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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: September 30, 2006
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the transition period from to
Commission File Number 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated Filer ¨ Accelerated Filer ¨ Non-accelerated filer x
Indicate 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 10, 2006 was 8,092,766.
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INDEX TO FORM 10-Q
Nobel Learning Communities, Inc.
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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” and in Item 1A. Risk Factors of the Company’s Annual Report on Form 10-K for the fiscal year ended July 1, 2006. 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.
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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except share amounts)
| (Unaudited) September 30, 2006 | July 1, 2006 | |||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 7,111 | $ | 9,837 | ||||
Accounts receivable, less allowance for doubtful accounts of $465 at September 30, 2006 and $698 at July 1, 2006 | 1,776 | 2,329 | ||||||
Deferred tax asset | 1,470 | 1,479 | ||||||
Prepaid rent | 2,604 | 2,559 | ||||||
Prepaid insurance and other | 3,258 | 2,836 | ||||||
Total Current Assets | 16,219 | 19,040 | ||||||
Property and equipment, at cost | 76,327 | 73,122 | ||||||
Accumulated depreciation and amortization | (48,754 | ) | (47,415 | ) | ||||
Property and equipment, net | 27,573 | 25,707 | ||||||
Goodwill | 38,374 | 38,374 | ||||||
Intangible assets, net | 1,673 | 1,528 | ||||||
Deferred tax asset | 875 | 866 | ||||||
Deposits and other assets | 1,273 | 904 | ||||||
Total Assets | $ | 85,987 | $ | 86,419 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current portion of long-term debt | $ | 2,107 | $ | 2,180 | ||||
Accounts payable and other current liabilities | 11,371 | 14,478 | ||||||
Deferred revenue | 15,794 | 11,885 | ||||||
Total Current Liabilities | 29,272 | 28,543 | ||||||
Long-term obligations | 10,505 | 11,000 | ||||||
Other long term liabilities | 503 | 596 | ||||||
Total Liabilities | 40,280 | 40,139 | ||||||
Commitments and Contingencies | ||||||||
Stockholders’ Equity: | ||||||||
Preferred stock, $0.001 par value; 10,000,000 shares authorized, issued and outstanding 3,311,159 at September 30, 2006 and 3,283,419 at July 1, 2006. $12,531 and $12,401 liquidation preference at September 30, 2006 and July 1, 2006 respectively | 3 | 3 | ||||||
Common stock, $0.001 par value; 20,000,000 shares authorized; 8,092,776 shares issued and outstanding at September 30, 2006 and July 1, 2006 | 8 | 8 | ||||||
Additional paid-in capital | 56,007 | 55,778 | ||||||
Accumulated deficit | (10,311 | ) | (9,509 | ) | ||||
Total Stockholders’ Equity | 45,707 | 46,280 | ||||||
Total Liabilities and Stockholders’ Equitiy | $ | 85,987 | $ | 86,419 | ||||
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 consolidated financial statements.
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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands except per share data)
(Unaudited)
| For the Thirteen Weeks Ended | ||||||||
| September 30, 2006 | October 1, 2005 | |||||||
Revenues | $ | 40,317 | $ | 37,502 | ||||
Operating expenses: | ||||||||
Personnel costs | 20,106 | 18,098 | ||||||
School operating costs | 6,778 | 6,206 | ||||||
Rent and other | 10,522 | 10,389 | ||||||
Cost of services | 37,406 | 34,693 | ||||||
Gross profit | 2,911 | 2,809 | ||||||
General and administrative expenses | 3,686 | 3,522 | ||||||
Operating loss | (775 | ) | (713 | ) | ||||
Interest expense | 322 | 396 | ||||||
Other income | (136 | ) | (47 | ) | ||||
Loss from continuing operations before income taxes | (961 | ) | (1,062 | ) | ||||
Income tax benefit | (375 | ) | (415 | ) | ||||
Loss from continuing operations | (586 | ) | (647 | ) | ||||
Loss from discontinued operations, net of income tax effect | $ | (84 | ) | $ | (66 | ) | ||
Net loss | (670 | ) | (713 | ) | ||||
Preferred stock dividends | 132 | 101 | ||||||
Net loss available to common stockholders | $ | (802 | ) | $ | (814 | ) | ||
Basic and diluted loss per share: | ||||||||
Loss from continuing operations | $ | (0.09 | ) | $ | (0.10 | ) | ||
Loss from discontinued operations | (0.01 | ) | (0.01 | ) | ||||
Net loss per share | $ | (0.10 | ) | $ | (0.11 | ) | ||
Weighted average common shares outstanding: | ||||||||
Basic and diluted | 8,093 | 7,457 | ||||||
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 consolidated financial statements.
