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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 June 2, 2000
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 requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
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 July 28, 2000 was
$10,376,040.
The number of shares of the registrant's common stock, $.01 par value per
share, outstanding at July 28, 2000 was 9,468,664.
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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 early childhood education and
care 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; 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.
Overview
Founded in 1969, KinderCare is the leading for-profit provider of
educational services and care to children primarily between the ages of six
weeks and five years in the United States. Recently, KinderCare has taken steps
to become a more broad-based education company that provides educational content
and services to 0 to 18 year olds. During the past year, we purchased a distance
learning company that offers an accredited high school program delivered through
correspondence format and over the internet. We have also invested in or entered
into alliances with other companies that distribute educational content and
services and have made internal investments, as described below:
Distance Learning. In June 2000, our new subsidiary, KC Distance Learning,
Inc., acquired NLKK, Inc., a distance learning company based in Bloomsburg,
Pennsylvania. KC Distance Learning now operates these three business units:
Keystone National High School, an accredited correspondence-based high school
program; Keystone eSchool, which provides the on-line delivery of most of the
same courses as Keystone National High School; and the Learning and Evaluation
Center, which provides subject extension or make-up and extra credit courses to
high school students.
Charter Schools. Charter schools have arisen as a publicly-funded
alternative to public schools in those states that have passed enabling
legislation. In February 2000, we made a minority investment in Beacon Education
Management, Inc., a charter school management company based in Westborough,
Massachusetts. At July 28, 2000, Beacon operated 26 charter schools primarily
located in the northeastern region of the United States.
Educational Content and Delivery for Public Schools. In June 2000, we made
a minority equity investment in Voyager Expanded Learning, Inc., which is a
leading provider of activity based after-school, in-school and summer school
programs for elementary and middle schools.
Educational Content. In August, 1999, we entered into an agreement with
Gateway Learning Corporation to deliver the Hooked on Phonics(R) reading and
literacy program in selected centers in order to enhance the value of our
educational services in our early childhood education and care centers. At July
28, 2000, over 200 of our centers offered the four-week
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program to four- and five-year-old children attending our centers. We intend to
offer Hooked on Phonics(R) in the majority of our centers within the next two
years.
Internet Initiatives. KinderCare has completed an evaluation, with the
assistance of a third-party consultant, of its current and potential uses of the
internet. As a result of that evaluation, we have restructured our website,
KinderCare.com. Our enhanced website, which was released in August 2000, is more
aesthetically pleasing and user friendly. We are now assessing potential
additional enhancements targeted at conversion of prospective customers and
communications with existing families. In addition to KinderCare.com, our
subsidiary KC Distance Learning sells and/or delivers its high school curriculum
over the keystonehighschool.com and creditmakeup.com websites. The information
on our websites is not incorporated by reference in this document.
In addition to these alliances and investments, we acquired 13 Ohio-based
child care centers from a local provider in January 2000. This acquisition was
part of our continuing effort to grow our primary business of providing
center-based early childhood educational services and care. In our early
childhood education and care business, we operate two primary types of centers:
KinderCare community centers and KinderCare At Work(R) centers. KinderCare
community centers, which comprise the vast majority of our centers, typically
provide educational services and care 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 early childhood education and
care for the families of their employees. At July 28, 2000, we operated a total
of 1,132 child care centers and served approximately 111,000 children and their
families. Of the 1,132 centers, 1,130 were located in 39 states in the United
States and two centers were located in the United Kingdom. KinderCare's total
center licensed capacity at July 28, 2000 was approximately 150,000.
KinderCare'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. KinderCare's tuition
rates vary for children of different ages and by location.
The principal executive offices of KinderCare are located at 650 N.E.
Holladay Street, Suite 1400, Portland, Oregon 97232 and our telephone number is
(503) 872-1300.
Business Strategy
We are pursuing a business strategy containing the following key elements:
Continue Accelerated Opening of Centers With Improved Economics. We plan to
expand by opening approximately 40 new community centers per year in locations
where we believe the market for educational services and care will support
higher tuition rates than our current average rates. We believe there are
opportunities to continue to locate centers in many attractive markets across
the United States. In 1997, we developed a new center prototype that reflects a
larger and more physically appealing design than prior prototypes. We added 97
of our new prototype centers in fiscal years 1998 through 2000. We have opened
three community centers from the end of fiscal year 2000 to July 28, 2000.
Capitalize on Strong Brand Identity and Reputation. Our high quality
educational and child care services, developed over 30 years, have enabled us to
develop a strong brand identity and reputation in the center-based 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 educational services and care.
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.
Pursue Strategic Growth Through Acquisitions and Investments. We plan to
continue to pursue opportunities for acquisition of, strategic investments in
and alliances with companies in our industry that offer educational content and
services
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to 0 to 18 year olds. We believe these initiatives will complement our
center-based educational services for children ages six weeks to 12 years and
will make us a more competitive and broad-based education company. Over the past
year we have expanded our educational distribution system. See "Overview."
KinderCare plans to continue that growth in the following areas:
o Educational content and services
o Distance learning
o Charter schools
o Private schools
o Regional and local early childhood education chains
o Internet initiatives
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 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.
Increase Existing Center Revenue and Customer Retention. KinderCare has
ongoing initiatives to grow revenue by (a) implementing targeted marketing
programs to further enhance brand image and awareness, (b) enhancing the
recruiting, retention and training of staff, and (c) 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 early childhood education and 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.
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 the children
and parents we serve and to prepare children for success in school and in life.
We provide curriculum-specific training for our staff to 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.
Increase Number of Accredited Centers. Although not mandated by any
regulatory authority, we are 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 education and care. We believe that the accreditation process
strengthens the quality of our centers by motivating the teaching staff and
enhancing their understanding of developmentally-appropriate early childhood
practices. At July 28, 2000, we had 311 accredited centers and over 200 centers
in various stages of the accreditation process.
Educational Programs
We have developed a complete array of educational programs, including five
separate proprietary age-specific 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, 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. 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.
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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. Specifically, we provide for advancement of the whole
child, including 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. 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 and encourages children to
learn with age-specific and developmentally-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 to 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 Preschool at KinderCare(R)
program emphasizes school readiness, including pre-reading skills, basic math
concepts, science inquiry and the development of social skills and problem
solving. The program incorporates KinderLetters(R) a phonics-based program
created by The Rigby Company, a publisher of literacy and reading materials. We
are also enhancing both preschool curricula with additional reading readiness
materials, such as the Hooked on Phonics(R) reading and literacy 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
curriculum provides these experiences.
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 July 28, 2000, KinderCare operated 42 on-site/near-site
employer-sponsored early childhood education and care centers for 37 different
employers, including Fred Meyer, Lego Systems, The Walt Disney Company and
several other businesses, universities and hospitals. In addition, we have
executed contracts with Universal Orlando and Saturn to open two more
employer-sponsored centers in fiscal year 2001. Of the current 42
on-site/near-site centers, 38 were KinderCare owned or leased and four 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.
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The viability of back-up child care, a new concept, is being tested by
KinderCare. Our existing centers would be utilized to provide back-up child care
services to the employees of subscribed employers. Currently, a pilot program is
being run in 23 centers for a national retailer. If such pilot program is
successful, KinderCare will consider further marketing efforts.
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 magazine,
radio and cable television 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 focused on center-specific marketing opportunities such as (1)
choosing sites that are convenient for customers in order to 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 can talk with
staff, visit classrooms and play with educational toys and computers. Currently,
interested 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 year 2000, our area managers and center directors received
sales and service training in a series of two day courses staggered throughout
the year designed to improve their skills at enrolling and retaining new
customers and retaining employees. We also 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. We also sponsor 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.
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 $120.75, $113.45 and $106.81 for fiscal years 2000, 1999 and
1998, respectively.
Seasonality
New enrollments are generally highest in October and February. 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
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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.
KinderCare's Real Estate Asset Management Program
At July 28, 2000, KinderCare owned 769, or 68%, of its 1,132 centers, with
land and buildings having a net book value of $475.4 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 continues to underperform, 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 2000, KinderCare closed 39 centers, 32 of which were leased.
From the end of fiscal year 2000 to July 28, 2000, 40 centers were closed, 34 of
which were leased.
During fiscal year 1999, a provision of $4.0 million was recorded related
to the planned early termination of operating leases for 38 underperforming
centers. The provision included an estimate of discounted future lease payments
and anticipated incremental costs related to closure of the centers. During
fiscal year 2000, 25 underperforming leased centers were closed. After further
review, we decided not to close eight of the originally identified centers due
to improved operating performance. However, in fiscal year 2000, 31 additional
leased centers were identified for closure. From the end of fiscal year 2000 to
July 28, 2000, 33 centers have been closed. We expect the remaining three leased
centers to be closed during the first quarter of fiscal year 2001.
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 three surplus
properties in fiscal year 2000. We were in the process of marketing an
additional 17 surplus properties at July 28, 2000.
Employees
At July 28, 2000, we employed approximately 26,000 people. Of these
employees, approximately 300 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- and part-time teachers, temporary and substitute
teachers, teachers' aides and non-teaching staff, including cooks and van
drivers. Approximately 7.4% of our 26,000 employees, including all management
and supervisory personnel, are salaried, all other employees are paid on an
hourly basis. We do not have an agreement with any labor union and believe that
we have good relations with our employees.
Human Resources
Regional and Center Personnel. At July 28, 2000, our center operations were
organized into four regions and 83 areas reporting to four Regional Vice
Presidents and a Vice President of Operations. During fiscal years 1998 through
2000, we took steps to strengthen our field operations by adding 33 area manager
positions and 12 regional support positions. In fiscal year 2001, we plan to
expand field management by creating two new regional manager positions. These
positions will focus on improving operations within selected markets in the
Southern and Midwestern regions of the United States.
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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 have
also implemented a new video series of orientation and staff training programs
that is easier to deliver and is expected to be more effective than prior
programs.
Employee Benefits. 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. During fiscal year 1999, we
completed the installation of new personal computers and fax machines in all of
our centers. Recently, we have upgraded our financial reporting software,
replaced our payroll system and are in the process of developing automated
government child care assistance billings and implementing upgraded human
resources information systems.
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.
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, including
church-affiliated and other non-profit 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, kindergarten 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.
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.
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Our competition also includes other large, national, for-profit companies
providing child care and education services, many of which offer child care at a
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 employment practices liability. These policies provide for a
variety of coverages, are subject to various limits, and include substantial
deductibles or self-insured retentions. Special insurance is sometimes obtained
with respect to specific hazards, if deemed appropriate and available at
reasonable cost. At July 28, 2000, KinderCare had approximately $7.3 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 2000, approximately
20.5% 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.
