================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
FORM 10-Q
-------------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 6, 1998
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 0-17098
KINDERCARE LEARNING CENTERS, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-0941966
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification Number)
650 N.E. Holladay, Suite 1400
Portland, Oregon 97232
(Address of principal executive offices)
(503) 872-1300
(Registrant's telephone number, including area code)
(Former name, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing required for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmation by the court. Yes [X] No [ ]
The number of shares of Registrant's common stock, $.01 par value per
share, outstanding at April 3, 1998 was 9,474,197.
================================================================================
<PAGE>
KinderCare Learning Centers, Inc. and Subsidiaries
Index
Page
Part I. Financial Information
Item 1. Consolidated financial statements (unaudited):
Consolidated balance sheets at March 6, 1998 and
May 30, 1997 (unaudited).................................. 2
Consolidated statements of operations for the twelve and
forty weeks ended March 6, 1998 and
March 7, 1997 (unaudited)................................. 3
Consolidated statements of shareholders' equity
for the forty weeks ended March 6, 1998
and the fiscal year ended May 30, 1997 (unaudited)........ 4
Consolidated statements of cash flows for the forty
weeks ended March 6, 1998 and
March 7, 1997 (unaudited)................................. 5
Notes to unaudited consolidated financial statements........ 6
Item 2. Management's discussion and analysis of
financial condition and results of operations............. 9
Part II. Other Information
Item 6. Exhibits and reports on Form 8-K............................20
Signatures....................................................................21
1
<PAGE>
PART I
Item 1. Consolidated Financial Statements (unaudited)
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except share amounts)
(Unaudited)
March 6, 1998 May 30, 1997
------------- ------------
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 9,361 $ 24,150
Receivables 17,588 13,649
Deferred income taxes 14,127 14,127
Prepaid expenses and supplies 6,123 6,114
------------- -----------
Total current assets 47,199 58,040
Property and equipment, net 504,026 471,558
Deferred income taxes 15,551 11,621
Deferred financing costs and other assets 26,877 28,659
------------- ------------
$ 593,653 $ 569,878
============= ============
Liabilities and Shareholders' Equity:
Current liabilities:
Bank overdrafts $ 8,432 $ 5,357
Accounts payable 7,913 10,746
Accrued expenses and other liabilities 61,345 69,056
Current portion of long-term debt 1,746 1,760
------------- ------------
Total current liabilities 79,436 86,919
Long-term debt 411,554 393,129
Self insurance liabilities 25,074 21,880
Other noncurrent liabilities 46,902 40,243
------------- ------------
Total liabilities 562,966 542,171
------------- ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value; authorized
10,000,000 shares; none outstanding --- ---
Common stock, $.01 par value; authorized
20,000,000 shares; issued and outstanding
9,474,197 and 9,368,421 shares, respectively 95 94
Additional paid-in capital 2,009 ---
Notes receivable from shareholders (1,490) ---
Retained earnings 30,160 27,753
Cumulative translation adjustment (87) (140)
------------- ------------
Total shareholders' equity 30,687 27,707
------------- ------------
$ 593,653 $ 569,878
============= ============
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except share and per share amounts)
(Unaudited)
Twelve Weeks Ended Forty Weeks Ended
---------------------------------- -----------------------------------
March 6, 1998 March 7, 1997 March 6, 1998 March 7, 1997
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Operating revenues, net $ 134,823 $ 126,657 $ 450,972 $ 426,408
Operating expenses: -----------------------------------------------------------------------------
Salaries, wages and benefits 73,872 67,960 247,638 230,175
Depreciation 7,730 7,182 26,898 26,390
Rent 7,060 6,968 21,099 21,475
Provision for doubtful accounts 967 898 2,932 2,749
Other 32,469 31,858 112,369 111,238
Recapitalization expenses --- 14,865 --- 14,880
Restructuring charges and other (income), net 92 --- 4,947 (1,543)
-----------------------------------------------------------------------------
Total operating expenses 122,190 129,731 415,883 405,364
-----------------------------------------------------------------------------
Operating income (loss) 12,633 (3,074) 35,089 21,044
Investment income, net 76 36 518 122
Interest expense (9,588) (4,587) (31,960) (12,728)
-----------------------------------------------------------------------------
Income (loss) before income taxes and
extraordinary items 3,121 (7,625) 3,647 8,438
Income tax expense 1,061 2,830 1,240 9,094
-----------------------------------------------------------------------------
Income (loss) before extraordinary items 2,060 (10,455) 2,407 (656)
Extraordinary items - loss on early retirement of
debt, net of income taxes --- (1,052) --- (7,532)
-----------------------------------------------------------------------------
Net income (loss) $ 2,060 $ (11,507) $ 2,407 $ (8,188)
=============================================================================
Income (loss) per common share - basic and
assuming dilution:
Income (loss) before extraordinary items $ 0.22 $ (0.61) $ 0.26 $ (0.04)
Extraordinary items, net of income taxes --- (0.06) --- (0.40)
-----------------------------------------------------------------------------
Net income (loss) $ 0.22 $ (0.67) $ 0.26 $ (0.44)
-----------------------------------------------------------------------------
Weighted average common shares outstanding 9,386,000 17,084,000 9,374,000 18,612,000
-----------------------------------------------------------------------------
Weighted average common shares outstanding and
potential common shares 9,413,000 17,084,000 9,382,000 18,612,000
-----------------------------------------------------------------------------
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(Dollars in thousands, except share amounts)
(Unaudited)
Common Stock Additional Cumulative
------------------------ Paid-in Notes Retained Translation Treasury
Shares Amount Capital Receivable Earnings Adjustment Stock Total
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at May 31, 1996 19,981,807 $ 199 $ 200,980 $ -- $ 61,799 $ (20) $ (523) $ 262,435