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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
For the Thirteen Weeks Ended September 30, 2006
(Dollars in thousands except share data)
Treasury Stock | Additional Paid-In Capital | Retained Earnings/ (Accumulated Deficit) | Total | |||||||||||||||||||||
| Preferred Stock | Common Stock | |||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||
July 1, 2006 | 3,283,419 | $ | 3 | 8,092,776 | $ | 8 | $ | 0 | $ | 55,778 | $ | (9,509 | ) | $ | 46,280 | |||||||||
Net loss | — | — | — | — | — | — | (670 | ) | (670 | ) | ||||||||||||||
Issuance of preferred stock | 27,740 | — | — | — | — | 131 | — | 131 | ||||||||||||||||
Compensation for employee stock options | — | — | — | — | — | 98 | — | 98 | ||||||||||||||||
Preferred dividends | — | — | — | — | — | — | (132 | ) | (132 | ) | ||||||||||||||
September 30, 2006 | 3,311,159 | $ | 3 | 8,092,776 | $ | 8 | $ | 0 | $ | 56,007 | $ | (10,311 | ) | $ | 45,707 | |||||||||
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 consolidated financial statements.
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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
(Dollars in thousands)
(Unaudited)
| Thirteen Weeks Ended | ||||||||
| September 30, 2006 | October 1, 2005 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net loss | $ | (670 | ) | $ | (713 | ) | ||
Adjustments to Reconcile Net loss to Net Cash | ||||||||
Provided by Operating Activities: | ||||||||
Depreciation and amortization | 1,621 | 1,461 | ||||||
Provision for losses on accounts receivable | 370 | 163 | ||||||
Stock option compensation | 98 | 80 | ||||||
Other | (28 | ) | (35 | ) | ||||
Changes in Assets and Liabilities: | ||||||||
Accounts receivable | 183 | 197 | ||||||
Prepaid assets | (467 | ) | (180 | ) | ||||
Other assets and liabilities | (371 | ) | 108 | |||||
Deferred revenue | 3,909 | 4,144 | ||||||
Accounts payable and accrued expenses | (2,976 | ) | (2,192 | ) | ||||
Total Adjustments | 2,339 | 3,746 | ||||||
Net Cash Provided by Operating Activities | 1,669 | 3,033 | ||||||
Cash Flows from Investing Activities: | ||||||||
Purchases of capital expenditures | (3,536 | ) | (1,083 | ) | ||||
Purchases of intangible assets | (204 | ) | — | |||||
Net Cash Used in Investing Activities | (3,740 | ) | (1,083 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Repayment of long term debt | (568 | ) | (584 | ) | ||||
Proceeds from exercise of stock options | — | 100 | ||||||
Dividends paid to preferred stockholders | (87 | ) | — | |||||
Net Cash (Used in) Provided by Financing Activities | (655 | ) | (484 | ) | ||||
Net (decrease) increase in cash and cash equivalents | (2,726 | ) | 1,466 | |||||
Cash and cash equivalents at beginning of period | 9,837 | 2,925 | ||||||
Cash and cash equivalents at end of period | $ | 7,111 | $ | 4,391 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Interest | $ | 256 | $ | 201 | ||||
Income taxes, net | $ | 559 | $ | 10 | ||||
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 consolidated financial statements.
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NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
for the thirteen weeks ended September 30, 2006 and October 1, 2005 (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 September 30, 2006 and results of operations for the thirteen weeks ended September 30, 2006 and October 1, 2005, 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 1, 2006.
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 2007 and Fiscal 2006 are to the 52 weeks ending June 30, 2007 and July 1, 2006 respectively. The first quarter of Fiscal 2007 and Fiscal 2006 are each comprised of 13 weeks.
Reclassifications. The Company has conformed amounts previously reported in its Quarterly Report on Form 10-Q for the period ended October 1, 2005 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 seven subleased or vacant schools for the period ended September 30, 2006 and 10 subleased or vacant schools and one open school for the period ended October 1, 2005.
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 September 30, 2006 and October 1, 2005. The common stock equivalents of stock options, convertible preferred stock issued and outstanding during the thirteen weeks ended September 30, 2006 and October 1, 2005 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 | ||||||||
| September 30, 2006 | October 1, 2005 | |||||||
Basic and diluted loss per share: | ||||||||
Net loss | $ | (670 | ) | $ | (713 | ) | ||
Less preferred dividends | 132 | 101 | ||||||
Loss available for common stock | (802 | ) | (814 | ) | ||||
Average common stock outstanding | 8,093 | 7,457 | ||||||
Basic and diluted loss per share | $ | (0.10 | ) | $ | (0.11 | ) | ||
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Note 3. Acquisition
On October 26, 2006, the Company announced that it had entered into an agreement to acquire all of the outstanding shares of Discovery Isle Child Development Center, Inc. (“Discovery Isle”). The transaction is expected to close on or about November 30, 2006. Discovery Isle is a leading preschool provider based in San Diego, California, and operates six preschools in Southern California. The acquisition price of approximately $12,000,000 will be financed through existing cash resources and the Company’s credit facility. This acquisition will not meet the requirements of furnishing pro-forma financial information as governed by SEC Regulation S-X.
