Nobel Learning Communities (NLCI) 10-Q 2010 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 2, 2010

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨

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 5, 2010 was 10,567,601.

INDEX TO FORM 10-Q

Nobel Learning Communities, Inc.

		Page Number
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements		1
	Consolidated Balance Sheets as of October 2, 2010 (Unaudited) and July 3, 2010		2
	Consolidated Statements of Operations (Unaudited) for the thirteen weeks ended October 2, 2010 and September 26, 2009		3
	Consolidated Statement of Changes in Stockholders’ Equity for the thirteen weeks ended October 2, 2010 (Unaudited)		4
	Consolidated Statements of Cash Flows (Unaudited) for the thirteen weeks ended October 2, 2010 and September 26, 2009		5
	Notes to Consolidated Interim Financial Statements (Unaudited)		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		30
Item 4.	Controls and Procedures		31
PART II. OTHER INFORMATION
Item 1A.	Risk Factors		31
Item 6.	Exhibits		32

i

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 Part I, Item 2; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A “Risk Factors” of this Quarterly Report on this Form 10-Q and under Part I, Item IA “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2010. Potential risks and uncertainties include, among others, unemployment rates impacting our current or future enrollments; changes in general economic conditions; the implementation and results of our ongoing strategic initiatives; our ability to compete with new or existing competitors; dependence on senior management and other key personnel; the litigation with the Department of Justice relating to alleged violations of the American with Disabilities Act; and the high concentration of ownership of the Company’s stock among its four largest stockholders. The Company’s results may also be affected by general factors, which include amongst other items, political developments and policy, interest and inflation rates, accounting standards and requirements, 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)

	October 2, 2010			July 3, 2010
	(Unaudited)
ASSETS
Cash and cash equivalents	$	1,116		$	1,606
Customer accounts receivable, less allowance for doubtful accounts of $449 at October 2, 2010 and $464 at July 3, 2010		1,057			957
Note receivable, current portion		250			250
Deferred tax asset		234			749
Prepaid rent		3,411			3,425
Prepaid expenses and other current assets		6,591			2,746
Total Current Assets		12,659			9,733
Property and equipment, at cost		88,427			86,907
Accumulated depreciation and amortization		(58,886	)		(57,863	)
Property and equipment, net		29,541			29,044
Goodwill		83,275			83,275
Intangible assets, net		7,491			8,062
Note receivable		227			473
Deposits and other assets		4,186			3,809
Total Assets	$	137,379		$	134,396
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and other current liabilities	$	19,276		$	19,534
Income taxes payable		—			752
Current portion of lease obligations		185			226
Deferred revenue		22,402			15,756
Total Current Liabilities		41,863			36,268
Long-term obligations		20,900			21,500
Long-term portion of lease obligations		494			533
Deferred tax liability		2,031			2,060
Other long term liabilities		2,284			2,055
Total Liabilities		67,572			62,416
Commitments and Contingencies
Stockholders’ Equity:
Preferred stock, $0.001 par value per share; 10,000,000 shares authorized; 1,063,830 shares issued and outstanding		1			1
Common stock, $0.001 par value; 20,000,000 shares authorized; 10,567,601 and 10,550,701 shares issued and outstanding at October 2, 2010 and July 3, 2010, respectively		10			10
Additional paid-in capital		60,713			60,427
Retained earnings		9,150			11,601
Accumulated other comprehensive loss		(67	)		(59	)
Total Stockholders’ Equity		69,807			71,980
Total Liabilities and Stockholders’ Equity	$	137,379		$	134,396

The accompanying notes are an integral part of these consolidated financial statements.

2

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Operations

(Dollars and shares outstanding amounts in thousands; except per share data)

(Unaudited)

	For the Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Revenues	$	52,230		$	50,623
Personnel costs		26,388			25,036
School operating costs		8,413			7,801
Rent and other		15,021			14,642
Cost of services		49,822			47,479
Gross profit		2,408			3,144
General and administrative expenses		5,963			4,887
Operating loss		(3,555	)		(1,743	)
Interest expense		417			267
Other income		(5	)		(7	)
Loss from continuing operations before income taxes		(3,967	)		(2,003	)
Income tax benefit		(1,602	)		(771	)
Loss from continuing operations		(2,365	)		(1,232	)
Loss from discontinued operations, net of income taxes		(86	)		(200	)
Net loss	$	(2,451	)	$	(1,432	)
Basic and diluted loss per share:
Loss from continuing operations	$	(0.22	)	$	(0.12	)
Loss from discontinued operations		(0.01	)		(0.02	)
Net loss per share	$	(0.23	)	$	(0.14	)
Weighted average basic and diluted common shares outstanding:		10,553			10,498

Net loss per share totals may not sum due to rounding.

The accompanying notes are an integral part of these consolidated financial statements.

3

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity

For the Thirteen Weeks Ended October 2, 2010

(Dollars in thousands except share data)

(Unaudited)

														Accumulated
									Additional					Other
	Preferred Stock				Common Stock				Paid-In		Retained			Comprehensive
	Shares		Amount		Shares		Amount		Capital		Earnings			(loss) income			Total
July 3, 2010		1,063,830	$	1		10,550,701	$	10	$	60,427	$	11,601		$	(59	)	$	71,980
Net loss		—		—		—		—		—		(2,451	)		—			(2,451	)
Change in fair value of swap contracts, net of tax		—		—		—		—		—		—			(8	)		(8	)
Total comprehensive loss																		(2,459	)
Stock option compensation		—		—		—		—		286		—			—			286
Issuance of restricted share awards		—		—		16,900		—		—		—			—			—
October 2, 2010		1,063,830	$	1		10,567,601	$	10	$	60,713	$	9,150		$	(67	)	$	69,807

The accompanying notes are an integral part of these consolidated financial statements.

4

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Cash Flows from Operating Activities:
Net loss	$	(2,451	)	$	(1,432	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		2,507			2,300
Reserve for lease costs for discontinued operations		77			94
Deferred taxes		487			351
Provision for losses on accounts receivable		183			141
Stock based compensation		286			305
Other		—			(12	)
Changes in Assets and Liabilities, net of business combinations:
Customer accounts receivable		(283	)		(405	)
Prepaid expenses and other current assets		(3,832	)		(2,262	)
Other assets and liabilities		(157	)		(193	)
Deferred revenue		6,646			2,877
Accounts payable and other current liabilities		(1,402	)		(4,766	)
Net Cash Provided by (Used in) Operating Activities		2,061			(3,002	)
Cash Flows from Investing Activities:
Purchases of fixed assets, net of acquired amounts		(2,201	)		(1,684	)
School acquisitions		—			(11,983	)
Proceeds from payment of note receivable		250			500
Net Cash Used in Investing Activities		(1,951	)		(13,167	)
Cash Flows from Financing Activities:
Borrowings of long term debt		12,975			37,650
Repayment of long term debt		(13,575	)		(19,550	)
Proceeds from exercise of stock options		—			9
Tax benefits from exercise of stock options and issuance of stock awards		—			1
Net Cash (Used in) Provided by Financing Activities		(600	)		18,110
Net (decrease) increase in cash and cash equivalents		(490	)		1,941
Cash and cash equivalents at beginning of period		1,606			786
Cash and cash equivalents at end of period	$	1,116		$	2,727
Supplemental disclosure of cash flow information:
Interest paid	$	162		$	179
Income taxes paid, net	$	820		$	237

The accompanying notes are an integral part of these consolidated financial statements.

5

NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES

Notes to Consolidated Interim Financial Statements

for the Thirteen Weeks Ended October 2, 2010

(Unaudited)

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

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 2, 2010 and results of operations for the thirteen weeks ended October 2, 2010 and September 26, 2009, 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 3, 2010.

Due to the inherently seasonal nature of the education and preschool 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.

References to Fiscal 2011 refer to the 52 weeks ending July 2, 2011. References to Fiscal 2010 refer to the 53 weeks ended July 3, 2010. The first quarters of Fiscal 2011 and Fiscal 2010 are each comprised of thirteen weeks.

The Company has reclassified certain previously reported amounts to conform to the current period’s presentation.

The Company’s critical accounting policies are unchanged from those described in the Company’s Annual Report on Form 10-K for Fiscal 2010 for the fiscal year ended July 2, 2010.

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different conditions or if assumptions change. The most significant estimates underlying the accompanying consolidated financial statements include long-lived assets and goodwill valuations and any potential impairment, the allowance for doubtful accounts, the valuation of stock compensation expense and estimates of future obligations related to closed facilities, valuations of liabilities for workers’ compensation claim liabilities retained by the Company and realization of our deferred tax assets.

New Accounting Pronouncements:

In July 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that will require companies to provide more information about the credit quality of their financing receivables in the disclosures to financial statements including, but not limited to, significant purchases and sales of financing receivables, aging information and credit quality indicators. The guidance is effective for the Company as of December 15, 2010. The Company does not anticipate that adoption will have a significant effect on its consolidated financial statements.

In January 2010, the FASB issued guidance that requires new disclosures and clarifies some existing disclosure requirements about fair value measurements. The new pronouncement requires a reporting entity: (1) to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and (2) to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs. In addition, it clarifies the requirements of the following existing disclosures: (1) for purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities, and (2) a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll-forward of activity in Level 3 fair value measurements, which became effective for the Company in Fiscal 2011. Adoption requires additional disclosure to delineate such categories in the notes to the Company’s consolidated financial statements (see Note 8).

6

In October 2009, the FASB issued new guidance regarding multiple deliverable revenue arrangements. The new guidance revises certain accounting for revenue arrangements with multiple deliverables. In particular when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, the new guidance allows use of a best estimate of the selling price to allocate the arrangement consideration among them. The new guidance is effective for Fiscal 2011. We do not expect that the adoption of this new guidance will have a material impact on our financial position, results of operations or cash flows.