8
<PAGE>
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 ("NHTSA") issued
interpretive letters that appear to modify its interpretation of regulations
governing the sale by automobile dealers of vehicles intended to be used for the
transportation of children to and from school by child care providers. These
letters indicate that dealers may no longer sell 15-passenger vans for this use,
and that any vehicle designed to transport eleven persons or more must meet
federal school bus standards if it is likely to be used significantly to
transport children to and from school or school-related events. These
interpretations have affected the type of vehicle that may be purchased by
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, in some jurisdictions, require drivers who have
commercial licenses. At July 28, 2000, we had 880 school buses out of a total of
2,540 vehicles used to transport children. Also, we have ordered approximately
80 additional school buses, which are expected to be delivered in August 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 Let Me Do It(R)
Families(SM) o Let's Move, Let's Play(R)
o I Think. I Can.(TM) o My Window On The World(R)
o KC Imagination Highway(R) o SmallTalk(R)
o Kid's Choice(TM) o The Whole Child is the Whole
o KinderCare At Work(R) Idea(TM)
o KinderCare Connections(TM) o Welcome To Learning(R)
o Lakemont Academy(TM) o Your Child's First Classroom(R)
A federal registration in the United States is effective for ten years and
may be renewed for ten-year periods perpetually, subject only to required
filings based on continued use of the mark by the registrant. A federal
registration provides the presumption of ownership of the mark by the registrant
and notice of its exclusive right to use such mark throughout the United States
in connection with the goods or services specified in the registration. In
addition, 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. On July 15, 2000, KinderCare signed an
amendment to its lease to add 4,400 square feet to its corporate office space in
July 2000 and an additional 2,300 square feet in July 2001. Rent for the
additional space is calculated at $23.00 per square foot for the remainder of
the first five years of the lease and will increase to $26.50 per square foot
for the second five years of the lease term.
Early Childhood Education and Care Centers. At July 28, 2000, we owned 769
of our operating centers, leased 359 operating centers and operated four 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 classrooms, 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
135 to 220 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 before and 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 250 children.
The KinderCare community and KinderCare At Work(R) centers operated by
KinderCare at July 28, 2000 were located as follows:
<TABLE>
<CAPTION>
Community KinderCare At
Location Centers Work(R) Centers Total
--------------------------------- ----------- --------------- ----------
<S> <C> <C> <C>
United States:
Alabama 9 -- 9
Arizona 15 2 17
Arkansas 3 -- 3
California 101 -- 101
Colorado 30 -- 30
Connecticut 13 2 15
Delaware 4 -- 4
Florida 65 6 71
Georgia 37 -- 37
Illinois 83 2 85
Indiana 24 1 25
Iowa 8 3 11
Kansas 14 -- 14
Kentucky 13 1 14
Louisiana 11 2 13
Maryland 23 -- 23
Massachusetts 21 -- 21
Michigan 32 2 34
Minnesota 37 -- 37
Mississippi 4 -- 4
Missouri 35 -- 35
Nebraska 10 1 11
Nevada 10 -- 10
10
<PAGE>
Community KinderCare At
Location Centers Work(R) Centers Total
--------------------------------- ----------- --------------- ----------
New Hampshire 2 -- 2
New Jersey 39 4 43
New Mexico 7 -- 7
New York 5 2 7
North Carolina 34 -- 34
Ohio 77 4 81
Oklahoma 7 -- 7
Oregon 12 4 16
Pennsylvania 42 -- 42
Rhode Island -- 1 1
Tennessee 21 1 22
Texas 107 1 108
Utah 6 1 7
Virginia 49 -- 49
Washington 54 1 55
Wisconsin 24 1 25
United Kingdom 2 -- 2
----------- --------------- ----------
1,090 42 1,132
=========== =============== ==========
</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 an automated work order system. Technicians are
notified and track all work orders via palm top computers. Specific geographic
areas are supervised by two regional directors and 12 facility managers, each of
whom manages between six and nine 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 lawsuits
of which we are aware, we believe that none of these allegations, claims or
lawsuits, either individually or in the aggregate, will have a material adverse
effect on our business or operations. In addition, we cannot predict the
negative impact of publicity that may be associated with any such allegation,
claim or lawsuit.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
11
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCK HOLDER MATTERS
Price Range of Common Stock
In February 1997, affiliates of Kohlberg Kravis Roberts & Co. ("KKR")
became owners of 7.8 million shares of our common stock in a recapitalization
transaction. Since then, 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 very limited
market due to the very low trading volume, the small number of brokerage firms
acting as market makers and the sporadic nature of the trading activity. The
average weekly trading volume during fiscal year 2000 was less than 400 shares.
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
---------- ----------
<S> <C> <C>
Fiscal year ended June 2, 2000
First quarter $ 33 $ 25
Second quarter 32 21 1/2
Third quarter 21 1/2 18
Fourth quarter 23 15
Fiscal year ended May 28, 1999
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
</TABLE>
Approximate Number of Security Holders
At July 28, 2000, there were 84 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, 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. The fiscal years are typically comprised of 52 weeks.
However, fiscal year 2000 includes 53 weeks. 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 (a)
---------------------------------------------------------------------------
June 2, 2000 May 28, May 29, May 30, May 31,
(53 Weeks) 1999 1998 1997 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues, net........................... $ 696,846 $ 632,985 $ 597,070 $ 563,135 $ 541,264
Operating expenses, exclusive of
recapitalization expenses,
restructuring and other charges,
net.................................. 619,756 565,238 546,376 515,481 488,071
Recapitalization expenses (b)........... -- -- -- 17,277 --
Restructuring and other charges (c)..... -- 4,157 5,201 10,275 1,484
------------ ------------ ------------ ------------ ------------
Total operating expenses............. 619,756 569,395 551,577 543,033 489,555
------------ ------------ ------------ ------------ ------------
Operating income................... 77,090 63,590 45,493 20,102 51,709
Investment income, net.................. 386 490 612 232 250
Interest expense........................ (45,375) (41,843) (40,677) (22,394) (16,727)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes
and extraordinary items............ 32,101 22,237 5,428 (2,060) 35,232
Income tax expense...................... 12,138 8,711 2,002 3,375 13,549
------------ ------------ ------------ ------------ ------------
Income (loss) before extraordinary
items.............................. 19,963 13,526 3,426 (5,435) 21,683
Extraordinary items, net of income
taxes (d)............................ -- -- -- (7,532) --
------------ ------------ ------------ ------------ ------------
Net income (loss).................. $ 19,963 $ 13,526 $ 3,426 $ (12,967) $ 21,683
============ ============ ============ ============ ============
Net income (loss) per share:
Basic - Income (loss) before
extraordinary items.................. $ 2.11 $ 1.43 $ 0.36 $ (0.33) $ 1.10
Extraordinary items, net................ -- -- -- (0.46) --
------------ ------------ ------------ ------------ ------------
Net income (loss).................. $ 2.11 $ 1.43 $ 0.36 $ (0.79) $ 1.10
============ ============ ============ ============ ============
Diluted - Income (loss) before
extraordinary items.................. $ 2.08 $ 1.40 $ 0.36 $ (0.33) $ 1.07
Extraordinary items, net................ -- -- -- (0.46) --
------------ ------------ ------------ ------------ ------------
Net income (loss).................. $ 2.08 $ 1.40 $ 0.36 $ (0.79) $ 1.07
============ ============ ============ ============ ============
Other Financial Data:
Adjusted EBITDA (e)..................... $ 117,132 $ 105,131 $ 93,247 $ 81,907 $ 87,165
Adjusted EBITDA margin.................. 16.8% 16.6% 15.6% 14.5% 16.1%
Depreciation............................ $ 40,042 $ 37,384 $ 42,553 $ 34,253 $ 33,972
Capital expenditures.................... 87,912 96,634 84,954 43,748 67,304
Child Care Center Data:
Number of centers at end of
fiscal year.......................... 1,169 1,160 1,147 1,144 1,148
Center licensed capacity at
end of fiscal year................... 150,000 146,000 143,000 143,000 141,000
Occupancy (f)........................... 69.8% 69.9% 70.6% 70.0% 70.3%
Average tuition rate (g)................ $ 120.75 $ 113.45 $ 106.81 $ 101.93 $ 99.24
Balance Sheet Data (at end of period):
Property and equipment, net............. $ 613,206 $ 566,365 $ 508,113 $ 471,558 $ 468,525
Total assets............................ 695,570 638,797 591,539 569,878 527,476
Total debt.............................. 460,446 425,795 403,097 394,889 146,617
Stockholders' equity.................... 76,673 51,790 31,900 27,707(h) 262,435
See accompanying notes to selected historical consolidated financial and other data.
</TABLE>
13
<PAGE>
Notes to Selected Historical Consolidated Financial and Other Data
(a) KinderCare's fiscal year ends on the Friday closest to May 31. Typically,
the fiscal years are comprised of 52 weeks. Fiscal year 2000, however,
includes 53 weeks.
(b) In fiscal year 1997, KinderCare incurred non-recurring expenses in order to
fund the transactions undertaken in the recapitalization.
(c) Restructuring and other charges, net, included the following, with dollars
in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------------------------
June 2, 2000 May 28, May 29, May 30, May 31,
53 (Weeks) 1999 1998 1997 1996
------------ ---------- ---------- ---------- ----------
<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)
------------ ---------- ---------- ---------- ----------
$ -- $ 4,157 $ 5,201 $ 10,275 $ 1,484
============ ========== ========== ========== ==========
</TABLE>
(d) In fiscal year 1997, KinderCare retired debt prior to maturity, the losses
on which were recorded as extraordinary items.
(e) Adjusted EBITDA is defined by KinderCare as its net income before interest
expense, income taxes, depreciation, amortization, recapitalization
expenses, restructuring and other charges, 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.
(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 centers' licensed capacity. FTE
attendance is not a strict head count. Rather, the methodology determines
an approximate number of full-time children based on weighted averages. For
example, an enrolled full-time child equates to one FTE, while a part-time
child enrolled for 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 all of the centers paid by parents for children to attend
the centers five full days during a week. However, the occupancy mix
between full- and part-time children can significantly affect these
averages with respect to any specific center.
(h) In connection with the 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.
14
<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 53 weeks ended June 2, 2000 as "fiscal
2000" and the 52 weeks ended May 28, 1999 and May 29, 1998 as "fiscal 1999" and
"fiscal 1998," respectively. Typically, KinderCare's first fiscal quarter has 16
weeks and the remaining quarters each have 12 weeks. However, the fourth quarter
of fiscal 2000 includes 13 weeks.
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 centers' licensed capacity. FTE attendance is not a
strict head count. Rather, the methodology determines an approximate number of
full-time children based on weighted averages. For example, an enrolled
full-time child equates to one FTE, while a part-time child enrolled for 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 the 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 all of the
centers paid by parents for children to attend the centers five full days during
a week. However, the occupancy mix between full- and part-time children at each
center can significantly affect these averages with respect to any specific
center.