Note 4. Credit Agreement
At September 30, 2006 the Company’s Credit Agreement with Harris Trust. in the amount of $25,000,000 provided 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 was scheduled to terminate on February 20, 2009. As of September 30, 2006 the Term Loan balance was $12,500,000 and the letters of credit outstanding were $1,699,000.
On October 30, 2006 the Company entered into an Amended and Restated Credit Agreement (“Agreement”) with BMO Capital Markets, an affiliate of Harris Trust. The new Agreement provides for a $50,000,000 Revolving Credit Commitment (“Revolver”). The Revolver replaces the prior $25,000,000 Term Loan and Revolving Credit Commitment facilities. On October 30, 2006 the Company retired its outstanding Term Loan in the amount of $12,500,000 and had $3,800,000 in Revolver borrowings outstanding under the new Agreement. Under terms of the Agreement, the Revolver may be used to fund permitted acquisitions (as defined), additional capital expenditures, and for general corporate purposes. Leverage driven matrix based Libor borrowings are lower by up to 75 basis points and bank base rate borrowings are lower by up to 50 basis points as compared to the prior facility. The new facility has a five year term expiring October 2011.
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, make capital expenditures and use proceeds from disposition of assets or equity related transactions. In addition, the Credit Agreement provides that the Company must meet or exceed amounts for defined EBITDA and fixed charges and must not exceed leverage ratios. At September 30, 2006, the Company would have been in compliance with all required covenants under the Agreement.
Note 5. Discontinued Operations
At the beginning of Fiscal 2006, discontinued operations consisted of ten schools, seven subleased and three vacant. During Fiscal 2006 one lease expired and two were returned to the respective landlords and the Company has no further obligations under these leases. During the first quarter of Fiscal 2007 discontinued operations consisted of seven schools, six of which are subleased, one of which is 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 | ||||||||
| September 30, 2006 | October 1, 2005 | |||||||
Cost of services | $ | 138 | $ | 108 | ||||
Loss from discontinued operations before income tax benefit | (138 | ) | (108 | ) | ||||
Income tax benefit | (54 | ) | (42 | ) | ||||
Loss from discontinued operations | $ | (84 | ) | $ | (66 | ) | ||
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Note 6 – Goodwill and Intangible Assets, Net
Intangible assets include non-compete agreements, a franchise agreement, and other identifiable intangibles acquired in acquisitions. At September 30, 2006 and July 1, 2006, the Company’s goodwill and intangible assets were as follows (dollars in thousands):
| September 30, 2006 | July 1, 2006 | |||||||
Goodwill | $ | 38,374 | $ | 38,374 | ||||
Franchise Agreement | 409 | 379 | ||||||
Non-compete Agreements | 255 | 405 | ||||||
Trade Names | 570 | 570 | ||||||
Student Roster from Acquisition | 655 | 655 | ||||||
| 40,263 | 40,383 | |||||||
Accumulated amortization | (216 | ) | (481 | ) | ||||
Total Goodwill and intangible assets, net | $ | 40,047 | $ | 39,902 | ||||
Amortization expense was $58,000 and $55,000 for the thirteen weeks ended September 30, 2006 and October 1, 2005, respectively.
Note 7 – 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 have been non-qualified 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 the date of grant.
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 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). 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 assumptions used for grants:
| Thirteen Weeks Ended | ||||||
September 30, 2006 | October 1, 2005 | |||||
Expected dividend yield | 0.0 | % | 0.0 | % | ||
Expected stock price volatility | 36.8 | % | 44.9 | % | ||
Risk-free interest rate | 4.0 | % | 4.2 | % | ||
Weighted average expected life of options | 5 years | 6 years | ||||
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Stock-based compensation expense included in the statement of operations for the thirteen weeks ended September 30, 2006 and October 1, 2005 was approximately $98,000 and $80,000, respectively. As of September 30, 2006, there was approximately $1,033,000 of total unrecognized stock-based compensation cost related to options granted under our plans that will be recognized over a weighted average period of 1.6 years.
A summary of option activity under the Company’s employee stock option plans as of July 1, 2006, 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 1, 2006 | 744,682 | $ | 7.20 | 7.44 | $ | 2,204,000 | |||||
Plus options granted | 126,000 | 10.08 | 10.00 | ||||||||
Less: | |||||||||||
Options exercised | — | ||||||||||
Options canceled or expired | (25,000 | ) | 9.13 | 5.50 | |||||||
Options outstanding at September 30, 2006 | 845,682 | $ | 7.57 | 7.67 | $ | 2,307,000 | |||||
Options exercisable at September 30, 2006 | 551,582 | $ | 7.09 | 7.06 | $ | 1,769,000 | |||||
Note 8 – 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 9 – New Accounting Pronouncements
In September 2006, the SEC staff issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, to address quantifying the financial statement effects of misstatements. The SEC believes that registrants and auditors must quantify the effects on the current year financial statements of correcting all misstatements, including both the carryover and reversing effects of uncorrected prior year misstatements. After considering all relevant quantitative and qualitative factors, if a misstatement is material to either the income statement or the balance sheet, a registrant’s financial statements must be adjusted. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company is currently evaluating the impact, if any, of SAB No. 108 on its consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109 “Accounting for Income Taxes.” FIN 48 provides guidance on recognizing, measuring, presenting and disclosing in the financial statements uncertain tax positions that a company has taken or expects to take on a tax return. FIN 48 is effective for the Company as of January 1, 2007. The Company is currently assessing the impact, if any, of FIN 48 on its consolidated financial statements.