Note 2. Earnings Per Share

Earnings per share is based on the weighted average number of shares and common stock equivalents outstanding during the period. In the calculation of basic earnings per share, weighted average number of shares outstanding is used as the denominator. In the calculation of diluted earnings per share, shares outstanding are adjusted to assume the exercise of options if such shares are dilutive. The Company was in a loss position for the thirteen weeks ended October 2, 2010 and September 26, 2009. The common stock equivalents of stock options during the thirteen weeks ended October 2, 2010 and September 26, 2009 were not included in the computation of diluted earnings per share as they were anti-dilutive. Earnings per share is computed as follows (dollars and average common stock outstanding in thousands):

	For the Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Basic loss per share:
Net loss	$	(2,451	)	$	(1,432	)
Weighted average common shares outstanding		10,553			10,498
Basic loss per share	$	(0.23	)	$	(0.14	)

The Company excluded 1,574,000 and 1,330,000 potentially dilutive common shares (stock options) from the computation of diluted net loss per share for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively, as their effect would have been anti-dilutive given the net loss incurred in these periods.

Note 3. Acquisitions:

During the first quarter of Fiscal 2010, the Company completed two acquisitions. Both acquisitions are consistent with the Company’s growth strategy in the private pay education market and provide an expansion within an existing market and the expansion of the Company’s learning platform. The acquisitions are summarized as follows:

• During the first quarter of Fiscal 2010, the Company completed the acquisition of all of the stock of Laurel Springs School (“LSS”) and substantially all of the assets of The Learning Springs (“TLS”), both based in Ojai, California. LSS is an online and distance learning school (www.laurelsprings.com). Laurel Springs’ educational program spans the entire K-12 market and has a fully accredited curriculum that includes Honors AP Courses, a Gifted and Talented program, a chapter of the National Honors Society and a strong college preparatory program. Laurel Springs’ student body and alumni includes elite athletes, entertainers, and home schooled students and concurrent students from all 50 states and from numerous foreign countries. Laurel Springs extends the Company’s educational programs through high school and provides a fully integrated K-12 platform.

• During the first quarter of Fiscal 2010 the Company completed the acquisition of all of the stock of Gifted Child Studies, Inc. (“GCS”). GCS added one elementary school to the Company’s existing market coverage in the San Diego, California market.

A summary of the purchase price and the allocation of estimated fair value of the net assets and liabilities acquired or assumed, are presented below (dollars in thousands):

								Acquired Intangible Assets at Fair Value
Acquired Entity	Net cash paid  at acquisition		Net non-cash working  capital assets/ (liabilities) included in purchase  price			Goodwill		Trade Name		Amortizable Asset Life (years)		Student Roster		Amortizable Asset Life (years)		Restrictive Covenants		Amortizable Asset Life (years)		Other Long-Term Assets (Liabilities) at Fair Value			Total purchase price of acquisition
Fiscal 2010 Acquisitions
Laurel Springs School	$	10,444	$	(2,539	)	$	9,088	$	1,126		5	$	2,035		10	$	150		5	$	585		$	12,984
Gifted Child Studies, Inc.		1,539		(1,611	)		2,698		264		20		302		7		—		n/a		(115	)		3,149
Total Fiscal 2010 acquisitions	$	11,983	$	(4,150	)	$	11,786	$	1,390			$	2,337			$	150			$	470		$	16,133

Total acquisition costs recognized as general and administrative expense during the thirteen weeks ended September 26, 2009 were $128,000. Goodwill is not deductible for income tax purposes for either LSS or GCS.

7

The following unaudited pro forma results of operations assume that acquisitions were completed at the beginning of Fiscal 2010 (dollars in thousands, except per share data):

	Thirteen Weeks Ended
	October 2, 2010			September 26, 2010
Revenues	$	52,230		$	51,886
Net loss		(2,451	)		(1,866	)
Loss per share - basic	$	(0.23	)	$	(0.18	)

Note 4. Goodwill and Intangible Assets, Net

Intangible assets include a franchise agreement and identifiable intangibles from acquisitions. At October 2, 2010 and July 3, 2010, the Company’s goodwill and intangible assets were as follows (dollars in thousands):

			October 2, 2010						July 3, 2010
	Weighted Average Amortization Period (in months)		Gross Carrying Amount		Accumulated Amortization		Net Balance		Gross Carrying Amount		Accumulated Amortization		Net Balance
Goodwill		n.a.	$	83,275	$	—	$	83,275	$	83,275	$	—	$	83,275
Amortized intangible assets:
Franchise agreement		130	$	580	$	277	$	303	$	580	$	260	$	320
Trade names		194		4,317		849		3,468		4,317		743		3,574
Student rosters		80		8,485		4,876		3,609		8,485		4,436		4,049
Restrictive covenants				150		39		111		150		31		119
Total Intangible Assets			$	13,532	$	6,041	$	7,491	$	13,532	$	5,470	$	8,062

Amortization expense related to intangible assets was $571,000 and $495,000 for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively.

Note 5. Credit Agreement

The Company and its lenders entered into a credit agreement during Fiscal 2008 which has subsequently been amended (“2008 Amended Credit Agreement”). The 2008 Amended Credit Agreement provides for a $75,000,000 Revolving Credit Commitment with a $25,000,000 accordion feature permitting the Company to increase the size of the facility under its current terms and conditions. Under the terms of the 2008 Amended Credit Agreement, proceeds may be used to fund permitted acquisitions, capital expenditures and ongoing business operations.

As of October 2, 2010 and July 3, 2010, outstanding borrowings totaled $20,900,000 and $21,500,000, respectively and outstanding letters of credit as of October 2, 2010 and July 3, 2010 were $2,615,000.

The Company’s obligation under its 2008 Amended Credit Agreement bears interest, at the Company’s option, at either:

(1) a selected LIBOR rate plus a margin based on our debt to defined EBITDA leverage ratio; or

(2) a defined base rate plus a margin based on our debt to defined EBITDA leverage ratio.

8

The applicable margins may be adjusted quarterly based on the leverage ratio and adjusted periodically based on adjustments to the indexed LIBOR rate or defined base rate. The Company also pays a letter of credit fee based on the face amount of each letter of credit calculated at the margin applicable to loans under the 2008 Amended Credit Agreement bearing interest based on the selected LIBOR rate.

The ranges of margins applicable during the thirteen week periods ended October 2, 2010 and September 26, 2009 were as follows:

	Spreads added to LIBOR or Base Rates Thirteen weeks ended
	October 2, 2010	September 26, 2009
LIBOR rate plus debt to defined EBITDA-indexed rate	2.50% - 3.75%	1.15% - 2.40%
Base rate plus debt to defined EBITDA-indexed rate	1.50% - 2.75%	0.15% - 0.90%
Letter of Credit fees LIBOR plus defined EBITDA-indexed rate	2.50% - 3.75%	1.15% - 2.40%

As of October 2, 2010 and July 3, 2010, included in deposits and other assets on the Company’s balance sheet are deferred financing costs of $701,000 and $791,000, respectively. These costs are amortized to interest expense on a straight-line basis over the life of the underlying indebtedness. During the thirteen weeks ended October 2, 2010 and September 26, 2009, the Company recognized interest expense related to the amortization of financing costs of $77,000 and $51,000, respectively.

The 2008 Amended Credit Agreement contains customary covenants and provisions that restrict the Company’s ability to change its business, acquire businesses, declare or pay dividends, grant liens, incur additional indebtedness, make capital expenditures, govern the use of proceeds from disposition of assets or equity related transactions and requires repayment in certain change of control events. In addition, the 2008 Amended Credit Agreement provides that the Company must meet or exceed amounts for defined EBITDA and fixed charge coverage ratios and must not exceed certain leverage ratios. The Company’s loan covenants under the 2008 Amended Credit Agreement limit the amount of senior debt borrowings and acquisitions that are permitted. The Company’s obligations under the 2008 Amended Credit Agreement are collateralized in part by a pledge of the stock of the Company’s subsidiaries and liens on all real and personal property owned by the Company.

Note 6. Note Receivable

During the fourth quarter of Fiscal 2008, the Company settled a contract dispute with a former sub-lessee. The settlement included the issuance to the Company of a note to be paid to the Company over five years with a face amount of $1,250,000. Consistent with the terms of this agreement, as of October 2, 2010, $750,000 of the note has been collected. The Company has imputed an interest rate of 4.25% in determining the present value of this receivable and this rate is consistent with other published discounts for liabilities the payee has with other creditors. The accretion of the discount related to this note will be recognized as income from discontinued operations during the collection period of the note. At October 2, 2010 and July 3, 2010, the unaccreted discount related to this note was $20,000 and $27,000, respectively. During the thirteen weeks ended October 2, 2010 and September 26, 2009, $7,000 was recognized as income from discontinued operations.

Note 7. Derivative Financial Instruments and Comprehensive Income:

Interest Rate Swap Agreements

The Company uses derivative financial instruments to manage its exposure to fluctuations in interest rates. The instruments are subject to varying degrees of market risk, including rate and price fluctuations and elements of credit risk in the event the counterparty should default. Amounts received or paid with regard to derivative instruments as a part of designated transactions result in the reclassification of amounts previously recognized as other comprehensive income related to the forecasted transaction, which when realized, are netted in interest expense. Amounts reclassified into earnings as additional interest expense related to designated derivative instruments for the thirteen weeks ended October 2, 2010 and September 26, 2009 were $41,000 and $75,000, respectively.

At October 2, 2010 and July 3, 2010, the Company had the following interest rate swap contracts outstanding that were designated as cash flow hedges and were determined to be highly-effective:

Swap #	Notional Amount		Fixed Rate Payment Obligation			Counterparty payments index	Termination Date
1	$	3,000,000		1.15	%	LIBOR		February 27, 2012
2		5,000,000		1.48	%	LIBOR		March 26, 2012

In addition to the above interest rate swaps, during Fiscal 2010, the Company entered into a “blend and extend” transaction with its bank, whereby the original interest rate swap was terminated and replaced with a new interest rate swap with a termination date of May 28, 2012 and a rate of 1.86%. This swap is not fully effective and changes in value are recognized on the Company’s Consolidated Statements of Operations. As of October 2, 2010, the fair value of the new interest rate swap was a liability of $119,000.