Fiscal 2000 (53 Weeks) compared to Fiscal 1999 (52 Weeks)
The following table shows the comparative operating results of KinderCare,
with dollars in thousands:
<TABLE>
<CAPTION>
Change
Fiscal Year Ended Fiscal Year Ended Amount
June 2, 2000 Percent of May 28, 1999 Percent of Increase/
(53 Weeks) Revenue (52 Weeks) Revenues (Decrease)
----------------- ---------- ----------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Revenues, net....................... $ 696,846 100.0% $ 632,985 100.0% $ 63,861
----------------- ---------- ----------------- ---------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense.................. 356,828 51.2 324,872 51.3 31,956
Field and corporate expense..... 26,891 3.9 23,996 3.8 2,895
----------------- ---------- ----------------- ---------- ----------
Total salaries, wages
and benefits.................. 383,719 55.1 348,868 55.1 34,851
Depreciation...................... 40,042 5.7 37,384 5.9 2,658
Rent.............................. 29,949 4.3 29,536 4.7 413
Other............................. 166,046 23.8 149,450 23.6 16,596
Restructuring and other charges... -- -- 4,157 0.7 (4,157)
----------------- ---------- ----------------- ---------- ----------
Total operating expenses........ 619,756 88.9 569,395 90.0 50,361
----------------- ---------- ----------------- ---------- ----------
Operating income.............. $ 77,090 11.1% $ 63,590 10.0% $ 13,500
================= ========== ================= ========== ==========
</TABLE>
Revenues, net--Net revenues increased $63.9 million, or 10.1%, to $696.8
million in fiscal 2000 from fiscal 1999. After adjusting fiscal 2000 to a
comparable 52-week basis, net revenues would have increased $50.3 million, or
7.9%, from fiscal 1999 to $683.2 million. The increase in net revenues was
primarily attributable to additional revenues generated by the newly opened
and/or acquired centers. During fiscal 2000 (on a 53-week basis), centers opened
and/or acquired in fiscal 2000, 1999 and 1998 contributed incremental net
revenues of $38.3 million over fiscal 1999, while centers that were closed
incrementally reduced net revenues by $9.7 million. During fiscal 2000,
KinderCare opened 48 centers, which included 13 acquired community centers and
two KinderCare At Work(R) centers, and closed 39 centers. During fiscal 1999,
KinderCare opened 39 centers, which consisted of 37 community centers and two
KinderCare At Work(R) centers, and closed 26 centers. Total licensed capacity
was approximately 150,000 and 146,000 at the end of fiscal 2000 and 1999,
respectively.
For the fiscal 2000, the average tuition rate increased $7.30, or 6.4%, to
$120.75 from $113.45 for fiscal 1999. The tuition increase was due in part to
targeted local increases at existing centers, as well as the addition of new
centers with higher than average tuition rates. Occupancy remained relatively
flat at 69.8% for fiscal 2000 and 69.9% for fiscal 1999.
15
<PAGE>
Salaries, wages and benefits--Expenses for salaries, wages and benefits
increased $34.9 million, or 10.0%, to $383.7 million in fiscal 2000 from fiscal
1999. The expense directly associated with the centers was $356.8 million in
fiscal 2000, an increase of $32.0 million from fiscal 1999. The increase in
center related expenses was primarily attributable to higher staff wage rates
and, to a lesser degree, increased hours and health benefit costs. The expense
related to field management and corporate administration was $26.9 million in
fiscal 2000, an increase of $2.9 million from fiscal 1999.
At the center level, salaries, wages and benefits expense, as a percentage
of net revenues, decreased slightly to 51.2% for fiscal 2000 from 51.3% for
fiscal 1999. See "Inflation and Wage Increases." Total salaries, wages and
benefits expense, as a percentage of net revenues, remained flat at 55.1% for
fiscal 2000 and fiscal 1999.
Depreciation--Depreciation expense increased $2.7 million to $40.0 million
in fiscal 2000 from fiscal 1999. The increase was due primarily to additional
depreciation as a result of the property and equipment related to newly opened
and/or acquired centers. The increase was offset, in part, by reduced asset
impairment charges.
Rent--Rent expense was $29.9 million in fiscal 2000 and $29.5 million in
fiscal 1999. See "Item 2. Properties." The rental rates experienced on renewed
center leases and center leases entered into currently are higher than those
experienced in previous fiscal years.
Other operating expenses--Other operating expenses increased $16.6 million,
or 11.1%, to $166.0 million in fiscal 2000 from fiscal 1999. Other operating
expenses include costs directly associated with the centers, such as food,
insurance, transportation, janitorial and maintenance costs, utilities and
marketing, and expenses related to field management and corporate
administration. The increase was due primarily to higher expenses related to
food, janitorial services, utilities and insurance. As a percentage of net
revenues, other operating expenses increased to 23.8% for fiscal 2000 from 23.6%
for fiscal 1999.
Restructuring and other charges--Restructuring and other charges, net,
included the following, with dollars in thousands:
Fiscal Year Ended
----------------------------
June 2, 2000 May 28,
(53 Weeks) 1999
------------ -------------
Restructuring charges, net........ $ -- $ 3,561
Write-off of offering costs....... -- 596
------------ -------------
$ -- $ 4,157
============ =============
During the fourth quarter of fiscal 1999, a provision of $4.0 million was
recorded related to the planned early termination of operating leases for 38
underperforming centers. The provision included an estimate of discounted future
lease payments and anticipated incremental costs related to closure of the
centers. During fiscal 2000, a total of 25 underperforming leased centers were
closed, which included 23 centers identified in fiscal 1999 and two additional
centers identified in fiscal 2000. KinderCare has paid and/or committed to pay
$1.9 million of lease termination and closure costs for such closed centers.
During the fourth quarter of fiscal 2000, the status of the remaining 15
centers was reviewed. Of the 15 centers, eight will remain open due to improved
operating performance and seven will be closed. Therefore, $0.8 million of the
provision related to the eight centers, which was originally recorded as a
restructuring charge, was reversed. The provision with respect to the seven
centers, was reduced by $0.1 million. In addition, the remaining provision with
respect to one center closed during fiscal 1999 was reduced by $0.5 million due
to a better than expected negotiated lease buyout. KinderCare identified 29
additional centers, in the fourth quarter of fiscal 2000, that are not meeting
performance expectations and committed to exit plans to close such centers. As a
result, restructuring charges of $1.4 million were recorded. The remaining 36
leased centers are expected to close during the first quarter of fiscal year
2001.
During fiscal 1998, KinderCare relocated its corporate offices from
Montgomery, Alabama to Portland, Oregon. In connection with the relocation,
KinderCare recognized $0.2 million in restructuring costs during fiscal 1999.
During the third quarter of fiscal 1999, the remaining provision 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 nonrecurring
costs were written off in connection with KinderCare's decision not to proceed
with a public equity offering.
16
<PAGE>
Operating income--Operating income increased $13.5 million, or 21.2%, to
$77.1 million in fiscal 2000 from fiscal 1999. The increased operating income
was due to the growth in net revenues, the absence of restructuring charges in
fiscal 2000 and the slight decline in total operating expenses, before
restructuring charges, as a percentage of net revenues.
Adjusted EBITDA, defined as net income before interest expense, income
taxes, depreciation and amortization, exclusive of restructuring and other
charges and investment income, was $117.1 million in fiscal 2000, an increase of
$12.0 million from fiscal 1999. As a percentage of net revenues, Adjusted EBITDA
for fiscal 2000 and fiscal 1999 was 16.8% and 16.6%, respectively. Adjusted
EBITDA is not 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, Adjusted EBITDA should
not be used as a tool for comparison as the computation may not be similar for
all companies.
Interest expense--Interest expense was $45.4 million for fiscal 2000
compared to $41.8 million for fiscal 1999. The increase was substantially
attributable to the additional draws on the revolving credit facility and higher
interest rates. KinderCare's weighted average interest rate on its long-term
debt, including amortization of deferred financing costs, was 10.2% for fiscal
2000 compared to 9.9% for fiscal 1999.
Income tax expense--Income tax expense during fiscal 2000 and fiscal 1999
of $12.1 and $8.7 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 primarily to state and
foreign income taxes, offset by tax credits.
Net income--Net income for fiscal 2000 was $20.0 million compared to $13.5
million during fiscal 1999. Basic and diluted net income per share for fiscal
2000 were $2.11 and $2.08, respectively, compared to $1.43 and $1.40,
respectively, for fiscal 1999.
Fiscal 1999 (52 Weeks) compared to Fiscal 1998 (52 Weeks)
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 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 fiscal 1999, 1998 and fiscal year
1997 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, consisting of 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.
17
<PAGE>
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. 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.
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.
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:
Fiscal Year Ended
-------------------------
May 28, May 29,
1999 1998
----------- -----------
Restructuring charges, net.......... $ 3,561 $ 5,697
Write-off of offering costs......... 596 --
Gains on litigation settlements..... -- (496)
----------- -----------
$ 4,157 $ 5,201
=========== ===========
During the fourth quarter of fiscal 1999, a provision of $4.0 million was
recorded related to the early termination of operating leases for 38
underperforming centers. 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
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 provision 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
18
<PAGE>
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.
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.
Liquidity and Capital Resources
KinderCare's principal sources of liquidity are cash flow generated from
operations, borrowings under the $300.0 million revolving credit facility and
the $100.0 million synthetic lease facility established in September 1999. At
June 2, 2000, KinderCare had drawn $88.0 million under the revolving credit
facility, had committed to outstanding letters of credit totaling $35.8 million
and had funded $33.5 million under the synthetic lease facility. KinderCare's
availability under the revolving credit facility at June 2, 2000 was $176.2
million. The revolving credit facility will terminate on February 13, 2004. The
synthetic lease facility will close to draws on February 13, 2001 and will
mature three years later.
KinderCare's consolidated net cash provided by operating activities for
fiscal 2000 was $60.3 million, which represented a $4.8 million decrease in net
cash flow from fiscal 1999 due primarily to an increase in other assets related
to pending draws under the synthetic lease facility. Cash and cash equivalents
totaled $1.4 million at June 2, 2000, compared to $5.8 million at May 28, 1999,
and the ratio of current assets to current liabilities was 0.36 to one at June
2, 2000, versus 0.39 to one at May 28, 1999.
KinderCare's principal uses of liquidity are meeting debt service
requirements, financing its capital expenditures and providing working capital.
In connection with the 1997 recapitalization, KinderCare borrowed $50.0 million
under a term loan facility and issued $300.0 million of 9 1/2% senior
subordinated notes due 2009. The term loan facility will mature on February 13,
2006 and provides for nominal annual amortization. During the second quarter of
fiscal 2000, KinderCare acquired $10.0 million aggregate principal amount of its
9 1/2% senior subordinated notes at an aggregate price of $9.6 million. This
transaction resulted in the write-off of deferred financing costs of $0.3
million and a gain of approximately $0.1 million.
In order to fund capital expenditures on new center development, KinderCare
entered into a $100.0 million synthetic lease facility. Under the synthetic
lease facility, a third-party lessor will finance construction of centers for
lease to KinderCare for a three to five year period, which might be extended,
subject to the consent of the lenders. KinderCare is contingently liable for a
significant portion of the cost through a residual guarantee, but will have the
right to acquire the property for its original cost at the end of the lease
term. The related leases, when executed, are expected to be classified as
operating leases. Accordingly, KinderCare expects lower depreciation and
interest expense and higher rent expense as a result of implementation of the
synthetic lease facility compared to such expenses that would have been incurred
if KinderCare financed the centers directly as owner.
KinderCare may experience decreased liquidity in the summer months and
during the calendar year-end holiday period due to decreased attendance during
these periods. New enrollments are generally highest in October and February,
with attendance declining 5% to 10% during the summer months and the calendar
year-end holiday period.