Net loss -- -- -- -- (12,967) -- -- (12,967)
Cumulative translation
adjustment -- -- -- -- -- (120) -- (120)
Issuance of common stock 7,986,842 80 151,670 -- -- -- -- 151,750
Purchase and retirement
of common stock (20,217,416) (201) (361,685) -- (21,079) -- 523 (382,442)
Purchase of outstanding
warrants -- -- (11,143) -- -- -- -- (11,143)
Exercise of stock options
and warrants 1,617,188 16 19,735 -- -- -- -- 19,751
Tax benefit of option
exercises -- -- 443 -- -- -- -- 443
-----------------------------------------------------------------------------------------------------
Balance at May 30, 1997 9,368,421 94 -- -- 27,753 (140) -- 27,707
Net income -- -- -- -- 2,407 -- -- 2,407
Issuance of common stock 105,776 1 2,009 (1,490) -- -- -- 520
Cumulative translation
adjustment -- -- -- -- -- 53 -- 53
-----------------------------------------------------------------------------------------------------
Balance at March 6, 1998 9,474,197 $ 95 $ 2,009 $ (1,490) $ 30,160 $ (87) $ -- $ 30,687
=====================================================================================================
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Forty Weeks Ended
-------------------------------------------------
March 6, 1998 March 7, 1997
-------------------------------------------------
<S> <C> <C>
Cash flows from operations:
Net income $ 2,407 $ (8,188)
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 26,898 26,390
Amortization of deferred financing costs and intangibles 2,377 1,026
Loss on sales and disposals of property and
equipment, net 7 --
Cumulative translation adjustment 53 (105)
Extraordinary items - loss on early retirement of debt,
net of income tax -- 7,532
Changes in operating assets and liabilities:
Increase in receivables (3,885) (397)
Decrease (increase) in prepaid expenses and supplies (9) 945
Decrease (increase) in other assets (1,398) 1,843
Increase (decrease) in accounts payable, accrued
expenses and other liabilities (4,749) 5,567
Other, net -- (130)
-------------------------------------------------
Net cash provided by operating activities 21,701 34,483
-------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (59,461) (34,453)
Proceeds from sales of property and equipment 840 12,722
Proceeds from collection of notes receivable and other 597 69
-------------------------------------------------
Net cash used by investing activities (58,024) (21,662)
-------------------------------------------------
Cash flows from financing activities:
Proceeds from long-term borrowings 20,000 350,000
Deferred financing costs -- (30,613)
Proceeds from issuance of common stock 520 151,750
Exercise of stock options and warrants -- 19,751
Payments on long-term borrowings (1,589) (107,282)
Payments on capital leases (472) --
Purchase and retirement of common stock -- (381,542)
Purchases of treasury stock and warrants -- (12,043)
Bank overdrafts 3,075 (949)
-------------------------------------------------
Net cash provided (used) by financing activities 21,534 (10,928)
-------------------------------------------------
Increase (decrease) in cash and cash equivalents (14,789) 1,893
Cash and cash equivalents at the beginning of the period 24,150 13,597
-------------------------------------------------
Cash and cash equivalents at the end of the period $ 9,361 $ 15,490
=================================================
Supplemental cash flow information:
Interest paid $ 34,628 $ 14,637
Income taxes paid (refunded), net (45) 1,014
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
5
<PAGE>
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Nature of Business and Basis of Presentation
KinderCare Learning Centers, Inc. ("KinderCare" or the "Company") is the
largest provider of for-profit preschool educational and childcare services in
the United States. At March 6, 1998, KinderCare operated a total of 1,145
centers, with 1,143 centers in 38 states in the United States and two centers in
the United Kingdom. The consolidated financial statements include the financial
statements of the Company and its wholly owned subsidiaries: Mini-Skools
Limited; KinderCare Development Corporation; KinderCare Real Estate; KinderCare
Learning Centres, Limited and KinderCare Properties, Limited. All significant
intercompany balances and transactions have been eliminated in consolidation.
The unaudited consolidated financial statements reflect, in the opinion of
management, all adjustments, all of which are of a normal recurring nature,
necessary to present fairly the financial position of the Company at March 6,
1998 and the results of operations and cash flows for each of the twelve and
forty week periods ended March 6, 1998 and March 7, 1997. Interim results are
not necessarily indicative of results to be expected for a full fiscal year. The
unaudited consolidated financial statements should be read in conjunction with
the annual consolidated financial statements and notes thereto included in the
Company's Form 10-K.
Fiscal Year
The Company's fiscal year ends on the Friday closest to May 31. The first
quarter is 16 weeks long and the second, third and fourth quarters are each
twelve weeks long. The 1998 and 1997 fiscal years are each 52 weeks long.
References to fiscal 1998 and fiscal 1997 are to the fiscal years ended May 29,
1998 and May 30, 1997, respectively.
Use of Estimates
The preparation of 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.
Reclassifications
Certain prior period amounts have been reclassified to conform to the
current period's presentation.
6
<PAGE>
Recently Issued Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes requirements for disclosure of
comprehensive income. The new standard becomes effective for the Company's
fiscal year 1999 and requires reclassification of earlier financial statements
for comparative purposes.
In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
disclosure about operating segments in annual financial statements and requires
disclosure of selected information about operating segments in interim financial
reports. It also establishes standards for related disclosures about products
and services, geographic areas and major customers. This statement superceded
SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. The new
standard becomes effective for the Company's fiscal year 1999 and requires that
comparative information from earlier years be restated to conform to the
requirements of this standard. The Company does not believe any substantial
changes to its disclosures will be made at the time SFAS No. 131 is adopted.
