10k97
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
F O R M 10 - K
[X] ANNUAL REPORT PURSUANT TO SECTION l3 OR l5(d) OF
THE SECURITIES EXCHANGE ACT OF l934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number 0-14368
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1097006
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
851 Irwin Street, Suite 200, San Rafael, California 94901
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 257-4200
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
None Not Applicable
Securities registered pursuant to Section l2(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
---------------------------
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 l934 during
the preceding l2 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 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. [___]
The aggregate market value of voting stock held by nonaffiliates of the
registrant on March 20, 1998 was approximately $61,623,778. On such date, the
last sale price of registrant's common stock was $10.625 per share. Solely for
the purposes of this calculation, shares beneficially owned by directors and
officers of registrant have been excluded, except shares with respect to which
such directors and officers disclaim beneficial ownership. Such exclusion should
not be deemed a determination or admission by registrant that such individuals
are, in fact, affiliates of registrant.
As of March 20, 1998 the Registrant had outstanding 6,744,499 shares of Common
Stock, $.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE:
Part of the Form
10-K into which
Document the Document is
Incorporated
Definitive Proxy Statement to Stockholders Part III, Items 10, 11, 12 and 13
<PAGE>
2
PART I
Item 1. Business
(a) General Development of Business.
Recent Events
On March 27, 1998, the Company entered into an Agreement and Plan of Merger (the
"Agreement") with Knowledge Beginnings, Inc., a privately-owned education
services company ("Parent") and its wholly-owned subsidiary, KBI Acquisition,
Corp. ("Purchaser"). Under the Agreement, Purchaser will undertake a tender
offer (supported by the Board of Directors) for all outstanding shares of CDC
common stock at a net price of $12.25 per share in cash and, following
consummation of the tender offer, will effect a merger with the Company (the
"Merger"). Pursuant to the Merger, all outstanding shares of CDC common stock
not acquired in the tender offer will be converted into the right to receive
$12.25 per share in cash, and the Company will become a wholly-owned subsidiary
of Parent. Holders of 1,363,700 shares of CDC common stock have simultaneously
entered into a support agreement pursuant to which they have agreed to tender
their shares and under certain circumstances sell their shares
to Parent for $12.25 per share in cash. The Company has also granted Parent an
option to purchase 1,342,155 previously unissued shares of CDC common stock
(equal to 19.9% of the outstanding shares of the Company) under certain
circumstances for $10.125 per share. The tender offer will be initiated upon
certain filings by Purchaser and the Company. The completion of the tender offer
is subject to certain conditions, including Purchaser's receipt of at least a
majority of the outstanding shares calculated on a full-diluted basis and
receipt of certain regulatory approvals. Consummation of the Merger is also
subject to certain conditions including stockholder approval, if legally
required.
Dr. Elanna S. Yalow, President and Chief Operating Officer, has entered into an
employment agreement with Parent to become effective on a date selected by
Parent (the "Effective Date") between the consummation of the tender offer and
consummation of the Merger. Richard A. Niglio, Chief Executive Officer and
Chairman of the Board, has entered into a two year consulting agreement with the
Company to become effective on the Effective Date, at which time will resign as
Chief Executive Officer and Chairman of the Board. Employment contracts between
the Company and Randall J. Truelove, Vice President of Finance, Jane Delaney,
Vice President, and Frank A. Devine, Secretary, will become effective on the
Effective Date.
Also, subject to consummation of the Merger, the Company has accelerated the
vesting of all outstanding stock options whether issued under Company plans or
otherwise (see Note 9), and the Company will offer to redeem all such options,
upon consummation of the Merger, for cash at a net price equal to $12.25 per
share, less the underlying exercise price of the option, any withholding taxes
due with respect to such redemption, and the balance of any loans then
outstanding from the Company to the optionholder.
General
Children's Discovery Centers of America, Inc. and Subsidiaries ("the Company"),
is a leading chain of preschools in the United States providing educational
services for children of both preschool and elementary school age, operating as
of December 31, 1997, 248 preschools in 22 states and the District of Columbia
with an aggregate licensed capacity of approximately 25,000 children. The
Company provides programs to children primarily between 2 1/2 and six years of
age as well as after school programs for school age children and infant care.
The Company's school age programs include private academic programs for children
in kindergarten through eighth grade, before and after school programs and
summer camps.
The Company's strategy is to grow through acquiring independent, community-based
preschools and chains, to expand in the growing employer-sponsored preschool
market and to increase programs and services in the growing school age market.
In pursuit of this strategy, from the period from January 1, 1995 through
December 31, 1997, the Company acquired or opened a total of 55 preschools (net
of closings). As of December 31, 1997, 59 of the preschools operated by the
Company are operated in conjunction with employer-sponsors, either on a
management contract basis or with one or more types of employer subsidies, such
as tuition subsidies, free or reduced rent or through the provision of services.
Also, as of December 31, 1997, the Company operated 20 elementary schools in
conjunction with its preschools, and also operated after school programs in nine
academic private schools operated by others.
The Company's proprietary computerized system monitors the staff-to-child ratio
in all of its preschools, enabling the Company to staff efficiently in response
to shifts in occupancy levels. The Company believes its "Piaget Discovery
Program" differentiates it from its competitors and appeals to both
employer-sponsors and parents.
The Company's principal executive offices are located at 851 Irwin Street, Suite
200, San Rafael, California 94901, and its telephone number is (415) 257-4200.
Expansion Strategy
The Company is currently pursuing an expansion strategy to take advantage of (i)
its experience in acquiring preschools, (ii) its success in adding
corporate-sponsored on-site or near site preschools and (iii) significant growth
opportunities in the private elementary school business.
Since the beginning of 1995, the Company has added 72 preschools, and closed 17
preschools. Of the preschools added, 16 were purchased in 1995 through the
acquisition of the business conducted by Prodigy Consulting, Inc., and
affiliated partnerships ("Prodigy"). <TABLE> <CAPTION>
The following table sets forth data regarding the number of preschools that the
Company has operated from January 1, 1993, through December 31, 1997, as well as
the approximate preschool capacity at the end of each period and average
percentage occupancy for each period.
<PAGE>
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Open at beginning of period 131 154 193 239 248
Opened during period(a) 26 42 52 14 6
Closed during period (3) (3) (6) (5) (6)
--- --- --- --- ---
Open at end of period 154 193 239 248 248
--- --- --- --- ---
Net increase 23 39 46 9 0
-- -- -- - -
Approximate school capacity (at 13,000 17,500 23,500 24,500 25,000
end of period)
Average percentage occupancy(b) 72% 73% 71% 69% 69%
<FN>
(a)Includes preschools acquired, new preschools opened and employer-sponsored
preschools which the Company commenced operating under management contracts.
Does not include preschools acquired during the period that were operated by
the Company in prior periods under management contracts.
(b)Average percentage occupancy is calculated by dividing revenue from
operations of all of the Company's preschools (other than preschools operated
on a management fee basis) for the respective periods by the product of (i)
preschool capacity for all of the Company's preschools (other than those
operated on a management fee basis) and (ii) the weighted average of the
basic tuition rate for full-time four-year old children at all such
preschools for the respective periods. The Company uses the tuition rate for
four-year olds for purposes of this calculation because that rate has
historically represented the rate paid for more than 50% of the total
children of all ages enrolled in the Company's preschools.
</FN>
</TABLE>
The Company intends to continue to expand its preschool business by acquiring
individual centers and small chains. In order to realize the benefits of
consolidation, the Company generally seeks either to acquire preschools in areas
close to the Company's existing preschools so that regional managers are able to
supervise the newly-acquired preschools, or to acquire a chain which has a
sufficient number of preschools to justify the employment of an additional
regional manager. The Company generally seeks to acquire preschools in states
with strict regulations in order to avoid unexpected expense and market
disruption that may be caused by complying with new regulations adopted in
states that previously lacked such regulations. The Company retains acquisition
specialists who visit and analyze acquisition opportunities on a continuing
basis.
The child care industry is highly fragmented, and a majority of existing
licensed preschools are owned by small operators with limited resources. The
Company believes that generally these small operators have limited opportunities
to sell their preschools, which enhances the Company's ability to acquire these
preschools on terms favorable to the Company. However, during 1995 and 1996 the
Company experienced increased competition from a few larger child care chains
for the acquisition of small child care operators. As a result, the Company has
found that prices in some instances have exceeded the price the Company was
willing to pay. These more competitive conditions contributed to a somewhat
slower growth rate for acquisitions in 1996 and in 1997. The Company attempts to
leverage its acquisitions by paying approximately one-third of the purchase
price in cash and issuing long-term promissory notes for the remainder. Because
many sellers own the preschool's real estate facility, the Company is often able
to lease these facilities on a long-term basis through exercise of successive
options, while avoiding fixed long-term obligations.
In evaluating acquisition candidates, the Company considers, among other things,
the location of a preschool, the local regulatory environment, demographic
trends, competition, quality of programs and management, the preschool's
existing community image, adequacy of the facility and opportunities for
increased utilization and low-cost expansion. In addition, the Company analyzes
the financial aspects of an acquisition with respect to pricing policies, cost
control and profit margins in order to identify areas for immediate and
long-term improvement. The Company also seeks to increase the revenues,
profitability and quality of preschools it acquires by instituting uniform
financial and operation controls and by introducing new and improved curricula
and other services. The Company believes that through this type of expansion it
will achieve the operating efficiencies of a national chain, while offering
parents a high quality of child care that reflects the character of each local
community.
Employer Child Care Services
As of December 31, 1997, the Company operated 58 employer-sponsored preschools,
of which 19 were operated for hospitals or other health care facilities, 21 for
governmental units and 18 for private sector companies, including TRW Space and
Electronics, Inc., and an affiliate of Southern New England Telecommunications
Corp. Of the 58 employer-sponsored preschools, 17 are operated by the Company
under management contracts pursuant to which the Company receives a fixed fee,
and the balance are operated with one or more types of employer subsidies,
generally in the form of tuition subsidies, free or reduced rent or through the
provision of services. During 1995,,,, the Company acquired the business of
Prodigy which managed, at the time of acquisition, nine employer-sponsored
preschools.
