our operating and
financial goals. We look for sites where we believe the market for our services
will support tuition rates higher than our current average rates. Our real
estate department performs comprehensive studies of geographic markets to
determine potential areas for new center development. These studies include
analysis of land prices, development costs, competitors, tuition pricing and
demographic data such as population, age, household income and employment
levels. In
8
addition, we review state and local laws, including zoning requirements,
development regulations and child care licensing regulations to determine the
timing and probability of receiving the necessary approvals to construct and
operate a new center.
We target sites that offer convenience for our customers, are located in
appealing markets and provide opportunities for drive-by interest. We make
specific site location decisions for new centers based upon a detailed site
analysis that includes feasibility and demographic studies, as well as
comprehensive financial modeling. Within a prospective area, we often analyze
several alternative sites. Each potential site is evaluated against our
standards for location, convenience, visibility, traffic patterns, size, layout,
affordability and functionality, as well as potential competition.
We opened 28 new centers during fiscal year 2003 and five more through
August 22, 2003. These new centers have an average licensed capacity of 176.
When mature, these larger centers are designed to generate higher revenues,
operating income and margins than the 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,
more profitable centers achieve anticipated levels.
Our real estate and development staff work closely with our operations,
purchasing, human resources and marketing personnel to streamline the new center
opening process. We believe this results in a more efficient transition of new
centers from the construction phase to field operation.
Real Estate Asset Management Program
At August 22, 2003, we owned 769, or 61.1%, of our 1,259 centers. Those
centers have an approximate net book value of $608.9 million, which includes
land, building and equipment costs. In July 2003, we completed a refinancing of
a portion of our debt that included a $300.0 million mortgage loan secured by
first mortgages or deeds of trust on 475 of our owned centers. We also mortgaged
another 119 of our owned centers as collateral for our new revolving credit
facility. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations, Liquidity and Capital Resources." These 594
centers are included in our 769 owned centers and have an approximate net book
value of $397.5 million.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We continue to manage the
operations of any centers that are sold in such transactions. During fiscal year
2003, we completed sales totaling $88.8 million, which represented 41 centers.
From the end of fiscal year 2003 through August 22, 2003, we completed another
$12.6 million of sales. We are currently in the process of negotiating another
$42.9 million of sales. It is possible that we will be unable to complete these
transactions. We expect this effort to continue, assuming the market for such
transactions remains favorable.
During fiscal years 2001 and 2000, we used a synthetic lease facility to
construct 44 centers. The related leases are classified as operating leases for
financial reporting purposes. The synthetic lease facility was terminated in
July 2003 as part of our debt refinancing. The 44 centers are now owned by us
and will be reflected in the fiscal year 2004 financial statements. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations, Liquidity and Capital Resources."
We routinely analyze the profitability of our existing centers through a
detailed evaluation that considers leased versus owned status, lease options,
operating history, premises expense, capital
9
requirements, area demographics, competition and site assessment. Through this
evaluation process, our asset management staff formulates a plan for the
property reflecting our strategic direction and marketing objectives. If a
center continues to underperform, exit strategies are employed in an attempt to
minimize our financial liability. We make an effort to time center closures to
minimize the negative impact on affected families. During fiscal year 2003, we
closed 28 centers. From the end of fiscal year 2003 to August 22, 2003, 10
additional centers were closed.
Our asset management department also manages the disposition of all surplus
real estate owned or leased by us. These real estate assets include undeveloped
sites, unoccupied buildings and closed centers. We disposed of ten surplus
properties in fiscal year 2003. From the end of fiscal year 2003 to August 22,
2003, three surplus properties were sold. We were in the process of marketing an
additional seven surplus properties at August 22, 2003.
Employees
At August 22, 2003, we employed approximately 25,000 people. Of these
employees, over 24,000 were employed in our centers. Center employees include
the following:
o center directors,
o assistant directors,
o regular full- and part-time teachers,
o temporary and substitute teachers
o teachers' aides, and
o non-teaching staff, including cooks and van drivers.
There are approximately 360 employees in the corporate headquarters and 150
field management and support personnel. Approximately 7.1% of our 25,000
employees, including all management and supervisory personnel, are salaried. All
other employees are paid on an hourly basis. We do not have an agreement with
any labor union and we believe that we have good relations with our employees.
Human Resources
Regional and Center Personnel. Our centers are organized into six
geographic regions, each headed by a region vice president. The region vice
presidents are supported by 81 area manager positions for KinderCare and nine
region director positions for Mulberry.
Individual centers are managed by a center director and, in most cases, an
assistant director. All center directors participate in periodic training
programs or meetings and must be familiar with applicable state and local
licensing regulations. During fiscal year 2002, we conducted a center director
retention survey. We believe the results of the survey reflect overall center
director satisfaction. As a result of the survey, we revised the center director
bonus plan in fiscal year 2003 to increase the focus on customer retention and
new enrollments.
Due to high employee turnover rates in the child care segment of the
education industry in general, we emphasize recruiting and retaining qualified
personnel. The turnover of personnel experienced by us and other providers in
our industry results in part from the fact that a significant portion of our
employees earn entry-level wages and are part-time employees.
Training Programs. All center teachers and other non-management staff are
required to attend an initial half-day training session prior to being assigned
full duties and to complete a six week on-the-job
10
basic training program. Our basic orientation and staff training program is
delivered via a video series. Additionally, we have developed and implemented
training programs to certify personnel as teachers of various age groups in
accordance with our internal standards and in connection with our age-specific
educational programs. We offer ongoing sales and service training to center
directors and area managers that focuses on enrollment and retention of
families, training on delivery of our educational programs, health and safety
related training. Center staff also participate in ongoing in-service training
as required by state licensing authorities, most of which is focused on
education and child health and safety related issues.
Employee Benefits. The corporate human resources department monitors
salaries and benefits for competitiveness.
Communication and Information Systems
We have a fully automated information, communication and financial
reporting system for our centers. This system uses personal computers and links
every center and regional office to the corporate headquarters. The system is
designed to provide timely information on items such as net revenues,
enrollments, attendance, expenses, payroll and staff hours.
Our nationwide network includes the internet and company-wide intranet and
email applications. Through the use of Netscape Navigator(R) software, our
intranet allows center directors to have immediate access to corporate
information and provides center directors with the ability to distribute
reports, update databases and revise center listings on a daily basis. We
regularly seek new uses for our intranet as a tool to communicate with our
centers. For example, in fiscal year 2002, we implemented a center visitation
program. The program provides an automated way to communicate information to the
corporate headquarters and for management to assess quality and identify best
practices.
Competition in the Child Care Segment of the Education Industry
The child care sector is competitive and highly fragmented, with the most
important competitive factors generally based upon reputation, location and
price. Competition consists principally of the following:
o other for-profit, center-based child care providers;
o preschool, kindergarten and before- and after-school programs provided
by public and private schools;
o child care franchising organizations;
o local nursery schools and child care centers, including
church-affiliated and other non-profit centers;
o providers of child care services that operate out of homes; and
o substitutes for organized child care, such as relatives, nannies and
one parent caring full-time for a child
Competition includes other large, national, for-profit companies providing
child education and care services, many of which offer these services at a lower
price than we do. These other for-profit providers continue to expand in many of
the same markets where we currently operate or plan to operate. We compete by
offering (i) high quality education and recreational programs, (ii)
contemporary, well-equipped facilities, (iii) trained teachers and supervisory
personnel and (iv) a range of services, including infant and toddler care,
drop-in service and the transportation of older children enrolled in our before-
and after-school program between the centers and schools.
11
In some markets, we also face competition with respect to preschool
services and before- and after-school programs from public schools that offer
such services at little or no cost to parents. In many instances, public schools
hire third party operators to manage these programs, and we are currently
evaluating opportunities in this area. The number of school districts offering
these services is growing and it is expected that this form of competition will
increase in the future.
Local nursery schools, child care centers and in-home providers generally
charge less for their services than we do. Many church-affiliated and other
non-profit child care centers have lower operating expenses than we do and may
receive donations and/or other funding to subsidize operating expenses.
Consequently, operators of such centers often charge tuition rates that are less
than our rates. In addition, fees for home-based care are normally substantially
lower than fees for center-based care because providers of home care are not
always required to satisfy the same health, safety, insurance or operational
regulations as our centers.
Our employer-sponsored centers compete with center-based child care chains,
some of which have divisions that compete for employer-sponsorship
opportunities, and with other organizations that focus exclusively on the
work-site segment of the child care market.
Insurance
Our insurance program currently includes the following types of policies:
workers' compensation, comprehensive general liability, automobile liability,
property, excess "umbrella" liability, directors' and officers' liability and
employment practices liability. These policies provide for a variety of
coverages, which are subject to various limits, and include substantial
deductibles or self-insured retentions. Special insurance is sometimes obtained
with respect to specific hazards, if deemed appropriate and available at
reasonable cost. Claims in excess of, or not included within, our coverage may
be asserted. The effects of these claims could have an adverse effect on us. At
August 22, 2003, approximately $34.0 million of letters of credit were
outstanding to secure obligations under retrospective and self-insurance
programs.
Governmental Laws and Regulations Affecting Us
Center Licensing Requirements. Our centers are subject to numerous state
and local regulations and licensing requirements. We have policies and
procedures in place to assist in complying with such regulations and
requirements. Although these regulations vary from jurisdiction to jurisdiction,
government agencies generally review the fitness and adequacy of buildings and
equipment, the ratio of staff personnel to enrolled children, staff training,
record keeping, childrens' dietary program, the daily curriculum and compliance
with health and safety standards. In most jurisdictions, these agencies conduct
scheduled and unscheduled inspections of the centers and licenses must be
renewed periodically. Most jurisdictions establish requirements for background
checks or other clearance procedures for new employees of child care centers.
Repeated failures of a center to comply with applicable regulations can subject
it to sanctions, which might include probation or, in more serious cases,
suspension or revocation of the center's license to operate and could also lead
to sanctions against our other centers located in the same jurisdiction. In
addition, this type of action could lead to negative publicity extending beyond
that jurisdiction.
We believe that our operations are in substantial compliance with all
material regulations applicable to our business. However, there is no assurance
that a licensing authority will not determine a particular center to be in
violation of applicable regulations and take action against that center and
possibly other centers in the same jurisdiction. In addition, there may be
unforeseen changes in regulations and licensing requirements, such as changes in
the required ratio of child center staff personnel to enrolled children, that
could have a material adverse effect on our operations. States in which
12
we operate routinely review the adequacy of regulatory and licensing
requirements and implement changes which may significantly increase our costs to
operate in those states.
Child Care Tax Incentives. Tax incentives for child care programs can
potentially benefit us. Section 21 of the Internal Revenue Code of 1986,
referred to as the Code, provides a federal income tax credit ranging from 20%
to 35% of specified child care expenses with maximum eligible expenses of $3,000
for one child and $6,000 for two or more children. The fees paid to us by
eligible taxpayers for child care services qualify for these tax credits,
subject to the limitations of Section 21 of the Code. However, these tax
incentives are subject to change.
Code Section 45F provides incentives to employers to offset costs related
to employer-provided child care facilities. Costs related to (a) acquiring or
constructing property used as a qualified child care center, (b) operating an
existing child care center, or (c) contracting with an independent child care
operator to care for the children of the taxpayer's employees will qualify for
the credit. The credit amount is 25% of the qualified costs. An additional
credit of 10% of qualified expenses for child care resource and referral
services has also been enacted. The maximum credit available for any taxpayer is
$150,000 per tax year.
Many states offer tax credits in addition to the federal credits discussed
above. Credit programs vary by state and may apply to both the individual
taxpayer and the employer.
Child Care Assistance Programs. During the twelve weeks ended August 22,
2003 and for fiscal year 2003, approximately 21.8% and 22.0%, respectively, of
our net revenues were generated from federal and state child care assistance
programs, primarily the Child Care and Development Block Grant and At-Risk
Programs. These programs are designed to assist low-income families with child
care expenses and are administered through various state agencies. Although
additional funding for child care may be available for low income families as
part of welfare reform and the reauthorization of the Block Grant, there is no
assurance that we will benefit from any such additional funding.
There can be no assurance that federal or state child care assistance
programs will continue to be funded at current levels. Many states have recently
experienced fiscal problems and have reduced or may in the future reduce
spending on social services. A termination or reduction of child care assistance
programs could have a material adverse effect on our business.
Americans with Disabilities Act. The federal Americans with Disabilities
Act, referred to as the ADA, and similar state laws prohibit discrimination on
the basis of disability in public accommodations and employment. Compliance with
the ADA requires that public accommodations reasonably accommodate individuals
with disabilities and that new construction or alterations made to commercial
facilities conform to accessibility guidelines unless structurally impracticable
for new construction or technically infeasible for alterations. Non-compliance
with the ADA could result in the imposition of injunctive relief, fines, an
award of damages to private litigants and additional capital expenditures to
remedy such noncompliance. We have not experienced any material adverse impact
as a result of these laws.
Federal Transportation Regulations. In August and September of 1998, the
National Highway Transportation Safety Administration, referred to as NHTSA,
issued interpretive letters that appear to modify its interpretation of
regulations governing the sale by automobile dealers of vehicles intended to be
used for the transportation of children to and from school by child care
providers. These letters indicate that dealers may no longer sell 15-passenger
vans for this use, and that any vehicle designed to transport eleven persons or
more must meet federal school bus standards if it is likely to be used
significantly to transport children to and from school or school-related events.
These interpretations have affected the type of vehicle that may be purchased by
us for use in transporting children between schools
13
and our centers and, in effect, required us to commence a scheduled replacement
of our remaining fleet of vans with school buses. NHTSA's interpretation and
potential related changes in state and federal transportation regulations have
increased our costs to transport children because school buses are more
expensive to purchase and maintain and, in some jurisdictions, require drivers
with commercial licenses. At August 22, 2003, we had 1,173 school buses out of a
total of 2,389 vehicles used to transport children.
Trademarks and Service Marks
We own and use various registered and unregistered trademarks and service
marks covering the name KinderCare, our schoolhouse logo and a number of other
names, slogans and designs, including:
o Feed Me Fun(R) o Lakemont Academy(TM)
o I Think. I Can.(TM) o Let's Move, Let's Play(R)
o KC Imagination Highway(R) o Mulberry Child Care Centers,
o Keystone National High School(TM) Inc.(R)
o Kid's Choice(TM) o Mulberry Child Care and
o Kindergarten at KinderCare... Preschool(R)
Journey to Discovery(R) o My Window On The World(R)
o KinderCare At Work(R) o Razzmatazz(R)
o KinderCare Connections(TM) o Summer ExplorationsSM
o Kindustry(TM) o Welcome To Learning(R)
o Your Child's First Classroom(R)
A federal registration in the United States is effective for ten years and
may be renewed for ten-year periods perpetually, subject only to required
filings based on continued use of the mark by the registrant. A federal
registration provides the presumption of ownership of the mark by the registrant
and notice of its exclusive right to use such mark throughout the United States
in connection with the goods or services specified in the registration. In
addition, we have registered various trademarks and service marks in other
countries, including Canada, Germany, Japan, the People's Republic of China and
the United Kingdom. However, many of these foreign countries require us to use
the marks locally to preserve our registration rights and, because we have not
conducted business in foreign countries other than the United Kingdom, we may
not be able to maintain our registration rights in all other foreign countries.
We believe that our name and logo are important to our operations. We intend to
maintain and renew our trademark and service mark registrations in the United
States and the United Kingdom.
14
ITEM 2. PROPERTIES
Early Childhood Education and Care Centers
Of our child care centers in operation at August 22, 2003, we owned 769,
leased 485 and operated five under management contracts. We own or lease other
centers that have not yet been opened or are being held for disposition. In
addition, we own real property held for the future development of centers.
The community and employer-sponsored centers we operated at August 22, 2003
were located as follows:
[Download Table]
Community Employer-Sponsored
Location Centers Centers Total
---------------- --------- ------------------ ---------
United States:
Alabama 9 -- 9
Arizona 21 2 23
Arkansas 3 -- 3
California 142 1 143
Colorado 35 -- 35
Connecticut 16 1 17
Delaware 5 -- 5
Florida 66 7 73
Georgia 31 -- 31
Illinois 96 1 97
Indiana 23 1 24
Iowa 9 3 12
Kansas 15 -- 15
Kentucky 13 1 14
Louisiana 9 2 11
Maryland 25 1 26
Massachusetts 49 1 50
Michigan 31 1 32
Minnesota 38 -- 38
Mississippi 3 -- 3
Missouri 32 -- 32
Nebraska 10 1 11
Nevada 10 -- 10
New Hampshire 4 -- 4
New Jersey 47 4 51
New Mexico 6 -- 6
New York 8 2 10
North Carolina 33 -- 33
Ohio 76 3 79
Oklahoma 6 -- 6
Oregon 16 4 20
Pennsylvania 64 1 65
Rhode Island -- 1 1
Tennessee 21 2 23
Texas 100 1 101
Utah 7 1 8
Virginia 54 -- 54
Washington 57 1 58
Wisconsin 23 1 24
United Kingdom 2 -- 2
--------- --------- ---------
1,215 44 1,259
========= ========= =========
Our typical community center is a one-story, air-conditioned building
constructed based on our design and located on approximately one acre of land.
Larger capacity centers are situated on parcels
15
ranging from one to four acres of land. The community centers contain
classrooms, play areas and complete kitchen and bathroom facilities. The centers
can accommodate from 70 to 270 children, with most centers able to accommodate
95 to 190 children. Over the past few years, we have opened community centers
that are larger in size with a capacity ranging from 135 to 220 children. New
prototype community centers range in capacity from 145 to 180 children,
depending on site and location. Each center is equipped with a variety of audio
and visual aids, educational supplies, games, puzzles, toys and outdoor play
equipment. Centers also lease vehicles used for field trips and transporting
children enrolled in our before- and after-school program. All community centers
are equipped with computers for children's educational programs.
KinderCare At Work(R) provides employer-sponsored child care programs
individualized for each such sponsor. Facilities are on or near the employer's
site and range in capacity from 75 to 230 children.
