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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 28, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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 No.)
650 NE Holladay Street, Suite 1400
Portland, OR 97232
(Address of principal executive offices)
(503) 872-1300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
(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
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 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 known information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant (assuming for purposes of this calculation, without conceding
that all executive officers and directors are "affiliates") at August 20, 1999
was $14,458,092.
The number of shares of the registrant's common stock, $.01 par value per
share, outstanding at August 20, 1999 was 9,474,197.
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PART I
ITEM 1. BUSINESS
Forward Looking Statements
When used in this report, press releases and elsewhere by KinderCare
Learning Centers, Inc. ("KinderCare") or management 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 KinderCare'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.
These 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 KinderCare, 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
KinderCare's forward-looking statements, including: the effects of economic
conditions; federal and state legislation regarding welfare reform,
transportation safety and minimum wage increases; competitive conditions in the
child care and early education industries; availability of a qualified labor
pool, the impact of labor organization efforts and the impact of government
regulations concerning labor and employment issues; 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
KinderCare or those entities with which KinderCare 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. KinderCare 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.
General
KinderCare, founded in 1969, is the leading for-profit provider of early
childhood care and education services in the United States in terms of number of
centers, number of children we serve and net revenue. We provide center-based
early childhood care and education services five days a week throughout the year
to children between the ages of six weeks and twelve years. At August 20, 1999,
we operated a total of 1,142 child care centers and served approximately 119,000
children and their families. Of the 1,142 centers, 1,140 are located in 39
states in the United States and two centers are located in the United Kingdom.
KinderCare's total center licensed capacity at August 20, 1999 was approximately
145,000.
We operate two primary types of child care and early education centers:
KinderCare community centers and KinderCare At Work(R) centers. KinderCare
community centers, which comprise the vast majority of our centers, typically
provide center-based early childhood care and education services to children
between the ages of six weeks and 12 years. At our KinderCare At Work(R)
centers, we partner with employers to meet their individual needs for
on-site/near-site child care for their employees. At August 20, 1999, we
operated 40 on-site/near-site centers for 35 different employers.
The Company's centers are open throughout the year, generally Monday
through Friday from 6:30 a.m. to 6:00 p.m., although hours vary by location.
Children are usually enrolled on a weekly basis for either full- or half-day
sessions and are accepted, where capacity permits, on an hourly basis. The
Company's tuition rates vary for children of different ages and by location.
The principal executive offices of the Company are located at 650 N.E.
Holladay Street, Suite 1400, Portland, Oregon 97232 and its telephone number is
(503) 872-1300.
Initiatives Since the Recapitalization
In February 1997, affiliates of Kohlberg Kravis Roberts & Co. ("KKR")
became owners of 83.6% of our outstanding common stock in a recapitalization
transaction. At August 20, 1999, the KKR affiliates owned 82.6% of the
outstanding common stock of KinderCare. Since the recapitalization, we have
effected a number of changes designed to improve the quality of our operations,
including the following:
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New management team. We added several new officers, increasing the depth
and professionalism of our senior management team. We relocated our headquarters
to Portland, Oregon, substantially rebuilt our corporate staff with experienced
professionals and redesigned many management processes.
Increased investment in our people. We took steps to strengthen our field
operations by adding back field management positions that had been eliminated in
prior years, including adding 27 area manager positions to bring our total to
77, and 12 regional support positions during fiscal years 1998 and 1999. These
measures have increased the support and control of our field operations, as well
as the quality and professionalism of our field employees.
Accelerated new center development and improved new center economics. We
developed a new center prototype that reflects a larger and more physically
appealing design than prior prototypes. We added 20 of our new prototype centers
in fiscal year 1998 and 39 more during fiscal year 1999.
Quality initiatives, including accreditation of our centers. We have
pursued a variety of initiatives including the promotion of operating standards
at our centers and the enhancement of training for staff and management
personnel. Although not mandated by any regulatory authority, we are also
pursuing accreditation of our centers by the National Association for the
Education of Young Children ("NAEYC"), a national organization that has
established comprehensive criteria for providing quality early childhood care
and education.
Management focus on center-level performance. Our new management team has
increased the focus of both corporate and field staff on center-level management
of all aspects of our operations. We linked incentives to center-level results,
involved center directors in budgeting and held them accountable for
center-level operating results.
Upgraded base of existing centers. We have invested, and will continue to
invest, in a renovation program that is designed to bring all of our centers to
a company standard for physical plant and equipment and to enhance the curb
appeal of these centers. In addition, we conduct regular strategic reviews of
our centers to assess their profitability and potential. Centers are closed when
our review process indicates that they are not meeting performance expectations.
Improved site selection and new center development process. We have refined
and expanded our new center site selection and development process to more
effectively target not only attractive markets, but also specific locations
within those markets to optimize retail appeal.
Business Strategy
We intend to capitalize on the initiatives that have taken place since the
recapitalization to pursue a business strategy containing the following key
elements:
Continue Accelerated Opening of Centers With Improved Economics. We plan to
expand by continuing our accelerated opening of new community centers in
locations where we believe the market for early childhood care and education
services will support higher tuition rates than our current average rates. We
plan to add approximately 45 to 50 new centers in fiscal year 2000. We believe
there are opportunities to continue to locate centers in many attractive markets
across the United States. To assist us in implementing this accelerated center
opening schedule, we have hired a Senior Director of New Centers, who has
primary responsibility for transitioning our centers from the construction stage
to full operation. KinderCare has opened two community centers from the end of
fiscal year 1999 to August 20, 1999.
Expand Employer-Sponsored Child Care Services. Due to the changing
demographics of today's workforce and the prevalence of dual career families, a
growing number of employers are providing on-site/near-site child care to
attract and retain employees. We consider this to be one of the fastest growing
segments of our industry and a significant opportunity for KinderCare. We intend
to pursue growth in this area of our business through expanded relationships
with our existing customers, as well as expansion of our customer base through
internal growth, selective acquisitions and strategic alliances.
Pursue Strategic Relationships and Acquisitions. We plan to pursue
opportunities for strategic investments in, joint ventures with or acquisitions
of companies in our industry that offer products and services that complement
our business strategy. We believe that these alliances will assist us in
implementing our strategy to become a more broad-based education company.
We intend to pursue opportunities in the following areas:
o Regional or Local Child Care Chains. We seek to acquire existing child
care centers where demographics, quality of facilities, operating
standards and programs complement our business strategy.
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o Employer-Sponsored Child Care. We see an opportunity not only to grow
our existing KinderCare at Work(R) operations internally, but to
expand in this area through acquisitions.
o Educational Content. We believe there is opportunity to selectively
acquire or partner with companies offering educational products and
services that could be delivered to KinderCare's customers to enhance
the value of our services.
o Products and Services to the Kindergarten through 12th Grade Market.
KinderCare believes it has core strengths and a well-developed
corporate infrastructure that position it well for expansion into this
market. These competencies make us an attractive partner for smaller
companies with products or services designed to serve the kindergarten
through 12th grade market.
o Private Schools. We believe that there is an opportunity to establish
a system of for-profit kindergarten through 12th grade private schools
to serve the growing number of parents who are dissatisfied with
current public school systems.
o Charter Schools. Charter schools have arisen as a publicly-funded
alternative to public schools in those states that have passed
enabling legislation. We see an opportunity to acquire or replicate a
successful charter school education and business model in those states
with sufficient per-student funding to support quality programs and
services.
Increase Existing Center Revenue and Customer Retention. KinderCare plans
to increase center occupancy by (a) implementing targeted marketing programs to
further enhance brand image and awareness, (b) enhancing the recruiting,
retention and training of staff, (c) improving customer retention and loyalty,
and (d) implementing center-specific tuition pricing. Our marketing activities
are currently designed to increase new enrollments primarily through local
marketing efforts, including direct mail solicitation, telephone directory
yellow pages and customer referrals. These methods communicate to parents
KinderCare's commitment to quality preschool education and child care by
emphasizing our nurturing environment, educational programs, quality staff and
excellent facilities and equipment.
Because a high quality teaching and administrative staff is a key factor in
maintaining and increasing center occupancy, KinderCare emphasizes recruiting
and retaining qualified center personnel. KinderCare's recruiting process seeks
to identify high quality candidates for its teaching, center director and area
manager positions. Additionally, we reward center directors and area managers
through a bonus program which is primarily based on center operating profit
performance.
KinderCare also strives to increase occupancy by improving customer
retention and loyalty. We initiate parent orientation meetings at centers during
the fall enrollment season, organize parent involvement programs and conduct
ongoing market research on customer satisfaction.
Capitalize on Strong Brand Identity and Reputation. Our high quality early
childhood care and education services, developed over 30 years, have enabled us
to develop a strong brand identity and reputation in the child care segment of
our industry, where personal trust and parent referrals play an important role
in attracting new customers. This brand recognition enhances our new center
marketing efforts and encourages potential customers to try our centers.
Throughout all of our communications, including informational brochures, parent
handbooks, advertising and marketing materials, we reinforce our image as the
market leader with a caring, well-trained staff and the resources necessary to
provide high quality early childhood care and education services.
Our large, nationwide customer base gives us the ability to spread the
costs of programs and services over a large number of centers, as well as giving
us a valuable distribution network for new products and services. We also
believe our strong market position enhances our opportunities to capitalize on
consolidation of the highly fragmented child care segment of the education
industry, which will enable us to acquire small regional operators that meet our
standards for quality and growth potential. Our market position also makes us an
attractive strategic partner for companies with compatible products and
services.
Further Enhance Our Educational Programs. We have developed high quality
proprietary curricula that incorporate age-specific learning programs based on
the latest educational research. We periodically revise our educational programs
to take advantage of the latest developments in early childhood education. All
of our educational programs are designed to respond to the needs of children and
parents we serve and to prepare children for success in school and in life. We
provide curriculum-specific training for our staff to ensure effective delivery
of our programs. See "Educational Programs."
Improve Our Operational Efficiencies. KinderCare plans to further improve
operating performance through continued evaluation of processes and systems and
by spreading relatively fixed corporate and centralized support costs over a
larger center base. We plan to continue our focus on center-level economics,
which makes each center director accountable for center expenditures. We believe
this focus will continue to have a positive effect on cost control at our
centers.
We also plan to improve our operating efficiencies by continually reviewing
the effectiveness and coverage of our support services and by providing
management with more timely information through our nationwide communications
network and our automated information systems. We are in the process of
implementing additional upgrades to our information systems, which will enable
us to obtain better and more timely information on such items as net revenues,
expenses, enrollments, attendance, payroll
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and staff hours. We continue to assess new ways in which we can effectively use
the internet and company-wide intranet applications, providing improved
communications among the corporate office and our centers and better access to
corporate information.
Increase Number of Accredited Centers. We will continue to pursue NAEYC
accreditation as we seek to improve the quality of our centers, which we believe
will further enhance our brand and help us grow in the future. We believe that
the accreditation process strengthens our centers by motivating the teaching
staff and enhancing their understanding of developmentally-appropriate early
childhood practices. At August 20, 1999, we had 127 accredited centers and
approximately 400 centers in various stages of the accreditation process. We
expect the recent hiring of four regional accreditation coordinators to increase
our rate of center accreditation.
Educational Programs
We have developed a complete array of educational programs, including five
separate proprietary age-appropriate curricula, under the direction of our
education department. KinderCare's educational programs recognize the recent
emphasis by experts on brain growth during the first years of a child's life,
the importance of adult-child interactions and environmental stimulation and
brain compatible learning, which focuses on teaching children in a way that is
compatible with how the brain is believed to develop during various stages of a
child's development. With this recognition of the importance of early childhood
education, KinderCare has positioned itself as "Your Child's First
Classroom(TM)". Educational programs are revised on a rotating basis to take
advantage of the latest research in early childhood learning, and, when
appropriate, qualified consultants are retained to assist in the revision
process.
Our curricula and other educational programs are designed to respond to the
needs of the children and parents we serve, and to prepare children for success
in school and in life. Our curricula provide for advancement of the whole child,
promoting physical, emotional, intellectual and social development.
Training. We provide curriculum-specific training for our teachers and
caregivers to assist them in effectively delivering our programs. Each
curriculum is designed to provide teachers with the necessary autonomy to
enhance the programs based on the resources and needs of the local community. We
emphasize selection of staff who are responsive to children and each teacher is
given the opportunity, training and resources to plan active and creative
programs. Opportunity for professional growth is available through a systematic
training progression. This process involves company-wide training programs, such
as the Certification of Excellence Program, which is a professional development
program we have established. We also make available more advanced training
opportunities for our teachers and caregivers, including tuition reimbursement
for employment-related college courses or course work in connection with
obtaining a Child Development Associate credential.
Infant and Toddler Curriculum. Our program for infants and toddlers,
Welcome to Learning(R), is an award winning, brain compatible curriculum
designed for children six weeks to 36 months. The program is in two distinct
parts, targeted first to infants and then to toddlers. The curriculum encourages
children to learn with age- and stage-appropriate learning environments and
activities.
Preschool Curricula. We have two preschool programs designed for children
ages three to five years. My Window On The World(R) encourages inquisitive
children to discover questions and formulate answers using the world of nature.
We use Your Big Backyard, the National Wildlife Federation's magazine for
preschoolers, as a resource for this program. Our Once Upon A Time ...(R)
preschool program is based on children's literature, both classic and modern.
These preschool programs emphasize pre-reading skills, basic math concepts,
developing social skills and problem solving. We are enhancing our preschool
programs with additional reading readiness materials, including
Kinderletters(R), a phonics-based program created by The Rigby Company, a
publisher of literacy and reading materials, to respond to parents' desires for
a greater emphasis on phonics. We believe that school readiness is becoming
increasingly important in customers' selection of a preschool program.
Kindergarten Curriculum. For five year olds, we offer the Kindergarten at
KinderCare: Journey to Discovery(R) program. In this thematic program, which
incorporates resources developed by the nationally recognized company,
Development Learning Materials, a division of Science Research Associates, Inc.,
children learn through play, hands-on exploration and activities and experiences
that are real-world and sensory in nature. This curriculum emphasizes reading
development, beginning math concepts and those skills necessary to give children
the confidence to succeed in school. KinderCare offers a kindergarten program in
approximately two-thirds of its centers that meets state requirements for
instructional curriculum prior to first grade.
School-aged Curriculum. KinderCare's KC Imagination Highway(R) program is a
project approach based curriculum, designed to meet the needs of school-aged
children. The program includes a number of stimulating and challenging
activities and projects, ranging from loud and active to quiet, thoughtful and
social, and culminates with an event or finale for parents. Parents are
increasingly looking for content-rich after-school experiences that keep
school-aged children interested and involved. We believe our school-aged
curricula provide these experiences.
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Employer-Sponsored Child Care Services
Through KinderCare At Work(R) we can offer a more flexible format for our
services by individually evaluating the needs of each employer to find the
appropriate format to fit the employer's needs for on-site/near-site employee
child care. Our current relationships with employers include centers owned or
leased by KinderCare and various forms of management contracts. KinderCare At
Work(R) can also assist organizations in one or more aspects of implementing a
child care related benefit, including needs assessments, financial analysis,
architectural design and development plans.
At August 20, 1999, KinderCare operated 40 on-site/near-site
employer-sponsored child centers for 35 different employers, including Fred
Meyer, Inc., Lego Systems, Inc., The Walt Disney Company, Inc. and several other
businesses, universities and hospitals. Of the 40 on-site/near-site centers, 37
were KinderCare owned or leased and three were operated by KinderCare under
management fee contracts. The management contracts for KinderCare At Work(R)
centers generally provide for a three to five year initial period with renewal
options ranging from two to five years. Our compensation under these existing
agreements is generally based on a fixed fee with annual escalation.
Marketing, Advertising and Promotions
We conduct our marketing efforts through various promotional activities and
customer retention and customer referral programs. In addition, our marketing
efforts include targeted direct mail, yellow pages advertising and have also
included magazine and radio advertisements. We continually evaluate the
effectiveness of our marketing efforts and attempt to use the most
cost-effective means of advertising. Since the recapitalization, we have
improved our ability to gain information about our current and potential
customers to better target our direct marketing efforts and have focused more
attention on marketing to our existing customers in an effort to increase
retention of those customers. We have also improved the content of our marketing
materials by more prominently highlighting our high quality curricula. Our
consumer magazine advertising campaign for fiscal year 1999 won the 1998 Award
of Excellence from Communication Arts Advertising Annual.
Since the recapitalization, we have also focused on the marketing
opportunities that are a natural outgrowth of our other improved business
practices, such as (1) choosing sites that are convenient for customers to
encourage drive-by identification, (2) renovating our existing centers to
enhance their curb appeal and (3) upgrading the signage at our centers to a
uniform standard to enhance customer recognition of our centers.
Our center pre-opening marketing efforts include direct mail and newspaper
support, as well as local public relations support. Every new center hosts an
open house and provides center tours where parents and children have
opportunities to talk with staff, visit classrooms and play with educational
toys and computers. Currently, potential customers can call toll free or access
the Company's internet website (http://www.kindercare.com) to locate their
nearest KinderCare center or obtain information. The information on our website
is not incorporated by reference in this document.
During fiscal years 1998 and 1999, we introduced a new video training
program designed to enhance the marketing capabilities of our center directors
and assistant directors. This training program emphasizes telephone skills and
how to give a center tour. Other aspects of the local marketing programs offered
by each KinderCare center include periodic extended evening hours and a five
o'clock snack that is provided to the children as they are picked up by their
parents. KinderCare also sponsors a referral program under which parents receive
tuition credits for every new customer referral that leads to a new enrollment.
Our center directors and area managers also are encouraged to market to
parents via local speaking engagements and interaction with local regulatory
agencies that may then refer potential customers to KinderCare. We hold parent
orientation meetings in the fall at which center directors and staff explain our
educational programs as well as policies and procedures. We also periodically
hold "meet the teachers" events and have established programs to involve parents
in center activities and events. These events offer us an opportunity to build
an awareness of the center in the local community.
Tuition
We determine tuition charges based upon a number of factors including the
age of the child, full- or part-time attendance, location and competition.
Tuition is generally collected on a weekly basis in advance, and tuition rates
are generally adjusted company-wide each year in the fall. However, we may
adjust individual center rates at any time based on competitive position,
occupancy levels and consumer demand. Our focus on center-level economics has
enabled us to better implement market specific increases in rates without losing
occupancy in centers where the quality of our services, demand and other market
conditions support such increases. KinderCare's weighted average tuition rate on
a weekly basis was $113.45 for the fiscal year ended May 28, 1999, $106.81 for
the fiscal year ended May 29, 1998 and $101.93 for the fiscal year ended May 30,
1997.
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Seasonality
New enrollments are generally highest in September and January. Enrollment
generally decreases 5% to 10% during the summer months and calendar year-end
holiday periods.
Site Selection for New Centers
KinderCare seeks to identify attractive new sites for its centers in large,
metropolitan markets and smaller, growth markets that meet our operating and
financial goals and where we believe the market for our services will support
higher tuition rates than our current average rates. Our real estate department
performs comprehensive studies of geographic markets to determine potential
areas for new center development. These studies include analysis of existing
center areas, land prices, development costs, competitors, tuition pricing and
demographic data such as population, age, household income, employment levels
and growth opportunities for that market. In addition, we review state and local
laws, including zoning requirements, development regulations and child care
licensing regulations to determine the timing and probability of receiving the
necessary approvals to construct and operate a new center.
Our site selection targets reflect the desire of our customers for
convenience and more appealing locations and take advantage of the opportunities
generated by drive-by customers. We make specific site location decisions for
new centers based upon a detailed site analysis that includes feasibility and
demographic studies, as well as comprehensive financial modeling. Within a
prospective area, we often analyze several alternative sites. Each potential
site is evaluated against our standards for location, convenience, visibility,
traffic patterns, size, layout, affordability and functionality, as well as
potential competition.
The real estate and development staff have worked closely with operations,
purchasing, human resources and marketing personnel to streamline the new center
opening process, resulting in the more efficient transition of new centers from
the construction phase to field operation. Our goal is to open new centers with
the highest achievable occupancy and profitability levels.
KinderCare's Real Estate Asset Management Program
At August 20, 1999, KinderCare owned 756, or 66%, of its 1,142 centers,
with land and buildings having a net book value of $562.1 million. We routinely
analyze the profitability of our existing centers through a detailed evaluation
that considers leased versus owned status, lease options, operating history,
premises expense, capital requirements, area demographics, competition and site
assessment. Through this evaluation process, the asset management staff
formulates a plan for the property reflecting our strategic direction and
marketing objectives. In growth markets, we attempt to renegotiate long-term,
fixed-rate leases for leased centers, avoiding rental increases tied to market
value or consumer indices. If a center is underperforming, exit strategies are
employed to minimize our financial liability. We make an effort to time center
closures to minimize the negative impact on affected families. During fiscal
year 1999, KinderCare closed 26 centers, 25 of which were leased. From the end
of fiscal year 1999 to August 20, 1999, 20 centers were closed, 19 of which were
leased.
KinderCare is in the process of negotiating the early termination of
operating leases for 36 underperforming centers. During the fourth quarter of
fiscal 1999, KinderCare recorded a provision of $4.0 million related to such
terminations. The provision includes an estimate of discounted future lease
payments and anticipated incremental costs related to closure of the centers. At
August 20, 1999, 19 of the 36 underperforming centers were closed. The remainder
of such centers are expected to be closed by mid fiscal year 2000.