In some cases, the Company has arrangements with employers who "reserve" a
certain number of enrollment spaces in particular preschools for children of
their employees and pay for such spaces whether or not they are utilized. The
Company also has arrangements with a number of large national employers,
including Bank of America, Sears and K-Mart to provide incentives for their
employees to enroll their children in the Company's preschools. The Company
intends to continue to pursue opportunities in the growing employer-sponsored
preschool market.
Private Elementary Schools
During 1997, the Company substantially expanded the number of elementary school
programs it operates. As of December 31, 1997, the Company operated 20
elementary school programs (compared to 14 as of December 31, 1996) and operated
135 kindergarten programs (compared to 111 as of December 31, 1996). The Company
intends to expand its kindergarten and elementary programs primarily by adding
new programs in its preschools and by adding additional grades to its elementary
programs as the currently enrolled children are ready to advance to a new grade.
(b) Financial Information About Industry Segments.
The Company operates in one industry, providing child care and elementary school
services under company-operated and employer-sponsored preschools.
(c) Narrative Description of Business.
Company Operations
Licensed capacity of the Company's individual preschools ranges from 30 to 380
children, although actual enrollments are generally higher because some children
are enrolled on a part-time basis. The average percentage occupancy of the
Company's preschools, measured by actual preschool revenues as a percentage of
total revenue capacity of all Company centers (other than those operated for
employer-sponsors pursuant to management contracts), was approximately 69% for
the year ended December 31, 1997.
The Company's preschools contain classroom and recreational areas and kitchen
and bathroom facilities. The preschools usually accommodate the grouping of
children by age. The preschools have outdoor playgrounds, often with separate
areas designed for infants and toddlers, with the exception of downtown urban
centers that often utilize nearby parks. Each preschool is equipped with a
variety of audio and visual aids, educational supplies, games, toys and indoor
and outdoor play equipment. In addition, some of the preschools are equipped
with personal computers with programs specifically designed for preschoolers and
school-age children. A number of preschools are equipped with Company-owned or
leased vehicles for the transportation of children to and from elementary school
and for field trips.
Each preschool is administered by a director who is responsible for the
operation and maintenance of the preschool. The duties of a preschool director
include the staffing and training of qualified teachers and assistants, record
keeping, regulatory compliance, tuition collection, parent relations, marketing
and home office reporting. Directors are trained and supervised by regional
managers, who generally supervise between eight and fourteen preschools in
geographical areas sufficiently compact to permit the regional managers to
personally visit the preschools under their supervision on a regular basis.
Pre-school directors and regional managers receive incentive compensation,
determined in part by the enrollment and/or profitability of their respective
preschools.
Children are usually enrolled in the preschools on a weekly basis for either
full-day or half-day sessions. Preschools provide enrolled children with snacks,
and in some locations, meals. The Company's current weekly charge for full-day
service ranges from $61.00 to $282.00 per child, depending on the location of a
particular preschool and the age of the child. Charges customarily are payable
in advance on a weekly or monthly basis.
The Company's preschools are generally open throughout the year, usually five
days a week, from 6:30 a.m. to 6:30 p.m. Nine preschools are operated in public
or private school facilities on a before and after school basis only. In
addition, one of the Company's subsidiaries operates after-school programs in
nine schools (which are not included within the total number of Company centers
set forth above). New enrollments are most often highest in September and
January, with the largest decrease in enrollment being generally during holiday
periods and the summer months (mirroring the seasonality of the school year end
and traditional vacation times). To offset the seasonal decline in enrollment,
some preschools offer summer day camp programs for children up to the age of 12.
Operating Controls and Procedures
Pre-school directors submit weekly financial and operations reports to the
Company's headquarters, which are reviewed by management. The Company has
installed in each of its preschools a personal computer with customized software
permitting faster and more comprehensive reporting of operating information.
These reports include, among other things, labor costs, scheduling, utilization
information, enrollment and tuition data by age group, a statement of prepaid
tuition and receivable data, and a listing of all cash receipts. The Company
uses such reports in conjunction with its own records of cash receipts and
disbursements to prepare monthly operating statements for each preschool.
Management reviews these operating statements with the directors on a monthly
basis. In addition, regional managers visit preschools on a regular basis to
monitor all aspects of the preschools' operation.
All funds received by each preschool are deposited in an account established by
the Company in a local bank. All payroll and most other preschool expenses are
paid by the Company directly out of the Company's headquarters. The Company also
purchases certain supplies for the preschools. Direct expenditures by the
preschools themselves are limited to miscellaneous operating expenses for which
the preschools are reimbursed by the Company by means of a petty cash system.
The Company is committed to an effective safety program, and its operating
procedures are designed to enhance the safety of the children. While the Company
is vigilant in its efforts to promote the safety of the children at its centers,
there can be no assurance that there will be no injuries to children, or
allegations thereof, in the future.
Marketing
The Company believes that it has benefited from a number of national demographic
trends including an increased birth rate through the early 1990's, an increase
in working mothers employed outside the home and a growing emphasis by employers
on making available on-site child care for employees. According to U.S.
government statistics, births in 1989 exceeded 4,000,000 for the first time
since 1964, and continued to exceed that number in each of 1990, 1991 and 1992.
Furthermore, the percentage of all American children under age six with mothers
in the labor force grew from 39% in 1975 to 58% in 1990, and the percentage of
children receiving preschool-based child care increased from 13% of the total
number of children receiving child care in 1977 to 28% in 1990. In addition, the
number of children who are ages six to twelve increased from approximately 25
million in 1990 to 26 million in 1993 and is projected to increase to in excess
of 28 million by 1999.
The Company believes that it can increase enrollment in its preschools by
developing and introducing high quality curricula and programs that provide
parents with meaningful reasons to choose the Company's centers for their
children over other alternatives. The Company has designed educational and
recreational programs to develop a child's social, intellectual and physical
skills, and it has distributed curriculum manuals developed by it for each age
group to its preschools. In addition, the Company is committed to ongoing
research to develop curricula appropriate to children's cognitive development.
The curriculum covered by the Company's "Piaget Discovery Preschool" trademark
was developed under the supervision of an outside consultant with a Ph.D. in
Educational Psychology.
The Company's primary source of new enrollments for its preschools and
elementary schools are recommendations from customers in the communities in
which it operates. The Company markets its services through display
advertisements and listings in the Yellow Pages, newspaper advertisements and
distribution of flyers at schools and community functions. The Company spends a
large portion of its advertising budget in the summer months in anticipation of
the fall enrollment period, with continued advertising throughout the year. The
Company markets its services to employer-sponsored preschools through
relationships with consultants, attendance at trade shows and industry
publications.
The director of each preschool is responsible for marketing and promoting the
preschool. The director encourages parental involvement in the preschool through
monthly newsletters and reports to parents as well as parent-teacher conferences
and parental visits to and inspections of the preschool. Preschools use
promotional activities such as "Grandparents' Day," holiday activities,
graduation and open houses as part of the total marketing program.
Competition
Based on data from trade publications, the Company is one of the largest chains
of preschools in the United States. The child care industry is highly
fragmented, with the 50 largest for-profit child care companies estimated by the
Company to account for no more than 10% of the industry's licensed capacity.
Competition within the child care industry is based largely upon location and
adequacy of facilities, quality of service and price. In most of the geographic
areas in which the Company operates, the Company competes with centers owned by
larger national chains such as Kinder-Care Learning Centers, Inc., and La Petite
Academy, Inc., as well as with centers owned by non-profit organizations that
may be supported by endowments and charitable contributions. The Company
primarily competes for employer-sponsored centers with organizations which focus
on the employer-sponsored market such as Corporate Family Solutions and Bright
Horizons, Inc. or child care chains that have divisions that focus on
corporate-sponsored business. Some of these competitors have significantly
greater financial resources thaN the Company. The Company also competes with
individually-owned proprietary child care centers, licensed child care homes,
in-home individual child care providers and corporations that provide child care
for their employees privately. Many non-profit child care centers have lower
occupancy costs for their facilities than the Company does and, consequently,
charge less for their services. Additionally, public schools are offering, on an
increasing basis, before and after school programs that compete with services
offered by the Company. Such programs have the built-in advantages of (i) being
able to use existing, well-established facilities, (ii) having a ready source of
enrollments from their existing student population, and (iii) having tax revenue
available to subsidize the cost of the programs. The Company competes
principally by offering trained personnel, professionally planned educational
and recreational programs, well equipped facilities, and additional services
such as transportation. The Company's private kindergarten and elementary
programs face competition from the public schools as well as other providers of
private education including religious institutions, and other operators of child
care centers. The Company believes that it can compete successfully in this
market based on the quality of its educational programs, the high customer
satisfaction of its preschool customer base, and its ability to be selective in
the staff hired and children attending the school.
Insurance
The Company maintains comprehensive general liability insurance that provides
coverage for both bodily injury and property damage claims up to a total of $15
million. The primary general liability policy has a limit of $1 million per
occurrence, and the Company maintains an excess umbrella liability policy that
provides coverage for an additional $14 million for a total liability insurance
of $15 million. The Company believes such insurance coverage is adequate. The
Company has procured limited coverage for child physical and sexual abuse
claims, subject to a $1,000,000 annual aggregate limitation. To date, the
Company has not incurred any liability with respect to any claims of abuse.
The Company has not experienced difficulty in obtaining insurance coverage, but
there can be no assurance that adequate, affordable insurance coverage will be
available in the future, or that the Company's current coverage will protect it
against all possible claims.
Government Regulation
Each preschool or school must be licensed under applicable state or local
licensing laws and is subject to a variety of state and local regulations.
