-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FIomGyIUU3+6/1nX8d/B1PcHwu50th2MK8lzoTD058bQkKdTYxC3L2I0zRKSgp+A oAcH75/2BI5aYUG7jxFX2A== 0000893877-97-000502.txt : 19970912 0000893877-97-000502.hdr.sgml : 19970911 ACCESSION NUMBER: 0000893877-97-000502 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970530 FILED AS OF DATE: 19970828 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KINDERCARE LEARNING CENTERS INC /DE CENTRAL INDEX KEY: 0000832812 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-CHILD DAY CARE SERVICES [8351] IRS NUMBER: 630941966 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-17098 FILM NUMBER: 97672003 BUSINESS ADDRESS: STREET 1: 2400 PRESIDENTS DR CITY: MONTGOMERY STATE: AL ZIP: 36116 BUSINESS PHONE: 3342775090 MAIL ADDRESS: STREET 1: P O BOX 20960 CITY: MONTGOMERY STATE: AL ZIP: 36120-0960 10-K 1 FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------- FORM 10-K ------------------- (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended May 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-17098 KINDERCARE LEARNING CENTERS, INC. (Exact name of registrant as specified in its charter) Delaware 63-0941966 (State or other (I.R.S. Employer jurisdiction of incorporation) Identification No.) 2400 Presidents Drive Montgomery, Alabama 36116 (Address of principal executive offices) (334) 277-5090 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value (Title of class) Indicate by check mark whether the registrant: (1) has filed all reports 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 required for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's known information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant (assuming for purposes of this calculation, without conceding, that all executive officers and directors are "affiliates") at July 29, 1997 was $182,684,000. The number of shares of Registrant's Common Stock, $.01 par value per share, outstanding at July 29, 1997 was 9,368,421. Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmation by the court. Yes [X] No [ ] Part III incorporates information by reference from the definitive Proxy Statement in connection with the Registrant's Annual Meeting of Shareholders to be held on November 11, 1997. ================================================================================ PART 1 ITEM 1. BUSINESS General KinderCare Learning Centers, Inc. ("KinderCare" or the "Company"), founded in 1969, is the largest provider of for-profit preschool educational and child care services in the United States based upon number of centers operated, children served and operating revenues. The Company provides center-based preschool educational and child care services five days a week throughout the year to children between the ages of six weeks and twelve years. At July 25, 1997, the Company operated a total of 1,144 child care centers, of which 728 are owned, 413 are leased and three are operated under management contracts. The centers are located in 38 states in the United States and two centers are located in the United Kingdom. At July 25, 1997, enrollment in all centers was approximately 105,000 full-time and part-time children. The Company's total licensed center capacity, at July 25, 1997, was approximately 143,000 full-time children. KinderCare seeks to differentiate its educational and other child care services through its Whole Child Development concept with professionally planned, age-specific educational programs provided in a caring, nurturing and safe environment. This concept includes programs that provide children with activities that support physical, intellectual, emotional and social development. New programs are developed and existing programs are frequently enhanced by the Company's education department, under the leadership of a professional with a Ph.D. in early childhood education. The Company operates three types of child care centers - KinderCare community centers, KinderCare At Work(R) centers and Kid's Choice(TM) centers. KinderCare community centers, which comprise approximately 93% of the Company's centers, and KinderCare At Work(R) centers typically provide educational and child care services to children between the ages of six weeks and 12 years. Kid's Choice(TM) centers are for school age children and are provided in separate facilities designed specifically for this age group. The Company has limited the development of its Kids Choice(TM) centers to contracts in progress. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company's centers are open throughout the year, generally Monday through Friday from 6:30 a.m. to 6:00 p.m., although hours vary by location. Children are usually enrolled on a weekly basis for either full-day or half-day sessions and are accepted, where capacity permits, on an hourly basis. The Company's tuition rates vary for children of different ages and by location. On October 3, 1996, the Company and KCLC Acquisition Corp. ("KCLC") entered into an Agreement and Plan of Merger (the "Merger Agreement"). KCLC was a wholly owned subsidiary of KLC Associates, L.P. (the "Partnership"), a partnership formed at the direction of Kohlberg Kravis Roberts & Co., a private investment firm ("KKR"). Pursuant to the Merger Agreement, on February 13, 1997, KCLC was merged with and into the Company (the "Merger"), with the Company continuing as the surviving corporation. Upon completion of the Merger, the Partnership owned 7,828,947 shares, or approximately 83.6%, of the Company's common stock outstanding after the Merger. 2 The principal executive offices of the Company are presently located at 2400 Presidents Drive, Montgomery, Alabama 36116, and its telephone number is (334) 277-5090. The Company is in the process of relocating its principal executive offices to Portland, Oregon and expects to complete the relocation in November 1997. The Company's Portland telephone number is (503) 872-1300. The interim address is 825 N.E. Multnomah, Suite 1050, Portland, Oregon 97232. The permanent address will be 600 N.E. Holladay, Suite 1400, Portland, Oregon 97232. When used in this report, press releases and elsewhere by management or the Company from time to time, the words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements concerning the Company's operations, economic performance and financial condition, including, in particular, the likelihood of the Company's success in developing and expanding its business. These statements are based on a number of assumptions and estimates which are inherently subject to significant uncertainties and contingencies, many of which are beyond the control of the Company, and reflect future business decisions which are subject to change. A variety of factors could cause actual results to differ materially from those anticipated in the Company's forward-looking statements, some of which include federal and state legislation regarding welfare reform or impending minimum wage increases, unforeseen changes in occupancy levels and other risk factors that are discussed from time to time in the Company's Securities and Exchange Commission ("SEC") reports and other filings. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date thereof. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof, or thereof, as the case may be, or to reflect the occurrence of unanticipated events. Business Strategy The Company's objective is to build on its position as the nation's leading preschool educational and child care services provider by offering high quality services in a caring, nurturing and safe environment. To meet this objective, management's business strategy includes the following: Accelerate New Center Development and Pursue Selective Acquisitions. The Company plans to expand by accelerating the development of new child care centers in attractive markets and selectively acquiring child care businesses. The Company seeks to identify attractive sites for its centers in large metropolitan and smaller, growth markets that meet the Company's operating and financial goals and where the Company believes the market for child care services will support higher tuition rates than the Company's existing rates. In addition to accelerating new center development, the Company may seek to acquire existing child care centers where demographics, operating standards and customer services complement the KinderCare business strategy. Management believes that the Company's competitive position, economies of scale and financial strength will allow it to capitalize on selective acquisition opportunities in the fragmented child care industry. 3 Increase Occupancy. The Company plans to increase center occupancy by: (i) enhancing marketing programs targeted to local markets prior to major enrollment periods, (ii) enhancing recruiting, retention and training of staff, and (iii) improving customer retention and loyalty. The Company's marketing activities are currently designed to increase new enrollments primarily through local marketing efforts, including direct mail solicitation, telephone directory yellow pages and customer referrals. See "---Marketing, Advertising and Promotions." These methods communicate to parents the Company's commitment to quality preschool education and child care by emphasizing KinderCare's nurturing environment, educational programs, quality staff and excellent facilities and equipment. Moreover, in late fiscal year 1997, the Company began implementation of an automated consumer inquiry tracking system to provide efficient responses to inquiries from potential customers and began development of a comprehensive and useable consumer database. Because a high quality teaching and administrative staff is a key factor in maintaining and increasing center occupancy, the Company emphasizes recruiting and retaining qualified center personnel. KinderCare's recruiting process seeks to identify high quality candidates for its teaching, center director and area manager positions. Additionally, the Company rewards center directors and area managers through an annual bonus program which is based on center operating profit performance. The Company also strives to increase occupancy by improving its customers' retention and loyalty by strengthening its current parents' emotional commitment to KinderCare. During fiscal year 1997, the Company initiated parent orientation meetings at centers during the fall enrollment season, introduced organized parent involvement programs and parent advisory forums and began conducting ongoing market research on customer satisfaction. The Company believes that retention and loyalty will be enhanced by a renewed focus on quality and consistency in its centers. Enhance Educational Programs and Quality of Services. The Company continually evaluates and strives to improve the quality of its preschool educational and child care services. KinderCare has invested significant resources in formulating a proprietary educational program, maintaining safe and up-to-date facilities and hiring, training and retaining high quality employees. The Company plans to continue to test and implement innovative services and offerings, such as its new continuous curriculum for infants and toddlers called Welcome To Learning(TM) and its new program for school-aged children called KC Imagination Highway(R), which encourages children to engage in meaningful, purposeful, long-lasting projects that require an active imagination. The Company also plans to continue encouraging its centers to become accredited by the National Association for the Education of Young Children, a national organization that has established comprehensive criteria for providing quality child care and has implemented a formal, though voluntary, child care center accreditation process. Improve Operational Effectiveness. In May 1997, the Company began to implement several organizational changes, including the addition of 22 area managers to reduce the span of control of field management and, thereby, provide more support and supervision to centers. The Company also created regional human resource manager and controller positions to provide more effective support for field operations. 