Item 1. Business
(a) General Development of Business.
Recent Events
On March 27, 1998, the Company entered into an Agreement and Plan of Merger (the "Agreement") with Knowledge Beginnings, Inc., a privately-owned education services company ("Parent") and its wholly-owned subsidiary, KBI Acquisition, Corp. ("Purchaser"). Under the Agreement, Purchaser will undertake a tender offer (supported by the Board of Directors) for all outstanding shares of CDC common stock at a net price of $12.25 per share in cash and, following consummation of the tender offer, will effect a merger with the Company (the "Merger"). Pursuant to the Merger, all outstanding shares of CDC common stock not acquired in the tender offer will be converted into the right to receive $12.25 per share in cash, and the Company will become a wholly-owned subsidiary of Parent. Holders of 1,363,700 shares of CDC common stock have simultaneously entered into a support agreement pursuant to which they have agreed to tender their shares and under certain circumstances sell their shares to Parent for $12.25 per share in cash. The Company has also granted Parent an option to purchase 1,342,155 previously unissued shares of CDC common stock (equal to 19.9% of the outstanding shares of the Company) under certain circumstances for $10.125 per share. The tender offer will be initiated upon certain filings by Purchaser and the Company. The completion of the tender offer is subject to certain conditions, including Purchaser's receipt of at least a majority of the outstanding shares calculated on a full-diluted basis and receipt of certain regulatory approvals. Consummation of the Merger is also subject to certain conditions including stockholder approval, if legally required.
Dr. Elanna S. Yalow, President and Chief Operating Officer, has entered into an employment agreement with Parent to become effective on a date selected by Parent (the "Effective Date") between the consummation of the tender offer and consummation of the Merger. Richard A. Niglio, Chief Executive Officer and Chairman of the Board, has entered into a two year consulting agreement with the Company to become effective on the Effective Date, at which time will resign as Chief Executive Officer and Chairman of the Board. Employment contracts between the Company and Randall J. Truelove, Vice President of Finance, Jane Delaney, Vice President, and Frank A. Devine, Secretary, will become effective on the Effective Date.
Also, subject to consummation of the Merger, the Company has accelerated the vesting of all outstanding stock options whether issued under Company plans or otherwise (see Note 9), and the Company will offer to redeem all such options, upon consummation of the Merger, for cash at a net price equal to $12.25 per share, less the underlying exercise price of the option, any withholding taxes due with respect to such redemption, and the balance of any loans then outstanding from the Company to the optionholder.
General
Children's Discovery Centers of America, Inc. and Subsidiaries ("the Company"), is a leading chain of preschools in the United States providing educational services for children of both preschool and elementary school age, operating as of December 31, 1997, 248 preschools in 22 states and the District of Columbia with an aggregate licensed capacity of approximately 25,000 children. The Company provides programs to children primarily between 2 1/2 and six years of age as well as after school programs for school age children and infant care. The Company's school age programs include private academic programs for children in kindergarten through eighth grade, before and after school programs and summer camps.
The Company's strategy is to grow through acquiring independent, community-based preschools and chains, to expand in the growing employer-sponsored preschool market and to increase programs and services in the growing school age market. In pursuit of this strategy, from the period from January 1, 1995 through December 31, 1997, the Company acquired or opened a total of 55 preschools (net of closings). As of December 31, 1997, 59 of the preschools operated by the Company are operated in conjunction with employer-sponsors, either on a management contract basis or with one or more types of employer subsidies, such as tuition subsidies, free or reduced rent or through the provision of services. Also, as of December 31, 1997, the Company operated 20 elementary schools in conjunction with its preschools, and also operated after school programs in nine academic private schools operated by others.
The Company's proprietary computerized system monitors the staff-to-child ratio in all of its preschools, enabling the Company to staff efficiently in response to shifts in occupancy levels. The Company believes its "Piaget Discovery Program" differentiates it from its competitors and appeals to both employer-sponsors and parents.
The Company's principal executive offices are located at 851 Irwin Street, Suite 200, San Rafael, California 94901, and its telephone number is (415) 257-4200.
Expansion Strategy
The Company is currently pursuing an expansion strategy to take advantage of (i) its experience in acquiring preschools, (ii) its success in adding corporate-sponsored on-site or near site preschools and (iii) significant growth opportunities in the private elementary school business.
Since the beginning of 1995, the Company has added 72 preschools, and closed 17 preschools. Of the preschools added, 16 were purchased in 1995 through the acquisition of the business conducted by Prodigy Consulting, Inc., and affiliated partnerships ("Prodigy"). The Company intends to continue to expand its preschool business by acquiring individual centers and small chains. In order to realize the benefits of consolidation, the Company generally seeks either to acquire preschools in areas close to the Company's existing preschools so that regional managers are able to supervise the newly-acquired preschools, or to acquire a chain which has a sufficient number of preschools to justify the employment of an additional regional manager. The Company generally seeks to acquire preschools in states with strict regulations in order to avoid unexpected expense and market disruption that may be caused by complying with new regulations adopted in states that previously lacked such regulations. The Company retains acquisition specialists who visit and analyze acquisition opportunities on a continuing basis.
The child care industry is highly fragmented, and a majority of existing licensed preschools are owned by small operators with limited resources. The Company believes that generally these small operators have limited opportunities to sell their preschools, which enhances the Company's ability to acquire these preschools on terms favorable to the Company. However, during 1995 and 1996 the Company experienced increased competition from a few larger child care chains for the acquisition of small child care operators. As a result, the Company has found that prices in some instances have exceeded the price the Company was willing to pay. These more competitive conditions contributed to a somewhat slower growth rate for acquisitions in 1996 and in 1997. The Company attempts to leverage its acquisitions by paying approximately one-third of the purchase price in cash and issuing long-term promissory notes for the remainder. Because many sellers own the preschool's real estate facility, the Company is often able to lease these facilities on a long-term basis through exercise of successive options, while avoiding fixed long-term obligations.
In evaluating acquisition candidates, the Company considers, among other things, the location of a preschool, the local regulatory environment, demographic trends, competition, quality of programs and management, the preschool's existing community image, adequacy of the facility and opportunities for increased utilization and low-cost expansion. In addition, the Company analyzes the financial aspects of an acquisition with respect to pricing policies, cost control and profit margins in order to identify areas for immediate and long-term improvement. The Company also seeks to increase the revenues, profitability and quality of preschools it acquires by instituting uniform financial and operation controls and by introducing new and improved curricula and other services. The Company believes that through this type of expansion it will achieve the operating efficiencies of a national chain, while offering parents a high quality of child care that reflects the character of each local community.
Employer Child Care Services
As of December 31, 1997, the Company operated 58 employer-sponsored preschools, of which 19 were operated for hospitals or other health care facilities, 21 for governmental units and 18 for private sector companies, including TRW Space and Electronics, Inc., and an affiliate of Southern New England Telecommunications Corp. Of the 58 employer-sponsored preschools, 17 are operated by the Company under management contracts pursuant to which the Company receives a fixed fee, and the balance are operated with one or more types of employer subsidies, generally in the form of tuition subsidies, free or reduced rent or through the provision of services. During 1995,,,, the Company acquired the business of Prodigy which managed, at the time of acquisition, nine employer-sponsored preschools.