2. Recapitalization
On October 3, 1996, the Company and KCLC Acquisition Corp. ("KCLC") entered
into an Agreement and Plan of Merger (the "Merger Agreement"). KCLC was a wholly
owned subsidiary of KLC Associates, L.P., a partnership formed at the direction
of Kohlberg Kravis Roberts & Co., a private investment firm ("KKR"). Pursuant to
the Merger Agreement, on February 13, 1997, KCLC was merged with and into the
Company (the "Merger"), with the Company continuing as the surviving
corporation. Upon completion of the Merger, affiliates of KKR owned 7,828,947
shares, or approximately 83.6% of the Company's common stock outstanding after
the Merger. Subject to certain provisions of the Merger Agreement, each issued
and outstanding share of common stock was converted, at the election of the
holder, into either the right to receive $19.00 in cash or the right to retain
one share of common stock, subject to proration.
In connection with the Merger, the Company repaid the outstanding $91.6
million balance on the Company's previous $150.0 million credit facility and
paid $382.4 million to redeem common stock, warrants and options. In order to
fund the transactions contemplated by the Merger (the "Recapitalization"), the
Company issued $300.0 million 9 1/2% senior subordinated notes, executed a
revolving credit facility of $300.0 million, executed a term loan facility of
$90.0 million, against which $50.0 million was immediately drawn, and issued
7,828,947 shares of common stock to KKR affiliates for $148.8 million.
During the third quarter of fiscal 1997, non-recurring costs in connection
with the Recapitalization of approximately $14.9 million were incurred and
expensed. Additionally, financing costs of $30.0 million have been deferred,
classified as other assets and will be amortized over the lives of the new debt
facilities.
7
<PAGE>
3. Restructuring Charges and Other Income, net
During fiscal 1997, the Company decided to relocate its corporate offices
from Montgomery, Alabama to Portland, Oregon in fiscal year 1998. The Company
recognized $0.6 million and $5.4 million in restructuring charges during the
twelve and forty weeks ended March 6, 1998, respectively. The charges are
primarily comprised of costs incurred in the retention, recruitment and
relocation of employees and travel costs related to the office relocation.
During the third quarter of fiscal 1998, the Company, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorney's fees, as settlement of the Company's claim in the United States
District Court in New York against Michael R. Milken, et al.
During the second quarter of fiscal 1997, the Company received a $1.5
million interest payment from Enstar Group Inc. ("Enstar"), the Company's former
parent, in connection with a settlement of the Company's claim against Enstar in
the U.S. Bankruptcy court in Montgomery, Alabama.
4. Income Taxes
For the twelve and forty weeks ended March 6, 1998 and March 7, 1997,
income tax expense was in excess of amounts computed by applying the statutory
federal income tax rate to income (loss) before income taxes due primarily to
state income taxes and, during the third quarter of fiscal 1997, non-deductible
recapitalization expenses, offset by tax credits.
5. Extraordinary Losses
During the first and second quarters of fiscal 1997, the Company purchased
$99.4 million aggregate principal amount of its 10 3/8% senior subordinated
notes for an aggregate price of $108.3 million. This transaction included the
write-off of deferred financing costs of $1.7 million and resulted in an
extraordinary loss of $6.5 million, net of income taxes of $4.1 million.
During the third quarter of fiscal 1997, in connection with the Merger and
retirement of existing debt, an extraordinary loss of $1.0 million, net of
income taxes of $0.7 million, was recognized for the write-off of deferred
financing costs related to the Company's previous credit facility.
6. Income (Loss) Per Share
In 1997, the FASB issued SFAS No. 128, Earnings per Share. SFAS No. 128
replaced the previously reported primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants or
convertible securities. Diluted earnings per share is very similar to previously
reported fully diluted earnings per share. All earnings per share amounts
8
<PAGE>
have been presented, and where necessary restated, to conform to the
requirements of SFAS No. 128.
Income (loss) before extraordinary items (numerator) was the same in the
calculation of basic and diluted income (loss) per share for the twelve and
forty weeks ended March 6, 1998 and March 7, 1997. The following table shows the
reconciliation of the weighted average common shares (shares in thousands):
<TABLE>
<CAPTION>
Twelve Weeks Ended Forty Weeks Ended
----------------------------------------------------------------------------
March 6, 1998 March 7, 1997 March 6, 1998 March 7, 1997
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average common shares
outstanding 9,386 17,084 9,374 18,612
Dilutive effect of options 27 -- 8 --
----------------------------------------------------------------------------
Weighted average common shares
outstanding and potential
common shares 9,413 17,084 9,382 18,612
============================================================================
</TABLE>
In accordance with SFAS No. 128, the potential common shares for the twelve
and forty weeks ended March 7, 1997 were not included in the calculation of
diluted income (loss) per share due to their anti-dilutive effect when a loss
before extraordinary items exists.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto included elsewhere in this
document. The Company's fiscal year ends on the Friday closest to May 31. The
information presented herein refers to the quarters ended March 6, 1998 ("third
quarter of fiscal 1998") and March 7, 1997 ("third quarter of fiscal 1997"),
each of which was twelve weeks long, and the forty weeks ended March 6, 1998 and
March 7, 1997.
Occupancy, a measure of the utilization of center capacity, is defined by
the Company as the full-time equivalent ("FTE") attendance at all of the
Company's centers divided by the sum of the licensed capacity of all of the
Company's centers. FTE attendance is not a strict head count. Rather, the
methodology is to determine an approximate number of full-time children based on
weighted averages. For example, an enrolled full-time child equates to one FTE,
while a part-time child enrolled for a half-day would equate to 0.5 FTE. The FTE
measurement of center capacity utilization does not necessarily reflect the
actual number of full- and part-time children enrolled.