4 The Company plans to continue to improve its operating performance primarily by reducing center labor costs through improved staff scheduling. The Company also plans to continue to leverage its economies of scale and purchasing power. Investment in Facilities. The Company plans to invest in a renovation program designed to bring all centers to a standard for physical plant and equipment over the next three to four years. The Company also plans to improve the delivery of required maintenance services to its centers. Capitalize on KinderCare's Strong Brand Identity. KinderCare's strong brand identity plays a significant role in the Company's continued growth of its preschool education and child care business, as management believes that, among other benefits, this factor contributes to higher enrollment for new child care centers. Furthermore, management believes there are opportunities to leverage the Company's brand identity. Possibilities include licensing of the KinderCare name for educational materials, clothes, toys and other consumer products, as well as potential brand extensions into other forms of educational or child care services, such as the operation of primary and private schools. Educational Programs The Company's educational programs are designed to provide opportunities for the development of the whole child, as embraced in the Company's slogan, The Whole Child Is The Whole Idea(R). The child-centered environment consists of classrooms that have been designed and furnished to meet the creative and developmental needs of young children. Classrooms encourage children to explore and learn at their own pace. The schedule of activities provides for quiet, active, group and individual participation with opportunities for outdoor play or specially designed Playscapes. The Company's age-specific programs offer a wide variety of curriculum activities based upon monthly topics and weekly themes such as transportation, seasons, colors, numbers, pets, safety, shapes and sizes. Each KinderCare center is designed to function as a neighborhood operation where the center director has the necessary autonomy to tailor the programs to the needs of the local community. The Company emphasizes selection of staff who are responsive to children and each teacher is given the opportunity, training and resources to plan active and creative programs. Opportunity for professional growth is available through company-wide training programs, the Certification of Excellence Program (a professional development program established by the Company) and tuition reimbursement for employment-related college course work or course work in connection with obtaining a Child Development Associate certificate. The Company also maintains an Education and Training Department in its corporate headquarters. This department is led by a professional with a Ph.D in early childhood education and is staffed by curriculum specialists. KinderCare's new program for infants and toddlers, Welcome To Learning(TM), is a continuous curriculum designed for children six weeks to thirty-six months and encourages children to learn with age and stage appropriate learning environments and activities. The new program replaces KinderCare's infant care program, Look At Me(R) and Let Me Do It(R). Welcome To Learning(TM), Level I is designed for infants (ages six weeks through fifteen 5 months) and Level II is designed for toddlers (ages twelve months to thirty-six months). Welcome To Learning(TM) is built upon four important components which provide the foundation or cornerstones of the new program: environment, interactions, parent involvement and developmental activities. Welcome To Learning(TM) involves parents in many ways including the daily My Day form, weekly and monthly parent activities and Welcome To Learning(TM) for Parents--a combination resource book, baby book and diary designed just for them. The Company has two preschool programs suitable for multi-age groups (ages three to five years). My Window On The World(R) is designed to encourage inquisitive children to discover questions and formulate answers using the world of nature. KinderCare utilizes Your Big Backyard, the National Wildlife Federation's magazine for preschoolers, as a resource for this program. Through this program, children learn expression through art, dramatic play, science, table games, books and music, as well as important language, literacy and math skills. The Company's Once Upon A Time...(TM) program based on children's literature, both classic and modern, is the second preschool program. The concepts developed in the stories provide a foundation for learning math relationships, colors and shapes, language and literacy skills, comparisons, social awareness, fine-motor skills and creative expression. Approximately two-thirds of the Company's centers have a Kindergarten at KinderCare program where children learn through play, as well as activities and experiences that are hands-on and sensory in nature. Children participate primarily in small group instruction and carefully designed free exploration activities that promote specific skills. Language arts, math, science, physical education, fine arts and music, health and safety and social studies are all curriculum components of the nationally recognized curriculum that supports Kindergarten at KinderCare, developed by Development Learning Materials, a division of Science Research Associates, Inc. The Company's KC Imagination Highway(R) program is designed to meet the needs of school-aged children. Because six to twelve-year-olds spend most of their school day sitting at desks and tables engaged in relatively quiet, traditional academic activities, the program is designed to include a number of stimulating and challenging activities and projects, ranging from loud and active to quiet, thoughtful and social. The foundation of this program is based upon group or individual involvement in projects. The goal is for children to use their imaginations to complete projects and present a culminating event or finale to parents. Tuition The Company determines tuition charges based upon a number of factors including age of child, full or part-time attendance, location and competition. Tuition is generally collected on a weekly basis in advance, and tuition rates are generally adjusted company-wide in the first week of November each year. For the fiscal years ended May 30, 1997 and May 31, 1996, the Company's weighted average weekly tuition rate was $103 and $101, respectively. 6 Seasonality New enrollments are generally highest in September and January. Enrollment generally decreases 5% to 10% during holiday periods and summer months. Marketing, Advertising and Promotions Management believes that its national presence and reputation for high quality preschool educational and child care services have created valuable and strong name recognition and parent loyalty. In an industry where personal trust and word-of-mouth referrals play a key role in attracting new customers, the Company believes that its reputation and strong name recognition are important competitive advantages. The Company intends to continue its marketing efforts through various promotional activities and customer retention and customer referral programs. Having implemented a lower cost marketing program in fiscal year 1997, in part by discontinuing national television advertising, the fall enrollment period in fiscal year 1998 will be supported by a direct mail and local merchandising campaign, as well as national magazine advertisements and radio advertisements in select markets. When new centers are opened, they receive the benefit of pre-opening direct mail support as well as local public relations support and newspaper advertisements. Every new center hosts an open house and provides for center tours where parents have opportunities to talk with staff, visit classrooms and play with educational toys and computers. Other aspects of the marketing programs offered by each KinderCare center include morning coffee for parents, periodic extended evening hours and a five o'clock snack that is provided to the children as they are picked up by their parents. Moreover, the Company sponsors a referral program under which parents receive free tuition for a week for every new customer referral that leads to a new enrollment and a new program for the 1997 fall season under which parents can give a free week to a newly referred customer. Center directors and staff also are trained to market to parents via telephone, local speaking engagements and interaction with local regulatory agencies that may then refer potential customers to the Company. A telephone inquiry tracking system is employed and center tours and "meet the teachers" events are held periodically. New parent orientation meetings are held in the fall at which center directors and staff explain educational and development programs as well as policies and procedures. In addition, the Company has established parent programs in centers to involve parents in center activities and events. At these events, the Company is able to build a high awareness of the center in the local community. In addition, each center has a five to seven member parent forum which functions as a sounding board for new ideas. Site Selection The Company seeks to identify attractive new sites for its centers in large, metropolitan markets and smaller, growth markets that meet the Company's operating and financial goals and where the Company believes the market for child care services will support higher tuition rates than the Company's existing rates. The Company's real estate department performs comprehensive studies of geographic markets to determine potential 7 areas for new center development. These studies include analyses of existing center areas, competitors, tuition pricing and demographic and marketplace data. Population, age, household income, employment levels, growth, land prices and development costs are all considered, as well as long-term growth opportunities for that market. In addition, the Company reviews state and local laws, including zoning requirements, development regulations and child care licensing regulations to determine the timing requirements and probability of receiving the necessary approvals to construct and operate a new child care center. The Company may identify several new specific areas from each broader geographical market study. KinderCare makes location decisions for new centers based upon a detailed site analysis that includes feasibility and demographic studies, as well as comprehensive financial modeling. Within a prospective specific area, the Company often analyzes several alternative sites. Each potential site is evaluated against the Company's standards for location, convenience, visibility, traffic patterns, size, layout, affordability and functionality, as well as potential competition. The real estate and development staff, working closely with operations, marketing and financial personnel, aims to open new centers with the highest achievable occupancy and profitability levels. Employer-Sponsored Child Care Services The Company organized its employer-sponsored child care services, referred to as KinderCare At Work(R), to offer businesses, universities and hospitals alternatives for providing on-site/near-site child care. These alternatives include developing and operating on-site/near-site centers, managing drop-in/back-up care centers and operating employers' on-site centers through management contracts. At July 25, 1997, the Company operated 38 on-site/near-site employer-sponsored child centers for corporations such as Delco Electronics Corp., Fred Meyer, Inc., Lego Systems, Inc., The Walt Disney Company, Inc. and several universities and hospitals. Of the 38 on-site/near-site centers, 35 are Company-owned or leased, with three operated by the Company under management fee contracts. The management contracts for KinderCare At Work(R) centers generally provide for a three-to-five-year initial period with renewal options ranging from two to five years. The Company's compensation under such agreements is generally based on a fixed fee with annual escalations. One KinderCare At Work(R) center was opened in fiscal