In some cases, the Company has arrangements with employers who "reserve" a certain number of enrollment spaces in particular preschools for children of their employees and pay for such spaces whether or not they are utilized. The Company also has arrangements with a number of large national employers, including Bank of America, Sears and K-Mart to provide incentives for their employees to enroll their children in the Company's preschools. The Company intends to continue to pursue opportunities in the growing employer-sponsored preschool market.
Private Elementary Schools
During 1997, the Company substantially expanded the number of elementary school programs it operates. As of December 31, 1997, the Company operated 20 elementary school programs (compared to 14 as of December 31, 1996) and operated 135 kindergarten programs (compared to 111 as of December 31, 1996). The Company intends to expand its kindergarten and elementary programs primarily by adding new programs in its preschools and by adding additional grades to its elementary programs as the currently enrolled children are ready to advance to a new grade.
(b) Financial Information About Industry Segments.
The Company operates in one industry, providing child care and elementary school services under company-operated and employer-sponsored preschools.
(c) Narrative Description of Business.
Company Operations
Licensed capacity of the Company's individual preschools ranges from 30 to 380 children, although actual enrollments are generally higher because some children are enrolled on a part-time basis. The average percentage occupancy of the Company's preschools, measured by actual preschool revenues as a percentage of total revenue capacity of all Company centers (other than those operated for employer-sponsors pursuant to management contracts), was approximately 69% for the year ended December 31, 1997.
The Company's preschools contain classroom and recreational areas and kitchen and bathroom facilities. The preschools usually accommodate the grouping of children by age. The preschools have outdoor playgrounds, often with separate areas designed for infants and toddlers, with the exception of downtown urban centers that often utilize nearby parks. Each preschool is equipped with a variety of audio and visual aids, educational supplies, games, toys and indoor and outdoor play equipment. In addition, some of the preschools are equipped with personal computers with programs specifically designed for preschoolers and school-age children. A number of preschools are equipped with Company-owned or leased vehicles for the transportation of children to and from elementary school and for field trips.
Each preschool is administered by a director who is responsible for the operation and maintenance of the preschool. The duties of a preschool director include the staffing and training of qualified teachers and assistants, record keeping, regulatory compliance, tuition collection, parent relations, marketing and home office reporting. Directors are trained and supervised by regional managers, who generally supervise between eight and fourteen preschools in geographical areas sufficiently compact to permit the regional managers to personally visit the preschools under their supervision on a regular basis. Pre-school directors and regional managers receive incentive compensation, determined in part by the enrollment and/or profitability of their respective preschools.
Children are usually enrolled in the preschools on a weekly basis for either full-day or half-day sessions. Preschools provide enrolled children with snacks, and in some locations, meals. The Company's current weekly charge for full-day service ranges from $61.00 to $282.00 per child, depending on the location of a particular preschool and the age of the child. Charges customarily are payable in advance on a weekly or monthly basis.
The Company's preschools are generally open throughout the year, usually five days a week, from 6:30 a.m. to 6:30 p.m. Nine preschools are operated in public or private school facilities on a before and after school basis only. In addition, one of the Company's subsidiaries operates after-school programs in nine schools (which are not included within the total number of Company centers set forth above). New enrollments are most often highest in September and January, with the largest decrease in enrollment being generally during holiday periods and the summer months (mirroring the seasonality of the school year end and traditional vacation times). To offset the seasonal decline in enrollment, some preschools offer summer day camp programs for children up to the age of 12.
Operating Controls and Procedures
Pre-school directors submit weekly financial and operations reports to the Company's headquarters, which are reviewed by management. The Company has installed in each of its preschools a personal computer with customized software permitting faster and more comprehensive reporting of operating information. These reports include, among other things, labor costs, scheduling, utilization information, enrollment and tuition data by age group, a statement of prepaid tuition and receivable data, and a listing of all cash receipts. The Company uses such reports in conjunction with its own records of cash receipts and disbursements to prepare monthly operating statements for each preschool. Management reviews these operating statements with the directors on a monthly basis. In addition, regional managers visit preschools on a regular basis to monitor all aspects of the preschools' operation.
All funds received by each preschool are deposited in an account established by the Company in a local bank. All payroll and most other preschool expenses are paid by the Company directly out of the Company's headquarters. The Company also purchases certain supplies for the preschools. Direct expenditures by the preschools themselves are limited to miscellaneous operating expenses for which the preschools are reimbursed by the Company by means of a petty cash system.
The Company is committed to an effective safety program, and its operating procedures are designed to enhance the safety of the children. While the Company is vigilant in its efforts to promote the safety of the children at its centers, there can be no assurance that there will be no injuries to children, or allegations thereof, in the future.
Marketing
The Company believes that it has benefited from a number of national demographic trends including an increased birth rate through the early 1990's, an increase in working mothers employed outside the home and a growing emphasis by employers on making available on-site child care for employees. According to U.S. government statistics, births in 1989 exceeded 4,000,000 for the first time since 1964, and continued to exceed that number in each of 1990, 1991 and 1992. Furthermore, the percentage of all American children under age six with mothers in the labor force grew from 39% in 1975 to 58% in 1990, and the percentage of children receiving preschool-based child care increased from 13% of the total number of children receiving child care in 1977 to 28% in 1990. In addition, the number of children who are ages six to twelve increased from approximately 25 million in 1990 to 26 million in 1993 and is projected to increase to in excess of 28 million by 1999.
The Company believes that it can increase enrollment in its preschools by developing and introducing high quality curricula and programs that provide parents with meaningful reasons to choose the Company's centers for their children over other alternatives. The Company has designed educational and recreational programs to develop a child's social, intellectual and physical skills, and it has distributed curriculum manuals developed by it for each age group to its preschools. In addition, the Company is committed to ongoing research to develop curricula appropriate to children's cognitive development. The curriculum covered by the Company's "Piaget Discovery Preschool" trademark was developed under the supervision of an outside consultant with a Ph.D. in Educational Psychology.
The Company's primary source of new enrollments for its preschools and elementary schools are recommendations from customers in the communities in which it operates. The Company markets its services through display advertisements and listings in the Yellow Pages, newspaper advertisements and distribution of flyers at schools and community functions. The Company spends a large portion of its advertising budget in the summer months in anticipation of the fall enrollment period, with continued advertising throughout the year. The Company markets its services to employer-sponsored preschools through relationships with consultants, attendance at trade shows and industry publications.
The director of each preschool is responsible for marketing and promoting the preschool. The director encourages parental involvement in the preschool through monthly newsletters and reports to parents as well as parent-teacher conferences and parental visits to and inspections of the preschool. Preschools use promotional activities such as "Grandparents' Day," holiday activities, graduation and open houses as part of the total marketing program.
Competition
Based on data from trade publications, the Company is one of the largest chains of preschools in the United States. The child care industry is highly fragmented, with the 50 largest for-profit child care companies estimated by the Company to account for no more than 10% of the industry's licensed capacity.
