Nobel Learning Communities 10Q 2003 Q4 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: December 31, 2003

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission File Number 1-10031

NOBEL LEARNING COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)


Delaware		22-2465204
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

1615 West Chester Pike, West Chester, PA		19382
(Address of principal executive offices)		(Zip Code)

(484) 947-2000

(Registrant’s telephone number, including area code)

Indicate by check whether the registrant (1) has filed all report(s) 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 ¨

Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2b of the Exchange Act) Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,799,375 shares of Common Stock outstanding at February 10, 2004.

INDEX TO FORM 10-Q

Nobel Learning Communities, Inc.


		Page Number
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets, December 31, 2003 (unaudited) and June 30, 2003	2

	Consolidated Statements of Operations for the three and six months ended December 31, 2003 and 2002 (unaudited)	3

	Consolidated Statements of Cash Flows for the six months ended December 31, 2003 and 2002	4

	Consolidated Statements of Stockholders’ Equity and Comprehensive Loss for the six months Ended December 31, 2003 (unaudited)	5

	Notes to Consolidated Interim Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3	Quantitative and Qualitative Disclosures About Market Risk	23

Item 4	Controls and Procedures	23

PART II.	OTHER INFORMATION

Item 6.	Exhibits and Reports on Form 8-K	24

PART I

Financial Information

“Safe Harbor” Statement under Private Securities Litigation Reform Act of 1995

Certain statements set forth in or incorporated by reference in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, without limitation, the Company’s outlook for the fiscal year ended June 30, 2004 (“Fiscal 2004”), other statements in this report other than historical facts relating to the financial conditions, results of operations, plans, objectives, future performance and business of the Company. In addition, words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Such statements are based on management’s currently available operating budgets and forecasts, which are based upon detailed assumptions about many important factors such as market demand, market conditions and competitive activities. While the Company believes that its assumptions are reasonable, readers are cautioned that there are inherent difficulties in predicting the impact of certain factors, especially those affecting the acceptance of the Company’s newly developed schools and businesses and performance of recently acquired businesses, which could cause actual results to differ materially from predicted results. Readers are cautioned that the forward-looking statements reflect management’s analysis only as of the date hereof, and the Company assumes no obligation to update these statements. Actual future results, events and trends may differ materially from those expressed in or implied by such statements depending on a variety of factors set forth throughout this Quarterly Report on Form 10-Q.

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share amounts)


	(unaudited)
	December 31, 2003			June 30, 2003
ASSETS
Cash and cash equivalents	$	3,953		$	4,722
Accounts receivable, less allowance for doubtful accounts of $837 at December 2003 and $803 at June 2002		4,367			5,111
Notes receivable		132			220
Refundable income taxes		715			1,203
Deferred tax asset		2,100			2,941
Prepaid rent		2,457			2,455
Prepaid insurance and other		1,878			1,941
Property and equipment held for sale		4,782			8,503

Total Current Assets		20,384			27,096

Property and equipment, at cost		61,267			57,602
Accumulated depreciation and amortization		(33,691	)		(30,147	)

Total property and equipment		27,576			27,455

Goodwill		39,965			39,965
Intangible assets, net		789			197
Investment, net of $1,000 allowance		1,500			1,500
Deferred tax asset		1,312			863
Deposits and other assets		818			892

Total Assets	$	92,344		$	97,968

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current portion of long-term obligations	$	16,986		$	24,860
Current portion of swap contract		644			910
Cash overdraft liability		3,775			3,429
Accounts payable and other current liabilities		9,488			10,662
Unearned income		11,473			10,330

Total Current Liabilities		42,366			50,191

Long-term obligations		580			677
Long-term subordinated debt		9,807			9,928
Other long term liabilities		1,201			3
Minority interest in consolidated subsidiary		99			94

Total Liabilities		54,053			60,893

Commitments and Contingencies

Stockholders’ Equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized, issued and outstanding 6,419,033 at December 2003 and 5,920,797 at June 2003. $14,434 and $11,524 aggregate liquidation preference at December 2003 and June 2003, respectively		6			6
Common stock, $0.001 par value; 20,000,000 shares authorized, issued 6,698,569 at December 2003 and 6,612,109 at June 2003, outstanding 6,468,059 at December 2003 and 6,381,599 at June 2003		7			6
Treasury stock, cost; 230,510 shares		(1,375	)		(1,375	)
Additional paid-in capital		50,988			47,753
Accumulated deficit		(10,936	)		(8,778	)
Accumulated other comprehensive loss		(399	)		(537	)

Total Stockholders’ Equity		38,291			37,075

Total Liabilities and Stockholders’ Equity	$	92,344		$	97,968

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K are an integral part of these financial statements.

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands except per share data)

(unaudited)


	For the Three Months Ended						For the Six Months Ended
	December 31, 2003			December 31, 2002			December 31, 2003			December 31, 2002
Revenues	$	40,192		$	37,866		$	75,458		$	70,534

Operating expenses:
Personnel costs		19,387			18,048			36,710			34,004
School operating costs		5,820			5,232			11,524			10,447
Insurance, taxes, rent and other		8,627			8,219			17,218			16,177
Depreciation and amortization		1,220			1,256			2,406			2,494
New school development		—			33			44			210

Total operating expenses		35,054			32,788			67,902			63,332

School operating profit		5,138			5,078			7,556			7,202

Goodwill impairment		—			2,200			—			2,200
Transaction related cost		—			600			—			1,018
General and administrative expenses		3,179			3,005			7,889			5,716

Operating income (loss)		1,959			(727	)		(333	)		(1,732	)
Interest expense		1,076			817			1,919			1,689
Other (income) expense		(68	)		(4	)		(59	)		15
Minority interest in income		4			6			5			10

Income (loss) from continuing operations before income taxes		947			(1,546	)		(2,198	)		(3,446	)
Income tax expense (benefit)		312			269			(840	)		(511	)

Income (loss) from continuing operations		635			(1,815	)		(1,358	)		(2,935	)
Income (loss) from discontinued operations, net of income tax effect		23			(1,556	)		(550	)		(2,291	)

Net income (loss)		658			(3,371	)		(1,908	)		(5,226	)
Preferred stock dividends		133			21			250			41

Income (loss) available to common shareholders	$	525		$	(3,392	)	$	(2,158	)	$	(5,267	)

Basic income (loss) per share:
Income (loss) from continuing operations	$	0.08		$	(0.29	)	$	(0.25	)	$	(0.47	)
Discontinued operations		0.00		$	(0.24	)		(0.09	)		(0.36	)

Income (loss) per share	$	0.08		$	(0.53	)	$	(0.34	)	$	(0.83	)

Dilutive income (loss) per share:
Income (loss) from continuing operations	$	0.07		$	(0.29	)	$	(0.25	)	$	(0.47	)
Discontinued operations		0.00			(0.24	)		(0.09	)		(0.36	)

Income (loss) per share	$	0.07		$	(0.53	)	$	(0.34	)	$	(0.83	)

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K are an integral part of these financial statements.