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In August 2006, the Securities and Exchange Commission (“SEC”) issued new requirements for “Executive Compensation and Related Person Disclosure.” These rules amend the disclosure requirements for total compensation for the principal executive officer, the principal financial officer, and three other most highly paid officers. In addition, these rules expand the compensation disclosures for directors and require that all compensation to each director be disclosed in a separate summary compensation table with improved narrative disclosure supplementing the tabular presentation. The Company anticipates adopting this ruling in the Company’s 2007 Annual Report on Form 10-K. The adoption of this ruling will have no impact on the Company’s consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides a new single authoritative definition of fair value, provides enhanced guidance for measuring the fair value of assets and liabilities and requires additional disclosures about the extent to which companies measure assets and liabilities at fair value, the information and methods used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 is effective for the Company as of January 1, 2008. The Company is currently assessing the impact, if any, of SFAS 157 on its consolidated financial statements.
Note 10 – 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. In accordance with SFAS 131, the Company discloses the charter schools as separate segment information in the “other” category.
The table below presents information about the financial results and condition of the Company’s operating segments for the thirteen weeks ended September 30, 2006 and October 31, 2005 (dollars in thousands):
| Thirteen Weeks ended September 30, 2006 | ||||||||||||
| Private Schools | Other | Corporate | Total | |||||||||
Revenues | $ | 39,787 | $ | 530 | $ | — | $ | 40,317 | ||||
School operating income | 2,690 | 221 | — | 2,911 | ||||||||
Depreciation and amortization | 1,197 | 116 | 308 | 1,621 | ||||||||
Goodwill | 38,374 | — | — | 38,374 | ||||||||
Segment assets | 82,019 | 964 | 3,004 | 85,987 | ||||||||
| 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: | 1,184 | 116 | 161 | 1,461 | ||||||||
Goodwill | 36,639 | — | — | 36,639 | ||||||||
Segment assets | 74,484 | 1,393 | 2,744 | 78,621 | ||||||||
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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 1, 2006.
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 1, 2006, 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 successfully execute its 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; |
| • | delays in new school openings or lower than expected enrollments; |
| • | 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; |
| • | government regulations affecting student/teacher ratios; |
| • | 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; |
| • | the growth of competitors as possible alternatives to the public school system, such as virtual charter schools, charter schools, and magnet schools; |
| • | decisions by local school systems which may adversely affect 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 school information systems and technology; |
| • | new regulations or changes in accounting requirements and standards and/or new interpretations of existing regulations or standards; |
| • | taxes, laws and regulations affecting the Company in markets where it competes; |
| • | environmental related events that could affect schools in areas impacted by such events; |
| • | the Company’s ability to obtain additional financing or capital required to implement fully its business and strategic plan; |
| • | the Company’s ability to defend itself in any litigation; and |
| • | the growth of competitors in our markets and their tactics to recruit our employees. |
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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 June 30, 2007 or June 28, 2008 (depending on the market capitalization test to be performed at December 31, 2006), 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 information systems in such a way that we have appropriate time to finish all the testing and documentation associated with the system 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 September 30, the Company operated 151 schools. Since July 1, 2006, the Company has opened one preschool. School counts for the thirteen weeks ended September 30, 2006 and October 1, 2005 and are as follows:
| Thirteen Weeks Ended | ||||
| September 30, 2006 | October 1, 2005 | |||
Number of schools at the beginning of period | 150 | 149 | ||
Openings | 1 | 1 | ||
Number of schools at the end of the period | 151 | 150 | ||
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The following table sets forth certain statement of operations data as a percent of revenue for the thirteen weeks ended September 30, 2006 and October 1, 2005 (dollars in thousands)
| Thirteen Weeks Ended September 30, 2006 | Percent of Revenues | Thirteen Weeks Ended October 1, 2005 | Percent of Revenues | ||||||||||||||||||
| Dollar | Percent | ||||||||||||||||||||
| Increase (decrease) | |||||||||||||||||||||
Revenues | $ | 40,317 | 100 | % | $ | 37,502 | 100 | % | $ | 2,815 | 7.5 | % | |||||||||
Personnel costs | 20,106 | 49.9 | 18,098 | 48.3 | 2,008 | 11.1 | |||||||||||||||