Center Maintenance Program
We use a centralized maintenance program to ensure consistent high-quality
maintenance of our facilities located across the country. Each of our
maintenance technicians has a van stocked with spare parts and handles
emergency, routine and preventative maintenance functions through an automated
work order system. Technicians are notified and track all work orders via palm
top computers. At August 22, 2003, specific geographic areas were supervised by
two regional directors and 13 facility managers, each of whom manages between
six and ten technicians.
Center Renovation Program
We have continued a renovation program, which includes interior and
playground renovations and signage replacements, to ensure that all of our
centers meet specified standards that we establish. We believe that our
properties are in good condition and are adequate to meet our current and
reasonably anticipated future needs.
Environmental Compliance
We are not aware of any existing environmental conditions that currently or
in the future could reasonably be expected to have a material adverse effect on
our financial position, operating results or cash flows. We have not incurred
material expenditures to address environmental conditions at any owned or leased
property. Approximately ten years ago, we established a process of obtaining
environmental assessment reports to reduce the likelihood of incurring
liabilities under applicable federal, state and local environmental laws upon
acquisition or lease of prospective new centers or sites. These assessment
reports have not revealed any environmental liability that we believe would have
a material adverse effect on us. Nevertheless, it is possible that these
assessment reports do not or will not reveal all environmental liabilities and
it is also possible that sites acquired prior to the establishment of our
current process have environmental liabilities. In connection with the
origination of a $300.0 million mortgage loan obtained in July 2003, see "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations, Liquidity and Capital Resources," a third party performed Phase I
environmental assessments for approximately half of the centers secured by the
mortgage loan. Although there were no material adverse findings, operations and
maintenance plans relating to lead paint and asbestos were recommended and have
been implemented. Additionally, from time to time, we have conducted additional
limited environmental investigations and remedial activities at some of our
former and current centers. However, we have not undertaken an in-depth
environmental review of all of our owned and leased centers. Consequently, there
may be material environmental liabilities of which we are unaware.
16
In addition, no assurances can be given that: future laws, ordinances or
regulations will not impose any material environmental liability; the current
environmental condition of our owned or leased centers will not be adversely
affected by conditions at locations in the vicinity of our centers (such as the
presence of leaking underground storage tanks) or by third parties unrelated to
us; or, on sites we lease to others, the tenants will not violate their leases
by introducing hazardous or toxic substances into our owned or leased centers
that could expose us to liability under federal, state, or local environmental
laws.
Corporate Headquarters
Our corporate office is located in Portland, Oregon. We lease approximately
80,000 square feet of office space for annual rental payments of $26.50 per
square foot. The initial term of the lease expires in November 2007 with one
five-year extension option at market rent.
ITEM 3. LEGAL PROCEEDINGS
We do not believe that there are any pending or threatened legal
proceedings that, if adversely determined, would have a material adverse effect
on our business or operations. However, we are subject to claims and litigation
arising in the ordinary course of business, including claims and litigation
involving allegations of physical or sexual abuse of children. We have notice of
such allegations that have not yet resulted in claims or litigation. Although we
cannot be assured of the ultimate outcome of the allegations, claims or lawsuits
of which we are aware, we believe that none of these allegations, claims or
lawsuits, either individually or in the aggregate, will have a material adverse
effect on our financial position, operating results or cash flows. In addition,
we cannot predict the negative impact of publicity that may be associated with
any such allegation, claim or lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4(a). Executive Officers of the Registrant
Set forth below is information regarding our executive officers:
[Download Table]
Name Age Position
--------------------- --- ----------------------------------------------------
David J. Johnson 57 Chief Executive Officer and Chairman of the Board
Dan R. Jackson 49 Executive Vice President, Chief Financial Officer
Edward L. Brewington 60 Senior Vice President, Human Resources and Education
S. Wray Hutchinson 43 Senior Vice President, Operations
Eva M. Kripalani 44 Senior Vice President, General Counsel and Secretary
Bruce A. Walters 46 Senior Vice President, Chief Development Officer
David J. Johnson. Mr. Johnson has been Chief Executive Officer and Chairman
of our Board since February 1997. Between September 1991 and November 1996, Mr.
Johnson served as President, Chief Executive Officer and Chairman of the Board
of Red Lion Hotels, Inc., which was formerly a KKR affiliate, or its
predecessor. From 1989 to September 1991, Mr. Johnson was a general partner of
Hellman & Friedman, a private equity investment firm based in San Francisco.
From 1986 to 1988, he served as President, Chief Operating Officer and director
of Dillingham Holdings, a diversified company headquartered in San Francisco.
From 1984 to 1987, Mr. Johnson was President and Chief Executive Officer of Cal
Gas Corporation, a principal subsidiary of Dillingham Holdings.
17
Dan R. Jackson. Mr. Jackson was promoted to Executive Vice President, Chief
Financial Officer in November 2002. He had served as Senior Vice President,
Finance since October 1999. He joined us in February 1997 as Vice President of
Financial Control and Planning. Prior to that time, Mr. Jackson held various
financial positions with Red Lion Hotels, Inc., or its predecessor, from
September 1985 to January 1997, the last of which was Vice President,
Controller. From 1978 to 1985, Mr. Jackson held several financial management
positions with Harsch Investment Corporation, a real estate holding company
based in Portland, Oregon.
Edward L. Brewington. Mr. Brewington was promoted in July 2001 to Senior
Vice President, Human Resources and Education. He had served as Vice President,
Human Resources since April 1997. From June 1993 to April 1997, Mr. Brewington
was with Times Mirror where his last position held was Vice President, Human
Resources for the Times Mirror Training Group. Prior to that time, Mr.
Brewington spent 25 years with IBM in various human resource, sales and
marketing positions.
S. Wray Hutchinson. Mr. Hutchinson was promoted to Senior Vice President,
Operations in October 2000. He had served as Vice President, Operations since
April 1996. He joined us in 1992 as District Manager in New Jersey and was later
promoted to Region Manager for the Chicago, Illinois market.
Eva M. Kripalani. Ms. Kripalani was promoted in July 2001 to Senior Vice
President, General Counsel and Secretary. She had served as Vice President,
General Counsel and Secretary since July 1997. Prior to joining us, Ms.
Kripalani was a partner in the law firm of Stoel Rives LLP in Portland, Oregon,
where she had worked since 1987.
Bruce A. Walters. Mr. Walters has served as Senior Vice President, Chief
Development Officer since July 1997. From June 1995 to February 1997, Mr.
Walters served as the Executive Vice President of Store Development for
Hollywood Entertainment Corporation in Portland, Oregon. Prior to that time, Mr.
Walters spent 14 years with McDonald's Corporation in various domestic and
international development positions.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCK HOLDER MATTERS
Stock Split
On July 15, 2002, the Board of Directors authorized a 2-for-1 stock split
of our common stock and an increase of the authorized common shares to 10.0
million shares. The 2-for-1 stock split was effective August 19, 2002 for
stockholders of record on August 9, 2002. All of the information in this report,
including all references to the number or price of shares of common stock, gives
effect to the stock split. The information in this report also gives effect to
adjustments in the number of shares available, the number of shares subject to
options granted and the exercise price of those options under our stock option
plan, in each case, to reflect the stock split.
Market Information
In February 1997, affiliates of KKR became owners of 15.7 million shares of
our common stock in a recapitalization transaction. Since then, our common stock
has been traded in the over-the-counter ("OTC") market in the "pink sheets"
published by the National Quotation Bureau. It is listed on the OTC Bulletin
Board under the symbol "KDCR."
The market for our common stock must be characterized as very limited due
to the very low trading volume, the small number of brokerage firms acting as
market makers and the sporadic nature of the trading activity. The following
table sets forth, for the periods indicated, information with respect to the
high and low bid quotations for our common stock as reported by a market maker
for our common stock, as reported on the OTC Bulletin Board. The quotations
represent inter-dealer quotations without retail markups, markdowns or
commissions and may not represent actual transactions.
[Download Table]
Common Stock
------------------------
High Bid Low Bid
---------- ----------
Fiscal year ended May 30, 2003 (a):
First quarter $ 11.50 $ 11.25
Second quarter 11.25 11.01
Third quarter 11.01 11.01
Fourth quarter 15.00 11.01
Fiscal year ended May 31, 2002 (a):
First quarter $ 13.00 $ 12.75
Second quarter 15.00 12.75
Third quarter 15.00 8.00
Fourth quarter 11.50 8.50
See "Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters."
(a) The average weekly trading volume during fiscal year 2003 and 2002 was
less than 100 shares and 1,000 shares, respectively.
Approximate Number of Security Holders, Outstanding Options and Warrants
At August 22, 2003, there were 135 holders of record of our common stock
and outstanding options or warrants to purchase 2,357,589 shares of our common
stock.
19
Dividend Policy
During the past two fiscal years, we have not declared or paid any cash
dividends or distributions on our capital stock. We do not intend to pay any
cash dividends for the foreseeable future. We intend to retain earnings, if any,
for the future operation and expansion of our business. Any determination to pay
dividends in the future will be at the discretion of our Board of Directors and
will be dependent upon our results of operations, financial condition,
contractual restrictions, restrictions imposed by applicable law and other
factors deemed relevant by our Board of Directors. Further, the indenture
governing our senior subordinated notes and our credit facility currently
contain limitations on our ability to declare or pay cash dividends on our
common stock, see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations, Liquidity and Capital Resources. Our credit
facility allows us to pay dividends provided that the aggregate amount paid does
not exceed $30.0 million plus 50.0% of the cumulative consolidated net income
available to stockholders at such time, and that, at the time of payment, the
consolidated debt to consolidated EBITDA ratio, as defined in the credit
agreement, is less than 3.0 to 1.0. As our consolidated debt to consolidated
EBITDA ratio is greater than 3.0 to 1.0, we are currently prohibited from paying
dividends. Future indebtedness or loan arrangements incurred by us may also
prohibit or restrict our ability to pay dividends and make distributions to our
stockholders.
The following table provides information about compensation plans
(including individual compensation arrangements) under which our equity
securities are authorized for issuance to employees or non-employees (such as
directors and consultants), at May 30, 2003:
[Enlarge/Download Table]
Number of
Number of securities
securities to be remaining available
issued upon Weighted-average for future issuance
exercise of exercise price under equity
outstanding of outstanding compensation plans
Plan Category options (a) options (b)
----------------------------- ------------------- ---------------- -------------------
Equity compensation plans
approved by security
holders:
1997 Stock Purchase and
Option Plan (referred to
as the 1997 Plan).......... 2,286,636 $ 11.29 2,213,363
2002 Stock Purchase and
Option Plan for California
Employees (referred to as
the California Plan)....... 7,000 13.87 93,000
Equity compensation plans
not approved by security
holders.................... N/A N/A N/A
------------------- ---------------- -------------------
Total........................ 2,293,636 $ 11.29 2,206,363
=================== ================ ===================
20
--------------
(a) Represents the number of shares of common stock issuable upon exercise of
outstanding options under the 1997 Plan and the California Plan, which were
approved during fiscal 1998 and 2003, respectively. See "Item 8. Financial
statements and supplementary Data, Note 11. Benefit Plans.
(b) Represents the shares remaining available for issuance under the 1997 Plan
and the California Plan. Future grants or awards under either plan may take
the form of purchased stock, restricted stock, incentive or nonqualified
stock options or other types of rights specified in each plan.
21
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth selected historical consolidated financial
and other data, with dollars in thousands, except per share amounts and child
care center data. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 8. Financial Statements and
Supplementary Data" included elsewhere in this report.
[Enlarge/Download Table]
Fiscal Year Ended (a)
----------------------------------------------------------------
May 30, May 31, June 1, June 2, 2000 May 28,
2003 2002 2001 (53 Weeks) 1999
----------- ----------- ----------- ------------ -----------
Statement of Operations Data:
Revenues, net................................ $ 850,043 $ 818,949 $ 733,617 $ 686,801 $ 623,251
Operating expenses, exclusive of
restructuring and other charges
(reversals)................................ 779,442 744,488 658,524 610,462 556,409
Restructuring and other charges
(reversals) (b)............................ -- -- (100) -- 4,157
----------- ----------- ----------- ------------ -----------
Total operating expenses................... 779,442 744,488 658,424 610,462 560,566
----------- ----------- ----------- ------------ -----------
Operating income......................... 70,601 74,461 75,193 76,339 62,685
Investment income............................ 420 560 582 386 490
Interest expense............................. (41,032) (44,075) (48,818) (45,371) (41,841)
Loss on minority investment.................. (6,700) (2,265) -- -- --
----------- ----------- ----------- ------------ -----------
Income before income taxes, discontinued
operations and cumulative effect of a
change in accounting principle........... 23,289 28,681 26,957 31,354 21,334
Income tax expense........................... (9,222) (11,329) (10,354) (11,856) (8,357)
----------- ----------- ----------- ------------ -----------
Income before discontinued operations and
cumulative effect of a change in
accounting principle..................... 14,067 17,352 16,603 19,498 12,977
Discontinued operations, net of income
taxes (c).................................. (652) (809) (142) 465 549
----------- ----------- ----------- ------------ -----------
Income before cumulative effect of a change
in accounting principle.................. 13,415 16,543 16,461 19,963 13,526
Cumulative effect of a change in accounting
principle, net of income taxes (d)......... -- -- (790) -- --
----------- ----------- ----------- ------------ -----------
Net income............................... $ 13,415 $ 16,543 $ 15,671 $ 19,963 $ 13,526
=========== =========== =========== ============ ===========
Net income per share (e):
Basic income before discontinued operations
and cumulative effect of a change in
accounting principle, net.................. $ 0.71 $ 0.87 $ 0.87 $ 1.03 $ 0.68
Discontinued operations, net of taxes........ (0.03) (0.04) (0.01) 0.02 0.03
Cumulative effect of a change in accounting
principle, net of taxes.................... -- -- (0.04) -- --
----------- ----------- ----------- ------------ -----------
Net income............................... $ 0.68 $ 0.83 $ 0.82 $ 1.05 $ 0.71
=========== =========== =========== ============ ===========
Diluted income before discontinued operations
and cumulative effect of a change in
accounting principle, net.................. $ 0.70 $ 0.86 $ 0.86 $ 1.02 $ 0.67
Discontinued operations, net of taxes........ (0.03) (0.04) (0.01) 0.02 0.03
Cumulative effect of a change in accounting
principle, net of taxes................... -- -- (0.04) -- --
----------- ----------- ----------- ------------ -----------
Net income............................... $ 0.67 $ 0.82 $ 0.81 $ 1.04 $ 0.70
=========== =========== =========== ============ ===========
Balance Sheet Data (at end of period):
Property and equipment, net.................. $ 665,815 $ 701,639 $ 666,227 $ 613,206 $ 566,365
Total assets................................. 811,093 845,451 805,367 695,570 638,797
Total long-term obligations, including
current portion................... 470,976 549,240 540,602 475,175 441,371
Stockholders' equity......................... 135,159 123,269 106,731 76,673 51,790
Other Financial Data:
Cash flows from operations................... 78,710 87,466 69,671 61,197 61,810
EBITDA (f)................................... 123,386 130,155 120,807 117,132 100,974
EBITDA margin................................ 14.5% 15.9% 16.5% 17.1% 16.2%
Depreciation and amortization, including
depreciation related to discontinued
operations................................. 60,563 59,293 46,632 40,042 37,384
Capital expenditures......................... 83,114 95,843 94,269 82,473 92,139
Child Care Center Data:
Number of centers at end of fiscal year...... 1,264 1,264 1,242 1,169 1,160
Center licensed capacity at end of
fiscal year............................... 167,000 166,000 162,000 150,000 146,000
Average weekly tuition rate (g).............. $ 144.45 $ 137.72 $ 129.34 $ 120.75 $ 113.45
Occupancy (h)................................ 63.3% 65.6% 68.3% 69.8% 69.9%
See accompanying notes to selected historical consolidated financial and other data.
22
Notes to Selected Historical Consolidated Financial and Other Data
(a) Our fiscal year ends on the Friday closest to May 31. Typically, the fiscal
years are comprised of 52 weeks. Fiscal year 2000, however, included 53
weeks.
(b) Restructuring and other charges included the following, with dollars in
thousands:
[Enlarge/Download Table]
Fiscal Year Ended
----------------------------------------------------------------
May 30, May 31, June 1, June 2, 2000 May 28,
2003 2002 2001 (53 Weeks) 1999
----------- ----------- ----------- ------------ -----------
Restructuring charges, net....... $ -- $ -- $ (100) $ -- $ 3,561
Offering costs................... -- -- -- -- 596
----------- ----------- ----------- ------------ -----------
$ -- $ -- $ (100) $ -- $ 4,157
=========== =========== =========== =-========== ===========
(c) Discontinued operations included the following, with dollars in thousands:
[Enlarge/Download Table]
Fiscal Year Ended
----------------------------------------------------------------
May 30, May 31, June 1, June 2, 2000 May 28,
2003 2002 2001 (53 Weeks) 1999
----------- ----------- ----------- ------------ -----------
Revenues, net.................... $ 4,505 $ 10,485 $ 9,780 $ 10,045 $ 9,734
----------- ----------- ----------- ------------ -----------
Salaries, wages and benefits..... 3,064 6,782 5,781 5,442 5,253
Depreciation..................... 1,141 1,044 583 472 388
Rent............................. 754 1,387 1,102 953 949
Other............................ 624 2,606 2,542 2,427 2,239
----------- ----------- ----------- ------------ -----------
Total operating expenses....... 5,583 11,819 10,008 9,294 8,829
----------- ----------- ----------- ------------ -----------
Operating income (loss)...... (1,078) (1,334) (228) 751 905
Interest expense................. (1) (3) (2) (4) (2)
----------- ----------- ----------- ------------ -----------
Discontinued operations
before income taxes........ (1,079) (1,337) (230) 747 903
Income tax benefit (expense)..... 427 528 88 (282) (354)
----------- ----------- ----------- ------------ -----------
Discontinued operations,
net of tax................. $ (652) $ (809) $ (142) $ 465 $ 549
=========== =========== =========== ============ ===========
(d) In fiscal year 2001, we adopted Securities and Exchange Commission ("SEC")
Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial
Statements, the impact of which was recorded as a cumulative effect of a
change in accounting principle.