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Cash Flow

For the Six Months Ended December 31, 2003 and 2002

(Dollars in thousands)


	2003			2002
Cash Flows from Operating Activities:
Net loss	$	(1,908	)	$	(5,226	)

Adjustment to Reconcile Net loss to Net Cash Provided by Operating Activities:
Depreciation and amortization		3,500			3,071
Non-compete and consulting contracts		990			—
Reserve for discontinued operations		(818	)		163
Amortization of debt discount		64			64
Provision for losses on accounts receivable		264			125
Provision for deferred taxes		393			—
Fixed asset write-offs		—			2,596
Goodwill impairment		—			2,200
Gain on sale of property		(76	)		—
Other		33			10

Changes in Assets and Liabilities:
Accounts receivable		1,055			(251	)
Prepaid assets		62			898
Other assets and liabilities		72			197
Unearned income		1,142			1,990
Accounts payable and accrued expenses		(594	)		(3,744	)

Total Adjustments		6,087			7,319

Net Cash Provided by Operating Activities		4,179			2,093

Cash Flows from Investing Activities:
Capital expenditures		(4,241	)		(3,589	)
Proceeds from sale of property and equipment		3,935			—
Repayment of notes receivable		—			(85	)

Net Cash Provided (Used) in Investing Activities		(306	)		(3,674	)

Cash Flows from Financing Activities:
Proceeds from revolving line of credit		—			3,681
Repayment of long term debt		(7,731	)		(1,071	)
Repayment of subordinated debt		(275	)		(1,036	)
Proceeds from the issuance of preferred stock		2,920			—
Changes in cash overdraft		346			(315	)
Repayment of capital lease obligation		(150	)		(73	)
Dividends paid to preferred stockholders		(41	)		(41	)
Cash distribution of minority interest		—			(158	)
Proceeds from exercise of stock options and warrants		289			25

Net Cash (Used) provided in Financing Activities		(4,642	)		1,012

Net decrease in cash and cash equivalents		(769	)		(569	)
Cash and cash equivalents at beginning of period		4,722			1,787

Cash and cash equivalents at end of period	$	3,953		$	1,218

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K are an integral part of these financial statements.

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss

For the Six Months Ended December 31, 2003

(Dollars in thousands except share data)


	Preferred Stock				Common Stock			Treasury Stock			Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive Loss			Total
	Shares		Amount		Shares	Amount		Treasury Stock			Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive Loss			Total
June 30, 2003	5,920,797		$	6	6,612,109	$	6	$	(1,375	)	$	47,753	$	(8,778	)	$	(537	)	$	37,075

Comprehensive loss:
Net loss	—			—	—		—		—			—		(1,908	)		—			(1,908	)
Swap contract, net of tax	—			—	—		—		—			—		—			138			138

Total comprehensive loss	—			—	—		—		—			—		—			—			(1,770	)
Issuance of preferred stock	588,236			1	—		—		—			2,919		—			—			2,920
Preferred stock converted to common	(90,000	)		—	26,460		—		—			—		—			—			—
Stock options exercised	—			—	60,000		—		—			289		—			—			289
Compensation for non employee stock options	—			—	—		—		—			27		—			—			27
Preferred dividends	—			—	—		—		—			—		(250	)		—			(250	)

December 31, 2003	6,419,033		$	7	6,698,569	$	6	$	(1,375	)	$	50,988	$	(10,936	)	$	(399	)	$	38,291

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K are an integral part of these financial statements.

NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES

Notes to Consolidated Interim Financial Statements

for the six months ended December 31, 2003 and 2002

(unaudited)

Note 1 – Basis of Presentation

The consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position and results of operations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2003.

Due to the inherent seasonal nature of the education and child care businesses, annualization of amounts in these interim financial statements may not be indicative of the actual operating results for the full year.

Future results of operations of the Company involve a number of risks and uncertainties. Factors that could affect future operating results and cause actual results to vary materially from historical results include, but are not limited to, consumer acceptance of the Company’s business strategy with respect to expansion into new and existing markets, the Company’s debt and related financial covenants, ability to refinance Company’s senior debt, difficulties in managing the Company’s growth including attracting and retaining qualified personnel and additional enrollments, impairment, if any, of goodwill, increased competition, changes in government policy and regulation and the ability to obtain additional financing or capital required to implement fully the Company’s business plan. Negative developments in these areas could have a material effect on the Company’s business, financial condition and results of operations.

Certain prior period amounts have been reclassified to conform to the current period’s presentation.

Note 2 – Liquidity

On May 28, 2003, the Company entered into its fifth amendment to the Amended and Restated Loan and Security Agreement. This amendment (i) waived the Company’s noncompliance with its financial ratios for the periods ending December 31, 2002 and March 31, 2003, (ii) reset future required financial covenant ratios, (iii) changed the maturity of the Acquisition Credit Facility to December 31, 2003, (iv) increased the interest rate spread over the prime rate, required a capital infusion of at least $5,000,000 by June 30, 2003, (v) required that a minimum of $4,000,000 of additional capital infusion be received by the Company with the proceeds applied against the Acquisition Credit Facility by August 30, 2003, and (vi) placed a limitation on capital expenditures.

On June 17, 2003 the Company completed a private placement of an aggregate of 1,333,333 shares of Series E Convertible Preferred Stock, $.001 par value, for a purchase price of $6,000,000. The Series E Preferred Stock is convertible into Common Stock at a conversion rate of one share of Common Stock for each Series E Convertible Preferred Stock. The proceeds from the issuance of the Series E Convertible Preferred Stock were used to pay down the Company’s Working Capital Line of Credit by $4,543,000 with the remainder being available for working capital purposes.

On August 28, 2003, the Company completed the sale of an owned school located in the greater Phoenix, Arizona area and received net proceeds of $3,934,000. On September 2, 2003, the Company used the proceeds for the sale of the Arizona property to make the required $4,000,000 payment against the Acquisition Credit Facility.

On September 9, 2003 the Company completed a private placement of an aggregate of 588,236 shares of Series F Convertible Preferred Stock, $.001 par value, for a purchase price of $3,000,000. The Series F Preferred Stock is convertible into Common Stock at a conversion rate of one share of Common Stock for each Series F Convertible Preferred Stock. The proceeds from the issuance of the Series F Convertible Preferred Stock was used for (i) the repayment of debt, (ii) to meet certain bank covenants related to capital expenditure restrictions, (iii) to meet certain requirements relating to the negotiations for the sixth amendment to the Amended and Restated Loan and Security Agreement, (iv) requirements for working capital and other general corporate purposes.