Our asset management department also manages the disposition of all surplus
real estate owned or leased by us. These real estate assets include undeveloped
sites, unoccupied buildings and closed centers. We disposed of 12 surplus
properties in fiscal year 1999 and two more after May 28, 1999. We were in the
process of marketing an additional 12 surplus properties at August 20, 1999.
Employees
At August 20, 1999, we employed approximately 25,400 people. Of these
employees, approximately 275 were corporate headquarters employees, 300 were
regional or area managers and their support personnel and the remainder were
employees at our centers. Center employees include center directors, assistant
directors, regular full-time and part-time teachers, temporary and substitute
teachers, teachers' aides and non-teaching staff, including cooks and van
drivers. Approximately 8% of our 25,400 employees, including all management and
supervisory personnel, are salaried all other employees are paid on an hourly
basis. We do not have an agreement with any labor union and believe that we have
good relations with our employees.
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Human Resources
Regional and Center Personnel. At August 20, 1999, our center operations
were organized into four regions and 77 areas reporting to four Regional Vice
Presidents and a Vice President of Operations. In fiscal year 1999, we expanded
field management by adding five additional area manager positions and four
accreditation coordinators. Individual centers are managed by a center director
and an assistant director. All center directors participate in periodic training
programs or meetings and must be familiar with applicable state and local
licensing regulations.
Training Programs. All center teachers and other non-management staff are
required to attend an initial half-day training session prior to being assigned
full duties and to complete a six week on-the-job basic training program.
Additionally, we have developed and implemented training programs to certify
personnel as teachers of various age groups in accordance with our internal
standards and in connection with our age-specific educational programs. We are
in the process of implementing a new video series of orientation and staff
training programs that is expected to be easier to deliver and more effective
than prior programs. We have added a Director of Employee Development to oversee
implementation of our quality training programs.
Employee Benefits. During fiscal year 1999, we enhanced our employee
benefit programs, employee recognition programs and our recruitment and
retention efforts. Those enhancements include the addition of matching
contributions by KinderCare to our 401(k) plan, the addition of a vision plan
and the implementation of programs to reward employees for length of service.
The corporate human resources department monitors salaries and benefits for
competitiveness. Due to high employee turnover rates in the child care segment
of the education industry in general, we emphasize recruiting and retaining
qualified personnel. The turnover of personnel experienced by KinderCare and
other providers in the child care segment of our industry results in part from
the fact that a significant portion of our employees earn entry-level wages and
are part-time employees.
Communication and Information Systems
We have a fully automated information, communication and financial
reporting system for our centers. This system uses personal computers and links
every center and regional office to the corporate headquarters. The system
provides timely information on such items as net revenues, expenses,
enrollments, attendance, payroll and staff hours. We recently completed the
installation of new personal computers and fax machines in all of our centers.
The new personal computers use a Windows NT(R) operating system, which is
expected to result in more efficient information processing and exchange between
the field and corporate office. In an effort to provide more comprehensive and
timely information throughout our business, we have upgraded our financial
reporting software, replaced our payroll system and are implementing upgraded
human resources information systems to better manage our workforce.
KinderCare also seeks to improve its operating efficiencies by continually
reviewing the effectiveness and coverage of its support services and providing
management with more timely information through its nationwide communications
network and its automated information systems. KinderCare employs company-wide
e-mail and on-line inquiry for all managers.
We have expanded our nationwide network to include the internet and
company-wide intranet applications. Through the use of Netscape Navigator(R)
software, KinderCare's intranet allows center directors to have immediate access
to corporate information and provides center directors with the ability to
distribute reports and questionnaires, update databases and revise center
listings on a daily basis. We regularly seek new uses for our intranet as a tool
to communicate with our centers.
Most of our computer systems have been upgraded, modified or replaced in
order to render these systems Year 2000 compliant. For additional information
regarding our Year 2000 compliance, see "Item 7. Management's Discussion and
Analysis of Financial Conditions and Results of Operations--Year 2000
Compliance."
Competition in the Child Care Segment of the Education Industry
The child care segment of the education industry is competitive and highly
fragmented, with the most important competitive factors generally based upon
reputation, location and price. Our competition consists principally of the
following:
o local nursery schools and child care centers, some of which are
non-profit, including church-affiliated centers
o other for profit, center-based child care providers
o providers of child care services that operate out of homes
o substitutes for organized child care, such as relatives, nannies and
one parent caring full-time for a child
o preschool and before and after school programs provided by public
schools
Local nursery schools, child care centers and in-home providers generally
charge less for their services than we do. Many church-affiliated and other
non-profit child care centers have lower operating expenses than we do and may
receive donations and/or other funding to subsidize operating expenses.
Consequently, operators of such centers often charge tuition rates that are less
than our rates. In addition, fees for home-based care are normally substantially
lower than fees for center-based care because providers of home care are not
always required to satisfy the same health, safety, insurance or operational
regulations as our centers.
7
<PAGE>
In some markets we also face competition with respect to preschool services
and before and after school programs from public schools that offer such
services at little or no cost to parents. The number of school districts
offering these services is growing and we expect this form of competition to
increase in the future.
Our competition also includes other large, national, for-profit companies
providing child care and education services, many of which offer child care at a
substantially lower price than we do. KinderCare competes by offering high
quality education and recreational programs, contemporary, well-equipped
facilities, trained teachers and supervisory personnel and a range of services,
including infant and toddler care, drop-in service and the transportation of
older children enrolled in our before and after school program between our
centers and schools.
Our KinderCare At Work(R) centers compete with center-based child care
chains, some of which have divisions which compete for employer-sponsorship
opportunities, and with other organizations that focus exclusively on the
work-site segment of the child care market.
Insurance
KinderCare's insurance program currently includes the following types of
policies: workers' compensation, comprehensive general liability, automobile
liability, property, excess "umbrella" liability, directors' and officers'
liability and employer practices liability. The policies provide for a variety
of coverages, are subject to various limits, and include substantial deductibles
or self-insured retention. Special insurance is sometimes obtained with respect
to specific hazards, if deemed appropriate and available at reasonable cost. At
August 20, 1999, KinderCare had approximately $7.4 million of letters of credit
available to secure its obligations under retrospective and self-insurance
programs. However, claims in excess of, or not included within, KinderCare's
coverage may be asserted, and the effects of these claims could have an adverse
effect on KinderCare.
Governmental Laws and Regulations Affecting KinderCare
Center Licensing Requirements. Our centers are subject to numerous state
and local regulations and licensing requirements and we have policies and
procedures in place in order to comply with such regulations and requirements.
Although these regulations vary from jurisdiction to jurisdiction, government
agencies generally review the fitness and adequacy of buildings and equipment,
the ratio of staff personnel to enrolled children, staff training, record
keeping, the dietary program, the daily curriculum and compliance with health
and safety standards. In most jurisdictions, these agencies conduct scheduled
and unscheduled inspections of the centers and licenses must be renewed
periodically. Most jurisdictions establish requirements for background checks or
other clearance procedures for new employees of child care centers. Repeated
failures of a center to comply with applicable regulations can subject it to
sanctions, which might include probation or, in more serious cases, suspension
or revocation of the center's license to operate and could also lead to
sanctions against our other centers located in the same jurisdiction. In
addition, this type of action could lead to negative publicity extending beyond
that jurisdiction.
We believe that our operations are in substantial compliance with all
material regulations applicable to our business. However, there is no assurance
that a licensing authority will not determine a particular center to be in
violation of applicable regulations and take action against that center. In
addition, there may be unforeseen changes in regulations and licensing
requirements, such as changes in the required ratio of child center staff
personnel to enrolled children, that could have a material adverse effect on our
operations. There are currently a number of states in which we operate that are
considering or in the process of implementing changes to their regulatory and
licensing requirements, which may significantly increase our costs to operate in
those states.
Child Care Tax Incentives. Tax incentives for child care programs
potentially can benefit KinderCare. Section 21 of the Internal Revenue Code of
1986 provides a federal income tax credit ranging from 20% to 30% of specified
child care expenses. For eligible taxpayers with one child, a credit can be
claimed on a maximum of $2,400 of eligible expenses. For eligible taxpayers with
two or more children, a credit can be claimed on a maximum of $4,800 of eligible
expenses. The fees paid to KinderCare by eligible taxpayers for child care
services qualify for these tax credits, subject to the limitations of Section 21
of the Code. However, these tax incentives are subject to change.
Child Care Assistance Programs. During fiscal year 1999, approximately 18%
of KinderCare's net revenues were generated from federal and state child care
assistance programs, primarily the Child Care and Development Block Grant and
At-Risk Programs. These programs are designed to assist low-income families with
child care expenses and are administered through various state agencies.
Although additional funding for child care may be available for low income
families as part of welfare reform, there is no assurance that we will benefit
from any such additional funding.
Americans with Disabilities Act. The federal Americans with Disabilities
Act, which became effective in 1992, and similar state laws prohibit
discrimination on the basis of disability in public accommodations and
employment. We have not experienced any material adverse impact as a result of
these laws.
8
<PAGE>
Federal Transportation Regulations. In August and September of 1998, the
National Highway Transportation Safety Administration ("NHTSA") issued
interpretive letters that appear to modify its interpretation of regulations
governing the sale by automobile dealers of vehicles intended to be used for the
transportation of children to and from school. These letters indicate that
dealers may no longer sell 15-passenger vans for this use, and that any vehicle
designed to transport eleven persons or more must meet federal school bus
standards if it is likely to be used significantly to transport children to and
from school or school-related events. These interpretations will affect the type
of vehicle that may be purchased by KinderCare in the future for use in
transporting children between schools and our centers. We anticipate that
NHTSA's recent interpretation and potential related changes in state and federal
transportation regulations will increase our costs to transport children because
school buses are more expensive to purchase and maintain and may require drivers
who have commercial licenses. We have ordered approximately 590 school buses,
315 of which have been delivered at August 20, 1999. The remainder are expected
to be delivered in early fiscal year 2000.
Trademarks and Service Marks
We own and use various registered and unregistered trademarks and service
marks covering the name KinderCare, its schoolhouse logo and a number of other
names, slogans and designs, including:
o Helping America's Busiest o Your Child's First Classroom(TM)
Families(R) o Look At Me(R)
o KC Imagination Highway(R) o My Window On The World(R)
o Kid's Choice(TM) o SmallTalk(R)
o KinderCare At Work(R) o The Whole Child is the
o Let Me Do It(R) Whole Idea(R)
o Let's Move, Let's Play(R) o Welcome To Learning(R)
A federal registration in the United States is effective for ten years and may
be renewed for ten-year periods perpetually, subject only to required filings
based on continued use of the mark by the registrant. A federal registration
provides the presumption of ownership of the mark by the registrant and notice
of its exclusive right to use such mark throughout the United States in
connection with the goods or services specified in the registration. In
addition, KinderCare has registered various trademarks and service marks in
other countries, including Canada, Germany, Japan, the People's Republic of
China and the United Kingdom. However, many of these foreign countries require
us to use the marks locally to preserve our registration rights and, because we
have not conducted business in foreign countries other than the United Kingdom,
we may not be able to maintain our registration rights in all other foreign
countries. KinderCare believes that its name and logo are important to its
operations and intends to maintain and renew its trademark and service mark
registrations in the United States and the United Kingdom.
9
<PAGE>
ITEM 2. PROPERTIES
Corporate Headquarters. KinderCare's corporate office is located in
Portland, Oregon. KinderCare entered into a ten year lease of approximately
73,000 square feet of office space, commencing on November 17, 1997. The lease
calls for annual rental payments of $22.50 per square foot for the first five
years of the lease term and $26.50 for the final five years, with one five-year
extension option at market rent.
Child Care and Education Centers. At August 20, 1999, we owned 756 of our
operating centers, leased or subleased 383 operating centers and operated
three centers under management contracts. KinderCare owns or leases other
centers which have not yet been opened or which are being held for disposition.
In addition, we own real property held for future development of centers.
A typical KinderCare community center is a one-story, air-conditioned
building located on approximately one acre of land, with larger capacity centers
situated on parcels ranging from one to four acres of land, constructed in
accordance with model designs generally developed by KinderCare. The community
centers contain open classroom and play areas and complete kitchen and bathroom
facilities and can accommodate from 65 to 270 children, with most centers able
to accommodate 95 to 170 children. Over the past few years, KinderCare has
opened community centers that are larger in size with a capacity ranging from
120 to 230 children. New prototype community centers accommodate approximately
180 children, depending on site and location. Each center is equipped with a
variety of audio and visual aids, educational supplies, games, puzzles, toys and
outdoor play equipment. Centers also have vehicles used for field trips and
transporting children enrolled in KinderCare's after school program. All
KinderCare community centers are equipped with computers for children's
educational programs.
KinderCare At Work(R) provides employer-sponsored child care programs
individualized for each such sponsor. Facilities are on or near the employer's
site and range in capacity from 80 to 225 children.
The KinderCare community and KinderCare At Work(R) centers operated by
KinderCare at August 20, 1999 were located as follows:
<TABLE>
<CAPTION>
Community KinderCare At
Location Centers Work(R) Centers Total
- ------------------------ --------- --------------- --------------
<S> <C> <C> <C>
United States:
Alabama 10 -- 10
Arizona 16 2 18
Arkansas 3 -- 3
California 97 -- 97
Colorado 28 -- 28
Connecticut 12 2 14
Delaware 4 -- 4
Florida 67 6 73
Georgia 39 -- 39
Illinois 80 2 82
Indiana 27 1 28
Iowa 8 2 10
Kansas 16 -- 16
Kentucky 13 1 14
Louisiana 11 2 13
Maryland 24 -- 24
Massachusetts 19 -- 19
Michigan 33 2 35
Minnesota 37 -- 37
Mississippi 4 -- 4
Missouri 45 -- 45
Nebraska 10 1 11
Nevada 10 -- 10
New Hampshire 2 -- 2
New Jersey 37 4 41
New Mexico 7 -- 7
10
<PAGE>
Community KinderCare At
Location Centers Work(R) Centers Total
- ------------------------ --------- --------------- --------------
<S> <C> <C> <C>
New York 3 1 4
North Carolina 34 -- 34
Ohio 67 4 71
Oklahoma 9 -- 9
Oregon 13 4 17
Pennsylvania 41 -- 41
Rhode Island -- 1 1
Tennessee 25 1 26
Texas 119 1 120
Utah 6 1 7
Virginia 50 -- 50
Washington 50 1 51
Wisconsin 24 1 25
United Kingdom 2 -- 2
-------- -------- --------
1,102 40 1,142
======== ======== ========
</TABLE>
Center Maintenance Program. We use a centralized maintenance program to
ensure consistent high-quality maintenance of our facilities located across the
country. Each of our maintenance technicians in our facilities department has a
van stocked with spare parts and handles emergency, routine and preventative
maintenance functions through a central telephone dispatch and systematic
checklist system. During fiscal year 1999, we implemented a computerized
maintenance system which connects all centers, maintenance technicians and
central dispatch. During fiscal year 1999, we hired eleven additional
maintenance technicians, which reduced the number of centers per technician from
17 to approximately 15. Specific geographic areas are supervised by two regional
directors and twelve facility managers, each of whom manages between four and
seven technicians.
Center Renovation Program. We have undertaken a renovation program, that
includes interior and playground renovations and signage replacements, to ensure
that all of our centers meet specified standards that we establish. We believe
that our properties are in good condition and are adequate to meet our current
and reasonably anticipated future needs.
Environmental Compliance. We have established an environmental assessment
process to reduce the likelihood of incurring liabilities under applicable
environmental laws, regulations and ordinances that could result from the
acquisition or lease of prospective new centers or properties. Following the
acquisition or lease of a new center site, our area managers, facilities
personnel and center directors continue to review and report on activities at or
near our centers that could result in environmental problems. We have not
incurred material expenditures to address environmental conditions at our
centers or our owned or leased properties during the past three years, nor are
we aware of circumstances likely to cause us to incur any such material
expenditures in the future.
ITEM 3. LEGAL PROCEEDINGS
We do not believe that there are any pending or threatened legal
proceedings that, if adversely determined, would have a material adverse effect
on our business or operations. However, we are subject to claims and litigation
arising in the ordinary course of business, including claims and litigation
involving allegations of physical or sexual abuse of children. We have notice of
such allegations that have not yet resulted in claims or litigation. Although we
cannot be assured of the ultimate outcome of the allegations, claims or suits of
which we are aware, we believe that none of the allegations, claims or suits,
either individually or in the aggregate, will have a material adverse effect on
our business or operations. In addition, we cannot predict the negative impact
of publicity that may be associated with any such allegation, claim or suit.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
11
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCK HOLDER MATTERS
Price Range of Common Stock
Since February 13, 1997, the date of the recapitalization, our common stock
has been traded in the over-the-counter market, in the "pink sheets" published
by the National Quotation Bureau, and has been listed on the OTC Bulletin Board
under the symbol "KDCR." The market for our common stock must be characterized
as a limited market due to the relatively low trading volume and the small
number of brokerage firms acting as market makers. The following table sets
forth, for the periods indicated, information with respect to the high and low
bid quotations for our common stock as reported by a market maker for our common
stock. The quotations represent inter-dealer quotations without retail markups,
markdowns or commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
Common Stock
----------------------
High Bid Low Bid
--------- ---------
Fiscal year ended May 28, 1999
<S> <C> <C>
First quarter $ 26 1/2 $ 21 1/2
Second quarter 26 1/2 21 1/2
Third quarter 24 21 1/2
Fourth quarter 33 22
Fiscal year ended May 29, 1998
First quarter $ 19 3/8 $ 18
Second quarter 19 1/2 18
Third quarter 19 5/8 18 1/8
Fourth quarter 22 18 3/4
</TABLE>
Approximate Number of Security Holders
At August 20, 1999, there were 88 holders of record of our common stock.
Dividend Policy
During the past three fiscal years, we have not declared or paid any cash
dividends or distributions on our capital stock. We do not intend to pay any
cash dividends for the foreseeable future but instead intend to retain earnings,
if any, for the future operation and expansion of our business. Any
determination to pay dividends in the future will be at the discretion of our
board of directors and will be dependent upon our results of operations,
financial condition, contractual restrictions, restrictions imposed by
applicable law and other factors deemed relevant by our board of directors. In
addition, both our credit facilities and the indenture governing our senior
subordinated notes currently contain limitations on our ability to declare or
pay cash dividends on our common stock. Future indebtedness or loan arrangements
incurred by us may also prohibit or restrict our ability to pay dividends and
make distributions to our stockholders.
12
<PAGE>
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth selected historical consolidated financial
and other data for KinderCare, with dollars in thousands, except per share
amounts and child care center data. KinderCare's fiscal year ends on the Friday
closest to May 31. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Item 8. Financial Statements
and Supplementary Data" included elsewhere in this document.
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------------------------------------
May 28, 1999 May 29, 1998 May 30, 1997 May 31, 1996 June 2, 1995
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues, net ............................. $ 632,985 $ 597,070 $ 563,135 $ 541,264 $ 506,505
Operating expenses, exclusive of
recapitalization expenses,
restructuring and other charges
(income), net........................... 565,238 546,376 515,481 488,071 456,607
Recapitalization expenses (a).............. -- -- 17,277 -- --
Restructuring and other charges (income),
net (b).................................. 4,157 5,201 10,275 1,484 (888)
------------ ------------ ------------ ------------ ------------
Total operating expenses................. 569,395 551,577 543,033 489,555 455,719
------------ ------------ ------------ ------------ ------------
Operating income ..................... 63,590 45,493 20,102 51,709 50,786
Investment income, net .................... 490 612 232 250 2,635
Interest expense .......................... (41,843) (40,677) (22,394) (16,727) (17,318)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes and
extraordinary items................... 22,237 5,428 (2,060) 35,232 36,103
Income tax expense ........................ 8,711 2,002 3,375 13,549 14,037
------------ ------------ ------------ ------------ ------------
Income (loss) before extraordinary items. 13,526 3,426 (5,435) 21,683 22,066
Extraordinary items, net of income
taxes (c) ............................... -- -- (7,532) -- --
------------ ------------ ------------ ------------ ------------
Net income (loss)..................... $ 13,526 $ 3,426 $ (12,967) $ 21,683 $ 22,066
============ ============ ============ ============ ============
Income (loss) per share:
Basic - Income (loss) before
extraordinary items...................... $ 1.43 $ 0.36 $ (0.33) $ 1.10 $ 1.10
Extraordinary items, net................. -- -- (0.46) -- --
------------ ------------ ------------ ------------ ------------
Net income (loss)..................... $ 1.43 $ 0.36 $ (0.79) $ 1.10 $ 1.10
============ ============ ============ ============ ============
Diluted - Income (loss) before
extraordinary items...................... $ 1.40 $ 0.36 $ (0.33) $ 1.07 $ 1.07
Extraordinary items, net................. -- -- (0.46) -- --
------------ ------------ ------------ ------------ ------------
Net income (loss)..................... $ 1.40 $ 0.36 $ (0.79) $ 1.07 $ 1.07
============ ============ ============ ============ ============
Other Financial Data:
Adjusted EBITDA (d)........................ $ 105,131 $ 93,247 $ 81,907 $ 87,165 $ 77,969
Adjusted EBITDA margin..................... 16.6% 15.6% 14.5% 16.1% 15.4%
Depreciation............................... $ 37,384 $ 42,553 $ 34,253 $ 33,972 $ 28,071
Capital expenditures....................... 96,634 84,954 43,748 67,304 74,376
Child Care Center Data:
Number of centers at end of period......... 1,160 1,147 1,144 1,148 1,137
Center licensed capacity at end of period . 146,000 143,000 143,000 141,000 n/c (e)
Occupancy (f).............................. 69.9% 70.6% 70.0% 70.3% n/c (e)
Average tuition rate (g)................... $ 113.45 $ 106.81 $ 101.93 $ 99.24 n/c (e)
Balance Sheet Data (at end of period) :
Property and equipment, net................ $ 566,365 $ 508,113 $ 471,558 $ 468,525 $ 442,446
Total assets............................... 638,797 591,539 569,878 527,476 503,274
Total debt ................................ 425,795 403,097 394,889 146,617 160,394
Stockholders' equity ..................... 51,790 31,900 27,707 (h) 262,435 241,216
See accompanying notes to selected historical consolidated financial and other
data.
