Nobel Learning Communities (NLCI) 10-Q 2005 Q3 Quarterly report

UNITED STATES

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: October 1, 2005

¨ 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, Suite 200, West Chester, PA	19382-6223
(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-2 of the Exchange Act).  Yes ¨  No x

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of the issuer’s common stock outstanding at November 11, 2005 was 7,506,307.

INDEX TO FORM 10-Q

Nobel Learning Communities, Inc.

		Page Number
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of October 1, 2005 (Unaudited) and July 2, 2005	2
	Consolidated Statements of Operations for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively (Unaudited)	3
	Consolidated Statements of Stockholders’ Equity and Comprehensive Loss for the thirteen weeks ended October 1, 2005 (Unaudited)	4
	Consolidated Statements of Cash Flows for the thirteen weeks ended October 1, 2005 and October 2, 2004 (Unaudited)	5
	Notes to Consolidated Interim Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
PART II.	OTHER INFORMATION
Item 6.	Exhibits	21

ii

PART I

Item 1. Financial Information

CAUTIONARY STATEMENTS ABOUT FORWARD-LOOKING INFORMATION

Statements included or incorporated herein which are not historical facts are forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When the Company uses words such as “believes,” “expects,” “anticipates,” “plans,” “estimates,” “projects,” “may,” “intends,” “seeks” or similar expressions, the Company is making forward-looking statements, but these terms are not the exclusive means of identifying forward-looking statements.

Forward-looking statements reflect management’s current views with respect to future events and financial performance, and are based on currently available competitive, financial and economic data and management’s assumptions regarding future events. While management believes that its assumptions are reasonable, forward-looking statements are subject to various known and unknown risks and uncertainties, and actual results may differ materially from those expressed or implied herein. In connection with the “safe harbor provisions” of the Private Securities Litigation Reform Act of 1995, the Company notes that certain factors, among others, which could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein are discussed in greater detail under “Management’s Discussion and Analysis.” In addition, the Company’s results may be affected by general factors, such as economic conditions, political developments, interest and inflation rates, accounting standards, taxes, and laws and regulations affecting it in markets where it competes.

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 or revise these statements or to update the reasons why actual results could differ from those projected in the forward-looking statements, whether as a result of new information, future developments or otherwise.

1

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share amounts)

	(Unaudited) October 1, 2005			July 2, 2005
ASSETS
Cash and cash equivalents	$	4,391		$	2,925
Accounts receivable, less allowance for doubtful accounts of $956 at October 1, 2005 and $879 at July 2, 2005		1,621			1,980
Deferred tax asset		2,145			2,200
Prepaid assets		5,095			4,915
Total Current Assets		13,252			12,020
Property and equipment, net		25,173			26,007
Goodwill and intangible assets, net		36,882			36,937
Deferred tax asset		2,254			2,212
Note receivable and other assets		1,060			1,168
Total Assets	$	78,621		$	78,344
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current portion of long-term debt	$	2,264		$	2,281
Accounts payable and other current liabilities		11,576			14,361
Deferred revenue		14,601			10,457
Total Current Liabilities		28,441			27,099
Long-term debt		12,612			13,180
Other long term liabilities		557			675
Total Liabilities		41,610			40,954
Commitments and Contingencies
Stockholders’ Equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized, issued 8,213,280 at October 1, 2005 and 8,160,157 at July 2, 2005, outstanding 3,228,960 at October 1, 2005 and 3,175,837 at July 2, 2005 $12,146 and $11,897 aggregate liquidation preference at October 1, 2005 and July 2, 2005, respectively.		3			3
Common stock, $0.001 par value; 20,000,000 shares authorized, issued 7,499,307 at October 1, 2005 and 7,486,807 at July 2, 2005, outstanding 7,462,597 at October 1, 2005 and 7,450,097 at July 2, 2005		8			8
Treasury stock, cost; 36,710 shares at October 1, 2005 and July 2, 2005		(375	)		(375	)
Additional paid-in capital		51,732			51,302
Accumulated deficit		(14,315	)		(13,501	)
Accumulated other comprehensive loss		(42	)		(47	)
Total Stockholders’ Equity		37,011			37,390
Total Liabilities and Stockholders’ Equity	$	78,621		$	78,344

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.

2

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands except per share data)

(Unaudited)

	For the Thirteen Weeks Ended
	October 1, 2005			October 2, 2004
Revenues	$	37,502		$	36,276
Personnel costs		18,098			17,631
School operating costs		6,206			5,965
Rent and other		10,389			10,256
Cost of services		34,693			33,852
Gross profit		2,809			2,424
General and administrative expenses		3,522			3,288
Operating loss		(713	)		(864	)
Interest expense		396			708
Other income		(47	)		(54	)
Loss from continuing operations before income taxes		(1,062	)		(1,518	)
Income tax benefit		(415	)		(577	)
Loss from continuing operations		(647	)		(941	)
Loss from discontinued operations, net of income tax effect		(66	)		(99	)
Net loss		(713	)		(1,040	)
Preferred stock dividends		101			180
Net loss available to common stockholders	$	(814	)	$	(1,220	)
Basic and diluted loss per share:
Loss from continuing operations	$	(0.10	)	$	(0.17	)
Loss from discontinued operations	$	(0.01	)	$	(0.01	)
Net loss per share	$	(0.11	)	$	(0.18	)
Weighted average common shares outstanding:
Basic and diluted		7,457			6,642

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.