Although these regulations vary greatly from jurisdiction to jurisdiction,
governmental agencies generally review with respect to a preschool the safety,
fitness and adequacy of the buildings and equipment; the ratio of staff to
children; the dietary program; the daily curriculum and compliance with health
standards. In most jurisdictions, these agencies conduct scheduled and
unscheduled inspections of the preschools, and licenses must be renewed
periodically. Repeated failures by a preschool to comply with applicable
regulations can subject it to sanctions that might include probation or, in more
serious cases, suspension or revocation of the preschool's license to operate.
The Company believes that each of its preschools is in substantial compliance
with such requirements. The Company generally seeks to operate preschools in
states with strict regulations in order to avoid unexpected expense and market
disruption that may be caused by compliance with regulations adopted in states
that previously lacked such regulations.
Federal regulations and licensing requirements require compliance with minimum
standards in order to qualify for participation in Federal assistance programs.
Under the Social Security Act, the Federal government provides assistance to
states that have an established plan for child-welfare services, including child
care services. As a result, state agencies have established minimum standards
for preschools, based on the number of eligible children enrolled in each
preschool, in order for each preschool to receive financial assistance. The
Company estimates that approximately 13% of its revenue is derived from various
state public assistance programs. Any significant reduction in the scope or
amount of such financial assistance may have a significant impact on the
Company's operating results.
In addition, the Company is subject to the Americans with Disabilities Act
("ADA"), which prohibits discrimination on the basis of disability in public
accommodations and employment. The ADA became effective as to public
accommodations in January 1992 and as to employment in July 1992. The Company
believes that its facilities are substantially in compliance with the
requirements of the ADA and has not received any complaints concerning
non-compliance with such requirements. A determination that the Company is not
in compliance with the ADA could result in the imposition of fines or an award
of damages to private litigants, and it could require significant expenditures
by the Company to bring the Company's facilities into compliance with the ADA.
The Internal Revenue Code of 1986, as amended (the "Code"), provides for an
income tax credit ranging from 20% to 30% of certain child care expenses subject
to certain maximum limitations. The fee paid to the Company for child care
services qualifies for the Federal tax credit under the Code, provided that
various requirements under the Code are met.
The Company is also subject to the Fair Labor Standards Act, which governs such
matters as minimum wages, overtime compensation and working conditions. Less
than 5% of the Company's personnel are paid at rates equal to the Federal
minimum wage and, accordingly, increases in the minimum wage ahould not
materially increase the Company's labor costs.
Income Taxes
The net operating loss carryforwards of the Company and its subsidiaries are
subject to certain rules set forth in the Code that limit the ability of the
Company and its subsidiaries to use such net operating loss carryforwards to
reduce income taxes.
Employees
The Company's preschools are currently organized into regions, each of which is
under the management of a trained regional manager. Individual preschools are
staffed with a director, teachers and teaching assistants and, depending on its
size, an assistant director. All management personnel participate in periodic
training programs and are required to meet applicable state and local regulatory
standards. It is the Company's policy to comply with all state regulations and
guidelines pertaining to staff-to-child ratios. These ratios vary from state to
state and with the age group of the children under supervision. In this regard,
the Company employs, with respect to (i) infants under the age of 13 months, one
staff member for each three to four children; (ii) toddlers between the ages of
12 and 36 months, one staff member for each four to twelve children; and (iii)
preschool children 3 to 5 years of age, one staff member for each eight to
twelve children. The Company maintains a proprietary computerized system that
monitors the staff-to-child ratio in all of its preschools, enabling the Company
to staff efficiently in response to shifts in occupancy levels.
As of December 31, 1997, the Company employed approximately 4,700 persons, of
whom approximately 35% are employed on a part-time basis. Two preschools
operated by a Company subsidiary have employees that are represented by unions.
The Company believes that its relations with its employees are good. The Company
experiences significant turnover of its hourly employees, which it believes is
typical of the child care industry.
Item 2. Properties
As of December 31, 1997, the Company operated 248 school programs in 22 states
and the District of Columbia, located as follows:
Location Number of Location Number of
Centers Centers
-------------------------------------------------------
Pennsylvania 49 Oregon 5
California 48 Nebraska 5
Connecticut 24 Kansas 5
New Jersey 21 Rhode Island 3
Indiana 11 Alabama 3
Illinois 11 Virginia 3
New York 11 Michigan 3
Massachusetts 10 Texas 2
Washington 9 Delaware 2
Wisconsin 7 Washington 1
D.C.
Georgia 7 Florida 1
Maryland 7
As of December 31, 1997, the Company owned 16 centers, leased 208 centers with
terms expiring on the leased properties on various dates between 1998 and 2015,
and operated 17 centers pursuant to management contracts with employers. Seven
of the centers are operated in public or private school facilities on a before
and after school basis only.
The Company's principal executive offices are located in San Rafael, California
in 6,900 square feet that the Company leases pursuant to the terms of a lease
agreement that expires in 1999. The remaining term of the lease provides for an
annual rent of approximately $168,088. The Company believes its properties are
adequate for its uses.
Item 3. Legal Proceedings
The Company is not a party to any material legal proceedings. The Company is a
party to certain legal proceedings arising in the ordinary course of business
that are primarily covered by insurance.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
The Common Stock has been included for quotation in the NASDAQ National
Market since May 20, 1986. Until February 9, 1994, the NASDAQ symbol for the
Common Stock was "CDCRA," at which time the symbol was changed to "CDCR." The
following table sets forth for the calendar quarters indicated the historical
high and low last sales prices of the Common Stock, as reported by NASDAQ.
1997 High Low
---- ---- ---
First Quarter $7.00 $4.875
Second Quarter $7.50 $4.625
Third Quarter $8.00 $6.375
Fourth Quarter $9.875 $4.75
1996 High Low
---- ---- ---
First Quarter $5.75 $4.00
Second Quarter $8.625 $4.625
Third Quarter $7.00 $5.00
Fourth Quarter $8.125 $4.75
At March 21, 1998, there were 307 record holders of the Company's Common Stock.
The Company has never declared or paid any cash dividends or made any other
distribution on its Common Stock, and it is anticipated that in the foreseeable
future the Company will follow a policy of retaining all earnings for
reinvestment in its business. Any future determination as to declaration and
payment of dividends will be made at the discretion of the Board of Directors of
the Company.
<PAGE>
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
(in thousands, except per share data) (1)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenue from $93,015 $87,480 $77,627 $55,323 $38,564
Operations
Operating Expenses 88,530 85,037 73,010 50,898 36,644
------ ------ ------ ------ ------
Income from 4,485 2,443 4,617 4,425 1,920
Operations
Other Expense, net (885) (1,317) (773) (744) (618)
----- ----- --- --- ---
Income before
provision for 3,600 1,126 3,844 3,681 1,302
income taxes
Provision for 1,100 225 1,208 921 197
----- --- ----- --- ---
Income Taxes
Net Income $2,500 $901 $2,636 $2,760 $1,105
------ --- ----- ----- ------
Net Income per
share: $0.37 $0.14 $0.43 $0.69 $0.43
Basic:
Diluted : $0.36 $0.13 $0.38 $0.57 $0.35
Weighted average
shares used in
calculation: 6,703 6,307 6,185 4,014 2,558
Basic:
Diluted : 6,899 6,723 6,929 4,831 3,175
Long-term $14,139 $16,634 $17,535 $13,736 $6,896
------- ------- ------- ------- ------
Obligations
Total Assets $77,740 $75,335 $73,795 $64,691 $36,093
------- ------- ------- ------ -------
<FN>
(1) Certain reclassifications have been made to prior years financial statements
to conform to the 1997 presentation. Share and per share amount have been
restated to reflect the adoption of SFAS No. 128 (see Note 1).
</FN>
</TABLE>
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
General
During the period from January 1, 1995, through December 31, 1997, the number of
preschools operated by the Company increased from 193 to 248 and preschool
capacity increased from approximately 17,500 to approximately 25,000 children.
The Company has achieved this growth primarily by acquiring existing preschools
and also by opening new preschools and entering into contracts to manage
preschools sponsored by employers. During 1997, the Company acquired or opened 6
preschools and closed 6 preschools. In 1996, the Company acquired or opened a a
total of 14 preschools and closed 5 preschools. During 1995, the Company
acquired or opened 52 preschools and closed 6 preschools. The results of
acquired or disposed preschools are included in the Company's financial
statements from the date ofacquisition or until the date of disposition.
Accordingly, year-to-year resultsmay fluctuate depending upon the timing of the
Company's acquisition of existingpreschools and the opening of new preschools.
Historically, the Company's operating revenues have followed the seasonality of
a school year, declining during the summer months and the year-end holiday
period.
<PAGE>
Results of Operations
Revenue from Operations
Revenue from operations increased 6% in 1997 to $93,015,000 from $87,480,000 in
1996. Revenues for those preschools open in corresponding time periods in both
years increased approximately 4%, with the remainder of the increase due to
acquisitions. Approximately 95% of the increase on a same-school basis was due
to price increases, and the remainder was due to enrollment increases. Revenue
from operations increased 13% in 1996 to $87,480,000 from $77,627,000 in 1995.
Revenues for those preschools open in corresponding time periods in both years
increased approximately 3%, with the remainder of the increase due to
acquisitions. All of the increase on a same-school basis was due to price
increases, as these preschools experienced a decrease in enrollments of
approximately 2%. Revenues from operations increased 40% in 1995 to $77,627,000
from $55,323,000 in 1994. Revenues for those preschools open in corresponding
time periods in both years increased approximately 3%, with the remainder of the
increase due to acquisitions. All of the increase on a same-school basis was due
to price increases, as these preschools experienced an enrollment decrease of
less than 2%.
Operating Expenses
Payroll and related expenses as a percentage of total revenues were 52.7%, 53.9%
and 54.4% in 1997, 1996 and 1995, respectively. The decreases from 1995 to 1996
to 1997 was due to an increase in supervisory controls and procedures instituted
in 1996 and to the Company having raised its tuition rates at a higher rate than
its payroll rates.