9

The following tables present the fair value of the Company’s interest rate swaps as well as their classification on the balance sheet as of October 2, 2010 and on the consolidated statement for income of the period ended October 2, 2010 (dollars in thousands):

Fair Value of Interest Rate Swaps as of October 2, 2010
	Notional Amount		Balance Sheet Classification	Fair Value
Interest rate swap contracts designated as hedging instruments	$	8,000	Other long term liabilities	$	(112	)
			Accumulated other comprehensive loss		67
Interest rate swap contract not designated as hedging instruments		5,000	Other long term liabilities		(119	)
The Effect of Interest Rate Swaps on the Statement of Operatons for the Thirteen Weeks Ended October 2, 2010
	Notional Amount		Statement of Income Classification	Unrealized Loss
Interest rate swap not designated as a hedging instrument	$	5,000	Interest expense	$	16

If the Company were to settle the underlying LIBOR-based debt instruments, any unrealized gains or losses reported in Accumulated Other Comprehensive Income for cash flow hedges would be reclassified into earnings during the period in which the underlying instruments were settled. The Company does not anticipate any of these instruments to settle during the twelve months subsequent to October 2, 2010.

Note 8. Fair Value of Financial Instruments

The Company determines fair value based upon a hierarchy that defines three levels of inputs that may be used to measure fair value:

Level 1—Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.

Level 3—Unobservable inputs that reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.

The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter; and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be rare.

The fair value of short-term financial instruments such as cash, accounts receivable and accounts payable and accrued expenses approximates their carrying value on the consolidated balance sheets.

The carrying values for the Company’s long-term debt and note receivable approximate fair value based on current rates that management believes could be obtained for similar debt instrument and note.

The Company receives third-party valuations from financial institutions to assign values to derivative instruments. The Company assessed the institutions’ valuation techniques, noting that the specialists use industry recognized discounted cash flow models that utilize inputs which substantially fall within Level 2 of the fair value hierarchy. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of October 2, 2010 and July 3, 2010, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

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The following table presents information about the Company’s assets and liabilities (including derivatives that are presented net, see Note 7) measured at fair value on a recurring basis as of October 2, 2010 and July 3, 2010, aggregated by the level in the fair value hierarchy within which those instruments fall:

	Quoted Prices in Active Markets Level 1		Significant Other Observable Inputs Level 2			Significant Unobservable Inputs Level 3
Total derivatives, net liability at October 2, 2010	$	—	$	(231	)	$	—
Total derivatives, net liability at July 3, 2010	$	—	$	(189	)	$	—

Note 9. Advertising

General advertising costs, which include yellow pages and mass media advertising, consulting fees for the development and delivery of advertising and marketing strategies and internet based hosting and search engine fees are expensed as incurred. Media production costs, targeted mailings and other marketing collateral are expensed when distributed to schools or when specific marketing events take place. Advertising and marketing costs during the thirteen weeks ended October 2, 2010 and September 26, 2009 were $1,012,000 and $951,000, respectively. As of October 2, 2010 and July 3, 2010, prepaid advertising expense totaled $303,000 and $324,000, respectively.

Note 10. Cash

The Company has an agreement with its primary bank that allows the bank to act as the Company’s agent in making daily investments with available funds in excess of a selected minimum account balance. This investment amounted to approximately $72,000 and $450,000 at October 2, 2010 and July 3, 2010, respectively. The Company’s funds were invested in money market accounts, which periodically exceed federally insured limits.

Note 11. Lease Reserves

The Company records estimated costs for school closures at the cease-use date. The reserves for closed schools are recorded at their estimated fair value by discounting to present value the net of all future rent payments and known or estimated sublease rentals over the respective lease term for the closed schools. The leases on the closed schools expire through 2017. At October 2, 2010 and July 3, 2010 the lease reserve for closed schools was $679,000 and $759,000, respectively. The following table summarizes activity recorded to the lease reserves (dollars in thousands):

Lease reserve at July 3, 2010	$	759
Payments against reserve		(157	)
Adjustments to reserve		77
Lease reserve at October 2, 2010	$	679

The Company has made guarantees for eleven leases that were assigned to third parties. All of these leases will expire no later than April of 2013. The Company has assessed its exposure regarding the assignment of the Guaranteed Properties and has determined that the fair value of this exposure is de minimis and therefore has not recorded a liability for this contingency. The maximum potential undiscounted amount of future payments the Company could be required to pay under these guarantees as of October 2, 2010 is $1,471,000.

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Note 12. Discontinued Operations

The results of operations for schools that are no longer operating under the Company’s management have been reflected in the consolidated financial statements and notes as discontinued operations for all periods presented. The operating results for discontinued operations in the unaudited statements of operations for all periods presented, net of tax are as follows (dollars in thousands):

	For the Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Cost of services		(22	)		(60	)
Rent and other		(120	)		(265	)
Loss from discontinued operations before income tax benefit		(142	)		(325	)
Income tax benefit		56			125
Loss from discontinued operations	$	(86	)	$	(200	)

Note 13. Accounts Payable and Other Current Liabilities

Accounts payable and other current liabilities were as follows (dollars in thousands):

	October 2, 2010		July 3, 2010
Accounts payable	$	6,833	$	8,016
Accrued payroll and related items		6,043		4,560
Accrued property taxes		1,315		1,401
Accrued rent		1,928		1,844
Other accrued expenses		3,157		3,713
	$	19,276	$	19,534

Note 14. Stock Based Compensation

As of October 2, 2010, approximately 1,485,000 stock options were issued and outstanding and 88,000 shares of restricted stock had been granted. As of October 2, 2010, the total number of shares of common stock still available for issuance under the Company’s stock compensation plans was 204,000.

2004 Omnibus Incentive Equity Compensation Plan:

On October 6, 2004, the stockholders approved the 2004 Omnibus Incentive Equity Compensation Plan (the “Plan”). Under the Plan, new shares of 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 stock option grants to date under the Plan have been non-qualified stock options which vest over three years (except that stock 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). Stock option grants under the Plan have contractual terms between seven and ten years and Restricted Stock Awards (“RSAs”) issued under the Plan vest three years after the issuance date. Through October 2, 2010, 1,256,000 non-qualified stock options and 88,000 RSAs had been issued and are outstanding under the Plan.

2000 Stock Option Plan for Consultants:

In February 2000, the Company established the 2000 Stock Option Plan for Consultants. This plan reserved up to an aggregate of 200,000 shares of common stock of the Company for issuance in connection with non-qualified stock options for non-employee consultants. Through October 2, 2010, 11,000 non-qualified stock options have been issued and are outstanding under the 2000 Stock Option Plan for Consultants. Stock option grants under the 2000 Stock Option Plan for Consultants have a contractual term between seven and ten years.

1995 Stock Incentive Plan:

With the approval of the 2004 Omnibus Incentive Equity Compensation Plan, the 1995 Stock Incentive Plan was terminated and the remaining shares reserved for issuance thereunder of 719,000 were cancelled. At October 2, 2010, 218,000 non-qualified stock options have been issued and are outstanding under the 1995 Stock Incentive Plan. Stock option grants under the 1995 Stock Incentive Plan have a contractual term of ten years.

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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:

	Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Expected dividend yield		0.0	%		0.0	%
Expected stock price volatility		28.2	%		26.3	%
Risk-free interest rate		2.9	%		3.6	%
Weighted average expected life of options		6 years			6 years
Expected rate of forfeiture		2.6	%		5.1	%

Stock option awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. Stock-based compensation expense is included in general and administrative expense in the Consolidated Statements of Operations for the thirteen weeks ended October 2, 2010 and September 26, 2009 and was $286,000 and $305,000, respectively. As of October 2, 2010, there was $1,288,000 of total unrecognized stock-based compensation cost related to options granted under our plans that will be recognized over a weighted average period of 1.49 years. The Company expects to continue its historical practice of issuing stock options and RSAs, which will result in additional stock-based compensation in the future, although amounts may vary.

A summary of option activity under the Company’s stock option plans for the thirteen weeks ended October 2, 2010 is as follows:

				Outstanding					Exercisable
	Shares Available for Grant			Shares			Weighted Average Grant & Exercise Price		Shares		Weighted Average Grant & Exercise Price
Balance at July 3, 2010		404,000			1,302,000		$	10.27		915,000	$	9.25
Granted at market		(208,000	)		208,000			6.17		—		—
Cancelled		25,000			(25,000	)		9.89		—		—
Exercised		—			—			—		—		—
Balance at October 2, 2010, not including RSAs		221,000			1,485,000		$	9.70		1,093,000	$	9.96
RSAs Granted at market		(17,000	)		n.a.			n.a.		n.a.		n.a.
Balance at October 2, 2010, net of RSA grants		204,000			1,485,000		$	9.70		1,093,000	$	9.96

The aggregate intrinsic value for options outstanding and options exercisable at October 2, 2010, was approximately $475,000. The weighted average remaining contractual terms for options outstanding and options exercisable at October 2, 2010 were approximately 5.0 years and 4.5 years, respectively. The total fair value of options vested during the thirteen weeks ended October 2, 2010 was $787,000. The weighted average fair value of stock options granted during the thirteen weeks ended October 2, 2010 was $1.98. The total number of options not yet vested as of October 2, 2010 was 393,000 shares with a weighted average exercise price of $9.01.

Note 15. Employee Benefit Plans

The Company has a 401(k) Plan in which eligible employees may elect to enroll after six months of service on scheduled enrollment dates. The Company matches 25% of an employee’s contribution to the Plan, up to 6% of an employee’s salary. The Company’s matching contributions under the Plan were $87,000 and $100,000 for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively.

The Company has a deferred compensation plan that permits certain members of management and highly compensated employees to defer up to 100% of their compensation and for identified individuals to receive a contribution from the Company. The Company’s contributions are made at the discretion of the Compensation Committee of the Company’s Board of Directors and are subject to a five-year vesting period subsequent to the employee’s initial plan participation date. At October 2, 2010 and July 3, 2010 the Company has included $1,481,000 and $1,281,000 in “Other long term liabilities” to reflect its liability under the plan, respectively. As of October 2, 2010 and July 3, 2010, there was $176,000 and $174,000 of unvested Company contributions to the deferred compensation plan, respectively. During the thirteen weeks ended October 2, 2010 and September 26, 2009, the Company has recognized $156,000 and $61,000 of general and administrative expense reflecting the prorated vesting of employer contributions into the plan, respectively.