Average tuition rate is defined by the Company as actual net operating
revenues, exclusive of fees (primarily reservation and registration) and
non-tuition income, divided by FTE attendance for the respective period. The
average tuition rate represents the approximate weighted average tuition rate at
each center paid by a parent for a child to attend a KinderCare center five full
days during one week. Center occupancy mix, however, can significantly affect
these averages with respect to any specific child care center.
9
<PAGE>
Results of Operations
Third Quarter of Fiscal 1998 compared to Third Quarter of Fiscal 1997
The following table shows the comparative operating results of the Company
(dollars in thousands):
<TABLE>
<CAPTION>
Twelve Weeks Twelve Weeks Change
Ended Percent Ended Percent Amount
March 6, of March 7, of Increase/
1998 Revenues 1997 Revenues (Decrease)
------------ ---------- ------------ ---------- ------------
<S> <C> <C> <C> <C> <C>
Operating revenues, net $ 134,823 100.0% $ 126,657 100.0% $ 8,166
------------ ---------- ------------ ---------- ------------
Operating expenses:
Salaries, wages and benefits 73,872 54.8 67,960 53.6 5,912
Depreciation 7,730 5.7 7,182 5.7 548
Rent 7,060 5.2 6,968 5.5 92
Other 33,436 24.8 32,756 25.9 680
Recapitalization expenses --- --- 14,865 11.7 (14,865)
Restructuring charges and other
(income), net 92 0.1 --- --- 92
------------ ---------- ------------ ---------- ------------
Total operating expenses 122,190 90.6 129,731 102.4 (7,541)
------------ ---------- ------------ ---------- ------------
Operating income (loss) $ 12,633 9.4% $ (3,074) (2.4%) $ 15,707
============ ========== ============ ========== ============
</TABLE>
Operating revenues, net - Net operating revenues increased $8.2 million, or
6.4%, to $134.8 million for the third quarter of fiscal 1998 from the comparable
quarter last year. The increase in net operating revenues is primarily
attributable to an approximate 4.4% weighted average tuition increase
implemented in the second quarter of fiscal 1998 and new center openings and
acquisitions. The average tuition rate and occupancy, respectively, increased to
$108.06 and 68.2% for the third quarter of fiscal 1998 from $102.18 and 67.8%
for the third quarter of fiscal 1997. The positive effect of these factors on
net operating revenues was offset in part by center closings.
During the third quarter of fiscal 1998, the Company opened three community
centers and closed six centers. During the third quarter of fiscal 1997, the
Company opened five community centers and closed or sold two centers. Total
licensed capacity at the end of the third quarter for both fiscal 1998 and
fiscal 1997 was 142,000. At March 6, 1998, the Company operated 1,145 centers.
Salaries, wages and benefits - Salaries, wages and benefits expense
increased $5.9 million, or 8.7%, to $73.9 million for the third quarter of
fiscal 1998 from the comparable quarter last year. The expense directly
associated with the centers was $68.3 million for the third quarter of fiscal
1998, an increase of $4.2 million from the third quarter of fiscal 1997. The
center level increase is attributable to increased staff wage rates and bonus
expense, offset by a decline in total hours. The expense related to field
management and corporate administration increased $1.7 million from the third
quarter of fiscal 1997. The increase is attributable to the addition of certain
field management positions, higher salaries as a result of the relocation of the
corporate office to Portland, Oregon and increased bonus expense.
At the center level, salaries, wages and benefits expense, as a percentage
of net operating revenues, remained flat at 50.7% for the third quarter of
fiscal 1998 and fiscal 1997. Total
10
<PAGE>
salaries, wages and benefits expense, as a percentage of net operating revenues,
increased to 54.8% for the third quarter of fiscal 1998 from 53.7% for the
comparable quarter last year.
Depreciation - Depreciation expense increased to $7.7 million for the third
quarter of fiscal 1998 from $7.2 million for the comparable quarter last year
due to additional depreciation expense related to new centers. The Company
opened 11 new centers and closed or sold 17 older centers since the end of the
third quarter of fiscal 1997.
Rent - Rent expense increased slightly to $7.1 million for the third
quarter of fiscal 1998 from $7.0 million for the comparable quarter last year.
The increase is primarily a result of administrative rent expense associated
with the Company's new headquarters in Portland, Oregon. The expense directly
associated with the centers decreased due to the closure of 17 leased centers,
offset slightly by the opening of one leased center, since the end of the third
quarter of fiscal 1997. The rental rates experienced on leases entered into
currently are higher than those experienced in previous periods.
Other operating expenses - Other operating expenses increased to $33.4
million for the third quarter of fiscal 1998 from $32.8 million for the
comparable quarter last year. Other operating expenses include costs directly
associated with the centers, such as food, educational materials, janitorial and
maintenance costs, utilities, transportation and insurance, and expenses related
to field management and corporate administration. Costs directly associated with
the centers increased slightly due to additional FTE attendance experienced
during the third quarter of fiscal 1998. As a percentage of net operating
revenues, other operating expenses decreased to 24.8% for the third quarter of
fiscal 1998 from 25.9% for the third quarter of fiscal 1997. The improvement in
other operating expenses, as a percentage of net operating revenues, is due to
effective cost control by management.