3

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss

For the Thirteen Weeks Ended October 1, 2005

(Dollars in thousands except share data)

							Treasury Stock			Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive Loss			Total
	Preferred Stock			Common Stock
	Shares	Amount		Shares	Amount
July 2, 2005	3,175,837	$	3	7,486,807	$	8	$	(375	)	$	51,302	$	(13,501	)	$	(47	)	$	37,390
Comprehensive income:
Net loss	—		—	—		—		—			—		(713	)		—			(713	)
Swap contract, net of tax	—		—	—		—		—			—		—			5			5
Total comprehensive loss																			(708	)
Issuance of preferred stock	53,123		0	—		—		—			250		—			—			250
Compensation for employee stock options	—		—	—		—		—			80		—			—			80
Stock options exercised				12,500		—		—			100		—			—			100
Preferred dividends	—		—	—		—		—			—		(101	)		—			(101	)
October 1, 2005	3,228,960	$	3	7,499,307	$	8	$	(375	)	$	51,732	$	(14,315	)	$	(42	)	$	37,011

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.

4

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Cash Flow

(Dollars in thousands)

(Unaudited)

	Thirteen Weeks Ended
	October 1, 2005			October 2, 2004
Cash Flows from Operating Activities:
Net loss	$	(713	)	$	(1,040	)
Adjustment to Reconcile Net loss to Net Cash
Provided by Operating Activities:
Depreciation and amortization		1,461			1,432
Gain on sale of property		—			(224	)
Provision for losses on accounts receivable		163			148
Stock option compensation		80			—
Other		(35	)		405
Changes in Assets and Liabilities:
Accounts receivable		197			71
Prepaid assets		(180	)		(204	)
Other assets and liabilities		108			86
Deferred revenue		4,144			4,257
Accounts payable and accrued expenses		(2,192	)		(3,382	)
Total Adjustments		3,746			2,589
Net Cash Provided by Operating Activities		3,033			1,549
Cash Flows from Investing Activities:
Purchases of capital expenditures		(1,083	)		(1,417	)
Proceeds from sale of property and equipment		—			1,131
Payment on note receivable		—			229
Net Cash Used in Investing Activities		(1,083	)		(57	)
Cash Flows from Financing Activities:
Repayment of long term debt		(584	)		(1,763	)
Cash overdraft		—			2,975
Proceeds from exercise of stock options		100			187
Dividends paid to preferred stockholders		—			(19	)
Net Cash (Used in) Provided by Financing Activities		(484	)		1,380
Net increase in cash and cash equivalents		1,466			2,872
Cash and cash equivalents at beginning of period		2,925			2,716
Cash and cash equivalents at end of period	$	4,391		$	5,588
Supplemental disclosure of cash flow information:
Interest	$	201		$	690
Income taxes, net	$	10		$	12

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.

5

NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES

Notes to Consolidated Interim Financial Statements

for the thirteen weeks ended October 1, 2005 and October 2, 2004

(Unaudited)

Note 1 - Basis of Presentation

The unaudited consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position at October 1, 2005 and results of operations for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively. 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 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 fiscal year ended July 2, 2005.

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 including those discussed elsewhere in this Quarterly Report on Form 10-Q.

Fiscal Period. References to Fiscal 2006 and Fiscal 2005 are to the 52 weeks ending July 1, 2006 and to the 52 weeks ended July 2, 2005, respectively. The first quarter of Fiscal 2006 and Fiscal 2005 are comprised of the 13 weeks each.

Reclassifications. The Company has conformed amounts previously reported in its Quarterly Report on Form 10-Q for the period ended October 2, 2004 to reflect discontinued operations and the reclassification of properties held for sale. Certain other prior period amounts have been reclassified to conform to the current period’s presentation.

Discontinued operations consist of 10 subleased or vacant schools for the period ended October 1, 2005 and 11 subleased or vacant schools and one open school for the period ended October 2, 2004.

Note 2 - 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 diluted earnings per share, shares outstanding are adjusted to assume conversion of the Company’s non-interest bearing convertible preferred stock and the exercise of options and warrants if such shares are dilutive. In the calculation of basic earnings per share, weighted average numbers of shares outstanding are used as the denominator. The Company was in a loss position for the thirteen weeks ended October 1, 2005 and October 2, 2004. The common stock equivalents of stock options, warrants and convertible securities issued and outstanding during the thirteen weeks ended October 1, 2005 and October 2, 2004 were not included in the computation of diluted earnings per share as they were antidilutive. Loss per share is computed as follows (dollars and average common stock outstanding in thousands):

	Thirteen Weeks Ended
	October 1, 2005			October 2, 2004
Basic and diluted loss per share:
Net loss	$	(713	)	$	(1,040	)
Less preferred dividends		101			180
Loss available for common stock		(814	)		(1,220	)
Average common stock outstanding		7,457			6,642
Basic and diluted loss per share	$	(0.11	)	$	(0.18	)

6

Note 3. Discontinued Operations

At the beginning of Fiscal 2005 discontinued operations consisted of eighteen schools and one undeveloped property held for sale. Of the eighteen schools, seven were subleased, six were vacant and five held for sale. The undeveloped property was sold during the second quarter of Fiscal 2005. Of the six vacant, one owned by the Company was sold in the first quarter of Fiscal 2005, two were returned to the respective landlords and the Company has no further obligations under these leases and three remain vacant at the end of Fiscal 2005.