Competition within the child care industry is based largely upon location and adequacy of facilities, quality of service and price. In most of the geographic areas in which the Company operates, the Company competes with centers owned by larger national chains such as Kinder-Care Learning Centers, Inc., and La Petite Academy, Inc., as well as with centers owned by non-profit organizations that may be supported by endowments and charitable contributions. The Company primarily competes for employer-sponsored centers with organizations which focus on the employer-sponsored market such as Corporate Family Solutions and Bright Horizons, Inc. or child care chains that have divisions that focus on corporate-sponsored business. Some of these competitors have significantly greater financial resources thaN the Company. The Company also competes with individually-owned proprietary child care centers, licensed child care homes, in-home individual child care providers and corporations that provide child care for their employees privately. Many non-profit child care centers have lower occupancy costs for their facilities than the Company does and, consequently, charge less for their services. Additionally, public schools are offering, on an increasing basis, before and after school programs that compete with services offered by the Company. Such programs have the built-in advantages of (i) being able to use existing, well-established facilities, (ii) having a ready source of enrollments from their existing student population, and (iii) having tax revenue available to subsidize the cost of the programs. The Company competes principally by offering trained personnel, professionally planned educational and recreational programs, well equipped facilities, and additional services such as transportation. The Company's private kindergarten and elementary programs face competition from the public schools as well as other providers of private education including religious institutions, and other operators of child care centers. The Company believes that it can compete successfully in this market based on the quality of its educational programs, the high customer satisfaction of its preschool customer base, and its ability to be selective in the staff hired and children attending the school.
Insurance
The Company maintains comprehensive general liability insurance that provides coverage for both bodily injury and property damage claims up to a total of $15 million. The primary general liability policy has a limit of $1 million per occurrence, and the Company maintains an excess umbrella liability policy that provides coverage for an additional $14 million for a total liability insurance of $15 million. The Company believes such insurance coverage is adequate. The Company has procured limited coverage for child physical and sexual abuse claims, subject to a $1,000,000 annual aggregate limitation. To date, the Company has not incurred any liability with respect to any claims of abuse.
The Company has not experienced difficulty in obtaining insurance coverage, but there can be no assurance that adequate, affordable insurance coverage will be available in the future, or that the Company's current coverage will protect it against all possible claims.
Government Regulation
Each preschool or school must be licensed under applicable state or local licensing laws and is subject to a variety of state and local regulations. Although these regulations vary greatly from jurisdiction to jurisdiction, governmental agencies generally review with respect to a preschool the safety, fitness and adequacy of the buildings and equipment; the ratio of staff to children; the dietary program; the daily curriculum and compliance with health standards. In most jurisdictions, these agencies conduct scheduled and unscheduled inspections of the preschools, and licenses must be renewed periodically. Repeated failures by a preschool to comply with applicable regulations can subject it to sanctions that might include probation or, in more serious cases, suspension or revocation of the preschool's license to operate. The Company believes that each of its preschools is in substantial compliance with such requirements. The Company generally seeks to operate preschools in states with strict regulations in order to avoid unexpected expense and market disruption that may be caused by compliance with regulations adopted in states that previously lacked such regulations.
Federal regulations and licensing requirements require compliance with minimum standards in order to qualify for participation in Federal assistance programs. Under the Social Security Act, the Federal government provides assistance to states that have an established plan for child-welfare services, including child care services. As a result, state agencies have established minimum standards for preschools, based on the number of eligible children enrolled in each preschool, in order for each preschool to receive financial assistance. The Company estimates that approximately 13% of its revenue is derived from various state public assistance programs. Any significant reduction in the scope or amount of such financial assistance may have a significant impact on the Company's operating results.
In addition, the Company is subject to the Americans with Disabilities Act ("ADA"), which prohibits discrimination on the basis of disability in public accommodations and employment. The ADA became effective as to public accommodations in January 1992 and as to employment in July 1992. The Company believes that its facilities are substantially in compliance with the requirements of the ADA and has not received any complaints concerning non-compliance with such requirements. A determination that the Company is not in compliance with the ADA could result in the imposition of fines or an award of damages to private litigants, and it could require significant expenditures by the Company to bring the Company's facilities into compliance with the ADA. The Internal Revenue Code of 1986, as amended (the "Code"), provides for an income tax credit ranging from 20% to 30% of certain child care expenses subject to certain maximum limitations. The fee paid to the Company for child care services qualifies for the Federal tax credit under the Code, provided that various requirements under the Code are met.
The Company is also subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime compensation and working conditions. Less than 5% of the Company's personnel are paid at rates equal to the Federal minimum wage and, accordingly, increases in the minimum wage ahould not materially increase the Company's labor costs.
Income Taxes
The net operating loss carryforwards of the Company and its subsidiaries are subject to certain rules set forth in the Code that limit the ability of the Company and its subsidiaries to use such net operating loss carryforwards to reduce income taxes.
Employees
The Company's preschools are currently organized into regions, each of which is under the management of a trained regional manager. Individual preschools are staffed with a director, teachers and teaching assistants and, depending on its size, an assistant director. All management personnel participate in periodic training programs and are required to meet applicable state and local regulatory standards. It is the Company's policy to comply with all state regulations and guidelines pertaining to staff-to-child ratios. These ratios vary from state to state and with the age group of the children under supervision. In this regard, the Company employs, with respect to (i) infants under the age of 13 months, one staff member for each three to four children; (ii) toddlers between the ages of 12 and 36 months, one staff member for each four to twelve children; and (iii) preschool children 3 to 5 years of age, one staff member for each eight to twelve children. The Company maintains a proprietary computerized system that monitors the staff-to-child ratio in all of its preschools, enabling the Company to staff efficiently in response to shifts in occupancy levels.
As of December 31, 1997, the Company employed approximately 4,700 persons, of whom approximately 35% are employed on a part-time basis. Two preschools operated by a Company subsidiary have employees that are represented by unions. The Company believes that its relations with its employees are good. The Company experiences significant turnover of its hourly employees, which it believes is typical of the child care industry.
Item 2.
Item 2. Properties
As of December 31, 1997, the Company operated 248 school programs in 22 states and the District of Columbia, located as follows:
Location Number of Location Number of Centers Centers ------------------------------------------------------- Pennsylvania 49 Oregon 5 California 48 Nebraska 5 Connecticut 24 Kansas 5 New Jersey 21 Rhode Island 3 Indiana 11 Alabama 3 Illinois 11 Virginia 3 New York 11 Michigan 3 Massachusetts 10 Texas 2 Washington 9 Delaware 2 Wisconsin 7 Washington 1 D.C. Georgia 7 Florida 1 Maryland 7
As of December 31, 1997, the Company owned 16 centers, leased 208 centers with terms expiring on the leased properties on various dates between 1998 and 2015, and operated 17 centers pursuant to management contracts with employers. Seven of the centers are operated in public or private school facilities on a before and after school basis only.
The Company's principal executive offices are located in San Rafael, California in 6,900 square feet that the Company leases pursuant to the terms of a lease agreement that expires in 1999. The remaining term of the lease provides for an annual rent of approximately $168,088. The Company believes its properties are adequate for its uses.
Item 3.
Item 3. Legal Proceedings
The Company is not a party to any material legal proceedings. The Company is a party to certain legal proceedings arising in the ordinary course of business that are primarily covered by insurance.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
The Common Stock has been included for quotation in the NASDAQ National Market since May 20, 1986. Until February 9, 1994, the NASDAQ symbol for the Common Stock was "CDCRA," at which time the symbol was changed to "CDCR." The following table sets forth for the calendar quarters indicated the historical high and low last sales prices of the Common Stock, as reported by NASDAQ.