(e) The per share amounts have been adjusted to reflect the 2-for-1 stock
split, which was effective August 19, 2002.
23
(f) EBITDA was calculated as follows, with dollars in thousands:
[Enlarge/Download Table]
Fiscal Year Ended
----------------------------------------------------------------
May 30, May 31, June 1, June 2, 2000 May 28,
2003 2002 2001 (53 Weeks) 1999
----------- ----------- ----------- ------------ -----------
Net income....................... $ 13,415 $ 16,543 $ 15,671 $ 19,963 $ 13,526
----------- ----------- ----------- ------------ -----------
Interest expense, net............ 40,612 43,515 48,236 44,985 41,351
Income tax expense............... 9,222 11,329 10,354 11,856 8,357
Depreciation and amortization.... 59,422 58,249 46,049 39,570 36,996
Discontinued operations:
Interest expense............... 1 3 2 4 2
Income tax (benefit) expense... (427) (528) (88) 282 354
Depreciation................... 1,141 1,044 583 472 388
----------- ----------- ----------- ------------ -----------
EBITDA...................... $ 123,386 $ 130,155 $ 120,807 $ 117,132 $ 100,974
=========== =========== =========== ============ ===========
EBITDA is 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. We have provided EBITDA in previous filings and continue
to provide this measure for comparability between periods. EBITDA was
restated from amounts reported in previous filings in order to comply with
SEC Regulation G, Conditions for Use of Non-GAAP Financial Measures. EBITDA
does not represent cash flow from operations as defined by accounting
principles 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. A reconciliation of
EBITDA to cash provided by operating activities was as follows, with
dollars in thousands:
[Enlarge/Download Table]
Fiscal Year Ended
----------------------------------------------------------------
May 30, May 31, June 1, June 2, May 28,
2003 2002 2001 2000 1999
----------- ----------- ----------- ------------ -----------
Net cash provided by operating
activities..................... $ 78,710 $ 87,466 $ 69,671 $ 61,197 $ 61,810
Income tax expense............... 9,222 11,329 10,354 11,856 8,357
Deferred income taxes............ 10,968 (6,431) 116 (4,271) (6,703)
Interest expense, net............ 40,612 43,515 48,236 44,985 41,353
Effect of discontinued operations
on interest and taxes.......... (426) (525) (86) 286 356
Change in operating assets and
liabilities.................... (16,332) (4,769) (6,997) 3,279 (3,567)
Other non-cash items............. 632 (430) (487) (200) (632)
----------- ----------- ----------- ------------ -----------
EBITDA...................... $ 123,386 $ 130,155 $ 120,807 $ 117,132 $ 100,974
=========== =========== =========== ============ ===========
(g) We calculate the average weekly tuition rate as net revenues, exclusive of
fees and non-tuition income, divided by the full-time equivalent, or FTE,
attendance for the related time period. The average weekly tuition rate
represents the approximate weighted average weekly tuition rate at all of
the centers paid by parents for children to attend the centers five full
days during a week. However, the occupancy mix between full- and part-time
children at each center can significantly affect these averages with
respect to any specific center. FTE attendance is not a strict head count.
Rather, the methodology determines an approximate number of full-time
children based on weighted averages. For example, an enrolled full-time
child equates to one FTE, while a part-time child enrolled for five
half-days equates to 0.5 FTE. The FTE measurement of center capacity
utilization does not necessarily reflect the actual number of full- and
part-time children enrolled.
24
(h) Occupancy is a measure of the utilization of center capacity. We calculate
occupancy as the FTE attendance at all of the centers divided by the sum of
the centers' licensed capacity.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
The following discussion should be read in conjunction with "Item 6.
Selected Historical Consolidated Financial and Other Data" and the consolidated
financial statements and the related notes presented in "Item 8. Financial
Statements and Supplementary Data" included elsewhere in this report. We utilize
a financial reporting schedule comprised of 13 four-week periods. Our fiscal
year ends on the Friday closest to May 31. The information presented refers to
the 52 weeks ended May 30, 2003 as "fiscal 2003," the 52 weeks ended May 31,
2002 as "fiscal 2002," and the 52 weeks ended June 1, 2001 as "fiscal 2001." Our
first fiscal quarter includes 16 weeks and the remaining quarters each include
12 weeks.
A center is included in comparable center net revenues when it has been
open and operated by us at least one year and it has not been rebuilt or
permanently relocated within that year. Therefore, a center is considered
comparable during the first four week period it has prior year net revenues.
Non-comparable centers include those that have been closed during the past year.
Fiscal 2003 compared to Fiscal 2002
The following table shows the comparative operating results of KinderCare,
with dollars in thousands, except the average weekly tuition rate:
[Enlarge/Download Table]
Change
Fiscal Year Percent Fiscal Year Percent Amount
Ended of Ended of Increase/
May 30, 2003 Revenues May 31, 2002 Revenues (Decrease)
------------ -------- ------------ -------- ----------
Revenues, net................. $ 850,043 100.0% $ 818,949 100.0% $ 31,094
------------ -------- ------------ -------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense............ 434,850 51.2 422,066 51.5 12,784
Region and corporate
expense............... 34,761 4.0 31,943 3.9 2,818
------------ -------- ------------ -------- ----------
Total salaries, wages 469,611 55.2 454,009 55.4 15,602
and benefits..........
Depreciation and amortization 59,422 7.0 58,249 7.1 1,173
Rent........................ 52,573 6.2 47,733 5.8 4,840
Other....................... 197,836 23.3 184,497 22.6 13,339
------------ -------- ------------ -------- ----------
Total operating expenses.. 779,442 91.7 744,488 90.9 34,954
------------ -------- ------------ -------- ----------
Operating income........ $ 70,601 8.3% $ 74,461 9.1% $ (3,860)
============ ======== ============ ======== ==========
Average weekly tuition rate... $ 144.45 $ 137.72 $ 6.73
Occupancy..................... 63.3% 65.6% (2.3)
25
Revenues, net. Net revenues increased $31.1 million, or 3.8%, from the same
period last year to $850.0 million in fiscal 2003. The increase was due to
higher average weekly tuition rates as well as additional net revenues generated
by newly opened centers. The average weekly tuition rate increased $6.73, or
4.9%, to $144.45 in fiscal 2003, due primarily to tuition increases. Occupancy
declined to 63.3% from 65.6% for the same period last year primarily due to
reduced full-time equivalent attendance within the population of older centers.
See "Item 6. Selected Historical Consolidated Financial and Other Data, Notes
(g) and (h)" for descriptions of average weekly tuition rate and occupancy.
Comparable center net revenues increased $10.2 million, or 1.3%.
During the periods indicated, we opened and closed centers as follows:
[Download Table]
Fiscal Year Ended
---------------------------
May 30, 2003 May 31, 2002
------------ ------------
Number of centers at the beginning of the
fiscal year................................ 1,264 1,242
Openings...................................... 28 35
Closures...................................... (28) (13)
------------ ------------
Number of centers at the end of the fiscal
year...................................... 1,264 1,264
============ ============
Total center licensed capacity at the end
of the fiscal year......................... 167,000 166,000
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $15.6 million, or 3.4%, from the same period last year to $469.6
million. Total salary, wage and benefit expense as a percentage of net revenues
was 55.2% and 55.4% for fiscal 2003 and 2002, respectively.
Salary, wage and benefit expense directly associated with the centers was
$434.9 million, an increase of $12.8 million from the same period last year. The
increase was primarily due to overall higher wage rates and higher medical
insurance costs. See "Inflation and Wage Increases." At the center level,
salary, wage and benefit expense as a percentage of net revenues improved to
51.2% for fiscal 2003 from 51.5% for fiscal 2002. This improvement was due
primarily to strong controls over the management of labor hours.
Depreciation and amortization. Depreciation and amortization expense
increased $1.2 million from the same period last year to $59.4 million.
Depreciation increased primarily due to newly opened centers, offset by the
cessation of goodwill amortization. Amortization of goodwill decreased $2.4
million as a result of the adoption of Statement of Financial Accounting
Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, in the first
quarter of fiscal 2003. See "Item 8. Financial Statements and Supplementary
Data, Note 2. Summary of Significant Accounting Policies, Goodwill and Other
Intangible Assets." Depreciation declined for those centers that were sold and
leased back as part of our sale-leaseback program, because those centers are now
classified as operating leases. See "Liquidity and Capital Resources."
Depreciation expense included $2.7 million and $3.0 million of impairment
charges related to certain under-performing centers and undeveloped properties
during fiscal 2003 and 2002, respectively. Under-performing centers are those
with estimated future cash flows, undiscounted and without interest charges,
less than the carrying value of the asset. We performed an undiscounted cash
flow analysis and determined that 43 centers were impaired in fiscal 2003
primarily as a result of occupancy declines at individual centers and the result
of electing to exit leases at certain centers. As a result of such analyses,
write-downs were taken to reduce the carrying value of those 43 centers to their
estimated fair value. In addition, discontinued operations included impairment
charges of $0.7 million and $0.6 million for fiscal 2002, respectively, related
to certain centers closed in fiscal 2003.
Rent. Rent expense increased $4.8 million from the same period last year to
$52.6 million primarily due to our sale-leaseback program. See "Liquidity and
Capital Resources." In addition, the
26
rental rates experienced on new and renewed center leases were higher than those
experienced in previous fiscal periods.
Other operating expenses. Other operating expenses include costs directly
associated with the centers, such as insurance, janitorial, maintenance,
utilities, transportation, provision for doubtful accounts, food and marketing
costs, and expenses relating to region management and corporate administration.
Other operating expenses increased $13.3 million, or 7.2%, from the same period
last year, to $197.8 million. Other operating expenses as a percentage of net
revenues were 23.3% and 22.6% for fiscal 2003 and 2002, respectively. The
increase was due primarily to insurance costs that were $12.7 million higher
than the same period last year. The provision for doubtful accounts declined
$2.3 million from the same period last year. The reduction in our provision for
doubtful accounts was due to the implementation of automated programming that
allows us to have stronger controls over our receivables.
Operating income. Operating income was $70.6 million, a decrease of $3.9
million, or 5.2%, from the same period last year. Operating income decreased
primarily due to higher insurance costs and rent expense, offset in part by the
impact of higher tuition rates. Operating income as a percentage of net revenues
was 8.3% compared to 9.1% for the same period last year.
Interest expense. Interest expense was $41.0 million compared to $44.1
million for the same period last year. The decrease was substantially
attributable to lower interest rates and a decrease in the principal balance,
both on our revolving credit facility. The weighted average interest rate on our
long-term debt, including amortization of deferred financing costs, was 8.0% and
7.8% for fiscal 2003 and 2002, respectively. A larger portion of our debt was
comprised of 9.5% senior subordinated notes during fiscal 2003, which resulted
in an increase in the weighted average interest rate in fiscal 2003 compared to
fiscal 2002. See "Item 8. Financial Statements and Supplementary Date, Note. 8,
Long-Term Debt."
Loss on minority investment. During the fourth quarter of fiscal 2003, we
wrote down the net book value of a minority investment, by $6.7 million due to a
reduced valuation of the subject company. During fiscal 2002, we recorded a
write down of $2.3 million to the net book value of the same investment for a
similar reason, in addition to dilution of our minority interest in that
investment. The minority investment was accounted for under the cost method. See
"Item 8. Financial Statements and Supplementary Data, Note 2. Summary of
Significant Policies."
Income tax expense. Income tax expense was $9.2 million, or 39.6% of pretax
income, in fiscal 2003 and $11.3 million, or 39.5% of pretax income, in fiscal
2002. The slight increase in the effective tax rate was due to the relative
impact of tax credits at different levels of taxable income, the impact of the
cessation of goodwill amortization and an increase in expenses that are
disallowed for income tax purposes. Income tax expense was computed by applying
estimated effective income tax rates to income before income taxes. Income tax
expense varies from the statutory federal income tax rate due primarily to state
and foreign income taxes, offset by tax credits.
Discontinued operations. Discontinued operations resulted in losses of $0.7
million and $0.8 million in fiscal 2003 and 2002, respectively. Discontinued
operations represents the operating results for all periods presented of the 28
centers closed during fiscal 2003.
27
Discontinued operations included the following, with dollars in thousands:
[Download Table]
Fiscal Year Ended
---------------------------
May 30, 2003 May 31, 2002
------------ ------------
Revenues, net................................. $ 4,505 $ 10,485
------------ ------------
Operating expenses:
Salaries, wages and benefits................ 3,064 6,782
Depreciation................................ 1,141 1,044
Rent........................................ 754 1,387
Provision for doubtful accounts............. 168 121
Other....................................... 456 2,485
------------ ------------
Total operating expenses................ 5,583 11,819
------------ ------------
Operating loss............................ (1,078) (1,334)
Interest expense............................. (1) (3)
------------ ------------
Discontinued operations before income
taxes..................................... (1,079) (1,337)
Income tax benefit........................... 427 528
------------ ------------
Discontinued operations, net of tax......... $ (652) $ (809)
============ ============
Depreciation expense related to discontinued operations included impairment
charges of $0.7 million and $0.6 million for fiscal 2003 and 2002, respectively.
Other operating expenses related to discontinued operations included gains on
closed center sales of $1.2 million in fiscal 2003.
Net income. Net income was $13.4 million in fiscal 2003, a decrease of $3.1
million, or 18.9%, from the same period last year. The decrease was due to
higher insurance costs, the write-down of a minority investment and increased
rent expense, offset in part by higher tuition rates and reduced interest costs.
Basic and diluted net income per share were $0.68 and $0.67 for fiscal 2003. For
fiscal 2002, basic and diluted net income per share were $0.83 and $0.82,
respectively.
Fiscal 2002 compared to Fiscal 2001
The following table shows the comparative operating results of KinderCare,
with dollars in thousands, except the average weekly tuition rate:
[Enlarge/Download Table]
Change
Fiscal Year Percent Fiscal Year Percent Amount
Ended of Ended of Increase/
May 31, 2002 Revenues June 1, 2001 Revenues (Decrease)
------------ -------- ------------ -------- ----------
Revenues, net.................... $ 818,949 100.0% $ 733,617 100.0% $ 85,332
------------ -------- ------------ -------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense............... 422,066 51.5 373,571 50.9 48,495
Region and corporate
expense.................. 31,943 3.9 28,638 3.9 3,305
------------ -------- ------------ -------- ----------
Total salaries, wages
and benefits............. 454,009 55.4 402,209 54.8 51,800
Depreciation and amortization.. 58,249 7.1 46,049 6.3 12,200
Rent........................... 47,733 5.8 38,138 5.2 9,595
Other.......................... 184,497 22.6 172,128 23.5 12,369
Restructuring charges
(reversals).................. -- -- (100) 0.0 100
------------ -------- ------------ -------- ----------
Total operating expenses..... 744,488 90.9 658,424 89.8 86,064
------------ -------- ------------ -------- ----------
Operating income........... $ 74,461 9.1% $ 75,193 10.2% $ (732)
============ ======== ============ ======== ==========
Average weekly tuition rate...... $ 137.72 $ 129.34 $ 8.38
Occupancy........................ 65.6% 68.3% (2.7)%
28
Revenues, net. Net revenues increased $85.3 million, or 11.6%, from the
same period last year to $818.9 million in fiscal 2002. The increase was
primarily due to the acquisition of the Mulberry centers in the fourth quarter
of fiscal 2001 and the additional net revenues generated by the newly opened
centers. Comparable center net revenues increased $6.1 million, or 0.8%.
The average weekly tuition rate increased $8.38, or 6.5%, to $137.72 in
fiscal 2002 due primarily to tuition increases. Occupancy declined to 65.6% in
fiscal 2002 from 68.3% in fiscal 2001 primarily due to reduced full-time
equivalent attendance within the older center population.
During fiscal 2002 and 2001, we opened, acquired and closed centers as
follows:
[Download Table]
Fiscal Year Ended
---------------------------
May 31, 2002 June 1, 2001
------------ ------------
Number of centers at the beginning of the
fiscal year............................... 1,242 1,169
Openings..................................... 35 44
Acquisitions................................. -- 75
Closures..................................... (13) (46)
------------ ------------
Number of centers at the end of the
fiscal year............................. 1,264 1,242
============ ============
Total center licensed capacity at the end of
the fiscal year............................ 166,000 162,000
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $51.8 million, or 12.9%, from the same period last year to $454.0
million. Total salary, wage and benefit expense as a percentage of net revenues
was 55.4% for fiscal 2002 compared to 54.8% for fiscal 2001.
Salary, wage and benefit expense directly associated with the centers was
$422.1 million, an increase of $48.5 million from fiscal 2001. The increase was
primarily due to costs from the acquired and newly opened centers and overall
higher wage rates. At the center level, salary, wage and benefit expense as a
percentage of net revenues increased to 51.5% in fiscal 2002 from 50.9% in
fiscal 2001 due primarily to higher medical insurance costs.
The expense related to region management and corporate administration was
$31.9 million, an increase of $3.3 million from the same period last year. The
increase was primarily due to the acquisition of Mulberry during the fourth
quarter of fiscal 2001. In addition, we expanded the field operations team that
oversees the KinderCare centers. During fiscal 2003, the field management
structure was reorganized, see "Item 1. Business, Human Resources."
Depreciation and amortization. Depreciation and amortization expense
increased $12.2 million from the same period last year to $58.2 million.
Depreciation increased due to the acquisition of the Mulberry centers, increased
capital spending, particularly for new center development, and a $3.0 million
asset impairment charge.
During the fourth quarter of fiscal 2002, 38 underperforming centers and
certain undeveloped properties were determined to be impaired, which resulted in
an impairment charge of $3.6 million, of which $0.6 million is included in the
discontinued operations for charges related to centers closed in fiscal 2003,
for the fiscal year compared to $1.0 million in fiscal 2001. Underperforming
centers are those with estimated future cash flows less than the net book value
of the center. We performed an undiscounted cash flow analysis and determined
that 38 centers were impaired primarily as a result of occupancy declines at
individual centers.