year 1997. Human Resources Currently, the Company's center operations are organized into four regions and 53 areas reporting to a vice president of operations. The Company is currently adding 22 area manager positions and additional regional support personnel to support field management's focus on quality. Individual centers are managed by a director and an assistant director. All center directors participate in periodic training programs or meetings and must comply with applicable state and local licensing regulations. All center teachers and other 8 nonmanagement staff are required to attend an initial half-day training session prior to beginning work and to complete a six week on-the-job basic training program. Additionally, the Company has developed and implemented extensive training programs to certify personnel as teachers of various age groups in accordance with the Company's internal standards and in connection with its age-specific educational programs. Due to high employee turnover rates in the child care industry in general, the Company focuses on and emphasizes recruiting and retaining qualified personnel. The turnover of personnel experienced by the Company results in part from the fact that a significant portion of the Company's employees earn entry-level wages and are part-time employees. Management believes, however, that the turnover of the Company's employees is in line with other companies in the industry. Corporate Human Resources monitors salaries and benefits for competitiveness. The Company plans to develop an assessment program which will aid in identification of high quality area manager and center director candidates. The Company strives to ensure the care and safety of the children enrolled in its centers. Extensive precautions are taken to ensure the safety and well-being of all children; however, a small number of incidents of alleged child abuse have been reported. It is the Company's policy to report any allegation of abuse to the appropriate authorities, to investigate all allegations of abuse, and, if appropriate, to place any accused employee on administrative leave pending resolution of the incident. Although no assurances can be made that allegations of abuse will not occur in the future, the Company's procedures are designed to prevent child abuse and the Company has not historically experienced a material adverse impact from allegations of child abuse. Competition The U.S. child care and preschool education industry is highly fragmented and competitive. The Company's competition consists principally of local nursery schools and child care centers, some of which are nonprofit (including church-affiliated centers), providers of services that operate out of their homes and other for-profit companies which may operate a number of centers. Many church-affiliated and other local nonprofit nursery schools and child care centers have no or lower rental costs than the Company and may receive donations or other funding to cover operating expenses. Consequently, tuition rates at these facilities are commonly less than the Company's rates. Additionally, fees for home-based care are normally lower than fees for center-based care because providers of home care are not always required to satisfy the same health, safety or operational regulation as the Company's centers. The Company's competition also consists of other large, national, for-profit child care companies that may have more aggressive tuition discounting and other pricing policies than the Company. The Company competes by offering professionally planned educational and recreational programs, contemporary, well-equipped facilities, trained teachers and supervisory personnel and a range of services, including infant and toddler care, drop-in service and the transportation of older children enrolled in the Company's before and after-school program between the Company's child care centers and schools. 9 Employees At July 25, 1997, the Company employed approximately 22,400 persons, of whom 270 were employed at corporate headquarters, 170 were regional or area managers and support personnel and the remainder were employed at the centers. Center employees include center directors; assistant directors; regular full-time and part-time teachers; temporary and substitute teachers; teachers' aides and non-teaching staff, including cooks and van drivers. Approximately 10% of the 22,400 employees, including all management and supervisory personnel are salaried, all other employees are paid on an hourly basis. The Company does not have an agreement with any labor union and believes that its relations with its employees are good. Governmental Laws and Regulation Child care centers are subject to numerous state and local regulations and licensing requirements and the Company has policies and procedures in place in order to comply with such regulations and requirements. Although these regulations vary from jurisdiction to jurisdiction, government agencies generally review the fitness and adequacy of buildings and equipment, the ratio of staff personnel to enrolled children, staff training, record keeping, the dietary program, the daily curriculum and compliance with health and safety standards. In most jurisdictions, these agencies conduct scheduled and unscheduled inspections of the centers and licenses must be renewed periodically. Repeated failures of a center to comply with applicable regulations can subject it to sanctions, which might include probation or, in more serious cases, suspension or revocation of the center's license to operate. The Company believes that its operations are in substantial compliance with all material regulations applicable to its business. There are certain tax incentives for child care programs. Section 21 of the Internal Revenue Code of 1986, as amended (the "Code"), provides a federal income tax credit ranging from 20% to 30% of certain child care expenses for "qualifying individuals" (as defined therein). The fees paid to the Company for child care services by eligible taxpayers qualify for the tax credit, subject to the limitations of Section 21 of the Code. During fiscal year 1997, approximately 13% of the Company's net operating revenues were generated from federal and state child care assistance programs, primarily the Child Care and Development Block Grant and At-Risk Programs. These programs are designed to assist low-income families with child care expenses and are administered through various state agencies. Although, under new legislation signed by President Clinton in August 1996, additional funding for child care will be available for low income families as part of welfare reform, no assurance can be given that the Company will benefit from any such additional funding. The Federal Americans With Disabilities Act (the "Disabilities Act") prohibits discrimination on the basis of disability in public accommodations and employment. The Disabilities Act became effective as to public accommodations in January, 1992 and as to employment in July, 1992. Since effectiveness of the Disabilities Act, the Company has not experienced any material adverse impact as a result of the legislation. 10 Insurance The Company's insurance program currently includes the following types of policies: workers' compensation, comprehensive general liability, automobile liability, property, excess "umbrella" liability and a medical payment program for accidents which applies to each child enrolled in a Company center. The policies provide for a variety of coverages, are subject to various limits, and include substantial deductibles or self-insured retention. Special insurance is sometimes obtained with respect to specific hazards, when and if deemed appropriate and available at reasonable cost. At July 25, 1997, the Company had approximately $7.5 million of letters of credit available to secure its obligations under retrospective and self-insurance programs. There is no assurance that claims in excess of, or not included within, the Company's coverage will not be asserted, the effect of which could have an adverse effect on the Company. Communication and Information Systems The Company has a fully automated information, communication and financial reporting system for its centers. The system uses personal computers and links every center and regional office to the corporate headquarters. This system provides timely information on such items as weekly revenues, expenses, enrollments, attendance, payroll and staff hours. The Company is also updating its financial reporting and human resources systems to provide more comprehensive and timely information throughout the Company. The Company also seeks to improve its operating efficiencies by continually reviewing the effectiveness and coverage of its support services and providing management with more timely information through its nationwide communications network and its automated information systems. The Company employs company-wide e-mail and on-line inquiry for all managers. KinderCare has also expanded its nationwide network to include the Internet and company-wide Intranet applications. Through the use of Netscape Navigator(R) software, the Company's intranet, called "KinderNet," allows center directors to have immediate access to corporate information and provides center directors with the ability to distribute reports and questionnaires, update databases and revise center listings on a daily basis. The Company believes that the sophistication and scope of its communications network and information system makes its system one of the more advanced in the child care industry and enables it to improve further the efficiency and quality of child care and enhance the educational experience of KinderCare students. Trademarks The Company has various registered and unregistered trademarks covering the name KinderCare, its schoolhouse logo, and a number of other names, slogans and designs, including, but not limited to: KinderCare At Work(R), My Window On The World(R), Helping America's Busiest Families(R), Look At Me(R), Let Me Do It(R), Let's Move, Let's Play(R), Small Talk(R), The Whole Child Is The Whole Idea(R), Once Upon A Time...(TM), Kid's Choice(TM), KC Imagination Highway(R), Playscapes At KinderCare(R) and Welcome To 11 Learning(TM). A federally registered trademark in the United States is effective for ten years subject only to a required filing and the continued use of the mark by the registrant. A federally registered trademark provides the presumption of ownership of the mark by the registrant in connection with its goods or services and constitutes constructive notice throughout the United States of such ownership. In addition, the Company has registered various trademarks in certain other countries, including Canada, Germany, Japan, the Peoples Republic of China and the United Kingdom. The Company believes that its name and logo are important to its operations and intends to continue to renew the trademark registrations thereof. ITEM 2. PROPERTIES The Company's home office is presently located in Montgomery, Alabama, in a 68,000 square foot building owned by the Company. The Company is in the process of relocating its corporate headquarters to Portland, Oregon. The Company currently expects to sell its Montgomery headquarters building following relocation of its headquarters functions. The Company has entered into a 10-year lease of approximately 70,000 square feet of office space currently under construction in Portland, Oregon. The lease term will run from the date of occupancy, currently expected to be early November 1997. The lease calls for annual rental payments of $22.50 per square foot for the first five years of the lease term and $26.50 for the final five years, with one five-year extension option at market rent. At July 25, 1997, the Company owned 728 of its operating child care centers, leased or subleased 413 operating child care centers and operated three child care centers under management contracts. The Company owns or leases certain other child care centers which have not yet been opened or which are being held for disposition. In addition, the Company owns certain real property held for future development of centers. A typical KinderCare community center is a one-story, air-conditioned building located on approximately one acre of land (larger capacity centers are situated on parcels ranging from one to four acres of land) constructed in accordance with model designs generally developed by the Company. The community centers contain open classroom and play areas and complete kitchen and bathroom facilities and can accommodate from 130 to 280 children, with most centers able to accommodate 90 to 135 children. Over the past few years, the Company opened community centers that are larger in size with a capacity ranging from 165 to 280 children. New prototype community centers accommodate approximately 180 children, depending on site and location. Each center is equipped with a variety of audio and visual aids, educational supplies, games, puzzles, toys and vehicles used for field trips and transporting children enrolled in the Company's after-school program. All KinderCare community centers are equipped with computers for children's educational programs. KinderCare At Work(R) provides child care programs individualized for each corporate sponsor. Facilities are on or near the corporate sponsor's site and range in capacity from 80 to 220 children. Kid's Choice(TM) centers contain homework, computer and game rooms and are able to accommodate from 75 to 180 children. Each provides school-age children with areas to perform activities of interest to them. 12 The KinderCare community, KinderCare At Work(R) and Kid's Choice(TM) centers operated by the Company at July 25, 1997 were located as follows:
Kids Community KinderCare At Choice(TM) Location Centers Work(R) Centers Centers Total --------------------- --------- --------------- --------- --------- Alabama 11 -- 1 12 Arizona 16 2 -- 18 Arkansas 4 -- -- 4 California 92 -- 2 94 Colorado 24 -- 1 25 Connecticut 13 2 -- 15 Delaware 5 -- -- 5 Florida 67 6 2 35 Georgia 37 -- 2 39 Illinois 73 3 8 84 Indiana 26 1 1 28 Iowa 7 2 1 10 Kansas 18 -- -- 18 Kentucky 13 1 1 15 Louisiana 13 2 -- 15 Maryland 23 -- 1 24 Massachusetts 17 -- -- 17 Michigan 32 2 1 35 Minnesota 31 -- 1 32 Mississippi 4 -- -- 4 Missouri 48 -- -- 48 Nebraska 10 1 -- 11 Nevada 10 -- -- 10 New Jersey 29 4 -- 33 New Mexico 7 -- -- 7 New York 2 1 -- 3 North Carolina 33 -- 2 35 Ohio 56 3 6 65 Oklahoma 10 -- -- 10 Oregon 13 3 -- 16 Pennsylvania 41 -- -- 41 Rhode Island -- 1 -- 1 Tennessee 27 1 2 30 Texas 121 1 7 129 Utah 6 1 -- 7 Virginia 52 -- 2 54 Washington 47 -- 2 49 Wisconsin 23 1 -- 24 United Kingdom 2 -- -- 2 --------- --------------- --------- --------- Total 1,063 38 43 1,144 ========= =============== ========= =========
Subsequent to January 1, 1993, the Company renegotiated approximately 70 leases related to under-performing centers in order to amend the terms and allow the Company to terminate these leases at any time with minimal notice. In connection with the termination option, the Company, in certain instances, prepaid rent totaling approximately $3.2 million. Such amounts are being amortized over the termination period or over the appropriate remaining months of the lease period. Commitments under these amended leases totaled 13 approximately $16.8 million over the original lease terms. Upon giving the landlord termination notice of at least six months, the amendments provide that the Company would be permitted to utilize the facilities for the final six-month period rent-free, as well as relieve itself of all future commitments remaining under the lease. At July 25, 1997, the Company has elected to close 34 of these centers and the remaining unamortized prepaid balance is $2.3 million. The Company utilizes a centralized maintenance program to ensure consistent high-quality maintenance of its facilities located across the country. The department's maintenance technicians, each with a van stocked with spare parts, handle routine and preventative maintenance functions through the central telephone dispatch and systematic checklist system. Each technician is responsible for the support of approximately 25 centers. A level of supervision also has been added to provide guidance and additional technical support to the technicians. Specific geographic areas are supervised by four regional directors and nine facility managers, each of whom manages between three and eight technicians. The Company plans to undertake a renovation program to ensure that all of its centers meet specified standards to be established by the Company. The Company anticipates that it will take three to four years to complete this planned renovation. The Company believes that its properties are in good condition and are adequate to meet its current and reasonably anticipated future needs. ITEM 3. LEGAL PROCEEDINGS The Company is presently, and is from time to time, subject to claims and suits arising in the ordinary course of business, including suits alleging child abuse. In certain of such actions, plaintiffs request damages that are covered by insurance. The Company believes that none of the claims or suits of which it is aware will materially affect its financial position, operating results or cash flows, although absolute assurance cannot be given with respect to the ultimate outcome of any such actions. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 14 ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below are the names, ages, positions with the Company and employment history of each of the executive officers of the Company, together with certain other key personnel:
Year First Elected Director or Name Age Position with Company Officer - ---- --- --------------------- ----------- David J. Johnson 51 Chief Executive Officer and Chairman of the Board 1997 Beth A. Ugoretz 42 Executive Vice President, Corporate Services 1997 Bruce Walters 40 Senior Vice President and Chief Development Officer 1997 Edward L. Brewington 54 Vice President, Human Resources 1997 Robert H. Fries 48 Vice President, Treasurer 1996 Marcia P. Guddemi, Ph.D. 44 Vice President, Education, Research and Training 1991 Mark F. Hoffmann 33 Vice President, Real Estate 1996 S. Wray Hutchinson 36 Vice President, Operations 1996 Dan R. Jackson 43 Vice President, Financial Controls and Planning 1997 Eva M. Kripalani 38 Vice President, General Counsel and Secretary 1997 Bobby J. Willey 56 Vice President, Information Services 1995
Mr. Johnson joined the Company as Chief Executive Officer and Chairman in February 1997. Between September 1991 and November 1996, Mr. Johnson served as President, Chief Executive Officer and Chairman of the Board of Red Lion Hotels, Inc. (formerly a KKR affiliate) or its predecessor. From 1989 to September 1991, Mr. Johnson was a general partner of Hellman & Friedman, a private equity investment firm based in San Francisco. From 1986 to 1988, he served as President, Chief Operating Officer and director of Dillingham Holdings, a diversified company headquartered in San Francisco. From 1984 to 1987, Mr. Johnson was President and Chief Executive Officer of Cal Gas Corporation, a principal subsidiary of Dillingham Holdings. Ms. Ugoretz joined the Company as Executive Vice President of Corporate Services in March 1997. Ms. Ugoretz served as Senior Vice President, General Counsel and Secretary of Red Lion Hotels, Inc. or its predecessor from June 1993 to December 1996. Prior to that time, Ms. Ugoretz was a partner with the law firm of Stoel Rives LLP in Portland, Oregon, where she had worked since 1983. Mr. Walters joined the Company as Senior Vice President and Chief Development Officer in July 1997. From June 1995 to February 1997, Mr. Walters served as the Executive Vice President of Store Development for Hollywood Entertainment Corporation in Portland, Oregon. Prior to that time, Mr. Walters spent 14 years with McDonald's Corporation in various domestic and international development positions. Mr. Brewington joined the Company as Vice President of Human Resources in April 1997. From June 1993 to April 1997 Mr. Brewington was with Times Mirror Training Group where his last position held was Vice President, Human Resources. Prior to that time, Mr. Brewington spent 25 years with IBM in various human resource, sales and marketing positions. 15 Mr. Fries was promoted to Vice President and Treasurer in April 1996. Mr. Fries began his employment with the Company in March 1994 as Assistant Treasurer, Debt and Income Taxes and Assistant Secretary. Prior to joining KinderCare, Mr. Fries served as Director of Taxes for Blount, Inc. from 1986 until 1994. Dr. Guddemi joined the Company in August 1991 as Vice President of Education and Research. For over five years prior to joining the Company, she was an assistant professor of early childhood education at the University of South Florida and at the University of South Carolina. Mr. Hoffmann joined the Company in February 1996 as Vice President of Real Estate. Prior to joining the Company, Mr. Hoffmann served as the Director of Real Estate for B.C. Great Lakes, LLC from 1993 until 1996 and in various real estate management positions of increased responsibility with Taco Bell Corporation from 1989 through 1993. Mr. Hutchinson was promoted to Vice President of Operations in April 1996. He began his employment with the Company in 1992 as a District Manager in New Jersey and was later promoted to Region Manager for the Chicago area. From 1990 until 1992, Mr. Hutchinson was self-employed. Mr. Jackson joined the Company in February 1997 as Vice President of Financial Controls and Planning. Prior to that time, Mr. Jackson served as Vice President Controller for Red Lion Hotels, Inc., or its predecessor, from September 1985 to January 1997. From 1978 to 1985, Mr. Jackson held several financial management positions with Harsch Investment Corporation, a real estate holding company based in Portland, Oregon. Ms. Kripalani joined the Company as Vice President, General Counsel and Secretary in July 1997. Prior to joining the Company, Ms. Kripalani was a partner in the law firm of Stoel Rives LLP in Portland, Oregon, where she had worked since 1987. Mr. Willey joined the Company in June 1995 as Vice President of Information Services. From 1992 to 1995, Mr. Willey served as MIS Director for PETSTUFF, Inc. and was Corporate Information Officer for ANCO Management Service, Inc. from 1989 to 1992. 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCK HOLDER MATTERS Price Range of Common Stock Until February 13, 1997, the date of the Merger, the common stock traded on the Nasdaq National Market System under the symbol KCLC. Following the Merger, the common stock was delisted from the Nasdaq National Market System and thereafter has been traded only in the over-the-counter market under the symbol KDCR. The following table sets forth, for the fiscal periods indicated, the high and low sales prices, rounded to the nearest eighth, reported by the Nasdaq National Market System with respect to sales of the common stock prior to February 13, 1997:
Common Stock --------------------------- High Low ----------- --------- Fiscal year ended May 30, 1997 First Quarter $ 15 11/16 $ 13 7/8 Second Quarter 20 15 1/4 Third Quarter (through February 13, 1997) 20 18 1/8 Fiscal year ended May 31, 1996 First Quarter $ 14 5/8 $ 12 1/4 Second Quarter 14 1/4 11 3/4 Third Quarter 13 3/8 11 3/4 Fourth Quarter 15 2/5 12 1/4
Since February 13, 1997, the Company's common stock has been traded in the over-the-counter market, in the "pink sheets" published by the National Quotation Bureau, and has been listed on the OTC Bulletin Board under the symbol KDCR. The market for the Company's common stock must be characterized as a limited market due to the relatively low trading volume and the small number of brokerage firms acting as market makers. The following table sets forth, for the periods indicated, certain information with respect to the high and low bid quotations for the common stock as reported by a market maker for the Company's common stock. The quotations represent inter-dealer quotations without retail markups, markdowns or commissions and may not represent actual transactions. No assurances can be given that the prices for the Company's common stock will be maintained at their present levels.