19
<PAGE>
KinderCare utilized approximately $18.1 million of net operating loss
carryforwards to offset taxable income in its 1998 and 1999 fiscal years.
Approximately $9.1 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.
Management believes that cash flow generated from operations and borrowings
under the revolving credit and synthetic lease facilities 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. 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, cash flow requirements, debt covenants,
competitive factors and seasonality of openings. If KinderCare experiences a
lack of working capital, it may reduce its future capital expenditures. If these
expenditures were substantially reduced, in management's opinion, KinderCare's
operations and its cash flow would be adversely impacted.
Capital Expenditures
During fiscal 2000 and 1999, KinderCare opened 48 and 39 centers,
respectively. KinderCare expects to open approximately 40 new centers per year
in the aggregate for at least the next several years and to continue its
practice of closing centers that are identified as not meeting performance
expectations. In addition, KinderCare may acquire existing centers for local or
regional early childhood education and care providers. KinderCare may not be
able to successfully negotiate and acquire sites and/or previously constructed
centers, meet its targets for new center additions or meet targeted deadlines
for development of new centers.
New centers are located based upon detailed site analyses that include
feasibility and demographic studies and financial modeling. The length of time
from site selection to construction and, finally, the opening of a community
center ranges from 18 to 24 months. Frequently, new site negotiations are
delayed or canceled or construction is delayed for a variety of reasons, many of
which are outside the control of KinderCare. The average total cost per
internally developed community center typically ranges from $1.4 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.
KinderCare has devised a new prototype for internally developed centers
that is larger and has a more physically appealing design than prior prototypes.
The new centers have a pro forma licensed capacity of 180, while the centers
constructed during fiscal 1997 and earlier have an average licensed capacity of
125. When mature, these larger centers are designed to generate higher revenues,
operating income and margins than KinderCare's existing centers. These new
centers have a higher average cost of construction and typically take three to
four years to reach maturity. Based on KinderCare's 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 more new centers are developed and opened,
profitability will be negatively impacted in the short-term, but is expected to
be enhanced in the long-term once these new, more profitable centers achieve
anticipated levels.
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.
20
<PAGE>
Capital expenditures included the following with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
---------------------------------------------
June 2, 2000 May 28, May 29,
(53 Weeks) 1999 1998
------------- ------------- -------------
<S> <C> <C> <C>
New center development.......................... $ 36,631 $ 57,633 $ 36,455
Renovation of existing facilities............... 36,646 29,753 23,698
Equipment purchases............................. 6,618 10,393 22,343
Acquisition of previously constructed centers... 5,029 -- --
Information systems purchases................... $ 2,988 $ 3,855 $ 2,548
------------- ------------- -------------
$ 87,912 $ 96,634 $ 84,954
============= ============= =============
</TABLE>
Capital expenditure limits under KinderCare's credit facilities for fiscal
year 2001 are $190.0 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, including through mortgages or sale-leaseback transactions,
subject to the limitations imposed by the indenture under which the senior
subordinated notes were issued and the credit facilities.
Recently Issued Accounting Standards
Statement of Financial Accounting Standards ("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.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial Statements,
which provides guidance related to revenue recognition. SAB 101 allows companies
to report any changes in revenue recognition related to adopting its provisions
as an accounting change at the time of implementation in accordance with
Accounting Principles Board Opinion No. 20, Accounting Changes. SAB 101 becomes
effective for the fourth quarter of KinderCare's fiscal year 2001, however,
early implementation is acceptable. Assuming SAB 101 is implemented in the first
quarter of fiscal year 2001, KinderCare would defer recognition of registration
and education fees totaling approximately $0.8 million, net of income taxes. The
one-time charge would be recorded as a cumulative effect of a change in
accounting principle. On a go-forward basis, registration and education fees
would be deferred and amortized over the estimated average enrollment period,
not to exceed 12 months.
Seasonality
New enrollments are generally highest in October and February. 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 2000, approximately 20.5% 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.
21
<PAGE>
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. KinderCare has 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 by child care providers. These
letters indicate that dealers may no longer sell 15-passenger vans for this use,
and that any vehicle designed to transport eleven persons or more must meet
federal school bus standards if it is likely to be used significantly to
transport children to and from school or school-related events. These
interpretations 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. NHTSA's recent interpretation and potential related changes in
state and federal transportation regulations are anticipated to increase the
cost to transport children because school buses are more expensive to purchase
and maintain and may require drivers who have commercial licenses. At June 2,
2000, KinderCare had 682 school buses out of a total of 2,540 vehicles used to
transport children.
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.
Expenses for salaries, wages and benefits represented approximately 55.1%
of net revenues for fiscal 2000. Low unemployment rates and positive economic
trends have challenged recruiting efforts and put pressure on wage rates in many
of KinderCare's markets. 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
Market risk represents the risk of loss that may impact the consolidated
financial position, results of operations or cash flows of KinderCare.
KinderCare is exposed to market risk in the areas of interest rates and foreign
currency exchange rates.
Interest Rates
KinderCare's exposure to market risk for changes in interest rates relates
primarily to debt obligations. KinderCare has no cash flow exposure due to rate
changes on its 9 1/2% senior subordinated notes aggregating $290.0 and $300.0
million at June 2, 2000 and May 28, 1999, respectively. KinderCare also has no
cash flow exposure on certain mortgages and industrial revenue bonds aggregating
$7.6 and $8.8 million at June 2, 2000 and May 28, 1999, respectively. However,
KinderCare does have cash flow exposure on its revolving credit facility, its
term loan facility, and certain industrial revenue bonds subject to variable
LIBOR or adjusted base rate pricing. Accordingly, for the years ended June 2,
2000 and May 28, 1999 a 1% change in the LIBOR rate and the adjusted base rate
would have resulted in interest expense changing by approximately $1.4 and $1.1
million, respectively.
Foreign Exchange Risk
KinderCare is exposed to foreign exchange risk to the extent of
fluctuations in the United Kingdom pound sterling. Based upon the relative size
of KinderCare's operations in the United Kingdom, KinderCare does not believe
that the reasonably possible near-term change in the related exchange rate would
have a material effect on KinderCare's financial position, results of operations
or cash flows.
22
<PAGE>
<TABLE>
<CAPTION>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
June 2, 2000 May 28, 1999
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents.......................................... $ 1,445 $ 5,750
Receivables, net................................................... 24,294 19,299
Prepaid expenses and supplies...................................... 7,244 6,056
Deferred income taxes.............................................. 12,208 14,442
------------ ------------
Total current assets............................................ 45,191 45,547
Property and equipment, net............................................ 613,206 566,365
Deferred income taxes.................................................. 1,374 3,499
Deferred financing costs and other assets.............................. 35,799 23,386
------------ ------------
$ 695,570 $ 638,797
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts.................................................... $ 4,549 $ 7,791
Accounts payable................................................... 6,487 8,825
Current portion of long-term debt.................................. 15,612 11,586
Accrued expenses and other liabilities............................. 99,690 88,899
------------ ------------
Total current liabilities....................................... 126,338 117,101
Long-term debt......................................................... 444,834 414,209
Self insurance liabilities............................................. 15,214 17,368
Deferred income taxes.................................................. 5,563 5,646
Other noncurrent liabilities........................................... 26,948 32,683
------------ ------------
Total liabilities............................................... 618,897 587,007
------------ ------------
Commitments and contingencies (Notes 7 and 11)
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 9,481,937 and 9,480,837 shares,
respectively.................................................... 95 95
Additional paid-in capital......................................... 13,509 8,355
Notes receivable from stockholders................................. (1,186) (1,128)
Retained earnings.................................................. 64,668 44,705
Accumulated other comprehensive income............................. (413) (237)
------------ ------------
Total stockholders' equity...................................... 76,673 51,790
------------ ------------
$ 695,570 $ 638,797
============ ============
See accompanying notes to consolidated financial statements.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
Fiscal Year Ended
----------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
------------ ------------ ------------
<S> <C> <C> <C>
Revenues, net................................. $ 696,846 $ 632,985 $ 597,070
------------ ------------ ------------
Operating expenses:
Salaries, wages and benefits............... 383,719 348,868 327,161
Depreciation............................... 40,042 37,384 42,553
Rent....................................... 29,949 29,536 27,985
Provision for doubtful accounts............ 5,107 4,377 5,529
Other...................................... 160,939 145,073 143,148
Restructuring and other charges, net....... -- 4,157 5,201
------------ ------------ ------------
Total operating expenses.............. 619,756 569,395 551,577
------------ ------------ ------------
Operating income........................ 77,090 63,590 45,493
Investment income............................. 386 490 612
Interest expense.............................. (45,375) (41,843) (40,677)
------------ ------------ ------------
Income before income taxes................. 32,101 22,237 5,428
Income tax expense............................ 12,138 8,711 2,002
------------ ------------ ------------
Net income............................ $ 19,963 $ 13,526 $ 3,426
============ ============ ============
Basic net income per share.................... $ 2.11 $ 1.43 $ 0.36
============ ============ ============
Diluted net income per share.................. $ 2.08 $ 1.40 $ 0.36
============ ============ ============
Weighted average common shares outstanding.... 9,477,000 9,477,000 9,397,000
============ ============ ============
Weighted average common shares outstanding
and potential common shares................ 9,597,000 9,633,000 9,398,000
============ ============ ============
See accompanying notes to consolidated financial statements.
</TABLE>
24
<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
Shares Amount Capital Receivable Earnings Income (Loss) Total
--------- --------- ---------- ------------- ----------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
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 3,508
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.................. 13,347
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
Comprehensive income:
Net income.................. -- -- -- -- 19,963 -- 19,963
Cumulative translation
adjustment................ -- -- -- -- -- (176) (176)
---------
Total comprehensive
income.................. 19,787
Issuance of common stock....... 20,108 -- 452 (338) -- -- 114
Purchase of common stock....... (19,008) -- (396) -- -- -- (396)
Proceeds from collection of
stockholders' notes
receivable.................. -- -- -- 280 -- -- 280
Reversal of pre-fresh start
contingency................. -- -- 5,098 -- -- -- 5,098
--------- --------- ---------- ------------- ----------- ------------- ---------
Balance at June 2, 2000... 9,481,937 $ 95 $ 13,509 $ (1,186) $ 64,668 $ (413) $ 76,673
========= ========= ========== ============= =========== ============= =========
See accompanying notes to consolidated financial statements.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
Fiscal Year Ended
----------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operations:
Net income................................. $ 19,963 $ 13,526 $ 3,426
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation............................. 40,042 37,384 42,553
Provision for doubtful accounts.......... 5,107 4,377 5,529
Amortization of deferred financial
costs and other assets................. 3,056 3,169 3,111
(Gain) loss on sales and disposals of
property and equipment, net............ (680) (639) 105
Deferred tax expense..................... 4,271 6,703 1,150
Changes in operating assets and
liabilities:
Increase in receivables................ (10,102) (9,453) (7,884)
Decrease (increase) in prepaid
expenses and supplies................ (1,188) (1,117) 1,175
Decrease (increase) in other assets.... (5,611) 272 (1,590)
Increase in accounts payable, accrued
expenses and other liabilities....... 5,667 11,072 8,791
Other, net............................... (176) (179) 82
------------ ------------ ------------
Net cash provided by operating activities.. 60,349 65,115 56,448
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment........ (82,883) (96,634) (84,954)
Acquisition of previously constructed
centers.................................. (9,490) -- --
Investment accounted for under the
cost method.............................. (5,460) -- --
Proceeds from sales of property and
equipment................................ 1,709 1,637 3,691
Proceeds from collection of notes
receivable............................... 63 1,175 765
------------ ------------ ------------
Net cash used by investing activities.... (96,061) (93,822) (80,498)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from long-term borrowings......... 78,000 50,000 20,000
Payments on long-term borrowings........... (43,349) (27,302) (11,792)
Proceeds from issuance of common stock..... 114 25 520
Proceeds from collection of stockholders'
notes receivable......................... 280 307 165
Purchases of common stock.................. (396) -- --
Bank overdrafts............................ (3,242) (393) 2,827
------------ ------------ ------------
Net cash provided by financing
activities............................. 31,407 22,637 11,720
------------ ------------ ------------
Decrease in cash and cash equivalents...... (4,305) (6,070) (12,330)
Cash and cash equivalents at the
beginning of the fiscal year............. 5,750 11,820 24,150
------------ ------------ ------------
Cash and cash equivalents at the end
of the fiscal year....................... $ 1,445 $ 5,750 $ 11,820
============ ============ ============
Supplemental cash flow information:
Interest paid.............................. $ 41,193 $ 31,472 $ 36,744
Income taxes paid, net..................... 3,387 688 561
See accompanying notes to consolidated financial statements.