Amortization of goodwill and other intangible assets increased $2.2 million
as a result of the acquisition of Mulberry in the fourth quarter of fiscal 2001.
29
Rent. Rent expense increased $9.6 million from the same period last year to
$47.7 million. The increase was primarily due to the acquisition of the Mulberry
leased centers in the fourth quarter of fiscal 2001 and rent from the synthetic
lease facility used to finance new center construction during fiscal 2001 and
2000. In addition, the rental rates experienced on new and renewed center leases
were higher than those experienced in previous fiscal periods.
Other operating expenses. Other operating expenses increased $12.4 million,
or 7.2%, from the same period last year, to $184.5 million. The increase was due
primarily to additional center level costs from the acquired and newly opened
centers. Other operating expenses as a percentage of net revenues declined to
22.6% from 23.5% for the same period last year as a result of cost controls over
variable center level and corporate expenditures.
Operating income. Operating income was $74.5 million, a decrease of $0.7
million, or 1.0%, from the same period last year. The decreased operating income
was primarily due to the $3.6 million impairment charge included in depreciation
expense, higher insurance costs and rent expense. Operating income was
positively impacted by the control of variable center level and corporate
expenditures. Operating income as a percentage of net revenues was 9.1% compared
to 10.2% for the same period last year.
Interest expense. Interest expense was $44.1 million compared to $48.8
million for the same period last year. The decrease was substantially
attributable to lower interest rates, offset partially by additional borrowings.
Our weighted average interest rate on our long-term debt, including amortization
of deferred financing costs, was 7.8% and 9.7% for fiscal 2002 and 2001,
respectively.
Loss on minority investment. During the fourth quarter of fiscal 2002, we
wrote down the net book value of a minority investment. The $2.3 million
write-down was due to a reduced valuation of the subject company and dilution of
our minority investment.
Income tax expense. Income tax expense was $11.3 million, or 39.5% of
pretax income, in fiscal 2002 and $10.4 million, or 38.4% of pretax income, in
fiscal 2001. The increase in the effective tax rate was due to additional
goodwill amortization, which is not deductible for tax purposes. Income tax
expense was computed by applying estimated effective income tax rates to the
income before income taxes. Income tax expense varies from the statutory federal
income tax rate due primarily to state and foreign income taxes, offset by tax
credits.
Discontinued operations. Discontinued operations resulted in losses of $0.8
and $0.1 million in fiscal 2002 and 2001, respectively. Discontinued operations
represents the operating results for all periods presented of the 28 centers
closed during fiscal 2003.
30
Discontinued operations included the following, with dollars in thousands:
[Download Table]
Fiscal Year Ended
---------------------------
May 31, 2002 June 1, 2001
------------ ------------
Revenues, net............................... $ 10,485 $ 9,780
------------ ------------
Operating expenses:
Salaries, wages and benefits.............. 6,782 5,781
Depreciation.............................. 1,044 583
Rent...................................... 1,387 1,102
Provision for doubtful accounts........... 121 137
Other..................................... 2,485 2,405
------------ ------------
Total operating expenses........... 11,819 10,008
------------ ------------
Operating loss............................ (1,334) (228)
Interest expense............................ (3) (2)
------------ ------------
Discontinued operations before income
taxes..................................... (1,337) (230)
Income tax benefit.......................... 528 88
------------ ------------
Discontinued operations, net of tax....... $ (809) $ (142)
============ ============
Depreciation expense related to discontinued operations included impairment
charges of $0.6 million for fiscal 2002. There were no impairment charges
related to discontinued operations in fiscal 2001.
Net income. Net income was $16.5 million, an increase of $0.9 million, or
5.6%, from the same period last year. The increase was due to lower interest
costs, offset partially by the write-down in a minority investment and a decline
in operating income due primarily to the $3.6 million asset impairment charge.
Basic and diluted net income per share were $0.83 and $0.82, respectively, for
fiscal 2002. For fiscal 2001, basic and diluted net income per share before the
cumulative effect of a change in accounting principle were $0.86 and $0.85,
respectively, and were $0.82 and $0.81, respectively, after such effect.
We implemented Securities and Exchange Commission SAB No. 101 with respect
to non-refundable fee revenues in the first quarter of fiscal 2001. This
resulted in a one-time charge of $0.8 million, net of taxes, which was recorded
as a cumulative effect of a change in accounting principle.
Liquidity and Capital Resources
In July 2003 we refinanced a portion of our debt. We obtained a new $125.0
million revolving credit facility, and, as described below in greater detail,
one of our subsidiaries obtained a $300 million mortgage loan. Proceeds from the
mortgage loan were used to pay off the $98.0 million balance on 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 repurchase $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 which is referred to as the CMBS Borrower. Because the CMBS Centers are
owned by the CMBS Borrower and subject to the CMBS Loan, recourse to the CMBS
Centers by our creditors will be effectively subordinated to recourse by holders
of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to
31
certain conditions. The CMBS Loan bears interest at a per annum rate equal to
LIBOR plus 2.25% and requires monthly payments of principal and interest.
Principal payments are based on a 30-year amortization (based on an assumed rate
of 6.5%). 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 7.0% 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.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 9, 2005, the loan may be partially prepaid
(a) up to $15.0 million each loan year in connection with releases of mortgaged
centers with no prepayment premium and (b) up to $5.0 million each loan year
subject to payment of the applicable prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan Agreement, of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing 13
periods ended July 1, 2003 was approximately $83.0 million. The maximum amount
of excess cash flow that can be escrowed is limited to one year of debt service
on the CMBS Loan and one year of rent due under the ground lease with the CMBS
Operator during the term of the CMBS Loan. The escrowed amounts are released if
the CMBS Centers generate the necessary minimum net operating income for two
consecutive quarters. The annual debt service on the CMBS Loan is approximately
$22.8 million (assuming a 6.50% interest rate). The annual rent due under the
ground lease is $34.0 million during the term of the CMBS Loan. These excess
cash flow provisions could limit the amount of cash made available to us.
During the fourth quarter of fiscal 2003, we committed to acquire $11.0
million aggregate principal amount of our 9.5% senior subordinated notes at an
aggregate price of $11.1 million, which included a loss of $0.1 million. In
addition, this transaction resulted in the write-off of deferred financing costs
of $0.2 million. These $0.3 million of costs were included in interest expense
in fiscal 2003. In June 2003, we acquired $4.0 million aggregate principal
amount of our 9.5% senior subordinated notes at an aggregate price of $4.1
million, which included a loss of $0.1 million and deferred financing costs of
$0.1 million were written off related to this transaction.
Our principal sources of liquidity are cash flow generated from operations,
proceeds received from our sale-leaseback program and borrowings under our
revolving credit facility. At August 22, 2003, we had drawn $20.0 million under
our new revolving credit facility and had outstanding letters of credit totaling
$73.6 million. Our availability under our new credit facility was $31.4 million.
Our principal uses of liquidity are new center development and debt service.
32
Our consolidated net cash provided by operating activities for fiscal 2003
was $78.7 million compared to $87.5 million in the same period last year. The
decrease in net cash flow was due to the change in working capital. Cash and
cash equivalents totaled $18.1 million at May 30, 2003, compared to $8.6 million
at May 31, 2002.
EBITDA, which is a non-GAAP financial measure, is defined as earnings
before interest, taxes, depreciation, amortization and the related components of
discontinued operations. EBITDA reflects a non-GAAP financial measure of our
liquidity. A non-GAAP financial measure is a numerical measure of historical or
future financial performance, financial position or cash flow that excludes or
includes amounts, or is subject to adjustments that have the effect of excluding
or including amounts, from the most directly comparable measure calculated and
presented in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). We believe EBITDA is a useful tool for
certain investors and creditors for measuring our ability to meet debt service
requirements. Additionally, management uses EBITDA for purposes of reviewing our
results of operations on a more comparable basis. We have provided EBITDA in
previous filings and continue to provide this measure for comparability between
periods. EBITDA was restated from amounts reported in previous filings in order
to comply with SEC Regulation G, Conditions for Use of Non-GAAP Financial
Measures. EBITDA does not represent cash flow from operations as defined by
GAAP, is not necessarily indicative of cash available to fund all cash flow
needs and should not be considered an alternative to net income under GAAP for
purposes of evaluating our results of operations. EBITDA was calculated as
follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Net income...................... $ 13,415 $ 16,543 $ 15,671
Interest expense, net........... 40,612 43,515 48,236
Income tax expense.............. 9,222 11,329 10,354
Depreciation and amortization... 59,422 58,249 46,049
Discontinued operations:
Interest expense.............. 1 3 2
Income tax benefit............ (427) (528) (88)
Depreciation.................. 1,141 1,044 583
------------ ------------ ------------
EBITDA...................... $ 123,386 $ 130,155 $ 120,807
============ ============ ============
EBITDA - percentage of net
revenues.................... 14.5% 15.9% 16.5%
A reconciliation of EBITDA to cash provided by operating activities was as
follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Net cash provided by operating
activities........................ $ 78,710 $ 87,466 $ 69,671
Income tax expense.................. 9,222 11,329 10,354
Deferred income taxes............... 10,968 (6,431) 116
Interest expense, net............... 40,612 43,515 48,236
Effect of discontinued operations
on interest and taxes............. (426) (525) (86)
Change in operating assets and
liabilities....................... (16,332) (4,769) (6,997)
Other non-cash items................ 632 (430) (487)
------------ ------------ ------------
EBITDA........................... $ 123,386 $ 130,155 $ 120,807
============ ============ ============
EBITDA was $123.4 million for fiscal 2003, a decrease of $6.8 million from
the same period last year. The decrease was primarily due to higher insurance
costs, the write-down of a minority investment and increased rent expense,
offset in part by higher tuition rates and control over center labor
33
productivity. In fiscal 2002, EBITDA increased $9.3 million from fiscal 2001 due
to the addition of the Mulberry centers and the additional contributions of the
newer centers.
We utilized approximately $10.3 million of net operating loss carryforwards
to offset taxable income in our 2001 through 2003 fiscal years. Approximately
$2.5 million of net operating loss carryforwards are available at May 30, 2003
to be utilized in future fiscal years. If such net operating loss carryforwards
were reduced due to a change of control or otherwise, we would be required to
pay additional taxes and interest, which would reduce available cash.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We will continue to manage the
operations of any centers that are sold in such transactions. The sales were
summarized as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Number of centers............ 41 5 --
Net proceeds from completed
sales...................... $ 88,783 $ 9,180 $ --
Deferred gains............... 32,507 2,600 --
The deferred gains are amortized on a straight-line basis, typically over a
period of 15 years. Subsequent to May 30, 2003, we closed $12.6 million in
sales, which included eight centers, and are currently in the process of
negotiating another $42.9 million of sales related to 20 centers. It is possible
that we will be unable to complete these transactions. We expect our
sale-leaseback efforts to continue into fiscal year 2004, assuming the market
for such transactions remains favorable.
We expect to fund future new center development through the new $125.0
million revolving credit facility and sale-leaseback proceeds, although
alternative forms of funding continue to be evaluated and new arrangements may
be entered into in the future.
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 for $97.9 million. As noted above, 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 will be reflected in our fiscal 2004 consolidated
financial statements.
34
In fiscal 2001, our acquisition spending, including transaction fees, for
Mulberry, NLKK, a distance learning company, and two independently operated
centers totaled $32.4 million in cash. In addition to the cash payments, we
issued 860,000 shares of our common stock to the sellers of Mulberry and assumed
$3.3 million of debt. In August 2002, 119,838 of the 860,000 shares were
returned to us, which included 99,152 shares that were released from an
indemnity escrow and 20,686 shares that were redeemed from certain former
shareholders of Mulberry. All 119,838 shares were cancelled.
We made a minority investment in an education-based company of $10.1
million in fiscal 2001. During fiscal 2001, notes receivable of $4.8 million
were issued to us by another company in which we hold a minority investment.
During fiscal 2002, $2.2 million of such notes were converted into additional
stock of the subject company. During the fourth quarters of fiscal 2003 and
fiscal 2002, we wrote down the net book value of a cost method minority
investment by $6.7 million and $2.3 million, respectively.
We believe that cash flow generated from operations, proceeds from our
sale-leaseback program and borrowings under the new revolving credit facility
will adequately provide for our working capital and debt service needs and will
be sufficient to fund our expected capital expenditures for the foreseeable
future. Any future acquisitions, joint ventures or similar transactions may
require additional capital, and such capital may not be available to us on
acceptable terms or at all. Although no assurance can be given that such sources
of capital will be sufficient, the capital expenditure program has substantial
flexibility and is subject to revision based on various factors, including but
not limited to, business conditions, cash flow requirements, debt covenants,
competitive factors and seasonality of openings. If we experience a lack of
working capital, it may reduce our future capital expenditures. If these
expenditures were substantially reduced, in management's opinion, our operations
and cash flow would be adversely impacted.
We may experience decreased liquidity during the summer months and the
calendar year-end holidays due to decreased attendance during these periods. See
"Item 1. Seasonality."
We have certain contractual obligations and commercial commitments.
Contractual obligations are those that will require cash payments in accordance
with the terms of a contract, such as a loan agreement or lease agreement.
Commercial commitments represent potential obligations for performance in the
event of demands by third parties or other contingent events, such as lines of
credit. Our contractual obligations and commercial commitments at May 30, 2003
were as follows, with dollars in thousands:
[Enlarge/Download Table]
Fiscal Year
----------------------------------------------------------------------
Total 2004 2005 2006 2007 2008 Thereafter
----------- ---------- ---------- ---------- ---------- ---------- ----------
Long-term debt............... $ 455,080 $ 13,744 $ 6,297 $ 2,810 $ 2,815 $ 178,838 $ 250,576
Capital lease obligations.... 30,086 2,535 2,240 2,279 2,396 2,415 18,221
Operating leases............. 418,494 47,727 41,412 38,520 34,866 31,709 224,260
Standby letters of credit.... 42,022 42,022 -- -- -- -- --
Other commitments............ 9,280 9,280 -- -- -- -- --
----------- ---------- ---------- ---------- ---------- ---------- ----------
$ 954,962 $ 115,308 $ 49,949 $ 43,609 $ 40,077 $ 212,962 $ 493,057
=========== ========== ========== ========== ========== ========== ==========
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 the current
portion of our $47.0 million term loan facility were classified as long-term
debt at May 30, 2003 since those current obligations were financed on a
long-term basis subsequent to May 30, 2003. Both are reflected above in
accordance with the payment schedule required as a result of the refinancing.
Other commitments include center development commitments, obligations to
purchase vehicles and other purchase order commitments, primarily related to
operations at our centers.
Capital Expenditures
During fiscal 2003 and 2002, we opened 28 and 35 new centers, respectively.
We expect to open approximately 25 to 30 new centers in fiscal year 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.
35
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, including the cost of land,
depending on the size and location of the center. However, the actual costs of a
particular center may vary from such range.
Our new centers typically have a licensed capacity ranging from 145 to 180,
while the centers constructed during fiscal 1997 and earlier have an average
licensed capacity of 125. When mature, these larger centers are designed to
generate higher revenues, operating income and margins than our older centers.
These new centers also have higher average costs of construction and typically
take three to four years to reach maturity. On average, our new centers should
begin to produce positive EBITDA during the first year of operation and begin to
produce positive net income by the end of the second year of operation.
Accordingly, as more new centers are developed and opened, profitability will be
negatively impacted in the short-term but is expected to be enhanced in the
long-term once these new centers achieve anticipated levels of occupancy.
Capital expenditures included the following, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
New center development.............. $ 50,651 $ 63,990 $ 44,254
Renovation of existing facilities... 18,945 18,979 37,829
Equipment purchases................. 11,731 9,508 7,993
Information systems purchases....... 1,787 3,366 4,193
------------ ------------ ------------
$ 83,114 $ 95,843 $ 94,269
============ ============ ============
In fiscal 2001, capital expenditures do not include the $64.4 million drawn
on the off-balance sheet synthetic lease facility during that fiscal year or the
acquisition of Mulberry. As discussed above, the synthetic lease facility was
terminated in July 2003 in connection with the refinancing of a portion of our
debt.
Capital expenditure limits under our new revolving credit facility for
fiscal year 2004 are $110.0 million. Also, we have some ability to incur
additional indebtedness, including through mortgages or sale-leaseback
transactions, subject to the limitations imposed by the indenture under which
our senior subordinated notes were issued and the new credit facility.
Application of Critical Accounting Policies
Critical Accounting Estimates. The preparation of financial statements in
conformity with GAAP 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 "Item 8.
Financial Statements and Supplementary Data, Note 2. Summary of Significant
Accounting Policies." 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.
36
Revenue recognition. Tuition revenues, net of discounts, and other revenues
are recognized as services are performed. Payments may be received in advance of
services being rendered, in which case the revenue is deferred and recognized
during the appropriate time period, typically a week. Our non-refundable
registration and education fees are amortized over the average enrollment
period, not to exceed one year. The recognition of our net revenues meets the
criteria of the Securities and Exchange Commission Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements, including the existence of an
arrangement, the rendering of services, a determinable fee and probable
collection.
Accounts receivable. Our accounts receivable are comprised primarily of
tuition due from governmental agencies, parents and employers. Accounts
receivable are presented at estimated net realizable value. We use estimates in
determining the collectibility of our accounts receivable and must rely on our
evaluation of historical experience, specific customer issues, governmental
funding levels 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 estimated
fair value. Such estimates require the use of judgment and numerous subjective
assumptions, which, if actual experience varies, could result in material
differences in the requirements for impairment charges.