On September 29, 2003, the Company entered into its sixth amendment to the Amended and Restated Loan and Security Agreement. This amendment (i) modified the definition of EBITDA (defined as earnings before interest expense, income taxes, depreciation and amortization and excludes certain one time charges) to allow for additional non-cash expenses associated with the Company’s Fiscal 2003 and its first quarter Fiscal 2004 results to be excluded from EBITDA, (ii) required a $1,000,000 pay down on the Acquisition Credit Facility, (iii) reduced the Working Capital Line of Credit from $10,000,000 to $5,000,000, (iv) required the Company to have a commitment by October 31, 2003 for refinancing of its existing senior credit facility and (v) required that all senior debt be paid off by December 31, 2003. On October 31, 2003, the Company received a commitment letter to refinance the existing debt.

On October 24, 2003, the Company and its senior lenders agreed to replace Exhibit I (defines non-cash charges to be excluded from the definition of EBITDA) to the sixth amendment to the Amended and Restated Loan and Security Agreement, to further modify the definition of EBITDA to allow the exclusion of additional non-cash expenses related to certain non-compete and consulting agreements (See Note 3).

As a result of the sixth amendment to the Amended and Restated Loan and Security Agreement and the required refinancing by December 31, 2003, all amounts outstanding under the Company’s senior credit facilities are classified as current.

As a result of these events and scheduled payments, the total amount outstanding under the Company’s senior credit facility was $14,893,000 at January 31, 2004 as compared to $23,990,000 at June 30, 2003, as shown below (dollars in thousands):


	January 31, 2004		December 31, 2003		June 30, 2003
Term Loan Facility	$	9,107	$	9,643	$	10,714
Acquisition Credit Facility		5,786		6,616		13,276
Working Capital Credit Facility		—		—		—

	$	14,893	$	16,259	$	23,990

The Company has entered into a letter of commitment with another financial institution to refinance the amounts outstanding under the Amended and Restated Loan and Security Agreement. The Company is in the process of completing the documentation required to close this refinancing. While the Company feels confident that this transaction will occur by February 28, 2004, there are no assurances that it will be successful in doing so.

Note 3 – Non-Compete and Consulting Agreements

On August 29, 2001, the Company entered into Employment and Termination Agreements with each of Mr. A.J. Clegg and Mr. John Frock. These agreements provided, as to each of these executives, that if such executive voluntarily terminated his employment with the Company, the Company would continue to provide, at its cost, family health insurance coverage to the executive and his spouse for the remainder of their lives or, in the event that the Company is unable under its then-current group health insurance plan to provide such family health insurance coverage, the Company would reimburse the executive and his spouse up to $24,000 per year for the cost of obtaining similar health insurance coverage. Upon such termination, the Company would also provide each executive with two full, annual scholarships per year for life to the Company school of his choice. In the Employment and Termination Agreements, each executive also agreed not to compete with the Company for a period of three years following termination of his employment, in exchange for which the Company would, for each such year, pay to Mr. A.J. Clegg the sum of $100,000 and to Mr. Frock the sum of $50,000. Annual payments made with respect to the agreements not to compete will be expensed annually.

Upon Mr. A.J. Clegg’s voluntary termination of his employment in July 2003, the Company became obligated to Mr. A.J. Clegg for the payments and benefits to be provided to him pursuant to the terms of his Employment and Termination Agreement. In addition, the Company, Mr. A.J. Clegg and Tuscan Business Solutions, Inc. (an entity owned and controlled by Mr. A.J. Clegg) entered into a consulting agreement, as required by Mr. A.J. Clegg’s Employment and Termination Agreement, pursuant to which Tuscan Business Solutions agreed, for a term of five years, to provide up to 10 hours of consulting services each month for the Company, for which Tuscan Business Solutions is being paid $200,000 per year.

Upon Mr. Frock’s voluntary termination of his employment in August 2003, the Company became obligated to Mr. Frock for the payments and benefits to be provided to him pursuant to the terms of his Employment and Termination Agreement. In addition, the Company and Mr. Frock entered into a consulting agreement, as required by Mr. Frock’s Employment and Termination Agreement, pursuant to which Mr. Frock agreed, for a term of five years, to provide up to 10 hours of consulting services each month for the Company, for which Mr. Frock is being paid $100,000 per year.

Total payments to be made with respect to the above consulting agreements over the next five years is $1,500,000 and estimated future payments for future health insurance coverage based on life expectancy is approximately $1,304,000. During the first quarter of Fiscal 2004, the Company recorded a $1,500,000 charge to cover the present value of the future payments to be made with respect to these consulting agreements of approximately $1,290,000 and charges for future health insurance coverage of approximately $210,000.

The Company and Mr. Frock are also parties to a Noncompete Agreement, dated as of March 11, 1997, which provided that the Company would make a payment to Mr. Frock of $255,000 following his termination for any reason (including, without limitation, resignation) if, within 30 days of his termination date, Mr. Frock delivered a letter to the Company agreeing not to engage in specified activities in competition with the Company for four years. On August 28, 2003, Mr. Frock resigned his employment with the Company, and delivered such a letter to the Company. Accordingly, the Company has made the payment to Mr. Frock required under the terms of this agreement, which was capitalized in the first quarter of Fiscal 2004 and will be amortized over the contract period.

On October 17, 2003, the Company announced that Scott Clegg was resigning as Vice Chairman, President and Chief Operating Officer of the Company, effective October 31, 2003.

The Company entered into a certain Separation Agreement and General Release with Mr. D. Scott Clegg dated October 15, 2003 (the “Clegg Separation Agreement”). Pursuant to the Clegg Separation Agreement, Mr. D. Scott Clegg’s employment with the Company terminated on October 31, 2003, and he agreed to continue to serve the Company as a consultant through April 30, 2004 (the “Salary Continuation Period”). The Agreement provided for Mr. D. Scott Clegg to continue to receive, on a bi-weekly basis for a period of six months, that amount which he would have received as his base salary had he still been employed by the Company. The Company has agreed to continue to forgive, during each month of the Salary Continuation Period, the remaining principal amount and interest on the sum of $35,000 previously paid to him for relocation expenses. Mr. D. Scott Clegg has agreed to 20 consulting days at an additional $1,000 per day, first to be used to offset any remaining relocation balance, with any additional sums to paid in cash. In addition, Mr. D. Scott Clegg received a lump sum payment equal to the number of days of vacation, which had accrued but were unused, multiplied by his prorated daily compensation. Pursuant to the Clegg Separation Agreement, Mr. D. Scott Clegg also agreed not to compete against the Company for a period of 18 months following his separation with the Company.