</TABLE>
26
<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 educational services and care for children between the ages of six
weeks and twelve years. At June 2, 2000, KinderCare operated a total of 1,169
centers, with 1,167 centers in 39 states in the United States and two centers in
the United Kingdom.
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. At June 2,
2000, the Partnership owned 82.6% of the outstanding common stock of KinderCare.
The consolidated financial statements include the financial statements of
KinderCare and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Fiscal Year
References to fiscal 2000, fiscal 1999 and fiscal 1998 are to the 53 weeks
ended June 2, 2000, the 52 weeks ended May 28, 1999 and the 52 weeks ended May
29, 1998, respectively. KinderCare's fiscal year ends on the Friday closest to
May 31. Typically, the first quarter is 16 weeks long and the second, third and
fourth quarters are each 12 weeks long. Fiscal 2000, however, is 53 weeks long
with 13 weeks in the fourth quarter.
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 other
services. Non-tuition income is primarily comprised of field trip revenue.
Advertising
Costs incurred to produce media advertising for seasonal campaigns are
expensed during the quarter in which the advertising first takes place. Costs
related to website development are capitalized in accordance with Statement of
Position No. 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. Other advertising costs are expensed as incurred.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash held in banks and liquid
investments with maturities, at the date of acquisition, not exceeding 90 days.
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.
27
<PAGE>
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.
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 2000 and
1999, impairment charges of $1.1 million and $2.1 million were recorded with
respect to certain underperforming 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. Such method approximates the effective
yield method.
Investments
Investments, wherein KinderCare does not exert significant influence or own
over 20% of the investee's voting common stock, are accounted for under the cost
method.
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. A summary of
self-insurance liabilities was as follows, with dollars in thousands:
<TABLE>
<CAPTION>
June 2, 2000 May 28, 1999
-------------- --------------
<S> <C> <C>
Balance at the beginning of the fiscal year... $ 24,427 $ 28,025
Expense....................................... 7,708 4,461
Claims paid................................... (8,754) (8,059)
-------------- --------------
Balance at the end of the fiscal year...... 23,381 24,427
Less current portion of self-insurance
liabilities................................ 8,167 7,059
-------------- --------------
$ 15,214 $ 17,368
============== ==============
</TABLE>
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
established.
28
<PAGE>
Stock-Based Compensation
KinderCare measures compensation expense for its stock-based employee
compensation plans using the method prescribed by Accounting Principles Board
Opinion ("APB") 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
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 per Share
The difference between basic and diluted net income per share was a result
of the dilutive effect of options, which are considered potential common shares.
A summary of the weighted average common shares was as follows, with shares in
thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Weighted average common shares
outstanding.................... 9,477 9,477 9,397
Dilutive effect of options....... 120 156 1
Weighted average common shares
outstanding and potential -------------- -------------- --------------
common shares.................. 9,597 9,633 9,398
============== ============== ==============
</TABLE>
In fiscal 2000, 92,500 shares were excluded from potential common shares
due to their anti-dilutive effect.
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. Since KinderCare operates in one reportable segment, no
changes have been made to KinderCare's current or previous years' disclosures as
a result of adoption of SFAS No. 131.
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.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial Statements,
which provides guidance related to revenue recognition. SAB 101 allows companies
to report any changes in revenue recognition related to adopting its provisions
as an accounting change at the time of implementation in accordance with APB
Opinion No. 20, Accounting Changes. SAB 101 becomes effective for the fourth
quarter of KinderCare's fiscal year 2001, however, early implementation is
acceptable. Assuming SAB 101 is implemented in the first quarter of fiscal year
2001, KinderCare would defer recognition of registration and education fees
totaling approximately $0.8 million, net of income taxes. The one-time charge
would be recorded as a cumulative effect of a change in accounting principles.
On a go-forward basis, registration and education fees would be deferred and
amortized over the estimated average enrollment period, not to exceed 12 months.
29
<PAGE>
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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. Restructuring and Other Charges, Net
During the fourth quarter of fiscal 1999, a provision of $4.0 million was
recorded related to the planned early termination of operating leases for 38
underperforming centers. The provision included an estimate of discounted future
lease payments and anticipated incremental costs related to closure of the
centers. During fiscal 2000, a total of 25 underperforming leased centers were
closed, which included 23 centers identified in fiscal 1999 and two additional
centers identified in fiscal 2000. KinderCare has paid and/or committed to pay
$1.9 million of lease termination and closure costs for such closed centers.
During the fourth quarter of fiscal 2000, the status of the remaining 15
centers was reviewed. Of the 15 centers, eight will remain open due to improved
operating performance and seven will be closed. Therefore, $0.8 million of the
provision related to the eight centers, which was originally recorded as a
restructuring charge, was reversed. The provision with respect to the seven
centers, was reduced by $0.1 million. In addition, the remaining provision with
respect to one center closed during fiscal 1999 was reduced by $0.5 million due
to a better than expected negotiated lease buyout. KinderCare identified 29
additional centers, in the fourth quarter of fiscal 2000, that are not meeting
performance expectations and committed to exit plans to close such centers. As a
result, restructuring charges of $1.4 million were recorded pursuant to the
original authorization of the Board of Directors. The remaining 36 leased
centers are expected to close during the first quarter of fiscal year 2001.
A summary of the lease termination reserve was as follows, with dollars in
thousands:
Balance at May 28, 1999............................ $ 4,000
Payments and/or commitments on 25 centers closed
during fiscal 2000.............................. (1,861)
Reversal related to 8 centers not to be closed..... (760)
Reduction related to 7 centers with closure dates
extended to fiscal year 2001.................... (111)
Reversal of the remaining reserve on 1 center
closed in fiscal 2000........................... (512)
Provision related to exit plans on 29 centers
to be implemented in fiscal year 2001........... 1,393
------------
Balance at June 2, 2000......................... $ 2,149
============
During fiscal 2000, 1999, and 1998, the centers that have been and will be
closed contributed aggregate net revenues of $16.0, $20.9 and $21.7 million,
respectively. Aggregate operating losses of $3.4, $3.2 and $2.0 million were
incurred in fiscal 2000, 1999, and 1998, 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
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 provision 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.
30
<PAGE>
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.
3. Receivables
Receivables consist of the following, with dollars in thousands:
June 2, 2000 May 28, 1999
------------- -------------
Tuition..................................... $ 27,377 $ 22,091
Allowance for doubtful accounts............. (4,790) (4,326)
------------- -------------
22,587 17,765
Other....................................... 1,707 1,534
------------- -------------
$ 24,294 $ 19,299
============= =============
4. Prepaid Expenses and Supplies
Prepaid expenses and supplies consist of the following, with dollars in
thousands:
June 2, 2000 May 28, 1999
------------- -------------
Inventories................................. $ 2,891 $ 2,364
Prepaid rent................................ 2,538 2,898
Other....................................... 1,815 794
------------- -------------
$ 7,244 $ 6,056
============= =============
5. Property and Equipment
Property and equipment consist of the following, with dollars in thousands:
June 2, 2000 May 28, 1999
------------- -------------
Land........................................ $ 159,618 $ 155,742
Buildings and leasehold improvements........ 468,986 418,413
Equipment................................... 151,526 130,610
Construction in progress.................... 29,529 22,809
------------- -------------
809,659 727,574
Accumulated depreciation and amortization... (196,453) (161,209)
------------- -------------
$ 613,206 $ 566,365
============= =============
6. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following, with
dollars in thousands:
June 2, 2000 May 28, 1999
------------- -------------
Accrued compensation, benefits and
related taxes............................. $ 38,734 $ 30,734
Deferred revenue............................ 13,525 11,312
Accrued interest............................ 9,486 8,979
Accrued income taxes........................ 8,719 4,633
Self insurance.............................. 8,163 7,059
Accrued property taxes...................... 7,219 7,450
Accrued restructuring and other charges..... 2,937 4,239
Other....................................... 10,907 14,493
------------- -------------
$ 99,690 $ 88,899
============= =============
31
<PAGE>
7. Long-Term Debt
Long-term debt consists of the following, with dollars in thousands:
<TABLE>
<CAPTION>
June 2, 2000 May 28, 1999
------------- -------------
<S> <C> <C>
Secured:
Borrowings under revolving credit facility, interest
at adjusted LIBOR plus 1.25% from 7.53% to 8.08%
at June 2, 2000 and 6.15% to 6.18% at May 28, 1999
and at the alternative base rate plus 0.00% of
9.50% at June 2, 2000.................................. $ 88,000 $ 35,000
Term loan facility, interest at adjusted LIBOR plus
2.50% of 9.32% and 7.41%, respectively................. 48,500 49,000
Industrial refunding revenue bonds at variable rates
of interest from 4.10% to 6.50% and 3.60% to 5.00%,
respectively, supported by letters of credit,
maturing calendar 2000 to 2009......................... 26,350 33,025
Real and personal property mortgages payable in
monthly installments through calendar 2005,
interest rate of 8.00%................................. 3,233 4,193
Industrial revenue bonds secured by real property
with maturities to calendar 2005 at interest rates
of 6.65% to 9.75% and 5.43% to 9.75%, respectively..... 4,363 4,577
Unsecured - Senior subordinated notes due 2009, interest
at 9 1/2%, payable semi-annually......................... 290,000 300,000
------------- -------------
460,446 425,795
Less current portion of long-term debt..................... 15,612 11,586
------------- -------------
$ 444,834 $ 414,209
============= =============
</TABLE>
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
o in the case of the term loan facility, a debt to
EBITDA-dependent rate ranging from 2.50% to 3.00%
o 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
o in the case of the term loan facility, a debt to EBITDA-dependent
rate ranging from 1.25% to 1.75%
o 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%
--------------
EBITDA is defined as net income before interest expense, income taxes,
depreciation and amortization.