Other operating expenses were 26.6% of revenues in 1997, 27.3% in 1996 and 25.5%
in 1995. The increase in other operating expenses in 1996 from 1995 was due to
occupancy expenses (rent, property taxes, utilities and maintenance and repair
expenses) increasing at a faster rate than the growth in average preschool
revenue. In 1997, the Company had the opposite effect from 1996, in that its
revenues on a same center basis increased faster than its occupancy expense.
Administrative expenses as a percentage of total revenue were 8.5% in 1997, 9.2%
in 1996, and 8.1% in 1995. The major part of the increase in 1996 was a one-time
charge of approximately $800,000 ($600,000 in administrative expense) in the
fourth quarter of 1996. The Company recorded this charge to provide for the
potential uncollectability of a receivable associated with a management
agreement for operation of an employer-sponsored preschool, the costs associated
with the possible settlement of a legal matter, and other miscellaneous
expenses. Without this charge, administrative expenses for 1996 as a percentage
of revenue would have been 8.5%. The increase in 1996 was due to the addition of
supervisory and financial personnel to enhance management and financial
controls. In 1997, administrative expenses as a percentage of revenue remained
flat with 1996 before the one-time charge.
Depreciation and amortization expenses increased by 18% in 1997, 35% in 1996,
and 62% in 1995. The increase in 1997 was due to improvements made by the
Company in its existing preschools and to acquisitions and startups made in 1997
and 1996. The increases in both 1996 and 1995 were due mainly to the increase in
new preschools acquired during those years and to the improvements made by the
Company in its existing preschools.
Advertising and promotion expenses as a percentage of revenues declined slightly
in 1997 from 1996 and 1995 due to a decrease in expenses at headquarters.
Other Expense
Interest income in 1997 compared to 1996 increased by $331,000, due to higher
average daily cash balances offset somewhat by lower average interest rates in
1997. Interest income in 1996 compared to 1995 decreased by $432,000, due to
lower average daily cash balances and to lower average interest rates in 1996.
Interest expense decreased by $101,000 in 1997 from 1996 and increased by
$112,000 in 1996 from 1995. The decrease in 1997 was due to lower average debt
outstanding as the Company paid off more debt than it issued in connection with
its addition of preschools and to slightly lower average interest rates. The
1996 increase was due to higher average debt outstanding because of debt issued
by the Company in connection with its acquisition of preschools, offset somewhat
by lower average interest rates on the Company's outstanding debt. The Company's
average interest rates decreased in both 1997 and 1996 due to the decline in
variable rates charged on certain Company borrowings, the retirement of higher
interest rate debt and the issuance of new debt in connection with its
acquisitions at lower average interest rates.
Income Taxes
The net operating loss carryforwards of the Company are subject to certain rules
set forth in the Internal Revenue Code that limit the ability of the Company to
use such net operating loss carryforwards to reduce future taxable income.
During 1997 and 1996, the Company reduced its deferred tax asset valuation
allowance to recognize a portion of the benefit related to its previously
reserved net operating loss carryforwards (see Note 7 to the accompanying
financial statements). The impact of the above, after considering alternative
minimum tax and the benefit of certain tax exempt income and tax credits,
resulted in the Company's effective tax rate decreasing to 20.0% in 1996 from
31.4% in 1995.
The higher effective tax rate in 1997 of 30.6% versus 20.0% in 1996 reflected
the fact that the benefit of net operating loss carryforwards in 1997 had a
proportionately smaller effect on the larger taxable income in 1997 as compared
to 1996.
Liquidity and Capital Resources
Since its inception, the Company has grown primarily through the acquisition of
existing preschools. For acquisitions of individual preschools or small chains,
it is the Company's general practice to acquire preschools for a combination of
cash and notes to sellers. These notes are payable generally over ten years. As
of December 31, 1997, the principal amount of such notes outstanding was
$11,391,000. Furthermore, the Company seeks whenever possible to lease the
preschool facilities on a long-term basis through the exercise of successive
options, while avoiding long-term obligations.
For transactions involving the acquisition of larger chains, the Company has
relied principally on the issuance of debt and equity securities as payment for
a substantial portion of the purchase price. In connection with the acquisition
of AFSC in November 1992, the Company issued to the stockholders of AFSC
approximately 138,000 shares of Common Stock, as well as shares of Preferred
Stock having a liquidation preference of $3,250,000, which were convertible into
approximately 591,000 shares of Common Stock. In 1995, shares of Preferred Stock
having a liquidation preference of $550,000 were converted into 100,000 shares
of Common Stock, in 1996 shares of Preferred Stock having a liquidation
preference of $565,000 were converted into approximately 103,000 shares of
Common Stock, and in 1997 the remaining shares with a liquidation preference of
$2,135,000 were converted into approximately 388,000 shares of Common Stock. In
1995, the Company purchased the assets of its Prodigy Division, consisting of
seven community based centers and nine employer-sponsored centers, in a
transaction for approximately $5,100,000. This purchase price consisted of
approximately $2,850,000 in cash and $2,250,000 in notes and assumed
liabilities.
Capital resources for the cash portion of acquisitions have generally been
obtained through public and private sales of the Company's securities at various
times since inception. In December 1994 and January 1995, the Company obtained
net proceeds of approximately $19,550,000 from a public offering of 2,137,500
shares of Common Stock at a price of $10.25 per share (the "1994 Stock
Offering").
During 1997, net cash provided by operations was $10,983,000. This internally
generated cash along with the issuance of $1,185,000 in debt for the acquisition
of property, plant and equipment funded all of the Company's cash needs for
repayment of debt, purchases of centers and purchases of property, plant and
equipment. During 1997, the Company issued or assumed $480,000 of indebtedness
related to acquisitions. As of December 31, 1997, the Company had cash and
short-term investment balances of $14,716,000. During 1996, net cash provided by
operations was $7,993,000. This internally generated cash funded all of the
Company's cash needs for repayment of debt, purchases of centers and purchases
of property, plant and equipment. During 1996, the Company issued or assumed
$1,054,000 of indebtedness related to acquisitions. During 1995, net cash
provided by operations was $4,682,000. This internally generated cash, along
with the issuance of $1,483,000 in debt for the acquisition of property, and
equipment funded all of the Company's needs for purchases of property, plant and
plant and equipment, funded all of the Company's needs for purchases of
property, plant andequipment, and $1,213,000 of debt payments. The Company also
used $3,115,000 of its cash balances to repay debt. Approximately $9,564,000 of
the proceeds from the 1994 stock offering was used for the acquisition or
opening of new preschools or elementary programs. During 1995 the Company issued
or assumed$7,919,000 of indebtedness related to acquisitions.
The Company's management believes that its internally generated cash will cover
its cash requirements for the foreseeable future and, along with its existing
cash balances, will allow it to continue to grow through the acquisition of
additional preschools and the opening of additional elementary school programs.
The Company also has available to it up to $5,000,000 under an unsecured line of
credit furnished by a commercial bank. The Company currently has no commitments
for capital expenditures, which might be deemed, either individually or in the
aggregate, material to its business.
Item 8. Financial Statements and Supplementary Data
See Page F.
Item 9. Change in and Disagreements with Accountants on
Accounting and Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning directors required by this item is incorporated by
reference to the Company's definitive proxy statement to be filed pursuant to
Regulation 14A not later than April 30, 1998.
Executive Officers
The executive officers of the Company are as follows:
Name Age Position
- -------------------------------------------------------
Richard A. Niglio 55 Chief Executive Officer
and Chairman
Elanna S. Yalow 43 President, Chief Operating
Officer
Randall J. Truelove 49 Vice President, Finance
Jane Delaney 34 Vice President
Frank A. Devine 51 Secretary/General Counsel
None of the above has any family relationship with any other person so named,
and there are no arrangements or understandings between any executive officer
and any other person pursuant to which any person was selected as an officer.
Officers are elected each year at the meeting of the Board of Directors
immediately following the annual meeting of the stockholders.
The business experience, principal occupations and employment of each of the
executive officers of the Company during at least the past five years, together
with their periods of service as executive officers of the Company, are set
forth below.
Richard A. Niglio was appointed Chief Executive Officer of the Company in March
1987. From 1982 until joining CDC, he was President, Chief Executive Officer and
a director of Victoria Station Incorporated, a restaurant chain based in
Larkspur, California. Mr. Niglio is currently a director of Psychiatric
Management Resources, Inc., a company that manages psychiatric partial
hospitalization services.
Elanna S. Yalow has been President of the Company since January
19, 1996, and Vice President since April 1992. From July 1989
until April 1992, Dr. Yalow was a self-employed consultant and
served as a consultant to the Company during that period. From
September 1987 until June 1989, Dr. Yalow attended Stanford
University, graduating with a Masters in Business
Administration. Dr. Yalow has a doctorate in Educational
Psychology from the Stanford University School of Education.
Randall J. Truelove has been Vice President, Finance of the
Company since December 1987. From 1982 until joining CDC, Mr.
Truelove was Controller of Victoria Station Incorporated.
Jane Delaney has been a Vice President of the Company since June 1995 and from
1991 to 1995 was a Regional Director with the Company.
Frank A. Devine has been Secretary and General Counsel of the
Company since October 1987. Prior to that time, Mr. Devine was
Corporate Counsel of Victoria Station Incorporated.
Item 11. Executive Compensation
Information required by this item is incorporated by reference to the
Company's definitive proxy statement to be filed pursuant to Regulation
14A not later than April 30, 1998.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Information required by this item is incorporated by reference to the
Company's definitive proxy statement to be filed pursuant to Regulation
14A not later than April 30, 1998.
Item 13. Certain Relationships and Related Transactions
Information required by this item is incorporated by reference to the
Company's definitive proxy statement to be filed pursuant to Regulation
14A not later than April 30, 1998.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
(a)1. Financial Statements: Index to Financial Statements at page F.
2. Financial Statement Schedules: None.
3. Exhibits.
Item Number (Exhibit Number referenced to Item 601 of Regulation S-K)
1. Underwriting Agreement: Not applicable
2. Plan of acquisition, reorganization, arrangement, liquidation or
succession: Not applicable.