Common Stock ----------------------------- High Bid Low Bid ------------ ------------ Fiscal year ended May 30, 1997 February 13, 1997 to March 7, 1997 $ 19 $ 19 Fourth Quarter N/A* N/A* * The Company was unable to identify any trades in the common stock in the over-the counter market during this period.
17 Approximate Number of Security Holders At July 25, 1997, there were approximately 80 holders of record of the Company's common stock. All warrants outstanding prior to the Merger were cancelled and converted into the right to receive an amount in cash determined as specified in the Merger Agreement at the effective time of the Merger. Dividend Policy During the past three fiscal years, the Company has not declared or paid any cash dividends or distributions on its capital stock. The Company currently intends to retain earnings of the Company for operations and does not anticipate paying cash dividends on the common stock in the foreseeable future. Further, the 9-1/2% senior subordinated notes due 2009 and the credit facilities entered into by the Company in connection with the Merger restrict any payment of dividends. 18 ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA The following table sets forth selected historical consolidated financial and other data for the Company. This information should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto and the information set forth in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The consolidated statement of operations for the year ended May 28, 1993 is presented for comparison to the fiscal years ended May 30, 1997, May 31, 1996, June 2, 1995 and June 3, 1994 to reflect the Company's change in fiscal year. On November 10, 1992, the Company filed a pre-arranged petition under Chapter 11 of the United States Bankruptcy Code. On March 31, 1993 the Company emerged from bankruptcy pursuant to its plan of reorganization. Due to the implementation on April 2, 1993 of fresh start reporting in accordance with AICPA Statement of Position 90-7 Financial Reporting by Entities in Reorganization Under the Bankruptcy Code ("SOP 90-7"), the consolidated statement of operations for the year ended May 28, 1993 includes both pre- and post-bankruptcy amounts, and is therefore not comparable to the other periods presented. The consolidated balance sheet data for the Company at May 30, 1997, May 31, 1996, June 2, 1995, June 3, 1994 and May 28, 1993 and the consolidated statements of operations data for the fiscal years ended May 30, 1997, May 31, 1996, June 2, 1995, June 3, 1994 and the eight weeks ended May 28, 1993, after giving effect to the Company's plan of reorganization, pursuant to which it emerged from bankruptcy on March 31, 1993, are not comparable to the historical financial condition or results of operations of the Company prior to the plan of reorganization. 19
Selected Historical Consolidated Financial and Other Data KinderCare Learning Centers, Inc. and Subsidiaries (Dollars in thousands, except per share amounts and child care center data) Post-Confirmation ------------------------------------------------------------------------ Fiscal Year Ended --------------------------------------------------------- Eight Weeks June 3, 1994 Ended May 30, 1997 May 31, 1996 June 2, 1995 (53 Weeks) May 28, 1993 ------------------------------------------------------------------------ Statement of Operations Data (b): Operating revenues, net $ 563,135 $ 541,264 $ 506,505 $ 488,726 $ 72,612 Operating expenses, exclusive of recapitalization expenses, restructuring and other charges (income), net 515,481 488,071 456,607 441,560 68,609 Recapitalization expenses (d) 17,277 -- -- -- -- Restructuring and other charges (income), net (e) 10,275 1,484 (888) -- -- ------------------------------------------------------------------------ Operating income (loss) 20,102 51,709 50,786 47,166 4,003 Net investment income 232 250 2,635 3,176 140 Interest expense 22,394 16,727 17,318 17,675 3,253 Reorganization items -- -- -- -- -- ------------------------------------------------------------------------ Income (loss) before taxes and extraordinary items (2,060) 35,232 36,103 32,667 890 Income tax expense (benefit) 3,375 13,549 14,037 12,837 273 ------------------------------------------------------------------------ Income (loss) before extraordinary items (5,435) 21,683 22,066 19,830 617 Extraordinary items, net of income taxes (7,532)(h) -- -- (2,397)(h) -- ------------------------------------------------------------------------ Net income (loss) $ (12,967) $ 21,683 $ 22,066 $ 17,433 $ 617 ======================================================================== Earnings (loss) per share (b): Primary - Income (loss) before extraordinary item, net $ (0.33) $ 1.10 $ 1.07 $ 0.97 $ 0.03 Extraordinary item, net (0.46) -- -- (0.12) -- ------------------------------------------------------------------------ Net income (loss) $ (0.79) $ 1.10 $ 1.07 $ 0.85 $ 0.03 ======================================================================== Fully diluted - Net income (loss) $ 1.05 =============== Other Financial Data (b): EBITDA (j) $ 47,055 $ 85,931 $ 81,492 $ 73,093 $ 8,373 Adjusted EBITDA (j) 81,907(k) 87,165(k) 77,969 72,314 8,233 Adjusted EBITDA margin 14.5% 16.1% 15.4% 14.8% 11.3% Capital expenditures $ 43,748 $ 67,304 $ 74,376 $ 35,710 $ 5,839 Child Care Center Data (b): Number of centers at end of period 1,144 1,148 1,137 1,132 1,166 Center licensed capacity at end of period 143,000 141,000 N/C(1) N/C(1) N/C(1) Occupancy (m) 70% 70% N/C(1) N/C(1) N/C(1) Average tuition rate (n) $ 103 $ 101 N/C(1) N/C(1) N/C(1) Balance Sheet Data (at end of period) (b): Total assets $ 569,878 $ 527,476(o) $ 503,274(o) $ 458,920(o) $ 459,388(o) Total debt (p) 394,889 146,617 160,394 178,692 218,037 Shareholders' equity 27,707(q) 262,435(o) 241,216(o) 203,882(o) 176,464(o) See accompanying notes to selected historical consolidated financial and other data.
20
Selected Historical Consolidated Financial and Other Data, cont'd. KinderCare Learning Centers, Inc. and Subsidiaries (Dollars in thousands, except per share amounts and child care center data) Pre-Confirmation ------------------------------------------ Thirteen Fiscal Year Year Ended Weeks Ended Ended May 28, April 2, January 1, 1993(a) 1993(a) 1993(a) ------------ ------------ ------------ Statement of Operations Data (b): Operating revenues, net $ 447,243 $ 114,705 $ 437,203 Operating expenses, exclusive of recapitalization expenses, restructuring and other charges (income), net 423,841 104,675 413,800(c) Recapitalization expenses (d) -- -- -- Restructuring and other charges (income), net (e) -- -- -- ------------------------------------------ Operating income (loss) 23,402 10,030 23,403 Net investment income 8,686 3,309 5,908 Interest expense 24,709(f) 692(f) 38,400(f) Reorganization items 103,483(g) 101,604(g) 1,879 ------------------------------------------ Income (loss) before taxes and extraordinary items (96,104) (88,957) (10,968) Income tax expense (benefit) (216) 404 (246) ------------------------------------------ Income (loss) before extraordinary items (95,888) (89,361) (10,722) Extraordinary items, net of income taxes 157,573(i) 157,573(i) -- ------------------------------------------ Net income(loss) $ 61,685 $ 68,212 $ (10,722) ========================================== Earnings (loss) per share (b): Primary - Income (loss) before extraordinary item, net N/A(a) $ (1.71) $ (0.21) Extraordinary item, net N/A(a) 3.01 -- ------------------------------------------ Net income (loss) N/A(a) $ 1.30 $ (0.21) ========================================== Fully diluted - Net income (loss) Other Financial Data (b): EBITDA (j) $ 114,175 $ 76,173 $ 54,281 Adjusted EBITDA (j) 51,399 16,895 50,252 Adjusted EBITDA margin 11.5% 14.7% 11.5% Capital expenditures 38,112 5,927 34,498 Child Care Center Data (b): Number of centers at end of period 1,166 1,166 1,196 Center licensed capacity at end of period N/C(1) N/C(1) N/C(1) Occupancy (m) N/C(1) N/C(1) N/C(1) Average tuition rate (n) N/C(1) N/C(1) N/C(1) Balance Sheet Data (at end of period) (b): Total assets $ 459,388(o) Total debt (p) 218,037 Shareholders' equity 176,464(o) See accompanying notes to selected historical consolidated financial and other data.