Impairment charges were as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Impairment charges included in
depreciation expense.............. $ 2,682 $ 2,982 $ 1,049
Impairment charges included in
depreciation expense within
discontinued operations........... 664 583 --
------------ ------------ ------------
Total impairment charges........ $ 3,346 $ 3,565 $ 1,049
============ ============ ============
Goodwill and other indefinite-lived intangible assets must be tested at
least annually for impairment and written down to their fair market values, if
necessary. At June 1, 2002, we had $42.6 million of goodwill recorded on our
consolidated balance sheet. We performed a transitional impairment test in the
second quarter of fiscal 2003, as required by SFAS No. 142. Although quoted
market prices are typically the best evidence in determining fair value, we used
the value of our stock as determined by the Board of Directors, as it was a more
practical measure to perform the transitional impairment test. The quoted market
price for our stock is not the best value indicator due to limited trading
volume. The fair value of the reporting unit related to the recorded goodwill,
as of June 1, 2002, exceeded the carrying value at the same date; hence, there
was no evidence of impairment. During the fourth quarter of fiscal 2003, we
performed the annual impairment test and again determined there was no evidence
that the $42.6 million of goodwill was impaired. We will perform our annual
impairment test in the fourth quarter of each subsequent fiscal year. Please
refer to "Initial Adoption of Accounting Policies" below.
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 value of these investments using multiples of comparable
companies and discounted cash flow analysis. During the
37
fourth quarters of fiscal 2003 and 2002, we wrote down a minority investment by
$6.7 million and $2.3 million, respectively, due to a reduced valuation on the
subject company and dilution of our minority investment.
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 insurance expense and accrued obligations for these self-insurance
programs were as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Insurance expense ................ $ 46,753 $ 32,634 $ 23,592
Accrued obligations at end of
the fiscal year.................. 45,131 35,473 31,483
Rising costs for medical care and stop loss coverage have resulted in
significant increases in workers' compensation and medical insurance expenses.
Our internal estimates are reviewed annually and updated quarterly by a third
party actuary. While we believe that the amounts accrued for these obligations
are sufficient, any significant increase in the number of claims and costs
associated with claims made under these programs could have a material adverse
effect on our financial position, cash flows or results of operations.
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 for the asset. Should any significant changes in the tax law
or our estimate of the necessary valuation allowance occur, we would be required
to record the impact of the change. This could have a material effect on our
financial position or results of operations.
Initial Adoption of Accounting Policies
During the fiscal year ended May 30, 2003, we adopted the following new
accounting pronouncements. Please also refer to "Item 8. Financial Statements
and Supplementary Data."
Goodwill and Other Intangible Assets. Effective June 1, 2002, we adopted
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires
discontinuing the amortization of goodwill and other intangible assets with
indefinite useful lives. Therefore, we ceased amortization of goodwill at June
1, 2002. Goodwill amortization was $2.4 million and $1.1 million, pretax, during
fiscal 2002 and 2001, respectively.
Impairment of Long-Lived Assets and Discontinued Operations. Effective June
1, 2002, we adopted SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and
the accounting and reporting provisions of APB No. 30, Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of business.
38
SFAS No. 144 modifies the accounting and reporting for long-lived assets to be
disposed of by sale and it broadens the presentation of discontinued operations
to include more disposal transactions. SFAS No. 144 does not apply to goodwill
and other indefinite-lived intangible assets, as these assets are governed by
SFAS No.142, as discussed above.
We have determined that the 28 centers closed during fiscal 2003, which
included five owned and 23 leased centers, met the criteria of discontinued
operations. Therefore, the operating results for these 28 centers were
classified as discontinued operations, net of tax, in the consolidated
statements of operations for all periods presented. Discontinued operations were
as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Revenues, net...................... $ 4,505 $ 10,485 $ 9,780
Operating expenses................. 5,583 11,819 10,008
------------ ------------ ------------
Operating loss................... (1,078) (1,334) (228)
Interest expense................... (1) (3) (2)
------------ ------------ ------------
Discontinued operations before
income tax..................... (1,079) (1,337) (230)
Income tax benefit................. 427 528 88
------------ ------------ ------------
Discontinued operations, net
of tax......................... $ (652) $ (809) $ (142)
============ ============ ============
We believe that most of our future center closures will now be categorized
as discontinued operations. The owned centers that meet the criteria of held for
sale have been classified as current in the consolidated balance sheets for all
periods presented. As a result, property and equipment of $0.7 million and $1.8
million was classified as current assets held for sale at May 30, 2003 and May
31, 2002, respectively.
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, was adopted in the second quarter of fiscal 2003. SFAS No. 146
requires costs associated with exit or disposal activities be recorded at their
fair values when a liability has been incurred, rather than at the date of
commitment to an exit or disposal plan. SFAS No. 146 was effective for disposal
activities initiated after December 31, 2002. This adoption did not have a
material impact on our financial position or results of operations.
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, amends the disclosure requirements of SFAS No. 123, Accounting for
Stock-Based Compensation, to require prominent disclosures in annual and interim
financial statements about the method of accounting for stock-based compensation
and the effect in measuring compensation expense. We have provided the required
disclosures commencing with this report. See "Item 8. Financial Statements and
Supplementary Data, Note 2. Summary of Significant Accounting Policies,
Stock-Based Compensation."
FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, requires expanded
disclosures by guarantors in interim and annual financial statements about
obligations under certain guarantees. In addition, FIN 45 requires guarantors to
recognize, at the inception of a guarantee, a liability for the obligation it
has undertaken in issuing the guarantee. The recognition and initial measurement
provision was applicable to guarantees issued or modified after December 31,
2002. FIN 45 does not have an impact on our financial position as a result of
paying off the synthetic lease facility in July 2003 as part of our refinancing.
Recently Issued Accounting Pronouncements
FIN 46, Consolidation of Variable Interest Entities, requires consolidation
where there is a controlling financial interest in a variable interest entity,
39
previously referred to as a special-purpose entity. FIN 46 will be effective
during the second quarter of our fiscal year 2004. We do not anticipate an
impact to our financial position or results of operations.
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 is effective for contracts entered into or modified and
for hedging relationships designated after June 30, 2003. SFAS No. 149 is
effective in our first quarter of our fiscal year 2004. We do not anticipate a
material impact to our financial position or results of operations.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective in our second quarter of our fiscal year 2004. This statement is not
expected to have a material impact to our financial position or results of
operations.
Seasonality
See "Item 1. Business, Seasonality."
Governmental Laws and Regulations Affecting Us
See "Item 1. Business, Governmental Laws and Regulations Affecting Us."
Inflation and Wage Increases
We do not believe that the effect of inflation on the results of our
operations has been significant in recent periods, including the last three
fiscal years.
Expenses for salaries, wages and benefits represented approximately 55.2%
of net revenues for fiscal 2003. We believe that, through increases in our
tuition rates, we can recover any future increase in expenses caused by
adjustments to the federal or state minimum wage rates or other market
adjustments. However, we may not be able to increase our rates sufficiently to
offset such increased costs. We continually evaluate our wage structure and may
implement changes at targeted local levels.
ITEM 7A. 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 had no cash flow exposure due to rate changes on our
9.5% senior subordinated notes aggregating $290.0 million at May 30, 2003. We
also had no cash flow exposure on certain industrial revenue bonds, mortgages
and notes payable, which aggregated $5.6 million at May 30, 2003. However, we
had cash flow exposure on certain industrial revenue bonds subject to variable
LIBOR, which aggregated $8.5 million at May 30, 2003. Accordingly, a 1% (100
basis points) change in the LIBOR rate would have resulted in interest expense
changing by approximately $0.1 million in each of fiscal 2003, 2002 and 2001. In
addition, we also had cash flow exposure on our vehicle leases with variable
interest rates. A
40
1% (100 basis points) change in the interest rate defined in the vehicle lease
agreement would have resulted in rent expense changing by approximately $0.5
million for each of fiscal 2003, 2002 and 2001.
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%. We have purchased an
interest rate cap agreement to protect us from significant movements in LIBOR
during the initial three years of the CMBS Loan. The LIBOR strike price is 6.50%
under the interest rate cap agreement, which terminates July 9, 2006, at which
time we are required to purchase an additional interest rate cap agreement. In
addition, we have cash flow exposure on our new revolving credit facility which
is subject to LIBOR pricing. The new credit facility currently bears interest at
a rate equal to LIBOR plus 3.25%, which is subject to change based on the
achievement of certain performance measures.
Foreign Exchange Risk
We are exposed to foreign exchange risk to the extent of fluctuations in
the United Kingdom pound sterling. Based upon the relative size of our
operations in the United Kingdom, we do not believe that the reasonably possible
near-term change in the related exchange rate would have a material effect on
our financial position, results of operations or cash flows.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
[Enlarge/Download Table]
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
May 30, 2003 May 31, 2002
------------ ------------
Assets
Current assets:
Cash and cash equivalents.............................. $ 18,066 $ 8,619
Receivables, net....................................... 31,493 31,657
Prepaid expenses and supplies.......................... 9,423 9,948
Deferred income taxes.................................. 14,500 13,904
Assets held for sale................................... 684 1,787
------------ ------------
Total current assets................................ 74,166 65,915
Property and equipment, net............................... 665,815 701,639
Deferred income taxes..................................... 1,868 8
Goodwill.................................................. 42,565 42,565
Other assets.............................................. 26,679 35,324
------------ ------------
$ 811,093 $ 845,451
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts........................................ $ 9,304 $ 9,779
Accounts payable....................................... 8,888 9,836
Current portion of long-term debt...................... 13,744 6,237
Accrued expenses and other liabilities................. 109,671 106,374
------------ ------------
Total current liabilities........................... 141,607 132,226
Long-term debt............................................ 441,336 526,080
Long-term self-insurance liabilities...................... 22,771 15,723
Deferred income taxes..................................... 3,696 12,208
Other noncurrent liabilities.............................. 66,524 35,945
------------ ------------
Total liabilities................................... 675,934 722,182
------------ ------------
Commitments and contingencies (Notes 8 and 14)
Stockholders' equity:
Preferred stock, $.01 par value; authorized 10,000,000
shares; none outstanding............................ -- --
Common stock, $.01 par value; authorized 100,000,000
shares; issued and outstanding 19,661,216 and
19,819,352 shares, respectively 197 198
Additional paid-in capital............................. 25,909 28,107
Notes receivable from stockholders..................... (1,085) (1,426)
Retained earnings...................................... 110,297 96,882
Accumulated other comprehensive loss................... (159) (492)
------------ ------------
Total stockholders' equity.......................... 135,159 123,269
------------ ------------
$ 811,093 $ 845,451
============ ============
See accompanying notes to consolidated financial statements.
42
[Enlarge/Download Table]
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Revenues, net............................. $ 850,043 $ 818,949 $ 733,617
------------ ------------ ------------
Operating expenses:
Salaries, wages and benefits........... 469,611 454,009 402,209
Depreciation and amortization.......... 59,422 58,249 46,049
Rent................................... 52,573 47,733 38,138
Provision for doubtful accounts........ 5,088 7,378 6,257
Other.................................. 192,748 177,119 165,871
Restructuring charges (reversals)...... -- -- (100)
------------ ------------ ------------
Total operating expenses........... 779,442 744,488 658,424
------------ ------------ ------------
Operating income..................... 70,601 74,461 75,193
Investment income......................... 420 560 582
Interest expense.......................... (41,032) (44,075) (48,818)
Loss on minority investment.............. (6,700) (2,265) --
------------ ------------ ------------
Income before income taxes,
discontinued operations and
cumulative effect of a change in
accounting principle, net............ 23,289 28,681 26,957
Income tax expense........................ (9,222) (11,329) (10,354)
------------ ------------ ------------
Income before discontinued operations
and cumulative effect of a change in
accounting principle, net............ 14,067 17,352 16,603
Discontinued operations net of income tax
benefit of $427, $528 and $88,
respectively........................... (652) (809) (142)
------------ ------------ ------------
Income before cumulative effect of a
change in accounting principle....... 13,415 16,543 16,461
Cumulative effect of a change in
accounting principle, net of income tax
benefit of $484......................... -- -- (790)
------------ ------------ ------------
Net income........................... $ 13,415 $ 16,543 $ 15,671
============ ============ ============
Basic net income per share:
Income before discontinued operations and
cumulative effect of a change in
accounting principle, net.............. $ 0.71 $ 0.87 $ 0.87
Discontinued operations, net of taxes..... (0.03) (0.04) (0.01)
Cumulative effect of a change in
accounting principle, net of taxes..... -- -- (0.04)
------------ ------------ ------------
Net income......................... $ 0.68 $ 0.83 $ 0.82
============ ============ ============
Diluted net income per share:
Income before discontinued operations and
cumulative effect of a change in
accounting principle, net.............. $ 0.70 $ 0.86 $ 0.86
Discontinued operations, net of taxes..... (0.03) (0.04) (0.01)
Cumulative effect of a change in
accounting principle, net of taxes... -- -- (0.04)
------------ ------------ ------------
Net income......................... $ 0.67 $ 0.82 $ 0.81
============ ============ ============
Weighted average common shares outstanding:
Basic................................... 19,700,888 19,819,352 19,072,726
Diluted................................. 19,908,010 20,110,688 19,274,502
See accompanying notes to consolidated financial statements.
43
[Enlarge/Download Table]
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Dollars in thousands)
Notes Accumulated
Common Stock Additional Receivable Other
--------------------- Paid-in from Retained Comprehensive
Shares Amount Capital Stockholders Earnings Loss Total
---------- -------- ---------- ------------ ----------- ------------- ----------
Balance at June 2, 2000........ 18,963,874 $ 190 $ 13,414 $ (1,186) $ 64,668 $ (413) $ 76,673
Comprehensive income:
Net income................... -- -- -- -- 15,671 -- 15,671
Cumulative translation
adjustment................. -- -- -- -- -- (145) (145)
----------
Total comprehensive income. 15,526
Issuance of common stock....... 882,024 8 12,074 (264) -- -- 11,818
Repurchase of common stock..... (26,546) -- (324) -- -- -- (324)
Proceeds from collection
of stockholders' notes
receivable................... -- -- -- 95 -- -- 95
Reversal of pre-fresh
start contingency............ -- -- 2,943 -- -- -- 2,943
---------- -------- ---------- ------------ ----------- ------------- ----------
Balance at June 1,2001..... 19,819,352 198 28,107 (1,355) 80,339 (558) 106,731
Comprehensive income:
Net income................... -- -- -- -- 16,543 -- 16,543
Cumulative translation
adjustment................. -- -- -- -- -- 66 66
----------
Total comprehensive income. 16,609
Proceeds from collection
of stockholders' notes
receivable................... -- -- -- 35 -- -- 35
Issuances of stockholders'
notes receivable............. -- -- -- (106) -- -- (106)
---------- -------- ---------- ------------ ----------- ------------- ----------
Balance at May 31, 2002.... 19,819,352 198 28,107 (1,426) 96,882 (492) 123,269
Comprehensive income:
Net income................... -- -- -- -- 13,415 -- 13,415
Cumulative translation
adjustment................. -- -- -- -- -- 333 333
----------
Total comprehensive income.. 13,748
Retirement of common stock...... (119,838) (1) (1,645) -- -- -- (1,646)
Repurchase of common stock...... (38,298) -- (553) -- -- -- (553)
Proceeds from collection
of stockholders' notes
receivable.................... -- -- -- 341 -- -- 341
---------- -------- ---------- ------------ ----------- ------------- ----------
Balance at May 30, 2003......... 19,661,216 $ 197 $ 25,909 $ (1,085) $ 110,297 $ (159) $ 135,159
========== ======== ========== ============ =========== ============= ==========
See accompanying notes to consolidated financial statements.
44
[Enlarge/Download Table]
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Cash flows from operations:
Net income.................................. $ 13,415 $ 16,543 $ 15,671
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation............................ 60,172 55,968 45,480
Amortization of deferred financing
costs, goodwill, other intangible
assets and deferred gain on
sale-leasebacks....................... 2,102 5,941 4,132
Provision for doubtful accounts......... 5,256 7,499 6,394
Loss on minority investment............. 6,700 2,265 --
Gain on sales and disposals of
property and equipment................ (1,851) (529) (1,125)
Deferred tax expense (benefit).......... (10,968) 6,431 (116)
Changes in operating assets and
liabilities:
Increase in receivables............... (6,740) (10,387) (9,492)
Decrease (increase) in prepaid
expenses and supplies............... 526 (2,113) 273
Decrease (increase) in other assets... (287) (1,485) 3,852
Increase (decrease) in accounts
payable, accrued expenses and
other liabilities................... 10,052 7,267 4,747
Other, net.............................. 333 66 (145)
------------ ------------ ------------
Net cash provided by operating activities. 78,710 87,466 69,671
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment......... (83,114) (95,843) (94,269)
Acquisitions of previously constructed
centers................................... -- -- (17,257)
Acquisition of new subsidiary, net of
cash acquired............................. -- -- (15,189)
Investments accounted for under the
cost method............................... -- -- (10,074)
Issuance of notes receivable................ (114) -- (4,836)
Proceeds from sales of property and
equipment................................. 93,975 8,862 7,948
Proceeds from collection of notes
receivable................................ -- 26 145
------------ ------------ ------------
Net cash provided (used) by investing
activities.............................. 10,747 (86,955) (133,532)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from long-term borrowings.......... 56,000 57,128 108,000
Payments on long-term borrowings............ (133,237) (51,769) (44,836)
Deferred financing costs.................... (1,242) -- --
Payments on capital leases.................. (844) (1,288) (1,647)
Proceeds from issuance of common stock...... -- -- 270
Proceeds from collection of
stockholders' notes receivable............ 341 35 95
Issuances of stockholders' notes
receivable................................ -- (106) (264)
Repurchases of common stock................. (553) -- (324)
Bank overdrafts............................. (475) 451 4,779
------------ ------------ ------------
Net cash provided (used) by financing
activities............................. (80,010) 4,451 66,073
------------ ------------ ------------
Increase in cash and cash
equivalents.......................... 9,447 4,962 2,212
Cash and cash equivalents at the
beginning of the fiscal year............. 8,619 3,657 1,445
------------ ------------ ------------
Cash and cash equivalents at the end of
the fiscal year.......................... $ 18,066 $ 8,619 $ 3,657
============ ============ ============
Supplemental cash flow information:
Interest paid.......................... $ 36,608 $ 41,360 $ 45,415
Income taxes paid, net................. 18,985 11,614 12,552
Non-cash financial activities:
Retirement of common stock............. $ 1,646 $ -- $ --
Property and equipment under
capital leases....................... -- 4,390 559
Conversion of stock on a minority
investment........................... -- 2,225 --
See accompanying notes to consolidated financial statements.