School operating costs | 6,778 | 16.8 | 6,206 | 16.5 | 572 | 9.2 | |||||||||||||||
Rent and other | 10,522 | 26.1 | 10,389 | 27.7 | 133 | 1.3 | |||||||||||||||
Cost of services | 37,406 | 92.8 | 34,693 | 92.5 | 2,713 | 7.8 | |||||||||||||||
Gross profit | 2,911 | 7.2 | 2,809 | 7.5 | 102 | 3.6 | |||||||||||||||
General and administrative expenses | 3,686 | 9.1 | 3,522 | 9.4 | 164 | 4.7 | |||||||||||||||
Operating loss | $ | (775 | ) | (1.9 | )% | $ | (713 | ) | (1.9 | )% | $ | (62 | ) | 8.7 | % | ||||||
Revenue
Revenue for the thirteen weeks ended September 30, 2006 increased $2,815,000 or 7.5% to $40,317,000 from $37,502,000 for the thirteen weeks ended October 1, 2005. The revenue increase for the thirteen weeks ended September 30, 2006 as compared to the same period in the prior year is as follows, (dollars in thousands):
| Thirteen Weeks Ended | Increase | Percent Increase | |||||||||||
| September 30, 2006 | October 1, 2005 | ||||||||||||
Comparable Schools | $ | 37,997 | $ | 36,462 | $ | 1,535 | 4.2 | % | |||||
Schools opened or acquired | 1,790 | 147 | 1,643 | 1,117.7 | |||||||||
Closed schools | — | 347 | (347 | ) | (100.0 | ) | |||||||
Other, non-school | 530 | 546 | (16 | ) | (2.9 | ) | |||||||
| $ | 40,317 | $ | 37,502 | $ | 2,815 | 7.5 | % | ||||||
Revenue for comparable schools (those which operated the entire first quarter of Fiscal 2007 and the entire first quarter of Fiscal 2006) increased $1,535,000 or 4.2% during the thirteen weeks ended September 30, 2006 as compared to the same period in the prior year.
Revenue for schools opened or acquired during the first quarter of either Fiscal 2007 or Fiscal 2006 increased $1,643,000 during the thirteen weeks ended September 30, 2006 as compared to the same period in the prior year. This increase was offset by revenues of $347,000 that were not obtained from three schools that closed after the first quarter of Fiscal 2006 and prior to the first quarter of Fiscal 2007.
Other revenues, primarily charter school management related, decreased by $16,000 during the thirteen weeks ended September 30, 2006 as compared to the same period in the prior year.
Revenue trends
Comparable private pay schools net revenue increased 4.2% for the thirteen weeks ended September 30, 2006 over the thirteen weeks ended October 1, 2005. Revenue increases were due primarily to average tuition increases of approximately 3.5% to 4.0% along with an increase in average enrollments for the back to school period which impacts the latter part of the quarter.
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
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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 September 30, 2006 personnel cost increased $2,008,000 or 11.1% versus the thirteen weeks ended October 1, 2005. This increase was primarily driven by increases in total wages, payroll tax, and vacation. Personnel cost increased to 49.9% of revenue for the thirteen weeks ended September 30, 2006 from 48.3% of revenue for the thirteen weeks ended October 1, 2005. Personnel cost increased as a percent of revenue as previously vacant school positions were filled and other positions were added or upgraded at a faster pace than revenue has grown. This trend may continue in the near term as we continue to add personnel in key positions and upgrade our school teams. Although we believe this trend will continue in the short term, we anticipate stronger revenue growth in the future that will ultimately result in leveraging our payroll expense.
School operating costs
School operating costs primarily include maintenance, janitorial, 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 September 30, 2006, school operating costs increased $572,000 or 9.2% versus the thirteen weeks ended October 1, 2005. School operating costs increased to 16.8% of revenue for the thirteen weeks ended September 30, 2006 from 16.5% of revenue for the thirteen weeks ended October 1, 2005.
Expense increases primarily consisted of increases in bad debt of $207,000, janitorial and building maintenance of $91,000, office supplies of $79,000, food of $75,000, program of $72,000, and utilities of $62,000. The bad debt cost increase resulted primarily from more uniform application of collection and timing of billing processes in certain schools. Other school operating cost increases coincide with the addition of acquired and new schools in Fiscal 2006 and Fiscal 2007 which were not operating during the first quarter of Fiscal 2006.
Management will continue to focus its efforts on improved school operations and control. Management believes its new school operating system provides greater visibility to school billing, collection and expenditure activities. Bad debt expense for the quarter was $370,000. The worst 25 schools accounted for approximately 68% or $253,000 of total bad debt expense. Sixteen of these 25 schools have customers who receive socioeconomic based government funding. The demographic characteristics of these schools are also not closely aligned with the Company’s private pay school operating model and strategy and as such require more intensive management follow up to ensure all facets of the agency based relationship are tightly managed. As management increases its attention to the billing and collection practices in these schools we expect there to be a reduction in the dollar increases in the future, and lower expense should result as compared to prior periods.