21 Notes to Selected Historical Consolidated Financial and Other Data (a) Due to the implementation of fresh start reporting, the consolidated financial statements of the Company after April 2, 1993 are not comparable in all material respects to any financial statements prior to that time and the operating results for the year ended May 28, 1993 include both pre- and post-bankruptcy amounts. Additionally, the presentation of historical earnings per share information for periods including both pre- and post-bankruptcy amounts are not meaningful. Primary earnings (loss) per share data on a pro-forma basis, assuming 20,000,000 shares of new common stock (issued at April 2, 1993, the effective time of the plan of reorganization) had been outstanding since the beginning of the year ended May 28, 1993 would be as follows: Loss before extraordinary item, net $(4.79) Extraordinary item, net 7.87 ------ Net income $ 3.08 ====== (b) The Company's fiscal year ends on the Friday closest to May 31. (c) In fiscal year 1992, $4.0 million of the 1990 closed center reserves were recaptured which reduced operating expenses. In addition, debt restructuring costs incurred in connection with the Company's efforts to reorganize its debt prior to filing for Chapter 11 on November 10, 1992 of $5.3 million are included in operating expenses for fiscal year 1992. (d) In fiscal year 1997, the Company incurred non-recurring recapitalization costs in order to fund the transactions contemplated by the Merger. (e) Restructuring and other charges (income), net, include restructuring charges of $3.4 million and $6.5 million in fiscal years 1997 and 1996, respectively, losses on asset impairments of $6.9 million and $6.3 million in fiscal years 1997 and 1996, respectively, gains on litigation settlements of $(1.5) million, $(11.3) million and $(0.9) million in fiscal years 1997, 1996 and 1995, respectively, and charges of $1.5 million to write-off certain assets in fiscal year 1997. (f) During the Chapter 11 petition from November 10, 1992 through March 31, 1993, the Company did not pay or accrue interest on approximately $356.5 million of debt obligations classified as liabilities subject to settlement under reorganization proceedings. (g) Reorganization items for the year ended May 28, 1993 and the 13 weeks ended April 2, 1993 include $97.7 million of net adjustments to state assets and liabilities at fair value in connection with the adoption of fresh start reporting. (h) In fiscal years 1994 and 1997, the Company retired debt prior to maturity, the losses on which were recorded as extraordinary items. (i) In connection with the Company's emergence from bankruptcy in fiscal year 1993, the value of cash distributed, new debt and equity securities issued and liabilities assumed was $157.6 million less than the allowed claims of $457.6 million and the resulting gain was recorded as an extraordinary item. (j) "EBITDA" represents earnings before interest expense, income taxes, depreciation and amortization. "Adjusted EBITDA" represents EBITDA exclusive of recapitalization 22 expenses, restructuring and other charges (income), net, investment income and extraordinary items. Neither EBITDA nor Adjusted EBITDA is intended to represent cash flow from operations as defined by generally accepted accounting principles and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. Adjusted EBITDA is presented because the Company believes that Adjusted EBITDA represents a more consistent financial indicator of the Company's ability to service its debt. (k) See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." (l) Prior to June 3, 1995, the Company utilized average occupancy and the three year old tuition rate to measure performance. Average occupancy was defined as actual operating revenues for the respective period divided by the building capacity of each of the Company's centers multiplied by such center's basic tuition rate for full-time, three-year-old students for the respective period. The three-year-old tuition rate represents the weekly tuition rate paid by a parent for a three-year-old child to attend a KinderCare center five full days during one week. The three-year-old tuition rate represented an approximate average of all tuition rates at each center. The child care center data utilized in prior fiscal years to measure performance is as follows:
Fiscal Year Ended --------------------------------------------- May 31,1996 June 2, 1995 June 3, 1994 Year Ended (53 weeks) May 28, 1993 ------------------------------------------------------------- Center building capacity at end of period 141,000 137,000 136,000 138,000 Average occupancy 76% 76% 77% 74% Average three-year-old tuition rate $ 100 $ 96 $ 90 $ 83
At June 3, 1995, the Company changed its method of measuring performance to the utilization of occupancy and average tuition rate (see notes (m) and (n) below). (m) Occupancy, a measure of the utilization of center capacity, is defined by the Company as the full-time equivalent ("FTE") attendance at all of the Company's centers divided by the sum of the licensed capacity of all of the Company's centers. FTE attendance is not a strict head count. Rather, the methodology is to determine an approximate number of full-time children based on weighted averages. For example, an enrolled full-time child equates to one FTE, while a part-time child enrolled for a half-day would equate to 0.5 FTE. The FTE measurement of center capacity utilization does not necessarily reflect the actual number of full- and part-time children enrolled. (n) Average tuition rate is defined by the Company as actual net operating revenues, exclusive of fees (primarily reservation and registration), divided by FTE attendance for the respective period. The average tuition rate represents the approximate weighted average tuition rate, at each center, paid by a parent for a child to attend a KinderCare center five full days during one week. Center occupancy mix, however, can significantly affect these averages with respect to any specific child care center. (o) At the Company's emergence from bankruptcy in 1993, the Company did not record a liability for accrued but untaken employee vacation. Accordingly, the accompanying financial statements for periods prior to June 1, 1996 and subsequent to the Company's 23 emergence from bankruptcy have been restated. The net effect of the restatement was to decrease additional paid-in capital by $3.0 million, reflecting the vacation accrual of $5.0 million net of the deferred tax effect of $2.0 million. The effect of the restatement is not material to the results of operations. (p) Total debt includes long-term debt, current portion of long-term debt and, at January 1, 1993, debt obligations of $356.5 million classified as liabilities subject to settlement under reorganization proceedings. (q) As part of the Merger and related transactions, KKR, through KCLC, contributed $148.75 million in common equity for approximately 83.6% of the shares outstanding immediately after the Merger and existing stockholders retained approximately 16.4% of the shares outstanding immediately after the Merger. 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this document. The Company's fiscal year ends on the Friday closest to May 31. The information presented herein refers to the years ended May 30, 1997 ("fiscal 1997"), May 31, 1996 ("fiscal 1996"), and June 2, 1995 ("fiscal 1995"), each of which was a 52-week fiscal year. Occupancy, a measure of the utilization of center capacity, is defined by the Company as the full-time equivalent ("FTE") attendance at all of the Company's centers divided by the sum of the licensed capacity of all of the Company's centers. FTE attendance is not a strict head count. Rather, the methodology is to determine an approximate number of full-time children based on weighted averages. For example, an enrolled full-time child equates to one FTE, while a part-time child enrolled for a half-day would equate to 0.5 FTE. The FTE measurement of center capacity utilization does not necessarily reflect the actual number of full- and part-time children enrolled. Average tuition rate is defined by the Company as actual net operating revenues, exclusive of fees (primarily reservation and registration), divided by FTE attendance for the respective period. The average tuition rate represents the approximate weighted average tuition rate at each center paid by a parent for a child to attend a KinderCare center five full days during one week. Center occupancy mix, however, can significantly affect these averages with respect to any specific child care center. Fiscal 1997 compared to Fiscal 1996 The following table shows the comparative operating results of the Company (dollars in thousands):
Fiscal Fiscal Change Year Ended Percent Year Ended Percent Amount May 30, of May 31, of Increase/ 1997 Revenues 1996 Revenues (Decrease) ---------- -------- ----------- ---------- ---------- Operating revenues, net $ 563,135 100.0% $ 541,264 100.0% $ 21,871 ---------- ---------- ----------- ---------- ---------- Operating expenses: Salaries, wages and benefits 300,580 53.4 284,115 52.5 16,465 Depreciation 34,253 6.1 33,972 6.3 281 Rent 28,140 4.9 26,515 4.9 1,625 Other 152,508 27.1 143,469 26.5 9,039 Recapitalization expenses 17,277 3.1 -- -- 17,277 Restructuring and other charges (income), net 10,275 1.8 1,484 0.2 8,791 ---------- ---------- ----------- ---------- ---------- Total operating expenses 543,033 96.4 489,555 90.4 53,478 ---------- ---------- ----------- ---------- ---------- Operating income $ 20,102 3.6% $ 51,709 9.6% $ (31,607) ========== ========== =========== ========== ==========