</TABLE>
13
<PAGE>
Notes to Selected Historical Consolidated Financial and Other Data
(a) In fiscal year 1997, KinderCare incurred non-recurring expenses in order to
fund the transactions undertaken in the recapitalization.
(b) Restructuring and other charges (income), net, included the following, with
dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------------------------------
May 28, May 29, May 30, May 31, June 2,
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Restructuring charges, net...... $ 3,561 $ 5,697 $ 3,400 $ 6,499 $ --
Write-off of offering costs..... 596 -- -- -- --
Losses on asset impairments..... -- -- 6,900 6,319 --
Write-offs of assets............ -- -- 1,518 -- --
Gains on litigation settlements. -- (496) (1,543) (11,334) (888)
========== ========== ========== ========== ==========
$ 4,157 $ 5,201 $ 10,275 $ 1,484 $ (888)
========== ========== ========== ========== =========-
</TABLE>
(c) In fiscal year 1997, KinderCare retired debt prior to maturity, the losses
on which were recorded as extraordinary items.
(d) Adjusted EBITDA is defined by KinderCare as its income before interest
expense, income taxes, depreciation, amortization, recapitalization
expenses, restructuring and other charges (income), net, investment income,
net and extraordinary items. Adjusted EBITDA is not intended to indicate
that cash flow is sufficient to fund all of our cash needs or represent
cash flow from operations as defined by generally accepted accounting
principles. In addition, Adjusted EBITDA should not be used as a tool for
comparison as the computation may not be similar for all companies.
(e) Prior to June 3, 1995, KinderCare used average occupancy and the
three-year-old tuition rate to measure performance. Average occupancy was
defined as net revenues for the respective period divided by the building
capacity of each of the centers multiplied by such center's basic tuition
rate for full-time, three-year-old students for the respective period. The
three-year-old tuition rate represented the weekly tuition rate paid by a
parent for a three-year-old child to attend a center five full days during
a week. The tuition rate represented an approximate average of all tuition
rates at each center. The child care center data utilized in prior fiscal
years to measure performance is as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------
May 31, 1996 June 2, 1995
------------ ------------
<S> <C> <C>
Center building capacity at end of period........ 141,000 137,000
Average occupancy................................ 76% 76%
Average three-year-old tuition rate.............. $ 100 $ 96
</TABLE>
At June 3, 1995, KinderCare changed its method of measuring performance to
the defined criteria of occupancy and average tuition rate. Prior to fiscal
1996, KinderCare did not track licensed capacity or full-time equivalent
attendance. Therefore, occupancy and average tuition rate could not be
calculated for fiscal year 1995.
(f) Occupancy, a measure of the utilization of center capacity, is defined by
KinderCare as the full-time equivalent, or FTE, attendance at all of the
centers divided by the sum of the licensed capacity of all of the centers.
FTE attendance is not a strict head count. Rather, the methodology used 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 equates to 0.5 FTE. The FTE
measurement of center capacity utilization does not necessarily reflect the
actual number of full- and part-time children enrolled.
(g) Average tuition rate is defined by KinderCare as net revenues, exclusive of
fees, which are primarily reservation and registration fees, 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 center
five full days during a week. The occupancy mix between full- and part-time
children, however, can significantly affect these averages with respect to
any specific child care center.
14
<PAGE>
Notes to Selected Historical Consolidated Financial and Other Data
(continued)
(h) In connection with the merger and recapitalization during fiscal year 1997,
KinderCare paid $382.4 million to redeem common stock, warrants and
options. KKR contributed $148.8 million in common equity for approximately
83.6% of the 9,368,421 shares outstanding immediately after the
recapitalization and existing stockholders retained approximately 16.4% of
the shares outstanding immediately after the merger.
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the
consolidated financial statements and the related notes included elsewhere in
this document. KinderCare's fiscal year ends on the Friday closest to May 31.
The information presented refers to the 52 weeks ended May 28, 1999 as "fiscal
1999," May 29, 1998 as "fiscal 1998" and May 30, 1997 as "fiscal 1997."
KinderCare's first fiscal quarter has 16 weeks and the remaining quarters each
have 12 weeks. The fiscal year ended June 2, 2000, or "fiscal 2000," will be a
53-week fiscal year and the fourth quarter of fiscal 2000 will be a 13-week
quarter.
KinderCare defines occupancy, a measure of the utilization of center
capacity, as the full-time equivalent, or FTE, attendance at all of the centers
divided by the sum of the licensed capacity of all of the centers. FTE
attendance is not a strict head count. Rather, the methodology used 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 equates to 0.5 FTE. The FTE measurement
of center capacity utilization does not necessarily reflect the actual number of
full- and part-time children enrolled.
KinderCare defines average tuition rate as net revenues, exclusive of fees,
which are primarily reservation and registration fees, 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 center five full days during a week. The
occupancy mix between full-time and part-time children at a center, however, can
significantly affect these averages with respect to any specific center.
16
<PAGE>
Fiscal 1999 compared to Fiscal 1998
The following table shows the comparative operating results of KinderCare,
with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Fiscal Change
Year Ended Percent Year Ended Percent Amount
May 28, of May 29, of Increase/
1999 Revenues 1998 Revenues (Decrease)
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Revenues, net.................................. $ 632,985 100.0% $ 597,070 100.0% $ 35,915
---------- ---------- ---------- ---------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense............................ 324,872 51.3 304,190 51.0 20,682
Field and corporate expense............... 23,996 3.8 22,971 3.8 1,025
---------- ---------- ---------- ---------- ----------
Total salaries, wages and benefits..... 348,868 55.1 327,161 54.8 21,707
Depreciation................................ 37,384 5.9 42,553 7.1 (5,169)
Rent........................................ 29,536 4.7 27,985 4.7 1,551
Other ...................................... 149,450 23.6 148,677 24.9 773
Restructuring and other charges, net........ 4,157 0.7 5,201 0.9 (1,044)
---------- ---------- ---------- ---------- ----------
Total operating expenses.................. 569,395 90.0 551,577 92.4 17,818
---------- ---------- ---------- ---------- ----------
Operating income....................... $ 63,590 10.0% $ 45,493 7.6% $ 18,097
========== ========== ========== ========== ==========
</TABLE>
Revenues, net--Net revenues increased $35.9 million, or 6.0%, to $633.0
million in fiscal 1999 from fiscal 1998. The increase in net revenues is
primarily attributable to a company-wide tuition increase implemented in the
first and second quarters of fiscal 1999, as well as targeted local increases
implemented throughout the fiscal year. The average tuition rate increased
$6.64, or 6.2%, to $113.45 for fiscal 1999 from $106.81 for fiscal 1998.
Occupancy declined 0.7 percentage points to 69.9% for fiscal 1999 from 70.6% for
fiscal 1998. The decline is primarily a result of the increased number of new
centers, particularly centers opened in the fourth quarter of the fiscal year.
New centers tend to open with lower than average enrollment and grow enrollment
over a three to four year maturity cycle. Existing center enrollment has been
relatively flat as FTE attendance has been adversely affected in some markets by
a public school provision of preschool and full day kindergarten for some
children.
During fiscal 1999, centers opened within the current and two most previous
fiscal years contributed incremental net revenues of $21.5 million over fiscal
1998. The increase in net revenues was offset in part by an incremental
reduction of $7.3 million due to the closure of centers. During fiscal 1999,
KinderCare opened 39 centers, 37 community centers and two KinderCare At Work(R)
centers, and closed 26 centers. During fiscal 1998, KinderCare opened 20
community centers and closed 17 centers.
Salaries, wages and benefits--Expenses for salaries, wages and benefits,
which include bonus incentives, increased $21.7 million, or 6.6%, to $348.9
million in fiscal 1999 from fiscal 1998. The expense directly associated with
the centers was $324.9 million in fiscal 1999, an increase of $20.7 million from
fiscal 1998. The center level increase is primarily attributable to increased
staff wage rates and, to a lesser degree, increased hours. The expense related
to field management and corporate administration was $24.0 million in fiscal
1999, an increase of $1.0 million from fiscal 1998. The increase is attributable
to the addition of field management positions during fiscal 1999 and 1998, which
was offset by reduced bonus expense.
At the center level, salaries, wages and benefits expense, as a percentage
of net revenues, increased slightly to 51.3% for fiscal 1999 from 51.0% for
fiscal 1998 due to higher wage rates discussed above. See "Inflation and Wage
Increases." Total salaries, wages and benefits expense, as a percentage of net
revenues, increased to 55.1% for fiscal 1999 from 54.8% for fiscal 1998.
Depreciation--Depreciation expense decreased $5.2 million to $37.4 million
in fiscal 1999 from fiscal 1998. The decrease is due to additional depreciation
expense recorded in fiscal 1998 of $9.4 million related to a change in the
estimated useful life and salvage value of center auxiliary equipment. Auxiliary
equipment is comprised of educational supplies such as toys, books and
playground equipment, furniture, cots and kitchen and other equipment used in
the operation of a center. See note 1 to KinderCare's consolidated financial
statements. The decrease related to center auxiliary equipment was offset by
additional depreciation expense as a result of the property and equipment added
at our new centers.
Rent--Rent expense increased $1.6 million to $29.5 million in fiscal 1999
from fiscal 1998. The increase is primarily a result of KinderCare's occupancy
of its new headquarters in Portland, Oregon during the second quarter of fiscal
1998. See "Item 2. Properties." In addition, the rental rates experienced on
renewed center leases and center leases entered into currently are higher than
those experienced in previous fiscal years.
17
<PAGE>
Other operating expenses--Other operating expenses increased $0.8 million,
or 0.5%, to $149.5 million in fiscal 1999 from $148.7 million in fiscal 1998.
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. The increase is due primarily to
increased center pre-opening costs, janitorial and maintenance expenses and
taxes and licenses, offset by reduced expenses related to insurance. As a
percentage of net revenues, other operating expenses decreased to 23.6% for
fiscal 1999 from 24.9% for fiscal 1998. The improvement in other operating
expenses, as a percentage of net revenues, is due to effective overall cost
control by management.
Restructuring and other charges, net-- Restructuring and other charges,
net, included the following, with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Restructuring charges, net.................. $ 3,561 $ 5,697
Write-off of offering costs................. 596 --
Gains on litigation settlements............. -- (496)
------------ ------------
$ 4,157 $ 5,201
============ ============
</TABLE>
KinderCare is in the process of negotiating the early termination of
operating leases for 36 underperforming centers. During the fourth quarter of
fiscal 1999, a provision of $4.0 million was recorded related to such
terminations. The provision includes an estimate of discounted future lease
payments and anticipated incremental costs related to closure of the centers.
During the fourth quarter of fiscal 1997, KinderCare decided to relocate
its corporate offices from Montgomery, Alabama to Portland, Oregon in fiscal
1998. In connection with the relocation, KinderCare recognized $0.2 and $5.7
million in restructuring costs during fiscal 1999 and 1998, respectively.
Expenses incurred were primarily for the retention, recruitment and relocation
of employees and travel costs related to the office relocation. During the third
quarter of fiscal 1999, the remaining restructuring reserve balance related to
employee termination benefits of $0.6 million was reversed following a favorable
determination in an arbitration proceeding.
During the fourth quarter of fiscal 1999, $0.6 million of non-recurring
costs were written off in connection with KinderCare's decision not to proceed
with a public equity offering.
During the third quarter of fiscal 1998, KinderCare, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorneys' fees, as settlement of a claim in the United States District Court in
New York.
Operating income--Operating income increased $18.1 million to $63.6 million
in fiscal 1999 from fiscal 1998. The increase is due primarily to the higher
average tuition rate which resulted in increased net revenues, the decrease in
depreciation expense and the effective control of operating expenses, offset in
part by increased labor costs, as discussed above.
EBITDA, defined as income before interest expense, income taxes,
depreciation and amortization, for fiscal 1999 was $101.5 million, $12.8 million
above fiscal 1998. As a percentage of net revenues, EBITDA for fiscal 1999 was
16.0% compared to 14.8% for fiscal 1998. Adjusted EBITDA, defined as EBITDA
exclusive of restructuring and other charges, net, investment income and
extraordinary items was $105.1 million in fiscal 1999, an increase of $11.9
million from fiscal 1998. As a percentage of net revenues, Adjusted EBITDA was
16.6% for fiscal 1999 and 15.6% for fiscal 1998. Neither EBITDA nor Adjusted
EBITDA is intended to indicate that cash flow is sufficient to fund all of
KinderCare's cash needs or represent cash flow from operations as defined by
generally accepted accounting principles. In addition, EBITDA and Adjusted
EBITDA should not be used as tools for comparison as the computation may not be
similar for all companies.
Interest expense--Interest expense was $41.8 and $40.7 million in fiscal
1999 and 1998, respectively. KinderCare's weighted average interest rate on its
long-term debt, including amortization of deferred financing costs, was 9.9% for
fiscal 1999 versus 10.1% for fiscal 1998.
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<PAGE>
Income tax expense--Income tax expense during fiscal 1999 and 1998 of $8.7
and $2.0 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 and foreign income taxes,
offset by tax credits.
Net income - Net income during fiscal 1999, was $13.5 million, or $1.43 per
share, compared to $3.4 million, or $0.36 per share, during fiscal 1998. The
$10.1 million, or 294.8%, increase over fiscal 1998 was due primarily to
increased operating income and the absence of a depreciation charge related to a
change in estimate in fiscal 1998, as discussed above.
Fiscal 1998 compared to Fiscal 1997
The following table shows the comparative operating results of KinderCare,
with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Fiscal Year Change
Ended Percent Ended Percent Amount
May 29, of May 30, of Increase/
1998 Revenues 1997 Revenues (Decrease)
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenues, net............................ $ 597,070 100.0% $ 563,135 100.0% $ 33,935
----------- ----------- ----------- ----------- -----------
Operating expenses:
Salaries, wages and benefits:
Center expense....................... 304,190 51.0 284,646 50.6 19,544
Field and corporate expense.......... 22,971 3.8 15,934 2.8 7,037
----------- ----------- ----------- ----------- -----------
Total salaries, wages and benefits...... 327,161 54.8 300,580 53.4 26,581
Depreciation............................ 42,553 7.1 34,253 6.1 8,300
Rent.................................... 27,985 4.7 28,140 4.9 (155)
Other .................................. 148,677 24.9 152,508 27.1 (3,831)
Recapitalization expenses............... --- --- 17,277 3.1 (17,277)
Restructuring and other charges, net.... 5,201 0.9 10,275 1.8 (5,074)
----------- ----------- ----------- ----------- -----------
Total operating expenses............. 551,577 92.4 543,033 96.4 8,544
----------- ----------- ----------- ----------- -----------
Operating income................... $ 45,493 7.6% $ 20,102 3.6% $ 25,391
=========== =========== =========== =========== ===========
</TABLE>
Revenues, net--Net revenues increased $33.9 million, or 6.0%, to $597.1
million in fiscal 1998 from fiscal 1997. The increase in net revenues was
primarily attributable to an approximate 4.4% weighted average tuition increase
implemented in the second quarter of fiscal 1998. The average tuition rate and
occupancy, respectively, increased to $106.81 and 70.6% for fiscal 1998 from
$101.93 and 70.0% for fiscal 1997. Centers opened during fiscal 1998 and 1997
contributed incremental net revenues of $12.6 million in fiscal 1998. The
positive effect of those factors on net revenues was offset in part by center
closings.
During fiscal 1998, KinderCare opened 20 community centers and closed 17
centers. During fiscal 1997, KinderCare opened 16 centers, including 15
community centers and one KinderCare at Work(R) center, and closed or sold 20
centers. Total licensed capacity was approximately 143,000 at the end of both
fiscal 1998 and 1997.
Salaries, wages and benefits--Expenses for salaries, wages and benefits,
which include incentives, increased $26.6 million, or 8.8%, to $327.2 million in
fiscal 1998 from fiscal 1997. The expense directly associated with the centers
was $304.2 million in fiscal 1998, an increase of $19.5 million from fiscal
1997. The center level increase was attributable to increased staff wage rates,
employee health costs and bonus expense.
The expense related to field management and corporate administration was
$23.0 million in fiscal 1998, an increase of $7.0 million from fiscal 1997. The
increase was attributable to the addition of 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 revenues, increased only slightly to 51.0% for fiscal 1998 from 50.6% for
fiscal 1997 despite increased wage rates and bonus expense due to the control of
labor hours by field management. Total salaries, wages and benefits expense, as
a percentage of net revenues, increased to 54.8% for fiscal 1998 from 53.4% for
fiscal 1997.
Depreciation--Depreciation expense increased $8.3 million to $42.6 million
in fiscal 1998 from fiscal 1997 due primarily to additional depreciation expense
of $9.4 million related to a change in the estimated useful life and salvage
value of center auxiliary equipment. See note 1 to to KinderCare's consolidated
financial statements. Exclusive of the impact from the change in estimate,
depreciation expense decreased slightly due to the effect of assets reaching the
end of their estimated depreciable lives.
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<PAGE>
Rent--Rent expense remained relatively flat at $28.0 million for fiscal
1998 and $28.1 million for fiscal 1997. During fiscal 1998, 17 leased centers
were closed, while three leased centers were opened. The rental rates
experienced on leases entered into currently are higher than those experienced
in previous periods. Administrative rent expense increased primarily as a result
of KinderCare's occupancy of its new headquarters in Portland, Oregon during the
second quarter of fiscal 1998.
Other operating expenses--Other operating expenses decreased $3.8 million,
or 2.5%, to $148.7 million in fiscal 1998 from fiscal 1997. The decrease was
primarily due to a reduction in expenses related to self-insurance, which was
offset by additional marketing expense to fund a targeted marketing program
during the fall of fiscal 1998 and increased bad debt expense. As a percentage
of net revenues, other operating expenses decreased to 24.9% for fiscal 1998
from 27.1% for fiscal 1997. The improvement in other operating expenses, as a
percentage of net revenues, was due to effective cost control by management.
Recapitalization expenses--During fiscal 1997 and in connection with the
recapitalization of KinderCare, KinderCare repaid the then outstanding $91.6
million balance on KinderCare's previous $150.0 million credit facility and paid
$382.4 million to redeem common stock, warrants and options. In order to fund
the recapitalization, KinderCare issued $300.0 million principal amount of its
9 1/2% senior subordinated notes, entered into a $300.0 million revolving credit
facility, borrowed $50.0 million against a term loan facility and issued
7,828,947 shares of common stock to affiliates to KKR. During fiscal 1997,
non-recurring recapitalization costs of approximately $17.3 million were
incurred and expensed and financing costs of approximately $27.2 million were
deferred and are being amortized over the lives of the new debt facilities.
See notes 2 and 8 to KinderCare's consolidated financial statements.
Restructuring and other charges, net--Restructuring and other charges, net,
included the following, with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------
May 29, 1998 May 30, 1997
------------ ------------
<S> <C> <C>
Corporate office restructuring charges........ $ 5,697 $ 3,400
Losses on asset impairments................... -- 6,900
Write-offs of assets.......................... -- 1,518
Gains on litigation settlements............... (496) (1,543)
------------ ------------
$ 5,201 $ 10,275
============ ============
</TABLE>
During fiscal 1997, KinderCare decided to relocate its corporate offices
from Montgomery, Alabama to Portland, Oregon in fiscal 1998. In connection with
the relocation, KinderCare recognized $5.7 million in restructuring costs in
fiscal 1998, primarily expenses incurred in the retention, recruitment and
relocation of employees and travel costs related to the office relocation.
During the fourth quarter of fiscal 1997, restructuring costs, primarily
severance related, of $3.4 million and a $5.0 million charge to write down
KinderCare's then headquarters facility in Montgomery, Alabama to net realizable
value were recognized.
During the fourth quarter of fiscal 1997, KinderCare recorded impairment
losses of $1.9 million, comprised of $1.3 million with respect to long-lived
assets held in the United Kingdom and $0.6 million related to anticipated
closure costs for Kids Choice(TM) centers, which are centers that cater solely
to school age children during before and after school hours in separate
facilities designed for this age group. KinderCare has discontinued implementing
this concept in its new centers. Additionally, charges of approximately $1.5
million were incurred to write-off deferred pre-opening costs on new centers and
certain marketing materials.
During the third quarter of fiscal 1998 KinderCare, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorneys' fees, as settlement of KinderCare's claim in the United States
District Court in New York. During the second quarter of fiscal 1997, a $1.5
million interest payment was received from Enstar Group Inc., KinderCare's
former parent, in connection with a settlement of KinderCare's claim in the U.S.
Bankruptcy court in Montgomery, Alabama.
Operating income--Operating income increased $25.4 million to $45.5 million
in fiscal 1998 from fiscal 1997. Operating income before recapitalization
expenses, restructuring and other charges, net, increased $3.0 million to $50.7
million in fiscal 1998 from fiscal 1997. The increase is primarily due to the
higher average tuition rate and occupancy.
20
<PAGE>
growth combined with strong cost controls, which was offset partially by
additional depreciation expense of $9.4 million due to a change in estimate, as
discussed above.