3. Articles of Incorporation and By-Laws
A. Certificate of Incorporation, filed on December 23, 1983, incorporated
by reference to Exhibit 3(A) to Registrant's Form 10-K for fiscal year
ended December 31, 1994 (the "1994 Form 10-K").
B. Amendment to Certificate of Incorporation filed on July 12, 1984,
incorporated by reference to Exhibit 3(B) to Registrant's 1994 Form
10-K.
C. Amendment to Certificate of Incorporation filed on January 29, 1985,
incorporated by reference to Exhibit 3(C) to Registrant's 1994 Form
10-K.
D. Amendment to Certificate of Incorporation filed on August 19, 1985,
incorporated by reference to Exhibit 3(D) to Registrant's 1994 Form
10-K.
E. Amendment to Certificate of Incorporation filed on May 27, 1987,
incorporated by reference to Exhibit 3(E) to Registrant's 1994 Form
10-K.
F. Amendment to Certificate of Incorporation filed on June 2, 1988,
incorporated by reference to Exhibit 3(F) to Registrant's 1994 Form
10-K.
G. Amendment to Certificate of Incorporation filed on March 18, 1991,
incorporated by reference to Exhibit 3(G) to Registrant's 1994 Form
10-K.
H. Amendment to Certificate of Incorporation, filed on October 10, 1991,
incorporated by reference to Exhibit (4)(A) to Form S-2 Registration
Statement No. 33-92533.
I. Amendment to Certificate of Incorporation filed on July 29, 1992
(incorporated by reference to Exhibit 3(H) to Registrant's Form 10-K for
the fiscal year ended December 31, 1992 (the "1992 Form 10-K").
J. Certificate of Amendment to Certificate of Incorporation filed on
December 6, 1993, incorporated by reference to Exhibit 3(H) to
Registrant's Form 10-K for the fiscal year ended December 31, 1993 (the
"1993 Form 10-K").
K. By-Laws as amended, incorporated by reference to Exhibit 3(g) to
Registrant's Form 10-K for the fiscal year ended December 31, 1989 (the
"1989 Form 10-K").
4. Instruments defining the rights of security holders, including indentures:
A. Excerpts from Certificate of Incorporation, as amended, incorporated by
reference to Exhibit 4(A) to Form S-4 Registration Statement No.
33-38858.
B. Excerpts from By-Laws, as amended, incorporated by
reference to Exhibit 4(B) to Form S-4 Registration
Statement No. 33-38858.
C. Specimen Certificate for Common Stock par value $.01 per share,
incorporated by reference to Registrant's 1993 Form 10-K.
D. Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock, incorporated by reference to Exhibit 4(D)
to Registrant's 1992 Form 10-K.
5. Opinion re legality: Not applicable.
6. Reserved: Not applicable.
7. Reserved: Not applicable.
8. Opinion re tax matters: Not applicable.
9. Voting trust agreement: Not applicable.
10. Material Contracts:
A.CDC Stock Option Plan, as amended, incorporated by
reference to Exhibit 10(A) of S-2 Registration Statement
No. 33-85878.
B.Form of Stock Option Agreement dated as of June 16, 1992, between the
Registrant and each of its non-employee directors, incorporated by
reference to Exhibit 10(C) to Registrant's 1993 Form 10-K.
C.Form of Stock Purchase Agreement dated March 22, 1993, and Registration
Rights Agreement attached as Exhibit A thereto, incorporated by
reference to Exhibit 10(H) to S-2 Registration Statement No. 33-70360.
D.Promissory Note of Richard A. Niglio dated May 28, 1993, in the
principal amount of $200,200, and related Pledge Agreement between the
Registrant and Mr. Niglio, incorporated by reference to Exhibit 10(I) to
S-2 Registration Statement No. 33-70360.
E.Non-Employee Directors' Stock Option Plan, incorporated
by reference to Exhibit 10(J) to S-2 Registration
Statement No. 33-70360.
F.Promissory Note of Richard A. Niglio dated December 16, 1994, in the
principal amount of $224,475, incorporated by reference to Exhibit 10(I)
to Registrant's 1994 Form 10-K.
G.Non-Employee Directors' Stock Option Plan (Amended and Restated as of
August 27, 1996, incorporated by reference to Exhibit 10(I) to
Registrant's 1996 Form 10-K.
H.Promissory Note of Richard A. Niglio dated October 1,
1997, in the principal amount of $232,500 filed as an
exhibit hereto.*
I.Non-Employee Directors' Stock Option Plan (Amended and Restated as of
August 27, 1996), incorporated by reference to Exhibit 10(I) to
Registrant's 1996 Form 10-K.
11. Statements re computation of per share earnings is not required because
the relevant computations can be clearly determined from the material
contained in the financial information included herein.
12. Statements re computation of ratios: Not Applicable.
13. Annual Report to security holders, Form 10-Q or quarterly
report to security holders: Not Applicable.
14. Reserved: Not Applicable.
15. Letter re unaudited interim financial information: Not
Applicable.
16. Letter re change in certifying accountants: Not
Applicable.
17. Letter re director resignation: Not Applicable.
18. Letter re change in accounting principles: Not Applicable.
19. Report furnished to security holders: Not Applicable.
20. Other documents or statements to security holders: Not
Applicable.
21. Subsidiaries of the Registrant:
Name of Subsidiary State of Incorporation
Magic Years Child Care and Learning Centers, Inc. Pennsylvania
Greentree Learning Center, Inc. New Jersey
Fox Day Schools, Inc. Illinois
Children's Discovery Centers of Illinois, Inc. Delaware
Children's Discovery Centers of Virginia, Inc. Delaware
Prodigy Consulting of Flint, Inc. Georgia
22. Published report regarding matters submitted to vote of
security holders: Not Applicable.
23. Consents of experts and counsel: Consent of Arthur Andersen LLP. (Filed
herewith).
24. Power of attorney: Not Applicable.
25. Statements of eligibility of trustees: Not Applicable.
26. Invitations for competitive bids: Not Applicable.
27. Financial Data Schedule: Filed herewith.
99. Additional exhibits: Not Applicable.
(b) Reports on Form 8-K.
None.
(c) Exhibits. Exhibits are attached.
(d) Additional Financial Statements or Schedules. None.
* Attached hereto.
<PAGE>
SIGNATURES
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
CHILDREN'S DISCOVERY CENTERS
OF AMERICA, INC.
Date: March 31, 1998 By: s/s Richard A. Niglio
----------------------- -------------------------
Richard A. Niglio
Chairman and Chief
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 Company and in
the capacities and on the date indicated.
Signature Title Date
s/s Richard A. Niglio Chairman of the Board March 31, 1998
---------------
Richard A. Niglio of Directors, and
Chief Executive Officer,
(Principal Executive Officer)
s/s Randall J. Truelove Vice President, Finance March 31, 1998
---------------
Randall J. Truelove (Principal Financial Officer
and Accounting Officer)
s/s Mark P. Clein Director March 31, 1998
- -----------------
Mark P. Clein
s/s Michael J. Connelly Director March 31, 1998
----------------
Michael J. Connelly
s/s Robert E. Kaufmann Director March 31, 1998
---------------
Robert E. Kaufmann
s/s W. Wallace McDowell, Jr. Director March 31, 1998
---------------
W. Wallace McDowell, Jr.
s/s Myron A. Wick, III Director March 31, 1998
---------------
Myron A. Wick, III
s/s Elanna S. Yalow Director March 31, 1998
- ----------------------
Elanna S. Yalow
<PAGE>
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Page
Report of Independent Public Accountants F-1
Financial Statements:
Consolidated Balance Sheets - F-2
December 31, 1997 and 1996
Consolidated Statements of Income for the F-3
Years Ended December 31, 1997, 1996, and 1995
Consolidated Statements of Stockholders' Equity F-4
for the Years Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years F-5
Ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements F-6
through F-15
All other schedules required by Regulation S-X have been omitted because they
are not applicable or because the required information is included in the
financial statements or notes thereto.