Operating revenues, net - Net operating revenues increased $21.9 million, or 4.0%, to $563.1 million in fiscal 1997 versus fiscal 1996. The increase in net operating revenues is primarily attributable to a 4.7% weighted average tuition increase implemented in the fall of 25 1996 and to new center openings and acquisitions. The average tuition rate increased to $103 in fiscal 1997 from $101 in fiscal 1996. The positive effect of those factors on net operating revenues was offset in part by declines in total company average occupancy and center closings. Total Company occupancy decreased slightly to 70.0% in fiscal 1997 from 70.3% in fiscal 1996. The Company believes the decline in occupancy was caused by a variety of factors including, in particular, the following recently implemented initiatives: (a) a reduced, lower cost marketing program, (b) an expanded employee child care discount program that may have precluded the enrollment of tuition paying children, and (c) changes in field operations management which provided less direct center supervision. The Company is in the process of evaluating such initiatives and has made certain revisions including funding a targeted marketing program for early fiscal year 1998, limiting the employee child care discount effective July 1997 and adding certain area manager positions and additional regional field support to increase center supervision and support. During fiscal 1997, the Company opened 16 new centers: 15 KinderCare community centers and one KinderCare At Work(R) center; and closed or sold 20 centers. During fiscal 1996, the Company opened 37 new centers: 22 KinderCare community centers, six KinderCare At Work(R) centers and nine Kid's Choice(TM) centers (including the conversion of one community center to a Kid's Choice(TM) center); and closed or sold 26 centers. Consequently, total licensed capacity increased to 143,000 at the end of fiscal 1997 from 141,000 at the end of fiscal 1996. Salaries, wages and benefits - Salaries, wages and benefits expense increased $16.5 million, or 5.8%, to $300.6 million in fiscal 1997 versus fiscal 1996. Approximately $7.0 million and $7.7 million of the year-to-date increases are attributable to increased center staff hours and wage rates, respectively. Average hourly center staff wages increased approximately 4.1% for fiscal 1997 versus fiscal 1996. Further, benefit costs have increased slightly due to the partial implementation of new employee health insurance plans. As a percentage of net operating revenues, salaries, wages and benefits expense increased to 53.4% in fiscal 1997 from 52.5% in fiscal 1996. Depreciation - Depreciation expense increased to $34.3 million in fiscal 1997 from $34.0 million in fiscal 1996 due to asset additions related to renovations of existing centers, purchases of short lived assets and to the opening of 16 new centers, offset partially by the closing of 20 older centers in fiscal 1997 and by a reduction in depreciation expense related to certain assets reaching the end of their estimated depreciable lives. Rent - Rent expense increased to $28.1 million in fiscal 1997 from $26.5 million in fiscal 1996. The increase is primarily a result of lease renewals at current market rates. During fiscal 1997, five leased centers were opened and 17 leased centers were closed. The rental rates experienced on leases entered into in fiscal 1997 are higher than those experienced in previous years. For fiscal year 1998, rent expense will include rent associated with the Company's new corporate headquarters in Portland, Oregon. See "Item 2. Properties." 26 Other operating expenses - Other operating expenses increased to $152.5 million in fiscal 1997 from $143.5 million in fiscal 1996. As a percentage of net operating revenues, other operating expenses increased to 27.1% in fiscal 1997 from 26.5% in fiscal 1996. This increase is principally due to increased center level operating and insurance costs and a provision for lease termination costs, offset partially by a reduced, lower cost marketing program and improved administrative and center support efficiencies from re-engineering efforts initiated during fiscal 1996. Recapitalization expenses - During fiscal 1997 and in connection with the merger of the Company and KCLC Acquisition Corp. ("KCLC"), a wholly owned subsidiary of a partnership formed at the direction of Kohlberg Kravis Roberts & Co., a private investment firm ("KKR") (the "Merger"), the Company repaid the $91.6 million balance on the Company's previous $150.0 million credit facility and paid $382.4 million to redeem common stock, warrants and options. In order to fund the transactions contemplated by the Merger (the "Recapitalization"), the Company issued $300.0 million principal amount 9-1/2% senior subordinated notes ("9-1/2% Senior Subordinated Notes"), entered into a $300.0 million revolving credit facility, executed a term loan facility of $90.0 million, against which $50.0 million was immediately drawn, and issued 7,828,947 shares of common stock to KKR affiliates. Non-recurring recapitalization costs of approximately $17.3 million were incurred and expensed and financing costs of approximately $27.2 million have been deferred and will be amortized over the lives of the new debt facilities (see Notes 2 and 8 to the Company's Consolidated Financial Statements). Restructuring and other charges (income), net - During the fourth quarter of fiscal 1997, the Company decided to relocate its corporate offices from Montgomery, Alabama to Portland, Oregon in fiscal year 1998. In connection with the relocation, the Company recognized $3.4 million in restructuring costs, primarily severance related, and recorded a $5.0 million charge to write-down its Montgomery, Alabama headquarters facility to net realizable value. During fiscal 1997, $0.2 million was paid in relation to the relocation. The Company anticipates incurring an additional $5.8 million in restructuring charges related to the relocation in fiscal year 1998. Additionally, the Company recorded impairment losses of $1.9 million comprised of $1.3 million with respect to a certain long-lived assets and $0.6 million related to Kids Choice(TM) anticipated lease termination costs. The Company also recorded charges of approximately $1.5 million to write-off marketing materials and deferred pre-opening costs on new centers. Finally, in the second quarter of fiscal 1997, the Company received a $1.5 million interest payment from Enstar Group, Inc. ("Enstar"), the Company's former parent, in connection with a settlement of the Company's claim against Enstar in the U.S. Bankruptcy Court in Montgomery, Alabama. During the first quarter of fiscal 1996, the Company received a cash distribution of $11.3 million from Enstar in connection with the Company's claim against Enstar referred to above, the Company limited the development of its Kid's Choice(TM) centers to contracts in process until the concept is more fully developed and recorded an impairment loss of $6.3 million, consisting of a writedown of $5.3 million for the recoverability of certain long lived assets, primarily leasehold improvements (which were valued based on anticipated discounted cash flows), and $1.0 million for anticipated lease termination costs. Additionally, during fiscal 1996, the Company made substantial changes to its field 27 operations and facilities management and to its support functions. As a result of these changes, the Company provided $6.5 million for restructuring costs, primarily to cover severance arrangements for the approximately 100 positions which were eliminated. Currently, the Company is in the process of evaluating these operational changes and certain other support functions and systems in an effort to improve the quality of services and future operating effectiveness and efficiency. Operating income - Operating income decreased $31.6 million, or 61.1%, to $20.1 million for fiscal 1997 as compared to fiscal 1996. Operating income before recapitalization expenses, restructuring and other charges (income), net, decreased $5.5 million, or 10.3%, to $47.7 million in fiscal 1997 as compared to fiscal 1996 due to decreased occupancy, increases in employee child care discounts and increased labor expenses, as discussed above. The Company has taken certain steps to address these issues including funding a targeted marketing program for early fiscal year 1998, limiting the employee child care discount effective July 1997 and adding 22 area manager positions and additional regional field support to increase center supervision and support. Fiscal 1997 EBITDA, defined as earnings before interest expense, income taxes, depreciation and amortization, of $47.1 million was $38.9 million below fiscal 1996. As a percentage of net operating revenues, EBITDA for fiscal 1997 was 8.4% versus 15.9% for fiscal 1996. Adjusted EBITDA, defined as EBITDA exclusive of recapitalization expenses, restructuring and other charges (income), net, investment income and extraordinary items was $81.9 million in fiscal 1997, a decrease of $5.3 million from fiscal 1996. In addition to the factors discussed above, as part of the Company's normal review of the adequacy of reserves, during fiscal 1996, self insurance reserves were reduced by $2.0 million, the impact of which was to increase EBITDA and Adjusted EBITDA by a like amount. In fiscal 1997, as part of the normal review of the adequacy of reserves, the Company increased self insurance reserves, which reduced EBITDA and Adjusted EBITDA by $2.0 million. In addition, during fiscal 1997, the Company recorded provisions of $1.2 million for anticipated lease termination costs which are included in other operating expenses. As a percentage of net operating revenues, Adjusted EBITDA declined to 14.5% in fiscal 1997 from 16.1% in fiscal 1996. Neither EBITDA nor Adjusted EBITDA is intended to indicate that cash flow is sufficient to fund all of the Company's cash needs or represent cash flow from operations as defined by generally accepted accounting principles. Net investment income - Net investment income was $0.2 million in each of fiscal 1997 and fiscal 1996. Interest expense - Interest expense increased to $22.4 million in fiscal 1997 from $16.7 million in fiscal 1996. This increase is substantially attributable to the increase of approximately $350.0 million of long-term debt which was incurred in the third quarter of fiscal 1997 to fund the Merger and repay $91.6 million on the Company's then existing line of credit. The Company's weighted average interest rate on its long-term debt, including amortization of debt issuance costs, was 8.5% for fiscal 1997 versus 10.8% for fiscal 1996. As a result of the Recapitalization, the Company expects to incur higher interest expense in fiscal year 1998 than in prior fiscal years. 28 Income tax expense - Income tax expense for fiscal 1997 of $3.4 million was in excess of amounts computed by applying statutory federal income tax rates to income before income taxes due primarily to non-deductible recapitalization expenses and state income taxes, reduced by tax credits. Fiscal 1996 compared to Fiscal 1995 The following table shows the comparative operating results of the Company (dollars in thousands):
Fiscal Year Fiscal Change Ended Percent Year Ended Percent Amount May 31, of June 2, of Increase 1996 Revenues 1995 Revenues (Decrease) ----------- ---------- ------------ -------- ---------- Operating revenues, net $ 541,264 100.0% $ 506,505 100.0% $ 34,759 ----------- ---------- ------------ -------- ---------- Operating expenses: Salaries, wages and benefits 284,115 52.5 263,527 52.0 20,588 Depreciation 33,972 6.3 28,071 5.5 5,901 Rent 26,515 4.9 26,099 5.2 416 Other 143,469 26.5 138,910 27.5 4,559 Restructuring and other charges (income), net 1,484 0.2 (888) (0.2) 2,372 ----------- ---------- ------------ -------- ---------- Total operating expenses 489,555 90.4 455,719 90.0 33,836 ----------- ---------- ------------ -------- ---------- Operating income $ 51,709 9.6% $ 50,786 10.0% $ 923 =========== ========== ============ ======== ==========