At June 2, 2000, the amount outstanding on the term loan facility was $48.5
million and the interest rate was 9.32%, which was adjusted LIBOR plus 2.50%.
Under the revolving credit facility, $20.0 million was outstanding at an
interest rate of 8.08%, $55.0 million was outstanding at an interest rate of
8.07% and $10.0 million was outstanding at an interest rate of 7.53%, which was
adjusted LIBOR plus 1.25%, while $30.0 million was outstanding at an interest
rate of 9.5%, which was the alternative base rate plus 0.00%.
32
<PAGE>
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 June 2, 2000, the
commitment fee rate was 0.25%. This fee is payable quarterly in arrears. During
fiscal 2000 and 1999, KinderCare paid commitment fees totaling $0.6 and $0.9
million, respectively.
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
June 2, 2000, the letter of credit fee rate was 1.25%, which included 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 June 2, 2000, KinderCare had approximately $35.8 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, as defined in the credit
agreement. 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.
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 2000 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 June 2, 2000, the refunded IRBs
bore interest at variable rates from 4.10% to 6.50%, 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
June 2, 2000, the IRBs bore interest at rates of 6.65% to 9.75%, and each is
secured by a letter of credit under the revolving credit facility.
9 1/2% Senior Subordinated 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.
During fiscal 2000, KinderCare acquired $10.0 million aggregate principal amount
of its 9 1/2% senior subordinated notes at an aggregate price of $9.6 million.
This transaction resulted in the write-off of deferred financing costs of $0.3
million and a gain of approximately $0.1 million.
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.
33
<PAGE>
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
Principal Payments
The aggregate minimum annual maturities of long-term debt for the five
fiscal years subsequent to June 2, 2000 are as follows, with dollars in
thousands:
Fiscal Year:
-----------
2001......................................... $ 15,612
2002......................................... 1,949
2003......................................... 5,597
2004......................................... 88,635
2005......................................... 4,153
Thereafter................................... $ 344,500
---------
$ 460,446
=========
8. Income Taxes
The provision for income taxes attributable to income before income taxes
consists of the following, with dollars in thousands:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal............................. $ 5,212 $ 1,360 $ 470
State............................... 2,736 648 60
Foreign............................. (81) -- 322
------------ ------------ ------------
7,867 2,008 852
Deferred:
Federal............................. 3,825 6,068 3,224
State............................... 478 758 1,426
Foreign............................. (32) (123) (3,500)
------------ ------------ ------------
4,271 6,703 1,150
------------ ------------ ------------
$ 12,138 $ 8,711 $ 2,002
============ ============ ============
</TABLE>
34
<PAGE>
A reconciliation between the statutory federal income tax rate and the
effective income tax rates on income before income taxes, with dollars in
thousands, is as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
------------ ------------ ------------
<S> <C> <C> <C>
Expected tax provision on income
before income taxes at the
federal rate of 35%................ $ 11,235 $ 7,783 $ 1,900
State income taxes, net of federal
tax benefit........................ 1,565 1,084 265
Non-deductible and other expenses.... 131 93 101
Foreign subsidiary valuation
adjustment......................... -- 436 --
Tax credits, net of valuation
adjustment......................... (1,002) (948) (332)
Other, net........................... 209 263 68
------------ ------------ ------------
$ 12,138 $ 8,711 $ 2,002
============ ============ ============
</TABLE>
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>
June 2, 2000 May 28, 1999
-------------- --------------
<S> <C> <C>
Deferred tax assets:
Self-insurance reserves....................... $ 9,968 $ 9,879
Net operating loss carryforwards.............. 3,441 5,212
Capital loss carryforwards.................... 66 374
Property and equipment, basis differences..... 1,065 176
Tax credits................................... 8,785 10,748
Compensation payments......................... 3,289 2,665
Other......................................... 2,442 7,319
-------------- --------------
Total gross deferred tax assets............. 29,056 36,373
Less valuation allowance.................. (3,039) (3,449)
-------------- --------------
Net deferred tax assets..................... 26,017 32,924
-------------- --------------
Deferred tax liabilities:
Property and equipment, basis differences..... (8,262) (11,184)
Property and equipment, basis differences
of foreign subsidiaries..................... (6,114) (5,823)
Stock basis of foreign subsidiary............. (3,622) (3,622)
-------------- --------------
Total gross deferred tax liabilities........ (17,998) (20,629)
-------------- --------------
Financial statement net deferred
tax assets................................ $ 8,019 $ 12,295
============== ==============
</TABLE>
The valuation allowance decreased by $0.4 million during fiscal 2000.
Deferred tax assets, net of valuation allowances, have been recognized to the
extent that their realization is more likely than not. However, the amount of
the deferred tax assets considered realizable could be adjusted in the future as
estimates of taxable income or the timing thereof are revised. If KinderCare is
unable to generate sufficient taxable income in the future through operating
results, increases in the valuation allowance may be required through an
increase to tax expense in future periods. Conversely, if KinderCare recognizes
taxable income of a suitable nature and in the appropriate periods, the
valuation allowance will be reduced through a decrease in tax expense in future
periods.
At June 2, 2000, KinderCare had $9.1 million of net operating losses
available for carryforward which expire over various dates through fiscal year
2020. Utilization of the net operating losses is subject to an annual limitation
of $9.8 million. KinderCare also has capital losses of $0.2 million, which are
available to offset future capital gains, and expire in fiscal year 2003.
Additionally, KinderCare has tax credits available for carryforward for federal
income tax purposes of $8.7 million, which are available to offset future
federal income taxes through fiscal year 2020.
9. Benefit Plans
Stock Purchase and Option Plans
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
35
<PAGE>
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 2000, 1999 and 1998, senior management purchased 20,108,
6,640 and 105,776 shares of restricted common stock in aggregate, respectively,
under the terms of the 1997 Plan. Certain members of senior management executed
term notes with KinderCare in order to purchase the restricted stock. The term
notes mature from calendar 2008 to 2010 and bear interest at rates ranging from
5.84% to 6.66% per annum, payable semi-annually on June 30 and December 31. At
June 2, 2000, the term notes totaled $1.2 million and are reflected as a
component of stockholders' equity.
Options to acquire an aggregate of 150,270, 54,100 and 264,440 shares of
common stock were granted to certain key management employees during fiscal
2000, 1999 and 1998, respectively. Each of such options had a weighted average
fair value, calculated using the Black Scholes option pricing model, of
approximately $9.81, $11.14 and $7.53 on the date of grant in fiscal 2000, 1999
and 1998, respectively. The assumptions used during fiscal 2000, 1999 and 1998,
respectively, to estimate the grant date present value were volatility of 35.1%,
33.6% and 26.0%, risk-free rate of return of 6.8%, 5.9% and 5.5%, 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 June 2, 2000.
Grants or awards under the 1997 Plan are made at fair market value as
determined by the Board of Directors. Options granted during fiscal 2000, 1999
and 1998 have exercise prices ranging from $19.00 to $23.83 per share.
A summary of outstanding options was as follows:
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Shares Price
--------- -----------
<S> <C> <C>
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
Granted................................. 150,270 22.85
Canceled................................ (52,521) 19.51
--------- -----------
Outstanding at June 2, 2000.......... 834,842 $ 19.73
========= ===========
</TABLE>
Options outstanding at June 2, 2000 have a remaining contractual life of
7.3 years. Exercisable options at June 2, 2000 totaled 385,322 and have a
weighted average exercise price of $19.02.
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 net income per share would have been as follows, with
dollars in thousands, except per share data:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
June 2, 2000 May 28, 1999 May 29, 1998
------------ ------------ ------------
<S> <C> <C> <C>
Net income............................. $ 19,176 $ 12,775 $ 2,743
Basic net income per share............. $ 2.03 $ 1.35 $ 0.29
Diluted net income per share........... $ 2.00 $ 1.32 $ 0.29
</TABLE>
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, other than highly compensated 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 nine months. Participants may contribute, in
increments of 1%, up to 18% of their compensation to the Savings Plan. The Board
of
36
<PAGE>
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.
Nonqualified Deferred Compensation Plan
The Board of Directors of KinderCare adopted the KinderCare Learning
Centers, Inc. Nonqualified Deferred Compensation Plan, effective August 1, 1996
and approved the restatement effective August 1, 1996. Under the Nonqualified
Deferred Compensation Plan, certain highly compensated or key management
employees are provided the opportunity to defer receipt and income taxation of
such employees' compensation. 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. Under this plan, non-employee members of the Board of
Directors may elect to defer receipt and income taxation of all or a portion of
their annual retainer. Any amounts deferred under the Directors' Deferred
Compensation Plan are credited to a phantom stock account. The number of shares
of phantom stock credited to the director's account will be determined based on
the amount of deferred compensation divided by the then fair value per share, as
defined in the Directors' Deferred Compensation Plan, of KinderCare's common
stock.
Distributions from the Directors' Deferred Compensation Plan are made in
cash and reflect the value per share of the common stock at the time of
distribution multiplied by the number of phantom shares credited to the
director's account. Distributions from the Directors' Deferred Compensation Plan
occur upon the earlier of (1) the first day of the year following the director's
retirement or separation from the Board or (2) termination of the Directors'
Deferred Compensation Plan.
10. Disclosures About Fair Value of Financial Instruments
Fair value estimates, methods and assumptions are set forth below for
KinderCare's financial instruments at June 2, 2000 and May 28, 1999.
Cash and cash equivalents, receivables, investments and current liabilities
Fair value approximates the carrying value of cash and cash equivalents,
receivables and current liabilities as reflected in the consolidated balance
sheets at June 2, 2000 and May 28, 1999 because of the short-term maturity of
these instruments. The fair value of KinderCare's cost method investments is not
readily determinable as the related securities are not actively traded.
Long-term debt
Based on recent market activity, the carrying value and estimated fair
value of KinderCare's 9 1/2% senior subordinated notes were $290.0 and $261.0
million at June 2, 2000 and $300.0 and $311.0 million at May 28, 1999,
respectively. The carrying values for KinderCare's remaining long-term debt of
$170.4 and $125.8 million at June 2, 2000 and May 28, 1999, respectively,
approximated market value based on current rates that management believes could
be obtained for similar debt.
11. 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 June 2, 2000, the remaining
unamortized balance of the prepaid amount was $1.5 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
37
<PAGE>
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 $11.1, $10.7 and $10.9 million for fiscal 2000, 1999 and 1998,
respectively.
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 June 2, 2000, with dollars in thousands:
Fiscal Year:
-----------
2001.......................................... $ 21,151
2002.......................................... 18,977
2003.......................................... 17,458
2004.......................................... 15,792
2005.......................................... 13,797
Subsequent years.............................. 99,906
At June 2, 2000, KinderCare had a revolving credit facility of $300.0
million, of which $35.8 million was committed under outstanding letters of
credit and $88.0 was drawn. In order to fund capital expenditures on new center
development, KinderCare entered into a $100.0 million synthetic lease facility
in September 1999. Under the synthetic lease facility, a third-party lessor will
finance construction of centers for lease to KinderCare for a three to five year
period, which might be extended, subject to the consent of the lenders. At June
2, 2000, $33.5 million had been funded under the synthetic lease facility. The
related leases, when executed, are expected to be classified as operating
leases.