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 September 30, 2006, rent and other increased $133,000 or 1.3% versus the thirteen weeks ended October 1, 2005. Rent and other decreased to 26.1% of revenue for the thirteen weeks ended September 30, 2006 from 27.7% of revenue for the thirteen weeks ended October 1, 2005.
Expense increases in occupancy of $389,000, corporate marketing of $86,000, and state and local taxes of $60,000, were partially offset by lower property damages of $218,000, regional marketing of $116,000, vehicle and equipment leases of $33,000, and school pre-opening costs of $32,000. 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 marketing increased from a shift in school based marketing previously carried in school operating expenses described above. Property damages decreased as there were no major hurricanes in the first quarter of Fiscal 2007, unlike the experience during the first quarter of Fiscal 2006 when a number of the Company’s facilities sustained damage from Hurricane Wilma. 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.
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Gross profit
Gross profit for the thirteen weeks ended September 30, 2006 increased $102,000 or 3.6% to $2,911,000 from $2,809,000 for the thirteen weeks ended October 1, 2005. Total gross profit was 7.2% of revenue for the thirteen weeks ended September 30, 2006 and 7.5% of revenue for the thirteen weeks ended October 1, 2005. The change in gross profit for the thirteen weeks ended September 30, 2006, as compared to the same period in the prior year, is as follows (dollars in thousands):
| Thirteen Weeks Ended | Increase | Percent Increase | |||||||||||||
| September 30, 2006 | October 1, 2005 | ||||||||||||||
Comparable Schools | $ | 2,732 | $ | 2,806 | $ | (74 | ) | (2.6 | )% | ||||||
Schools opened or acquired | 83 | (51 | ) | 134 | 262.7 | ||||||||||
Closed schools | (130 | ) | (192 | ) | 62 | 32.3 | |||||||||
Other, non-school | 226 | 246 | (20 | ) | (8.1 | ) | |||||||||
| $ | 2,911 | $ | 2,809 | $ | 102 | 3.6 | % | ||||||||
General and administrative expenses
General and administrative expenses for the thirteen weeks ended September 30, 2006 increased $164,000 to $3,686,000 from $3,522,000 for the thirteen weeks ended October 1, 2005.
Corporate personnel costs increased approximately $220,000 as a number of positions were filled that had been vacant in the first quarter of Fiscal 2006, including the addition of a Senior Vice President of Corporate Development. Increases in corporate personnel costs were partially offset by a decrease in consulting and contracting fees of approximately $187,000.
Corporate depreciation increased $146,000 as the Company invested in a number of information technology enhancements during Fiscal 2006. This includes the roll out of new information systems, which provides fully integrated general ledger and ERP capabilities.
Operating Loss
As a result of the factors mentioned above, operating loss increased $62,000 to $775,000 for the thirteen weeks ended September 30, 2006 from $713,000 for the thirteen weeks ended October 1, 2005.
Interest expense
As a result of lower average rates and outstanding borrowings. interest expense decreased $74,000 or 18.7% to $322,000 for the thirteen weeks ended September 30, 2006 from $396,000 for the thirteen weeks ended October 1, 2005.
Income tax benefit
Income tax benefit for the thirteen weeks ended September 30, 2006 was $375,000 as compared to $415,000 for the thirteen weeks ended October 1, 2005. The Company’s effective tax rate was 39.0% for the thirteen weeks ended September 30, 2006 and for the thirteen weeks ended October 1, 2005.
Discontinued operations
During the first quarter of Fiscal 2006, discontinued operations consisted of ten schools, seven subleased and three vacant.
During the first quarter of Fiscal 2007 discontinued operations consisted of seven schools, six of which are subleased, and one of which is vacant.
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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 | ||||||||
| September 30, 2006 | October 1, 2005 | |||||||
Cost of services | $ | 138 | $ | 108 | ||||
Loss from discontinued operations before income tax benefit | (138 | ) | (108 | ) | ||||
Income tax benefit | (54 | ) | (42 | ) | ||||
Loss from discontinued operations | $ | (84 | ) | $ | (66 | ) | ||
Net Loss
As a result of the above factors, the Company’s net loss was $670,000 for the thirteen weeks ended September 30, 2006 as compared to $713,000 for the thirteen weeks ended October 1, 2005.
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Liquidity and Capital Resources
Senior Debt
At September 30, 2006 the Company’s Credit Agreement with Harris Trust. in the amount of $25,000,000 provided 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 was scheduled to terminate on February 20, 2009. As of September 30, 2006 the Term Loan balance was $12,500,000 and the letters of credit outstanding were $1,699,000.