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The Company has established a rabbi trust fund to finance the obligations under the plan with Company owned whole life insurance contracts on certain individuals who are participants in the plan. At October 2, 2010 and July 3, 2010, there were two individuals, both employees of the Company. At October 2, 2010 and July 3, 2010, the total carrying value of the two policies was $13,400,000. The Company has included $1,622,000 and $1,238,000 in “Deposits and other assets” as of October 2, 2010 and July 3, 2010, respectively, which represents the cash surrender value of these policies.

Note 16. Segment Information:

The Company’s operations are organized into the following operating segments:

(1) “Private Pay Schools” includes a national network of nonsectarian private schools, including preschools, elementary schools, middle schools and specialty high schools in 15 states and the District of Columbia. “Other” includes corporate overhead expenses which primarily support the Private Pay Schools operations.

(2) The Laurel Springs School is a global K-12 online distance learning school headquartered in Ojai, California which includes students in all fifty United States and a number of other countries. The Laurel Springs School was acquired during September of Fiscal 2010.

	Thirteen Weeks Ended
	October 2, 2010									September 26, 2009
	Private Schools & Other			Laurel Springs School			Total			Private Schools & Other			Laurel Springs School		Total
Total revenue	$	50,760		$	1,470		$	52,230		$	50,008		$	615	$	50,623
Depreciation and amortization:
Continuing operations	$	2,236		$	271		$	2,507		$	2,276		$	13	$	2,289
Discontinued operations		—			—			—			11			—		11
Depreciation and amortization	$	2,236		$	271		$	2,507		$	2,287		$	13	$	2,300
Gross profit	$	1,653		$	755		$	2,408		$	2,922		$	222	$	3,144
Interest expense		417			—			417			267			—		267
Income tax (benefit) expense		(1,375	)		(227	)		(1,602	)		(810	)		39		(771	)
Net (loss) income		(2,103	)		(348	)		(2,451	)		(1,493	)		61		(1,432	)
Total additions to property, plant and equipment		2,148			53			2,201			1,664			20		1,684
Intangible assets, excluding goodwill		4,180			3,311			7,491			6,796			2,650		9,446
Goodwill		74,187			9,088			83,275			73,848			9,519		83,367
Total Assets	$	119,798		$	15,357		$	135,155		$	124,455		$	14,733	$	139,188

Note 17. Commitments and Contingencies

The United States Department of Justice (Disability Rights Section of the Civil Rights Division) filed a lawsuit on April 29, 2009 in the U.S. District Court for the Eastern District of Pennsylvania against the Company alleging that the Company violated Title III of the Americans with Disabilities Act of 1990 by excluding children with disabilities from its schools and programs. The complaint seeks an unspecified amount in compensatory damages and civil penalties, as well as declaratory and injunctive relief.

The Company is not able at this time to estimate the range of loss, if any, arising out of this matter since its outcome is uncertain. Although it does not expect that the resolution of the matter will have a material adverse effect on its financial condition, results of operations or cash flows, there can be no assurances in this regard.

The Company is engaged in other 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 statements, although 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 property, fire and other casualty insurance on its schools and general liability insurance in amounts which management believes are adequate. 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 coverage have insurance sublimits per claim in the general liability coverage.

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Note 18. Shareholder Rights Plan

During the first quarter of Fiscal 2009, the Company’s Board of Directors adopted a limited duration Shareholder Rights Plan designed to protect the Company’s shareholders in the event of an attempt to acquire control of the Company on terms which do not secure fair value for all of the Company’s shareholders. The Plan will expire, in accordance with its terms, on July 19, 2012, rather than the more common ten-year term. The four-year term was selected to provide the Company with an opportunity to maximize long-term shareholder value by enabling management of the Company to execute on its growth strategy, while protecting shareholders from a creeping acquisition or other tactics to gain control of the Company without offering all shareholders an adequate price. In addition, the Plan is not intended to prevent a takeover. Instead, it is intended to encourage anyone seeking to acquire the Company to negotiate with the Company’s Board of Directors prior to attempting a takeover in order to ensure that any takeover reflects an adequate price and that the interests of all of the Company’s shareholders and other constituencies are protected.

Terms of the Plan provide for a dividend distribution of one right (each a “Right” and, collectively, the “Rights”) for each share of common stock of the Company to holders of record at the close of business on July 31, 2008. The Rights will become exercisable only in the event that, with certain exceptions, an acquiring party accumulates 20% or more of the Company’s common stock then outstanding or, as of July 19, 2008, any existing holder of more than 20% of the Company’s common stock acquires any additional shares. Each Right will entitle the holder to buy one one-hundredth of a share of a new series of preferred stock at a price of $45.00. In addition, upon the occurrence of certain events, holders of the Rights will be entitled to purchase either the Company’s stock or shares in an “acquiring entity” at half the market value. The Company will generally be entitled to redeem the Rights at $0.01 per right at any time until the tenth day following the acquisition of 20% of its common stock, subject to extension by a majority of the Directors. The Rights will expire on July 19, 2012.

Note 19. Subsequent Events

The Company has evaluated subsequent events through the filing of this Form 10-Q and has determined that there have not been any other events that have occurred that would require adjustments to or additional disclosures in these interim unaudited consolidated financial statements.

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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 for the year ended July 3, 2010, filed with the SEC.

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 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 this Quarterly Report on Form 10-Q, the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2010, 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, but are not limited to:

• changing economic conditions including unemployment rates, as demand for the Company’s products and services are expected to lag the economic recovery;

• changing social and economic conditions and their impact on public school systems;

• the Company’s ability to hire and retain qualified executive directors, principals, teachers and teachers’ aides;

• the Company’s ability to retain key individuals in acquired schools and/or successfully grow and integrate acquired schools’ operations;

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

• impact of regulations related to federal healthcare legislation and increased employer costs of employee healthcare benefits and further employer subsidies;

• control of a majority of the outstanding common stock of the Company by a small number of shareholders;

• the effect of anti-takeover provisions in the Company’s certificate of incorporation, bylaws and Delaware law;

• the Company’s ability to renew existing location leases on terms acceptable to the Company;

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

• competitive conditions in the pre-school, elementary school, and secondary school education and services industry, such as the growth of competitors as possible alternatives to the public school system, including virtual charter schools, charter schools and magnet schools;

• government regulations affecting school operations, including square footage requirements per student and student/teacher ratios;

• impacts of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

• the Company’s ability to protect its intellectual property;

• if additional jurisdictions pass “living wage” laws, our operations in those jurisdictions could be negatively impacted;

• breaches in data security could adversely affect the Company’s financial condition and operating results;

• maintaining accreditation and certain course approvals in its schools and distance learning programs;

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

• the Company’s ability to maintain compliance with operational covenants as defined among the Company and its lenders;

• the impact of the litigation with the U.S. Department of Justice concerning alleged violation of the Americans with Disabilities Act of 1990 on our results of operations or cash flows in future periods; and

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• environmental or health-related events that could affect schools in areas impacted by such events.

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.

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 critical 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 2010. To date, there have been no changes to these accounting policies.

Interim Goodwill Impairment Analysis

The Company has considered whether a triggering event for potential testing of goodwill impairment may have occurred for the reporting period covered herein. One item of consideration and analysis is that the company’s market capitalization exceeded its book value as of this balance sheet date. Based on this and consideration of other facts and circumstances, the Company believes it has not had a triggering event for this period which would require interim goodwill impairment testing.

Overview

The Company operates a national network of over 180 nonsectarian private Preschool and K+ schools and a global K-12 distance learning and online school. The Company offers an array of ancillary educational services, including before and after school programs, the Camp Zone^® summer program and learning support programs. The Company is dedicated to providing a high quality private education through small class sizes, caring and skilled teachers, and attention to individual learning styles. The Company’s school facilities are located in fifteen different states and the District of Columbia.

During the first quarter of Fiscal 2010, the Company acquired Laurel Springs School, an online distance learning provider of K-12 education programs. The Laurel Springs School acquisition is intended to broaden the Company’s educational platform by addressing the K-12 distance learning market, including international opportunities.

During the current economic cycle, the Company has strategically reduced the number of new school openings to coincide with lower demand and the slowdown in housing starts.

The number of students enrolled in our schools and tuition rates are two factors, among several, that impact the Company’s revenue and gross profits. The unemployment rate is one variable that has a direct impact upon enrollments. If unemployment rates improve within the key age groups that represent the majority of our families, the Company believes this will result in increases in future enrollments, revenue and gross profit. Additionally, the Company has historically implemented tuition increases when appropriate and intends to continue this practice while considering trends in the costs to provide services and competitive factors.

Results from operations are measured each fiscal period by reporting and analyzing results at the Company level. Additionally, the Company seeks to measure revenue and profit growth in the following categories: (i) Comparable Schools, (ii) Core Schools, (iii) New Schools and (iv) Acquired Schools or businesses. Management seeks to balance growth in these categories in order to improve revenue and gross profit while adding to overall system capacity and total company performance. These four categories are measured individually and through several different metrics to help management better understand where growth is derived and manage the balance between growth, investment and profitability the Company seeks to achieve. It is important to note that the set of schools in each category may differ from reporting period to reporting period as schools may be opened, acquired, closed or become comparable at different times during the fiscal year. The four categories are more fully described below.

i. Comparable Schools – consists of an identical set of schools open for each of the entire periods being reported, sometimes referred to as “same schools.” By definition, Comparable Schools are always the same number of identical schools in each comparable period. Comparing results of the performance of these schools provides an “apples-to-apples” comparison of results between periods. Results are measured by revenue, operating expense and gross profit performance for this identical group of schools for the current period versus the prior period. Management seeks to grow revenue and increase gross margin in this category through annual tuition rate increases, enrollment growth and expense management.