Recapitalization expenses - During fiscal 1997 and in connection with the
merger (the "Merger") of the Company and KCLC Acquisition Corp. ("KCLC"), a
wholly owned subsidiary of a partnership formed at the direction of Kohlberg
Kravis Roberts & Co., a private investment firm ("KKR"), the Company repaid the
$91.6 million balance on the Company's previous $150.0 million credit facility
and paid $382.4 million to redeem common stock, warrants and options. In order
to fund the transactions contemplated by the Merger (the "Recapitalization"),
the Company issued $300.0 million principal amount 9 1/2 % senior subordinated
notes, entered into a $300.0 million revolving credit facility, executed a term
loan facility of $90.0 million, against which $50.0 million was immediately
drawn, and issued 7,828,947 shares of common stock to KKR affiliates. During the
third quarter of fiscal 1997, non-recurring recapitalization costs of
approximately $14.9 million were incurred and expensed, and financing costs of
approximately $30.0 million were deferred and will be amortized over the lives
of the new debt facilities.
Restructuring charges and other income, net - During fiscal 1997, the
Company decided to relocate its corporate offices from Montgomery, Alabama to
Portland, Oregon in fiscal 1998. During the third quarter of fiscal 1998, the
Company recognized $0.6 million in restructuring charges. The charges are
primarily comprised of costs incurred in the retention, recruitment and
relocation of employees and travel costs related to the office relocation.
11
<PAGE>
During the third quarter of fiscal 1998, the Company, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorney's fees, as settlement of the Company's claim in the United States
District Court in New York against Michael R. Milken, et. al.
Operating income (loss) - Operating income increased $15.7 million to $12.6
million for the third quarter of fiscal 1998 from the comparable quarter last
year. Operating income before recapitalization expenses, restructuring charges
and other income, net, increased $0.9 million, or 7.9%, to $12.7 million for the
third quarter of fiscal 1998 from the comparable quarter last year. The increase
is primarily due to the higher average tuition rate and the effective management
of labor hours and costs directly associated with the centers, as discussed
above.
Third quarter of fiscal 1998 EBITDA, defined as earnings before interest
expense, income taxes, depreciation and amortization, of $20.4 million was $17.3
million above the comparable quarter last year. As a percentage of net operating
revenues, EBITDA for the third quarter of fiscal 1998 was 15.1% compared to 2.4%
for the third quarter of fiscal 1997. Adjusted EBITDA, defined as EBITDA
exclusive of recapitalization expenses, restructuring charges and other income,
net, investment income and extraordinary items was $20.5 million for the third
quarter of fiscal 1998, an increase of $1.5 million from the comparable quarter
last year. As a percentage of net operating revenues, Adjusted EBITDA was 15.2%
for the third quarter of fiscal 1998 and 15.0% for the third quarter of fiscal
1997. Neither EBITDA nor Adjusted EBITDA is intended to indicate that cash flow
is sufficient to fund all of the Company's cash needs or represent cash flow
from operations as defined by generally accepted accounting principles.
Interest expense - Interest expense increased to $9.6 million for the third
quarter of fiscal 1998 from $4.6 million for the comparable quarter last year.
This increase is substantially attributable to the $350.0 million of long-term
debt which was incurred in the third quarter of fiscal 1997 to fund the Merger
and repay $91.6 million on the Company's then existing line of credit. The
Company's weighted average interest rate on its long-term debt, including
amortization of deferred financing costs, was 10.1% for the third quarter of
fiscal 1998 versus 8.9% for the third quarter of fiscal 1997. As a result of the
Recapitalization, the Company expects to incur higher interest expense in fiscal
1998 than in prior fiscal years.
Income tax expense - Income tax expense for the third quarter of fiscal
1998 and 1997 of $1.1 and $2.8 million, respectively, was computed by applying
estimated effective income tax rates to income before income taxes. Income tax
expense varies from the statutory federal income tax rate due to state income
taxes and, during the third quarter of fiscal 1997, non-deductible
recapitalization expenses, offset by tax credits.
Extraordinary items - During the third quarter of fiscal 1997, in
connection with the Merger and retirement of existing debt, an extraordinary
loss of $1.0 million, net of income taxes of $0.7 million, was recognized for
the write-off of deferred financing costs related to the Company's previous
credit facility.
12
<PAGE>
Forty Weeks Ended March 6, 1998 compared to Forty Weeks Ended March 7, 1997
The following table shows the comparative operating results of the Company
(dollars in thousands):
<TABLE>
<CAPTION>
Forty Weeks Forty Weeks Change
Ended Percent Ended Percent Amount
March 6, of March 7, of Increase/
1998 Revenues 1997 Revenues (Decrease)
-------------- ---------- ------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Operating revenues, net $ 450,972 100.0% $ 426,408 100.0% $ 24,564
-------------- ---------- ------------- ---------- ------------
Operating expenses:
Salaries, wages and benefits 247,638 54.9 230,175 54.0 17,463
Depreciation 26,898 5.9 26,390 6.2 508
Rent 21,099 4.7 21,475 5.0 (376)
Other 115,301 25.6 113,987 26.7 1,314
Recapitalization expenses --- --- 14,880 3.5 (14,880)
Restructuring charges and other
(income), net 4,947 1.1 (1,543) (0.3) 6,490
------------- ---------- ------------- ------------ -------------
Total operating expenses 415,883 92.2 405,364 95.1 10,519
------------- ---------- ------------- ------------ -------------
Operating income $ 35,089 7.8% $ 21,044 4.9% $ 14,045
============= ========== ============= ============ =============
</TABLE>
Operating revenues, net - Net operating revenues increased $24.6 million,
or 5.8%, to $451.0 million for the forty weeks ended March 6, 1998 from the
comparable period last year. The increase in net operating revenues is primarily
attributable to higher average tuition rates and new center openings and
acquisitions. The average tuition rate and occupancy, respectively, increased to
$106.20 and 69.3% for the forty weeks ended March 6, 1998 from $101.64 and 68.8%
for the forty weeks ended March 7, 1997. The positive effect of these factors on
net operating revenues was offset in part by center closings.