Of the five open schools included in discontinued operations at the start of Fiscal 2005, one was closed and the remaining four were evaluated by the Company to determine their future viability during the third quarter of Fiscal 2005. Based on the absence of reasonable offers to purchase these schools, the Company determined the four schools would return to operating schools and as such, they are included in results from continuing operations as of the third quarter of Fiscal 2005. As a result, the Company no longer holds any schools for sale.

During the first quarter of Fiscal 2006, discontinued operations consisted of ten schools, seven subleased and three vacant.

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

	Thirteen Weeks Ended
	October 1, 2005			October 2, 2004
Revenues	$	—		$	182
Cost of services		108			585
Gross loss		(108	)		(403	)
Gain on sale of property		—			243
Loss from discontinued operations before income tax benefit		(108	)		(160	)
Income tax benefit		(42	)		(61	)
Loss from discontinued operations	$	(66	)	$	(99	)

Note 4 – Goodwill and Intangible Assets, Net

Intangible assets include non-compete agreements, trademarks and other identifiable intangibles acquired in acquisitions. In the first quarter of Fiscal 2004, the Company recorded a liability of $705,000 for non-compete obligations related to former employees. Such intangibles are being amortized over the life of the intangibles, ranging from 3 to 5 years.

At October 1, 2005 and July 2, 2005, the Company’s goodwill and intangible assets were as follows (dollars in thousands):

	October 1, 2005			July 2, 2005
Goodwill	$	36,639		$	36,639
Non-compete		3,198			3,198
Other		1,276			1,276
		41,113			41,113
Accumulated amortization		(4,231	)		(4,176	)
Total Goodwill and intangible assets, net	$	36,882		$	36,937

Amortization expense was $55,000 and $70,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively.

7

Note 5 – Stock Based Compensation

On October 6, 2004, the stockholders approved the 2004 Omnibus Incentive Equity Compensation Plan. The total number of shares of common stock available for issuance is 1,395,000. Under the Plan, common stock may be issued in connection with stock grants, incentive stock options and non-qualified stock options for key employees and outside directors. The purpose of the Plan is to attract and retain quality employees. All grants to date under the Plan (other than a certain stock grant which was terminated) have been non-qualified stock options or incentive stock options which vest over three years (except that options issued to directors vest at the end of the fiscal year in which the options were granted and options granted to new directors upon joining the Board of Directors vest immediately).

The number of options granted under the 2004 Omnibus Incentive Equity Compensation Plan is determined from time to time by the Compensation Committee of the Board of Directors, except for options granted to non-employee directors, which is determined by a formula set forth in the Plan. Incentive stock options are granted at market value or above, and non-qualified stock options are granted at a price fixed by the Compensation Committee at the date of grant. Options are exercisable for up to ten years from date of grant.

Prior to July 2, 2005, the Company accounted for employee stock option grants using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations. Accordingly, compensation expense, if any, was measured as the excess of the underlying stock price over the exercise price on the date of grant. The Company complied with the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock Based Compensation”, as amended by SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure” which required pro-forma disclosure of compensation expense associated with stock options under the fair value method.

Effective July 3, 2005, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) SFAS Statement No. 123(R), “Share-Based Payment”, using modified prospective-transition method. Under that transition method, compensation cost recognized in the first quarter of Fiscal 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 2, 2005, based on the grant date fair value estimated in accordance with the original provision of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to July 3, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated. For purposes of calculating grant-date fair value, the value of the options is estimated using a Black-Scholes option–pricing formula and amortized to expense over the options’ vesting periods.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants:

	Thirteen Weeks Ended October 1, 2005		Fiscal Year 2005
Expected dividend yield	0.0	%	0.0	%
Expected stock price volatility	44.9	%	48.1	%
Risk-free interest rate	4.2	%	3.0% -3.1	%
Weighted average expected life of options	6 years		4 years

Stock-based compensation expense included in the statement of operations for the thirteen weeks ended October 1, 2005 was approximately $80,000. As of October 1, 2005, there was approximately $894,000 of total unrecognized stock-based compensation cost related to options granted under our plans that will be recognized over a weighted average period of 2.4 years.

The following table illustrates the effect on net income and earnings per share for thirteen weeks ended October 2, 2004 if the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Company’s stock option plans in all periods presented. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option–pricing formula and amortized to expense over the options’ vesting periods (dollars in thousands).

	Thirteen Weeks Ended October 2, 2004
Net loss - as reported	$	(1,040	)
Add:  Stock based compensation included in reported net loss, net of related tax effects		—
Deduct: Total stock based compensation expense determined under fair value based methods for all awards, net of related tax effects		(31	)
Pro Forma net loss	$	(1,071	)
Basic and diluted loss per share - as reported	$	(0.18	)
Basic and diluted loss per share - pro forma	$	(0.19	)

8

A summary of option activity under the Company’s employee stock option plans as of October 1, 2005, and changes during the thirteen weeks then ended is presented below:

	Number of shares		Weighted average exercise price		Weighted average remaining contractual term (years)	Aggregate intrinsic value
Options outstanding at July 2, 2005	577,532		$	6.38	6.11
Plus options granted	103,100		$	9.32	10.00
Less:
Options exercised	(12,500	)	$	8.03
Options canceled or expired	—		$	—
Options outstanding at October 1, 2005	668,132		$	6.80	7.00	$	1,689,000
Options exercisable at October 1, 2005	368,099		$	6.45	2.34	$	1,062,000

Note 6 – 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 are 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 7 – Interest Rate Swap Agreement

The Company does not enter into derivative transactions for trading purposes. The Company has an interest rate swap with Harris Trust and Savings Bank. Under the swap, $9,643,000 of the Company’s term loan was allocated to the swap agreement. 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. At October 1, 2005, the Company’s interest rate swap contract outstanding had a total notional amount of $5,357,000. Under the interest rate swap contract, the Company agreed to pay a fixed rate of 5.46% and the counterparty agreed to make payments based on 3-month LIBOR. The market value of the interest rate swap agreement at October 1, 2005 resulted in a liability of $68,000 and is included as a component of Accumulated Other Comprehensive Loss of $42,000, net of taxes.