Note 4 – Earnings Per Share

Earnings per share are based on the weighted average number of shares and common stock equivalents outstanding during the period. In the calculation of dilutive earnings per share, shares outstanding are adjusted to assume conversion of the Company’s non-interest bearing convertible preferred stock if they are dilutive. In the calculation of basic earnings per share, weighted average number of shares outstanding are used as the denominator. The Company was in a loss position for the six months ended December 31, 2003 and December 31, 2002 and the three months ended December 31, 2002. The common stock equivalents of stock options, warrants and convertible securities issued and outstanding during each six and three month periods were not included in the computation of diluted earnings per share as they were antidilutive. Earnings per share are computed as follows (dollars and average common stock outstanding in thousands):


	For the Three Months Ended December 31,					For the Six Months Ended December 31,
	2003		2002			2003			2002
Basic loss per share:
Net income (loss)	$	658	$	(3,371	)	$	(1,908	)	$	(5,226	)
Less preferred dividends		133		21			250			41

Income (loss) available for common stock		525		(3,392	)		(2,158	)		(5,267	)

Average common stock outstanding		6,459		6,332			6,425			6,328

Basic income (loss) per share	$	0.08	$	(0.53	)	$	(0.34	)	$	(0.83	)

Dilutive loss per share:
Income (loss) available for common stock and dilutive securities	$	658	$	(3,392	)	$	(2,158	)	$	(5,267	)
Average common stock outstanding		6,459		6,332			6,425			6,328
Convertible preferred stock, options and warrants		2,808		—			—			—

Average common stock and dilutive securities outstanding		9,267		6,332			6,425			6,328

Dilutive income (loss) per share	$	0.07	$	(0.53	)	$	(0.34	)	$	(0.83	)

Note 5. Discontinued Operations

Effective July 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the disposal of a segment of business. SFAS 144 modifies the accounting and reporting for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations.

During the first quarter of Fiscal 2003, the Company discontinued the operations of a leased school in Sarasota, Florida. In January 2003, the Company entered into a sub-lease agreement for the remaining term of that lease in excess of the future lease payment obligations. The Company recorded a charge during the six months ended December 31, 2003 of $585,000 for the write-off of the leasehold improvements related to this school.

In May 2003, the Company subleased to the Unified School District No. 11, of Maricopa County, Arizona, the premises at which the Company had previously operated its Fletcher Heights Charter Elementary School. The sublease with the Unified School District No. 11 is for five years with a two year out provision. The Company’s commitment under the lease expires August 2016.

In the second quarter of Fiscal 2003, the Company entered into an agreement to sell its Desert Heights Charter Elementary School and reduced the carrying value of that property to its net realizable value of $3,850,000. The Company recorded a charge of $2,297,000 for the write-down of this asset to its net realizable value. In August 2003, the Company sold to Partnership With Parents, Inc. (an Arizona non-profit corporation), for $3,934,000, the premises at which the Company had previously owned and operated its Desert Heights Charter Elementary School.

In the fourth quarter of Fiscal 2003, the Company created a plan to develop exit strategies for schools identified as under-performing and/or which do not fit well with the Company’s business or geographic strategies. The plan includes 10 schools (two of which are owned and the rest leased) and one undeveloped school location. The Company is actively seeking buyers for these schools and will continue to operate these schools until disposal or the expiration of their lease terms. As part of this plan, in June 2003, the Company closed an elementary school located in Wilmington, North Carolina and in August 2003, the Company closed a pre-elementary school located in Cary, North Carolina.

In April 2001, the Company entered into a lease agreement to lease and open a school in the Atlanta, Georgia area by October 1, 2003. The Company decided not to pursue the development of this school and as a result, the Company was required to purchase the property on October 1, 2003 for approximately $1,860,000. The Company has listed the property

with a real estate broker and is actively pursuing the sale and disposition of this property. It is anticipated that the proceeds from the sale of this property will be between $1,200,000 and $1,300,000. At June 30, 2003, the Company recorded an expected loss on the sale of this property of $594,000, which amount was included in losses from discontinued operations. Additional cost to be incurred related to this property in the future is estimated to be between $100,000 to $200,000 for related carrying cost and closing fees.

The operating results for schools classified as discontinued operations in the unaudited statements of operations for all periods presented, net of tax is as follows (dollars in thousands):


	For the Three Months Ended December 31,					For the Six Months Ended December 31,
	2003		2002			2003			2002
Revenues	$	1,524	$	3,176		$	3,114		$	5,345
Operating expenses		1,488		3,517			4,035			6,607

Discontinued operations before income tax expense		36		(341	)		(921	)		(1,262	)
Write down of property and equipment				(2,297	)					(2,460	)
Reserve for closed schools				—						(162	)

Loss from discontinued operations before income tax benefit		36		(2,638	)		(921	)		(3,884	)
Income tax expense (benefit)		13		(1,082	)		(371	)		(1,593	)

Loss from discontinued operations	$	23	$	(1,556	)	$	(550	)	$	(2,291	)

At June 30, 2003, the Company recorded a reserve for closed schools of $1,904,000. As of December 31, 2003, the Company has paid $855,000 in cash items related to this reserve. Of this amount, $255,000 is related to lease payments on closed schools and $594,000 related to the excess purchase price of certain property above its market value.

Note 6 – Segment Information

The Company manages private schools, which consist of pre-elementary, elementary, and programs for special needs children in 14 states. In Fiscal 2000, the Company acquired The Activities Club and began providing management services to charter schools. These operations have different characteristics and are managed separately from the school operations. These operations do not currently meet the quantification criteria and therefore are not deemed reportable under SFAS 131, “Disclosures about Segments of an Enterprise and Related Information” and are reflected in the “other” category.

The table below presents information about the financial results and condition of the Company’s operating segments for the three and six months ended December 31, 2003 and 2002 (dollars in thousands):


	Private Schools		Other		Corporate		Total
Three months ended December 31,
2003
Revenues	$	39,577	$	615	$	—	$	40,192
School operating income		4,946		192		—		5,138

Depreciation and amortization:
Continuing operations	$	1,110	$	110	$	179	$	1,399
Discontinued operations		—		131				131

Total depreciation and amortization	$	1,110	$	241	$	179	$	1,530

Goodwill		39,965		—		—		39,965

Segment assets
Continuing operations	$	77,793	$	3,797	$	3,956	$	85,546
Discontinued operations		5,580		1,218				6,798

Total assets	$	83,373	$	5,015	$	3,956	$	92,344

2002
Revenues	$	37,317	$	549	$	—	$	37,866
School operating income		4,981		97		—		5,078

Depreciation and amortization
Continuing operations	$	1,123	$	126	$	119	$	1,368
Discontinued operations		101		78				179

Total depreciation and amortization	$	1,224	$	204	$	119	$	1,547

Goodwill		46,176		—		—		46,376

Segment assets
Continuing operations	$	74,602	$	6,153	$	5,697	$	86,452
Discontinued operations		6,018		4,766				10,784

Total assets	$	80,620	$	10,919	$	5,697	$	97,236

Six months ended December 31,
2003
Revenues	$	74,296	$	1,162	$	—	$	75,458
School operating income		7,185		371		—		7,556

Depreciation and amortization:
Continuing operations	$	2,175	$	236	$	349	$	2,760
Discontinued operations		586		154				740

Total depreciation and amortization	$	2,761	$	390	$	349	$	3,500

2002
Revenues	$	69,376	$	1,158	$	—	$	70,534
School operating income		6,920		282		—		7,202

Depreciation and amortization
Continuing operations	$	2,231	$	263	$	215	$	2,709
Discontinued operations		219		143				362

Total depreciation and amortization	$	2,450	$	406	$	215	$	3,071

Note 7 – Intangible Assets

Intangible assets include non-compete agreements, trademarks and other identifiable intangibles acquired in acquisitions. In the first quarter of Fiscal 2004, the Company recorded $705,000 of non-compete obligations related to former employees. Such intangibles are being amortized over the life of the intangibles ranging from 3 – 20 years.