On October 30, 2006 the Company entered into an Amended and Restated Credit Agreement (“Agreement”) with BMO Capital Markets, an affiliate of Harris Trust. The new Agreement provides for a $50,000,000 Revolving Credit Commitment (“Revolver”). The Revolver replaces the prior $25,000,000 Term Loan and Revolving Credit Commitment facilities. On October 30, 2006 the Company retired its outstanding Term Loan in the amount of $12,500,000 and had $3,800,000 in Revolver borrowings outstanding under the new Agreement. Under terms of the Agreement, the Revolver may be used to fund permitted acquisitions (as defined), additional capital expenditures, and for general corporate purposes. Leverage driven matrix based Libor borrowings are lower by up to 75 basis points and bank base rate borrowings are lower by up to 50 basis points as compared to the prior facility. The new facility has a five year term expiring October 2011.
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, make capital expenditures and use proceeds from disposition of assets or equity related transactions. In addition, the Credit Agreement provides that the Company must meet or exceed amounts for defined EBITDA and fixed charges and must not exceed leverage ratios. At September 30, 2006, the Company would have been in compliance with all required covenants under the Agreement.
Cash Flow
The Company’s principal sources of liquidity are cash flow from operations, and amounts available under its Revolver. The Company evaluates opportunities from time to time to sell properties to third parties. 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 and acquisitions. At September 30, 2006 there was $12,500,000 outstanding under the Term Loan, this was retired as described above on October 30, 2006. On October 30, 2006, there was $3,800,000 outstanding under the Revolver and there was $1,699,000 outstanding for letters of credit. The total unused portion of the Revolver, after allowance for the letters of credit, at October 30, 2006 was $44,501,000. The Company’s loan covenants under its Agreement limit the amount of borrowings. At October 30, 2006 the available borrowings under the Revolver, after allowance for the letters of credit was $36,600,000.
Total cash and cash equivalents decreased by $2,726,000 to $7,111,000 at September 30, 2006 from $9,837,000 at July 1, 2006. The decrease is primarily related to $3,536,000 in capital expenditures, $204,000 in purchases of intangible assets, and $655,000 in repayments on senior debt and payment of cash dividends, and was offset by cash provided by operations of $1,669,000. See additional discussion in the capital expenditures section below.
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 as of October 31, 2006 are as follows: (dollars in thousands)
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| Total | Thirty Five Weeks June 30, 2007 | ||||||||||||||||||||
| For Fiscal Year | |||||||||||||||||||||
| 2008 | 2009 | 2010 | 2011 | Thereafter | |||||||||||||||||
Long term debt obligations (1) | $ | 5,463 | $ | 222 | $ | 333 | $ | 333 | $ | 333 | $ | 333 | $ | 3,909 | |||||||
Letters of credit | 1,699 | 1,699 | — | — | — | — | — | ||||||||||||||
Operating leases | 212,134 | 23,337 | 29,439 | 26,938 | 25,162 | 22,539 | 84,719 | ||||||||||||||
Non-competes and consulting contracts | 501 | 199 | 302 | — | — | — | |||||||||||||||
Total | $ | 219,797 | $ | 25,457 | $ | 30,074 | $ | 27,271 | $ | 25,495 | $ | 22,872 | $ | 88,628 | |||||||
| (1) | The long-term debt consists of $3.8 million (principal value), which bears interest at bank base rate plus a defined EBIDA dependent rate. Amounts above include contractual interest using applicable rates as of October 31, 2006. |
The operating lease commitments reflected above do not reflect sublease amounts due to the Company of $5,232,000. 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.
During Fiscal 2006, the Company received notice under a previously subleased property that the existing sub-lessee exited the sublease two years prior to its contract termination. The annual base rents under this sublease are currently $835,000 and the lease term is through May 2015. The company believes the former sub-lessee remains obligated under the terms of the sublease, however the sub-lessee is no longer performing under the sublease. The Company has recorded a lease reserve in the amount of $835,000 in connection with this situation; the amount reserved is based on the assumption that another tenant sublessee will be located within the next year. In addition to the amount reserved, the Company continues to bear customary triple-net lease obligations related to this location. The Company intends to take all appropriate actions to protect its interest under the sublease, however until agreement can be reached either through negotiation or the courts the company is obligated to continue landlord rent payments. The Company has continued to explore alternatives to sublease the location in order to mitigate the potential loss resulting from the attempt of the previous sub-lessee to vacate the location prior to the end of their contract term. To the extent the Company is not successful in mitigating its obligations under the lease it will incur additional expense to its statement of operations.
Capital Expenditures
Capital expenditures for new school development include school equipment, furniture and fixtures, and curricula purchased by the Company for the operations of the school. Funding of capital expenditures for these schools is expected to be provided by cash from operations or funds available under the Company’s Credit Agreement. Renovations and equipment purchases are expenditures incurred for existing schools in order to maintain the operations and, where necessary, upgrade the school facility.
During the first quarter of Fiscal 2007, the Company placed one new school in operation. the new school which opened in the first quarter of Fiscal 2007, was financed by a developer and leased to the Company. Two additional schools are anticipated to be opened during Fiscal 2007.