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ii. Core Schools – consists of schools reported as Comparable Schools for each specific period presented. By definition, the population of Core Schools is schools open and comparable versus the prior period at a fixed point in time. We measure Core Schools’ performance as a percentage of revenue to develop period-over-period trends to understand the contribution provided by our efforts to grow the Core School base. When presenting Core School results there may be schools included within Core School results that were subsequently classified as discontinued operations.

iii. New Schools – consists of newly developed schools. By definition, the population of schools in each period should be different for each period as the Company continues to add schools.

New Schools are an integral part of the Company’s business development strategy and are defined as newly developed schools as compared to “Acquired Schools” which are discussed below. In planning New School development activity, management typically seeks to balance the pre-opening costs and start-up losses associated with the ramp up of new schools and achieving an appropriate growth and profitability balance for the Company as a whole.

New School revenue is expressed as a percentage of total operating revenue for each comparative period. This information is included in the revenue section below. We also measure New School gross profit, gross margin and expense items as a percentage of revenue to develop period-over-period trends to understand the contribution provided by our efforts from this activity when compared to the prior period. We seek to improve New School period-over-period performance by minimizing the impact of pre-opening and ramp up costs, as well as shortening the time it takes a new school to ramp up.

iv. Acquired Schools – consists of purchased schools previously operated by independent third parties.

Acquired Schools are an integral part of the Company’s business development strategy. Management seeks to acquire schools that expand or complement existing markets as well as schools that provide platforms for additional growth in new markets within our demographic parameters. Management seeks to add schools at a rate and in a manner that promotes the appropriate growth and profitability balance described above. While the Company has typically acquired schools that are already profitable, in some cases the Company acquires schools that are just beginning their ramp up periods, and as such may not yet be profitable. Acquired Schools’ revenue is expressed as a percentage of total operating revenue for each comparative period. This information is included in the revenue section below. We measure Acquired Schools’ gross profit, gross margin and expense items as a percentage of revenue to develop period-over-period trends to understand the contribution provided by our efforts from this activity when compared to the prior period.

Results for Comparable Schools for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively, are included in Revenue, Personnel Costs, School Operating Costs and Rent and Other section of the Results of Operations section below and results for Core Schools, Acquired Schools and New Schools are summarized in tables presented in the Gross Profit section of the Results of Operations section below.

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Results of Operations

At October 2, 2010 the Company operated 184 schools. During the thirteen weeks ending October 2, 2010, the Company did not open any new schools or acquire any schools. During the thirteen weeks ending September 26, 2009, the Company acquired one elementary school and opened three new preschools. Additionally, The Laurel Springs School (“LSS”) was acquired during the first quarter of Fiscal 2010. LSS delivers its curriculum on-line and a physical school location does not exist for its students. Therefore, LSS is not included in the school counts below for the thirteen weeks ended October 2, 2010, and September 26, 2009:

	Thirteen Weeks Ended
	October 2, 2010		September 26, 2009
Number of schools at the beginning of period		184		180
Acquisitions		—		1
Openings		—		3
Closings		—		—
Number of schools at the end of the period		184		184

The table below identifies schools and the periods they were acquired, opened or closed during Fiscal 2010 through October 2, 2010 (the acquisition of LSS is not included in these counts):

	Fiscal 2010									Fiscal 2011
	1st Quarter		2nd Quarter			3rd Quarter		4th Quarter		1st Quarter		Total
Acquired		1		—			—		—		—		1
Opened		3		—			1		—		—		4
Closed		—		(1	)		—		—		—		(1	)
		4		(1	)		1		—		—		4

The following table sets forth certain statement of operations data as a percentage of revenue for the thirteen weeks ended October 2, 2010, and September 26, 2009 (dollars in thousands):

	Thirteen						Thirteen
	Weeks Ended			Percent of			Weeks Ended			Percent of			Increase (decrease)
	October 2, 2010			Revenues			September 26, 2009			Revenues			Dollar			Percent
Revenues	$	52,230			100.0	%	$	50,623			100.0	%	$	1,607			3.2	%
Personnel costs		26,388			50.5			25,036			49.5			1,352			5.4
School operating costs		8,413			16.1			7,801			15.4			612			7.8
Rent and other		15,021			28.8			14,642			28.9			379			2.6
Cost of services		49,822			95.4			47,479			93.8			2,343			4.9
Gross profit		2,408			4.6			3,144			6.2			(736	)		(23.4	)
General and administrative expenses		5,963			11.4			4,887			9.7			1,076			22.0
Operating loss	$	(3,555	)		(6.8	)%	$	(1,743	)		(3.4	)%	$	(1,812	)		104.0	%

The table below shows the number of schools included in each of the four growth categories. Each category is discussed below for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively:

	Thirteen Weeks Ended
School Category	October 2, 2010		September 26, 2009
Comparable		179		179
Core schools		179		167
Acquired schools		1		7
New schools		4		10
Total		184		184

19

Revenue

Revenue for the thirteen weeks ended October 2, 2010 increased $1,607,000, or 3.2%, to $52,230,000 from $50,623,000 for the thirteen weeks ended September 26, 2009. The revenue increase for the thirteen week periods was comprised of the following (dollars in thousands):

	Thirteen weeks ended				Increase (decrease)
	October 2, 2010		September 26, 2009		Dollar			Percent
Total Company revenue	$	52,230	$	50,623	$	1,607			3.2	%
Comparable Schools	$	49,196	$	49,438	$	(242	)		(0.5	)%
Schools acquired, opened or closed after June 27, 2009:
Acquired		592		—		592			n.m.
New		935		238		697			292.9
Closed		—		167		(167	)		(100.0	)
LSS		1,470		615		855			139.0
Other		37		165		(128	)		(77.6	)
	$	52,230	$	50,623	$	1,607			3.2	%

Total Company revenue growth for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was primarily the result of the acquisitions of LSS and an elementary school, both of which occurred during September 2009, and the ramp-up of new schools opened during Fiscal 2009. The Company also opened three new preschools during the first quarter of Fiscal 2010 and another preschool during the third quarter of Fiscal 2010.

Revenue Trends

The revenue results of each of the school categories for the thirteen weeks ended October 2, 2010 (schools acquired, opened or closed subsequent to June 27, 2009) and the thirteen weeks ended September 26, 2009 (schools acquired, opened or closed subsequent to June 28, 2008) are as follows:

	Thirteen weeks ended October 2, 2010		Number of Schools		Percent of Revenue			Thirteen weeks ended September 26, 2009		Number of Schools		Percent of Revenue
Core Schools	$	49,196		179		94.2	%	$	46,781		167		92.4	%
Acquired Schools		592		1		1.1			2,279		10		4.5
New Schools		935		4		1.8			783		7		1.5
LSS		1,470				2.8			615				1.2
Other		37				0.1			165				0.3
	$	52,230				100.0	%	$	50,623				100.0	%

Acquired Schools’ revenue decreased as a percentage of total revenue to 1.1% for the thirteen weeks ended October 2, 2010, as compared to 4.5% for the thirteen weeks ended September 26, 2009. Acquired Schools for the thirteen weeks ended October 2, 2010 consisted of one elementary school, compared to six preschools and four elementary schools for the thirteen weeks ended September 26, 2009. New Schools’ revenue increased as a percentage of total revenue to 1.8% for the thirteen weeks ended October 2, 2010, as compared to 1.5% for the thirteen weeks ended September 26, 2009. This was reflective of the typical enrollment ramp-up period common to New Schools. New Schools included in the thirteen weeks ended October 2, 2010 were operated an average of 389 days with three of the four New Schools included in this period’s results operating for more than 400 days. New Schools included in the thirteen weeks ended September 26, 2009 were operated an average of 208 days with two of the seven New Schools included in this period’s results operating for more than 270 days and two of the seven operating more than 300 days.

LSS revenue increased as a percentage of total revenue to 2.8% for the thirteen weeks ended October 2, 2010, as compared to 1.2% for the thirteen weeks ended September 26, 2009. LSS results during the thirteen weeks ended September 26, 2009 were not reflective of an entire fiscal quarter, as LSS was acquired during September of 2009.

20

Enrollment trends

The Company estimates Comparable School enrollment trends based on the relationship of average tuition rate increases to Comparable School revenue performance. As an example, a 3% increase in Comparable School revenue could result from a 2% tuition increase and a 1% Comparable School enrollment increase. Tuition rate and implied enrollment decreases for each thirteen week period during Fiscal 2011 and Fiscal 2010 as compared to the same thirteen week periods during Fiscal 2010 and Fiscal 2009 were as follows:

	Comparable School increase (decrease)
Thirteen Weeks Ended	Revenue			Tuition Rate			Enrollment
September 26, 2009 compared to September 27, 2008		(5.8	)%		4.5	%		(10.3	)%
December 26, 2009 compared to December 27, 2008		(4.8	)%		4.5	%		(9.3	)%
March 27, 2010 compared to March 28, 2009		(3.9	)%		3.0	%		(6.9	)%
June 26, 2010 compared to June 27, 2009(1)		(1.8	)%		3.0	%		(4.8	)%
October 2, 2010 compared to September 26, 2009		(0.5	)%		2.3	%		(2.8	)%

(1) The fourth quarter of Fiscal 2010 included fourteen weeks whereas the fourth quarter of Fiscal 2009 included thirteen weeks. The above reflects revenues during the first thirteen weeks of the fourth quarter of Fiscal 2010.

Personnel costs

Personnel costs primarily include teacher salaries, wages, payroll taxes, employee benefits and vacation costs. This category of costs is partially variable and primarily affected by wage rate changes, incentive compensation, health care benefit and participant rate increases, staffing ratio requirements and changes in enrollment. The 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, personnel costs tend to be higher as a percentage of revenue as a base level of personnel and associated costs are established in the early years of a school’s life. However, we expect to leverage these front-end investments as enrollments increase. Preschool staffing ratios are mandated by state requirements which can result in very low student to teacher ratios when class sizes are not optimal, especially in periods of declining enrollment.