Note 8 – Segment Information

The Company primarily manages the same type of business in its private pay schools. In accordance with SFAS 131, “Disclosures about Segments of an Enterprise and Related Information”, the private pay schools are disclosed as a segment. The Company also performs back office services for three charter schools and through most of Fiscal 2005 operated The Activities Club. In accordance with SFAS 131, the Company discloses the charter schools and The Activities Club as separate segment information in the “other” category. The Activities Club was closed during Fiscal 2005.

9

The table below presents information about the financial results and condition of the Company’s operating segments for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively (dollars in thousands):

	Thirteen Weeks ended October 1, 2005
	Private Schools		Other		Corporate		Total
Revenues	$	36,956	$	546	$	—	$	37,502
School operating income		2,589		220		—		2,809
Depreciation and amortization:
Continuing operations	$	1,184	$	116	$	161		1,461
Discontinued operations		—		—		—		0
Total depreciation and amortization	$	1,184	$	116	$	161	$	1,461
Goodwill		36,639		—		—		36,639
Segment assets
Continuing operations	$	74,484	$	1,393	$	2,744	$	78,621
Discontinued operations		—		—		—		—
Total assets	$	74,484	$	1,393	$	2,744	$	78,621
	Thirteen Weeks ended October 2, 2004
	Private Schools		Other		Corporate		Total
Revenues	$	35,697	$	579	$	—	$	36,276
School operating income		2,198		226		—		2,424
Depreciation and amortization:
Continuing operations		1,172		116		122		1,410
Discontinued operations		22		—		—		22
Total depreciation and amortization	$	1,194	$	116	$	122	$	1,432
Goodwill		36,639		—		—		36,639
Segment assets
Continuing operations	$	76,456	$	3,877	$	5,572	$	85,905
Discontinued operations		1,152		—		—		1,152
Total assets	$	77,608	$	3,877	$	5,572	$	87,057

10

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

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K filed with the SEC for the year ended July 2, 2005.

The Company has made statements in this report that constitute forward-looking statements as that term is defined in the federal securities laws. These forward-looking statements concern the Company’s operations, economic performance and financial condition and may include statements regarding: opportunities for growth; the number of pre-elementary and elementary schools expected to be added in future years; the profitability of newly opened schools; capital expenditure levels; the ability to incur additional indebtedness; strategic acquisitions, investments and other transactions; and changes in operating systems and policies. The forward-looking statements are subject to various known and unknown risks, uncertainties and other factors. When words such as “believes,” “expects,” “anticipates,” “plans,” “estimates”, “projects” or similar expressions are used in this Quarterly Report on Form 10-Q, the Company is making forward-looking statements.

Although the Company believes that any forward-looking statements are based on reasonable assumptions, expected results may not be achieved. Actual results may differ materially from the Company’s expectations. Among other risk factors that are discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2005, filed with the SEC, and, from time to time in the Company’s other SEC reports and filings, important factors that could cause actual results to differ from expectations include:

• the Company’s inability to execute successfully its growth strategy;

• the effects of general economic conditions, including interest and inflation rates, and world events;

• competitive conditions in the pre-elementary and elementary school education and services industry; including advertising and tuition price sensitivity;

• competitive conditions in the charter school management business;

• delays in new school openings;

• various factors affecting occupancy levels, including, but not limited to, the reduction in or changes to the general labor force that would reduce the need or demand for private schools, or newly opened competitor schools;

• the availability of a qualified labor pool and the impact of government regulations concerning labor and employment issues;

• federal and state regulations regarding changes in child care assistance programs, welfare reform, minimum wages and licensing standards;

• the loss of government funding for child care assistance programs;

• the establishment of governmentally mandated universal pre-K programs or benefits that do not allow for participation by for-profit operators or allows for participation at low reimbursement rates;

• decisions by local school systems which may adversely effect acceptance of course credits from our special purpose high schools;

• the Company’s inability to defend successfully against or counter negative publicity associated with claims involving alleged incidents at its schools;

• the Company’s inability to obtain insurance at the same levels, or at costs comparable to those incurred historically;

• the acceptance of the Company’s newly developed schools and businesses and performance of acquired businesses;

• the Company’s ability to successfully implement new school information systems and technology;

• accounting standards;

• new regulations or changes in accounting requirements and standards and/or new interpretations of existing regulations or standards;

• taxes, and laws and regulations affecting the Company in markets where it competes;

• environmental related disasters that could affect schools in areas impacted by such disasters;

• the Company’s ability to obtain additional financing or capital required to implement fully its business plan; and

• the Company’s ability to defend itself in any litigation.

11

Negative developments in these areas could have a material adverse effect on the Company’s business, financial condition and results of operations.