EBITDA for fiscal 1998 of $88.7 million was $41.6 million above fiscal
1997. As a percentage of net revenues, EBITDA for fiscal 1998 was 14.8% compared
to 8.4% for fiscal 1997. Adjusted EBITDA was $93.2 million in fiscal 1998, an
increase of $11.3 million from fiscal 1997. As a percentage of net revenues,
Adjusted EBITDA was 15.6% for fiscal 1998 and 14.5% for fiscal 1997. Neither
EBITDA nor Adjusted EBITDA is intended to indicate that cash flow is sufficient
to fund all of KinderCare's cash needs or represent cash flow from operations as
defined by generally accepted accounting principles.
Interest expense--Interest expense increased to $40.7 million in fiscal
1998 from $22.4 million in fiscal 1997. This increase was substantially
attributable to the $350.0 million of long-term debt which was incurred in the
third quarter of fiscal 1997 to fund the recapitalization and repay $91.6
million on KinderCare's then existing line of credit. KinderCare's weighted
average interest rate on its long-term debt, including amortization of deferred
financing costs, was 10.1% for fiscal 1998 versus 8.5% for fiscal 1997.
Income tax expense--Income tax expense during fiscal 1998 and 1997 of $2.0
and $3.4 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
fiscal 1997, non-deductible recapitalization expenses, offset by tax credits.
Extraordinary items--During fiscal 1997, KinderCare 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 income taxes of $4.1 million. In connection with the
recapitalization 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 KinderCare's previous credit facility.
Net income - Net income, during fiscal 1998, was $3.4 million, or $0.36 per
share, compared to a net loss of $13.0 million, or $(0.79) per share, during
fiscal 1997. The $16.4 million growth in net income was due primarily to
increased operating income, despite the recordation of a depreciation charge
related to a change in estimate in fiscal 1998, and the absence of
recapitalization expenses and extraordinary items, as discussed above, during
fiscal 1998.
Liquidity and Capital Resources
KinderCare's principal sources of liquidity are cash flow generated from
operations and borrowings under the $300.0 million revolving credit facility.
KinderCare's principal uses of liquidity are meeting debt service requirements,
financing its capital expenditures and renovations and providing working
capital.
In connection with the recapitalization, KinderCare entered into credit
facilities totaling $390.0 million, comprised of (a) a $90.0 million term loan
facility, of which $50.0 million was drawn at the time of the recapitalization
and $40.0 million has since expired, and (b) a $300.0 million revolving credit
facility. In addition, KinderCare issued $300.0 million of 9 1/2% senior
subordinated notes. At May 28, 1999, KinderCare was committed on outstanding
letters of credit totaling $42.0 million and had outstanding draws of $35.0
million under the revolving credit facility. KinderCare's availability under the
revolving credit facility at May 28, 1999 was $223.0 million.
The term loan facility is subject to mandatory repayment with the proceeds
of asset sales and debt offerings and a portion of excess cash flow, as defined
in such facility. The term loan facility will mature on February 13, 2006 and
provides for nominal annual amortization. The revolving credit facility will
terminate on February 13, 2004.
KinderCare's consolidated net cash provided by operating activities for
fiscal 1999 was $65.1 million, which represents a $8.7 million increase in net
cash flow from operations from fiscal 1998. The increase in net cash flow from
operations is primarily a result of increased net income, the components of
which were discussed above, as well as the net impact of changes in operating
assets and liabilities. Cash and cash equivalents totaled $5.8 million at May
28, 1999, compared to $11.8 million at May 29, 1998, and the ratio of current
assets to current liabilities was 0.39 to one at May 28, 1999, versus 0.46 to
one at May 29, 1998.
21
<PAGE>
During the first quarter of fiscal 1997, KinderCare repurchased $30.0
million aggregate principal amount of its 10 3/8% senior subordinated notes due
2001 at an aggregate price of $31.5 million which resulted in an extraordinary
loss of $1.2 million, net of income taxes. During the second quarter of fiscal
1997 and in connection with the recapitalization, KinderCare announced and
completed a tender offer and consent solicitation for the remainder of its
outstanding 10 3/8% senior subordinated notes seeking the elimination of
substantially all of the restrictive covenants, and 99.7% of such notes were
purchased at an aggregate price of $76.8 million. This second transaction
resulted in an extraordinary loss of $5.3 million, net of income taxes. During
fiscal 1999 and 1998, KinderCare repurchased the $0.2 million remaining
aggregate principal amount of 10 3/8% senior subordinated notes.
On June 3, 1996, the Board of Directors of KinderCare authorized the
repurchase of $23.0 million of KinderCare's common stock. During fiscal 1997,
852,500 shares and 315,000 warrants were repurchased for $14.1 million. All
shares that were repurchased have been retired. Other than in connection with
the recapitalization, no shares of common stock or warrants have been purchased
by KinderCare since July 22, 1996 and the stock buyback programs were terminated
at the effective time of the recapitalization.
KinderCare utilized approximately $7.9 million of net operating loss
carryforwards to offset taxable income in its 1997 and 1998 fiscal years.
Approximately $12.8 million of net operating loss carryforwards are available to
be utilized in future fiscal years. If such net operating loss carryforwards
were reduced due to a change of control or otherwise, KinderCare would be
required to pay additional taxes and interest, which would reduce available
cash.
KinderCare's new enrollments are generally highest in September and January
and attendance generally declines during the summer months and the calendar
year-end holiday period. Decreased attendance may result in decreased liquidity
during these periods.
Management believes that cash flow generated from operations and borrowings
under the revolving credit facility will adequately provide for its working
capital and debt service needs and will be sufficient to fund KinderCare's
expected capital expenditures for the foreseeable future. In addition,
KinderCare is currently evaluating new sources of capital, including the
possible financing of capital expenditures on new centers through a third party
lessor, as well as sale leaseback arrangements with respect to existing centers.
Any future acquisitions, joint ventures or similar transactions may require
additional capital, and such capital may not be available to KinderCare on
acceptable terms or at all. Although no assurance can be given that such sources
of capital will be sufficient, the capital expenditure program has substantial
flexibility and is subject to revision based on various factors, including but
not limited to, business conditions, changing time constraints, cash flow
requirements, debt covenants, competitive factors and seasonality of openings.
If KinderCare experiences a lack of working capital, it may reduce its capital
expenditures. In the long term, if these expenditures were substantially
reduced, in management's opinion, its operations and its cash flow would be
adversely impacted.
Capital Expenditures
We have recently developed a new center prototype that is larger and has a
more physically appealing design than prior prototypes. The new centers have a
proforma licensed capacity of 180, while the centers constructed during fiscal
1996 and earlier have an average licensed capacity of 125. When mature, these
larger centers are designed to generate higher revenues, operating income and
margins than our existing centers. These new centers have a higher average cost
of construction and typically take three to four years to reach maturity. Based
on our prototype, on average a new center should begin to produce positive
EBITDA by the end of its first year of operation and begin to produce positive
net income by the end of its second year of operation. Accordingly, as the
opening of our new centers is accelerated, profitability will be negatively
impacted in the short-term, but is expected to be enhanced in the long-term once
these new, more profitable centers achieve anticipated levels.
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 $1.8 million to $2.2 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 located based upon detailed site analyses
that include feasibility and demographic studies and financial modeling.
However, KinderCare may not be able to successfully negotiate and acquire
properties, meet its targets for new center additions or meet targeted
deadlines. Frequently, new site negotiations are delayed or canceled or
construction is delayed for a variety of reasons, many outside the control of
KinderCare.
During fiscal 1999, KinderCare opened 39 centers, which included 37
community centers and two KinderCare At Work(R) centers. During fiscal 1998,
KinderCare opened 20 community centers. In fiscal 1997, KinderCare opened 16
centers, including 15 community centers and one KinderCare At Work(R) center.
For the next three years, KinderCare expects to increase its rate of opening
and/or acquiring new centers to approximately 45 to 50 new centers per year,
which
22
<PAGE>
KinderCare expects will be primarily community centers, and to continue its
practice of closing centers that are identified as not meeting performance
expectations.
KinderCare also plans to make significant capital expenditures in
connection with a renovation program, which includes interior and playground
renovations and signage replacements, that is designed to bring all of its
existing facilities to a company standard for plant and equipment and to enhance
the curb appeal of these centers.
KinderCare anticipates substantially increasing its capital expenditure
budget over the next several years due to an increased rate of opening and/or
acquiring new centers and the renovation of existing facilities. Based on the
planned increase in capital expenditures, KinderCare expects higher depreciation
expense in the future. However, KinderCare is currently evaluating several
alternatives to finance some or all of such new center growth through operating
leases. Under one alternative, a third-party lessor would finance the
acquisition and construction of centers for lease to KinderCare for a
three-to-five year period, which might be extended. KinderCare would be
contingently liable for a significant portion of the cost through a residual
guarantee or similar arrangement, but would have the right to acquire the
property for its original cost. Under a second alternative, KinderCare could
enter into sale leaseback arrangements with respect to centers that it owns or
acquires. Under such arrangements, KinderCare would be liable for the lease
payments, but may be able to acquire a center for its fair market value at the
end of the applicable lease term. Implementation of either alternative would be
expected to result in lower depreciation, debt and interest expense, and in
higher rent expense, in each case compared to such expenses KinderCare would
incur if it financed the centers directly as owner. There is no assurance that
KinderCare will enter into either of these lease arrangements.
Capital expenditures during fiscal 1999 totaled approximately $96.6
million. Expenditures for new center development were $57.6 million, while
expenditures for renovations of existing facilities were $24.7 million during
fiscal 1999. Purchases of equipment were $10.4 million and corporate information
systems were $3.9 million during fiscal 1999. Capital expenditures during fiscal
1998 and 1997 totaled approximately $85.0 and $43.7 million, respectively.
Expenditures for new center development were $36.5 and $21.3 million, while
expenditures for renovations of existing facilities were $23.7 and $12.2 million
during fiscal 1998 and 1997, respectively. Purchases of equipment were $22.3 and
$7.2 million and corporate information systems were $2.5 and $3.0 million,
respectively, during fiscal 1998 and 1997.
Capital expenditure limits under KinderCare's credit facilities for fiscal
year 2000 are $185.0 million. Capital expenditure limits may be increased by
carryover of a portion of unused amounts from previous periods and are subject
to exceptions. Also, KinderCare has some ability to incur additional
indebtedness under the provisions of the indenture under which the senior
subordinated notes were issued and the credit facilities, including through
mortgages or sale-leaseback transactions.
Year 2000 Compliance
The Year 2000 issue is the result of computer programs being written to use
two digits to define year dates. Computer programs running date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in systems failures or miscalculations causing
disruptions of operations. KinderCare does not use information technology in
delivery of its services, but it uses such technology extensively for financial
reporting systems, payroll, purchasing and other important support functions.
KinderCare has completed an inventory of all hardware, software
applications and data flow exchanges to, or from, third parties and has
identified and assigned test priorities for systems that are critical to
KinderCare's operations. KinderCare has completed testing of approximately 75%
of its critical systems, has determined that there are no material Year 2000
weaknesses in those systems and has remediated any minor weaknesses identified.
KinderCare expects to complete testing of all remaining critical systems and
remediation of any identified weaknesses by the end of September 1999.
KinderCare recently replaced its non-Year 2000 compliant payroll system
based primarily on other business considerations. The new human resource/payroll
software package has been certified by the vendor as Year 2000 compliant and
KinderCare also tested the software for compliance during software
implementation. The total cost of purchasing and implementing the human
resource/payroll system, most of which was incurred in fiscal 1999, was
approximately $2.0 million. These costs have been expensed as incurred or will
be amortized over five years in accordance with generally accepted accounting
principles.
23
<PAGE>
KinderCare has sent Year 2000 compliance questionnaires to third party
vendors, utility companies and government agencies administering subsidized
tuition programs. KinderCare has also requested compliance certificates from any
vendors identified as critical.
KinderCare's critical vendors are representing that they will achieve Year
2000 compliance. KinderCare will continue to monitor the compliance statements
of these vendors and will develop test and/or contingency plans as deemed
necessary.
KinderCare is having limited success in obtaining Year 2000 certifications
from government agencies administering subsidized tuition programs. However,
KinderCare's preliminary assessment of the Year 2000 risks is that, although
payments from these agencies may be delayed, payments ultimately will be made.
Management believes that Year 2000 failures among these agencies would not have
a material adverse effect on KinderCare's business and operations.
KinderCare is developing a contingency plan to address any material Year
2000 risks, and this plan is expected to be complete by the end of September
1999. After that time, KinderCare will continue to monitor its Year 2000 risks
and will make modifications to its contingency plan as appropriate.
KinderCare has not incurred significant incremental costs specifically in
connection with its Year 2000 project and all upgrades and system replacements
made in connection with its Year 2000 project were part of previously planned
software and hardware upgrades. In order to achieve Year 2000 compliance,
KinderCare has needed, and expects that it will continue to need, only existing
employees who otherwise have been assigned to planned upgrades of KinderCare's
software and hardware. Although KinderCare has engaged a Year 2000 consultant to
validate its testing methodology and to conduct a readiness review, the
associated costs are expected to be immaterial.
Notwithstanding KinderCare's progress to date, there are several ways in
which its systems could still be affected by the Year 2000 problem. First, the
software code KinderCare uses in its information systems may not in fact be Year
2000 compliant in all instances. Second, KinderCare may be unable to complete
the remaining upgrades to its information technology systems by the year 2000.
Third, even if KinderCare completes the system upgrades by the year 2000, it may
be unable to fully test and monitor the upgrades, making it difficult for
KinderCare to identify and remedy any problems that might exist. Fourth,
KinderCare's vendors, governmental agencies and other third parties with which
KinderCare does business may be unable to achieve Year 2000 compliance in time.
KinderCare believes that the most reasonably likely worst-case scenario
resulting from KinderCare's inability, or the inability of KinderCare vendors or
government agencies, to become Year 2000 compliant, includes the following
adverse effects:
o Vendor Problems. KinderCare may be unable to receive materials and
supplies due to Year 2000-related failures on the part of its
suppliers causing KinderCare to be unable to meet its scheduled new
center openings. In addition, suppliers of food and other products
necessary to operate existing centers could be affected. Although
KinderCare believes that it could obtain these supplies from alternate
sources, it would likely result in increased costs.
o Payment Delays. As discussed above, payments from governmental
agencies administering tuition programs could be delayed, requiring
KinderCare to fund cash flow requirements through additional
borrowings.
KinderCare's assessment of its Year 2000 compliance is based on numerous
assumptions about future events, including third party modification plans.
However, there can be no guarantee that this assessment is correct and actual
results could differ materially from those anticipated. Specific factors that
might cause such material differences include the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer codes and similar uncertainties.
Recently Issued Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. This statement requires
that an entity recognize all derivatives as either assets or liabilities and
measure those instruments at fair value. The new standard becomes effective for
KinderCare's fiscal year 2002. KinderCare does not believe the adoption of SFAS
No. 133 will have a material impact on its financial position or results of
operations.
24
<PAGE>
Seasonality
New enrollments are generally highest in September and January. Enrollment
generally decreases 5% to 10% during the summer months and calendar year-end
holiday periods.
Governmental Laws and Regulations Affecting KinderCare
Child Care Tax Incentives. Tax incentives for child care programs
potentially can benefit KinderCare. Section 21 of the Internal Revenue Code of
1986 provides a federal income tax credit ranging from 20% to 30% of specified
child care expenses. For eligible taxpayers with one child, a credit can be
claimed on a maximum of $2,400 of eligible expenses. For eligible taxpayers with
two or more children, a credit can be claimed on a maximum of $4,800 of eligible
expenses. The fees paid to KinderCare by eligible taxpayers for child care
services qualify for these tax credits, subject to the limitations of Section 21
of the Code. However, these tax incentives are subject to change.
Child Care Assistance Programs. During fiscal 1999, approximately 18% of
KinderCare's net revenues were generated from federal and state child care
assistance programs, primarily the Child Care and Development Block Grant and
At-Risk Programs. These programs are designed to assist low-income families with
child care expenses and are administered through various state agencies.
Although additional funding for child care may be available for low-income
families as part of welfare reform, there is no assurance that we will benefit
from any such additional funding.
Americans with Disabilities Act. The federal Americans with Disabilities
Act, which became effective in 1992, and similar state laws prohibit
discrimination on the basis of disability in public accommodations and
employment. We have not experienced any material adverse impact as a result of
these laws.
Federal Transportation Regulations. In August and September of 1998, the
National Highway Transportation Safety Administration issued interpretive
letters that appear to modify its interpretation of regulations governing the
sale by automobile dealers of vehicles intended to be used for the
transportation of children to and from school. These letters indicate that
dealers may no longer sell 15-passenger vans for this use, and that any vehicle
designed to transport eleven persons or more must meet federal school bus
standards if it is likely to be used significantly to transport children to and
from school or school-related events. These interpretations will affect the type
of vehicle that may be purchased by KinderCare in the future for use in
transporting children between schools and our centers. We anticipate that
NHTSA's recent interpretation and potential related changes in state and federal
transportation regulations will increase our costs to transport children because
school buses are more expensive to purchase and maintain and may require drivers
who have commercial licenses. We have ordered approximately 590 school buses,
315 of which have been delivered at August 20, 1999. The remainder are expected
to be delivered in early fiscal year 2000.
Inflation and Wage Increases
Management does not believe that the effect of inflation on the results of
KinderCare's operations has been significant in recent periods, including its
last three fiscal years.
Salaries, wages and benefits represented approximately 55.1% of net
revenues for fiscal 1999. Low unemployment rates and positive economic trends
have challenged recruiting efforts and put pressure on wage rates in many of
KinderCare's markets. During 1996, Congress enacted an increase in the federal
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 has not been material to KinderCare's results of
operations. KinderCare believes that, through increases in its tuition rates, it
can recover any future increase in expenses caused by adjustments to the federal
or state minimum wage rates or other market adjustments. However, KinderCare may
not be able to increase its rates sufficiently to offset such increased costs.
KinderCare continually evaluates its wage structure and may implement changes at
targeted local levels.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents.............................................. $ 5,750 $ 11,820
Receivables, net....................................................... 19,299 14,987
Prepaid expenses and supplies.......................................... 6,056 4,939
Deferred income taxes.................................................. 14,442 12,412
------------ ------------
Total current assets.............................................. 45,547 44,158
Property and equipment, net............................................... 566,365 508,113
Deferred income taxes..................................................... 3,499 12,030
Deferred financing costs and other assets................................. 23,386 27,238
------------ ------------
$ 638,797 $ 591,539
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Bank overdrafts........................................................ $ 7,791 $ 8,184
Accounts payable....................................................... 8,825 9,796
Current portion of long-term debt...................................... 11,586 1,839
Accrued expenses and other liabilities................................. 88,899 76,221
------------ ------------
Total current liabilities......................................... 117,101 96,040
Long-term debt............................................................ 414,209 401,258
Self insurance liabilities................................................ 17,368 20,922
Deferred income taxes..................................................... 5,646 5,444
Other noncurrent liabilities.............................................. 32,683 35,975
------------ ------------
Total liabilities................................................. 587,007 559,639
------------ ------------
Commitments and contingencies (Notes 8 and 12)
Stockholders' 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 9,480,837 and 9,474,197 shares,
respectively........................................................ 95 95
Additional paid-in capital............................................. 8,355 2,009
Notes receivable from stockholders..................................... (1,128) (1,325)
Retained earnings...................................................... 44,705 31,179
Accumulated other comprehensive income................................. (237) (58)
------------ ------------
Total stockholders' equity........................................ 51,790 31,900
------------ ------------
$ 638,797 $ 591,539
============ ============
See accompanying notes to consolidated financial statements.