Personnel costs for the thirteen weeks ended October 2, 2010 increased $1,352,000, or 5.4%, to $26,388,000 from $25,036,000 for the thirteen weeks ended September, 2009. The increase in personnel costs for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively, was comprised of the following (dollars in thousands):

	Thirteen weeks ended				Increase (decrease)
	October 2, 2010		September 26, 2009		Dollar			Percent
Total Company personnel costs	$	26,388	$	25,036	$	1,352			5.4	%
Comparable Schools	$	25,077	$	24,548	$	529			2.2	%
Schools acquired, opened or closed after June 27, 2009:
Acquired		375		—		375			n.m.
New		540		227		313			137.9
Closed		—		140		(140	)		(100.0	)
LSS		396		121		275			227.3
	$	26,388	$	25,036	$	1,352			5.4	%

21

The Company’s overall increase in personnel costs for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was primarily the result of the acquisitions of LSS and an elementary school, both of which occurred during September of 2009. In addition, comparable school payroll increased due to increases in staffing required for the opening of new classrooms. The Company also opened three new preschools during the first quarter of Fiscal 2010 and another preschool during the third quarter of Fiscal 2010.

Personnel costs increased to 50.5% of revenue for the thirteen weeks ended October 2, 2010 as compared to 49.5% for thirteen weeks ended September 26, 2009. This was comprised of the following:

	Personnel costs as a percentage of revenue
	Thirteen weeks ended
	October 2, 2010			September 26, 2009
Total Company		50.5	%		49.5	%
Comparable Schools		51.0	%		49.7	%
Schools acquired or opened subsequent to June 27, 2009 for Fiscal 2011 and June 28, 2008 for Fiscal 2010
Core Schools		51.0	%		49.3	%
Acquired Schools		63.3	%		56.1	%
New Schools		57.8	%		69.2	%

Increases in personnel costs as a percentage of revenue at Comparable Schools and Core Schools for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 are reflective of a combination of declining enrollments and some additional payroll spending in our schools for new classrooms. Wage rates were generally frozen during the second quarter of Fiscal 2009 and there have not been any Company-wide wage rate increases through October 2, 2010. However, the Company has increased wage rates in connection with promotions, for competitive reasons and with respect to new hires whose salaries may be higher than those of the employees they have replaced. In addition, preschool staffing ratios are mandated by state regulations and as such, some classes and schools are not able to reduce wage costs in line with lower or less than full enrollments and lower revenue. In addition, the Company opened some additional classrooms and added payroll to staff those rooms.

Acquired Schools’ personnel costs increased as a percentage of revenue to 63.3% for the thirteen weeks ended October 2, 2010, as compared to 56.1% for the thirteen weeks ended September 26, 2009. Acquired Schools for the thirteen weeks ended October 2, 2010 included one elementary school. Acquired Schools for the thirteen weeks ended September 26, 2009 included four preschools and three elementary schools.

New Schools’ personnel costs decreased as a percentage of revenue to 57.8% for the thirteen weeks ended October 2, 2010, as compared to 69.2% for the thirteen weeks ended September 26, 2009. This was reflective of the typical enrollment ramp-up period common to New Schools. New Schools included in the thirteen weeks ended October 2, 2010 were operated an average of 389 days with three of the four New Schools included in this period’s results operating for more than 400 days. New Schools included in the thirteen weeks ended September 26, 2009 were operated an average of 208 days with two of the seven New Schools included in this period’s results operating for more than 270 days and two of the seven operating more than 300 days.

School operating costs

School operating costs primarily include food, utilities, transportation, maintenance, janitorial, supplies, school level marketing spending and ancillary programs. This category is partially variable with increases driven by additional enrollment. In the case of New Schools, school operating costs tend to be higher as a percentage of revenue because a base level of costs are incurred in the early period of a school’s life and are expected to be leveraged as enrollments increase.

22

School operating costs for the thirteen weeks ended October 2, 2010 increased $612,000, or 7.8%, to $8,413,000 from $7,801,000 for the thirteen weeks ended September 26, 2009. The increase in school operating costs for the thirteen weeks was comprised of the following (dollars in thousands):

	Thirteen weeks ended				Increase (decrease)
	October 2, 2010		September 26, 2009		Dollar			Percent
Total Company operating costs	$	8,413	$	7,801	$	612			7.8	%
Comparable Schools	$	7,872	$	7,374	$	498			6.8	%
Schools acquired, opened or closed after June 27, 2009:
Acquired		111		—		111			n.m.
New		173		62		111			179.0
Closed		26		99		(73	)		(73.7	)
LSS & Other		231		266		(35	)		(13.2	)
	$	8,413	$	7,801	$	612			7.8	%

School operating costs for comparable schools for the thirteen weeks ended October 2, 2010 increased $498,000 as compared to the thirteen weeks ended September 26, 2009. This increase included increased food costs of $124,000, facility maintenance and repair costs of $109,000, teaching supplies of $119,000 and energy costs of $89,000.

The Company’s overall increase in school operating costs for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was also the result of the acquisitions of LSS and an elementary school, both of which occurred during September of 2009. The Company also opened three new preschools during the first quarter of Fiscal 2010 and another preschool during the third quarter of Fiscal 2010.

School operating costs increased to 16.1% of revenue for the thirteen weeks ended October 2, 2010 as compared to 15.4% for the thirteen weeks ended September 26, 2009. This was comprised of the following:

	School operating costs as a percentage of revenue
	Thirteen weeks ended
	October 2, 2010			September 26, 2009
Total Company		16.1	%		15.4	%
Comparable Schools		16.0	%		14.9	%
Schools acquired or opened subsequent to June 27, 2009 for Fiscal 2011 and June 28, 2008 for Fiscal 2010
Core Schools		16.0	%		14.8	%
Acquired Schools		18.8	%		17.6	%
New Schools		18.5	%		20.2	%

Comparable Schools’ operating costs as a percentage of revenue increased to 16.0% from 14.8% for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009. The increase was the result of higher food, facility, teaching supply and energy costs as described above.

Acquired Schools’ operating costs increased as a percentage of revenue to 18.8% for the thirteen weeks ended October 2, 2010, as compared to 17.6% for the thirteen weeks ended September 26, 2009. Acquired Schools for the thirteen weeks ended October 2, 2010 included one elementary school. Acquired Schools for the thirteen weeks ended September 26, 2009 included four preschools and three elementary schools.

New Schools’ operating costs decreased as a percentage of revenue to 18.5% for the thirteen weeks ended October 2, 2010, as compared to 20.2% for the thirteen weeks ended September 26, 2009. This was reflective of the typical enrollment ramp-up period common to New Schools. New Schools included in the thirteen weeks ended October 2, 2010 were operated an average of 389 days with three of the four New Schools included in this period’s results operating for more than 400 days. New Schools included in the thirteen weeks ended September 26, 2009 were operated an average of 208 days with two of the seven New Schools included in this period’s results operating for more than 270 days and two of the seven operating more than 300 days.

23

Rent and other

Rent and other costs primarily include property rent and property taxes, the portion of claims retained by the Company for workers’ compensation and property insurance, depreciation and amortization, regional and school marketing, vehicle and equipment rent, and pre-opening costs. Much of this category of costs is relatively fixed in nature with increases related to contractual obligations, changes in marketing initiatives and the addition of new or acquired schools. In the case of New Schools, rent and other costs tend to be higher as a percentage of revenue because these costs are incurred in the early period of a school’s life and are expected to be leveraged as enrollments increase.

Rent and other costs for the thirteen weeks ended October 2, 2010 increased $379,000, or 2.6%, to $15,021,000 from $14,642,000 for the thirteen weeks ended September 26, 2009. The increase in rent and other costs for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively, was comprised of the following (dollars in thousands):

	Thirteen weeks ended				Increase (decrease)
	October 2, 2010		September 26, 2009		Dollar			Percent
Total Company rent and other costs	$	15,021	$	14,642	$	379			2.6	%
Comparable Schools	$	13,985	$	14,006	$	(21	)		(0.1	)%
Schools acquired, opened or closed after June 27, 2009:
Acquired		181		—		181			n.m.
New		492		367		125			34.1
Closed		271		259		12			4.6
LSS		92		10		82			820.0
	$	15,021	$	14,642	$	379			2.6	%

The Company’s overall increase in rent and other costs for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was primarily the result of the acquisitions of LSS and an elementary school, both which occurred during September of 2009. The Company also opened three new preschools during the first quarter of Fiscal 2010 and another preschool during the third quarter of Fiscal 2010.

Rent and other costs slightly decreased to 28.8% of revenue for the thirteen weeks ended October 2, 2010 as compared to 28.9% for thirteen weeks ended September 26, 2009. This was comprised of the following:

	Rent and other costs as a percentage of revenue
	Thirteen weeks ended
	October 2, 2010			September 26, 2009
Total Company		28.8	%		28.9	%
Comparable Schools		28.4	%		28.3	%
Schools acquired or opened subsequent to June 27, 2009 for Fiscal 2011 and June 28, 2008 for Fiscal 2010
Core Schools		28.4	%		27.6	%
Acquired Schools		30.6	%		32.5	%
New Schools		52.6	%		97.1	%

Increases in rent and other costs as a percentage of revenue at Comparable Schools and Core Schools are reflective of overall contractual rent and property tax escalations at these schools coinciding with overall enrollment declines due in large part to current economic activity, including increased unemployment rates.

New Schools’ rent and other costs decreased as a percentage of revenue to 52.6% for the thirteen weeks ended October 2, 2010, as compared to 97.1% for the thirteen weeks ended September 26, 2009. This was reflective of the typical enrollment ramp-up period common to New Schools. New Schools included in the thirteen weeks ended October 2, 2010 were operated an average of 389 days with three of the four New Schools included in this period’s results operating for more than 400 days. New Schools included in the thirteen weeks ended September 26, 2009 were operated an average of 208 days with two of the seven New Schools included in this period’s results operating for more than 270 days and two of the seven operating more than 300 days.