F
<PAGE>
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Children's Discovery Centers of America, Inc.:
We have audited the accompanying consolidated balance sheets of Children's
Discovery Centers of America, Inc. (a Delaware corporation) and subsidiaries as
of December 31, 1997 and 1996, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in the
period ended December 31, 1997. 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 generally accepted auditing
standards. 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, the financial statements referred to above present fairly, in
all material respects, the financial position of Children's Discovery Centers of
America, Inc., and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California,
February 27, 1998
(except with respect
to the matter
discussed in Note 10,
as to which the date
is March 27, 1998)
<PAGE>
<TABLE>
<CAPTION>
F-15
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- DECEMBER 31, 1997 AND 1996 (In thousands
except share information)
ASSETS 1997 1996
- ------ ---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $3,763 $4,826
Short-term investments 10,953 6,914
Accounts receivable, net of allowance
for doubtful accounts of $260 and 2,774 3,308
$143, respectively
Prepaid expenses and other 1,428 1,623
----- -----
Total current assets 18,918 16,671
------ ------
PROPERTY, PLANT AND EQUIPMENT:
Land 1,659 1,320
Buildings 7,558 6,179
Furniture, fixtures and equipment 11,477 11,015
Transportation equipment 2,370 2,233
Leasehold improvements 9,642 8,832
Construction in Progress 4 750
Less: Accumulated depreciation and (10,194) (8,798)
amortization ---------- ------
22,516 21,531
INTANGIBLE ASSETS, net 33,487 35,381
------ ------
OTHER ASSETS 2,819 1,752
----- -----
Total Assets $77,740 $75,335
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $2,934 $2,095
Accounts payable 701 501
Payroll and related accruals 3,352 3,090
Accrued liabilities and other 2,694 1,730
----- -----
Total current liabilities 9,681 7,416
----- -----
LONG-TERM DEBT, net of current portion 14,139 16,634
------ ------
ACCRUED STRAIGHT- LINE RENT 1,091 998
----- ---
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Special Stock - authorized
5,000,000 shares; outstanding as:
Series A Convertible Preferred,
par value $.01 per share,
liquidation value $0,
no shares outstanding in 1997 and
2,135 shares outstanding in 1996 0 0
Common Stock, par value $.01 per share,
Authorized 20,000,000 shares,
outstanding: 6,744,129 in 1997, and 137 133
6,306,958 in 1996
Treasury Stock (7,200,844 in 1997 and 0 0
1996)
Paid-in Capital in Excess of Par 53,011 52,722
Unrealized Gain on Short-Term 15 0
Investments
Loans to Stockholder Officers (976) (710)
Retained earnings (accumulated deficit) 642 (1,858)
---- ------
Total stockholders' equity 52,829 50,287
Total liabilities and stockholders' $77,740 $75,335
equity ======= =======
<FN>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (in thousands,
except per share data)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
REVENUE FROM OPERATIONS $93,015 $87,480 $77,627
Payroll and related expenses 49,059 47,131 42,235
Other center operating expenses 24,783 23,848 19,811
Administrative expenses 7,937 8,042 6,317
Depreciation and amortization 6,040 5,118 3,804
Advertising and promotion 711 898 843
--- --- ---
Total operating expenses 88,530 85,037 73,010
------ ------ ------
INCOME FROM OPERATIONS 4,485 2,443 4,617
OTHER INCOME (EXPENSE):
Interest income 706 375 807
Interest expense (1,591) (1,692) (1,580)
--------- --------- ------
INCOME BEFORE INCOME TAXES 3,600 1,126 3,844
PROVISION FOR INCOME TAXES 1,100 225 1,208
----- --- -----
NET INCOME $2,500 $ 901 $2,636
====== ===== ======
NET INCOME PER SHARE:
Basic $0.37 $0.14 $0.43
Diluted $0.36 $0.13 $0.38
===== ====== =====
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic 6,703 6,307 6,185
Diluted 6,899 6,723 6,929
===== ====== =====
<FN>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND
1995 (In thousands)
Series A
Preferred Common
Stock Stock
----------------------
Unrealized
Paid-In Loans Gain Retained
Number Number Capital to (Loss) Earnings Total
of of in Excess Stock- on (Accumu- Stock-
Shares Amt Shares Amt of Par Holder Short lated holders'
Officers Term Deficit) Equity
Invest-
ment
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
December 31, 3 $- 5,932 $130 $51,391 $(640) $(30) $(5,395) $45,456
1994
Public - - 138 1 1,242 - - - 1,243
Offering
Exercise of - - 34 - 49 - - - 49
Options
Preferred
Stock - - 100 1 (1) - - - -
Conversion
Interest and
Loans to - - - - 42 (143) - - (101)
Stockholder
Officers
Unrealized
Gain on - - - - - - 40 - 40
Short Term
Investments
Net Income - - - - - - - 2,636 2,636
-----------------------------------------------------------------
BALANCE,
December 31, 3 - 6,204 132 52,723 (783) 10 (2,759) 49,323
1995
Preferred
Stock (1) - 103 1 (1) - - - -
Conversion
Interest and
Loans to - - - - - 73 - - 73
Stockholder
Officers
Unrealized
Loss on - - - - - - (10) - (10)
Short Term
Investments
Net Income - - - - - - - 901 901
-------------------------------------------------------------
BALANCE,
December 31, 2 - 6,307 133 52,722 (710) - (1,858) 50,287
1996
Preferred
Stock (2) - 388 4 (4) - - - -
Conversion
Exercise of - - 49 - 293 - - - 293
Options
Interest and
Loans to - - - - - (266) - - (266)
Stockholder
Officers
Unrealized
Gain on - - - - - - 15 - 15
Short Term
Investments
Net Income - - - - - - - 2,500 2,500
-------------------------------------------------------------
BALANCE,
December 31, - $- 6,744 $137 $53,011 $(976) $15 $642 $52,829
1997
-------------------------------------------------------------
<FN>
The accompanying notes to consolidated financial
statements are an integral part of these statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(In thousands)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,500 $901 $2,636
Adjustments to reconcile net income
to net cash
provided by operating activities:
Depreciation 3,166 2,409 1,960
Amortization 2,874 2,709 1,844
Changes in assets and liabilities -
Accounts receivable 534 (1,035) (1,059)
Prepaid expenses and other 195 941 (1,022)
Accounts payable 200 (125) (172)
Payroll and related accruals 262 876 527
Accrued liabilities, straight-line 1,252 1,317 ( 32)
rent and other ----- ----- -----
Net cash provided by operating activities 10,983 7,993 4,682
------ ----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (4,024) (1,829) (21,253)
Proceeds from sale of short-term 0 2,899 14,599
investments
Payments for acquisitions of child ( 674) (874) (9,089)
care centers
Payments for the start-up of centers (1,155) (812) ( 475)
Purchases of property, plant and (3,000) (3,524) (4,952)
equipment, net
Other, net (1,084) 236 ( 496)
-------- ----- ------
Net cash used for investing activities (9,937) (3,904) (21,666)
--------- --------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common 27 - 1,191
stock, net of issuance costs
Proceeds from issuance of long-term 1,185 340 1,483
debt
Repayments of long-term debt (3,321) (2,523) (4,328)
------- ------ -------
Net cash used for financing activities (2,109) (2,183) (1,654)
--------- --------- -----
Net increase (decrease) in cash and (1,063) 1,906 (18,638)
cash equivalents
CASH AND CASH EQUIVALENTS, beginning of 4,826 2,920 21,558
year ----- ----- ------
CASH AND CASH EQUIVALENTS, end of year $3,763 $4,826 $2,920
------ ------ ------
<FN>
The accompanying notes to consolidated financial
statements are an integral part of these statements.
</FN>
</TABLE>
<PAGE>
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations:
Children's Discovery Centers of America, Inc. and subsidiaries ("the Company")
provides preschool child care services at company-operated and
employer-sponsored child care centers. At December 31, 1997, the Company
operated 248 centers located in 22 states and the District of Columbia with an
aggregate licensed capacity of approximately 25,000 children (see Note 2 with
respect to the acquisition of centers). The Company provides child care and
preschool programs to children primarily between 2 1/2 and six years of age and
to a lesser extent, after school programs for older children and infant care.
Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, including Magic Years Child Care and Learning
Centers, Inc. ("Magic Years") and Greentree Learning Centers, Inc.
("Greentree"). All material intercompany accounts and transactions have been
eliminated. Certain reclassifications have been made to the 1996 and 1995
financial statements to conform to the 1997 presentation. The preparation of
these consolidated financial statements in conformity with generally accepted
accounting principles 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.
Property, plant and equipment:
Property, plant and equipment is stated at cost. Provision for depreciation is
made on a straight-line basis over the related estimated useful lives of the
assets or, in the case of leasehold improvements, the lesser of the term of the
related lease or the useful life of the improvement. A summary of useful lives
is as follows:
Buildings 40 years
Furniture, fixtures and equipment 3 - 10 years
Transportation equipment 3 - 5 years
Leasehold improvements 3 - 20 years
Depreciation of property, plant and equipment included in the accompanying
consolidated statements of income was $3,166,000, $2,409,000, and $1,960,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
The Company expenses repair and maintenance costs as incurred. Repair and
maintenance costs included in the accompanying consolidated statements of income
amounted to $1,233,000, $1,229,000, and $960,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
Revenue recognition:
The Company recognizes child care fees upon delivery of child care service. For
employer-sponsored centers, revenue is recognized ratably over contract terms as
child care service is provided. The Company's revenue includes $13,186,000,
$11,093,000, and $9,195,000 in 1997, 1996, and 1995, respectively, received from
various state public assistance programs.
<PAGE>
Short-term investments:
The Company follows a policy of investing only in short-term marketable
securities and holding them to maturity; however, since the Company may sell
certain securities to meet cash requirements for center acquisitions, the
Company's short-term investments have been categorized as available-for-sale as
required by Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities".
The aggregate fair values, amortized cost, gross unrealized holding gain, and
gross unrealized holding loss of the major types of debt securities at December
31, 1997, were as follows (in thousands):
Gross Unrealized
Holding
Fair Value Amortized Gain Loss
Cost
Municipal Bonds and $10,926 $10,911 $15 $-
Other
The contractual maturities of the Company's debt securities as of December 31,
1997 were all less than two years. The net change in unrealized gain (loss) was
a $15,000 gain.
Income taxes:
The Company provides for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires the asset and liability
method of accounting for income taxes. Under this method, deferred income taxes
are recognized for the tax consequences of "temporary differences" by applying
the statutory tax rate to the differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities. Under
SFAS No. 109, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date based on the
tax rate applicable to the year of the calculation.
The net operating loss carryforwards of the Company are subject to certain rules
set forth in the Internal Revenue Code that limit the ability of the Company to
use such operating loss carryforwards to reduce future taxable income.
<TABLE>
<CAPTION>
Intangible assets:
Intangible assets include goodwill related to the acquisition of child care
centers, covenants not to compete and management contracts, as follows (in
thousands):
1997 1996
---- ----
<S> <C> <C>
Goodwill $22,225 $ 21,601
Covenants not to compete 13,688 13,531
Other intangibles 7,665 7,676
----- -----
43,578 42,808
Accumulated amortization (10,091) (7,427)
-------- --------
$33,487 $ 35,381
-------- --------
<FN>
These assets are being amortized over the following lives: Goodwill from
acquisitions of major chains 40 years Goodwill from acquisitions of
individual units 15 years Covenants not to compete Life of agreement
(3 - 15 years)
Intangibles with management contracts Life of contract
(3 - 10 years)
</FN>
</TABLE>
Amortization of intangible assets charged to expense amounted to $2,874,000,
$2,709,000, and $1,844,000 for the years ended December 31, 1997, 1996, and
1995, respectively.