At December 31, 2003 and June 30, 2003 the Company’s intangibles assets were as follows (dollars in thousands):


	December 31, 2003			June 30, 2003
Non-compete	$	3,198		$	2,493
Other		1,276			1,276

		4,474			3,769
Accumulated amortization		(3,685	)		(3,572	)

	$	789		$	197

Amortization expense was $70,000 and $83,000 for the three months ended December 31, 2003 and December 31, 2002, respectively and $112,000 and $174,000 for the six months ended December 31, 2003 and December 31, 2002, respectively.

Note 8 – Stock Based Compensation

The Company accounts for options under the recognition and measurement principles of Account Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company has adopted only the disclosure provisions of SFAS No. 148, “Accounting for Stock Based Compensation-Transaction and Disclosure, an amendment of FASB Statement 123”. Accordingly, no stock –based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant date for awards consistent with the provisions of SFAS No. 148, the Company’s net loss and net loss per share would have been decreased to the pro forma amounts indicated below (dollars in thousands except per share data):


	For the Three Months, Ended December 31,						For the Six Months, Ended December 31,
	2003			2002			2003			2002
Net income (loss) - As reported	$	658		$	(3,371	)	$	(1,908	)	$	(5,226	)
Add: stock based compensation included in net (loss) income as reported		—			—			—			—
Deduct stock based compensation determined under fair value based methods for all awards		(33	)		(39	)		(66	)		(77	)

Pro Forma net income (loss)	$	625		$	(3,410	)	$	(1,974	)	$	(5,303	)

Basic income (loss) per share - as reported	$	0.08		$	(0.53	)	$	(0.34	)	$	(0.83	)
Basic income (loss) per share - pro forma	$	0.08		$	(0.54	)	$	(0.35	)	$	(0.85	)
Dilutive income (loss) per share - as reported	$	0.07		$	(0.53	)	$	(0.34	)	$	(0.83	)
Dilutive income (loss) per share - proforma	$	0.07		$	(0.54	)	$	(0.35	)	$	(0.85	)

Note 9 – Commitments and Contingencies

The Company is engaged in legal actions arising in the ordinary course of its business. The Company currently believes that the ultimate outcome of all such pending matters will not have a material adverse effect on the Company’s consolidated financial position. The significance of these pending matters on the Company’s future operating results and cash flows depends on the level of future results of operations and cash flows as well as on the timing and amounts, if any, of the ultimate outcome.

The Company carries fire and other casualty insurance on its schools and liability insurance in amounts which management believes is adequate for its operations. As is the case with other entities in the education and preschool industry, the Company cannot effectively insure itself against certain risks inherent in its operations. Some forms of child abuse have insurance sublimits per claim in the general liability coverage.

Note 10 – Interest Rate Swap Agreement

In connection with the May 2001 amendment to the Company’s Amended and Restated Loan and Security Agreement, the Company entered an interest rate swap agreement in June 2002 on its $15,000,000 Term Loan Facility. The Company uses this derivative financial instrument to manage its exposure to fluctuations in interest rates. The instrument involves, to varying degrees, market risk, as the instrument is subject to rate and price fluctuations, and elements of credit risk in the event the counterparty should default. The Company does not enter into derivative transactions for trading purposes. At December 31, 2003 the Company’s interest rate swap contract outstanding had a total notional amount of $9,643,000. Under the interest rate swap contract, the Company agrees to pay a fixed rate of 5.48% and the counterparty agrees to make payments based on 3-month LIBOR. The market value of the interest rate swap agreement at December 31, 2003 resulted in a liability of $644,000 and is included as a component of Accumulated Other Comprehensive Loss as $399,000, net of taxes, of which a portion is expected to be reclassified to the consolidated statement of income within one year. As a result of the Term Loan Facility becoming due December 31, 2003 pursuant to the most recent amendment to the Amended and Restated Loan and Security Agreement, all of the interest rate swap liability is classified as a current liability.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management Changes

On July 10, 2003, Mr. A.J. Clegg resigned as Chief Executive Officer and Chairman of the Board of Directors of the Company, and on August 28, 2003, Mr. Frock resigned as the Company’s Vice Chairman of Corporate Development. In August 2003, Mr. A.J. Clegg and Mr. Frock resigned from the Board of Directors of the Company.

On July 25, 2003, George Bernstein was appointed as the Company’s Chief Executive Officer and appointed to its Board of Directors.

On September 3, 2003, Jeanne Marie Welsko was appointed Vice President of Human Resources.

On October 17, the Company announced that Scott Clegg was resigning as Vice Chairman, President and Chief Operating Officer of the Company, effective October 31, 2003.

On October 23, 2003, the Company announced that it had hired Osborne F. Abbey, Jr., Ed.D. as its new Vice President of Education, effective December 1, 2003.

On January 7, 2004, the Company announced that it had hired Thomas Frank as its new Chief Financial Officer.

On January 12, 2004, the Company announced that it had hired Patricia Miller as its new Chief Operating Officer.

Results of Operations

For the Second Quarter ended December 31, 2003 (“Second quarter 2004”) vs. the Second Quarter ended December 31, 2002 (“Second quarter 2003”)

At December 31, 2003, the Company operated 172 schools. Since December 31, 2002, the Company has opened one pre-elementary school. The Company has also closed nine schools during this period. Seven of the schools closed are included in discontinued operations and were closed prior to the expiration of their lease terms. Two additional schools closed at the end of their lease term.

Reporting periods for the second quarter and the six months ended December 31, 2003 vary from the same periods in the prior year. The variation in the reporting periods for Fiscal 2004 is a result of the timing of the calendar month end as compared to the prior year. As a result, the second quarter ended December 31, 2003 has one extra day verses the same period in the prior year and the six months ended December 31, 2003 has two extra days verses the same period in the prior year. The effects of these additional days are indicated in the respective discussion below.