45
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to 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 services in
the United States. At May 30, 2003, we served approximately 127,000 children and
their families at 1,264 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 167,000
at May 30, 2003.
We operate child care centers under two brands as follows:
o KinderCare - At May 30, 2003, we operated 1,194 KinderCare centers.
The brand was established in 1969 and includes centers in 39 states,
as well as two centers located in the United Kingdom.
o Mulberry - We operated 70 Mulberry centers at May 30, 2003, which are
located primarily in the northeast region of the United States and
southern California. In addition, we had 12 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 1,264 centers, at May
30, 2003, are 47 employer-sponsored centers. In addition to our center-based
child care operations, we own and operate a distance learning company serving
teenagers and young adults. Our subsidiary, KC Distance Learning, Inc., offers
an accredited high school program delivered in either online or correspondence
format. We have made minority investments in Voyager Expanded Learning, Inc., a
developer of educational curricula for elementary and middle schools and a
provider of a public school teacher retraining program and Chancellor Beacon
Academies, Inc., a charter school management company.
2. Summary of Significant Accounting Policies
Basis of Presentation. The 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.
Fiscal Year. References to fiscal 2003, fiscal 2002 and fiscal 2001 are to
the 52 weeks ended May 30, 2003, the 52 weeks ended May 31, 2002 and the 52
weeks ended June 1, 2001, respectively. We utilize a financial reporting
schedule comprised of 13 four-week periods. Our fiscal year ends on the Friday
closest to May 31. The first quarter includes 16 weeks and the second, third and
fourth quarters each include 12 weeks.
Revenue Recognition. We recognize revenue for child care services as earned
in accordance with Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements. Net
revenues include tuition, fees and non-tuition income, reduced by discounts. We
receive fees for reservation, registration, education and other services.
Non-tuition income is primarily comprised of field trip revenue. Registration
and education fees are amortized over the estimated average enrollment period,
not to exceed 12 months. Tuition, other fees and non-tuition income are
recognized as the related services are provided.
46
On June 3, 2000, we implemented SAB No. 101. As a result of that
implementation, a non-recurring charge of $0.8 million, net of income tax
benefit of $0.5 million, was recorded in the first quarter of fiscal 2001
related to non-refundable registration and education fee revenues that were
originally recognized in the fourth quarter of fiscal 2000. This one-time charge
was recorded as a cumulative effect of a change in accounting principle.
Advertising. Costs incurred to produce media advertising for seasonal
campaigns are expensed during the quarter in which the advertising first takes
place. Costs related to website development are capitalized or expensed in
accordance with Statement of Position ("SOP") No. 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use. SOP 98-1 identifies
the characteristics of internal use software and related costs, and provides
guidance on whether the costs should be expensed as incurred or capitalized.
Other advertising costs are expensed as incurred. Advertising costs were $10.8
million, $12.1 million and $12.5 million during fiscal 2003, 2002 and 2001,
respectively.
Cash and Cash Equivalents. Cash and cash equivalents consist of cash held
in banks and liquid investments with maturities, at the date of acquisition, not
exceeding 90 days.
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, specific customer issues, governmental
funding levels 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 our estimates.
Property and Equipment. Property and equipment are stated at cost. Interest
and overhead costs incurred in the construction of buildings and leasehold
improvements are capitalized. Depreciation on buildings and equipment is
provided on the straight-line basis over the estimated useful lives of the
assets. Leasehold improvements are amortized over the shorter of the estimated
useful life of the improvements or the lease term, including expected lease
renewal options where we have the unqualified right to exercise the option and
expect to exercise such option.
Our property and equipment is depreciated using the following estimated
useful lives:
Life
--------------
Buildings........................................ 10 to 40 years
Building renovations............................. 2 to 15 years
Leasehold improvements........................... 2 to 15 years
Computer equipment............................... 3 to 5 years
All other equipment.............................. 3 to 10 years
Asset Impairments. Long-lived assets and certain identifiable intangibles
to be held and used are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. We regularly evaluate long-lived assets for impairment by comparing
projected undiscounted cash flows for each asset to the carrying value of such
asset. If the projected undiscounted cash flows are less than the asset's
carrying value, we record an impairment charge, if necessary, to reduce the
carrying value to estimated fair value. During fiscal 2003, 2002 and 2001,
impairment charges of $3.3 million, $3.6 million and $1.0 million, respectively,
were recorded with respect to certain underperforming and undeveloped centers.
The impairment charges are included as a component of depreciation expense from
continuing and discontinued operations in the statement of operations.
47
Goodwill and Other Intangible Assets. Effective June 1, 2002, we adopted
Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other
Intangible Assets. As a result, we ceased amortization of goodwill at June 1,
2002. Amortization of goodwill for fiscal 2002 and 2001 was $2.4 million and
$1.1 million, pre-tax, respectively. These assets must now be tested at least
annually for impairment and written down to their fair market values, if
necessary. At June 1, 2002, we had $42.6 million of goodwill recorded on our
consolidated balance sheet. We performed a transitional impairment test in the
second quarter of fiscal 2003, as required by SFAS No. 142. In addition, we
performed our annual impairment test in the fourth quarter of fiscal 2003.
Although quoted market prices are the best evidence in determining fair value,
we used the value of our stock as determined by the Board of Directors, as it
was a more practical measure to perform the transitional impairment test. The
fair value of the reporting unit related to the recorded goodwill, as of June 1,
2002 and May 30, 2003, exceeded the carrying value at the same date, hence there
was no evidence of impairment.
If SFAS No. 142 had been adopted in the prior fiscal year, our pro forma
net income and net income per share for fiscal 2002 and 2001 would have been as
follows, with dollars in thousands, except per share amounts:
[Enlarge/Download Table]
Fiscal Year Ended
---------------------------------------------------------------------
May 31, 2002 June 1, 2001
--------------------------------- ---------------------------------
Net income per share Net income per share
Net --------------------- Net ---------------------
Income Basic Diluted Income Basic Diluted
--------- --------- --------- --------- --------- ---------
Reported..................... $ 16,543 $ 0.83 $ 0.82 $ 15,671 $ 0.82 $ 0.81
Goodwill amortization,
net of applicable taxes.... 2,042 0.10 0.10 809 0.04 0.04
--------- --------- --------- --------- --------- ---------
Adjusted................. $ 18,585 $ 0.93 $ 0.92 $ 16,480 $ 0.86 $ 0.85
========= ========= ========= ========= ========= =========
Certain amounts of goodwill amortization were not tax deductible in fiscal
2002 and 2001, and therefore are not shown net of tax above. Non-deductible
goodwill amortization was $1.4 million and $0.3 million in fiscal 2002 and 2001,
respectively.
Our finite-lived intangibles, which are non-competition agreements,
included in other assets in the consolidated balance sheets were as follows,
with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Original cost................... $ 3,151 $ 3,151 $ 3,151
Accumulated amortization........ (3,145) (2,754) (1,874)
------------ ------------ ------------
Net book value................ $ 6 $ 397 $ 1,277
============ ============ ============
Amortization expense during the
fiscal year................... $ 391 $ 880 $ 13
============ ============ ============
These intangible assets are amortized on a straight-line basis over their
contractual lives that range from 3 to 5 years. Amortization of these
intangibles will be substantially complete in the second quarter of fiscal year
2004.
Deferred Financing Costs. Deferred financing costs are amortized on a
straight-line basis over the lives of the related debt facilities. Such method
approximates the effective yield method.
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 value of these investments using multiples of comparable
companies and discounted cash flow analysis. During the
48
fourth quarters of fiscal 2003 and 2002, we wrote down a minority investment by
$6.7 million and $2.3 million, respectively, due to a reduced valuation on the
subject company and dilution of our minority investment.
Self-Insurance Programs. We are self-insured for certain levels of general
liability, workers' compensation, auto, property and employee medical insurance
coverage. Estimated costs of these self-insurance programs are accrued at the
undiscounted value of projected settlements for known and anticipated claims
incurred. A summary of self-insurance liabilities was as follows, with dollars
in thousands:
[Download Table]
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Balance at the beginning of the
fiscal year...................... $ 35,473 $ 31,483 $ 29,485
Expense............................ 46,753 32,634 23,592
Claims paid........................ (37,095) (28,643) (21,594)
------------ ------------ ------------
Balance at the end of the fiscal
year........................... 45,131 35,473 31,483
Less current portion of
self-insurance liabilities....... 22,360 19,750 15,664
------------ ------------ ------------
Long-term portion of self-
insurance liabilities...... $ 22,771 $ 15,723 $ 15,819
============ ============ ============
Income Taxes. Income tax expense is based on pre-tax financial accounting
income. Deferred income taxes result primarily from the expected tax
consequences of temporary differences between financial and tax reporting. If it
is more likely than not that some portion or all of a deferred tax asset will
not be realized, a valuation allowance is established.
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 SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, had been applied in measuring
compensation expense.
49
Had compensation expense for our stock option plans been determined based
on the estimated weighted average fair value of the options at the date of grant
in accordance with SFAS No. 148, our net income and basic and diluted net income
per share would have been as follows, with dollars in thousands, except per
share data:
[Enlarge/Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Reported net income...................... $ 13,415 $ 16,543 $ 15,671
Compensation cost for stock option plan.. (346) (509) (600)
------------ ------------ ------------
Pro forma net income..................... $ 13,069 $ 16,034 $ 15,071
============ ============ ============
Pro forma net income per share:
Basic income per share before
discontinued operations and
cumulative effect of a change in
accounting principle, net............ $ 0.69 $ 0.84 $ 0.84
Discontinued operations, net of taxes.. (0.03) (0.04) (0.01)
Cumulative effect of a change in
accounting principle, net of taxes... -- -- (0.04)
------------ ------------ ------------
Adjusted net income per share..... $ 0.66 $ 0.80 $ 0.79
============ ============ ============
Diluted income per share before
discontinued operations and
cumulative effect of a change in
accounting principle, net............ $ 0.68 $ 0.83 $ 0.83
Discontinued operations, net of taxes.. (0.03) (0.04) (0.01)
Cumulative effect of a change in
accounting principle, net of taxes... -- -- (0.04)
------------ ------------ ------------
Adjusted net income, per share.... $ 0.65 $ 0.79 $ 0.78
============ ============ ============
A summary of the weighted average fair values was as follows:
[Enlarge/Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Weighted average fair value, using the
Black-Scholes option pricing model.... $ 4.27 $ 5.55 $ 5.07
Assumptions used to estimate the
present value of options at the
grant date:
Volatility.......................... 36.2% 36.5% 34.1%
Risk-free rate of return............ 3.9% 4.7% 6.2%
Dividend yield...................... 0.0% 0.0% 0.0%
Number of years to exercise options. 7 7 7
Comprehensive Income. Comprehensive income does not include the reversal of
certain contingency accruals as a result of fresh-start reporting related to our
emergence from bankruptcy in March 1993. Such contingency accruals represent
reserves equal to the tax benefit of pre-bankruptcy income tax net operating
loss carryforwards. The tax benefits were reserved due to uncertainty associated
with their future realization. As realization of these benefits becomes more
likely than not, the reserve is reversed from other liabilities and credited to
additional paid-in capital. Up to an additional $9.5 million may be reversed in
future periods.
Discontinued Operations. Effective June 1, 2002, we adopted SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of, and the accounting and reporting
provisions of APB No. 30, Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and
50
Transactions, for the disposal of a segment of business. SFAS No. 144 modifies
the accounting and reporting for long-lived assets to be disposed of by sale and
broadens the presentation of discontinued operations to include more disposal
transactions.
We closed 28 centers in fiscal 2003, which included five owned and 23
leased centers. These center closures meet the criteria of discontinued
operations in SFAS No. 144. The operating results for these 28 centers were
classified as discontinued operations, net of tax, in the consolidated
statements of operations for all periods presented. A summary of discontinued
operations follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Revenues, net........................ $ 4,505 $ 10,485 $ 9,780
Operating expenses................... 5,583 11,819 10,008
------------ ------------ ------------
Operating loss..................... (1,078) (1,334) (228)
Interest expense..................... (1) (3) (2)
------------ ------------ ------------
Discontinued operations before
income tax....................... (1,079) (1,337) (230)
Income tax benefit................... 427 528 88
------------ ------------ ------------
Discontinued operations, net
of tax........................... $ (652) $ (809) $ (142)
============ ============ ============
Operating expenses included impairment charges of $0.7 million and $0.6
million for fiscal 2003 and 2002, respectively, and gains on closed center sales
in the amount of $1.2 million for fiscal 2003. The owned centers that meet the
criteria of held for sale have been classified as current in the consolidated
balance sheets for all periods presented. As a result, property and equipment of
$0.7 million and $1.8 million was classified as current assets held for sale at
May 30, 2003 and May 31, 2002, respectively.
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:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Basic weighted average common
shares outstanding.............. 19,700,888 19,819,352 19,072,726
Dilutive effect of options........ 207,122 291,336 201,776
------------ ------------ ------------
Diluted weighted average common
shares outstanding.............. 19,908,010 20,110,688 19,274,502
============ ============ ============
Shares excluded from potential
shares due to their
anti-dilutive effect............ 981,060 299,060 394,910
============ ============ ============
Stock split. On July 15, 2002, the Board of Directors authorized a 2-for-1
stock split of our $0.01 par value common stock effective August 19, 2002 for
stockholders of record on August 9, 2002. All references to the number of common
shares and per share amounts within these consolidated financial statements and
notes thereto for the fiscal years ended May 30, 2003, May 31, 2002 and June 1,
2001 have been restated to reflect the stock split. Concurrent with the stock
split, the number of authorized common shares was increased from 20.0 million to
100.0 million shares.
Reporting for Segments. We operate in one reportable segment.
Exit or Disposal Activities. In the second quarter of fiscal 2003, we
adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 requires that costs
51
associated with exit or disposal activities be recorded at their fair values
when a liability has been incurred, rather than at the date of commitment to an
exit or disposal plan. SFAS No. 146 was effective for disposal activities
initiated after December 31, 2002. This adoption did not have a material impact
on our financial position or results of operations.
Guarantees. Financial Accounting Standards Board ("FASB") Interpretation 45
("FIN 45"), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, requires expanded
disclosures by guarantors in interim and annual financial statements about
obligations under certain guarantees. In addition, FIN 45 requires guarantors to
recognize, at the inception of a guarantee, a liability for the obligation it
has undertaken in issuing the guarantee. The recognition and initial measurement
provision was applicable to guarantees issued or modified after December 31,
2002. FIN 45 does not currently have an impact on our financial position as a
result of paying off the synthetic lease facility in July 2003 as part of our
refinancing.
Recently Issued Accounting Pronouncements. FASB FIN 46, Consolidation of
Variable Interest Entities, requires consolidation where there is a controlling
financial interest in a variable interest entity, previously referred to as a
special-purpose entity. FIN 46 will become effective during the second quarter
of our fiscal year 2004. We do not anticipate an impact to our financial
position or results of operations.
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 is effective for contracts entered into or modified and
for hedging relationships designated after June 30, 2003. SFAS No. 149 is
effective in our first quarter of our fiscal year 2004. We do not anticipate a
material impact to our financial position or results of operations.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective in our second quarter of our fiscal year 2004. This statement is not
expected to have a material impact to our financial position or results of
operations.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts 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 accompanying 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 28 centers closed in fiscal 2003, we
have restated amounts previously reported in our consolidated statements of
operations for fiscal years 2002 and 2001 to reflect the results of discontinued
operations separate from continuing operations. We have also restated the first
three quarters of fiscal 2003 and each of the four quarters of fiscal 2002 for
similar reasons. See "Note 16. Quarterly Results (Unaudited)." In addition,
certain other prior period amounts have been reclassified to conform to the
current year's presentation.
52
3. Receivables
Receivables consisted of the following, with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Tuition............................ $ 34,399 $ 33,996
Allowance for doubtful accounts.... (4,837) (6,381)
------------ ------------
29,562 27,615
Other.............................. 1,931 4,042
------------ ------------
$ 31,493 $ 31,657
============ ============
4. Prepaid Expenses and Supplies
Prepaid expenses and supplies consisted of the following, with dollars in
thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Inventories........................ $ 2,946 $ 4,167
Prepaid rent....................... 1,943 2,211
Other.............................. 4,534 3,570
------------ ------------
$ 9,423 $ 9,948
============ ============
5. Property and Equipment
Property and equipment consisted of the following, with dollars in
thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Land................................. $ 157,711 $ 165,232
Buildings and leasehold improvements. 586,780 577,610
Equipment............................ 183,653 178,242
Construction in progress............. 22,708 35,907
------------ ------------
950,852 956,991
Accumulated depreciation and
amortization......................... (285,037) (255,352)
------------ ------------
$ 665,815 $ 701,639
============ ============
6. Other Assets
Other assets consisted of the following, with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Minority investments, cost method.... $ 10,047 $ 15,757
Deferred financing costs............. 8,203 11,405
Notes receivable..................... 1,423 2,548
Other................................ 7,006 5,614
------------ ------------
$ 26,679 $ 35,324
============ ============
53
7. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consisted of the following, with
dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Accrued compensation, benefits and
related taxes.......................... $ 32,655 $ 30,589
Current portion of self-insurance
liabilities............................ 22,360 19,750
Deferred revenue......................... 19,165 20,032
Accrued property taxes................... 9,161 8,879
Accrued interest......................... 8,060 8,975
Accrued income taxes..................... 6,632 5,854
Current portion of capital lease
obligations............................ 226 854
Other.................................... 11,412 11,441
------------ ------------
$ 109,671 $ 106,374
============ ============
8. Long-Term Debt
Long-term debt consisted of the following, with dollars in thousands:
[Enlarge/Download Table]
Secured: May 30, 2003 May 31, 2002
------------ ------------
Borrowings under revolving credit facility, interest at:
o May 30, 2003 - adjusted LIBOR plus 1.25%, of 2.57%
and ABR of 4.25%
o May 31, 2002 - adjusted LIBOR plus 1.50%, from
3.34% to 3.67%......................................... $ 104,000 $ 175,000
Term loan facility, interest at adjusted LIBOR plus 2.50%,
of 3.82% and 4.43%, respectively.......................... 47,000 47,500
Industrial refunding revenue bonds at variable rates of
interest of 1.70% and 1.60% to 2.50%, respectively,
supported by letters of credit, maturing calendar 2009.... 8,500 12,598
Industrial revenue bonds secured by real property with
maturities to calendar 2005 at interest rates of 2.98% to
4.55% and 3.33% to 4.55%, respectively.................... 3,739 3,846
Real and personal property mortgages payable in monthly
installments through calendar 2005, interest rates of
7.00% and 8.00% to 8.25%, respectively.................... 34 920
Unsecured:
Senior subordinated notes due calendar 2009, interest at
9.5%, payable semi-annually............................... 290,000 290,000
Notes payable in monthly installments through calendar 2008,
interest rate at 8.00%.................................... 1,807 2,453
------------ ------------
455,080 532,317
Less current portion of long-term debt........................ 13,744 6,237
------------ ------------
$ 441,336 $ 526,080
============ ============
Refinancing. In July 2003 we refinanced a portion of our debt. We obtained
a new $125.0 million revolving credit facility, and, as described below in
greater detail, one of our subsidiaries obtained a $300.0 million mortgage loan.