Other assets:
Other assets include deferred tax assets related to net operating loss
carryforwards and notes receivable. Included in notes receivable are notes from
KidActive, LLC (an educational toy company) which may be converted during 1998,
and along with the Company's existing shares would give the Company an
approximate nineteen percent ownership in KidActive, LLC.
<PAGE>
Net income per share:
Effective December 15, 1997, the Company adopted SFAS No. 128 "Earnings Per
Share." SFAS No. 128 supersedes APB Opinion 15. As a result, all prior year net
income per share information has been restated.
Net income per basic common share has been computed by dividing net income
available to common stockholders by the weighted average number of common shares
outstanding during each year. Net income per diluted common and common
equivalent share has been computed by dividing net income available to common
stockholders by the weighted average number of common and common equivalent
shares outstanding during each year. Shares issuable upon exercise of
outstanding stock options, warrants and convertible securities are included in
the computation using the treasury stock method. <TABLE> <CAPTION>
The reconciliation of the numerators and denominators of the basic and
diluted net income per share are as follows:
Income Shares Per
(Numerator) (Denominator) Share
Amount
<S> <C> <C> <C>
For the Year 1995:
Basic net income per share:
Income available to holders of $2,636,000 6,185,077 $0.43
common stock
Shares issuable upon exercise
of stock options using 252,984
treasury stock method
Shares outstanding based on
assumed conversion 490,909
of preferred stock
Diluted net income per share:
--------- ---------- --------
Income available to holders of
common stock and $2,636,000 6,928,970 $0.38
common stock equivalents
--------- ---------- --------
For the Year 1996:
Basic net income per share:
Income available to holders of $901,000 6,306,958 $0.14
common stock
Shares issuable upon exercise
of stock options using 27,601
treasury stock method
Shares outstanding based on
assumed conversion 388,182
of preferred stock
Diluted net income per share:
--------- ---------- --------
Income available to holders of
common stock and $901,000 6,722,741 $0.13
common stock equivalents
--------- ---------- --------
For the Year 1997:
Basic net income per share:
Income available to holders of $2,500,000 6,702,607 $0.37
common stock
Shares issuable upon exercise
of stock options using 196,615
treasury stock method
Diluted net income per share:
--------- ---------- --------
Income available to holders of
common stock and $2,500,000 6,899,222 $0.36
common stock equivalents
--------- ---------- --------
</TABLE>
Consolidated statements of cash flows:
Cash and cash equivalents include deposits and short-term investments (at cost,
which approximates market) with original maturities of three months or less.
The Company made cash payments for interest and income taxes (or received
refunds) for the years ended December 31, 1997, 1996 and 1995, as follows (in
thousands):
1997 1996 1995
---- ---- ----
Interest $1,581 $1,693 $1,580
Income taxes $918 $(426) $1,654
Supplemental Schedule of Noncash Investing and Financing Activities:
<TABLE>
<CAPTION>
The Company purchased centers during the years ended December 31, 1997, 1996 and
1995, as follows (in thousands):
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash payments and/or expenses $674 $874 $9,089
Notes issued to sellers 480 981 6,416
Liabilities assumed - 73 1,503
----------- ----------- ---------
Total value of centers acquired $ 1,154 $1,928 $17,008
======= ====== =======
</TABLE>
New accounting standards:
In June 1997, the Financial Accounting Standards Boards issued SFAS No. 130,
"Reporting Comprehensive Income." This statement establishes standards for
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. The adoption of the standard as
required on January 1, 1998 will not have a material impact on the Company's
financial statements.
(2) ACQUISITIONS
The Company acquired or started six centers in 1997, fourteen centers during
1996, and a total of fifty-two centers during 1995.
All acquisitions are accounted for as purchases. The cost in excess of the fair
value of the net tangible assets acquired was first assigned to certain
identifiable intangible assets including covenants not to compete, and
management contracts. Any portion of the purchase price remaining after these
allocations has been recorded as goodwill.
(3) LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1997 and 1996, (in
thousands):
1997 1996
Long-term borrowings:
Notes payable to banks (a) $5,682 $5,244
Notes payable to sellers (b 11,391 13,485
17,073 18,729
Less - Current portion (2,934) (2,095)
------- -------
$14,139 $16,634
(a) Consists of various secured and unsecured installment and term loans at
rates ranging from 4.8% to 13.5%, payable through 2014. The Company is
currently obligated under certain loan agreements to maintain minimum
balances with lenders of $25,000 in total cash.
(b) Consists of notes payable to previous owners of child care centers
acquired by the Company with interest rates ranging from 8.0% to 11.9% and
payable in installments of varying amounts through 2012.
A summary of the maturities of long-term debt is as follows for the years ending
December 31 (in thousands):
1998 $2,934
1999 2,104
2000 1,812
2001 2,373
2002 2,645
Thereafter 5,205
$17,073
The Company also has available to it up to $5,000,000 under an unsecured line of
credit furnished by a commercial bank. Amounts drawn down bear interest of 1.75%
above the bank's LIBOR rate and will convert to a five year term loan on August
1, 1998. During 1997 the Company did not use any of the funds available under
the line of credit. Under the terms of the agreement the Company is required to
maintain certain financial and non-financial covenants.
(4) LEASE OBLIGATIONS
The Company leases certain facilities under operating leases. Total rental
expense for facilities under operating leases amounted to $11,605,000,
$11,318,000, and $9,342,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
Future minimum payments under operating leases (not including unexercised
renewal options) are as follows for the years ending December 31 (in thousands):
1998 $10,671
1999 8,794
2000 7,513
2001 6,509
2002 5,758
Thereafter 15,039
Total future minimum
lease payments $54,284
Minimum lease payments for operating leases shown above do not include
contingent rentals which are based on the consumer price index increases and
percentages of revenues. Contingent rentals charged to expense under operating
leases amounted to approximately $152,000 in 1997, $219,000 in 1996, and $45,000
in 1995.
Rent expense due under lease agreements with a duration longer than twelve
months is recognized on a straight line basis over the term of the lease,
excluding unexercised renewal options, in accordance with SFAS No. 13,
"Accounting for Leases".
(5) COMMON STOCK
During 1997 the Company issued 388,182 shares of Common Stock on conversion of
2,135 shares of its Series A Convertible Preferred Stock (see Note 6).
During 1996, the Company issued 102,727 shares of Common Stock on the conversion
of 565 shares of its Series A Convertible Preferred Stock (see Note 6).
In January 1995, the Company issued an additional 138,477 shares of Common Stock
at $10.25 per share, associated with the Company's December 1994, public
offering for net proceeds of $1,243,000, after deducting offering expenses of
$83,000 and underwriters discount of $93,000.
During 1995, the Company issued 100,000 shares of Common Stock on the conversion
of 550 shares of its Series A Convertible Preferred Stock (see Note 6).
(6) PREFERRED STOCK
The Company's stockholders, at a special meeting in November 1992, authorized
Series A Convertible Preferred Stock. These shares were convertible into the
Company's Common Stock at an initial conversion price of $5.50 per share and had
a liquidation value of $1,000 per share. If 50% of these shares were not
redeemed or converted by November 5, 1997 and the remaining 50% by November 5,
1998, then the conversion price would reset at that time to 70% of the then
current market price of the Company's Common Stock. These shareholders were
entitled to share on a pro rata basis in any dividends payable with respect to
the Common Stock, based on the number of shares of Common Stock into which each
share of Series A Convertible Preferred Stock is then convertible.
During 1997, 1996 and 1995, holders of the Series A Convertible Preferred stock
exchanged all 3,250 shares of the Series A Convertible Preferred for 590,909
shares of the Company's Common Stock.
(7) INCOME TAXES
At December 31, 1997, the Company has net operating loss carryforwards of
approximately $5,200,000. The tax net operating loss carryforwards are available
to offset future taxable income, if any, subject to the limitations described
below. These carryforwards expire between the years 2001 and 2006.
The Tax Reform Act of 1986 introduced a limitation on the amount of net
operating loss, capital loss and tax credit carryforwards that can be used
annually. This limitation applies following certain "changes in ownership". This
limitation was triggered in 1988 and again in 1991 and 1994 pursuant to public
offerings of Common Stock by the Company . As a result of the 1991 change in
ownership, beginning in 1992 the net operating loss that the Company may use to
offset future taxable income, if any, will be subject to an annual limitation of
approximately $350,000. In addition, the Company's subsidiary, Magic Years, has
separate net operating loss carryforwards for tax purposes of approximately
$900,000 which expire between the years 2001 and 2006. This net operating loss
is subject to the "change in ownership" limitation discussed above. The
limitation is approximately $100,000 per year.
The Company's subsidiary, Greentree, has separate net operating loss
carryforwards for tax purposes of approximately $1,020,000 available to offset
future taxable income of Greentree, if any, and expire between the years 2004
and 2006. This net operating loss is subject to the "change in ownership"
limitation discussed above. The annual limitation is
approximately $188,000.
Given the uncertainty relating to the Company's ability to ultimately benefit
from its net operating loss carryforwards due to the annual limitations and that
they have to be used by the individual corporations, the Company has provided a
valuation allowance against a substantial portion of its net deferred tax asset.
In determining the valuation allowance, management considered the likelihood of
future levels of taxable income sufficient for the Company to utilize the net
operating loss carryforwards within the limitations noted above. The net change
in the valuation allowance for the year ended December 31, 1997 was $426,000 of
which $195,000 was recognized as a reduction in goodwill.
Approximately $470,000 of the valuation allowance will be allocated to reduce
goodwill or acquired noncurrent assets if the net operating losses for Magic
Years and Greentree are subsequently recognized.