1997 High Low ---- ---- --- First Quarter $7.00 $4.875 Second Quarter $7.50 $4.625 Third Quarter $8.00 $6.375 Fourth Quarter $9.875 $4.75
1996 High Low ---- ---- --- First Quarter $5.75 $4.00 Second Quarter $8.625 $4.625 Third Quarter $7.00 $5.00 Fourth Quarter $8.125 $4.75
At March 21, 1998, there were 307 record holders of the Company's Common Stock.
The Company has never declared or paid any cash dividends or made any other distribution on its Common Stock, and it is anticipated that in the foreseeable future the Company will follow a policy of retaining all earnings for reinvestment in its business. Any future determination as to declaration and payment of dividends will be made at the discretion of the Board of Directors of the Company.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
During the period from January 1, 1995, through December 31, 1997, the number of preschools operated by the Company increased from 193 to 248 and preschool capacity increased from approximately 17,500 to approximately 25,000 children. The Company has achieved this growth primarily by acquiring existing preschools and also by opening new preschools and entering into contracts to manage preschools sponsored by employers. During 1997, the Company acquired or opened 6 preschools and closed 6 preschools. In 1996, the Company acquired or opened a a total of 14 preschools and closed 5 preschools. During 1995, the Company acquired or opened 52 preschools and closed 6 preschools. The results of acquired or disposed preschools are included in the Company's financial statements from the date ofacquisition or until the date of disposition. Accordingly, year-to-year resultsmay fluctuate depending upon the timing of the Company's acquisition of existingpreschools and the opening of new preschools.
Historically, the Company's operating revenues have followed the seasonality of a school year, declining during the summer months and the year-end holiday period.
Results of Operations
Revenue from Operations
Revenue from operations increased 6% in 1997 to $93,015,000 from $87,480,000 in 1996. Revenues for those preschools open in corresponding time periods in both years increased approximately 4%, with the remainder of the increase due to acquisitions. Approximately 95% of the increase on a same-school basis was due to price increases, and the remainder was due to enrollment increases. Revenue from operations increased 13% in 1996 to $87,480,000 from $77,627,000 in 1995. Revenues for those preschools open in corresponding time periods in both years increased approximately 3%, with the remainder of the increase due to acquisitions. All of the increase on a same-school basis was due to price increases, as these preschools experienced a decrease in enrollments of approximately 2%. Revenues from operations increased 40% in 1995 to $77,627,000 from $55,323,000 in 1994. Revenues for those preschools open in corresponding time periods in both years increased approximately 3%, with the remainder of the increase due to acquisitions. All of the increase on a same-school basis was due to price increases, as these preschools experienced an enrollment decrease of less than 2%.
Operating Expenses
Payroll and related expenses as a percentage of total revenues were 52.7%, 53.9% and 54.4% in 1997, 1996 and 1995, respectively. The decreases from 1995 to 1996 to 1997 was due to an increase in supervisory controls and procedures instituted in 1996 and to the Company having raised its tuition rates at a higher rate than its payroll rates.
Other operating expenses were 26.6% of revenues in 1997, 27.3% in 1996 and 25.5% in 1995. The increase in other operating expenses in 1996 from 1995 was due to occupancy expenses (rent, property taxes, utilities and maintenance and repair expenses) increasing at a faster rate than the growth in average preschool revenue. In 1997, the Company had the opposite effect from 1996, in that its revenues on a same center basis increased faster than its occupancy expense.
Administrative expenses as a percentage of total revenue were 8.5% in 1997, 9.2% in 1996, and 8.1% in 1995. The major part of the increase in 1996 was a one-time charge of approximately $800,000 ($600,000 in administrative expense) in the fourth quarter of 1996. The Company recorded this charge to provide for the potential uncollectability of a receivable associated with a management agreement for operation of an employer-sponsored preschool, the costs associated with the possible settlement of a legal matter, and other miscellaneous expenses. Without this charge, administrative expenses for 1996 as a percentage of revenue would have been 8.5%. The increase in 1996 was due to the addition of supervisory and financial personnel to enhance management and financial controls. In 1997, administrative expenses as a percentage of revenue remained flat with 1996 before the one-time charge.
Depreciation and amortization expenses increased by 18% in 1997, 35% in 1996, and 62% in 1995. The increase in 1997 was due to improvements made by the Company in its existing preschools and to acquisitions and startups made in 1997 and 1996. The increases in both 1996 and 1995 were due mainly to the increase in new preschools acquired during those years and to the improvements made by the Company in its existing preschools.
Advertising and promotion expenses as a percentage of revenues declined slightly in 1997 from 1996 and 1995 due to a decrease in expenses at headquarters.
Other Expense
Interest income in 1997 compared to 1996 increased by $331,000, due to higher average daily cash balances offset somewhat by lower average interest rates in 1997. Interest income in 1996 compared to 1995 decreased by $432,000, due to lower average daily cash balances and to lower average interest rates in 1996. Interest expense decreased by $101,000 in 1997 from 1996 and increased by $112,000 in 1996 from 1995. The decrease in 1997 was due to lower average debt outstanding as the Company paid off more debt than it issued in connection with its addition of preschools and to slightly lower average interest rates. The 1996 increase was due to higher average debt outstanding because of debt issued by the Company in connection with its acquisition of preschools, offset somewhat by lower average interest rates on the Company's outstanding debt. The Company's average interest rates decreased in both 1997 and 1996 due to the decline in variable rates charged on certain Company borrowings, the retirement of higher interest rate debt and the issuance of new debt in connection with its acquisitions at lower average interest rates.
Income Taxes
The net operating loss carryforwards of the Company are subject to certain rules set forth in the Internal Revenue Code that limit the ability of the Company to use such net operating loss carryforwards to reduce future taxable income.
During 1997 and 1996, the Company reduced its deferred tax asset valuation allowance to recognize a portion of the benefit related to its previously reserved net operating loss carryforwards (see Note 7 to the accompanying financial statements). The impact of the above, after considering alternative minimum tax and the benefit of certain tax exempt income and tax credits, resulted in the Company's effective tax rate decreasing to 20.0% in 1996 from 31.4% in 1995.
The higher effective tax rate in 1997 of 30.6% versus 20.0% in 1996 reflected the fact that the benefit of net operating loss carryforwards in 1997 had a proportionately smaller effect on the larger taxable income in 1997 as compared to 1996.
Liquidity and Capital Resources
Since its inception, the Company has grown primarily through the acquisition of existing preschools. For acquisitions of individual preschools or small chains, it is the Company's general practice to acquire preschools for a combination of cash and notes to sellers. These notes are payable generally over ten years. As of December 31, 1997, the principal amount of such notes outstanding was $11,391,000. Furthermore, the Company seeks whenever possible to lease the preschool facilities on a long-term basis through the exercise of successive options, while avoiding long-term obligations.