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.
12. Quarterly Results (Unaudited)
A summary of results of operations for fiscal 2000 and fiscal 1999 is as
follows, with dollars in thousands, except per share data:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Fiscal year ended June 2, 2000 (a):
Revenues, net.......................... $ 207,775 $ 153,130 $ 154,852 $ 181,089
Operating income....................... 19,003 14,100 19,735 24,252
Net income............................. 3,759 2,608 5,779 7,817
Basic net income per share............. 0.40 0.28 0.61 0.82
Diluted net income per share........... 0.39 0.27 0.61 0.82
Fiscal year ended May 28, 1999 (b):
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
--------------
(a) The first quarter contains 16 weeks, the second and third quarters each contain 12 weeks
and the fourth quarter contains 13 weeks.
(b) The first quarter contains 16 weeks and the second, third and fourth quarters each contain
12 weeks.
</TABLE>
38
<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 as of June 2, 2000 and May 28, 1999,
and the related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years ended June 2, 2000,
May 28, 1999, and May 29, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of KinderCare Learning Centers, Inc.
and subsidiaries as of June 2, 2000 and May 28, 1999, and the results of their
operations and their cash flows for each of the years ended June 2, 2000, May
28, 1999, and May 29, 1998, in conformity with accounting principles generally
accepted in the United States of America.
DELOITTE & TOUCHE LLP
Portland, Oregon
July 21, 2000
39
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
40
<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 the
Name and Age Last Five Years and Other Directorships
--------------------------------------- ---------------------------------------------------------
<S> <C>
David J. Johnson (54).................. 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.
Henry R. Kravis (56) (a)............... Henry R. Kravis has been a director of KinderCare 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, Alliance Imaging, Inc., Amphenol Corporation,
BRW Acquisition Inc. (Bristol West Insurance Group), Birch
Telecom, Inc., Borden, Inc., The Boyds Collection Ltd.,
Evenflo Company, Inc., The Gillette Company, IDEX
Corporation, KSL Recreation Corporation, MedCath
Incorporated, Owens-Illinois, Inc., PRIMEDIA, Inc., Regal
Cinemas, Inc., Shoppers Drug Mart Limited, Sotheby's
Holdings, Inc., Spalding Holdings Corporation, TI Group
plc, Trinity Acquistion plc, which is the parent company
of Willis Group Limited, U.S. Natural Resources, Inc. and
United Fixtures Company.
George R. Roberts (56) (a)............. George R. Roberts has been a director of KinderCare 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, Alliance Imaging, Inc., Amphenol Corporation,
Borden, Inc., The Boyds Collection, Ltd., Birch Telecom,
Inc., DPL Inc., Evenflo Company, Inc., IDEX Corporation,
KSL Recreation Corporation, MedCath Incorporated,
Owens-Illinois, Inc., PRIMEDIA, Inc., Regal Cinemas, Inc.,
Safeway Inc., Spalding Holdings Corporation, Trinity
Acquisition plc, which is the parent company of Willis
Group Limited, U.S. Natural Resources Inc., United
Fixtures Company and World Crest Group.
Michael W. Michelson (49).............. Michael W. Michelson has been a director of KinderCare
since December 1999. He is a 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 Alliance Imaging,
Inc., Amphenol Corporation, AutoZone, Inc. and
Owens-Illinois, Inc.
41
<PAGE>
Position with the Company, Year First Elected Director,
Principal Occupation During at Least the
Name and Age Last Five Years and Other Directorships
--------------------------------------- ---------------------------------------------------------
<S> <C>
Nils P. Brous (36)..................... Nils P. Brous has been a director of KinderCare since
February 1997. Mr. Brous has been an executive at KKR
since 1992. Prior to that time, he was an associate at
Goldman, Sachs & Co. Mr. Brous is also a director of
Nexstar Financial Corporation.
Scott C. Nuttall (27).................. Scott C. Nuttall has been a director of KinderCare since
December 1999. Mr. Nuttall has been an executive at KKR
since 1996. Prior to that time, he was an executive at The
Blackstone Group L.P. He is also a director of BRW
Acquisition, Inc. (Bristol West Insurance Group), Trinity
Acquisition plc, which is the parent company of Willis
Group Limited, and Walter Industries Inc.
Stephen A. Kaplan (41)................. Stephen A. Kaplan has been a director of KinderCare 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., Force Energy, Inc., Cherokee
International, L.L.C., GeoLogistics Corporation and Roller
Bearing Holding Co.
---------------
(a) 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, Michelson, Brous and Nuttall 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. Michelson, Brous
and Nuttall. 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. Michelson, Brous and Nuttall 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
KinderCare:
Name Age Position
---- --- --------
David J. Johnson........... 54 Chief Executive Officer and
Chairman ofthe Board
Robert Abeles.............. 54 Executive Vice President, Chief
Financial Officer
Dan R. Jackson............. 46 Senior Vice President, Finance
Bruce A. Walters........... 43 Senior Vice President, Chief
Development Officer
42
<PAGE>
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.
Robert Abeles joined KinderCare as Executive Vice President, Chief
Financial Officer in October, 1999. Mr. Abeles served as Executive Vice
President, Chief Financial Officer and Director of Transamerica Life Companies
from June 1996 to October 1998. Prior to that time, Mr. Abeles spent 24 years at
First Interstate Bank of California and served as Executive Vice President and
Chief Financial Officer from July 1990 to May 1996.
Dan R. Jackson was promoted in October 1999 to Senior Vice President,
Finance. He 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.
Bruce A. Walters joined KinderCare as Senior Vice President, 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.
Other Officers
Name Age Position
---- --- --------
Trudy R. Anderson.......... 36 Region Vice President, Central
David A. Benedict.......... 46 Vice President, Tax
DeeAnn M. Besch............ 43 Region Vice President, Southeast
Edward L. Brewington....... 57 Vice President, Human Resources
Kendra L. Decious.......... 35 Vice President, Controller
S. Wray Hutchinson......... 40 Vice President, Operations
Joseph W. Keough........... 54 Vice President, Real Estate
Lauren A. Klein............ 44 Region Vice President, Western
Eva M. Kripalani........... 41 Vice President, General Counsel
and Secretary
Miriam D. Liggett.......... 39 Region Vice President, Northeast
Bobby J. Willey............ 60 Vice President, Information Services
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,
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.
43
<PAGE>
Kendra L. Decious was promoted in August 2000 to Vice President,
Controller. She joined KinderCare in May 1997 as Senior Director, Controller.
Prior to joining KinderCare, Ms. Decious was Director, SEC and Financial
Reporting at Red Lion Hotels, Inc. from May 1996 to May 1997. From 1995 to May
1996, she provided financial consulting services to KPMG LLP on a self-employed
basis. Previously, Ms. Decious spent over six years with the Los Angeles office
of KPMG LLP.
S. Wray Hutchinson was promoted in April 1996 to Vice President,
Operations. He joined KinderCare in 1992 as District Manager in New Jersey and
was later promoted to Region Manager for the Chicago, Illinois area.
Joseph W. Keough joined KinderCare in December 1999 as Vice President, Real
Estate. Prior to that time, he served as Vice President of Development for
America's Best Contacts & Eyeglasses. Mr. Keough previously held a similar
position with Eye Care Centers of America.
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 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.
Bobby J. Willey joined KinderCare in June 1995 as Vice President,
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.
44
<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
Annual Compensation Awards-Securities All other
Fiscal ------------------------ Underlying Compensation
Name and Principal Position Year Salary Bonus Options (a) (b) (c) (d)
---------------------------------- ------ ----------- ----------- ----------------- ------------
<S> <C> <C> <C> <C> <C>
David J. Johnson.................. 2000 $ 663,381 $ 489,575 -- $ 113,399
Chief Executive Officer 1999 629,458 479,649 -- 104,642
and Chairman of the Board 1998 606,138 658,266 -- --
Robert Abeles..................... 2000 $ 158,654 $ 87,101 34,845 $ 131,135
Executive Vice President, 1999 -- -- -- --
Chief Financial Officer 1998 -- -- -- --
Beth A. Ugoretz (e)............... 2000 $ 236,916 $ 123,629 -- $ 15,588
Former Executive Vice 1999 210,480 123,131 -- 12,901
President, Corporate Services 1998 201,750 164,324 33,183 --
Dan R. Jackson.................... 2000 $ 186,206 $ 90,541 5,000 $ 17,505
Senior Vice President, 1999 165,132 73,979 -- 15,359
Finance 1998 151,310 105,855 24,887 --
Bruce A. Walters.................. 2000 $ 219,065 $ 104,275 -- $ 15,606
Senior Vice President, 1999 207,179 104,004 -- 13,186
Chief Development Officer 1998 176,923 127,739 32,895 --
</TABLE>
--------------
(a) Stock options granted under the 1997 Stock Purchase and Option Plan.
(b) Matching contributions by KinderCare under KinderCare's Savings and
Investment Plan and Nonqualified Deferred Compensation Plan were as
follows:
<TABLE>
<CAPTION>
Nonqualified Deferred Savings and
Compensation Plan Investment Plan
---------------------- ----------------------
Fiscal Year Fiscal Year
---------------------- ----------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
David J. Johnson........ $ 11,430 $ 2,693 $ 340 $ 320
Robert Abeles........... $ -- $ -- $ -- $ --
Beth A. Ugoretz......... $ 3,588 $ 901 $ -- $ --
Dan R. Jackson.......... $ 2,668 $ 716 $ 337 $ 143
Bruce A. Walters........ $ 3,306 $ 886 $ -- $ --
</TABLE>
(c) Life insurance premiums paid on behalf of the executive officers were as
follows:
Fiscal Year
--------------------------
2000 1999
----------- -----------
David J. Johnson............ $ 101,629 $ 101,629
Robert Abeles............... 54,816 --
Beth A. Ugoretz............. 12,000 12,000
Dan R. Jackson.............. 14,500 14,500
Bruce A. Walters............ 12,300 12,300
(d) Mr. Abeles received consideration of $76,319 for relocation costs during
fiscal year 2000.
(e) Ms. Ugoretz resigned her position effective June 2, 2000. In connection
with her resignation, KinderCare exercised its option to purchase 13,273
shares of common stock owned by Ms. Ugoretz and cancelled options to
purchase
45
<PAGE>
33,183 shares of common stock. In consideration of these transactions,
KinderCare made a payment of $432,039 to Ms. Ugoretz.