Proceeds from the mortgage loan were used to pay off the balance on the then
existing revolving credit facility, the term loan facility and the synthetic
lease facility. We also used a portion of the remaining proceeds to repurchase
$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.
54
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 which is referred to as the CMBS Borrower.
Because the CMBS Centers are is owned by the CMBS Borrower and subject to the
CMBS Loan, recourse to the CMBS Centers by our creditors will be effectively
subordinated to recourse by holders of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
30-year amortization (based on an assumed rate of 6.5%). 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
7.0% 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.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 9, 2005, the loan may be partially prepaid
(a) up to $15.0 million each loan year in connection with releases of mortgaged
centers with no prepayment premium and (b) 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 to $50.0 million, as adjusted. The
net operating income of the CMBS Centers for the trailing 13 periods ended July
1, 2003 was approximately $83.0 million. The maximum amount of excess cash flow
that can be escrowed is limited to one year of debt service on the CMBS Loan and
one year of the rent due under the ground lease with the CMBS Operator. The
escrowed amounts are released if the CMBS Centers generate the necessary minimum
net operating income for two consecutive quarters. The maximum annual debt
service on the CMBS Loan is approximately $22.8 million (assuming a 6.50%
interest rate). The maximum 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.
Credit Facility. Our new $125.0 million credit facility is secured by first
mortgages or deeds of trusts on 119 of our owned centers and certain other
collateral and has a maturity date of July 9, 2008. The revolving credit
facility includes borrowing capacity of up to $75.0 million for letters of
credit and up to $10.0 million for selected short-term borrowings.
55
The credit facility bears interest, at our option, at either of the
following rates, which are adjusted in quarterly increments based on the
achievement of performance goals:
o an adjusted LIBOR rate plus, a rate ranging from 2.00% to 3.25%,
dependent upon the ratio of total consolidated debt to total
consolidated EBITDA, initially 3.25% at August 22, 2003.
o an alternative base rate plus, a rate ranging from 0.75% to 2.00%,
dependent upon the ratio of total consolidated debt to total
consolidated EBITDA.
---------------
EBITDA is defined in the credit facility as net income before interest
expense, income taxes, depreciation, amortization , non-recurring
charges, non-cash charges, gains and losses on asset sales,
restructuring charges or reserves and non-cash gains.
The credit facility contains customary covenants and provisions that
restrict our ability to:
o make certain fundamental changes to our business,
o consummate asset sales,
o declare dividends,
o grant liens,
o incur additional indebtedness, amend the terms of or repay certain
indebtedness, and
o make capital expenditures.
In addition, the credit facility requires us to meet or exceed certain
leverage and interest and lease expense coverage ratios.
Under the new revolving credit facility we are required to pay a commitment
fee at a rate ranging from 0.40% to 0.50% on the available commitment. The fee
is payable quarterly in arrears. In addition, we are required to pay a letter of
credit fee at a rate of LIBOR minus 0.125% plus a fronting fee of 0.125%. These
fees are also payable quarterly in arrears.
Series A Through E Industrial Revenue Bonds. We are obligated to various
issuers of industrial revenue bonds, which are referred to as refunded IRBs.
Such bonds mature in calendar 2009. The refunded IRBs were issued to provide
funds for refunding an equal principal amount of industrial revenue bonds that
were used to finance the cost of acquiring, constructing and equipping specific
centers. At May 30, 2003, the refunded IRBs bore interest at a variable rate of
1.70%, and each was secured by a letter of credit under the revolving credit
facility.
Other Industrial Revenue Bonds. We are also obligated to various issuers of
other industrial revenue bonds that mature to calendar 2005. The principal
amount of such IRBs was used to finance the cost of acquiring, constructing and
equipping specific child care centers. The IRBs are secured by these centers. At
May 30, 2003, the IRBs bore interest at rates of 2.98% to 4.55%.
Senior Subordinated Notes. In fiscal 1997, we issued $300.0 million
aggregate principal amount of 9.5% unsecured senior subordinated notes under an
indenture between Marine Midland Bank, as
56
trustee, and us. During fiscal 2000 we acquired $10.0 million aggregate
principal amount of our 9.5% senior subordinated debt at an aggregate price of
$9.6 million. This transaction resulted in a write-off of deferred financing
costs of $0.3 million and a gain of approximately $0.1 million.
During the fourth quarter of fiscal 2003, we committed to acquire $11.0
million aggregate principal amount of our 9.5% senior subordinated notes at an
aggregate price of $11.1 million, which included loss of $0.1 million. In
addition, this transaction resulted in the write-off of deferred financing costs
of $0.2 million. The $0.3 million of costs related to the loss and the write-off
of the deferred financing costs associated with the repurchase were included in
interest expense in fiscal 2003. The $11.4 million aggregate purchase, which
included $0.3 million of accrued interest, was completed in June 2003.
During fiscal year 2004, we have acquired an additional $41.0 million
aggregate principal amount of our 9.5% senior subordinated notes at an aggregate
price of $41.8 million, resulting in the write-off of deferred financing costs
of $0.9 million and a loss of approximately $0.8 million that will be recognized
during fiscal 2004. We used $37.0 million of proceeds from our debt refinancing
and $4.0 million of cash flow from operations to repurchase the 9.5% senior
subordinated notes. We will continue to repurchase aggregate principal amounts
of our 9.5% subordinated notes using cash flow from operations and proceeds
under our sale-leaseback program as long as the market supports such
transactions.
The 9.5% notes are due February 15, 2009 and are general unsecured
obligations, ranked behind all existing and future indebtedness that is not
expressly ranked behind, or made equal with, the notes. The 9.5% notes bear
interest at a rate of 9.5% per year, payable semi-annually on February 15 and
August 15 of each year. The 9.5% notes may be redeemed at any time, in whole or
in part, on or after February 15, 2002 at a redemption price equal to 104.75% of
the principal amount of the notes in the first year and declining yearly to par
at February 15, 2005, plus accrued and unpaid interest, if any, to the date of
redemption.
Upon the occurrence of a change of control, we will be required to make an
offer to repurchase all notes properly tendered at a price equal to 101% of the
principal amount plus accrued and unpaid interest to the date of repurchase.
The indenture governing the notes contains covenants that limit our ability
to:
o incur additional indebtedness or liens,
o incur or repay other indebtedness,
o pay dividends or make other distributions,
o repurchase equity interests,
o consummate asset sales,
o enter into transaction with affiliates,
o merge or consolidate with any other person or sell, assign, transfer,
lease, convey or otherwise dispose of all or substantially all of our
assets, and
o enter into guarantees of indebtedness.
57
Principal Payments. At May 30, 2003, the aggregate minimum annual
maturities of long-term debt for the five fiscal years subsequent to May 30,
2003 were as follows, with dollars in thousands:
Fiscal Year:
2004........................................ $ 13,744
2005........................................ 6,297
2006........................................ 2,810
2007........................................ 2,815
2008........................................ 178,838
Thereafter.................................. 250,576
------------
$ 455,080
============
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 the current
portion of our $47.0 million term loan facility were classified as long-term
debt at May 30, 2003 since those current obligations were financed on a
long-term basis subsequent to May 30, 2003. Both are reflected above in
accordance with the payment schedule required as a result of the refinancing.
9. Restructuring Charges (Reversals)
During the fourth quarter of fiscal 1999, the Board of Directors authorized
a provision of $4.0 million for the planned early termination of certain center
operating leases. The provision included an estimate of discounted future lease
payments and anticipated incremental costs related to closure of the centers. A
total of 61 underperforming leased centers were closed: 36 in fiscal 2001 and 25
in fiscal 2000.
By June 1, 2001 we had paid and/or entered into contractual commitments to
pay $3.9 million of lease termination and closure costs for such closed centers.
During the fourth quarter of fiscal 2001, the remaining reserve of $0.1 million
was reversed.
A summary of the lease termination reserve was as follows, with dollars in
thousands:
Balance at June 2, 2000...................................... $ 2,946
Payments with respect to the closed centers.................. (2,176)
Contractual commitments with respect to the closed centers... (670)
Reversal of remaining reserve................................ (100)
---------
Balance at June 1, 2001.................................... $ --
=========
A summary of the aggregate financial operating performance of the 61 closed
centers was as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Net revenues............. $ -- $ -- $ 2,131
Operating losses......... 63 191 951
58
10. Income Taxes
The provision for income taxes attributable to income before income taxes
and cumulative effect of a change in accounting principle consisted of the
following, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Current:
Federal...................... $ 14,683 $ 3,042 $ 7,025
State........................ 4,975 1,388 3,403
Foreign...................... 105 (60) (46)
------------ ------------ ------------
19,763 4,370 10,382
Deferred:
Federal...................... (8,003) 5,868 152
State........................ (1,048) 753 23
Foreign...................... (1,917) (190) (291)
------------ ------------ ------------
(10,968) 6,431 (116)
------------ ------------ ------------
Income tax expense, net of
discontinued operations...... 8,795 10,801 10,266
Income tax benefit related
to discontinued operations... 427 528 88
------------ ------------ ------------
Income tax expense............. $ 9,222 $ 11,329 $ 10,354
============ ============ ============
A reconciliation between the statutory federal income tax rate and the
effective income tax rates on income before income taxes and cumulative effect
of a change in accounting principle was as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
------------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Expected tax provision at the federal
rate of 35%........................... $ 7,781 $ 9,565 $ 9,080
State income taxes, net of federal tax
benefit............................... 1,080 1,330 1,258
Goodwill and other non-deductible
expenses.............................. 401 678 272
Tax credits, net of valuation
adjustment............................ (780) (780) (1,050)
Other, net.............................. 313 8 706
------------ ------------ ------------
$ 8,795 $ 10,801 $ 10,266
============ ============ ============
59
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities were summarized
as follows, with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Deferred tax assets:
Deferred gains and deferred revenue.......... $ 14,618 $ --
Self-insurance reserves...................... 14,118 11,693
Compensation payments........................ 5,132 4,668
Tax credits.................................. 3,317 7,214
Net operating loss carryforwards............. 2,282 1,987
Property and equipment, basis differences.... 1,118 226
Other........................................ 7,663 5,302
------------ ------------
Total gross deferred tax assets............ 48,248 31,090
Less valuation allowance................. (5,336) (5,211)
------------ ------------
Net deferred tax assets.................... 42,912 25,879
------------ ------------
Deferred tax liabilities:
Property and equipment, basis differences.... (20,031) (14,707)
Property and equipment, basis differences of
foreign subsidiaries....................... (5,059) (5,716)
Stock basis of foreign subsidiary............ (3,621) (3,622)
Goodwill..................................... (1,500) --
Other........................................ (29) (130)
------------ ------------
Total gross deferred tax liabilities....... (30,240) (24,175)
------------ ------------
Financial statement net deferred tax assets $ 12,672 $ 1,704
============ ============
The valuation allowance increased by $0.1 million during fiscal 2003 due to
the creation of foreign net operating loss carryforwards, of which the eventual
utilization are in doubt. Deferred tax assets, net of valuation allowances, have
been recognized to the extent that their realization is more likely than not.
However, the amount of the deferred tax assets considered realizable could be
adjusted in the future as estimates of taxable income or the timing thereof are
revised. If we are unable to generate sufficient taxable income in the future
through operating results, increases in the valuation allowance may be required
through an increase to tax expense in future periods. Conversely, if we
recognize taxable income of a suitable nature and in the appropriate periods,
the valuation allowance will be reduced through a decrease in tax expense in
future periods.
At May 30, 2003, we had $2.5 million of net operating losses available for
carryforward that expire over various dates through fiscal year 2010.
Utilization of the net operating losses is subject to an annual limitation. We
have tax credits available for carryforward for federal income tax purposes of
$3.2 million, which are available to offset future federal income taxes through
fiscal year 2023.
11. Benefit Plans
Stock Purchase and Option Plans. During fiscal 1997, the Board of Directors
adopted and, during fiscal 1998, the stockholders approved the 1997 Stock
Purchase and Option Plan for Key Employees of KinderCare Learning Centers, Inc.
and Subsidiaries, referred to as the 1997 Plan. The 1997 Plan authorizes grants
of stock or stock options covering 5,000,000 shares of our common stock. Grants
or awards under the 1997 Plan may take the form of purchased stock, restricted
stock, incentive or nonqualified stock options or other types of rights
specified in the 1997 Plan.
During fiscal 2003, the Board of Directors adopted the 2002 Stock Purchase
and Option Plan for Key California Employees of KinderCare Learning Centers,
Inc. and Subsidiaries, referred to as the California Stock Plan. The California
Stock Plan authorizes 100,000 shares of our common stock as
60
available for grants. The California Stock Plan is substantially similar to the
1997 plan, except for modifications required by California law.
During fiscal 2001, certain officers purchased 22,024 shares of restricted
common stock in aggregate, respectively, under the terms of the 1997 Plan. No
shares were purchased in fiscal 2003 or 2002. All of the officers, with the
exception of the CEO, have executed term notes in order to purchase restricted
stock. The term notes mature from calendar 2005 to 2011 and bear interest at
rates ranging from 2.69% to 4.44% per annum, payable semi-annually on June 30
and December 31. At May 30, 2003, the term notes totaled $1.1 million and are
reflected as a component of stockholders' equity.
Grants or awards under the 1997 Plan and the California Plan are made at
fair market value as determined by the Board of Directors. Options granted
during fiscal 2003, 2002 and 2001 have exercise prices ranging from $12.21 to
$14.67 per share. At May 30, 2003, options outstanding had exercise prices
ranging from $9.50 to $14.67. A summary of outstanding options for the 1997 Plan
and the California Plan was as follows:
[Download Table]
Weighted
Number Average
of Exercise
Shares Price
--------- --------
Outstanding at June 2, 2000... 1,669,684 $ 9.87
Granted............................ 194,060 12.26
Canceled........................... (91,366) 9.95
--------- --------
Outstanding at June 1, 2001..... 1,772,378 10.12
Granted............................ 125,000 13.66
Canceled........................... (35,000) 12.14
--------- --------
Outstanding at May 31, 2002..... 1,862,378 10.32
Granted............................ 583,000 14.52
Canceled........................... (151,742) 11.77
--------- --------
Outstanding at May 30, 2003.... 2,293,636 $ 11.29
========= ========
The stock options granted were non-qualified options that vest 20% per year
over a five-year period. Options outstanding at May 30, 2003 had the following
characteristics:
1997 Plan California Plan
--------- ---------------
Exercisable options.................. 1,460,860 1,000
Weighted average exercise price...... $ 9.89 $ 13.61
Remaining average contractual life,
in years........................... 5.8 8.4
There were 2,213,362 shares and 93,000 shares available for issuance under
the 1997 Plan and the California Plan at May 30, 2003, respectively.
We have adopted the disclosure only provisions of SFAS No. 148.
Accordingly, no compensation cost has been recognized for stock options granted
with an exercise price equal to or less than the fair value of the underlying
stock on the date of grant. Please see "Note 2. Summary of Significant
Accounting Policies, Stock-Based Compensation" for our pro forma disclosures of
net income and earnings per share had compensation cost been recognized for our
stock options.
Savings and Investment Plan. The Board of Directors adopted the KinderCare
Learning Centers, Inc. Savings and Investment Plan, referred to as the Savings
Plan, effective January 1, 1990 and approved the restatement of the Savings Plan
effective July 1, 1998. Effective June 10, 2003, the Board
61
approved the adoption of a new prototype plan. All employees, other than highly
compensated employees, over the age of 21 are eligible to participate in the
Savings Plan on entry dates of April 1 and October 1, whichever most closely
follows the employee's date of hire. Participants may contribute, in increments
of 1%, up to $12,000 per calendar year to the Savings Plan. We have matched
participants' contributions up to 1% of compensation on a discretionary basis.
During fiscal years 2003, 2002 and 2001, we contributed $0.4 million, $0.3
million and $0.4 million, respectively, to the Savings Plan.
Nonqualified Deferred Compensation Plan. The Board of Directors adopted the
KinderCare Learning Centers, Inc. Nonqualified Deferred Compensation Plan,
effective August 1, 1996 and approved a restatement of the plan effective
January 1, 1999. Under the Nonqualified Deferred Compensation Plan, certain
highly compensated or key management employees are provided the opportunity to
defer receipt and income taxation of such employees' compensation. We have
matched participants' contributions up to 1% of compensation on a discretionary
basis. During each of fiscal years 2003, 2002 and 2001 we contributed $0.1
million to the Nonqualified Deferred Compensation Plan.
Directors' Deferred Compensation Plan. On May 27, 1998, the Board of
Directors adopted the KinderCare Learning Centers, Inc. Directors' Deferred
Compensation Plan. Under this plan, non-employee members of the Board of
Directors may elect to defer receipt and income taxation of all or a portion of
their annual retainer. Any amounts deferred under the Directors' Deferred
Compensation Plan are credited to a phantom stock account. The number of shares
of phantom stock credited to the director's account will be determined based on
the amount of deferred compensation divided by the then fair value per share, as
defined in the Directors' Deferred Compensation Plan, of our common stock.