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
Fiscal Year Ended
------------------------------------------
May 28, 1999 May 29, 1998 May 30, 1997
------------ ------------ ------------
<S> <C> <C> <C>
Revenues, net......................................................... $ 632,985 $ 597,070 $ 563,135
------------ ------------ ------------
Operating expenses:
Salaries, wages and benefits....................................... 348,868 327,161 300,580
Depreciation....................................................... 37,384 42,553 34,253
Rent............................................................... 29,536 27,985 28,140
Provision for doubtful accounts.................................... 4,377 5,529 4,697
Other.............................................................. 145,073 143,148 147,811
Recapitalization expenses.......................................... -- -- 17,277
Restructuring and other charges, net............................... 4,157 5,201 10,275
------------ ------------ ------------
Total operating expenses...................................... 569,395 551,577 543,033
------------ ------------ ------------
Operating income................................................ 63,590 45,493 20,102
Investment income..................................................... 490 612 232
Interest expense...................................................... (41,843) (40,677) (22,394)
------------ ------------ ------------
Income (loss) before income taxes and extraordinary items.......... 22,237 5,428 (2,060)
Income tax expense.................................................... 8,711 2,002 3,375
------------ ------------ ------------
Income (loss) before extraordinary items........................... 13,526 3,426 (5,435)
Extraordinary items --loss on early retirement of debt,
net of income taxes of $4,815...................................... -- -- (7,532)
------------ ------------ ------------
Net income (loss)............................................. $ 13,526 $ 3,426 $ (12,967)
============ ============ ============
Income (loss) per common share:
Basic - Income (loss) before extraordinary items................... $ 1.43 $ 0.36 $ (0.33)
Extraordinary items - net of income taxes....................... -- -- (0.46)
------------ ------------ ------------
Net income (loss)............................................. $ 1.43 $ 0.36 $ (0.79)
============ ============ ============
Assuming dilution - Income (loss) before extraordinary items....... $ 1.40 $ 0.36 $ (0.33)
Extraordinary items - net of income taxes....................... -- -- (0.46)
------------ ------------ ------------
Net income (loss)............................................. $ 1.40 $ 0.36 $ (0.79)
============ ============ ============
Weighted average common shares outstanding......................... 9,477,000 9,397,000 16,479,000
============ ============ ============
Weighted average common shares outstanding and potential common
shares.......................................................... 9,633,000 9,398,000 16,479,000
============ ============ ============
See accompanying notes to consolidated financial statements.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Dollars in thousands)
Accumulated
Common Stock Additional Stockholders' Other
------------------ Paid-in Notes Retained Comprehensive Treasury
Shares Amount Capital Receivable Earning Income 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
------------ ----------- -------------
Comprehensive income:
Net loss....................... -- -- -- -- (12,967) -- -- (12,967)
Cumulative translation
adjustment................... -- -- -- -- -- (120) -- (120)
---------- ------ ---------- ------------ ----------- ------------- ---------- ----------
Total comprehensive income. -- -- -- -- (12,967) (120) -- (13,087)
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
------------ ----------- -------------
Comprehensive income:
Net income..................... -- -- -- -- 3,426 -- -- 3,426
Cumulative translation
adjustment.................. -- -- -- -- -- 82 -- 82
---------- ------ ---------- ------------ ----------- ------------- ---------- ----------
Total comprehensive income.. 3,426 82 3,508
Issuance of common stock......... 105,776 1 2,009 (1,490) -- -- -- 520
Proceeds from collection of
stockholders' notes receivable. -- -- -- 165 -- -- -- 165
---------- ------ ---------- ------------ ----------- ------------- ---------- ----------
Balance at May 29, 1998..... 9,474,197 95 2,009 (1,325) 31,179 (58) -- 31,900
------------ ----------- -------------
Comprehensive income:
Net income..................... -- -- -- -- 13,526 -- -- 13,526
Cumulative translation
adjustment................... -- -- -- -- -- (179) -- (179)
---------- ------ ---------- ------------ ----------- ------------- ---------- ----------
Total comprehensive income... -- -- -- -- 13,526 -- 13,347
Issuance of common stock......... 6,640 -- 135 (110) -- -- -- 25
Proceeds from collection of
stockholders' notes receivable. -- -- -- 307 -- -- -- 307
Reversal of pre-fresh-start
contingency.................... -- -- 6,211 -- -- -- -- 6,211
---------- ------ ---------- ------------ ----------- ------------- ---------- ----------
Balance at May 28, 1999..... 9,480,837 $ 95 $ 8,355 $ (1,128) $ 44,705 $ (237) $ -- $ 51,790
========== ====== ========== ============ =========== ============= =========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
Fiscal Year Ended
----------------------------------------
May 28, May 29, May 30,
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operations:
Net income (loss)............................................... $ 13,526 $ 3,426 $ (12,967)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation............................................... 37,384 42,553 34,253
Provision for doubtful accounts............................ 4,377 5,529 4,697
Write-down of property and equipment....................... -- -- 6,300
Amortization of deferred financing costs and other assets.. 3,169 3,111 1,822
(Gain) loss on sales and disposals of property and
equipment, net........................................... (639) 105 (12)
Deferred tax expense....................................... 6,703 1,150 (1,982)
Extraordinary items - loss on early retirement of debt,
net of income taxes...................................... -- -- 7,532
Changes in operating assets and liabilities:
Increase in receivables.................................... (9,453) (7,884) (2,481)
Decrease (increase) in prepaid expenses and supplies....... (1,117) 1,175 3,002
Decrease (increase) in other assets........................ 272 (1,590) 2,004
Increase in accounts payable, accrued expenses and other
liabilities.............................................. 11,072 8,791 8,189
Other, net................................................. (179) 82 (120)
---------- ---------- ----------
Net cash provided by operating activities...................... 65,115 56,448 50,237
---------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment............................... (96,634) (84,954) (43,748)
Proceeds from sales of property and equipment..................... 1,637 3,691 12,438
Proceeds from collection of notes receivable and other............ 1,175 765 396
---------- ---------- ----------
Net cash used by investing activities.......................... (93,822) (80,498) (30,914)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from long-term borrowings................................ 50,000 20,000 350,000
Deferred financing costs.......................................... -- -- (27,160)
Proceeds from issuance of common stock............................ 25 520 151,750
Exercise of stock options and warrants............................ -- -- 20,194
Proceeds from collection of stockholders' notes receivable........ 307 165 --
Payments on long-term borrowings.................................. (27,302) (11,792) (107,558)
Purchase and retirement of common stock........................... -- -- (382,442)
Purchases of treasury stock and warrants.......................... -- -- (11,143)
Bank overdrafts................................................... (393) 2,827 (4,411)
---------- ---------- ----------
Net cash provided (used) by financing activities............... 22,637 11,720 (10,770)
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents.................. (6,070) (12,330) 8,553
Cash and cash equivalents at the beginning of the fiscal year........ 11,820 24,150 15,597
---------- ---------- ----------
Cash and cash equivalents at the end of the fiscal year........... $ 5,750 $ 11,820 $ 24,150
========== ========== ==========
Supplemental cash flow information:
Interest paid.................................................... $ 31,472 $ 36,744 $ 14,325
Income taxes paid, net............................................ 688 561 3,160
See accompanying notes to consolidated financial statements.
</TABLE>
29
<PAGE>
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Nature of Business and Basis of Presentation
KinderCare Learning Centers, Inc. ("KinderCare") is the leading for-profit
provider of early childhood care and education services in the United States. At
May 28, 1999, KinderCare operated a total of 1,160 centers, with 1,158 centers
in 39 states in the United States and two centers in the United Kingdom. The
consolidated financial statements include the financial statements of KinderCare
and its wholly owned subsidiaries: Mini-Skools Limited; KC Development Corp.;
KinderCare Real Estate Corp.; KinderCare Learning Centres Limited and KinderCare
Properties Limited. All significant intercompany balances and transactions have
been eliminated in consolidation.
Fiscal Year
KinderCare'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 12
weeks long. References to fiscal 1999, fiscal 1998 and fiscal 1997 are to the 52
weeks ended May 28, 1999, May 29, 1998 and May 30, 1997, respectively.
Revenue Recognition
KinderCare recognizes revenue for child care services as earned. Net
revenues include tuition, fees and non-tuition income, reduced by discounts.
KinderCare receives fees for reservation, registration, education and
transportation services. Non-tuition income is primarily comprised of field trip
revenue.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash held in banks and liquid
investments with original maturities, at the date of acquisition, not exceeding
90 days.
Property and Equipment
Property and equipment are stated at cost. Depreciation on buildings and
equipment is provided on the straight-line basis over the estimated useful lives
of the assets. Leasehold improvements are amortized over the shorter of the
estimated useful life of the improvements or the lease term, including expected
lease renewal options where KinderCare has the unqualified right to exercise the
option.
KinderCare's property and equipment is depreciated using the following
estimated useful lives:
Life
--------------
Buildings....................................... 10 to 40 years
Building renovations............................ 2 to 10 years
Leasehold improvements.......................... 2 to 10 years
Computer equipment.............................. 3 to 5 years
All other equipment............................. 3 to 10 years
During the fourth quarter of fiscal 1998, KinderCare changed the estimated
useful life of auxiliary equipment to three years and the salvage value to 50%
of the original cost. The change was made to better align the estimated useful
life and salvage value of auxiliary equipment with actual experience.
Depreciation expense increased $9.4 million in fiscal 1998 as a result of the
change in estimate. The after-tax impact was a reduction in net income and basic
and diluted income per share of $5.6 million and $0.60 per share, respectively.
Auxiliary equipment is comprised of educational supplies, such as toys, books
and playground equipment, furniture, cots and kitchen and other equipment used
in the operation of a center. Auxiliary equipment is depreciated to 50% of its
initial cost on the straight-line basis over three years. Subsequent
replacements are expensed when placed in service.
30
<PAGE>
Asset Impairments
Long-lived assets and certain identifiable intangibles to be held and used
by KinderCare are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. KinderCare regularly evaluates long-lived assets for impairment by
comparing projected undiscounted cash flows for each asset to the carrying value
of such asset. If the projected undiscounted cash flows are less than the
asset's carrying value, KinderCare records an impairment charge, if necessary,
to reduce the carrying value to estimated fair value. During fiscal 1999, an
impairment charge of $2.1 million was recorded with respect to certain
underperforming community centers. The impairment charge was included as a
component of depreciation expense in the statement of operations.
Deferred Financing Costs
Deferred financing costs are amortized on a straight-line basis over the
lives of the related debt facilities.
Pre-Opening Costs
Pre-opening costs, which are expensed as incurred, include training
salaries, grand opening and promotion expenses and the initial purchase of forms
and supplies needed to operate the center.
Self-Insurance Programs
KinderCare is self-insured for certain levels of general liability,
workers' compensation, auto, property and employee medical coverage. Estimated
costs of these self-insurance programs are accrued at the undiscounted value of
projected settlements for known and anticipated claims.
Income Taxes
Deferred income taxes result primarily from temporary differences between
financial and tax reporting. If it is more likely than not that some portion or
all of a deferred tax asset will not be realized, a valuation allowance is
recognized.
Stock-Based Compensation
KinderCare measures compensation expense for its stock-based employee
compensation plans using the method prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and provides, if
material, pro forma disclosures of net income and earnings per share as if the
method prescribed by Statement of Financial Accounting Standards ("SFAS") No.
123, Accounting for Stock-Based Compensation, had been applied in measuring
compensation expense.
Comprehensive Income
Effective May 30, 1998, KinderCare adopted SFAS No. 130, Reporting
Comprehensive Income. KinderCare has disclosed comprehensive income and its
components in the consolidated statements of stockholders' equity and
comprehensive income for all periods presented. Comprehensive income does not
include the reversal of certain contingency accruals established in fresh-start
reporting when KinderCare emerged from bankruptcy in March 1993. Such amounts
are credited to additional paid-in capital.
Net Income (Loss) per Share
KinderCare reports basic and diluted net income (loss) per share in
accordance with SFAS No. 128, Earnings per Share. The difference between basic
and diluted net income per share is a result of the dilutive effect of options,
which are considered potential common shares. The potential common shares for
fiscal 1997 were not included in the calculation of diluted loss per share due
to their anti-dilutive effect when a loss before extraordinary items exists.
Reporting for Segments
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information, 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. No changes have been made to KinderCare's current year's or
previous years' disclosures as a result of adoption of SFAS No. 131.
31
<PAGE>
Recently Issued Accounting Pronouncements
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. This statement requires that an entity recognize all
derivatives as either assets or liabilities and measure those instruments at
fair value. The new standard becomes effective for KinderCare's fiscal year
2002. KinderCare does not believe the adoption of SFAS No. 133 will have a
material impact on KinderCare's financial position or results of operations.
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 year's presentation.
2. Recapitalization
On October 3, 1996, KinderCare and KCLC Acquisition Corp. ("KCLC") entered
into an Agreement and Plan of Merger. KCLC was a wholly owned subsidiary of KLC
Associates, L.P. (the "Partnership"), a partnership formed at the direction of
Kohlberg Kravis Roberts & Co. ("KKR"), a private investment firm. Pursuant to
the merger agreement, on February 13, 1997, KCLC was merged with and into
KinderCare, with KinderCare continuing as the surviving corporation. Upon
completion of the merger, affiliates of KKR owned 7,828,947 shares, or
approximately 83.6% of the 9,368,421 shares of common stock outstanding after
the merger. At May 29, 1998, the Partnership owned 82.6% of the outstanding
common stock of KinderCare. 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, KinderCare repaid the then outstanding $91.6
million balance on KinderCare'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, collectively referred to as the
recapitalization, KinderCare issued $300.0 million 9 1/2% senior subordinated
notes, executed a revolving credit facility of $300.0 million, borrowed $50.0
million from a term loan facility and issued 7,828,947 shares of common stock to
KKR affiliates for $148.8 million.
During the third and fourth quarters of fiscal 1997, non-recurring costs in
connection with the recapitalization of approximately $17.3 million were
incurred and expensed. Additionally, financing costs of $27.2 million were
deferred, classified as other assets and are being amortized over the lives of
the applicable debt facilities.
3. Restructuring and Other Charges (Income), Net
KinderCare is in the process of negotiating early termination of operating
leases for 36 underperforming centers. During the fourth quarter of fiscal 1999,
a provision of $4.0 million was recorded related to such terminations. The
provision includes an estimate of discounted future lease payments and
anticipated incremental costs related to closure of the centers. KinderCare
expects the 36 centers to be closed by mid fiscal year 2000. During fiscal 1999,
1998 and 1997, these centers contributed aggregate net revenues of $12.1, $12.6
and $12.9 million, respectively. Aggregate operating losses of $3.2, $2.1 and
$1.4 million were incurred in fiscal 1999, 1998 and 1997, respectively related
to the centers.
During the fourth quarter of fiscal 1997, KinderCare decided to relocate
its corporate offices from Montgomery, Alabama to Portland, Oregon in fiscal
1998. In connection with the relocation, KinderCare recognized $0.2 and $5.7
million in restructuring costs during fiscal 1999 and 1998, respectively.
Expenses incurred were primarily for the retention, recruitment and relocation
of employees and travel costs related to the office relocation. During the third
quarter of fiscal 1999, the remaining restructuring reserve balance related to
employee termination benefits of $0.6 million was reversed following a favorable
determination in an arbitration proceeding. During the fourth quarter of fiscal
1997, restructuring costs, primarily severance related, of $3.4 million and a
$5.0 million charge to write down KinderCare's then headquarters facility in
Montgomery, Alabama to net realizable value were recognized.
32
<PAGE>
During the fourth quarter of fiscal 1999, $0.6 million of non-recurring
costs were written off in connection with KinderCare's decision not to proceed
with a public equity offering.
During the fourth quarter of fiscal 1997, KinderCare recorded impairment
losses of $1.9 million, comprised of $1.3 million with respect to long-lived
assets held in the United Kingdom and $0.6 million related to anticipated
closure costs for Kids Choice(TM) centers, which are centers that cater solely
to school age children during the before and after school hours in separate
facilities designed for this age group. KinderCare has discontinued implementing
this concept in its new centers. Additionally, charges of approximately $1.5
million were incurred to write-off deferred pre-opening costs on new centers and
certain marketing materials.
During the third quarter of fiscal 1998, KinderCare, as a member of the
Presidential Life Global Class Action, received a $0.5 million payment, net of
attorneys' fees, as settlement of a claim in the United States District Court in
New York. During the second quarter fiscal 1997, a $1.5 million interest payment
was received from Enstar Group Inc., KinderCare's former parent, in connection
with a settlement of KinderCare's claim in the U.S. Bankruptcy court in
Montgomery, Alabama.
4. Receivables
Receivables consist of the following, with dollars in thousands:
<TABLE>
<CAPTION>
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Tuition.......................................... $ 22,091 $ 17,817
Allowance for doubtful accounts.................. (4,326) (3,695)
---------- ----------
17,765 14,122
Other............................................ 1,534 865
---------- ----------
$ 19,299 $ 14,987
========== ==========
</TABLE>
5. Prepaid Expenses and Supplies
Prepaid expenses and supplies consist of the following, with dollars in
thousands:
<TABLE>
<CAPTION>
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Prepaid rent..................................... $ 2,898 $ 3,279
Inventories...................................... 2,364 1,224
Other............................................ 794 436
---------- ----------
$ 6,056 $ 4,939
========== ==========
</TABLE>
6. Property and Equipment
Property and equipment consist of the following, with dollars in thousands:
<TABLE>
<CAPTION>
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Land............................................. $ 155,742 $ 147,535
Buildings and leasehold improvements............. 418,413 364,235
Equipment........................................ 130,610 107,472
Construction in progress......................... 22,809 18,097
---------- ----------
727,574 637,339
Accumulated depreciation and amortization........ (161,209) (129,226)
---------- ----------
$ 566,365 $ 508,113
========== ==========
</TABLE>
33
<PAGE>
7. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following, with
dollars in thousands:
<TABLE>
<CAPTION>
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Accrued compensation, benefits and related taxes...... $ 30,734 $ 29,475
Accrued interest...................................... 8,979 8,845
Deferred revenue...................................... 11,312 8,210
Accrued property taxes................................ 7,450 6,605
Accrued restructuring and other charges............... 4,239 1,625
Self insurance........................................ 7,059 7,103
Accrued income taxes.................................. 4,633 3,047
Other................................................. 14,493 11,311
---------- ----------
$ 88,899 $ 76,221
========== ==========
</TABLE>
8. Long-Term Debt
Long-term debt consists of the following, with dollars in thousands:
<TABLE>
<CAPTION>
May 28, May 29,
1999 1998
---------- ----------
<S> <C> <C>
Secured:
Borrowings under revolving credit facility, interest at
adjusted LIBOR plus 1.25% and 2.50%, respectively ($20.0
million at 6.18% and $15.0 million at 6.15% at
May 28, 1999 and 7.15% at May 29, 1998).................... $ 35,000 $ 10,000
Term loan facility, interest at adjusted LIBOR plus
2.50% and 3.00%, respectively (7.41% and 8.14%,
respectively).............................................. 49,000 49,500
Industrial refunding revenue bonds at variable rates of
interest from 3.60% to 5.00% and 4.05% to 5.70%,
respectively, supported by letters of credit, maturing
calendar 1999 to 2009...................................... 33,025 33,025
Real and personal property mortgages payable in monthly
installments
through calendar 1999, interest rate of 8.00%.............. 4,193 5,223
Industrial revenue bonds secured by real property with
maturities to calendar 2005 at interest rates of 5.43%
to 9.75% and 5.95% to 12.75%, respectively................ 4,577 5,190
Unsecured:
Senior subordinated notes due 2009, interest at 9 1/2%,
payable semi-annually...................................... 300,000 300,000
Senior subordinated notes due 2001, interest at 10 3/8 %,
payable semi-annually...................................... -- 159
---------- ----------
425,795 403,097
Less current portion of long-term debt......................... 11,586 1,839
---------- ----------
$ 414,209 $ 401,258
========== ==========
</TABLE>
34
<PAGE>
Credit Facilities
KinderCare has credit facilities which are provided by a syndicate of
financial institutions. The credit facilities consist of the $90.0 million term
loan facility, of which $50.0 million was drawn at the time of the
recapitalization and $40.0 million has since expired, and the $300.0 million
revolving credit facility. The revolving credit facility includes borrowing
capacity of up to $75.0 million for letters of credit and up to $25.0 million
for selected short-term borrowings. The term loan facility will mature on
February 13, 2006 and provides for $0.5 million annual interim amortization. The
revolving credit facility commitment will mature on February 13, 2004.
KinderCare's obligations under the credit facilities are guaranteed by
subsidiaries of KinderCare and secured by a pledge of stock of KinderCare
subsidiaries.
The credit facilities bear interest, at KinderCare's option, at either of
the following rates, which may be adjusted in quarterly increments based on the
achievement of performance goals:
o an adjusted LIBOR rate plus
- in the case of the term loan facility, a debt to EBITDA-dependent
rate ranging from 2.50% to 3.00%
- in the case of the revolving credit facility, a debt to EBITDA or
EBITDA to interest expense-dependent rate ranging from 1.25% to
2.50%
o an alternative base rate plus
- in the case of the term loan facility, a debt to EBITDA-dependent
rate ranging from 1.25% to 1.75%
- in the case of the revolving credit facility, a debt to EBITDA or
EBITDA to interest expense-dependent rate ranging from 0.00% to
1.25%
At May 28, 1999, the amount outstanding on the term loan facility was $49.0
million and the interest rate was 7.41%, which was adjusted LIBOR plus 2.50%.
Under the revolving credit facility, $20.0 million was outstanding at an
interest rate of 6.18% and $15.0 million was outstanding at an interest rate of
6.15%, which was adjusted LIBOR plus 1.25%,
KinderCare also pays a commitment fee calculated at a rate, which may be
adjusted quarterly in increments based on a debt to EBITDA or EBITDA to interest
expense-dependent ratio, ranging from 0.25% to 0.50% per year on the undrawn
portion of the commitments under the credit facilities. At May 28, 1999, the
commitment fee rate was 0.30%. This fee is payable quarterly in arrears.
In addition, KinderCare pays a letter of credit fee based on the face
amount of each letter of credit calculated at the rate per year then applicable
to loans under the revolving credit facility bearing interest based on adjusted
LIBOR, less a fronting fee calculated at a rate equal to 0.125% per year. At May
28, 1999, the letter of credit fee rate was 1.50%, including the fronting fee.
These fees are payable quarterly in arrears. In addition, KinderCare will pay
customary transaction charges in connection with any letter of credit. At May
28, 1999, KinderCare had approximately $42.0 million committed under outstanding
letters of credit.
The term loan facility will be subject to mandatory prepayment with the
proceeds of specified asset sales, specified debt issuances and, on an annual
basis, with 50% of KinderCare's excess cash flow. The term loan facility is also
subject to mandatory prepayment with the proceeds of specified sale leaseback
transactions, child care center mortgage financings and real estate
securitization transactions involving properties owned, operated or leased on
the date of the February 3, 1997 closing of the credit facilities, but only to
the extent that such proceeds exceed $50 million in the aggregate.
The credit facilities contain customary covenants and provisions that
restrict KinderCare's ability to:
o change its business
o declare dividends
o grant liens
o incur additional indebtedness
o make capital expenditures
In addition, the credit facilities provide that KinderCare must meet or
exceed defined interest coverage ratios and must not exceed leverage ratios.