For transactions involving the acquisition of larger chains, the Company has relied principally on the issuance of debt and equity securities as payment for a substantial portion of the purchase price. In connection with the acquisition of AFSC in November 1992, the Company issued to the stockholders of AFSC approximately 138,000 shares of Common Stock, as well as shares of Preferred Stock having a liquidation preference of $3,250,000, which were convertible into approximately 591,000 shares of Common Stock. In 1995, shares of Preferred Stock having a liquidation preference of $550,000 were converted into 100,000 shares of Common Stock, in 1996 shares of Preferred Stock having a liquidation preference of $565,000 were converted into approximately 103,000 shares of Common Stock, and in 1997 the remaining shares with a liquidation preference of $2,135,000 were converted into approximately 388,000 shares of Common Stock. In 1995, the Company purchased the assets of its Prodigy Division, consisting of seven community based centers and nine employer-sponsored centers, in a transaction for approximately $5,100,000. This purchase price consisted of approximately $2,850,000 in cash and $2,250,000 in notes and assumed liabilities.
Capital resources for the cash portion of acquisitions have generally been obtained through public and private sales of the Company's securities at various times since inception. In December 1994 and January 1995, the Company obtained net proceeds of approximately $19,550,000 from a public offering of 2,137,500 shares of Common Stock at a price of $10.25 per share (the "1994 Stock Offering").
During 1997, net cash provided by operations was $10,983,000. This internally generated cash along with the issuance of $1,185,000 in debt for the acquisition of property, plant and equipment funded all of the Company's cash needs for repayment of debt, purchases of centers and purchases of property, plant and equipment. During 1997, the Company issued or assumed $480,000 of indebtedness related to acquisitions. As of December 31, 1997, the Company had cash and short-term investment balances of $14,716,000. During 1996, net cash provided by operations was $7,993,000. This internally generated cash funded all of the Company's cash needs for repayment of debt, purchases of centers and purchases of property, plant and equipment. During 1996, the Company issued or assumed $1,054,000 of indebtedness related to acquisitions. During 1995, net cash provided by operations was $4,682,000. This internally generated cash, along with the issuance of $1,483,000 in debt for the acquisition of property, and equipment funded all of the Company's needs for purchases of property, plant and plant and equipment, funded all of the Company's needs for purchases of property, plant andequipment, and $1,213,000 of debt payments. The Company also used $3,115,000 of its cash balances to repay debt. Approximately $9,564,000 of the proceeds from the 1994 stock offering was used for the acquisition or opening of new preschools or elementary programs. During 1995 the Company issued or assumed$7,919,000 of indebtedness related to acquisitions.
The Company's management believes that its internally generated cash will cover its cash requirements for the foreseeable future and, along with its existing cash balances, will allow it to continue to grow through the acquisition of additional preschools and the opening of additional elementary school programs. The Company also has available to it up to $5,000,000 under an unsecured line of credit furnished by a commercial bank. The Company currently has no commitments for capital expenditures, which might be deemed, either individually or in the aggregate, material to its business.
Item 8.
Item 8. Financial Statements and Supplementary Data
See Page F.
Item 9.
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information concerning directors required by this item is incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than April 30, 1998.
Executive Officers
The executive officers of the Company are as follows:
Name Age Position - ------------------------------------------------------- Richard A. Niglio 55 Chief Executive Officer and Chairman Elanna S. Yalow 43 President, Chief Operating Officer Randall J. Truelove 49 Vice President, Finance Jane Delaney 34 Vice President Frank A. Devine 51 Secretary/General Counsel
None of the above has any family relationship with any other person so named, and there are no arrangements or understandings between any executive officer and any other person pursuant to which any person was selected as an officer. Officers are elected each year at the meeting of the Board of Directors immediately following the annual meeting of the stockholders.
The business experience, principal occupations and employment of each of the executive officers of the Company during at least the past five years, together with their periods of service as executive officers of the Company, are set forth below.
Richard A. Niglio was appointed Chief Executive Officer of the Company in March 1987. From 1982 until joining CDC, he was President, Chief Executive Officer and a director of Victoria Station Incorporated, a restaurant chain based in Larkspur, California. Mr. Niglio is currently a director of Psychiatric Management Resources, Inc., a company that manages psychiatric partial hospitalization services.
Elanna S. Yalow has been President of the Company since January 19, 1996, and Vice President since April 1992. From July 1989 until April 1992, Dr. Yalow was a self-employed consultant and served as a consultant to the Company during that period. From September 1987 until June 1989, Dr. Yalow attended Stanford University, graduating with a Masters in Business Administration. Dr. Yalow has a doctorate in Educational Psychology from the Stanford University School of Education.
Randall J. Truelove has been Vice President, Finance of the Company since December 1987. From 1982 until joining CDC, Mr. Truelove was Controller of Victoria Station Incorporated.
Jane Delaney has been a Vice President of the Company since June 1995 and from 1991 to 1995 was a Regional Director with the Company.
Frank A. Devine has been Secretary and General Counsel of the Company since October 1987. Prior to that time, Mr. Devine was Corporate Counsel of Victoria Station Incorporated.
Item 11.
Item 11. Executive Compensation
Information required by this item is incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than April 30, 1998.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item is incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than April 30, 1998.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this item is incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than April 30, 1998.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)1. Financial Statements: Index to Financial Statements at page F.
2. Financial Statement Schedules: None.
3. Exhibits.
Item Number (Exhibit Number referenced to Item 601 of Regulation S-K)
1. Underwriting Agreement: Not applicable
2. Plan of acquisition, reorganization, arrangement, liquidation or succession: Not applicable.
3. Articles of Incorporation and By-Laws
A. Certificate of Incorporation, filed on December 23, 1983, incorporated by reference to Exhibit 3(A) to Registrant's Form 10-K for fiscal year ended December 31, 1994 (the "1994 Form 10-K").
B. Amendment to Certificate of Incorporation filed on July 12, 1984, incorporated by reference to Exhibit 3(B) to Registrant's 1994 Form 10-K.
C. Amendment to Certificate of Incorporation filed on January 29, 1985, incorporated by reference to Exhibit 3(C) to Registrant's 1994 Form 10-K.
D. Amendment to Certificate of Incorporation filed on August 19, 1985, incorporated by reference to Exhibit 3(D) to Registrant's 1994 Form 10-K.
E. Amendment to Certificate of Incorporation filed on May 27, 1987, incorporated by reference to Exhibit 3(E) to Registrant's 1994 Form 10-K.
F. Amendment to Certificate of Incorporation filed on June 2, 1988, incorporated by reference to Exhibit 3(F) to Registrant's 1994 Form 10-K.
G. Amendment to Certificate of Incorporation filed on March 18, 1991, incorporated by reference to Exhibit 3(G) to Registrant's 1994 Form 10-K.
H. Amendment to Certificate of Incorporation, filed on October 10, 1991, incorporated by reference to Exhibit (4)(A) to Form S-2 Registration Statement No. 33-92533.
I. Amendment to Certificate of Incorporation filed on July 29, 1992 (incorporated by reference to Exhibit 3(H) to Registrant's Form 10-K for the fiscal year ended December 31, 1992 (the "1992 Form 10-K").
J. Certificate of Amendment to Certificate of Incorporation filed on December 6, 1993, incorporated by reference to Exhibit 3(H) to Registrant's Form 10-K for the fiscal year ended December 31, 1993 (the "1993 Form 10-K").
K. By-Laws as amended, incorporated by reference to Exhibit 3(g) to Registrant's Form 10-K for the fiscal year ended December 31, 1989 (the "1989 Form 10-K").