Distributions from the Directors' Deferred Compensation Plan are made in
cash and reflect the value per share of the common stock at the time of
distribution multiplied by the number of phantom shares credited to the
director's account. Distributions from the Directors' Deferred Compensation Plan
occur upon the earlier of (1) the first day of the year following the director's
retirement or separation from the Board or (2) termination of the Directors'
Deferred Compensation Plan.
12. Disclosures About Fair Value of Financial Instruments
Fair value estimates, methods and assumptions are set forth below for our
financial instruments at May 30, 2003 and May 31, 2002.
Cash and cash equivalents, receivables, investments and current
liabilities. Fair value approximates the carrying value of cash and cash
equivalents, receivables and current liabilities as reflected in the
consolidated balance sheets at May 30, 2003 and May 31, 2002 because of the
short-term maturity of these instruments. Our minority investments, accounted
for under the cost method, are recorded at cost or net realizable value, which
approximate fair value.
Long-term debt. Based on recent market activity, the estimated fair value
of our $290.0 million of 9.5% senior subordinated notes was $293.1 million at
May 30, 2003. At May 31, 2002, the estimated fair value approximated the $290.0
million book value of the 9.5% senior subordinated notes. The carrying values
for our remaining long-term debt of $165.1 and $242.3 million at May 30, 2003
and May 31, 2002, respectively, approximated market value based on current
rates. At August 22, 2003, we had $238.0 million outstanding on our 9.5% senior
subordinated notes with an estimated fair value of $244.0 million.
13. Acquisitions
In April 2001, we acquired Mulberry Child Care Centers, Inc., referred to
as Mulberry, a child care and early education company based in Dedham,
Massachusetts. We acquired 100% of Mulberry's
62
stock in exchange for 860,000 shares of our common stock valued at $11.8
million. In connection with the transaction, we paid $13.1 million to the
sellers and assumed $3.3 million of Mulberry's debt. In August 2002, 119,838 of
the 860,000 shares were returned to us, which included 99,152 shares that were
released from an indemnity escrow and 20,686 shares that were repurchased from
certain former shareholders of Mulberry. All 119,838 shares have been cancelled.
Our subsidiary, KC Distance Learning, Inc., acquired NLKK, Inc., referred to as
NLKK, a distance learning company based in Bloomsburg, Pennsylvania in June
2000. NLKK was purchased for $15.1 million in cash. See "Consolidated Statements
of Cash Flows."
Both acquisitions were accounted for under the purchase method. The results
of operations for Mulberry and NLKK for the periods subsequent to the
acquisitions were included in our results of operations for all periods
presented. The purchase price for both transactions was allocated to the assets
and liabilities of the respective companies based on their estimated fair
values. Goodwill from the purchase of Mulberry totaled $26.4 million and from
NLKK totaled $15.2 million. The net book value of goodwill related to these
acquisitions was $40.0 million at May 30, 2003 and May 31, 2002 and $38.6
million at June 1, 2001.
14. Commitments and Contingencies
We conduct a portion of our operations from leased or subleased day care
centers. At May 30, 2003, we leased 529 operating centers under various lease
agreements that average twenty year terms. Most leases contain standard renewal
clauses. A majority of the leases contain standard covenants and restrictions,
all of which we were in compliance with at May 30, 2003. A majority of the
leases are classified as operating leases for financial reporting purposes. We
have 15 center leases that were classified as capital leases, as well as certain
equipment capital leases.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We will continue to manage the
operations of any centers that are sold in such transactions. The sales are
summarized as follows, with dollars in thousands:
[Download Table]
Fiscal Year Ended
----------------------------------------
May 30, 2003 May 31, 2002 June 1, 2001
------------ ------------ ------------
Number of centers............ 41 5 --
Net proceeds from completed
sales...................... $ 88,783 $ 9,180 $ --
Deferred gains............... 32,507 2,600 --
The deferred gains are amortized on a straight-line basis typically over a
period of 15 years.
Each vehicle in our fleet is leased pursuant to the terms of a 12-month
non-cancelable master lease which may be renewed on a month-to-month basis after
the initial 12-month lease period. Payments under the vehicle leases vary with
the number, type, model and age of the vehicles leased. The vehicle leases
require that we guarantee specified residual values upon cancellation. At May
30, 2003, our residual guarantee was $5.7 million. In most cases, we expect that
substantially all of the leases will be renewed or replaced by other leases as
part of the normal course of business. All such leases are classified as
operating leases. Expenses incurred in connection with the fleet vehicle leases
were $9.2 million, $9.8 million and $11.7 million for fiscal 2003, 2002 and
2001, respectively.
63
Following is a schedule of future minimum lease payments under capital and
operating leases, that have initial or remaining non-cancelable lease terms in
excess of one year at May 30, 2003, with dollars in thousands:
[Download Table]
Capitalized Operating
Leases Leases
----------- -----------
Fiscal Year:
2004.................................. $ 2,535 $ 47,727
2005.................................. 2,240 41,412
2006.................................. 2,279 38,520
2007.................................. 2,396 34,866
2008.................................. 2,415 31,709
Subsequent years...................... 18,221 224,260
----------- -----------
30,086 $ 418,494
===========
Less amounts representing interest.... 14,190
-----------
Present value of minimum
capitalized lease payments at
May 30, 2003..................... $ 15,896
===========
In July 2003 we completed a refinancing of a portion of our debt, which
included terminating the $97.9 million synthetic lease facility. See "Note 8.
Long-Term Debt."
The present value of the future minimum lease payments for leases
classified as capital leases were as follows, with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Present value of minimum capitalized lease
payments................................... $ 15,896 $ 16,740
Less current portion of capitalized lease
obligations................................ 769 854
------------ ------------
Long-term capitalized lease obligations.. $ 15,127 $ 15,886
============ ============
The net book value of property and equipment recorded under capital leases
was as follows, with dollars in thousands:
[Download Table]
May 30, 2003 May 31, 2002
------------ ------------
Buildings under capital leases................ $ 16,595 $ 16,573
Equipment under capital leases................ 5,203 5,308
------------ ------------
21,798 21,881
Accumulated depreciation...................... (8,801) (6,731)
------------ ------------
Net book value of property and equipment
under capital leases...................... $ 12,997 $ 15,150
============ ============
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 for $97.9 million. As noted above, 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 will be reflected in our fiscal year 2004
consolidated financial statements.
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
64
materially affect our financial position, operating results or cash flows,
although assurance cannot be given with respect to the ultimate outcome of any
such actions.
15. Subsequent Event
In July 2003 we refinanced a portion of our debt. We obtained a $300.0
million mortgage loan, as well as a new $125.0 million revolving credit
facility. See "Note 8. Long-Term Debt" for a more detailed discussion of the
mortgage loan and revolving credit facility.
16. Quarterly Results (Unaudited)
A summary of results of operations for fiscal 2003 and fiscal 2002 was as
follows, with dollars in thousands, except per share data. The first quarter of
each fiscal year included 16 weeks and the second, third and fourth quarters
each included 12 weeks. The quarterly results for the first three quarters of
fiscal 2003 and each of the four quarters of fiscal 2002 were restated to
exclude the operating results of 28 centers closed in fiscal 2003. The operating
results for these centers were classified as discontinued operations.
[Enlarge/Download Table]
First Second Third Fourth
Quarter Quarter Quarter Quarter(a)
----------- ----------- ----------- -----------
Fiscal Year ended May 30, 2003
Revenues, net................... $ 255,039 $ 196,127 $ 192,742 $ 206,135
Operating income................ 13,992 15,847 19,075 21,687
Net income...................... 457 4,300 5,298 3,360
Net income per share:
Basic net income per share.... $ 0.02 $ 0.22 $ 0.27 $ 0.17
Diluted net income per share.. 0.02 0.22 0.27 0.17
Fiscal Year ended May 31, 2002
Revenues, net................... $ 245,152 $ 189,694 $ 185,309 $ 198,794
Operating income................ 11,467 19,529 21,596 21,869
Net income (loss)............... (1,770) 5,453 7,148 5,712
Net income (loss) per share:
Basic net income (loss) per
share........................ $ (0.09) $ 0.27 $ 0.36 $ 0.29
Diluted net income (loss) per
share........................ (0.09) 0.27 0.35 0.29
(a) Net income during the fourth quarter of fiscal 2003 and fiscal 2002
included a loss on minority investment of $4.0 million and $1.4 million,
net of taxes, respectively.
65
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
KinderCare Learning Centers, Inc.
We have audited the accompanying consolidated balance sheets of KinderCare
Learning Centers, Inc., and subsidiaries as of May 30, 2003 and May 31, 2002,
and the related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years ended May 30, 2003,
May 31, 2002 and June 1, 2001. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of KinderCare Learning Centers, Inc.
and subsidiaries as of May 30, 2003 and May 31, 2002, and the results of their
operations and their cash flows for each of the years ended May 30, 2003, May
31, 2002 and June 1, 2001, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill
and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, effective June 1, 2002.
DELOITTE & TOUCHE LLP
Portland, Oregon
August 11, 2003
66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. DISCLOSURE 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 as of 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,
as of the end of the period covered by this report, our disclosure controls and
procedures are effective in ensuring that information required to be disclosed
in our Exchange Act reports is (1) recorded, processed, summarized and reported
in a timely manner and (2) 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 control over financial reporting that occurred during our fiscal year
ended May 30, 2003 that has materially affected, or is reasonably likely to
materially affect, our internal controls over financial reporting.
67
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors appearing under the caption "Election of
Directors" and "Board of Directors Meetings, Committees and Compensation" in our
Proxy Statement for the 2003 Annual Meeting of Shareholders is hereby
incorporated by reference.
Information regarding executive officers is included in Part I of this
report, see "Item 4(a), Executive Officers of the Registrant."
Information required by Item 405 of Regulation S-K appearing under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance" in our 2003
Proxy Statement is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information appearing under the captions "Board of Directors Meetings,
Committees and Compensation" and under "Executive Compensation" in our 2003
Proxy Statement is hereby incorporated by reference. See "Item 5. Market for the
Registrant's Common Equity and Related Stockholder Matters," for information
concerning our equity compensation plans.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information appearing under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plans" in our 2003
Proxy Statement is hereby incorporated by reference. See "Item 5. Market for the
Registrant's Common Equity and Related Stockholder Matters," for information
concerning our equity compensation plans.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information appearing under the caption "Certain Relationships and Related
Transactions," in our 2003 Proxy Statement is hereby incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information appearing under the caption "Independent Public Accountants" in
our 2003 Proxy Statement is hereby incorporated by reference.
68
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following is an index of the financial statements, schedules and
exhibits included in this report or incorporated herein by reference:
(a)(1) Financial Statements:
Page
Consolidated balance sheets at May 30, 2003 and May 31, 2002...... 42
Consolidated statements of operations for the fiscal years
ended May 30, 2003, May 31, 2002 and June 1, 2001........... 43
Consolidated statements of stockholders' equity and
comprehensive income for the fiscal years ended
May 30, 2003, May 31, 2002 and June 1, 2001................. 44
Consolidated statements of cash flows for the fiscal year ended
May 30, 2003, May 31, 2002 and June 1, 2001................. 45
Notes to consolidated financial statements........................ 46-65
Independent auditors' report...................................... 66
(a)(2) Schedules to Financial Statements: None.
(a)(3) Exhibits: The following exhibits are filed with this report or
incorporated herein by reference:
Exhibit Description
Number of Exhibits
------- ---------------
2(a) Stockholders' Agreement between KinderCare and the stockholders
parties thereto (incorporated by reference from Exhibit 2.3 of our
Registration Statement on Form S-4, filed March 11, 1997, File No.
333-23127).
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).
10(a) Revolving Credit Agreement dated July 1, 2003 among KinderCare, the
several lenders from time to time parties thereto (referred to as
Lenders), and Citicorp North America, Inc. as Administrative Agent for
the lenders.
10(b) Guarantee dated July 1, 2003 among certain subsidiaries of KinderCare
and Citicorp North America, Inc.
69
Exhibit Description
Number of Exhibits
------- ---------------
10(c) Pledge Agreement dated July 1, 2003 among KinderCare, certain
subsidiaries of KinderCare and Citicorp North America, Inc..
10(d) Security Agreement dated July 1, 2003 among KinderCare, certain
subsidiaries of KinderCare and Citicorp North America, Inc.
10(e) Form of Mortgage, Assignment of Leases and Rents, Security Agreement
and Financing Statement dated July 1, 2003 from KinderCare and certain
subsidiaries of KinderCare to Citicorp North America, Inc.
10(f) Registration Rights Agreement dated February 13, 1997 among KCLC
Acquisition, KLC Associates L.P. and KKR Partners II, L.P.
(incorporated by reference from Exhibit 10.2 of our Registration
Statement on Form S-4, filed March 11, 1997, File No. 333-23127).
10(g) Lease between 600 Holladay Limited Partnership and KinderCare dated
June 2, 1997 (incorporated by reference from Exhibit 10(f) of our
Annual Report on Form 10-K for the fiscal year ended May 30, 1997).
10(h) Addendum dated June 28, 2000 to Lease dated June 2, 1997 between 600
Holladay Limited Partnership and KinderCare (incorporated by reference
from Exhibit 10(a) to our Quarterly Report on Form 10-Q for the
quarterly period ended September 22, 2000).
10(i)* 1997 Stock Purchase and Option Plan for Key Employees of KinderCare
Learning Centers, Inc. and Subsidiaries (incorporated by reference
from Exhibit 10(c) to our Quarterly Report on Form 10-Q for the
quarterly period ended September 19, 1997).
10(j)* 2002 Stock Purchase and Option Plan for Key California Employees.
10(k)* Form of Restated Management Stockholder's Agreement (incorporated by
reference from Exhibit 10(f) to our Annual Report on Form 10-K for the
fiscal year ended June 1, 2001).
10(l)* Form of Non-Qualified Stock Option Agreement (incorporated by
reference from Exhibit 10(g) to our Annual Report on Form 10-K for the
fiscal year ended June 1, 2001).
10(m)* Form of Restated Sale Participation Agreement (incorporated by
reference from Exhibit 10(h) to our Annual Report on Form 10-K for the
fiscal year ended June 1, 2001).
10(n)* Form of Term Note.
10(o)* Form of Pledge Agreement (incorporated by reference from Exhibit 10(h)
to our Quarterly Report on Form 10-Q for the quarterly period ended
September 19, 1997).
10(p)* Stockholders' Agreement dated as of February 14, 1997 between
KinderCare and David J. Johnson (incorporated by reference from
Exhibit 10(l) to our Quarterly Report on Form 10-Q for the quarterly
period ended September 19, 1997).
10(q)* Nonqualified Stock Option Agreement dated February 14, 1997 between
KinderCare and David J. Johnson (incorporated by reference from
Exhibit 10(j) to our Quarterly Report on Form 10-Q for the quarterly
period ended September 19, 1997).
10(r)* Sale Participation Agreement dated February 14, 1997 among KKR
Partners II, L.P., KLC Associates, L.P. and David J. Johnson
(incorporated by reference from Exhibit 10(k) to our Quarterly Report
on Form 10-Q for the quarterly period ended September 19, 1997).
10(s)* Directors' Deferred Compensation Plan (incorporated by reference from
Exhibit 10(q) to our Annual Report on Form 10-K for the fiscal year
ended May 29, 1998).
10(t) Form of Indemnification Agreement for Directors and Officers of
KinderCare (incorporated by reference from Exhibit 10(r) to our Annual
Report on Form 10-K for the fiscal year ended May 29, 1998).
10(u)* Restated Nonqualified Deferred Compensation Plan effective January 1,
1999 (incorporated by reference from Exhibit 10(a) to our Quarterly
Report on Form 10-Q for the quarterly period ended March 5, 1999).
10(v)* Form of Executive Split Dollar Life Insurance Agreement (incorporated
by reference from Exhibit 10(b) to our Quarterly Report on Form 10-Q
for the quarterly period ended March 5, 1999).
70
Exhibit Description
Number of Exhibits
------- ---------------
10(w) Loan Agreement dated July 1, 2003 between KC Propco, LLC and Morgan
Stanley Mortgage Capital, Inc.
10(x) First Amendment to Loan Agreement dated August 1, 2003 between KC
Propco, LLC and Morgan Stanley Capital, Inc.
10(y) Management Agreement dated July 1, 2003 between KC Opco, LLC and
KinderCare.
10(aa) Lease Agreement dated July 1, 2003 between KC Propco, LLC and KC Opco,
LLC.
10(bb)* Form of letter regarding the Fiscal Year 2004 Management Bonus Plan.
10(cc)* Employment Separation Agreement, Waiver and Release dated October 9,
2002, between KinderCare and Robert Abeles (incorporated by reference
from Exhibit 10(aa) of our Registration Statement on Form 10, filed
December 9, 2002, File No. 0-17098).
21 Subsidiaries of KinderCare.
23 Independent Auditors' Consent - Deloitte & Touche LLP.
31(a) Rule 13(a)-14(a) Certification of Chief Executive Officer.
31(b) Rule 13(a)-14(a) Certification of Chief Financial Officer.
32(a) Section 1350 Certification of Chief Executive Officer.
32(b) Section 1350 Certification of Chief Financial Officer.
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K: Filed April 22, 2003 for third quarter earnings
released April 21, 2003.
(c) Exhibits Required by Item 601 of Regulation S-K: The exhibits to this
report are listed under Item 15(a)(3) above.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 August 28, 2003.
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)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on August 28, 2003:
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)
By: /s/ HENRY R. KRAVIS
------------------------------------
Henry R. Kravis
Director
By: /s/ GEORGE R. ROBERTS
------------------------------------
George R. Roberts
Director
By: /s/ MICHAEL W. MICHELSON
------------------------------------
Michael W. Michelson
Director
By: /s/ SCOTT C. NUTTALL
------------------------------------
Scott C. Nuttall
Director
By: /s/ RICHARD J. GOLDSTEIN
------------------------------------
Richard J. Goldstein
Director
72
Dates Referenced Herein and Documents Incorporated by Reference
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