24

Gross profit

As a result of the factors described above, gross profit for the thirteen weeks ended October 2, 2010 decreased $736,000, or 23.4%, to $2,408,000 from $3,144,000 for the thirteen weeks ended September 26, 2009.

The change in gross profit for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was as follows (dollars in thousands):

	Thirteen Weeks Ended October 2, 2010		Percent of Revenues			Thirteen Weeks  Ended September 26, 2009		Percent of Revenues
											Increase (decrease)
											Dollar			Percent
Revenues	$	52,230		100.0	%	$	50,623		100.0	%	$	1,607			3.2	%
Personnel costs		26,388		50.5			25,036		49.5			1,352			5.4
School operating costs		8,413		16.1			7,801		15.4			612			7.8
Rent and other		15,021		28.8			14,642		28.9			379			2.6
Cost of services		49,822		95.4			47,479		93.8			2,343			4.9
Gross profit	$	2,408		4.6	%	$	3,144		6.2	%	$	(736	)		(23.4	)%

The change in gross profit for Comparable Schools for the thirteen weeks ended October 2, 2010 as compared to the same period ended September 26, 2009 was as follows (dollars in thousands):

	Thirteen Weeks Ended October 2, 2010		Percent of Revenues			Thirteen Weeks Ended September 26, 2009		Percent of Revenues
											Increase (decrease)
											Dollar			Percent
Revenues	$	49,196		100.0	%	$	49,438		100.0	%	$	(242	)		(0.5	)%
Personnel costs		25,077		51.0			24,548		49.7			529			2.2
School operating costs		7,872		16.0			7,374		14.9			498			6.8
Rent and other		13,985		28.4			14,006		28.3			(21	)		(0.1	)
Cost of services		46,934		95.4			45,928		92.9			1,006			2.2
Gross profit	$	2,262		4.6	%	$	3,510		7.1	%	$	(1,248	)		(35.6	)%

25

The table below shows comparative information as a percentage of revenue for the thirteen weeks ended October 2, 2010 and September 26, 2009 for Core Schools, New Schools, Acquired Schools and Closed Schools (dollars in thousands):

	Thirteen weeks ended October 2, 2010			Percentage of Revenue			Thirteen weeks ended September 26, 2009			Percentage of Revenue			Increase (Decrease)			Percent Increase (Decrease)
Core Schools
Number of schools		179			—			167			—
Revenue	$	49,196			100.0	%	$	46,781			100.0	%	$	2,415			5.2	%
Personnel Cost		25,077			51.0			23,085			49.3			1,992			8.6
School Operating Cost		7,872			16.0			6,916			14.8			956			13.8
Rent and Other		13,985			28.4			12,932			27.6			1,053			8.1
Gross Profit	$	2,262			4.6	%	$	3,848			8.2	%	$	(1,586	)		(41.2	)%
Acquired Schools
Number of schools		1						10
Revenue	$	592			100.0	%	$	2,279			100.0	%	$	(1,687	)		(74.0	)%
Personnel Costs		375			63.3			1,278			56.1			(903	)		(70.7	)
School Operating Costs		111			18.8			402			17.6			(291	)		(72.4	)
Rent and Other		181			30.6			740			32.5			(559	)		(75.5	)
Gross Profit	$	(75	)		(12.7	)%	$	(141	)		(6.2	)%	$	66			(46.8	)%
New Schools
Number of schools		4						7
Revenue	$	935			100.0	%	$	783			100.0	%	$	152			19.4	%
Personnel Costs		540			57.8			542			69.2			(2	)		(0.4	)
School Operating Costs		173			18.5			158			20.2			15			9.5
Rent and Other		492			52.6			760			97.1			(268	)		(35.3	)
Gross Loss	$	(270	)		(28.9	)%	$	(677	)		(86.5	)%	$	407			(60.1	)%
Closed Schools
Number of schools		1						4
Revenue	$	—			n.m.		$	—			n. m.		$	—			—
Personnel Costs		—			n.m.			10			n.m.			(10	)		(100.0	)
School Operating Costs		26			n.m.			59			n.m.			(33	)		(55.9	)
Rent and Other		271			n.m.			200			n.m.			71			35.5
Gross Profit	$	(297	)		n.m.		$	(269	)		n.m.		$	(28	)		(10.4	)%
Laurel Springs School
Revenue	$	1,470			100.0	%	$	615			100.0	%	$	855			139.0	%
Personnel Costs		396			26.9			121			19.7			275			227.27
School Operating Costs		226			15.4			262			42.6			(36	)		(13.7	)
Rent and Other		92			6.3			10			1.6			82			n.m.
Gross Profit	$	756			51.4	%	$	222			36.1	%	$	534			240.5	%
Other
Revenue	$	37			100.0	%	$	165			100.0	%	$	(128	)		(77.6	)%
Personnel Costs		—			—			—			—			—			n.a.
School Operating Costs		5			13.5			4			2.4			1			25.0
Rent and Other		—			—			—			—			—			n.a.
Gross Profit	$	32			86.5	%	$	161			97.6	%	$	(129	)		(80.1	)%
Total
Revenue	$	52,230			100.0	%	$	50,623			100.0	%	$	1,607			3.2	%
Personnel Costs		26,388			50.5			25,036			49.5			1,352			5.4
School Operating Costs		8,413			16.1			7,801			15.4			612			7.8
Rent and Other		15,021			28.8			14,642			28.9			379			2.6
Gross Profit	$	2,408			4.6	%	$	3,144			6.2	%	$	(736	)		(23.4	)%

26

General and administrative expenses

For the thirteen weeks ended October 2, 2010, general and administrative expenses increased $1,076,000, or 22.0%, to $5,963,000 from $4,887,000 for the thirteen weeks ended September 26, 2009. This increase was primarily the result of $947,000 of increased expenses (excluding amortization expense), associated with the Laurel Springs School which was acquired during September of 2009. General and administrative expenses also included legal fees which were incurred in connection with the Company’s defense in regard to a lawsuit filed by the United States Department of Justice alleging the Company violated Title III of the Americans with Disabilities Act of 1990 of $275,000 and $158,000 during the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively.

Operating loss

As a result of the factors mentioned above, the Company’s operating loss increased $1,812,000 to $3,555,000 for the thirteen weeks ended October 2, 2010 from $1,743,000 of operating loss for the thirteen weeks ended September 26, 2009.

Interest expense

Interest expense for the thirteen weeks ended October 2, 2010 and September 26, 2009 was $417,000 and $267,000, respectively. During the thirteen weeks ended October 2, 2010, the Company had average daily debt outstanding of $22,300,000 as compared to average daily debt outstanding of $19,800,000 during the thirteen weeks ended September 26, 2009.

Other Income

Other income for the thirteen weeks ended October 2, 2010 decreased $2,000 to $5,000 for the thirteen weeks ended October 2, 2010 from income of $7,000 for the thirteen weeks ended September 26, 2009.

Income taxes

Income tax benefit for the thirteen weeks ended October 2, 2010 was $1,602,000 as compared to $771,000 for the thirteen week period ended September 26, 2009. The Company’s effective tax rate was 40.0% and 38.5% for the thirteen week periods ended October 2, 2010 and September 26, 2009, respectively.

Discontinued operations

The results of operations for schools that are no longer operating under the Company’s management have been reflected in the consolidated financial statements and notes as discontinued operations for all periods presented. The operating results for discontinued operations in the unaudited statements of operations for all periods presented, net of tax, and are as follows (dollars in thousands):

	For the Thirteen Weeks Ended
	October 2, 2010			September 26, 2009
Cost of services		(22	)		(60	)
Rent and other		(120	)		(265	)
Loss from discontinued operations before income tax benefit		(142	)		(325	)
Income tax benefit		56			125
Loss from discontinued operations	$	(86	)	$	(200	)

Net loss

As a result of the above factors, the Company’s net loss was $2,451,000 for the thirteen weeks ended October 2, 2010 as compared to $1,432,000 for the thirteen weeks ended September 26, 2009.

Liquidity and Capital Resources

Cash Flow

The Company’s principal sources of liquidity are cash flow from operations and amounts available under its revolving credit commitment under the 2008 Amended Credit Agreement. Principal uses of liquidity are to meet working capital needs, debt service, capital expenditures related to the renovation and maintenance of its existing schools, capital expenditures related to new school development, furniture, fixtures, technology, curriculum and acquisitions.

Under the 2008 Amended Credit Agreement, at October 2, 2010 and November 5, 2010, there was $20,900,000 and $22,575,000 of borrowings outstanding, respectively. In addition, there was $2,615,000 outstanding for letters of credit at October 2,

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2010 and November 10, 2010. The total unused and available portion of the 2008 Amended Credit Agreement, after allowance for the letters of credit, at October 2, 2010 was $51,485,000 and at November 5, 2010 was $49,810,000. The Company uses derivative financial instruments to manage its exposure to fluctuations in interest rates, at October 2, 2010 and November 10, 2020, the Company had interest rate swap contracts with notional amounts totaling $13,000,000.

Due to the inherent nature of the education and preschool business, cash flows during the thirteen week periods presented are not necessarily indicative of cash flow patterns of the remaining business cycle. During the first quarter of the fiscal year, operating income is typically lower than any other period during the year. Also, during this period, collection of registration fees and the pre-payment of tuition are at a peak.

Cash provided by operating activities for the thirteen weeks ended October 2, 2010 was $2,061,000 and cash used for operating activities for the thirteen weeks ended September 26, 2009 was $3,002,000. The $5,063,000 increase in the thirteen weeks ended October 2, 2010 as compared to same period ended September 26, 2009 was primarily due to an increase in deferred revenue of $3,769,000 and an increase in accounts payable and other accrued expenses of $3,364,000 partially offset by an increase of prepaid expenses and other current assets of $1,570,000 and a decrease in net income of $1,019,000.

Cash used in investing activities for the thirteen weeks ended October 2, 2010 and the same period ended September 26, 2009 was $1,951,000 and $13,167,000, respectively. During the first quarter of Fiscal 2010, the Company used $11,983,000 for the acquisition of one elementary school and an on-line distance learning school.