During the forty weeks ended March 6, 1998, the Company opened 11 community
centers and closed or sold 10 centers. During the forty weeks ended March 7,
1997, the Company opened 16 centers: 15 community centers and one KinderCare at
Work(R) center, and closed or sold 13 centers.
Salaries, wages and benefits - Salaries, wages and benefits expense
increased $17.5 million, or 7.6%, to $247.6 million for the forty weeks ended
March 6, 1998 from the comparable period last year. The expense directly
associated with the centers was $230.4 million for the forty weeks ended March
6, 1998, an increase of $12.5 million from the forty weeks ended March 7, 1997.
The center level increase is attributable to increased staff wage rates and
bonus expense. The expense related to field management and corporate
administration increased $5.0 million from the forty weeks ended March 7, 1997.
The increase is attributable to the addition of certain field management
positions, higher salaries as a result of the relocation of the corporate office
to Portland, Oregon and increased bonus expense.
At the center level, salaries, wages and benefits expense, as a percentage
of net operating revenues, remained flat at 51.1% for the forty weeks ended
March 6, 1998 and March 7, 1997. Total salaries, wages and benefits expense, as
a percentage of net operating revenues, increased to 54.9% for the forty weeks
ended March 6, 1998 from 54.0% for the comparable period last year.
13
<PAGE>
Depreciation - Depreciation expense increased slightly to $26.9 million for
the forty weeks ended March 6, 1998 from $26.4 million for the comparable period
last year due to additional depreciation expense related to new centers.
Rent - Rent expense decreased slightly to $21.1 million for the forty weeks
ended March 6, 1998 from $21.5 million for the comparable period last year. The
decrease is primarily a result of the closure of 17 leased centers, offset
slightly by the opening of one leased center, since the end of the third quarter
of fiscal 1997. The rental rates experienced on leases entered into currently
are higher than those experienced in previous periods. During the second quarter
of fiscal 1998 administrative rent expense increased as a result of the
Company's occupancy of its new headquarters in Portland, Oregon.
Other operating expenses - Other operating expenses increased to $115.3
million for the forty weeks ended March 6, 1998 from $114.0 million for the
comparable period last year. The increase is primarily due to an additional $2.0
million of marketing expenses which funded a targeted marketing program during
the fall of fiscal 1998. Costs directly associated with the centers increased
due to the additional FTE attendance experienced during the forty weeks ended
March 6, 1998, while corporate administration expenses, for the most part,
declined. As a percentage of net operating revenues, other operating expenses
decreased to 25.6% for the forty weeks ended March 6, 1998 from 26.7% for the
forty weeks ended March 7, 1997. The improvement in other operating expenses, as
a percentage of net operating revenues, is due to effective cost control by
management.
Recapitalization expenses - During fiscal 1997 and in connection with the
merger (the "Merger") of the Company and KCLC Acquisition Corp. ("KCLC"), a
wholly owned subsidiary of a partnership formed at the direction of Kohlberg
Kravis Roberts & Co., a private investment firm("KKR"), the Company repaid the
$91.6 million balance on the Company's previous $150.0 million credit facility
and paid $382.4 million to redeem common stock, warrants and options. In order
to fund the transactions contemplated by the Merger (the "Recapitalization"),
the Company issued $300.0 million principal amount 9 1/2 % senior subordinated
notes, entered into a $300.0 million revolving credit facility, executed a term
loan facility of $90.0 million, against which $50.0 million was immediately
drawn, and issued 7,828,947 shares of common stock to KKR affiliates. During the
forty weeks ended March 7, 1997, non-recurring recapitalization costs of
approximately $14.9 million were incurred and expensed and financing costs of
approximately $30.0 million were deferred and will be amortized over the lives
of the new debt facilities.
Restructuring charges and other income, net - During fiscal 1997, the
Company decided to relocate its corporate offices from Montgomery, Alabama to
Portland, Oregon in fiscal 1998. During the forty weeks ended March 6, 1998, the
Company recognized $5.4 million in restructuring charges. The charges are
primarily comprised of costs incurred in the retention, recruitment and
relocation of employees and travel costs related to the office relocation.
During the third quarter of fiscal 1998, the Company, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorney's fees, as settlement of the Company's claim in the United States
District Court in New York against Michael R. Milken, et al.
14
<PAGE>
During the second quarter of fiscal 1997, the Company received a $1.5
million interest payment from Enstar Group Inc. ("Enstar"), the Company's former
parent, in connection with a settlement of the Company's claim against Enstar in
the U.S. Bankruptcy court in Montgomery, Alabama.
Operating income - Operating income increased $14.0 million, or 66.7%, to
$35.1 million for the forty weeks ended March 6, 1998 from the comparable period
last year. Operating income before recapitalization expenses, restructuring
charges and other income, net, increased $5.7 million, or 16.4%, to $40.0
million for the forty weeks ended March 6, 1998 from the comparable period last
year. The increase is primarily due to the higher average tuition rate and the
effective management of labor hours, costs directly associated with the centers
and corporate administration expenses, as discussed above.
EBITDA, defined as earnings before interest expense, income taxes,
depreciation and amortization, for the forty weeks ended March 6, 1998 of $62.5
million was $22.5 million above the comparable period last year. As a percentage
of net operating revenues, EBITDA for the forty weeks ended March 6, 1998 was
13.9% compared to 9.4% for the forty weeks ended March 7, 1997. Adjusted EBITDA,
defined as EBITDA exclusive of restructuring charges and other income, net,
investment income and extraordinary items was $66.9 million for the forty weeks
ended March 6, 1998, an increase of $6.2 million from the comparable period last
year. As a percentage of net operating revenues, Adjusted EBITDA was 14.8% for
the forty weeks ended March 6, 1998 and 14.3% for the forty weeks ended March 7,
1997. Neither EBITDA nor Adjusted EBITDA is intended to indicate that cash flow
is sufficient to fund all of the Company's cash needs or represent cash flow
from operations as defined by generally accepted accounting principles.