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 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
Option Grants in Fiscal Year 2000
The following table sets forth the individual option grants during the
fiscal year ended June 2, 2000 to the Named Executive Officers:
<TABLE>
<CAPTION>
Percent of
Total
Number of Options
Securities Granted to
Underlying Employees Exercise Grant Date
Options in Fiscal Price Present
Name Granted (a) Year Per Share Expiration Date Value (b)
---- ----------- ---------- --------- ----------------- ----------
<S> <C> <C> <C> <C> <C>
David J. Johnson.............. -- --% $ -- -- $ --
Robert Abeles................. 34,845 23.2 22.42 October 18, 2009 341,829
Beth A. Ugoretz............... -- -- -- -- --
Dan R. Jackson................ 5,000 3.3 23.05 February 8, 2010 49,050
Bruce A. Walters.............. -- -- -- -- --
--------------
(a) The options become exercisable 20% per year over a five-year period, with the first 20%
becoming exercisable on the first anniversary of the vesting commencement date. Vesting ceases
upon termination of employment; however, options vest in full upon death or disability. The
options expire upon the earlier of (i) ten years following grant date, (ii) the first
anniversary of death or disability or retirement, (iii) a specified period following any
termination of employment other than for cause, (iv) termination for cause and (v) the date of
any merger or certain other transactions. Exercisability of options will accelerate upon a
change of control of KinderCare.
46
<PAGE>
(b) Although KinderCare believes that it is not possible to place a value on an option, in
accordance with the rules of the Securities and Exchange Commission, a modified Black-Scholes
model of option valuation has been used to estimate grant date present value. The actual value
realized, if any, may vary significantly from the values estimated by this model. Any further
values realized will ultimately depend upon the excess of the stock price over the exercise
price on the date the option is exercised. The assumptions used to estimate the grant date
present value of this option were volatility of 35.1%, risk-free rate of return of 6.8%,
dividend yield of 0.0% and time to exercise of seven years.
</TABLE>
Aggregated Option Exercises in Fiscal Year 2000 and 2000 Fiscal Year End
Option Values
The following table sets forth the unexercised options held at June 2, 2000
by the Named Executive Officers:
<TABLE>
<CAPTION>
Value of Unexercised
Number of Unexercised "In-The-Money"
Options at June 2, 2000 Options at June 2, 2000(a)
---------------------------- ----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
David J. Johnson............. 252,632 168,421 $ 1,427,371 $ 951,579
Robert Abeles................ -- 34,845 -- 77,704
Beth A. Ugoretz (b).......... 19,910 13,273 112,492 77,535
Dan R. Jackson............... 14,932 14,955 84,366 64,246
Bruce A. Walters............. 13,158 19,737 74,343 111,514
--------------
(a) The value of options represents the aggregate difference between the fair value, as
determined by the Board of Directors, at June 2, 2000 and the applicable exercise
price.
(b) Subsequent to June 2, 2000, these options were cancelled in connection with
KinderCare's purchase of common stock owned by Ms. Ugoretz. She received a payment of
$107,912 in consideration for such options, net of the exercise price.
</TABLE>
Compensation of KinderCare's Directors
During fiscal year 2000, 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.
Compensation Committee Interlocks and Insider Participation
The Board of Directors has approved the appointment of a compensation
committee composed of Michael W. Michelson, Nils P. Brous and Scott C. Nuttall.
Mr. Michaelson is a member of KKR & Co. L.L.C., the limited liability company
which serves as the general partner of KKR, and Messrs. Brous and Nuttall are
executives at KKR. See "Item 13. Certain Relationships and Related
Transactions."
47
<PAGE>
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 July 28, 2000 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
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 9,468,664 shares of common stock outstanding as of July 28, 2000 and the
381,438 shares subject to option grants which have vested or will vest prior to
September 26, 2000.
<TABLE>
<CAPTION>
Shares Percent of
Beneficially Class
Name Owned Outstanding
---- ------------ -----------
<S> <C> <C>
KKR-KLC L.L.C. and affiliated entities (1)...................... 7,828,947 82.7%
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)............................................ 410,527 4.2%
Robert Abeles (3)............................................... 13,938 *
Dan R. Jackson (3).............................................. 24,887 *
Bruce A. Walters (3)............................................ 32,895 *
Henry R. Kravis (1)............................................. -- --
George R. Roberts (1)........................................... -- --
Michael W. Michaelson (1)....................................... -- --
Nils P. Brous (1)............................................... -- --
Scott C. Nuttall(1)............................................. -- --
Stephen A. Kaplan (2)........................................... -- --
All directors and executive officers as a group
(10 individuals) (3).......................................... 482,247 4.9%
--------------
* Percentage of shares of common stock beneficially owned does not exceed one percent.
(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, Scott M. Stuart and Edward A. Gilhuly. Messrs.
Kravis and Roberts are members of the Executive Committee of KKR-KLC L.L.C. and are
also directors of KinderCare. Mr. Michelson is also a director 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.
48
<PAGE>
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(Y)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
September 26, 2000 as follows:
Number of
Name Options
---- ---------
David J. Johnson................................ 252,632
Robert Abeles................................... --
Dan R. Jackson.................................. 14,932
Bruce A. Walters................................ 19,737
Beth A. Ugoretz, former Executive Vice President, Corporate Services, resigned prior
to July 28, 2000. In connection with her resignation, shares owned by Ms. Ugoretz were
purchased by KinderCare and all outstanding options were cancelled.
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Relationship with KKR
At July 28, 2000, affiliates of Kohlberg Kravis Roberts & Co. beneficially
owned in the aggregate approximately 82.7% 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, Scott M. Stuart and Edward A.
Gilhuly. Messrs. Kravis and Roberts 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 receives fees and expense reimbursement for management, consulting and
financial services provided to KinderCare and may receive customary investment
banking fees for services, plus reimbursement of its related expenses. During
fiscal year 2000, KinderCare paid $577,939 in fees and reimbursements to KKR.
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.
49
<PAGE>
Management Indebtedness
The following table sets forth the amount of indebtedness due under term
notes executed by certain Named Executive Officers:
<TABLE>
<CAPTION>
Largest Aggregate Amount of
Amount of Indebtedness
Indebtedness During Outstanding at
Name Fiscal Year 2000 July 28, 2000
---- ------------------- --------------
<S> <C> <C>
Robert Abeles.......................... $ 212,490 $ 156,245
Beth A. Ugoretz........................ 77,187 --
Dan R. Jackson......................... 84,145 84,145
Bruce A. Walters....................... 50,002 50,002
</TABLE>
The term notes mature from calendar 2008 to 2009 and bear interest at rates
ranging from 5.84% to 6.29% per year, payable semi-annually on June 30 and
December 31. The term notes are secured by shares of restricted stock purchased
by the executive officers under the terms of the 1997 Plan.
50
<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 June 2, 2000 and
May 28, 1999............................................. 23
Consolidated statements of operations for the fiscal years
ended June 2, 2000, May 28, 1999 and May 29, 1998........ 24
Consolidated statements of stockholders' equity and
comprehensive income for the fiscal years ended
June 2, 2000, May 28, 1999 and May 29, 1998.............. 25
Consolidated statements of cash flows for the fiscal year
ended June 2, 2000, May 28, 1999 and May 29, 1998........ 26
Notes to consolidated financial statements................. 27-38
Independent auditors' report............................... 39
(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
(incorporated by reference from Exhibit 3(b) to KinderCare's
Annual Report on Form 10-K for the fiscal year ended May 28,
1999).
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).
4(c) First Supplemental Indenture dated as of September 1, 1999 to
the Indenture dated as of February 13, 1997 between KinderCare
and HSBC Bank USA (formerly known as Marine Midland Bank), as
Trustee (incorporated by reference from Exhibit 4(a) to
KinderCare's Quarterly Report on Form 10-Q for the quarterly
period ended September 17, 1999).
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 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).
51
<PAGE>
Exhibit
Number Description of Exhibits
------ -----------------------
10(c) 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(d)* 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(e)* 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(f)* 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(g)* 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(h)* Form of Term Note (incorporated by reference from Exhibit
10(g) to KinderCare's Quarterly Report on Form 10-Q for the
quarterly period ended September 19, 1997).
10(i)* 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(j)* 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(k)* 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(l)* 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(m)* 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(n)* 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(o)* 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(p)* 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(q)* Form of Letter regarding the Fiscal Year 2001 Management Bonus
Plan.
10(r) Credit Agreement among the Lessor, the Agent and the Lenders,
dated as of September 2, 1999 (incorporated by reference from
Exhibit 10(a)to KinderCare's Quarterly Report on Form 10-Q for
the quarterly period ended September 17, 1999).
10(s) Participation Agreement among KinderCare Learning Centers,
Inc., as Lessee, The KinderCare Realty Trust, as Lessor,
Scotiabanc Inc., as an Investor, The Chase Manhattan Bank, as
Agent for the Lenders, who may become a party to the Credit
Agreement and the Lenders, dated as of September 2, 1999
(incorporated by reference from Exhibit 10(b)to KinderCare's
Quarterly Report on Form 10-Q for the quarterly period ended
September 17, 1999).
10(t) Rules of Usage and Definitions under the Participation
Agreement (incorporated by reference from Exhibit 10(c)to
KinderCare's Quarterly Report on Form 10-Q for the quarterly
period ended September 17, 1999).
10(u) Agency Agreement between the Lessor and the Lessee, dated as
of September 2, 1999 (incorporated by reference from Exhibit
10(d)to KinderCare's Quarterly Report on Form 10-Q for the
quarterly period ended September 17, 1999).
10(v) Guarantee made by Lessee, KinderCare Real Estate Corp. and
KinderCare Development Corp. to the Agent, the Lenders and the
Investor, dated as of September 2, 1999 (incorporated by
reference from Exhibit 10(e)to KinderCare's Quarterly Report
on Form 10-Q for the quarterly period ended September 17,
1999).
10(w) Lease, Security Agreement and Financing Statement between the
Lessor and the Lessee, dated as of September 2, 1999
(incorporated by reference from Exhibit 10(f)to KinderCare's
Quarterly Report on Form 10-Q for the quarterly period ended
September 17, 1999).
52
<PAGE>
Exhibit
Number Description of Exhibits
------ -----------------------
21 Subsidiaries of KinderCare.
23 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 fiscal year 2001.
(b) Reports on Form 8-K - The registrant filed no reports on Form 8-K during
the fourth quarter of fiscal 2000.
(c) Exhibits Required by Item 601 of Regulation S-K - The exhibits to this
document are listed under item 14(a)(3) above.
53
<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 24, 2000.
KINDERCARE LEARNING CENTERS, INC.
By: /s/ DAVID J. JOHNSON
------------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities indicated, on August 24, 2000:
By: /s/ DAVID J. JOHNSON
-----------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
By: /s/ ROBERT ABELES
-----------------------------------
Robert Abeles
Executive Vice President,
Chief Financial Officer
(Principal Financial and Accounting
Officer)
By: /s/ HENRY R. KRAVIS
-----------------------------------
Henry R. Kravis
Director
By: /s/ GEORGE R. ROBERTS
-----------------------------------
George R. Roberts
Director
By: /s/ MICHAEL W. MICHELSON
-----------------------------------
Michael W. Michelson
Director
By: /s/ NILS P. BROUS
-----------------------------------
Nils P. Brous
Director
By: /s/ SCOTT C. NUTTALL
-----------------------------------
Scott C. Nuttall
Director
By: /s/ STEPHEN KAPLAN
-----------------------------------
Stephen Kaplan
Director
54