4. Instruments defining the rights of security holders, including indentures:
A. Excerpts from Certificate of Incorporation, as amended, incorporated by reference to Exhibit 4(A) to Form S-4 Registration Statement No. 33-38858.
B. Excerpts from By-Laws, as amended, incorporated by reference to Exhibit 4(B) to Form S-4 Registration Statement No. 33-38858.
C. Specimen Certificate for Common Stock par value $.01 per share, incorporated by reference to Registrant's 1993 Form 10-K.
D. Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock, incorporated by reference to Exhibit 4(D) to Registrant's 1992 Form 10-K.
5. Opinion re legality: Not applicable.
6. Reserved: Not applicable.
7. Reserved: Not applicable.
8. Opinion re tax matters: Not applicable.
9. Voting trust agreement: Not applicable.
10. Material Contracts:
A.CDC Stock Option Plan, as amended, incorporated by reference to Exhibit 10(A) of S-2 Registration Statement No. 33-85878.
B.Form of Stock Option Agreement dated as of June 16, 1992, between the Registrant and each of its non-employee directors, incorporated by reference to Exhibit 10(C) to Registrant's 1993 Form 10-K.
C.Form of Stock Purchase Agreement dated March 22, 1993, and Registration Rights Agreement attached as Exhibit A thereto, incorporated by reference to Exhibit 10(H) to S-2 Registration Statement No. 33-70360.
D.Promissory Note of Richard A. Niglio dated May 28, 1993, in the principal amount of $200,200, and related Pledge Agreement between the Registrant and Mr. Niglio, incorporated by reference to Exhibit 10(I) to S-2 Registration Statement No. 33-70360.
E.Non-Employee Directors' Stock Option Plan, incorporated by reference to Exhibit 10(J) to S-2 Registration Statement No. 33-70360.
F.Promissory Note of Richard A. Niglio dated December 16, 1994, in the principal amount of $224,475, incorporated by reference to Exhibit 10(I) to Registrant's 1994 Form 10-K.
G.Non-Employee Directors' Stock Option Plan (Amended and Restated as of August 27, 1996, incorporated by reference to Exhibit 10(I) to Registrant's 1996 Form 10-K.
H.Promissory Note of Richard A. Niglio dated October 1, 1997, in the principal amount of $232,500 filed as an exhibit hereto.*
I.Non-Employee Directors' Stock Option Plan (Amended and Restated as of August 27, 1996), incorporated by reference to Exhibit 10(I) to Registrant's 1996 Form 10-K.
11. Statements re computation of per share earnings is not required because the relevant computations can be clearly determined from the material contained in the financial information included herein.
12. Statements re computation of ratios: Not Applicable.
13. Annual Report to security holders, Form 10-Q or quarterly report to security holders: Not Applicable. 14. Reserved: Not Applicable. 15. Letter re unaudited interim financial information: Not Applicable. 16. Letter re change in certifying accountants: Not Applicable.
17. Letter re director resignation: Not Applicable. 18. Letter re change in accounting principles: Not Applicable. 19. Report furnished to security holders: Not Applicable. 20. Other documents or statements to security holders: Not Applicable. 21. Subsidiaries of the Registrant:
Name of Subsidiary State of Incorporation Magic Years Child Care and Learning Centers, Inc. Pennsylvania Greentree Learning Center, Inc. New Jersey Fox Day Schools, Inc. Illinois Children's Discovery Centers of Illinois, Inc. Delaware Children's Discovery Centers of Virginia, Inc. Delaware Prodigy Consulting of Flint, Inc. Georgia
22. Published report regarding matters submitted to vote of security holders: Not Applicable.
23. Consents of experts and counsel: Consent of Arthur Andersen LLP. (Filed herewith).
24. Power of attorney: Not Applicable. 25. Statements of eligibility of trustees: Not Applicable. 26. Invitations for competitive bids: Not Applicable. 27. Financial Data Schedule: Filed herewith. 99. Additional exhibits: Not Applicable.
(b) Reports on Form 8-K.
None.
(c) Exhibits. Exhibits are attached.
(d) Additional Financial Statements or Schedules. None.
* Attached hereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC.
Date: March 31, 1998 By: s/s Richard A. Niglio ----------------------- ------------------------- Richard A. Niglio Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated.
Signature Title Date
s/s Richard A. Niglio Chairman of the Board March 31, 1998 --------------- Richard A. Niglio of Directors, and Chief Executive Officer, (Principal Executive Officer)
s/s Randall J. Truelove Vice President, Finance March 31, 1998 --------------- Randall J. Truelove (Principal Financial Officer and Accounting Officer)
s/s Mark P. Clein Director March 31, 1998 - ----------------- Mark P. Clein
s/s Michael J. Connelly Director March 31, 1998 ---------------- Michael J. Connelly
s/s Robert E. Kaufmann Director March 31, 1998 --------------- Robert E. Kaufmann
s/s W. Wallace McDowell, Jr. Director March 31, 1998 --------------- W. Wallace McDowell, Jr.
s/s Myron A. Wick, III Director March 31, 1998 --------------- Myron A. Wick, III
s/s Elanna S. Yalow Director March 31, 1998 - ---------------------- Elanna S. Yalow
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Page
Report of Independent Public Accountants
Financial Statements:
Consolidated Balance Sheets - December 31, 1997 and 1996
Consolidated Statements of Income for the Years Ended December 31, 1997, 1996, and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements through
All other schedules required by Regulation S-X have been omitted because they are not applicable or because the required information is included in the financial statements or notes thereto.
F
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Children's Discovery Centers of America, Inc.:
We have audited the accompanying consolidated balance sheets of Children's Discovery Centers of America, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Children's Discovery Centers of America, Inc., and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California, February 27, 1998 (except with respect to the matter discussed in Note 10, as to which the date is March 27, 1998)
CHILDREN'S DISCOVERY CENTERS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations:
Children's Discovery Centers of America, Inc. and subsidiaries ("the Company") provides preschool child care services at company-operated and employer-sponsored child care centers. At December 31, 1997, the Company operated 248 centers located in 22 states and the District of Columbia with an aggregate licensed capacity of approximately 25,000 children (see Note 2 with respect to the acquisition of centers). The Company provides child care and preschool programs to children primarily between 2 1/2 and six years of age and to a lesser extent, after school programs for older children and infant care.
Consolidation:
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, including Magic Years Child Care and Learning Centers, Inc. ("Magic Years") and Greentree Learning Centers, Inc. ("Greentree"). All material intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to the 1996 and 1995 financial statements to conform to the 1997 presentation. The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property, plant and equipment:
Property, plant and equipment is stated at cost. Provision for depreciation is made on a straight-line basis over the related estimated useful lives of the assets or, in the case of leasehold improvements, the lesser of the term of the related lease or the useful life of the improvement. A summary of useful lives is as follows:
Buildings 40 years Furniture, fixtures and equipment 3 - 10 years Transportation equipment 3 - 5 years Leasehold improvements 3 - 20 years
Depreciation of property, plant and equipment included in the accompanying consolidated statements of income was $3,166,000, $2,409,000, and $1,960,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company expenses repair and maintenance costs as incurred. Repair and maintenance costs included in the accompanying consolidated statements of income amounted to $1,233,000, $1,229,000, and $960,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Revenue recognition:
The Company recognizes child care fees upon delivery of child care service. For employer-sponsored centers, revenue is recognized ratably over contract terms as child care service is provided. The Company's revenue includes $13,186,000, $11,093,000, and $9,195,000 in 1997, 1996, and 1995, respectively, received from various state public assistance programs.