Revenues

Revenues for the second quarter 2004 increased $2,326,000 or 6.1% to $40,192,000 from $37,866,000 for the second quarter 2003. The increase in revenues is primarily attributable to a full year of operations for schools opened in Fiscal 2003 tuition increases for schools opened before June 30, 2002 and an extra day in the second quarter 2004 as compared to the second quarter 2003. The revenue increase for the second quarter 2004 as compared to the second quarter 2003 is as follows (dollars in thousands):


	Fiscal 2004		Fiscal 2003		Increase (decrease)
Schools open before June 30, 2003	$	37,651	$	36,613	$	1,038
Schools opened in Fiscal 2003		1,795		1,220		575
New schools in Fiscal 2004		175		—		175
Period end variance - one day		571		—		571
Closed schools		—		33		(33	)

	$	40,192	$	37,866	$	2,326

Schools opened before June 30, 2002 increased $1,038,000 or 2.8% in the second quarter 2004 compared to second quarter 2003. This increase was primarily due to tuition increases. The schools that opened in Fiscal 2003 had an increase in revenues of $575,000 due to normal ramp up in enrollment for newer schools. The one new school opened in the second quarter of 2004 had revenues of $175,000. The additional day in the second quarter 2004 resulted in additional revenue of $571,000 as compared to the same period last year.

School operating profit

School operating profit for the second quarter, 2004 increased $60,000 or 1.2% to $5,138,000 from $5,078,000 for the second quarter 2003. Total school operating profit as a percentage of revenue was 12.8% for the second quarter 2004 and 13.4% for the second quarter 2003. The increase in school operating profit for the second quarter 2004 as compared to the second quarter 2003 is as follows (dollars in thousands):


	Fiscal 2004			Fiscal 2003			Increase (decrease)
Schools open before June 30, 2002	$	5,279		$	5,586		$	(307	)
Schools opened in Fiscal 2003		(208	)		(500	)		292
New schools in Fiscal 2004		(85	)		—			(85	)
Period end variance - one day		152			—			152
Closed schools		—			(8	)		8

	$	5,138		$	5,078		$	60

Operating profit from schools opened before June 30, 2002 decreased $307,000 in the second quarter 2004 compared to the second quarter 2003. School operating profit as a percentage of applicable revenue for these schools decreased to 14.0% in second quarter 2004 from 15.3% in second quarter 2003. This decrease is primarily due to increases in school labor cost, increases in insurance costs for health care benefits and annual rent increases.

The schools that opened in Fiscal 2003 had a reduction in school operating losses of $292,000 due in part to normal ramp up in enrollment for schools in their second year of operations. New schools opened in Fiscal 2004 had losses of $85,000 due in part to the normal new school enrollment ramp up period. The additional day in the second quarter 2004 resulted in additional school operating profit of $152,000 as compared to the same period last year.

General and administrative expenses

General and administrative expenses increased $174,000 from $3,005,000 for the second quarter 2003 to $3,179,000 for the second quarter 2004. The increase in general and administrative expenses from the second quarter 2003 to the second quarter of 2004 were due primarily to increases in recruiting and relocation.

Transaction related cost

Transaction related costs during the second quarter 2003 of $600,000 were related to legal and professional fees associated with a merger agreement that was terminated on February 3, 2003.

Goodwill Impairment

Due to the termination of a merger agreement and the decline in the stock price in the second quarter of Fiscal 2003, the Company was required by SFAS 142 to evaluate the Company’s goodwill for recovery based on the facts and circumstances at December 31, 2002. An independent valuation consultant engaged by the Company estimated fair values for each reporting unit using discounted cash flow projections in evaluating and measuring a potential impairment charge. The level one impairment test as required under SFAS 142 as of December 31, 2002 indicated that two of the Company’s ten reporting units were impaired (Washington/Oregon and Pennsylvania/New Jersey). Based on the consultant’s independent valuation and completion of the level two analysis, the Company recorded an impairment loss related to these two reporting units of $2,200,000.

Operating Income (Loss)

As a result of the factors mentioned above, operating income increased $2,686,000 from a loss of $727,000 for the second quarter 2003 to a profit of $1,959,000 for the second quarter 2004.

Interest expense

Interest expense increased $259,000 or 31.7% from $817,000 for the second quarter 2003 to $1,076,000 for the second quarter 2004. The increase in interest expense is related to $387,000 in fees paid to Fleet Bank in connection with amendments to the Company’s senior credit facility. This increase was offset by reduced interest on the Company’s senior debt as a result of debt repayments.

Income tax benefit

Income tax expense for the second quarter 2004 was $312,000 as compared to $269,000 for the same period in the prior year. The Company’s effective tax rate for the second quarter 2004 was 33% and is less than the statutory rate of 38% due to the realization of some of the Company’s deferred tax assets.

Discontinued operations

The operating results for schools classified as discontinued operations in the unaudited statements of operations for all periods presented, net of tax is as follows (dollars in thousands):


	For the Three Months Ended December 31,
	2003		2002
Revenues	$	1,524	$	3,176
Operating expenses		1,488		3,517

Discontinued operations before income tax expense		36		(341	)

Write down of property and equipment				(2,297	)
Reserve for closed schools				—

Loss from discontinued operations before income tax benefit		36		(2,638	)

Income tax expense (benefit)		13		(1,082	)

Loss from discontinued operations	$	23	$	(1,556	)

Net loss

As a result of the above factors, the Company had net income of $658,000 for the second quarter 2004 as compared to a net loss of $3,371,000 in the second quarter 2003

For the Six Months ended December 31, 2003 vs. the Six Months ended December 31, 2002

Revenues

Revenues for the six months ended December 31, 2003 increased $4,924,000 or 7.0% to $75,458,000 from $70,534,000 for the same period in prior year. The increase in revenues is primarily attributable to a full year of operations for schools opened in Fiscal 2003, tuition increases for schools opened before June 30, 2002, and two additional days in the six months ended December 31, 2003 as compared to the six months ended December 31, 2002. The revenue increase for the six months ended December 31, 2003 as compared to six months ended December 31, 2002 is as follows (dollars in thousands):


	Fiscal 2004		Fiscal 2003		Increase (decrease)
Schools open before June 30, 2003	$	70,470	$	68,677	$	1,793
Schools opened in Fiscal 2003		3,407		1,780		1,627
New schools in Fiscal 2004		262		—		262
Period end variance - 2 days		1,319		—		1,319
Closed schools		—		77		(77	)

	$	75,458	$	70,534	$	4,924

Schools opened before June 30, 2002 increased $1,793,000 or 2.6% in the six months ended December 31, 2003 compared to the same period in the prior year. This increase was primarily due to tuition increases. The schools that opened in Fiscal 2003 had an increase in revenues of $1,627,000 due to normal ramp up in enrollment for newer schools. The one new school opened in Fiscal 2004 had revenues of $262,000. The two additional days in the six months ended December 31, 2003 resulted in additional revenue of $1,319,000 as compared to the same period last year.