Interest expense - Interest expense increased to $32.0 million for the
forty weeks ended March 6, 1998 from $12.7 million for the comparable period
last year. This increase is substantially attributable to the $350.0 million of
long-term debt which was incurred in the third quarter of fiscal 1997 to fund
the Merger and repay $91.6 million on the Company's then existing line of
credit. The Company's weighted average interest rate on its long-term debt,
including amortization of deferred financing costs, was 10.3% for the forty
weeks ended March 6, 1998 versus 9.5% for the forty weeks ended March 7, 1997.
As a result of the Recapitalization, the Company expects to incur higher
interest expense in fiscal 1998 than in prior fiscal years.
Income tax expense - Income tax expense for the forty weeks ended March 6,
1998 and March 7, 1997 of $1.2 and $9.1 million, respectively, was computed by
applying estimated effective income tax rates to income before income taxes.
Income tax expense varies from the statutory federal income tax rate due to
state income taxes and, during the forty weeks ended March 7, 1997,
non-deductible recapitalization expenses, offset by tax credits.
Extraordinary items - During the forty weeks ended March 7, 1997, the
Company purchased $99.4 million aggregate principal amount of its 10 3/8% senior
subordinated notes for an aggregate price of $108.3 million. The transactions
included the write-off of deferred financing costs of $1.7 million and resulted
in an extraordinary loss of $6.5 million, net of
15
<PAGE>
income taxes of $4.1 million. In connection with the Merger and retirement of
existing debt, an extraordinary loss of $1.0 million, net of income taxes of
$0.7 million, was recognized for the write-off of deferred financing costs
related to the Company's previous credit facility.
Liquidity and Capital Resources
The Company's principal sources of liquidity are cash flow generated from
operations and future borrowings under the $300.0 million revolving credit
facility. The Company's principal uses of liquidity are meeting debt service
requirements, financing the Company's capital expenditures and renovations and
providing working capital.
Proceeds of $20.0 million, drawn during the third quarter of fiscal 1998
from the revolving credit facility, were used to finance capital expenditures
and a semi-annual interest payment due on the 9 1/2% senior subordinated notes.
Subsequent to March 6, 1998, $5.0 million was repaid on the revolving credit
facility from cash flow generated from operations. At April 3, 1998, of the
$300.0 million available under the revolving credit facility, the Company had
approximately $41.9 utilized by outstanding letters of credit and $15.0 million
drawn.
The Company's consolidated net cash flow from operations for the forty
weeks ended March 6, 1998 was $21.7 million, compared to $34.5 million for the
comparable period last year. The decrease in net cash flow from operations is
primarily a result of increased interest expense, offset by higher operating
income. Cash and cash equivalents totaled $9.4 million at March 6, 1998 compared
to $24.2 million at May 30, 1997.
New enrollments are generally highest in September and January, with
attendance declining 5% to 10% during the summer months and the year-end holiday
period. The decreased attendance in the summer months and during the year-end
holiday period may result in decreased liquidity during these periods.
Capital Expenditures
The Company anticipates substantial increases in its capital expenditures
budget over the next several years. During fiscal 1998, the Company anticipates
opening approximately 20 new centers. Over the next three years, the Company
expects to increase its rate of opening and/or acquiring new centers to between
50 and 75 new centers per year in the aggregate (excluding center closings),
which the Company expects will be primarily community centers, and to continue
its practice of closing centers that are identified as underperforming. The
length of time from site selection to the opening of a community center ranges
from 18 to 24 months. The average total cost per community center typically
ranges from $1.5 million to $1.8 million depending on the size and location of
the center; however, the actual costs of a particular center may vary from such
range. New centers are based upon detailed site analyses that include
feasibility and demographic studies and financial modeling. No assurance can be
given by the Company that it will be able to successfully negotiate and acquire
properties, or meet targeted deadlines. Frequently, new site negotiations are
delayed or canceled or construction delayed for a variety of reasons, many
outside the control of the Company.
16
<PAGE>
The Company also plans to make significant capital expenditures in
connection with the renovation of its existing facilities. The Company expects
to make these improvements over the next three to four years.
During the forty weeks ended March 6, 1998, the Company opened 11 community
centers. There are no planned additions to the Company's Kid's Choice(TM) format
as management does not believe that the concept is meeting its full potential
and needs further refinement. The Company currently anticipates that any Kid's
Choice(TM) center that is underperforming when its lease expires will be closed
at that time. During the forty weeks ended March 7, 1997, center openings
totaled 16 centers; consisting of 15 KinderCare community centers and one
KinderCare At Work(R) center.
Capital expenditures, during the forty weeks ended March 6, 1998, totaled
approximately $59.5 million compared to $34.5 million for the forty weeks ended
March 7, 1997. During the forty weeks ended March 6, 1998 and March 7, 1997,
expenditures for new center development were $23.8 and $16.9 million and
renovations on existing facilities were $17.3 and $9.4 million, respectively.
Purchases of equipment and corporate information systems were $16.3 and $2.1
million, respectively, during the forty weeks ended March 6, 1998 and $5.4 and
$2.8 million, respectively, during the forty weeks ended March 7, 1997.