<PAGE>
<TABLE>
<CAPTION>
Deferred tax assets and liabilities as of December 31, 1997 and 1996
consisted of the following:
1997 1996
---- ----
<S> <C> <C>
Deferred tax assets
Net operating loss $1,768 $1,972
carryforwards
Straight-line rent 425 379
Other 760 606
--- ---
2,953 2,957
----- -----
Deferred tax asset (1,325) (1,751)
--------- -----------
valuation allowance
Deferred tax liabilities
Depreciation (780) (720)
Reserves - (252)
Other ( 8) ( 13)
---- ------
(788) (985)
---- ------
Net deferred tax asset $840 $221
==== ====
</TABLE>
<TABLE>
<CAPTION>
The difference between the statutory Federal income tax rate on income before
income taxes and the Company's effective income tax rate is summarized as
follows:
Year Ended December 31
--------------------------------------
1997 1996 1995
--------------------------------------
<S> <C> <C> <C>
Statutory Federal income tax 34.0% 34.0% 34.0%
rate
State income taxes, net of 5.0 4.6 3.1
Federal benefit
Change in valuation allowance (6.4) (19.6) (2.9)
Alternative Minimum Tax - 14.7 -
Tax exempt interest (3.2) (7.8) (2.5)
Other, net 1.2 (5.9) (0.3)
--------------------------------------
Effective income tax rate 30.6% 20.0% 31.4%
--------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Income tax expense consisted of the following:
Year Ended December 31
--------------------------------------
1997 1996 1995
--------------------------------------
<S> <C> <C> <C>
Federal:
Current $1,445 $270 $855
Deferred (617) (124) 171
State:
Current 300 79 126
Deferred (28) - 56
----- ---- ----
$1,100 $225 $1,208
========== ==== ======
</TABLE>
<PAGE>
(8) COMMITMENTS AND CONTINGENCIES
The Company maintains comprehensive general liability insurance, that provides
coverage for both bodily injury and property damage claims up to a total of $15
million. The primary general liability policy has a limit of $1 million per
occurrence and the Company maintains an excess umbrella liability policy that
provides coverage for an additional $14 million for a total liability insurance
of $15 million. The Company believes such insurance coverage is adequate. The
Company has procured limited coverage for child physical and sexual abuse
claims, subject to a $1,000,000 annual aggregate limitation. To date, the
Company has not incurred any liability with respect to any claims of abuse.
The Company has not experienced difficulty in obtaining insurance coverage, but
there can be no assurance that adequate, affordable insurance coverage will be
available in the future, or that the Company's current coverage will protect it
against all possible claims.
In the ordinary course of business, the Company is subject to various legal
matters including certain employee related matters. In the opinion of
management, after discussion with counsel, the ultimate outcome of these legal
matters will not materially impact the Company's financial position.
(9) STOCK OPTIONS AND WARRANTS
Employee Stock Option Plan
The Company has a stock option plan pursuant to which options for the purchase
of up to 800,000 shares of its Common Stock may be granted to officers and
employees. The exercise price is required to be at least the fair market value
of the common stock on the date of grant, as determined by the Board of
Directors. The plan will terminate on November 8, 1999. As of December 31, 1997,
options for 715,289 shares have been granted and remain outstanding under this
plan.
Non-Employee Director Stock Option Plan
During 1993, the Board of Directors adopted and the stockholders approved a
Non-Employee Director Stock Option Plan, pursuant to which non-qualified options
for a maximum of 180,000 shares may be granted to the Company's non-employee
directors under the plan. The plan will terminate on October 14, 2003. As of
December 31, 1997, options for 122,500 shares have been granted and remain
outstanding under this plan.
Options not issued under plans
The Company has also issued options outside of either of the above two plans in
1994 and earlier. The exercise price for these non-qualified options is required
to be at least the fair market value of the common stock on the date of the
grant, as determined by the Board of Directors. Options for 90,376 shares have
been granted and remain outstanding at December 31, 1997.
The Company accounts for the Plans under APB Opinion No. 25, and accordingly no
compensation cost has been recognized, as under the option Plans, the option
exercise price equals the market value of the Company's stock on the date of
grant. SFAS No. 123 "Accounting for Stock-Based Compensation" is effective for
fiscal years beginning after December 15, 1995 (i.e. calendar 1996). If fully
adopted, SFAS No. 123 changes the methods for recognition of compensation cost
on the Company's stock option plans. Adoption of SFAS N0. 123 is optional;
however, pro forma disclosures as if the Company adopted the cost recognition
requirements under SFAS No. 123 beginning in 1995 are presented below. The
Plans' options vest over four years, and all options expire after ten years.
<PAGE>
<TABLE>
<CAPTION>
Had compensation cost for the Plans and other options issued been determined
consistent with SFAS No. 123, "Accounting for Stock-Based Compensation", the
Company's net income (and earnings per share) would have been reduced to the
following pro forma amounts:
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net As $2,500 $901 $2,636
income: Reported
Pro Forma $2,309 $176 $2,603
Basic As $ 0.37 $0.14 $0.43
EPS: Reported
Pro Forma $ 0.34 $0.03 $0.42
Diluted As $ 0.36 $0.13 $0.38
EPS: Reported
Pro Forma $ 0.33 $0.03 $0.38
</TABLE>
The significant decrease in pro forma net income in 1996 reflects additional
compensation cost associated with the repricing of options during 1996 to reduce
the exercise price of the options to the current fair market value of the common
stock of the Company. Because the SFAS No. 123 method of accounting has not been
applied to options granted prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in future
years. <TABLE> <CAPTION>
A summary of the status of the Company stock option plan at December 31, 1997,
1996 and 1995, and changes during the years then ended is presented in the table
and narrative below:
1997 1996 1995
---------------- ------------------ ----------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at 808,840 $5.37 648,338 $8.06 646,838 $7.81
beg. of year $ 7081 $ 7081 $ 7081
Granted 186,500 $4.94 592,502 $5.20 17,500 $16.38
Exercised (49,259) $5.96 0 $0.00 (6,950) $6.99
Canceled (17,916) $4.80 (432,000) $9.16 (9,050) $8.25
-------- --------- -------
Outstanding at 928,165 $5.27 808,840 $5.37 648,338 $8.06
------- ------- -------
end of year
Exercisable at 728,679 647,875 506,233
end of year
Weighted average $2.10 $1.82 $6.73
fair value
of options
granted
----------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
OUTSTANDING AND EXERCISABLE BY PRICE RANGE
As of December 31, 1997
Range of Number Weighted Weighted Number Weighted
Exercise Outstanding Average Average Exercisable Average
Price Remaining Exercise Exercise
Contractual Price Price
Life
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$3.63 - $4.88 283,415 8.06 $4.78 114,230 $4.74
$5.25 - $5.25 455,000 6.54 $5.25 428,765 $5.25
$5.50 - $6.00 185,250 4.31 $6.00 184,784 $6.00
$7.00 - $7.50 4,500 4.83 $7.50 900 $7.50
------------- ------- ---- ----- ----- -----
$3.63 - $7.50 928,165 6.55 $5.27 728,679 $5.36
$7.50
<FN>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997, 1996, and 1995, respectively: weighted
average risk-free interest rates of 5.0% to 6.7%; expected dividend yield of 0%;
expected lives of two years from vest date; expected volatility of 50%.
</FN>
</TABLE>
(10) SUBSEQUENT EVENT - ACQUISITION OF THE COMPANY
On March 27, 1998, the Company entered into an Agreement and Plan of Merger (the
"Agreement") with Knowledge Beginnings, Inc., a privately-owned education
services company ("Parent") and its wholly-owned subsidiary, KBI Acquisition,
Corp. ("Purchaser"). Under the Agreement, Purchaser will undertake a tender
offer (supported by the Board of Directors) for all outstanding shares of CDC
common stock at a net price of $12.25 per share in cash and, following
consummation of the tender offer, will effect a merger with the Company (the
"Merger"). Pursuant to the Merger, all outstanding shares of CDC common stock
not acquired in the tender offer will be converted into the right to receive
$12.25 per share in cash, and the Company will become a wholly-owned subsidiary
of Parent. Holders of 1,363,700 shares of CDC common stock have simultaneously
entered into a support agreement pursuant to which they have agreed to tender
their shares and under certain circumstances sell their shares
to Parent for $12.25 per share in cash. The Company has also granted Parent an
option to purchase 1,342,155 previously unissued shares of CDC common stock
(equal to 19.9% of the outstanding shares of the Company) under certain
circumstances for $10.125 per share. The tender offer will be initiated upon
certain filings by Purchaser and the Company. The completion of the tender offer
is subject to certain conditions, including Purchaser's receipt of at least a
majority of the outstanding shares calculated on a full-diluted basis and
receipt of certain regulatory approvals. Consummation of the Merger is also
subject to certain conditions including stockholder approval, if legally
required.
Dr. Elanna S. Yalow, President and Chief Operating Officer, has entered into an
employment agreement with Parent to become effective on a date selected by
Parent (the "Effective Date") between the consummation of the tender offer and
consummation of the Merger. Richard A. Niglio, Chief Executive Officer and
Chairman of the Board, has entered into a two year consulting agreement with the
Company to become effective on the Effective Date, at which time will resign as
Chief Executive Officer and Chairman of the Board. Employment contracts between
the Company and Randall J. Truelove, Vice President of Finance, Jane Delaney,
Vice President, and Frank A. Devine, Secretary, will become effective on the
Effective Date.
Also, subject to consummation of the Merger, the Company has accelerated the
vesting of all outstanding stock options whether issued under Company plans or
otherwise (see Note 9), and the Company will offer to redeem all such options,
upon consummation of the Merger, for cash at a net price equal to $12.25 per
share, less the underlying exercise price of the option, any withholding taxes
due with respect to such redemption, and the balance of any loans then
outstanding from the Company to the optionholder.
<PAGE>
EXHIBIT INDEX
Item No. Item Title Sequentially Numbered Page
23 Consent of Arthur Andersen LLP 1
Dated: March 27, 1998
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report included in this Form 10-K, into the Company's previously filed
Registration Statements File Nos. 33-76954 and 33-59351.
s/s Arthur Andersen LLP
ARTHUR ANDERSEN LLP
San Francisco, California
March 27, 1998
1
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Children's Discovery Centers of America, Inc. 1997 10-K
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