School operating profit

School operating profit for the six months ended December 31, 2003 increased $354,000 or 4.9% to $7,556,000 from $7,202,000 for the same period in the prior year. Total school operating profit, as a percentage of revenue was 10.0% for the six months ended December 31, 2003 and 10.2% for six months ended December 31, 2002. The increase in school operating profit for the six months ended December 31, 2003 as compared to the same period in the prior year is as follows (dollars in thousands):


	Fiscal 2004			Fiscal 2003			Increase (decrease)
Schools open before June 30, 2003	$	7,820		$	8,460		$	(640	)
Schools opened in Fiscal 2003		(449	)		(1,199	)		750
New schools in Fiscal 2004		(202	)		—			(202	)
Period end variance - 2 days		390			—			390
Closed schools		(3	)		(59	)		56

	$	7,556		$	7,202		$	354

Operating profit from schools opened before June 30, 2002 decreased $640,000 in the six months ended December 31, 2003 as compared to the same period in the prior year. School operating profit as a percentage of applicable revenue for these schools decreased to 11.1% in the six months ended December 31, 2003 from 12.3% during the same period in the prior year. This decrease is primarily due to increases in school labor cost, increases in insurance costs for health care benefits and annual rent increases.

The schools that opened in Fiscal 2003 had increases in school operating profit of $750,000 due in part to normal ramp up in enrollment for schools in their second year of operations. New schools opened in Fiscal 2004 had losses of $202,000 due in part to the normal new school enrollment ramp up period. The two additional days in six months ended December 31, 2003 resulted in additional school operating profit of $390,000 as compared to the same period last year.

General and administrative expenses

General and administrative expenses increased $2,173,000 from $5,716,000 for the six months ended December 31, 2002 to $7,889,000 for the six months ended December 31, 2003. The largest portion of this increase was a $1,500,000 charge related to the present value of the future payments to be made with respect to consulting agreements with two former executives of approximately $1,290,000 and charges for future health insurance coverage of approximately $210,000. In addition, general and administrative expenses increases were due to increases in recruiting and relocation costs.

Transaction related cost

Transaction related costs during the six months ended December 31, 2002 of $1,018,000 were related to legal and professional fees associated with a merger agreement that was terminated on February 3, 2003.

Goodwill Impairment

Operating Loss

As a result of the factors mentioned above, operating loss decreased $1,399,000 from a loss of $1,732,000 for the six months ended December 31, 2002 to a loss of $333,000 for the six months ended December 31, 2003.

Interest expense

Interest expense increased $230,000 or 13.6% from $1,689,000 for the six months ended December 31, 2002 to $1,919,000 for the six months ended December 31, 2003. The increase in interest expense is related to $445,000 in fees paid to Fleet Bank in connection with amendments to the Company’s senior credit facility. This increase was offset by reduced interest on the Company’s senior debt as a result of debt repayments.

Income tax benefit

Income tax benefit for the six months ended December 31, 2003 was $840,000 as compared to $511,000 for the same period in the prior year. The Company’s effective tax rate for the six months ended December 31, 2003 was 38% and for the six months ended December 31, 2002 it was 14.8%.

Discontinued operations

The operating results for schools classified as discontinued operations in the unaudited statements of operations for all periods presented, net of tax is as follows (dollars in thousands):


	For the Six Months Ended December 31,
	2003			2002
Revenues	$	3,114		$	5,345
Operating expenses		4,035			6,607

Discontinued operations before income tax expense		(921	)		(1,262	)
Write down of property and equipment					(2,460	)
Reserve for closed schools					(162	)

Loss from discontinued operations before income tax benefit		(921	)		(3,884	)
Income tax expense (benefit)		(371	)		(1,593	)

Loss from discontinued operations	$	(550	)	$	(2,291	)

Net loss

As a result of the above factors, the Company’s net loss decreased by $3,318,000 to $1,908,000 for the six months ended December 31, 2003 as compared to a net loss of $5,226,000 in the six months ended December 31, 2002

Liquidity and Capital Resources

On September 9, 2003 the Company completed a private placement of an aggregate of 588,236 shares of Series F Convertible Preferred Stock, $.001 par value, for a purchase price of $3,000,000. The Series F Preferred Stock is convertible into Common Stock at a conversion rate of one share of Common Stock for each Series F Convertible Preferred Stock. The proceeds from the issuance of the Series F Convertible Preferred Stock was used for (i) the repayment of debt, (ii) to meet certain bank covenants related to capital expenditure requirements, (iii) to meet certain requirements relating to the negotiations for the sixth amendment to the Amended and Restated Loan and Security Agreement, (iv) requirements for working capital and other general corporate purposes.

As a result of these events and scheduled payments, the total amount outstanding under the Company’s senior credit facility was $14,893,000 at January 31, 2003 as compared to $23,990,000 at June 30, 2003, as shown below (dollars in thousands):


	January 31, 2004		December 31, 2003		June 30, 2003
Term Loan Facility	$	9,107	$	9,643	$	10,714
Acquisition Credit Facility		5,786		6,616		13,276
Working Capital Credit Facility		—		—		—

	$	14,893	$	16,259	$	23,990

Cash Flow

The Company’s principal sources of liquidity are cash flow from operations. In addition, the Company uses third parties and site developers to build new schools and lease them to the Company. Principal uses of liquidity are debt service and capital expenditures related to the maintenance of its existing schools.

Total cash and cash equivalents decreased by $769,000 from $4,722,000 at June 30, 2003 to $3,953,000 at December 31, 2003. The decrease was primarily related to $3,647,000 in capital expenditures and repayments on senior and subordinated debt of $8,006,000. The use of cash was offset by cash provided from operations totaling $3,585,000 (primarily as a result of an increase from unearned income of $1,142,000 and a decrease from accounts receivable of $1,055,000) proceeds from the sale of preferred stock of $2,920,000, and $3,935,000 in proceeds from the sale of the Arizona property. .

Long-Term Obligations and Commitments

The Company has significant commitments under operating lease agreements and has certain contractual obligations. Contractual obligations are those that will require cash payments in accordance with the terms of a contract, such as a loan agreement or lease agreement. The Company’s contractual obligations are as follows: (dollars in thousands)


	Total		For the Fiscal Year ended June 30,
	Total		2004		2005		2006		2007		2008		Thereafter
Long term debt and capital lease obligations	$	35,465	$	24,860	$	235	$	5,360	$	5,010	$	—	$	—
Letters of credit		736		736
Swap agreement		778		778		—		—
Operating leases		227,487		26,126		25,151		24,168		22,616		21,159		108,267
Non-competes and consulting contracts		2,205		705		450		450		300		300

Total	$	266,671	$	53,205	$	25,836	$	29,978	$	27,926	$	21,459	$	108,267

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. Actual results may vary from estimates in amounts that may be material to the financial statements.

The Company’s significant accounting policies are described in note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003. The following accounting policies are considered critical to the preparation of the Company’s financial statements due to the estimation processes and business judgment involved in their application.