Capital expenditures were significantly higher in the first quarter of Fiscal 2007 as the Company’s worked to ready schools for the critical back to school period. This amount of first quarter capital expenditures is more seasonally appropriate and should not be annualized to infer a significantly increased amount of spending for fiscal 2007. Other than the opening of new schools or significant renovations capital expenditure levels are expected to remain within prior year spending levels for routine location refurbishment requirements.
The Company’s current senior bank credit facility has annual limitations on the amount of capital expenditures. For Fiscal 2007, this limitation is $8,000,000. Capital expenditures for the thirteen weeks ended September 30, 2006 and October 1, 2005, respectively, are as follows (dollars in thousands):
| Thirteen Weeks Ended | ||||||
| September 30, 2006 | October 1, 2005 | |||||
New school development | $ | 563 | $ | 145 | ||
Renovations and equipment purchases | 2,597 | 754 | ||||
Corporate and information systems | 376 | 184 | ||||
Total capital expenditures | $ | 3,536 | $ | 1,083 | ||
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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 Company’s consolidated financial statements.
The Company’s significant accounting policies are described in note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for Fiscal 2006. The following accounting policies are considered critical to the preparation of the Company’s consolidated financial statements due to the estimation processes and business judgment involved in their application.
Revenue Recognition
The recognition of net revenues meets the following criteria: the existence of an arrangement through an enrollment agreement or contract, the rendering of educational services, a specific tuition rate and/or fee and probable collection. Net revenues include tuition, fees and other income, reduced by discounts. Fees are received for registration, other educational services and charter school management fees. Other income is primarily comprised of supplemental fees from summer programs, camps, and field trips. 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 deferred revenue. The Company does not receive payments for services that extend beyond the current operating cycle. 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.
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 grant 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. The Company’s schools are located in 13 states and as a result, the Company is not dependent on economic conditions in one demographic area or market.
Long-lived and Intangible Assets
Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment 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.
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Goodwill
The Company estimates fair values for each reporting unit using discounted cash flow projections in evaluating and measuring a potential impairment charge on an annual basis in the fourth quarter of each fiscal year. The Company engages an independent third party consultant to review its calculations required by SFAS No. 142, “Goodwill and Other Intangible Assets” and if necessary the level two analysis in order to determine the amount of goodwill impaired. Any impairment of goodwill resulting from the required testing by SFAS 142 is recorded as a component of income from operations.
For Fiscal 2006, the Company performed its annual impairment test as required by SFAS 142. The level one impairment test for Fiscal 2006 indicated that no impairment existed for the Company’s reporting units, as such the Company did not record goodwill impairment for Fiscal 2006; however, there can be no assurance that such a charge will not be recorded in 2007 or future periods.
Long Term Note Receivable
The Company has a $2,500,000 subordinated note receivable pursuant to a Credit Agreement entered into in Fiscal 2000 with Total Education Solutions, Inc. (“TES”). The TES note receivable was due May 2005 and $2,250,000 of the note receivable can be converted into 30% ownership of TES. During Fiscal 2003, the Company reserved $1,000,000 of the note receivable with TES. Due to continued performance deterioration during the second quarter of Fiscal 2005, the Company reserved the remainder of the TES note of $1,500,000. TES also has senior debt in the amount of $1,000,000. Subsequently, TES advised that it was in default under the terms of its senior debt.
During the first quarter of Fiscal 2007, the Company acquired the $1,000,000 TES senior debt from its senior lender for $200,000 in order among other things, to give the Company a first security position in the TES debt. TES has advised that they are seeking to recapitalize its business; the outcome of this effort is uncertain at this time.
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 attribution of income.
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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 form of interest rates.
Interest Rates
The Company’s exposure to market risk for changes in interest rates relates primarily to debt obligations. The Company also had cash flow exposure on certain notes payable and other subordinate debt agreements aggregating $112,000 and $180,000 at September 30, 2006 and July 1, 2006, respectively. However, the Company does have cash flow exposure on its Credit Agreement. The Revolving Credit Agreement and the Term Loan were 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 $32,000 and $37,000 for the thirteen weeks ended September 30, 2006 and October 1, 2005, respectively.
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 September 30, 2006. 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.
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Other Information
There have been no material changes to the risk factors faced by the Company since July 1, 2006.
| 10.1 | Amended and Restated Credit Agreement, dated as of October 30, 2006 among Registrant, certain of its subsidiaries as Guarantors, and BMO Capital Markets, a subsidiary of Harris N.A. as administrative agent. (Filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K, filed on November 3, 2006, and incorporated herein by reference.) | |
| 10.2 | Amended and restated Security Agreement dated as of October 30, 2006. (Filed as Exhibit 10.2 to the Registrant’s Current Report on From 8-K, filed on November 3, 2006 and incorporated herein by reference.) | |
| 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.) | |
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Table of Contents
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 13, 2006 | By: | /s/ Thomas Frank | ||
| Thomas Frank | ||||
| Chief Financial Officer | ||||
(duly authorized officer and | ||||
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