Cash used in financing activities during the thirteen weeks ended October 2, 2010 was $600,000 which consisted of the Company’s net pay-down of long-term debt. Cash provided by financing activities during the thirteen weeks ended September 26, 2009 was $18,110,000 which included net borrowings of $18,100,000, of which $11,983,000 was used to fund the acquisition of one elementary school and an on-line distance learning school.

As a result of the above cash flow activity, total cash and cash equivalents decreased by $490,000 from $1,606,000 at July 3, 2010 to $1,116,000 at October 2, 2010.

Revolving Credit Agreement

The Company and its lenders entered into a credit agreement during Fiscal 2008 which has subsequently been amended (“2008 Amended Credit Agreement”). The 2008 Amended Credit Agreement provides for a $75,000,000 Revolving Credit Commitment with a $25,000,000 accordion feature permitting the Company to increase the size of the facility under its current terms and conditions. Under the terms of the 2008 Amended Credit Agreement, proceeds may be used to fund permitted acquisitions, capital expenditures and ongoing business operations.

As of October 2, 2010 and July 3, 2010, outstanding borrowings totaled $20,900,000 and $21,500,000, respectively and outstanding letters of credit as of October 2, 2010 and July 3, 2010 were $2,615,000.

The Company’s obligation under its 2008 Amended Credit Agreement bears interest, at the Company’s option, at either:

(1) a selected LIBOR rate plus a margin based on our debt to defined EBITDA leverage ratio; or

(2) a defined base rate plus a margin based on our debt to defined EBITDA leverage ratio.

The applicable margins may be adjusted quarterly based on the leverage ratio and adjusted periodically based on adjustments to the indexed LIBOR rate or defined base rate. The Company also pays a letter of credit fee based on the face amount of each letter of credit calculated at the margin applicable to loans under the 2008 Amended Credit Agreement bearing interest based on the selected LIBOR rate.

The ranges of margins applicable during the thirteen week periods ended October 2, 2010 and September 26, 2009 were as follows:

	Spreads added to LIBOR or Base Rates Thirteen weeks ended
	October 2, 2010	September 26, 2009
LIBOR rate plus debt to defined EBITDA-indexed rate	2.50% - 3.75%	1.15% - 2.40%
Base rate plus debt to defined EBITDA-indexed rate	1.50% - 2.75%	0.15% - 0.90%
Letter of Credit fees LIBOR plus defined EBITDA-indexed rate	2.50% - 3.75%	1.15% - 2.40%

The 2008 Amended Credit Agreement contains customary covenants and provisions that restrict the Company’s ability to change its business, acquire businesses, declare or pay dividends, grant liens, incur additional indebtedness, make capital expenditures, govern the use of proceeds from disposition of assets or equity related transactions and requires repayment in certain change of control events. In addition, the 2008

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Amended Credit Agreement provides that the Company must meet or exceed amounts for defined EBITDA and fixed charge coverage ratios and must not exceed certain leverage ratios. The Company’s loan covenants under the 2008 Amended Credit Agreement limit the amount of senior debt borrowings and acquisitions that are permitted. The Company’s obligations under the 2008 Amended Credit Agreement are collateralized in part by a pledge of the stock of the Company’s subsidiaries and liens on all real and personal property owned by the Company.

The 2008 Amended Credit Agreement contains customary covenants and provisions that restrict the Company’s ability to change its business, acquire businesses, declare or pay dividends, grant liens, incur additional indebtedness, make capital expenditures, govern the use of proceeds from disposition of assets or equity related transactions and requires repayment in certain change of control events. In addition, the 2008 Amended Credit Agreement provides that the Company must meet or exceed amounts for defined EBITDA and fixed charge coverage ratios and must not exceed certain leverage ratios. The Company’s loan covenants under its 2008 Amended Credit Agreement limit the amount of senior debt borrowings and acquisitions that are permitted.

Long-Term Obligations and Commitments

The Company has certain contractual obligations and commercial commitments. 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. Commercial commitments represent potential obligations for performance in the event of demands by third parties. At October 2, 2010, letter of credit commitments totaled $2,615,000.

The Company’s most significant contractual obligations are real estate leases for its schools. Additionally, the Company has closed locations for which it continues to have cash obligations under lease agreements with third party landlords. The Company attempts to mitigate these cash payment obligations by subleasing the locations to third parties. The Company has cash risk for the future real estate leases for closed schools for which it does not have third party sublease coverage or where third party sublease coverage on any specific sublease may not equal the total cash obligation under the lease agreement for that property.

Future minimum lease obligations, by year and in the aggregate, for all real properties, vehicle and other leases that the Company and its subsidiaries have entered into, consisted of the following at October 2, 2010 (dollars in thousands):

					Fiscal
	Total		Thirty-nine weeks ending July 2, 2011		2012		2013		2014		2015		Thereafter
Long term debt obligations including contractual interest	$	23,715	$	919	$	919	$	21,877	$	—	$	—	$	—
Letters of credit		2,615		2,615		—		—		—		—		—
Operating leases		343,363		31,413		40,285		37,162		34,148		31,763		168,592
Total	$	369,693	$	34,947	$	41,204	$	59,039	$	34,148	$	31,763	$	168,592

Most of the above real estate leases are triple-net leases requiring the Company to pay all applicable real estate taxes, utility expenses, maintenance and insurance costs, that are not included in the amounts presented above. Most of the above operating leases are real estate leases that contain annual rent increase provisions based on changes in consumer price indexes or other formulas, which are not reflected in the above schedule.

At October 2, 2010, there were five leased properties included in discontinued operations. Three of these properties were sub-leased and two remained vacant. The obligations of the leases that are subject to a sublease are substantially covered by the subtenant. If the parties under these sublease agreements default, the Company has the obligation to pay rent under the terms of these leases. The operating lease commitments reflected are net of sublease amounts due to the Company of $6,165,000. Some of the closed location real estate lease obligations extend beyond the term of the current subleases on those properties. The leases on the closed schools expire between 2010 and 2017. The Company’s liability with respect to closed school lease commitments could change if sublessees default under their sublease with the Company or if the Company is 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 the respective property.

In addition to the lease obligations noted above, the Company has made guarantees for fourteen leases that were assigned to third parties. All of these leases will expire no later than April of 2013. The Company has assessed its exposure regarding the assignment of the Guaranteed Properties and has determined that the fair value of this exposure is de minimis and therefore has not recorded a liability for this contingency. The maximum potential undiscounted amount of future payments the Company could be required to pay under these guarantees as of October 2, 2010 is $1,471,000.

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Capital Expenditures

Company-funded capital expenditures for New School development includes school equipment, furniture, fixtures and curricula purchased by the Company for the operations of the New Schools. The funds used to open or acquire these schools were provided by cash flow from operations, the Company’s Revolving Credit Agreement or asset sales. Renovations and equipment purchases are capital expenditures incurred for existing schools in order to maintain the operations and, where necessary, upgrade the school facility and/or extend the service life of the school. The Company’s current senior bank credit facility has annual limitations on the amount of capital expenditures. This limitation is $15,000,000 for Fiscal 2011 and Fiscal 2010.

Capital expenditures for the thirteen weeks ended October 2, 2010 and September 26, 2009 were as follows (dollars in thousands):

	Thirteen weeks ended
	October 2, 2010		September 26, 2009
New school development	$	311	$	776
Facility Renovations		961		437
Curriculum		453		213
Corporate and information systems		475		258
	$	2,201	$	1,684

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.

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 has cash flow exposure as a result of the Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement and the 2008 Credit Agreement 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 $43,000 and $11,000 for the thirteen weeks ended October 2, 2010 and September 26, 2009, respectively.

Interest Rate Swap Agreements

The Company uses derivative financial instruments to manage its exposure to fluctuations in interest rates. The instruments are subject to varying degrees of market risk, including rate and price fluctuations and elements of credit risk in the event the counterparty should default. Amounts received or paid with regard to derivative instruments as a part of designated transactions result in the reclassification amounts previously recognized as other comprehensive income related to the forecasted transaction, which when realized, are netted in interest expense. Amounts reclassified into earnings related to designated derivative instruments for the thirteen weeks ended October 2, 2010 and September 26, 2009 were $41,000 and $75,000, respectively.

At October 2, 2010 and July 3, 2010, the Company had the following interest rate swap contracts outstanding that were designated as cash flow hedges and were determined to be highly-effective:

Swap #	Notional Amount		Fixed Rate Payment Obligation			Counterparty payments index	Termination Date
1	$	3,000,000		1.15	%	LIBOR		February 27, 2012
2		5,000,000		1.48	%	LIBOR		March 26, 2012

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In addition to the above interest rate swaps, during Fiscal 2010, the Company entered into a “blend and extend” transaction with its bank, whereby the original interest rate swap was terminated and replaced with a new interest rate swap with a termination date of May 28, 2012 and a rate of 1.86%. This swap is not fully effective and changes in value are recognized on the Company’s Consolidated Statement of Operations. As of October 2, 2010, the fair value of the new interest rate swap was a liability of $119,000.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management has evaluated, with the participation of its Chief Executive Officer and its Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of October 2, 2010. 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 Commission’s 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 the Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation, the Chief Executive Officer and the 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 period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II

Other Information

Item 1A. Risk Factors

There have been no material changes to the risk factors discussed in Part 1, “Item 1A. Risk Factors” of the Company’s Fiscal 2010 Annual Report on Form 10-K for the fiscal year ended July 3, 2010. The reader should carefully consider the risks described in the Company’s Form 10-K, which could materially affect the Company’s business, financial condition or future results. The risks described in the Company’s Form 10-K are not the Company’s only risks. Additional risks and uncertainties not currently known to the Company or that the Company currently deem to be immaterial also may materially adversely affect the Company’s business, financial condition, and/or operating results. If any of the risks actually occur, the business, financial condition, and /or results of operations could be negatively affected.

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Item 6. Exhibits

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.)

* Filed herewith

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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 10, 2010	By:	/S/    THOMAS FRANK
		Thomas Frank
		Chief Financial Officer
		(duly authorized officer and principal financial officer)

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