35
<PAGE>
Industrial Revenue Bonds
Series A Through E Industrial Revenue Bonds. KinderCare is obligated to
various issuers of industrial revenue bonds, which are referred to as refunded
IRBs. Such bonds mature from calendar 1999 to 2009. The refunded IRBs were
issued to provide funds for refunding an equal principal amount of industrial
revenue bonds which were used to finance the cost of acquiring, constructing and
equipping specific facilities of KinderCare. At May 28, 1999, the refunded IRBs
bore interest at variable rates from 3.60% to 5.00%, and each is secured by a
letter of credit under the revolving credit facility.
Other IRBs. KinderCare also is obligated to various issuers of other
industrial revenue bonds which mature to calendar 2005. The principal amount of
such IRBs was used to finance the cost of acquiring, constructing and equipping
specific child care facilities and the IRBs are secured by these facilities. At
May 28, 1999, the IRBs bore interest at rates of 5.43% to 9.75%, and each is
secured by a letter of credit under the revolving credit facility.
Senior Subordinated Notes
9 1/2% Notes. In fiscal 1997, KinderCare issued $300.0 million aggregate
principal amount of 9 1/2% unsecured senior subordinated notes under an
indenture between KinderCare and Marine Midland Bank, as trustee. The 9 1/2%
notes are due February 15, 2009 and are general unsecured obligations of
KinderCare, ranked behind all existing and future indebtedness of KinderCare
that is not expressly ranked behind, or made equal with, the notes. The 9 1/2%
notes bear interest at a rate of 9 1/2% per year, payable semi-annually on
February 15 and August 15 of each year.
The 9 1/2% notes may be redeemed at any time, in whole or in part, on or
after February 15, 2002 at a redemption price equal to 104.75% of the principal
amount of the notes in the first year and declining yearly to par at February
15, 2005, plus accrued and unpaid interest, if any, to the date of redemption.
In addition, on or prior to February 15, 2000, KinderCare may also redeem with
the proceeds of one or more equity offerings of KinderCare up to 40% of the
original aggregate principal amount of the notes originally issued at a
redemption price equal to 109.5% of the aggregate principal amount of the notes
plus accrued and unpaid interest, if any, to the date of redemption; provided
that at least 60% of the original aggregate principal amount of the notes remain
outstanding immediately after each such redemption.
Upon the occurrence of a change of control, KinderCare will be required to
make an offer to repurchase all notes properly tendered at a price equal to 101%
of the principal amount plus accrued and unpaid interest to the date of
repurchase.
The indenture governing the notes contains covenants that limit the ability
of KinderCare and its subsidiaries to:
o incur additional indebtedness or liens
o incur or repay other indebtedness
o pay dividends or make other distributions
o repurchase equity interests
o consummate asset sales
o enter into transaction with affiliates
o merge or consolidate with any other person or sell, assign, transfer,
lease, convey or otherwise dispose of all or substantially all of the
assets of KinderCare or its subsidiaries
o enter into guarantees of indebtedness
10 3/8% Notes. In fiscal 1994, KinderCare issued $100.0 million aggregate
principal amount of 10 3/8% unsecured senior subordinated notes due June 1,
2001. In connection with the recapitalization, KinderCare retired 99.7% of the
10 3/8% senior subordinated notes. During fiscal 1999 and 1998 KinderCare
repurchased all remaining aggregate principal amount of 10 3/8% senior
subordinated notes.
36
<PAGE>
Principal Payments
The aggregate minimum annual maturities of long-term debt for the five
fiscal years subsequent to May 28, 1999 are as follows, with dollars in
thousands:
Fiscal Year:
2000.............................................. $ 11,586
2001.............................................. 14,475
2002.............................................. 717
2003.............................................. 4,733
2004.............................................. 35,635
Thereafter........................................ 358,649
---------
$ 425,795
=========
9. Income Taxes
The provision (benefit) for income taxes attributable to income (loss)
before income taxes and extraordinary items consists of the following, with
dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------
May 28, 1999 May 29, 1998 May 30, 1997
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal....................................... $ 1,360 $ 470 $ 3,980
State ........................................ 648 60 815
Foreign....................................... -- 322 562
------------ ------------ ------------
2,008 852 5,357
============ ============ ============
Deferred:
Federal....................................... 6,068 3,224 (1,390)
State ........................................ 758 1,426 (530)
Foreign ...................................... (123) (3,500) (62)
------------ ------------ ------------
6,703 1,150 (1,982)
------------ ------------ ------------
$ 8,711 2,002 3,375
============ ============ ============
</TABLE>
A reconciliation between the statutory federal income tax rate and the
effective income tax rates on income (loss) before income taxes and
extraordinary items, with dollars in thousands, is as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------
May 28, 1999 May 29, 1998 May 30, 1997
------------ ------------ ------------
<S> <C> <C> <C>
Expected tax provision (benefit) on income (loss)
before income taxes and extraordinary items at
the federal rate of 35%......................... $ 7,783 $ 1,900 $ (721)
State income taxes, net of federal tax benefit..... 1,084 265 (235)
Non-deductible and other expenses.................. 93 101 4,594
Foreign subsidiary valuation adjustment............ 436 - -
Tax credits, net of valuation adjustment........... (948) (332) (620)
Other, net......................................... 263 68 357
------------ ------------ ------------
$ 8,711 $ 2,002 $ 3,375
============ ============ ============
</TABLE>
37
<PAGE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are summarized
as follows, with dollars in thousands:
<TABLE>
<CAPTION>
May 28, 1999 May 29, 1998
------------ ------------
<S> <C> <C>
Deferred tax assets:
Self-insurance reserves.................................. $ 9,879 $ 11,232
Net operating loss carryforwards......................... 5,212 9,461
Capital loss carryforwards............................... 374 361
Property and equipment, basis differences................ 176 --
Tax credits.............................................. 10,748 9,466
Vacation and Bonus Pay................................... 2,665 2,537
Other.................................................... 7,319 4,860
----------- -----------
Total gross deferred tax assets........................ 36,373 37,917
Less valuation allowance............................. (3,449) (3,000)
----------- -----------
Net deferred tax assets................................ 32,924 34,917
----------- -----------
Deferred tax liabilities:
Property and equipment, basis differences................ (11,184) (6,853)
Property and equipment, basis differences of foreign
subsidiaries........................................... (5,823) (5,444)
Stock basis of foreign subsidiary........................ (3,622) (3,622)
----------- -----------
Total gross deferred tax liabilities................... (20,629) (15,919)
----------- -----------
Financial statement net deferred tax assets............ $ 12,295 $ 18,998
=========== ===========
</TABLE>
The valuation allowance increased by $0.4 million during fiscal 1999.
Deferred tax assets have been recognized to the extent of existing deferred tax
liabilities and income taxes paid that are subject to recovery through
carryback. Future recognized tax benefits relating to the valuation allowance of
$3.4 million will reduce tax expense.
At May 28, 1999, KinderCare had $12.8 million of net operating losses
available for carryforward which expire in fiscal year 2013. Utilization of the
net operating losses is subject to an annual limitation of $9.8 million.
KinderCare also has capital losses of $0.9 million, which are available to
offset future capital gains, and expire in fiscal year 2000. Additionally,
KinderCare has tax credits available for carryforward for federal income tax
purposes of $10.7 million, which are available to offset future federal income
taxes through fiscal year 2014.
10. Benefit Plans
Stock Purchase and Option Plans
During 1993, KinderCare adopted the KinderCare Learning Centers, Inc. 1993
Stock Option and Incentive Plan, referred to as the 1993 Plan. Prior to the
merger, this plan authorized a committee of the Board of Directors of KinderCare
to grant or award to eligible employees of KinderCare and its subsidiaries and
affiliates, stock options and restricted stock and related warrants of
KinderCare beginning on March 31, 1993. In connection with the 1993 Plan,
KinderCare reserved approximately 1.9 million shares of common stock for
issuance to employees of KinderCare upon exercise of options available for
grants made by the Board of Directors of KinderCare.
At the effective time of the merger, all stock options granted by
KinderCare under the 1993 Plan were cancelled and each option was exchanged for
a payment from KinderCare after the merger (subject to any applicable
withholding taxes) equal to the product of (i) the total number of shares of
common stock previously subject to such stock option and (ii) the excess of
$19.00 over the exercise price per share of the common stock previously subject
to such stock option. The cancellation of the stock options resulted in payments
of approximately $3.8 million. The 1993 Plan was terminated at the effective
time of the merger.
During fiscal 1997, the Board of Directors of KinderCare adopted and,
during fiscal 1998, the stockholders approved the 1997 Stock Purchase and Option
Plan for Key Employees of KinderCare Learning Centers, Inc. and Subsidiaries,
referred to as the 1997 Plan. The 1997 Plan authorizes grants of stock or stock
options covering 2,500,000 shares of KinderCare's common stock. Grants or awards
under the 1997 Plan may take the form of purchased stock, restricted stock,
incentive or nonqualified stock options or other types of rights specified in
the 1997 Plan.
During fiscal 1999, 1998 and 1997, senior management purchased 6,640,
105,776 and 157,895 shares of restricted common stock in aggregate,
respectively, under the terms of the 1997 Plan. Certain members of senior
management
38
<PAGE>
executed term notes with KinderCare in order to purchase the restricted stock.
The term notes are due February 20, 2008 and bear interest at 5.84% per annum,
payable semi-annually on June 30 and December 31. At May 28, 1999, the term
notes totaled $1.1 million and are reflected as a component of stockholders'
equity.
Options to acquire an aggregate of 54,100, 264,440 and 421,053 shares of
common stock were granted to certain key management employees during fiscal
1999, 1998 and 1997, respectively. Each of such options had a weighted average
fair value, calculated using the Black Scholes option pricing model, of
approximately $11.14, $7.53 and $8.35 on the date of grant in fiscal 1999, 1998
and 1997, respectively. The assumptions used during fiscal 1999, 1998 and 1997,
respectively, to estimate the grant date present value were volatility of 33.6%,
26.0% and 28.0%, risk-free rate of return of 5.9%, 5.5% and 5.8% dividend yield
of 0.0% and time to exercise of seven years. All of the stock options granted
were non-qualified options which vest 20% per year over a five-year period. No
other options were outstanding at May 28, 1999.
Grants or awards under the 1997 Plan are made at prices determined by the
Board of Directors. Options granted during fiscal 1999 have exercise prices
ranging from $19.93 to $20.57 per share. All options granted during fiscal 1998
and 1997 have an exercise price of $19.00 per share.
A summary of outstanding options is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Shares Price
---------- ---------
<S> <C> <C>
Outstanding at May 31, 1996...................... 744,138 $ 11.48
Granted........................................ 460,053 18.60
Exercised...................................... (596,058) 11.70
Canceled....................................... (187,080) 11.36
---------- ---------
Outstanding at May 30, 1997...................... 421,053 19.00
Granted........................................ 264,440 19.00
---------- ---------
Outstanding at May 29, 1998.................... 685,493 19.00
Granted........................................ 54,100 20.12
Canceled....................................... (2,500) 19.93
---------- ---------
Outstanding at May 28, 1999...................... 737,093 $ 19.08
========== =========
</TABLE>
Options outstanding at May 28, 1999 have a remaining contractual life of
7.8 years. Exercisable options at May 28, 1999 totaled 257,487.
As discussed in Note 1, KinderCare has adopted the disclosure-only
provisions of SFAS No. 123. Accordingly, no compensation cost has been
recognized for stock options granted with an exercise price equal to the fair
value of the underlying stock on the date of grant. Had compensation cost for
KinderCare's stock option plans been determined based on the estimated weighted
average fair value of the options at the date of grant, KinderCare's net income
and basic and diluted income per share for fiscal 1999 would have been $12.8
million and $1.35 and $1.32 per share compared to the reported amounts of $13.5
million and $1.43 and $1.40, respectively. Net income and basic and diluted
income per share would have been $2.8 million and $0.29 per share compared to
the reported amounts of $3.4 million and $0.36, respectively, in fiscal 1998.
During fiscal 1997, the pro forma and reported amounts did not materially
differ.
Savings and Investment Plan
The Board of Directors of KinderCare adopted the KinderCare Learning
Centers, Inc. Savings and Investment Plan, referred to as the Savings Plan,
effective January 1, 1990 and approved the restatement of the Savings Plan
effective July 1, 1998. All employees over the age of 21 of KinderCare and its
subsidiaries are eligible to participate in the Savings Plan on the quarterly
entry date after the employee has been employed a minimum of six months and
completed 1,000 hours of service. Participants may contribute, in increments of
1%, up to 18% of their compensation to the Savings Plan. The Board of Directors
elected from April 1, 1991 to December 31, 1998, not to match employee
contributions. Effective January 1, 1999, KinderCare implemented an employer
match of up to 1% of compensation.
39
<PAGE>
Nonqualified Deferred Compensation Plan
The Board of Directors of KinderCare adopted the KinderCare Learning
Centers, Inc. Nonqualified Deferred Compensation Plan, referred to as the
Deferred Comp. Plan, effective August 1, 1996 and approved the restatement of
the Deferred Comp. Plan effective August 1, 1996. Under the Deferred Comp. Plan,
certain highly compensated or key management employees are provided the
opportunity to defer receipt and income taxation of such employees'
compensation. Effective January 1, 1999, KinderCare implemented an employer
match of up to 1% of compensation.
Directors' Deferred Compensation Plan
On May 27, 1998, the Board of Directors adopted the Directors' Deferred
Compensation Plan, referred to as the Directors' Deferred Comp. Plan. Under this
plan, non-employee members of the Board of Directors may elect to defer receipt
and income taxation of all or a portion of their annual retainer. Any amounts
deferred under the Directors' Deferred Comp. Plan are credited to a phantom
stock account. The number of shares of phantom stock credited to the director's
account will be determined based on the amount of deferred compensation divided
by the then fair value per share, as defined in the Directors' Deferred Comp.
Plan, of KinderCare's common stock.
Distributions from the Directors' Deferred Comp. Plan are made in cash and
reflect the value per share of the common stock at the time of distribution
multiplied by the number of phantom shares credited to the director's account.
Distributions from the Directors' Deferred Comp. Plan occur upon the earlier of
(1) the first day of the year following the director's retirement or separation
from the Board or (2) termination of the Directors' Deferred Comp. Plan.
11. Disclosures About Fair Value of Financial Instruments
Fair value estimates, methods and assumptions are set forth below for
KinderCare's financial instruments at May 28, 1999 and May 29, 1998.
Cash and cash equivalents, receivables and current liabilities
Fair value approximates carrying value as reflected in the consolidated
balance sheets at May 28, 1999 and May 29, 1998 because of the short-term
maturity of these instruments.
Long-term debt
The carrying value of KinderCare's 9 1/2% senior subordinated notes, at
May 28, 1999 and May 29, 1998, approximated fair value based on current market
activity. The carrying values for KinderCare's remaining long-term debt of
$125.8 and $103.1 million at May 28, 1999 and May 29, 1998, respectively,
approximated market value based on current rates that management believes could
be obtained for similar debt.
12. Commitments and Contingencies
KinderCare conducts a portion of its operations from leased or subleased
day care centers. Subsequent to January 1, 1993, KinderCare re-negotiated
certain day care center leases to amend the terms to allow KinderCare the right
to terminate the lease at any time with minimal notice. In connection with the
termination option, KinderCare, in certain instances, prepaid up to 12 months
rent. Such amounts, totaling approximately $3.2 million, are being amortized on
a straight line basis over the termination transition period or over the
appropriate remaining months of the lease period. At May 28, 1999, the remaining
unamortized balance of the prepaid amount was $2.1 million.
Each vehicle in KinderCare's fleet is leased pursuant to the terms of a
12-month non-cancelable master lease which may be renewed on a month-to-month
basis after the initial 12-month lease period. Payments under the vehicle leases
vary with the number, type, model and age of the vehicles leased. The vehicle
leases require that KinderCare guarantee specified residual values upon
cancellation. In most cases, KinderCare expects that substantially all of the
leases will be renewed or replaced by other leases as part of the normal course
of business. All such leases are classified as operating leases. Expenses
incurred in connection with the fleet vehicle leases were $10.7, $10.9 and $10.1
million for fiscal 1999, 1998 and 1997, respectively.
40
<PAGE>
Following is a schedule of future minimum lease payments under operating
leases, that have initial or remaining non-cancelable lease terms in excess of
one year at May 28, 1999, with dollars in thousands:
Fiscal Year:
------------
2000...................................... $ 18,610
2001...................................... 15,008
2002...................................... 12,725
2003...................................... 11,380
2004...................................... 9,816
Subsequent years.......................... 59,100
At May 28, 1999, KinderCare had a revolving credit facility of $300.0
million, of which $42.0 million was committed under outstanding letters of
credit and $35.0 was drawn.
KinderCare is presently, and is from time to time, subject to claims and
litigation arising in the ordinary course of business, including claims and
litigation involving allegations of physical or sexual abuse of children. In
certain of such actions, plaintiffs request damages that are covered by
insurance. KinderCare believes that none of the claims or litigation of which it
is aware will materially affect its financial position, operating results or
cash flows, although absolute assurance cannot be given with respect to the
ultimate outcome of any such actions.
13. Stock Repurchase Programs
On May 2, 1996, the Board of Directors authorized the repurchase of $10
million of KinderCare's common stock and increased it to $23.0 million on June
3, 1996. During fiscal 1997, under the stock buyback program, 852,500 shares and
315,000 warrants were repurchased for $14.1 million. All shares repurchased were
retired. Other than in connection with the merger, no additional shares or
warrants were repurchased subsequent to July 22, 1996 and the stock buyback
programs were terminated at the effective time of the merger.
14. Extraordinary Items
During fiscal 1997, KinderCare 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. In addition, in connection with the
recapitalization, 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 KinderCare's previous credit facility.
15. Quarterly Results (Unaudited)
A summary of results of operations for fiscal 1999 and fiscal 1998 is as
follows, with dollars in thousands, except per share data:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter (a) Quarter (b) Quarter (b) Quarter (b)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Fiscal year ended May 28, 1999:
Revenues, net................................... $ 192,274 $ 142,237 $ 143,039 $ 155,435
Operating income ............................... 18,230 13,225 16,820 15,315
Net income...................................... 3,543 2,221 4,624 3,138
Basic net income per share...................... 0.37 0.23 0.49 0.33
Diluted net income per share.................... 0.37 0.23 0.48 0.32
Fiscal year ended May 29, 1998:
Revenues, net.................................... $ 180,562 $ 135,587 $ 134,823 $ 146,098
Operating income................................. 12,649 9,807 12,633 10,404
Net income....................................... 28 319 2,060 1,019
Basic and diluted income per share............... 0.00 0.03 0.22 0.11
- --------------
(a) Sixteen week quarter
(b) Twelve week quarters
</TABLE>
41
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
KinderCare Learning Centers, Inc.
We have audited the accompanying consolidated balance sheets of KinderCare
Learning Centers, Inc. and subsidiaries ("the Company") as of May 28, 1999 and
May 29, 1998, and the related consolidated statements of operations,
stockholders' equity and comprehensive income, and cash flows for each of the
years ended May 28, 1999, May 29, 1998 and May 30, 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, such consolidated financial statements present fairly, in all
material respects, the financial position of KinderCare Learning Centers, Inc.
and subsidiaries as of May 28, 1999 and May 29, 1998, and the results of their
operations and their cash flows for each of the years ended May 28, 1999, May
29, 1998 and May 30, 1997, in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
Portland, Oregon
July 9, 1999
42
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
43
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
The following table sets forth information regarding the directors that are
subject to the reporting requirements of the Securities Exchange Act of 1934 or
any company registered as an investment company under the Investment Company Act
of 1940. For information concerning directors' ownership of common stock, see
"Item 12. Security Ownership of Certain Beneficial Owners."
<TABLE>
<CAPTION>
Position with the Company, Year First Elected
Director, Principal Occupation During at Least
Name and Age the Last Five Years and Other Directorships
- ------------------------ --------------------------------------------------
<S> <C>
David J. Johnson........ David J. Johnson joined KinderCare as Chief
(53) Executive Officer and Chairman of the Board in
February 1997. Between September 1991 and November
1996, Mr. Johnson served as President, Chief
Executive Officer and Chairman of the Board of Red
Lion Hotels, Inc., which was formerly a KKR
affiliate, or its predecessor. From 1989 to
September 1991, Mr. Johnson was a general partner
of Hellman & Friedman, a private equity investment
firm based in San Francisco. From 1986 to 1988, he
served as President, Chief Operating Officer and
director of Dillingham Holdings, a diversified
company headquartered in San Francisco. From 1984
to 1987, Mr. Johnson was President and Chief
Executive Officer of Cal Gas Corporation, a
principal subsidiary of Dillingham Holdings.
Henry R. Kravis......... Henry R. Kravis has been a director of KinderCare
(55) since February 1997. He is a managing member of KKR
& Co. L.L.C., the limited liability company which
serves as the general partner of KKR. He is also a
director of Accuride Corporation, Amphenol
Corporation, Borden, Inc., The Boyds Collection,
Ltd., Evenflo Company, Inc., The Gillette Company,
IDEX Corporation, KSL Recreation Corporation,
Owens-Illinois, Inc., PRIMEDIA, Inc., Randalls Food
Markets, Inc., Regal Cinemas, Inc., Sotheby's
Holdings, Inc., Spalding Holdings Corporation, and
TI Group plc.