Revenue Recognition

Tuition revenues, net of discounts and other revenues are recognized as services are performed. Any tuition payments received in advance of the time period for which service is to be performed is recorded as unearned revenues. Charter school management fees are recognized based on a contractual relationship with the charter school and do not include any tuition revenues received by the charter school. Certain fees may be received in advance of services being rendered, in which case the fee revenue is deferred and recognized over the appropriate period of service. The Company’s net revenues meet the criteria of SAB No. 101, including the existence of an arrangement, the rendering of services, a determinable fee and probable collection.

Accounts Receivable

The Company’s accounts receivable are comprised primarily of tuition due from governmental agencies and parents. Accounts receivable are presented at estimated net realizable value. The Company uses estimates in determining the collectibility of its accounts receivable and must rely on its evaluation of historical trends, governmental funding processes, specific customer issues and current economic trends to arrive at appropriate reserves. Material differences may result in the amount and timing of bad debt expense if actual experience differs significantly from management estimates.

The Company provides its services to the parents and guardians of the children attending the schools. The Company does not extend credit for an extended period of time, nor does it require collateral. Exposure to losses on receivables is principally dependent on each person’s financial condition. The Company also has investments in other entities. The collectibility of such investments is dependent upon the financial performance of these entities. The Company monitors its exposure for credit losses and maintains allowances for anticipated losses.

Long-lived and Intangible Assets

During the first quarter of Fiscal 2003, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under the requirements of SFAS No. 144, the Company assesses the potential impairment of property and equipment and identifiable intangibles whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An asset’s value is impaired if management’s estimate of the aggregate future cash flows, undiscounted and without interest charges, to be generated by the asset are less than the carrying value of the asset. Such cash flows consider factors such as expected future operating income and historical trends, as well as the effects of demand and competition. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the asset over the fair value of the asset. Such estimates require the use of judgment and numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges.

Goodwill

The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but will be assessed for impairment at least annually or upon an adverse change in operations. The annual impairment testing required by SFAS No. 142 requires judgments and estimates and could require the Company to write down the carrying value of its goodwill and other intangible assets in future periods.

Income Taxes

The Company accounts for income taxes using the asset and liability method, in accordance with FAS 109, “Accounting for Income Taxes.” Under the asset and liability method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rate is recognized as income in the period of enactment. A valuation allowance is recorded based on the uncertainty regarding the ultimate realizability of deferred tax assets.

The Company files a U.S. federal income tax return and various state income tax returns, which are subject to examination by tax authorities. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. The Company’s estimated tax liability is subject to change as examinations of specific tax years are completed in the respective jurisdictions including possible adjustments related to the nature and timing of deductions and the local allocation of income.

Item 3 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 the Company. The Company is exposed to market risk in the areas of interest rates and interest rate swap agreements.

Interest Rates

The Company’s exposure to market risk for changes in interest rates relate primarily to debt obligations. The Company had no cash flow exposure due to rate changes on its 12.0%, $10,000,000 senior subordinated debt at December 31, 2003 and June 30, 2003. The Company also had no cash flow exposure on certain mortgages, notes payable, capitalized leases and subordinate debt agreements aggregating $1,307,000 and $1,731,000 at December 31, 2003 and June 30, 2003, respectively. However, the Company does have cash flow exposure on two of its credit facilities under the Amended and Restated Loan and Security Agreement. The Working Capital and the Acquisition Credit Facility are subject to variable prime base rate pricing. Accordingly, a 1.0% change in the LIBOR rate and the prime rate would have resulted in interest expense changing by approximately $58,000 and $64,000 for the six months ended December 31, 2003 and 2002, respectively.

Interest Rate Swap Agreement

In connection with the May 2001 amendment to the Company’s Amended and Restated Loan and Security Agreement, the Company entered an interest rate swap agreement on the $15,000,000 Term Loan Facility. The Company uses this derivative financial instrument to manage its exposure to fluctuations in interest rates. The instrument involves, to varying degrees, market risk, as the instrument is subject to rate and price fluctuations and elements of credit risk in the event the counterparty should default. The Company does not enter into derivative transactions for trading purposes. At December 31, 2003 the Company’s interest rate swap contract outstanding had a total notional amount of $9,643,000. Under the interest rate swap contract, the Company agrees to pay a fixed rate of 5.48% and the counterparty agrees to make payments based on 3-month LIBOR. The market value of the interest rate swap agreement at December 31, 2003 which resulted in a liability of $644,000, and is included as a component of Accumulated Other Comprehensive Loss as $399,000, net of taxes, of which a portion is expected to be reclassified to the consolidated statement of income within one year.As a result of the Term Loan Facility becoming due December 31, 2003 pursuant to a recent amendment to the Amended and Restated Loan and Security Agreement, all of the interest rate swap liability is included as a current liability.

Item 4 Controls and Procedures

The Company’s management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2003. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this quarterly report on Form 10-Q has been appropriately recorded, processed, summarized and reported. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, the Company’s disclosure controls were effective as of the end of the period covered by this report. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II

Other Information

Item 4 - Submission of Matters to Vote of Security Holders

None

Item 6. Exhibits and Reports on Form 8-K

(A) Exhibits


31.1		Certifications of the Chief Executive Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (Filed herewith.)

31.2		Certifications of the Chief Financial Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (Filed herewith.)

32.1		Certifications of the Chief Executive Officer of the Registrant required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, as amended.) (Filed herewith.)

32.2		Certifications of the Chief Financial Officer of the Registrant required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, as amended.) (Filed herewith.)

(B) Reports on Form 8-K


1.		On September 30, 2003, the Registrant filed a Current Report on Form 8-K announcing information regarding the Company’s earnings for the fiscal year ended June 30, 2003 (Items 5 and 7).

2.		On October 17, 2003, the Registrant filed a Current Report on Form 8-K announcing the resignation of Scott Clegg as Vice Chairman, President and Chief Operating Officer of the Company (Items 5 and 7).

3.		On October 23, 2003, the Registrant filed a Current Report on Form 8-K announcing the hiring of Osborne F. Abby, Jr., Ed.D. as Vice President of Education (Items 5 and 7).

4.		On November 13, 2003, the Registrant filed a Current Report on Form 8-K announcing information regarding the Company’s first quarter performance (Items 5 and 7).

5.		On December 31, 2003, the Registrant filed a Current Report on Form 8-K announcing certain developments regarding the restructuring of the Company’s senior debt (Items 5 and 7).

SIGNATURES

Pursuant to the requirements 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.


	NOBEL LEARNING COMMUNITIES, INC.

Dated: February 17, 2004	By:	/s/ Thomas Frank
		Thomas Frank
		Chief Financial Officer
		(duly authorized officer and principal financial officer)

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Nobel Learning Communities (NLCI) Inactive 10-Q2003 Q4 Quarterly report

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