In addition, beginning with the Company’s Annual Report on Form 10-K for the year ending either July 1, 2006 or June 30, 2007 (depending on the market capitalization test to be performed at December 31, 2005), Section 404 of the Sarbanes-Oxley Act of 2002 will require the Company to include a report of management’s assessment of the effectiveness of its internal control over financial reporting as of the end of the fiscal year. That report is also required to include a statement that the Company’s independent auditors have issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. Risk factors associated with these new requirements include:

• The Company’s inability to complete the work necessary to issue management’s attestation report in a timely manner, or to complete the extensive work that will be required for the Company to report that its internal control over financial reporting is effective;

• The inability of the Company’s independent auditors to complete the work required for them to issue an attestation report on management’s assessment in a timely manner;

• The Company’s inability to ensure that no internal control deficiencies will emerge, or that any remediation efforts will be completely successful;

• The Company’s inability to implement and integrate throughout our schools a new system in such a way that we have appropriate time to finish all the testing and documentation associated with the system conversion and;

• Substantial increase in professional fees associated with compliance requirements.

Readers are cautioned that these risks may not be exhaustive. The Company operates in a continually changing business and regulatory environment and new risks and requirements emerge from time to time. Readers should not rely upon forward-looking statements except as statements of management’s present intentions and expectations that may or may not occur. Readers should read these cautionary statements as being applicable to all forward-looking statements wherever they appear. The Company assumes no obligation to update or revise the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

Results of Operations

At October 1, 2005, the Company operated 150 schools. Since July 2, 2005, the Company has opened one pre-elementary school. School counts for the thirteen weeks ended October 1, 2005 and October 2, 2004 are as follows:

	Thirteen Weeks Ended
	October 1, 2005	October 2, 2004
Number of schools at the beginning of period	149	149
Openings	1	2
Closures	—	—
Number of schools at the end of the period	150	151

12

The following table sets forth certain statement of operations data as a percent of revenue for the thirteen weeks ended October 1, 2005 and October 2, 2004 (dollars in thousands)

	Thirteen Weeks Ended October 1, 2005					Thirteen Weeks Ended October 2, 2004					Change Amount Increase/ (Decrease)		Percent Increase (Decrease)
				Percent of Revenues					Percent of Revenues
Revenues	$	37,502		100.0	%	$	36,276		100.0	%	$	1,226	3.4	%
Personnel costs		18,098		48.3			17,631		48.6			467	2.6
School operating costs		6,206		16.5			5,965		16.4			241	4.0
Rent and other		10,389		27.7			10,256		28.3			133	1.3
Cost of services		34,693		92.5			33,852		93.3			841	2.5
Gross profit		2,809		7.5			2,424		6.7			385	15.9
General and administrative expenses		3,522		9.4			3,288		9.1			234	7.1
Operating loss	$	(713	)	(1.90	)%	$	(864	)	(2.38	)%	$	151	(17.5	)%

Revenue

Revenue for the thirteen weeks ended October 1, 2005 increased $1,226,000 or 3.4% to $37,502,000 from $36,276,000 for the thirteen weeks ended October 2, 2004. The revenue increase for the thirteen weeks ended October 1, 2005 as compared to the same period in the prior year is as follows, respectively (dollars in thousands):

	Thirteen Weeks Ended				Increase (decrease)		Percent Increase (Decrease)
	October 1, 2005		October 2, 2004
Schools open before June 30, 2004	$	36,835	$	36,060	$	775	2.1	%
Schools opened in Fiscal 2005		520		216		304	140.7
New school in Fiscal 2006		147		—		147	n/a
	$	37,502	$	36,276	$	1,226	3.4	%

Revenue for schools opened before June 30, 2004 increased $775,000 or 2.1% during the thirteen weeks ended October 1, 2005 as compared to the same period in the prior year.

For the comparative thirteen week periods, revenue increases for schools opened prior to June 30, 2004 were due primarily to average tuition increases of approximately 4.0% to 4.5% offset by a decrease in average enrollments. Schools that opened in Fiscal 2005 had an increase in revenue of $304,000 during the thirteen weeks ended October 1, 2005 due to normal ramp-up in enrollment for newer schools and the annual tuition increase disclosed previously.

The one new school opened in Fiscal 2006 added revenue of $147,000 during the thirteen weeks ended October 1, 2005.

Revenue trends

Comparable private schools revenue increased 3.1% for the thirteen weeks ended October 1, 2005 over the thirteen weeks ended October 2, 2004.

During October 2005 and continuing into November 2005, the Company’s 10 schools in Florida were impacted by hurricane Wilma. This represents approximately 7% of the Company’s total of 150 schools. As of November 7, 2005, all 10 schools were open. The Company expects that this event will negatively impact the Company’s second quarter 2006 performance. While the Company does not believe that the effects of the hurricane will have a material long term negative impact, the Company cannot be certain of the ongoing local economic impact and its effect on enrollments.

Personnel costs

Personnel costs primarily include wages, payroll taxes, employee benefits and vacation costs. This category of costs is partially variable primarily affected by incentive compensation, rate increases, staffing ratios and enrollment changes. The

13

category tends to be variable on a step function basis when staffing ratios indicate additional teachers are required without full enrollment in a class. In the case of new schools, a base level of personnel and associated costs are incurred in the early years of a schools life which are leveraged as enrollments ramp up.