George R. Roberts....... George R. Roberts has been a director of KinderCare
(55) since February 1997. He is a managing member of KKR
& Co. L.L.C., the limited liability company which
serves as the general partner of KKR. He is also a
director of Accuride Corporation, Amphenol
Corporation, Borden, Inc., The Boyds Collection,
Ltd., BRW Acquisition, Inc., Evenflo Company, Inc.,
IDEX Corporation, KSL Recreation Corporation,
MedCath Incorporated, Neway Anchorlok International
Inc., Owens-Illinois, Inc., Owens-Illinois Group,
Inc., PRIMEDIA, Inc., Randalls Food Markets, Inc.,
Regal Cinemas, Inc., Rhine Reinsurance Company,
Safeway Inc., Spalding Holdings Corporation,
Trinity Acquisition plc, which is the parent
company of Willis Corroon Group Limited, United
Fixtures Company, and U.S. Natural Resources Inc.
Clifton S. Robbins...... Clifton S. Robbins has been a director of
(40) KinderCare since February 1997. Mr. Robbins was a
General Partner of KKR from January 1, 1995 until
January 1, 1996 when he became a member of the
limited liability company which serves as the
general partner of KKR. Prior to that, he was an
executive of that company. Mr. Robbins is also a
director of Borden Inc., Corning Consumer Products,
IDEX Corporation, Newsquest plc and Regal Cinemas,
Inc.
44
<PAGE>
Nils P. Brous........... Nils P. Brous has been a director of KinderCare
(35) since February 1997. Mr. Brous has been an
executive of KKR since 1992. Prior to that time, he
was an associate at Goldman, Sachs & Co. Mr. Brous
is also a director of Bruno's, Inc., Randall's
Food Markets, Inc. and Nexstar Financial
Corporation.
Stephen A. Kaplan....... Stephen A. Kaplan has been a director of KinderCare
(40) since January 1996. He has been a Principal of
Oaktree Capital Management, LLC since 1995. Oaktree
provides investment management services pursuant to
a sub-advisory agreement with TCW Asset Management
Company, the general partner of TCW Special Credits
Fund V-The Principal Fund. Mr. Kaplan was a
Managing Director of Trust Company of the West from
1993 to 1995. Prior to that time, Mr. Kaplan was a
partner with the law firm of Gibson, Dunn &
Crutcher. Mr. Kaplan is also a director of Acorn
Products, Inc., CollaGenex Pharmaceuticals, Inc.,
Cherokee International, L.L.C., GeoLogistics
Corporation and Roller Bearing Holding Co.
Messrs. Kravis and Roberts are first cousins.
</TABLE>
Committees of KinderCare's Board of Directors
The Board of Directors of KinderCare has three standing committees: (1) an
audit committee, (2) a compensation committee and (3) an executive committee.
Executive Committee. Messrs. Johnson, Robbins and Brous comprise the
executive committee of the Board of Directors. The executive committee exercises
authority of the Board of Directors, to the extent permitted by law, in the
management of the business of KinderCare between meetings of the full Board of
Directors.
Audit Committee. The audit committee consists of Messrs. Robbins and Brous.
The Audit Committee selects and engages, on behalf of KinderCare, the
independent public accountants to audit KinderCare's annual financial
statements, reviews and approves the planned scope of the annual audit and
reviews KinderCare's internal accounting practices and policies.
Compensation Committee. Messrs. Robbins, Brous and Kravis serve as members
of the compensation committee. The compensation committee establishes
compensation levels for officers of KinderCare and performs such functions as
provided under KinderCare's employee benefit programs and executive compensation
programs or as delegated by the Board of Directors with respect to such
programs.
Executive Officers
Set forth below is information regarding the executive officers of the
Company.
Name Age Position
---- --- --------
David J. Johnson 53 Chief Executive Officer and Chairman
of the Board
Beth A. Ugoretz 44 Executive Vice President,
Corporate Services
Bruce A. Walters 42 Senior Vice President and
Chief Development Officer
Dan R. Jackson 45 Vice President, Financial Control
and Planning
David J. Johnson joined KinderCare as Chief Executive Officer and Chairman
of the Board in February 1997. Between September 1991 and November 1996, Mr.
Johnson served as President, Chief Executive Officer and Chairman of the Board
of Red Lion Hotels, Inc., which was formerly a KKR affiliate, or its
predecessor. From 1989 to September 1991, Mr. Johnson was a general partner of
Hellman & Friedman, a private equity investment firm based in San Francisco.
From 1986 to 1988, he served as President, Chief Operating Officer and director
of Dillingham Holdings, a diversified company headquartered in San Francisco.
From 1984 to 1987, Mr. Johnson was President and Chief Executive Officer of Cal
Gas Corporation, a principal subsidiary of Dillingham Holdings.
Beth A. Ugoretz joined KinderCare as Executive Vice President, Corporate
Services in March 1997. Ms. Ugoretz served as Senior Vice President, General
Counsel and Secretary of Red Lion Hotels, Inc. or its predecessor from June 1993
to
45
<PAGE>
December 1996. Prior to that time, Ms. Ugoretz was a partner with the law firm
of Stoel Rives LLP in Portland, Oregon, where she had worked since 1983.
Bruce A. Walters joined KinderCare as Senior Vice President and Chief
Development Officer in July 1997. From June 1995 to February 1997, Mr. Walters
served as the Executive Vice President of Store Development for Hollywood
Entertainment Corporation in Portland, Oregon. Prior to that time, Mr. Walters
spent 14 years with McDonald's Corporation in various domestic and international
development positions.
Dan R. Jackson joined KinderCare in February 1997 as Vice President of
Financial Control and Planning. Prior to that time, Mr. Jackson served as Vice
President, Controller for Red Lion Hotels, Inc., or its predecessor, from
September 1985 to January 1997. From 1978 to 1985, Mr. Jackson held several
financial management positions with Harsch Investment Corporation, a real estate
holding company based in Portland, Oregon.
Other Officers
<TABLE>
<CAPTION>
Name Age Position
--------------------------------------------------------------------------
<S> <C> <C>
Trudy R. Anderson................... 35 Region Vice President, Central
David A. Benedict................... 45 Vice President, Tax
DeeAnn M. Besch..................... 42 Region Vice President,
Southeast
Edward L. Brewington................ 56 Vice President, Human Resources
S. Wray Hutchinson.................. 39 Vice President, Operations
Lauren A. Klein..................... 43 Region Vice President, Western
Eva M. Kripalani.................... 40 Vice President, General Counsel
and Secretary
Miriam D. Liggett................... 38 Region Vice President, Northeast
William O. Robards, Jr.............. 46 Vice President, Real Estate
Bobby J. Willey..................... 59 Vice President, Information
Services
</TABLE>
Trudy R. Anderson was promoted in April 1996 to Vice President of the
Central Region. She joined KinderCare in February 1989 as a Center Director in
California and was promoted to District Manager in California. She later served
as a District Manager in Minnesota and was subsequently promoted to Region
Manager.
David A. Benedict joined KinderCare in January 1998 as Vice President, Tax.
From May 1997 through December 1997, Mr. Benedict was a Director, Tax Services
in the Portland, Oregon office of Price Waterhouse, LLP. From May 1996 to March
1997, he was Vice President of Corporate Tax for Red Lion Hotels, Inc. Prior to
that, he spent 10 years with the Portland office of Deloitte & Touche LLP, where
he was a Senior Manager in the tax department.
DeeAnn M. Besch was promoted in April 1997 to Vice President of the
Southeast Region. She joined KinderCare in June 1984 as a Center Director in
Minnesota and was later promoted first to District Manager and then Area Manager
in Minneapolis, Minnesota.
Edward L. Brewington joined KinderCare in April 1997 as Vice President of
Human Resources. From June 1993 to April 1997 Mr. Brewington was with Times
Mirror where his last position held was Vice President, Human Resources for the
Times Mirror Training Group. Prior to that time, Mr. Brewington spent 25 years
with IBM in various human resource, sales and marketing positions.
S. Wray Hutchinson was promoted in April 1996 to Vice President of
Operations. He began his employment with KinderCare in 1992 as District Manager
in New Jersey and was later promoted to Region Manager for the Chicago, Illinois
area.
Lauren A. Klein was promoted in April 1996 to Vice President of the Western
Region. She joined KinderCare in February 1989 as District Manager of the
Connecticut and Western Massachusetts area and was later promoted to Region
Manager in January 1990.
Eva M. Kripalani joined KinderCare in July 1997 as Vice President, General
Counsel and Secretary. Prior to joining KinderCare, Ms. Kripalani was a partner
in the law firm of Stoel Rives LLP in Portland, Oregon, where she had worked
since 1987.
Miriam D. Liggett was promoted in April 1996 to Vice President of the
Northeast Region. She joined KinderCare in October 1988 and held various
center-level management positions until she was promoted to District Manager for
Northern
46
<PAGE>
Virginia. Ms. Liggett was later promoted first to Northeast Account Executive
for KinderCare At Work and then Region Manager for the Mid-Atlantic Area,
including Maryland and Virginia.
William O. Robards joined KinderCare in August 1997 as Vice President of
Real Estate. Prior to joining KinderCare, Mr. Robards spent 19 years in various
real estate development positions with McDonald's Corporation, most recently as
Senior Real Estate Manager.
Bob J. Willey joined KinderCare in June 1995 as Vice President of
Information Services. From 1992 to 1995, Mr. Willey served as MIS Director for
PETSTUFF, Inc. and was Corporate Information Officer for ANCO Management
Service, Inc. from 1989 to 1992.
47
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation awarded or paid to or
earned by the Chief Executive Officer and Chairman of the Board of Directors of
KinderCare and each of the other executive officers, referred to collectively as
the "Named Executive Officers":
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
-Securities All other
Fiscal Annual Compensation Underlying Compensation
Name and Principal Position Year Salary Bonus Options (a) (b) (c) (d)
- --------------------------- ------ --------- --------- ------------- -------------
<S> <C> <C> <C> <C> <C>
David J. Johnson.................. 1999 $ 629,458 $ 479,649 - $ 101,815
Chief Executive Officer and 1998 606,138 658,266 - -
Chairman of the Board 1997 176,385 105,231 421,053 -
Beth A. Ugoretz................... 1999 $ 210,480 $ 123,131 - 12,684
Executive Vice President, 1998 201,750 164,325 33,183 -
Corporate Services 1997 50,000 22,500 - -
Bruce A. Walters.................. 1999 $ 207,179 $ 104,004 - 13,184
Senior Vice President & 1998 176,923 127,739 32,895 -
Chief Development Officer 1997 - - - -
Dan R. Jackson.................... 1999 $ 165,132 $ 73,979 - 14,510
Vice President, Financial 1998 151,310 105,855 24,887 -
Control and Planning 1997 37,500 13,125 - -
- --------------
(a) Stock options granted under the 1997 Stock Purchase and Option Plan.
(b) Matching contributions by KinderCare under KinderCare's Savings and
Investment Plan were $320 and $143 for Mr. Johnson and Mr. Jackson,
respectively, in fiscal 1999.
(c) Matching contributions by KinderCare under KinderCare's Nonqualified
Deferred Compensation Plan were $2,693, $901, $886 and $716 for Mr.
Johnson, Ms. Ugoretz, Mr. Walters and Mr. Jackson, respectively, in fiscal
1999.
(d) Life insurance premiums paid on behalf of Mr. Johnson, Ms. Ugoretz, Mr.
Walters and Mr. Jackson were $98,802, $11,783, $12,298 and $13,651,
respectively, in fiscal 1999.
</TABLE>
1997 Stock Purchase and Option Plan
KinderCare adopted the 1997 Stock Purchase and Option Plan at the closing
of the recapitalization of KinderCare. The 1997 Plan authorizes grants of stock
or options to purchase shares of authorized but unissued or reacquired shares of
KinderCare common stock, subject to adjustment to reflect events such as stock
dividends, stock splits, recapitalizations, mergers or reorganizations. Grants
or awards under the 1997 Plan may take the form of purchased stock, restricted
stock, incentive or nonqualified stock options or other types of rights
specified in the 1997 Plan. A total of 2,500,000 shares of common stock have
been authorized for issuance under the 1997 Plan, and the maximum number of
shares that may be granted to any one person is 1,000,000. The 1997 Plan is
intended to accomplish the following:
o promote the long term financial interests and growth of KinderCare and its
subsidiaries by attracting and retaining management personnel with the
training, experience and ability to enable them to make a substantial
contribution to the success of KinderCare's business
o motivate management personnel by means of growth-related incentives to
achieve long range goals
o further align the interests of participants with those of the other
stockholders of KinderCare through opportunities for increased stock or
stock-based ownership in KinderCare
The Compensation Committee of the Board of Directors administers the 1997
Plan and determines the employees to whom grants will be made, the number of
shares of common stock subject to each grant, and the various terms of such
grants, including the period for vesting. The Compensation Committee of the
Board of Directors may from time to time amend the
48
<PAGE>
terms of any grant, but such action may not adversely affect the rights of any
participant under the 1997 Plan with respect to the options without such
participant's consent, except for either of the following:
o Adjustments made upon a change in the outstanding common stock of
KinderCare by reason of a stock split, spin-off, stock dividend, stock
combination or reclassification, recapitalization or merger, change of
control or similar event
o In the event of a merger or consolidation of KinderCare into another
corporation, the exchange of all or substantially all of the assets of
KinderCare for another corporation's securities, the acquisition by another
corporation of 80% or more of KinderCare's voting stock or the
recapitalization, reclassification, liquidation or dissolution of
KinderCare, in the discretion of the Board of Directors option grants may
be made exercisable for some period of time prior to such event and then
terminable upon occurrence of such event
The Board of Directors retains the right to amend, suspend or terminate the
1997 Plan.
There were no option grants during fiscal year 1999 for the Named Executive
Officers.
Aggregated Option Exercises in Fiscal Year 1999 and 1999 Fiscal Year End Option
Values
The following table shows the unexercised options held at May 28, 1999 by
the Named Executive Officers:
<TABLE>
<CAPTION>
Value of Unexercised
Number of Unexercised "In-The-Money"
Options at May 28, 1999 Options at May 28, 1999(a)
---------------------------- ----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
David J. Johnson..................... 168,421 252,632 $ 508,632 $ 762,948
Beth A. Ugoretz...................... 13,273 19,910 40,085 60,128
Bruce A. Walters..................... 6,579 26,316 19,869 79,474
Dan R. Jackson....................... 9,955 14,932 30,063 45,095
- --------------
(a) The value of options represents the aggregate difference between the
fair value, as determined by KinderCare, at May 28, 1999 and the
applicable exercise price.
</TABLE>
There were no shares acquired upon exercise of options during fiscal 1999.
Compensation of KinderCare's Directors
During fiscal year 1999, non-employee directors of KinderCare received an
annual retainer of $30,000, paid in advance in quarterly installments. Directors
who are employees of KinderCare were not paid any additional compensation for
their service as directors. All directors were reimbursed for travel and other
expenses incurred in connection with the performance of their duties.
On May 27, 1998, the Board of Directors adopted the Directors' Deferred
Compensation Plan. Under this plan, non-employee members of the Board of
Directors may elect to defer receipt and income taxation of all or a portion of
their annual retainer. Any amounts deferred under the Directors' Plan are
credited to a phantom stock account. The number of shares of phantom stock
credited to the director's account will be determined based on the amount of
deferred compensation divided by the then fair value per share, as defined in
the Directors' Plan, of KinderCare's common stock.
Distributions from the Directors' Plan are made in cash and reflect the
value per share of the common stock at the time of distribution multiplied by
the number of phantom shares credited to the director's account. Distributions
from the Directors' Plan occur upon the earlier of (1) the first day of the year
following the director's retirement or separation from the Board or (2)
termination of the Directors' Plan.
49
<PAGE>
Compensation Committee Interlocks and Insider Participation
Following the recapitalization, the Board of Directors of the Company
approved the appointment of a compensation committee composed of Henry R.
Kravis, Clifton S. Robbins and Nils P. Brous. Messrs. Kravis and Robbins are
general partners of KKR and Mr. Brous is an executive of KKR. See "Item 13.
Certain Relationships and Related Transactions."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Security Ownership of Certain Beneficial Owners
The following table sets forth information with respect to the beneficial
ownership of KinderCare's common stock at August 20, 1999 by each of the
following:
o each person who is known by KinderCare to beneficially own more than
5% of KinderCare's common stock
o the Named Executive Officers
o each of KinderCare's directors
o all directors and executive officers of KinderCare as a group
Unless otherwise indicated, the address of each person named in the table
below is KinderCare Learning Centers, Inc., 650 N.E. Holladay Street, Suite
1400, Portland, Oregon 97232. The amounts and percentages of common stock
beneficially owned are reported on the basis of regulations of the Securities
and Exchange Commission governing the determination of beneficial ownership of
securities. Under the rules of the Commission, a person is deemed to be a
"beneficial owner" of a security if that person has or shares "voting power,"
which includes the power to vote or to direct the voting of such security, or
"investment power," which includes the power to dispose of or to direct the
disposition of such security. A person is also deemed to be a beneficial owner
of any securities of which that person has a right to acquire beneficial
ownership within 60 days. Under these rules, more than one person may be deemed
a beneficial owner of the same securities and a person may be deemed to be a
beneficial owner of securities as to which such person has no economic interest.
The percentage of class outstanding is based on the 9,474,197 shares of common
stock outstanding as of August 20, 1999 and the 270,512 shares subject to option
grants which have vested or will vest prior to October 19, 1999.
<TABLE>
<CAPTION>
Shares Percent of
Beneficially Class
Name and Address Owned Outstanding
- ---------------- ------------ -----------
<S> <C> <C>
KKR-KLC L.L.C. and affiliated entities (1)........................ 7,828,947 82.6%
c/o Kohlberg Kravis Roberts & Co. L.P.
9 West 57th Street
New York, New York 10019
The TCW Group, Inc. and affiliated entities (2)................... 949,244 10.0
865 South Figueroa Street
Los Angeles, California 90017
David J. Johnson (3).............................................. 326,316 3.4
Beth A. Ugoretz (3)............................................... 26,546 *
Bruce A. Walters (3).............................................. 26,316 *
Dan R. Jackson (3)................................................ 19,910 *
Henry R. Kravis (1)............................................... -- --
George R. Roberts (1)............................................. -- --
Clifton S. Robbins (1)............................................ -- --
Nils P. Brous (1)................................................. -- --
Stephen A. Kaplan (2)............................................. -- --
All directors and executive officers as a group
(9 individuals) (3)............................................... 399,088 4.1
- --------------
* Percentage of shares of common stock beneficially owned does not exceed one
percent.
50
<PAGE>
(1) Shares of common stock shown as beneficially owned by KKR-KLC L.L.C. are
directly held by KLC Associates, L.P. KKR-KLC L.L.C. is the sole general
partner of KKR Associates (KLC), L.P., which is the sole general partner of
KLC Associates, L.P., and possesses sole voting and investment power with
respect to such shares. KKR-KLC L.L.C. is a limited liability company, the
members of which are Messrs. Henry R. Kravis, George R. Roberts, Robert I.
MacDonnell, Paul E. Raether, Michael W. Michelson, James H. Greene, Jr.,
Michael T. Tokarz, Perry Golkin, Clifton S. Robbins, Scott M. Stuart and
Edward A. Gilhuly. Messrs. Kravis and Roberts are members of the Executive
Committee of KKR-KLC L.L.C. Messrs. Kravis, Roberts and Robbins are also
directors of KinderCare. Each of such individuals may be deemed to share
beneficial ownership of the shares shown as beneficially owned by KKR-KLC
L.L.C. Each of such individuals disclaims beneficial ownership of such
shares. Mr. Nils P. Brous is a limited partner of KKR Associates (KLC),
L.P. and is also a director of KinderCare. In addition, KKR Partners II,
L.P., an affiliate of KKR-KLC L.L.C., beneficially owns 101,842 shares of
the common stock.
(2) TCW and its affiliates have voting and dispositive powers over such
beneficially owned shares as an investment manager on behalf of TCW Special
Credits Fund V-The Principal Fund. In addition, Oaktree Capital Management,
LLC is an investment sub-advisor with respect to The Principal Fund.
Stephen A. Kaplan, a Principal of Oaktree, is a director of KinderCare. To
the extent Mr. Kaplan, on behalf of Oaktree or affiliates of TCW, as
applicable, participates in the process of voting or disposing of any such
shares, Mr. Kaplan may be deemed under such circumstances for the purpose
of Section 13 of the Exchange Act to be the beneficial owner of such
shares. Mr. Kaplan disclaims beneficial ownership of all shares
beneficially held by Oaktree and TCW.
(3) Shares owned by KinderCare's executive officers are subject to restrictions
on transfer. The shares beneficially owned by the Named Executive Officers
include shares subject to options that are currently exercisable or become
exercisable prior to October 19, 1999 as follows:
Number of
Name Options
---- ---------
David J. Johnson.................. 168,421
Beth A. Ugoretz................... 13,273
Bruce A. Walters.................. 13,158
Dan R. Jackson.................... 9,955
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Relationship with KKR
At August 20, 1999, affiliates of Kohlberg Kravis Roberts & Co.
beneficially owned in the aggregate approximately 82.6% of KinderCare's
outstanding shares of common stock. The members of KKR-KLC L.L.C. are Messrs.
Henry R. Kravis, George R. Roberts, Robert I. MacDonnell, Paul E. Raether,
Michael W. Michelson, Michael T. Tokarz, James H. Greene, Jr., Perry Golkin,
Clifton S. Robbins, Scott M. Stuart and Edward A. Gilhuly. Messrs. Kravis,
Roberts and Robbins are also directors of KinderCare, as is Mr. Nils P. Brous,
who is a limited partner of KKR Associates (KLC) L.P., the general partner of
KLC Associates, L.P. with sole investment and voting powers. Each of the members
of KKR-KLC L.L.C. is also a member of the limited liability company that serves
as the general partner of KKR, and Mr. Brous is an executive of KKR.