Short-term investments:
The Company follows a policy of investing only in short-term marketable securities and holding them to maturity; however, since the Company may sell certain securities to meet cash requirements for center acquisitions, the Company's short-term investments have been categorized as available-for-sale as required by Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities".
The aggregate fair values, amortized cost, gross unrealized holding gain, and gross unrealized holding loss of the major types of debt securities at December 31, 1997, were as follows (in thousands):
Gross Unrealized Holding Fair Value Amortized Gain Loss Cost Municipal Bonds and $10,926 $10,911 $15 $- Other
The contractual maturities of the Company's debt securities as of December 31, 1997 were all less than two years. The net change in unrealized gain (loss) was a $15,000 gain.
Income taxes:
The Company provides for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying the statutory tax rate to the differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date based on the tax rate applicable to the year of the calculation.
The net operating loss carryforwards of the Company are subject to certain rules set forth in the Internal Revenue Code that limit the ability of the Company to use such operating loss carryforwards to reduce future taxable income.
Amortization of intangible assets charged to expense amounted to $2,874,000, $2,709,000, and $1,844,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
Other assets:
Other assets include deferred tax assets related to net operating loss carryforwards and notes receivable. Included in notes receivable are notes from KidActive, LLC (an educational toy company) which may be converted during 1998, and along with the Company's existing shares would give the Company an approximate nineteen percent ownership in KidActive, LLC.
Net income per share:
Effective December 15, 1997, the Company adopted SFAS No. 128 "Earnings Per Share." SFAS No. 128 supersedes APB Opinion 15. As a result, all prior year net income per share information has been restated.
Net income per basic common share has been computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each year. Net income per diluted common and common equivalent share has been computed by dividing net income available to common stockholders by the weighted average number of common and common equivalent shares outstanding during each year. Shares issuable upon exercise of outstanding stock options, warrants and convertible securities are included in the computation using the treasury stock method.
Consolidated statements of cash flows:
Cash and cash equivalents include deposits and short-term investments (at cost, which approximates market) with original maturities of three months or less.
The Company made cash payments for interest and income taxes (or received refunds) for the years ended December 31, 1997, 1996 and 1995, as follows (in thousands):
1997 1996 1995 ---- ---- ---- Interest $1,581 $1,693 $1,580 Income taxes $918 $(426) $1,654
Supplemental Schedule of Noncash Investing and Financing Activities:
New accounting standards:
In June 1997, the Financial Accounting Standards Boards issued SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The adoption of the standard as required on January 1, 1998 will not have a material impact on the Company's financial statements.
(2) ACQUISITIONS
The Company acquired or started six centers in 1997, fourteen centers during 1996, and a total of fifty-two centers during 1995.
All acquisitions are accounted for as purchases. The cost in excess of the fair value of the net tangible assets acquired was first assigned to certain identifiable intangible assets including covenants not to compete, and management contracts. Any portion of the purchase price remaining after these allocations has been recorded as goodwill.
(3) LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1997 and 1996, (in thousands):
1997 1996 Long-term borrowings: Notes payable to banks (a) $5,682 $5,244 Notes payable to sellers (b 11,391 13,485 17,073 18,729 Less - Current portion (2,934) (2,095) ------- ------- $14,139 $16,634
(a) Consists of various secured and unsecured installment and term loans at rates ranging from 4.8% to 13.5%, payable through 2014. The Company is currently obligated under certain loan agreements to maintain minimum balances with lenders of $25,000 in total cash.
(b) Consists of notes payable to previous owners of child care centers acquired by the Company with interest rates ranging from 8.0% to 11.9% and payable in installments of varying amounts through 2012.
A summary of the maturities of long-term debt is as follows for the years ending December 31 (in thousands):
1998 $2,934 1999 2,104 2000 1,812 2001 2,373 2002 2,645 Thereafter 5,205 $17,073
The Company also has available to it up to $5,000,000 under an unsecured line of credit furnished by a commercial bank. Amounts drawn down bear interest of 1.75% above the bank's LIBOR rate and will convert to a five year term loan on August 1, 1998. During 1997 the Company did not use any of the funds available under the line of credit. Under the terms of the agreement the Company is required to maintain certain financial and non-financial covenants.
(4) LEASE OBLIGATIONS
The Company leases certain facilities under operating leases. Total rental expense for facilities under operating leases amounted to $11,605,000, $11,318,000, and $9,342,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Future minimum payments under operating leases (not including unexercised renewal options) are as follows for the years ending December 31 (in thousands):
1998 $10,671 1999 8,794 2000 7,513 2001 6,509 2002 5,758 Thereafter 15,039 Total future minimum lease payments $54,284
Minimum lease payments for operating leases shown above do not include contingent rentals which are based on the consumer price index increases and percentages of revenues. Contingent rentals charged to expense under operating leases amounted to approximately $152,000 in 1997, $219,000 in 1996, and $45,000 in 1995.
Rent expense due under lease agreements with a duration longer than twelve months is recognized on a straight line basis over the term of the lease, excluding unexercised renewal options, in accordance with SFAS No. 13, "Accounting for Leases".
(5) COMMON STOCK
During 1997 the Company issued 388,182 shares of Common Stock on conversion of 2,135 shares of its Series A Convertible Preferred Stock (see Note 6).
During 1996, the Company issued 102,727 shares of Common Stock on the conversion of 565 shares of its Series A Convertible Preferred Stock (see Note 6).
In January 1995, the Company issued an additional 138,477 shares of Common Stock at $10.25 per share, associated with the Company's December 1994, public offering for net proceeds of $1,243,000, after deducting offering expenses of $83,000 and underwriters discount of $93,000.
During 1995, the Company issued 100,000 shares of Common Stock on the conversion of 550 shares of its Series A Convertible Preferred Stock (see Note 6).
(6) PREFERRED STOCK
The Company's stockholders, at a special meeting in November 1992, authorized Series A Convertible Preferred Stock. These shares were convertible into the Company's Common Stock at an initial conversion price of $5.50 per share and had a liquidation value of $1,000 per share. If 50% of these shares were not redeemed or converted by November 5, 1997 and the remaining 50% by November 5, 1998, then the conversion price would reset at that time to 70% of the then current market price of the Company's Common Stock. These shareholders were entitled to share on a pro rata basis in any dividends payable with respect to the Common Stock, based on the number of shares of Common Stock into which each share of Series A Convertible Preferred Stock is then convertible.
During 1997, 1996 and 1995, holders of the Series A Convertible Preferred stock exchanged all 3,250 shares of the Series A Convertible Preferred for 590,909 shares of the Company's Common Stock.
(7) INCOME TAXES
At December 31, 1997, the Company has net operating loss carryforwards of approximately $5,200,000. The tax net operating loss carryforwards are available to offset future taxable income, if any, subject to the limitations described below. These carryforwards expire between the years 2001 and 2006.