For the thirteen weeks ended October 1, 2005, personnel cost increased $467,000 or 2.7% versus the thirteen weeks ended October 2, 2004. Personnel cost decreased to 48.3% of revenue for the thirteen weeks ended October 1, 2005 from 48.6% of revenue for the thirteen weeks ended October 2, 2004. Personnel cost improved as a percent of revenue as revenue increases outpaced wage and benefit cost increases in addition to more efficient school labor management.

Total wage, payroll tax and vacation increases accounted for $284,000 and amounted to approximately 1.9% of the total 2.7% increase. Healthcare accounted for $145,000 or 0.8% of the 2.7% increase. Healthcare as a line item increased 15.1% for the thirteen weeks ended October 1, 2005 compared to the thirteen weeks ended October 2, 2004.

School operating costs

School operating costs primarily include maintenance, food, supplies, utilities, transportation, school level marketing spending and ancillary programs. The category is partially variable with increases in revenue primarily when those revenue increases are driven by additional enrollment. In the case of new schools a base level of costs are incurred in the early years of a schools life which are leveraged in future years as enrollments ramp up.

For the thirteen weeks ended October 1, 2005, school operating costs increased $241,000 or 4.0% versus the thirteen weeks ended October 2, 2004. School operating costs increased to 16.5% of revenue for the thirteen weeks ended October 1, 2005 from 16.4% of revenue for the thirteen weeks ended October 2, 2004.

Expense increases in bad debt, $135,000, program, $105,000, janitorial, $78,000, transportation, $72,000 and utility, $64,000, were partially offset by lower school based marketing, $71,000, supplies, $65,000 and building maintenance, $40,000. The bad debt increase resulted from management efforts to tighten collection practices in certain schools which also may have an impact on enrollment. Increased program expense resulted from the implementation of a new Spanish language curriculum. Janitorial cost increases resulted from emphasis on improved maintenance efforts which was partially offset by lower building maintenance expense. Transportation and utility increases resulted from higher energy costs. Lower school based marketing resulted from a shift to corporate based marketing included in general and administrative expense and not an overall reduction in marketing spending. Supply expense decreases resulted from better vendor relationships and field expense management practices.

Rent and other

Rent and other costs primarily include property rent and property taxes, insurance including workmen’s compensation and property, depreciation and amortization, regional marketing, vehicle and equipment rent, and pre-opening costs. This category of costs is relatively fixed in nature with increases related to contractual occupancy obligations, changes in marketing initiatives or a ramp up in school openings.

For the thirteen weeks ended October 1, 2005, rent and other increased $133,000 or 1.3% versus the thirteen weeks ended October 2, 2004. Rent and other decreased to 27.7% of revenue for the thirteen weeks ended October 1, 2005 from 28.3% of revenue for the thirteen weeks ended October 2, 2004.

Expense increase in occupancy, $247,000, and corporate based marketing, $63,000, were partially offset by lower pre-opening $74,000, vehicle and equipment leases, $62,000, and insurance, $59,000. The increase in occupancy costs is due to the addition of one new school in the period as well as the full period effect of two prior year openings in the period, contractual rent increases driven by the Consumer Price Index (CPI), certain lease renewals or extensions and property tax increases. Corporate based marketing increased from a shift in school based marketing previously carried in school operating expenses described above. Pre-opening decreased a result of opening one school this period versus two in the prior period. Vehicle and equipment leases decreased due to a reduction in the number of vehicles leased and a reduction in copier and personal computer leases for the schools.

14

Gross profit

Gross profit for the thirteen weeks ended October 1, 2005 increased $385,000 or 15.9% to $2,809,000 from $2,424,000 for the thirteen weeks ended October 2, 2004. Total gross profit was 7.5% of revenue for the thirteen weeks ended October 1, 2005 and 6.7% of revenue for the thirteen weeks ended October 2, 2004. The change in gross profit for the thirteen weeks ended October 1, 2005, as compared to the same period in the prior year, is as follows (dollars in thousands):

	Thirteen Weeks Ended						Increase (decrease)			Percent Increase (Decrease)
	October 1, 2005			October 2, 2004
Schools open before June 30, 2004	$	2,912		$	2,693		$	219		8.1	%
Schools opened in Fiscal 2005		(52	)		(269	)		217		80.7
New school in Fiscal 2006		(51	)		—			(51	)	n/a
	$	2,809		$	2,424		$	385		15.9	%

Gross profit from schools opened before June 30, 2004 increased $219,000 or 8.1% during the thirteen weeks ended October 1, 2005 as compared to the same period in the prior year.

Gross profit as a percentage of applicable revenue for these schools increased to 7.9% for the thirteen weeks ended October 1, 2005 from 7.5% for the thirteen weeks ended October 2, 2004. This increase in gross profit as a percentage of applicable revenue is due primarily to tuition increases of approximately 4.0 to 4.5%, offset by decreases in average enrollment and more efficient school labor management offset by wage increases.

The two schools opened in Fiscal 2005 had a decrease in gross losses of $217,000 during the thirteen weeks ended October 1, 2005, as compared to the same period in the prior year, due in part to normal ramp-up in enrollment for schools in their second year of operations as well as an increase in tuition.

One new school opened in Fiscal 2006 had losses of $51,000 for the thirteen weeks ended October 1, 2005, due in part to low enrollments associated with new schools as they enter the normal new school enrollment ramp-up period and $79,000 in pre-opening expenses.