KKR may receive customary investment banking fees for services rendered to
KinderCare in connection with divestitures, acquisitions and other transactions,
plus reimbursement of its related expenses. The following table shows the type
and amount of fees and reimbursements paid to KKR:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
May 28, 1999 May 29, 1998 May 30, 1997
------------ ------------ ------------
<S> <C> <C> <C>
Management, consulting and financial
services................................ $ 583,088 $ 625,255 $ 214,500
Investment banking services............... 35,747 122,064 --
</TABLE>
In addition to the above amounts, KKR received a cash fee of $8.0 million
from KinderCare, during fiscal 1997, for negotiating the recapitalization and
arranging the related financing, plus the reimbursement of its associated
expenses of $250,680.
51
<PAGE>
Former Chief Executive Officer
Pursuant to an agreement between KCLC Acquisition Corp. and Dr. Sandra W.
Scarr (the "Scarr Letter Agreement"), effective upon consummation of the
recapitalization, Dr. Scarr retired from her position as Chairman of the Board
and Chief Executive Officer of the Company. Dr. Scarr continued to serve as a
director of the company until April 1999. In connection with the Scarr Letter
Agreement, Dr. Scarr performs consulting, advisory and other services for
KinderCare and is subject to a non-competition covenant. In consideration of the
services and her obligation not to compete with KinderCare, Dr. Scarr will
receive total payment of $1.1 million from KinderCare, payable in equal monthly
installments of $36,667 through December 1999. In addition, pursuant to the
Scarr Letter Agreement, the Company continued to provide certain medical,
disability and life insurance coverage through June 1998.
Registration Rights
Each of KLC Associates, L.P. and its affiliate, KKR Partners II, L.P., has
the right to require KinderCare to register under the Securities Act of 1933
shares of common stock held by it pursuant to a registration rights agreement
entered into in connection with the recapitalization. Such registration rights
will generally be available to KLC Associates and KKR Partners II until
registration under the Securities Act is no longer required to enable it to
resell the common stock owned by it. The registration rights agreement provides
that KinderCare will pay all expenses in connection with the first six
registrations requested by KLC Associates and/or KKR Partners II and in
connection with any registration commenced by KinderCare as a primary offering.
In addition, pursuant to stockholders' agreements, Oaktree and members of
KinderCare's management may be allowed to participate in specified registration
processes. In addition, Oaktree and the management stockholders have the right,
under certain circumstances and subject to certain conditions, to participate in
any registration process, subject to certain exceptions.
Management Indebtedness
During fiscal year 1998, the Named Executive Officers, excluding David J.
Johnson, purchased 36,386 shares of restricted stock in aggregate under the
terms of the 1997 Plan. In conjunction with such purchases, options to acquire
an aggregate of an additional 90,965 shares of common stock were granted to such
Named Executive Officers. The following table shows the amount of indebtedness
due under term notes executed by such Named Executive Officers with respect to
their purchases of restricted stock:
<TABLE>
<CAPTION>
Largest Aggregate Amount of
Amount of Indebtedness
Indebtedness During Outstanding at
Name Fiscal Year 1999 August 20, 1999
---- ------------------- ---------------
<S> <C> <C>
Beth A. Ugoretz.................... $ 77,187 $ 77,187
Bruce A. Walters................... 150,002 50,002
Dan R. Jackson..................... 94,145 84,145
</TABLE>
The term notes were issued on February 20, 1998, are due February 20, 2008
and bear interest at 5.84% per year, payable semi-annually on June 30 and
December 31.
52
<PAGE>
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following is an index of the financial statements, schedules and
exhibits included in this document or incorporated herein by reference:
(a)(1) Financial Statements -
Page
Consolidated balance sheets at May 28, 1999 and May 29, 1998.......26
Consolidated statements of operations for the fiscal years
ended May 28, 1999, May 29, 1998 and
May 30, 1997.....................................................27
Consolidated statements of stockholders' equity and
comprehensive income for the fiscal years ended
May 28, 1999, May 29, 1998 and May 30, 1997......................28
Consolidated statements of cash flows for the fiscal
years ended May 28, 1999, May 29, 1998 and
May 30, 1997.....................................................29
Notes to consolidated financial statements......................30-41
Independent auditors' report.......................................42
(a)(2) Schedules to Financial Statements - None.
(a)(3) Exhibits - The following exhibits are filed with this document or
incorporated herein by reference:
Exhibit
Number Description of Exhibits
------- -----------------------
2(a) Agreement and Plan of Merger dated as of October 3, 1996, between
KinderCare Learning Centers, Inc. and KCLC Acquisition Corp.
(incorporated by reference from Exhibit 2.1(a) to KinderCare's Form
S-4, filed January 7, 1997, File No. 333-19345).
2(b) Merger Agreement Amendment dated as of December 27, 1996 between
KinderCare and KCLC Acquisition Corp. (incorporated by reference
from Exhibit 2.1(b) to KinderCare's Form S-4, filed January 7, 1997,
File No. 333-19345).
2(c) Stockholders' Agreement between KinderCare and the stockholders
parties thereto (incorporated by reference from Exhibit 2.3 of
KinderCare's Registration Statement on Form S-4, filed March 11,
1997, File No. 333-23127).
3(a) Certificate of Merger of KCLC Acquisition into KinderCare
(incorporated by reference from Exhibit 3.1 of Amendment No. 1 to
KinderCare's Registration Statement on Form S-4, filed March 11,
1997, File no. 333-23127)
3(b) By-Laws of KinderCare as amended through December 2, 1998
4(a) Indenture dated as of February 13, 1997 between KinderCare and
Marine Midland Bank, as Trustee (incorporated by reference from
Exhibit 4.1 of KinderCare's Registration Statement on Form S-4,
filed March 11, 1997, File No. 333-23127).
4(b) Form of 9 1/2% Series B Senior Subordinated Note due 2009
(incorporated by reference from Exhibit 4.3 of KinderCare's
Registration Statement on Form S-4, filed March 11, 1997, File No.
333-23127).
10(a) Credit Agreement, dated as of February 13, 1997, among KinderCare,
the several lenders from time to time parties thereto, and the Chase
Manhattan Bank as administrative agent (incorporated by reference
from Exhibit 10.1 of KinderCare's Registration Statement on Form
S-4, filed March 11, 1997, File No. 333-23127).
10(b) Registration Rights Agreement, dated as of February 13, 1997, among
KCLC Acquisition, KLC Associates
53
<PAGE>
L.P. and KKR Partners II, L.P. (incorporated by reference from
Exhibit 10.2 of KinderCare's Registration Statement on Form S-4,
filed March 11, 1997, File No. 333-23127).
10(c)* Letter Agreement relating to termination of employment of Sandra
Scarr dated January 8, 1997 (incorporated by reference from Exhibit
10(d) of KinderCare's Annual Report on Form 10-K for the fiscal year
ended May 30, 1997).
10(d) Lease between 600 Holladay Limited Partnership and KinderCare
Learning Centers, Inc. dated June 2, 1997 (incorporated by reference
from Exhibit 10(f) of KinderCare's Annual Report on form 10-K for
the fiscal year ended May 30, 1997).
10(e)* 1997 Stock Purchase and Option Plan for Key Employees of KinderCare
Learning Centers, Inc. and Subsidiaries (incorporated by reference
from Exhibit 10(c) to KinderCare's Quarterly Report on Form 10-Q for
the Quarterly Period ended September 19, 1997).
10(f)* Form of Management Stockholder's Agreement (incorporated by
reference from Exhibit 10(d) to KinderCare's Quarterly Report on
Form 10-Q for the Quarterly Period ended September 19, 1997).
10(g)* Form of Non-Qualified Stock Option Agreement (incorporated by
reference from Exhibit 10(e) to KinderCare's Quarterly Report on
Form 10-Q for the Quarterly Period ended September 19, 1997).
10(h)* Form of Sale Participation Agreement (incorporated by reference from
Exhibit 10(f) to KinderCare's Quarterly Report on Form 10-Q for the
Quarterly Period ended September 19, 1997).
10(i)* Form of Term Note (incorporated by reference from Exhibit 10(g) to
KinderCare's Quarterly Report on Form 10-Q of the Quarterly Period
ended September 19, 1997).
10(j)* Form of Pledge Agreement (incorporated by reference from Exhibit
10(h) to KinderCare's Quarterly Report on Form 10-Q for the
Quarterly Period ended September 19, 1997).
10(k)* Stockholders' Agreement dated as of February 14, 1997 between
KinderCare Learning Centers, Inc. and David J. Johnson (incorporated
by reference from Exhibit 10(l) to KinderCare's Quarterly Report on
Form 10-Q for the Quarterly Period ended September 19, 1997).
10(l)* Nonqualified Stock Option Agreement dated as of February 14, 1997
between KinderCare Learning Centers, Inc. and David J. Johnson
(incorporated by reference from Exhibit 10(j) to KinderCare's
Quarterly Report on Form 10-Q for the Quarterly Period ended
September 19, 1997).
10(m)* Sale Participation Agreement dated as of February 14, 1997 among KKR
Partners II, L.P., KLC Associates, L.P. and David J. Johnson
(incorporated by reference from Exhibit 10(k) to KinderCare's
Quarterly Report on Form 10-Q for the Quarterly Period ended
September 19, 1997).
10(n)* Directors' Deferred Compensation Plan (incorporated by reference
from Exhibit 10(q) to KinderCare's Annual Report on Form 10-K for
the fiscal year ended May 29, 1998).
10(o)* Form of Indemnification Agreement for Directors and Officers of
KinderCare (incorporated by reference from Exhibit 10(r) to
KinderCare's Annual Report on Form 10-K for the fiscal year ended
May 29, 1998).
10(p)* Restated KinderCare Learning Centers, Inc. Nonqualified Deferred
Compensation Plan effective January 1, 1999 (incorporated by
reference from Exhibit 10(a) to KinderCare's Quarterly Report on
Form 10-Q for the Quarterly Period ended March 5, 1999).
10(q)* Form of Executive Split Dollar Life Insurance Agreement
(incorporated by reference from Exhibit 10(b) to KinderCare's
Quarterly Report on Form 10-Q for the Quarterly Period ended March
5, 1999).
10(r)* Form of Letter Regarding Fiscal Year 2000 Management Bonus Plan.
16 Letter from KPMG LLP regarding Change in Certifying Accountant
(incorporated by reference from Exhibit 16 of the Registrant's
Current Report on Form 8-K dated April 7, 1997).
21 Subsidiaries of KinderCare.
23(a) Accountants' Consent - Deloitte & Touche LLP.
27 Financial Data Schedule
* Management contract or compensatory plan or arrangement.
The Company does not intend to send an annual report and proxy materials to
stockholders during calendar year 2000.
(b) Reports on Form 8-K - The registrant filed no reports on Form 8-K during
the fourth quarter of fiscal 1999.
(c) Exhibits Required by Item 601 of Regulation S-K - The exhibits to this
report are listed under item 14(a)(3) above.
54
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on August 26, 1999.
KINDERCARE LEARNING CENTERS, INC.
By: DAVID J. JOHNSON
-------------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities indicated, on August 26, 1999:
By: DAVID J. JOHNSON
-------------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
By: DAN JACKSON
-------------------------------------
Dan Jackson
Vice President,
Financial Control and Planning
(Principal Financial and Accounting
Officer)
By: HENRY R. KRAVIS
-------------------------------------
Henry R. Kravis
Director
By: GEORGE R. ROBERTS
-------------------------------------
George R. Roberts
Director
By: CLIFTON S. ROBBINS
-------------------------------------
Clifton S. Robbins
Director
By: NILS P. BROUS
-------------------------------------
Nils P. Brous
Director
By: STEPHEN KAPLAN
-------------------------------------
Stephen Kaplan
Director
55
1
KINDERCARE LEARNING CENTERS, INC.
BY-LAWS
AS AMENDED THROUGH DECEMBER 2, 1998
ARTICLE I
MEETINGS OF STOCKHOLDERS
Section 1. Place of Meeting and Notice. Meetings of the stockholders
of the Corporation shall be held at such place either within or without the
State of Delaware as the Board of Directors may determine.
Section 2. Annual and Special Meetings. Annual meetings of
stockholders shall be held, at a date, time and place fixed by the Board of
Directors and stated in the notice of meeting, to elect a Board of Directors and
to transact such other business as may properly come before the meeting. Special
meetings of the stockholders may be called by the Chief Executive Officer for
any purpose and shall be called by the Chief Executive Officer or Secretary if
directed by the Board of Directors or requested in writing by the holders of not
less than 25% of the capital stock of the Corporation. Each such stockholder
request shall state the purpose of the proposed meeting.
Section 3. Notice. Except as otherwise provided by law, at least 10
and not more than 60 days before each meeting of stockholders, written notice of
the time, date and place of the meeting, and, in the case of a special meeting,
the purpose or purposes for which the meeting is called, shall be given to each
stockholder.
Section 4. Quorum. At any meeting of stockholders, the holders of
record, present in person or by proxy, of a majority of the Corporation's issued
and outstanding capital stock shall constitute a quorum for the transaction of
business, except as otherwise provided by law. In the absence of a quorum, any
officer entitled to preside at or to act as secretary of the meeting shall have
power to adjourn the meeting from time to time until a quorum is present.
Section 5. Voting. Except as otherwise provided by law, all matters
submitted to a meeting of stockholders shall be decided by vote of the holders
of record, present in person or by proxy, of a majority of the Corporation's
issued' and outstanding capital stock.
<PAGE>
2
ARTICLE II
DIRECTORS
Section 1. Number, Election and Removal of Directors. The number of
Directors that shall constitute the Board of Directors shall not be less than
one or more than fifteen. The first Board of Directors shall consist of two
Directors. Thereafter, within the limits specified above, the number of
Directors shall be determined by the Board of Directors or the stockholders. The
Directors shall be elected by stockholders at their annual meeting. Vacancies
and newly created directorships resulting from any increase in the number of
Directors may be filled by a majority of the Directors then in office, although
less than a quorum, or by the sole remaining Director or by the stockholders. A
Director may be removed with or without cause by the stockholders.
Section 2. Meetings. Regular meetings of the Board of Directors shall
be held at such times and places as may from time to time be fixed by the Board
of Directors or as may be specified in a notice of meeting.
Section 3. Quorum. One-third of the total number of Directors shall
constitute a quorum for the transaction of business. If a quorum is not present
at any meeting of the Board of Directors, the Directors present may adjourn the
meeting from time to time, without notice other than announcement at the
meeting, until such a quorum is present. Except as otherwise provided by law,
the Certificate of Incorporation of the Corporation, these by-laws or any
contract or agreement to which the Corporation is a party, the act of a majority
of the Directors present at any meeting at which there is a quorum shall be the
act of the Board of Directors.
Section 4. Committees. The Board of Directors may, by resolution
adopted by a majority of the whole Board, designate one or more committees,
including, without limitation, an Executive Committee, to have and exercise such
power and authority as the Board of Directors shall specify. In the absence or
disqualification of a member of a committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not he or
they constitute a quorum, may unanimously appoint another Director to act at the
absent or disqualified member.
<PAGE>
3
ARTICLE III
OFFICERS
The officers of the Corporation shall consist of a Chief Executive
Officer, a Secretary, and such other additional officers with such titles as the
Board of Directors shall determine, all of which shall be chosen by and shall
serve at the pleasure of the Board of Directors. Such officers shall have the
usual powers and shall perform all the usual duties incident to their respective
offices. All officers shall be subject to the supervision and direction of the
Board of Directors. The authority, duties or responsibilities of any officer of
the Corporation may be suspended by the Chief Executive Officer with or without
cause, and the Chief Executive Officer may terminate the employment of any
officer with or without cause Any officer elected or appointed by the Board of
Directors may be removed by the Board of Directors with or without cause.
ARTICLE IV
INDEMNIFICATION
The Corporation shall indemnify Directors and officers (as such terms
are defined in the Certificate of Incorporation) of the Corporation as specified
in the Certificate of Incorporation. In addition, to the fullest extent
permitted by the Delaware General Corporation Law, the corporation shall
indemnify any current or former Director or officer of the Corporation and may,
at the discretion of the Board of Directors, indemnify any current or former
employee or agent of the Corporation against all expenses, judgments, fines and
amounts paid in settlement actually and reasonably incurred by him in connection
with any threatened, pending or completed action, suit or proceeding brought by
or in the right of the Corporation or otherwise, to which he was or is a party
by reason of his current or former position with the Corporation or by reason of
the fact that he is or was serving, at the request of the Corporation, as a
director, officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise.
Expenses incurred by a person who is or was a director or officer of
the Corporation in appearing at, participating in or defending any such action,
suit or proceeding shall be paid by the Corporation at reasonable intervals in
advance of the final disposition of such action, suit or proceeding upon receipt
of an undertaking by or on behalf of the director or officer to repay such
amount if it shall ultimately be determined that he is not entitled to be
indemnified by the Corporation as authorized by this Article. If a claim under
this Article is not paid in full by the Corporation within ninety days after a
written claim has been received by the Corporation, the claimant may at any time
thereafter bring suit against the Corporation to recover the unpaid amount of
the claim and, if successful in whole or in part, the claimant shall be paid
also the expense of prosecuting such claim. It shall be a defense to any such
action (other than an action brought to enforce a claim for expenses incurred in
defending any proceeding in advance of its final disposition where the required
undertaking, if any is required, has been tendered to the Corporation) that the
claimant has not met the standards of
<PAGE>
4
conduct which make it permissible under the Delaware General Corporation Law or
other applicable law for the corporation to indemnify the claimant for the
amount claimed, but the burden of proving such defense shall be on the
Corporation. Neither the failure of the Corporation (including its board of
directors, independent legal counsel, or its stockholders) to have made a
determination prior to the commencement of such action that indemnification of
the claimant is proper in the circumstances because he has met the applicable
standard of conduct set forth in the Delaware General Corporation Law or other
applicable law, nor an actual determination by the Corporation (including its
board of directors, independent legal counsel, or its stockholders) that the
claimant has not met the applicable standard of conduct, shall be a defense to
the action or create a presumption that the claimant has not met the applicable
standard of conduct.
ARTICLE V
GENERAL PROVISIONS
Section 1. Notices. Whenever any statute, the Certificate of
Incorporation or these by-laws require notice to be given to any Director or
stockholder, such notice may be given in writing by mail, addressed to such
Director or stockholder at his address as it appears in the records of the
Corporation, with postage thereon prepaid. Such notice shall be deemed to have
been given when it is deposited in the United States mail. Notice to Directors
may also be given by telegram.
Section 2. Fiscal Year. The fiscal year of the Corporation shall be
fixed by the Board of Directors.
August 25, 1999
___________________
___________________
___________________
Dear ____________:
For Fiscal Year 2000, your target bonus is _____% of your annual earnings during
the fiscal year from the effective date you became employed in a bonus eligible
position, and will be determined as follows:
1. 90% based on the Company's Earnings Before Interest, Taxes,
Depreciation and Amortization (EBITDA).
2. 10% based on how well you achieve your personal objectives.
Annual earnings do not include Bonus Payments, Short Term Disability Benefits,
State Disability Benefits, Long Term Disability Benefits, Workers' Compensation
Payments or other forms of compensation paid with respect to periods you were
not actively working.
To receive a bonus, you will need to be employed in a bonus eligible position on
the last day of Fiscal Year 2000: June 2, 2000. If you transfer from one bonus
eligible position to another bonus eligible position during the fiscal year,
your bonus will be calculated using the formula set forth above through the end
of the accounting period that includes the effective date of the transfer, and
using the formula appropriate for your new position beginning on the first day
of the next accounting period.
The bonus plan is designed to reward excellent performance. To receive any
amount with respect to the portion of your Fiscal Year 2000 Bonus that is based
on the Company's EBITDA performance, the Company must achieve EBITDA of at least
<PAGE>
___________________
August 25, 1999
Page 2 of 2
90% of the target EBITDA that is reflected in the Fiscal Year 2000 Financial
Plan for the Company (the FY 00 Plan). If the Company achieves 100% of it's
targeted FY 00 Plan EBITDA, you will receive 100% of your target bonus that is
based on Company EBITDA. If the Company achieves 110% of targeted FY 00 Plan
EBITDA, you will receive two times the amount of your target bonus that is based
on Company EBITDA. The attached worksheet illustrates the amount of the Company
EBITDA portion of your bonus you will receive based on various levels of assumed
Company EBITDA performance. It also illustrates how the portion of your bonus
based on achievement of your personal objectives will be calculated.
A portion of your bonus is based on how well you accomplish your personal
objectives and you need to work with your supervisor to establish them. Attached
is a Personal Bonus Objectives - Bonus 2000 form. Your supervisor will meet with
you to discuss your personal objectives for the year. Upon approval, the
objectives will be forwarded, with a signed copy of this letter, to the
Compensation and Benefits Department, where they will be maintained throughout
the year. These items are due in our office no later than October 1, 1999.
Any questions you have about the bonus plan can be directed to me, Robyn Giger
at (503) 872-1380, or Tanya Holtzclaw at (503) 872-1489 in the Compensation and
Benefits Department.
Sincerely,
EDWARD L. BREWINGTON
Edward L. Brewington
Vice President, Human Resources
By signing below, I acknowledge receipt and understanding of the FY 00 Bonus
Plan.
______________________________________________________ _____________________
Name Date
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