Many of the Company's computer systems will require modification or
replacement over the next two years in order to render these systems compliant
with the "Year 2000." The Company has conducted a review of its computer systems
to identify those areas which may be affected by the Year 2000 issue and is
developing an implementation plan to provide resolution. The Company presently
believes, with modification to existing software and converting to new software,
the Year 2000 will not pose significant operational problems. However, there can
be no assurance that the systems of other companies on which the Company may
rely also will be timely converted or that such failure to convert by another
company would not have an adverse effect on the Company's systems. Costs
associated with Year 2000 compliance, which will be expensed as incurred, are
not anticipated to be material to the Company's financial position or results of
operations in any given year.
Capital expenditure limits under the credit facilities for fiscal 1998 are
$100.0 million. Capital expenditure limits may be increased by carryover of a
portion of unused amounts from previous periods and are subject to certain
exceptions. Also, the Company is permitted a degree of flexibility under the
provisions of the indenture under which the senior subordinated notes were
issued and the credit facilities with respect to the incurrence of additional
indebtedness, including through certain mortgages or sale-leaseback
transactions.
Management believes that cash flow generated from operations and future
borrowings under the revolving credit facility will adequately provide for its
working capital and debt service needs and will be sufficient to fund the
Company's expected capital expenditures over the next several years. Although no
assurance can be given that such sources will be sufficient, the capital
expenditure program has substantial flexibility and is subject to revision based
on various factors, including but not limited to, business conditions, changing
time constraints, cash flow requirements, debt covenants, competitive factors
and seasonality of openings. If the Company experiences a lack of working
capital, it may reduce its capital expenditures. In the
17
<PAGE>
long term, if these expenditures were substantially reduced, in management's
opinion, its operations and its cash flow would be adversely impacted.
Inflation and Wage Increases
Management does not believe that the effect of inflation on the results of
the Company's operations has been significant in recent periods.
Salaries, wages and benefits represented approximately 54.9% of net
operating revenues for the forty weeks ended March 6, 1998. During the forty
weeks ended March 6, 1998, the Company's average wage rate for hourly employees
was $6.70 per hour, compared to the current federal minimum wage rate of $5.15
per hour. During 1996, Congress enacted an increase in the minimum hourly wage
from $4.25 to $4.75 effective October 1, 1996, with an additional increase to
$5.15 effective on September 1, 1997. The effect of the federal minimum wage
increase is not material to the results of operations.
The Company believes that, through increases in its tuition rates, it can
recover any future increase in expenses caused by the minimum wage rate.
However, there can be no assurance that the Company will be able to increase its
rates sufficiently to offset such increased costs. The Company continually
evaluates its wage structure and may implement further changes in addition to
those discussed above.
18
<PAGE>
Forward Looking Statements
When used in this report, press releases and elsewhere by management or the
Company from time to time, the words "believes," "anticipates," "expects" and
similar expressions are intended to identify forward-looking statements, within
the meaning of federal securities law, concerning the Company's operations,
economic performance and financial condition, including, in particular, the
number of centers expected to be added in future years, planned transactions and
changes in operating systems and policies and their intended results, and
similar statements concerning anticipated future events and expectations that
are not historical facts. The forward-looking statements are based on a number
of assumptions and estimates which are inherently subject to significant
uncertainties and contingencies, many of which are beyond the control of the
Company, and reflect future business decisions which are subject to change. A
variety of factors could cause actual results to differ materially from those
anticipated in the Company's forward-looking statements, including the effects
of economic conditions; federal and state legislation regarding welfare reform
and minimum wage increases; competitive conditions in the child care and early
education industries; availability of a qualified labor pool and the impact of
government regulations; various factors affecting occupancy levels; availability
of sites and/or licensing or zoning requirements affecting new center
development; the impact of Year 2000 compliance by the Company or those entities
with which the Company does business; and other risk factors that are discussed
in this report and, from time to time, in other Securities and Exchange
Commission reports and filings. One or more of the foregoing factors may cause
actual results to differ materially from those expressed in or implied by the
statements herein. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date thereof. The Company
undertakes no obligation to publicly release the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof, or thereof, as the case may be, or to
reflect the occurrence of unanticipated events.
19
<PAGE>
PART II
Other Information
Item 6. Exhibit and reports on Form 8-K
(a) Exhibit:
27 Financial Data Schedule
(b) Reports on Form 8-K--None
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this to be signed on its behalf by the undersigned,
thereunto duly authorized:
KINDERCARE LEARNING CENTERS, INC.
(Registrant)
Date: April 15, 1998 /s/ DAVID J. JOHNSON
-----------------------------------------
David J. Johnson
Chairman of the Board of Directors and
Chief Executive Officer
Date: April 15, 1998 /s/ DAN R. JACKSON
-----------------------------------------
Dan Jackson
Vice President, Financial Control and
Planning
(Principal Financial and Accounting
Officer)
21
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> MAY-29-1998
<PERIOD-START> MAY-31-1997
<PERIOD-END> MAR-06-1998
<EXCHANGE-RATE> 1
<CASH> 9,361
<SECURITIES> 0
<RECEIVABLES> 19,982
<ALLOWANCES> 2,394
<INVENTORY> 0
<CURRENT-ASSETS> 47,199
<PP&E> 628,867
<DEPRECIATION> 124,841
<TOTAL-ASSETS> 593,653
<CURRENT-LIABILITIES> 79,436
<BONDS> 411,554
0
0
<COMMON> 95
<OTHER-SE> 30,592
<TOTAL-LIABILITY-AND-EQUITY> 593,653
<SALES> 0
<TOTAL-REVENUES> 450,972
<CGS> 0
<TOTAL-COSTS> 415,883
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,932
<INTEREST-EXPENSE> 31,960
<INCOME-PRETAX> 3,647
<INCOME-TAX> 1,240
<INCOME-CONTINUING> 2,407
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,407
<EPS-PRIMARY> .26
<EPS-DILUTED> .26
</TABLE>