General and administrative expenses

General and administrative expenses for the thirteen weeks ended October 1, 2005 increased $234,000 to $3,522,000 from $3,288,000 for the thirteen weeks ended October 2, 2004.

Expense increases in professional fees, $231,000, consulting, $114,000 and stock options, $80,000 were offset by salary and benefits, $117,000, and recruiting $56,000. Professional fees increased on higher legal and audit fees on higher compliance related costs as well as services for the charter school management business. Consulting costs increased on management’s strategic planning directed efforts. Stock option costs were higher on adoption of new accounting treatment, FASB 123(R), requiring expensing of stock based compensation. Salary and benefits improved on lower head count at corporate headquarters. Recruiting decreased on reduced recruiting needs in the period.

Operating Loss

As a result of the factors mentioned above, operating loss decreased $151,000 to $713,000 for the thirteen weeks ended October 1, 2005 from $864,000 for the thirteen weeks ended October 2, 2004.

Interest expense

Interest expense decreased $312,000 or 44.1% to $396,000 for the thirteen weeks ended October 1, 2005 from $708,000 for the thirteen weeks ended October 2, 2004. The decrease in interest expense is related primarily to the reduction in the retirement of the Company’s $10,000,000 senior subordinated 13.25% notes during the fourth quarter of Fiscal 2005.

15

Income tax benefit

Income tax benefit for the thirteen weeks ended October 1, 2005 was $415,000 as compared to $577,000 for the thirteen weeks ended October 2, 2004. The Company’s effective tax rate for the thirteen weeks ended October 1, 2005 was 39% as compared to 38% for the thirteen weeks ended October 2, 2005.

Discontinued operations

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

	Thirteen Weeks Ended
	October 1, 2005			October 2, 2004
Revenues	$	—		$	182
Cost of services		108			585
Gross loss		(108	)		(403	)
Gain on sale of property		—			243
Loss from discontinued operations before income tax benefit		(108	)		(160	)
Income tax benefit		(42	)		(61	)
Loss from discontinued operations	$	(66	)	$	(99	)

At the end of Fiscal 2004 discontinued operations consisted of twenty schools and one undeveloped property held for sale. Of the twenty schools, nine ceased operations in Fiscal 2004 (eight in the fourth quarter of Fiscal 2004), six ceased operations in Fiscal 2003 and five were placed as held for sale.

Of the fifteen closed schools, eight were subleased, five were vacant, one was sold, and one was returned to the landlord under a lease buyout and early termination. Of the five vacant schools one vacant school, owned by the Company, was sold during the first quarter of Fiscal 2005. The remaining four continue to be accounted for as discontinued operations as of October 1, 2005.

Of the five operating (held for sale) schools, one was closed and the remaining four were evaluated by the Company to determine their future viability during the third quarter of Fiscal 2005. Based on the absence of reasonable offers to purchase these schools, the Company determined the four schools would return to operating schools and as such, they have been included in results from continuing operations since the third quarter of Fiscal 2005. As a result, the Company no longer holds any operating schools for sale.

Discontinued operations consist of 10 subleased or vacant schools for the period ended October 1, 2005 and 11 subleased or vacant schools and one open school for the period ended October 2, 2004.

Net Loss

As a result of the above factors, the Company’s net loss was $713,000 for the thirteen weeks ended October 1, 2005 as compared to $1,040,000 for the thirteen weeks ended October 2, 2004.

16

Liquidity and Capital Resources

Senior Debt

The Company continues its senior credit relationship with Harris Bank. A Credit Agreement with Harris Bank in the amount of $25,00,000 provides for a $15,000,000 Term Loan, a $10,000,000 Revolving Credit Commitment and up to $3,500,000 in letters of credit as a sub-limit of the Revolving Credit Commitment. The Credit Agreement terminates February 20, 2009. As of October 1, 2005 the Term Loan balance was $14,500,000 and the letters of credit outstanding were $1,412,709, As of October 31, 2005 the Term Loan Balance was $14,000,000 as a result of a scheduled principal payment. Since its inception in February 2004 the Company has not had any borrowings in connection with the Revolving Credit Commitment.

The Credit Agreement contains customary covenants and provisions that restrict the Company’s ability to change its business, declare dividends, grant liens, incur additional indebtedness and make capital expenditures. In addition, the Credit Agreement provides that the Company must meet or exceed defined amounts for defined EBITDA and fixed charges and must not exceed leverage ratios. At October 1, 2005, the Company was in compliance with all required covenants under the Credit Agreement.

Cash Flow

The Company’s principal sources of liquidity are cash flow from operations, and amounts available under its Revolving Credit Commitment. 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 or addition of new schools. The Company evaluates opportunities from time to time to sell properties to third parties. At October 1, 2005 and October 31, 2005, there were no amounts outstanding under the Revolving Credit Commitment and there was $1,412,709 outstanding for letters of credit. The total unused portion of the Revolving Credit Commitment, after allowance for the letters of credit, at October 1, 2005 was $8,587,000. The Company’s loan covenants under its Credit Agreement limit the amount of senior debt borrowings. At October 1, 2005, the entire unused portion under the Revolving Credit Commitment, after allowance for the letters of credit was available.

Total cash and cash equivalents increased by $1,466,000 to $4,391,000 at October 1, 2005 from $2,925,000 at July 2, 2005. The increase is primarily related to cash provided by operations of $3,033,000 and was offset by $1,083,000 in capital expenditures and $584,000 in repayments on senior debt and notes payable.