The Tax Reform Act of 1986 introduced a limitation on the amount of net operating loss, capital loss and tax credit carryforwards that can be used annually. This limitation applies following certain "changes in ownership". This limitation was triggered in 1988 and again in 1991 and 1994 pursuant to public offerings of Common Stock by the Company . As a result of the 1991 change in ownership, beginning in 1992 the net operating loss that the Company may use to offset future taxable income, if any, will be subject to an annual limitation of approximately $350,000. In addition, the Company's subsidiary, Magic Years, has separate net operating loss carryforwards for tax purposes of approximately $900,000 which expire between the years 2001 and 2006. This net operating loss is subject to the "change in ownership" limitation discussed above. The limitation is approximately $100,000 per year.
The Company's subsidiary, Greentree, has separate net operating loss carryforwards for tax purposes of approximately $1,020,000 available to offset future taxable income of Greentree, if any, and expire between the years 2004 and 2006. This net operating loss is subject to the "change in ownership" limitation discussed above. The annual limitation is approximately $188,000.
Given the uncertainty relating to the Company's ability to ultimately benefit from its net operating loss carryforwards due to the annual limitations and that they have to be used by the individual corporations, the Company has provided a valuation allowance against a substantial portion of its net deferred tax asset. In determining the valuation allowance, management considered the likelihood of future levels of taxable income sufficient for the Company to utilize the net operating loss carryforwards within the limitations noted above. The net change in the valuation allowance for the year ended December 31, 1997 was $426,000 of which $195,000 was recognized as a reduction in goodwill.
Approximately $470,000 of the valuation allowance will be allocated to reduce goodwill or acquired noncurrent assets if the net operating losses for Magic Years and Greentree are subsequently recognized.
(8) COMMITMENTS AND CONTINGENCIES
The Company maintains comprehensive general liability insurance, that provides coverage for both bodily injury and property damage claims up to a total of $15 million. The primary general liability policy has a limit of $1 million per occurrence and the Company maintains an excess umbrella liability policy that provides coverage for an additional $14 million for a total liability insurance of $15 million. The Company believes such insurance coverage is adequate. The Company has procured limited coverage for child physical and sexual abuse claims, subject to a $1,000,000 annual aggregate limitation. To date, the Company has not incurred any liability with respect to any claims of abuse.
The Company has not experienced difficulty in obtaining insurance coverage, but there can be no assurance that adequate, affordable insurance coverage will be available in the future, or that the Company's current coverage will protect it against all possible claims.
In the ordinary course of business, the Company is subject to various legal matters including certain employee related matters. In the opinion of management, after discussion with counsel, the ultimate outcome of these legal matters will not materially impact the Company's financial position.
(9) STOCK OPTIONS AND WARRANTS
Employee Stock Option Plan
The Company has a stock option plan pursuant to which options for the purchase of up to 800,000 shares of its Common Stock may be granted to officers and employees. The exercise price is required to be at least the fair market value of the common stock on the date of grant, as determined by the Board of Directors. The plan will terminate on November 8, 1999. As of December 31, 1997, options for 715,289 shares have been granted and remain outstanding under this plan.
Non-Employee Director Stock Option Plan
During 1993, the Board of Directors adopted and the stockholders approved a Non-Employee Director Stock Option Plan, pursuant to which non-qualified options for a maximum of 180,000 shares may be granted to the Company's non-employee directors under the plan. The plan will terminate on October 14, 2003. As of December 31, 1997, options for 122,500 shares have been granted and remain outstanding under this plan.
Options not issued under plans
The Company has also issued options outside of either of the above two plans in 1994 and earlier. The exercise price for these non-qualified options is required to be at least the fair market value of the common stock on the date of the grant, as determined by the Board of Directors. Options for 90,376 shares have been granted and remain outstanding at December 31, 1997.
The Company accounts for the Plans under APB Opinion No. 25, and accordingly no compensation cost has been recognized, as under the option Plans, the option exercise price equals the market value of the Company's stock on the date of grant. SFAS No. 123 "Accounting for Stock-Based Compensation" is effective for fiscal years beginning after December 15, 1995 (i.e. calendar 1996). If fully adopted, SFAS No. 123 changes the methods for recognition of compensation cost on the Company's stock option plans. Adoption of SFAS N0. 123 is optional; however, pro forma disclosures as if the Company adopted the cost recognition requirements under SFAS No. 123 beginning in 1995 are presented below. The Plans' options vest over four years, and all options expire after ten years.
The significant decrease in pro forma net income in 1996 reflects additional compensation cost associated with the repricing of options during 1996 to reduce the exercise price of the options to the current fair market value of the common stock of the Company. Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
(10) SUBSEQUENT EVENT - ACQUISITION OF THE COMPANY
On March 27, 1998, the Company entered into an Agreement and Plan of Merger (the "Agreement") with Knowledge Beginnings, Inc., a privately-owned education services company ("Parent") and its wholly-owned subsidiary, KBI Acquisition, Corp. ("Purchaser"). Under the Agreement, Purchaser will undertake a tender offer (supported by the Board of Directors) for all outstanding shares of CDC common stock at a net price of $12.25 per share in cash and, following consummation of the tender offer, will effect a merger with the Company (the "Merger"). Pursuant to the Merger, all outstanding shares of CDC common stock not acquired in the tender offer will be converted into the right to receive $12.25 per share in cash, and the Company will become a wholly-owned subsidiary of Parent. Holders of 1,363,700 shares of CDC common stock have simultaneously entered into a support agreement pursuant to which they have agreed to tender their shares and under certain circumstances sell their shares to Parent for $12.25 per share in cash. The Company has also granted Parent an option to purchase 1,342,155 previously unissued shares of CDC common stock (equal to 19.9% of the outstanding shares of the Company) under certain circumstances for $10.125 per share. The tender offer will be initiated upon certain filings by Purchaser and the Company. The completion of the tender offer is subject to certain conditions, including Purchaser's receipt of at least a majority of the outstanding shares calculated on a full-diluted basis and receipt of certain regulatory approvals. Consummation of the Merger is also subject to certain conditions including stockholder approval, if legally required.
Dr. Elanna S. Yalow, President and Chief Operating Officer, has entered into an employment agreement with Parent to become effective on a date selected by Parent (the "Effective Date") between the consummation of the tender offer and consummation of the Merger. Richard A. Niglio, Chief Executive Officer and Chairman of the Board, has entered into a two year consulting agreement with the Company to become effective on the Effective Date, at which time will resign as Chief Executive Officer and Chairman of the Board. Employment contracts between the Company and Randall J. Truelove, Vice President of Finance, Jane Delaney, Vice President, and Frank A. Devine, Secretary, will become effective on the Effective Date.
Also, subject to consummation of the Merger, the Company has accelerated the vesting of all outstanding stock options whether issued under Company plans or otherwise (see Note 9), and the Company will offer to redeem all such options, upon consummation of the Merger, for cash at a net price equal to $12.25 per share, less the underlying exercise price of the option, any withholding taxes due with respect to such redemption, and the balance of any loans then outstanding from the Company to the optionholder.
EXHIBIT INDEX
Item No. Item Title Sequentially Numbered Page
23 Consent of Arthur Andersen LLP 1 Dated: March 27, 1998
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statements File Nos. 33-76954 and 33-59351.
s/s Arthur Andersen LLP ARTHUR ANDERSEN LLP
San Francisco, California March 27, 1998