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		Thirty Nine Weeks Ended July 1, 2006		For Fiscal Year
					2007		2008		2009		2010		Thereafter
Long term debt obligations	$	14,500	$	1,500	$	2,000	$	2,000	$	9,000	$	—	$	—
Letters of credit		1,413		1,413		—		—		—		—		—
Swap agreement		68		68				—		—		—		—
Operating leases		207,690		22,485		27,798		25,678		23,235		21,906		86,588
Non-competes and consulting contracts		878		278		300		300		—		—		—
Total	$	224,549	$	25,744	$	30,098	$	27,978	$	32,235	$	21,906	$	86,588

The Company’s liability with respect to closed school lease commitments could change if sublessors default under their sublease with the Company or if the Company is successful or unsuccessful in subleasing additional closed schools or extending existing sublease agreements. Some of the closed school lease commitments extend beyond the term of the current subleases on those properties.

17

Capital Expenditures

During the first quarter of Fiscal 2006, the Company placed one new school in operation. The new school opened in the first quarter of Fiscal 2006 was financed by developers and leased to the Company. Capital expenditures for new school development include school equipment, furniture and fixtures, and curricula purchased by the Company for the operations of the school. No additional schools are anticipated to be opened during Fiscal 2006. Funding of capital expenditures for these schools was provided by cash from operations. Renovations and equipment purchases are expenditures incurred for existing schools in order to maintain the operations and, where necessary, upgrade the school facility. The Company’s current senior bank credit facility has annual limitations on the amount of capital expenditures. For Fiscal 2006, this limitation is $7,000,000. Capital expenditures for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively, are as follows (dollars in thousands):

	Thirteen Weeks Ended
	October 1, 2005		October 2, 2004
New school development	$	145	$	237
Renovations and equipment purchases		754		986
Corporate and information systems		184		194
Total capital expenditures	$	1,083	$	1,417

Insurance

Companies involved in the education and care of children may not be able to obtain insurance for the totality of risks inherent in their operations. In particular, general liability coverage can have insurance sub-limits per claim for child abuse. The Company believes it has adequate insurance coverage at this time. There can be no assurance that in future years the Company will not become subject to lower limits or substantial increases in insurance premiums.

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 Fiscal 2005. 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 revenue, net of discounts and other revenue, is recognized as services are performed. Any tuition payments received in advance of the time period for which service is to be performed are recorded as deferred revenue. Tuition payments received from state and local government agencies (which comprise approximately 3% of total revenue) are recognized over the period services are performed and, due to the fact that such agencies pay in arrears, are recorded as receivables from such agencies at the time the service is performed. Charter school management fees are recognized based on a contractual relationship with the charter school and do not include any tuition revenue 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 revenue meets the criteria of SAB No. 101, including the existence of an arrangement, the rendering of services, a determinable fee and probable collection.

18

Accounts Receivable

The Company’s accounts receivable are comprised primarily of tuition due from parents and governmental agencies. 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 its 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 monitors its exposure for credit losses and maintains allowances for anticipated losses.

Long-lived and Intangible Assets

During the first quarter of Fiscal 2004, 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 is less than the carrying value of the asset. Such estimates of cash flow 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 SFAS No. 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.

19

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 relates primarily to debt obligations. The Company also had no cash flow exposure on certain notes payable and other subordinate debt agreements aggregating $376,000 and $461,000 at October 1, 2005 and July 2, 2005, respectively. However, the Company does have cash flow exposure on its Credit Agreement. The Working Capital Line and the Term Loan 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 $37,000 and $34,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively.

Interest Rate Swap Agreement

The Company does not enter into derivative transactions for trading purposes. The Company has an interest rate swap with Harris Trust and Savings Bank. Under the swap, $9,643,000 of the Term Loan has been allocated to the swap agreement. 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. At October 1, 2005, the Company’s interest rate swap contract outstanding had a total notional amount of $5,357,000. Under the interest rate swap contract, the Company agrees to pay a fixed rate of 5.46% and the counterparty agrees to make payments based on 3-month LIBOR. The market value of the interest rate swap agreement at October 1, 2005 resulted in a liability of $68,000 and is included as a component of accumulated other comprehensive loss of $42,000, net of taxes.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management has evaluated, with the participation of its Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of October 1, 2005. The Company’s 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 within the time periods specified in the Commissions rules and forms. The Company’s disclosure controls and procedures are also designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation, the Company’s 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 Quarterly Report on Form 10-Q.

Internal Control Over Financial Reporting

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.

20

Part II

Other Information

Item 6. Exhibits

10.1	Form of Incentive Stock Option Certificate, for stock option grants under the Omnibus Incentive Equity Compensation Plan
10.2	Form of Non-Qualified Stock Option Agreement (Non-Employee Director), for stock option grants under the Omnibus Incentive Equity compensation Plan
10.3	Form of Non-Qualified Stock Option Agreement (Employee), for stock option grants under the Omnibus Incentive Equity Compensation Plan
10.4	Form of Stock Award Certificate, for stock grants under the Omnibus Incentive Equity Compensation Plan
31.1	Certification of the Chief Executive Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2	Certification of the Chief Financial Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32.1	Certification of the Chief Executive Officer of the Registrant pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. (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.)
32.2	Certification of the Chief Financial Officer of the Registrant pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. (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.)

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 November 15, 2005	By:	/s/    THOMAS FRANK
		Thomas Frank Chief Financial Officer (duly authorized officer and principal financial officer)

21