Operating revenues, net - Fiscal 1996 net operating revenues increased $34.8 million or 6.9% over fiscal 1995. The increase in net operating revenues was primarily attributable to a 4.2% weighted average tuition increase implemented during the second quarter fiscal of 1996 and to new center openings and acquisitions, offset by center closings. Total Company occupancy decreased slightly in fiscal 1996 from fiscal 1995. The Company believes the slight decrease in occupancy was attributable to heavy competitor promotional activities and increasing market price sensitivities during the fall of 1995. During fiscal 1996, the Company opened 37 new centers: 22 KinderCare community centers, six KinderCare At Work(R) centers and nine Kid's Choice(TM) centers (including the conversion of one community center to a Kid's Choice(TM) center); and closed or sold 26 centers. During fiscal 1995, the Company opened or acquired 45 new centers: 29 KinderCare community centers (including 12 acquired centers), three KinderCare At Work(R) centers and 13 Kid's Choice(TM) centers (including the conversion of three community centers to Kid's Choice(TM) centers); and closed or sold 40 centers. Total licensed capacity increased to141,000 at the end of fiscal 1996 from 136,000 at the end of fiscal 1995. Salaries, wages and benefits - Salaries, wages and benefits increased, as a percentage of net operating revenues, to 52.5% in fiscal 1996 from 52.0% in fiscal 1995. The increase was attributable to increased hours and wage rates since the end of fiscal 1995, offset partially by improvements in field overhead and administrative costs due to management reorganizations. Depreciation - Depreciation expense increased $5.9 to $34.0 million in fiscal 1996 million from $28.1 million in fiscal 1995. This increase was primarily attributable to the 29 opening of 36 new centers and to the expenditure of $27.3 million in fiscal 1996 for center renovations and short-lived assets, such as the computers for children's educational programs, offset somewhat by the closing of 25 older centers in fiscal 1996. Rent - Rent expense increased $0.4 million in fiscal 1996 from fiscal 1995. This increase was attributable to rent incurred on new Kid's Choice(TM) and community center leases, offset partially by the closing of 17 leased community centers and the favorable effects of the disposal of some leased vehicles. Other operating expenses - Other operating expenses, as a percentage of net operating revenues, decreased to 26.5% in fiscal 1996 from 27.5% in fiscal 1995. This improvement was mostly due to: (a) a decrease in insurance costs due to improving claims experience, (b) gains on the sales of assets and (c) improvements associated with the field management reorganization, such as, decreases in travel costs and office supplies. These improvements were partially offset by increased costs associated with upgrades in the food and educational programs and increased marketing costs. Restructuring and other charges (income), net - During fiscal 1995, the Company received $0.9 million in connection with litigation settlements with Enstar and KinderCare's former Chairman of the Board. Operating income - Fiscal 1996 operating income increased 1.8% or $0.9 million. As a percentage of net operating revenues, fiscal 1996 operating margin of 9.6% decreased from the prior year operating income margin of 10.0% for the reasons discussed above. Before restructuring and other charges (income), net, as discussed above, fiscal 1996 operating income of $53.2 million was $3.3 million greater than fiscal 1995 operating income of $49.9 million and, as a percentage of net operating revenues, operating income margin remained about flat at 9.8%. Fiscal 1996 EBITDA increased 5.4% or $4.4 million over fiscal 1995. As a percentage of net operating revenues, EBITDA decreased to 15.9% for fiscal 1996 from 16.1% for fiscal 1995. Adjusted EBITDA increased 11.8% or $9.2 million to $87.2 million from $78.0 million in fiscal 1995, and, as a percentage of net operating revenues, improved to 16.1% from 15.4%. Neither EBITDA nor Adjusted EBITDA is intended to indicate that cash flow is sufficient to fund all of the Company's cash needs or represent cash flow from operations as defined by generally accepted accounting principles. Net investment income - Net investment income was $0.2 million for fiscal 1996 compared to $2.6 million for fiscal 1995. The decrease was primarily due to gains on the sale of certain securities during fiscal 1995. Interest expense - Interest expense decreased to $16.7 million for fiscal 1996 from $17.3 million for fiscal 1995. This decrease was attributable to a reduction of long-term debt obligations offset by higher average interest rates. The Company's weighted average interest rate on its long-term debt, including amortization of debt issuance costs, was 10.8% for fiscal 1996 versus 10.0% for fiscal 1995. 30 Income tax expense - Income tax expense for fiscal 1996 of $13.5 million was in excess of amounts computed by applying statutory federal income tax rates to income before income taxes due primarily to state income taxes. Additional paid-in capital was increased by $4.1 million for tax benefits recognized in fiscal 1996 relating to valuation allowances established for deferred taxes at April 2, 1993, the effective date of the Company's emergence from bankruptcy. Liquidity and Capital Resources The Company's principal sources of liquidity are cash flow generated from operations and future borrowings under the $300.0 million revolving credit facility. The Company's principal uses of liquidity are meeting debt service requirements, financing the Company's capital expenditures and renovations and providing working capital. In connection with the Merger, the Company's consolidated indebtedness has increased to approximately $394.9 million at May 30, 1997 from $146.6 million at May 31, 1996. This indebtedness includes $390.0 million under credit facilities comprised of a $90.0 million term loan facility (the "Term Loan Facility"), of which $50.0 million was drawn at the time of the Merger, and a $300.0 million revolving credit facility (the "Revolving Credit Facility," and, together with the Term Loan Facility, the "Credit Facilities"), of which, at May 30, 1997, $42.2 million was committed on outstanding letters of credit, and $300.0 million of 9-1/2% Senior Subordinated Notes. The Term Loan Facility is subject to mandatory repayment with the proceeds of certain asset sales and certain debt offerings and a portion of excess cash flow (as defined in the Credit Facilities). The Term Loan Facility will mature on February 13, 2006 and provides for nominal annual amortization. The Revolving Credit Facility will terminate on February 13, 2004. The Company utilized approximately $64.8 million of net operating loss carryforwards to offset taxable income in its 1994 through 1997 fiscal years. Approximately $12.1 million of net operating loss carryforwards are available to be utilized in the 1998 and future fiscal years. If such net operating loss carryforwards were reduced, the Company would be required to pay additional taxes and interest, thereby reducing available cash. The Company's consolidated net cash flow from operations for fiscal 1997 was $50.2 million, compared to $75.9 million for fiscal 1996. The decrease in net cash flow from operations is primarily a result of the net loss before extraordinary items, net, of $5.4 million in fiscal 1997 as compared to net income of $21.7 million in fiscal 1996, the components of which are discussed above. Cash and cash equivalents totaled $24.2 million at May 30, 1997 compared to $15.6 million at May 31, 1996 and the ratio of current assets to current liabilities was .67 to one at May 30, 1997, versus .57 to one at May 31, 1996. During the first quarter of fiscal 1997, the Company repurchased $30.0 million aggregate principal amount of its 10-3/8% senior subordinated notes ("10-3/8% Senior Subordinated Notes") at an aggregate price of $31.5 million which resulted in an extraordinary loss of $1.2 million, net of income taxes. During the second quarter of fiscal 31 1997 and in connection with the Merger, the Company announced and completed a tender offer and consent solicitation for the remainder of its outstanding 10-3/8% Senior Subordinated Notes seeking the elimination of substantially all of the restrictive covenants, and 99.7% of the notes were purchased at an aggregate price of $76.8 million. This second transaction resulted in an extraordinary loss of $5.2 million, net of income taxes. On June 3, 1996, the Board of Directors authorized the repurchase of $23.0 million of the Company's common stock. At the end of the first quarter of fiscal 1997, 842,500 shares and 370,000 warrants had been repurchased for $14.1 million. All shares that were repurchased have been retired. Other than in connection with the Merger, no shares of common stock or warrants have been purchased by the Company since July 22, 1996 and the stock buyback programs were terminated at the effective time of the Merger. Capital Expenditures The Company anticipates substantial increases in its capital expenditures budget over the next several years. During fiscal year 1998, the Company anticipates opening 20 to 25 new centers. Over the next three years, the Company expects to increase its rate of opening and/or acquiring new centers to between 50 and 75 new centers per year in the aggregate (excluding center closings), which the Company expects will be primarily community centers, and to continue its practice of closing centers that are identified as underperforming. The length of time from site selection to the opening of a center ranges from 18 to 24 months. The average total cost per community center ranges from $1.5 million to $1.8 million depending on the size and location of the center; however, the actual costs of a particular center may vary from such range. New centers are based upon detailed site analyses that include feasibility and demographic studies and financial modeling. No assurance can be given by the Company that it will be able to successfully negotiate and acquire properties, or meet targeted deadlines. Frequently, new site negotiations are delayed or canceled or construction delayed for a variety of reasons, many outside the control of the Company. The Company also plans to make significant capital expenditures in connection with the renovation of its existing facilities. The Company expects to make these improvements over the next three to four years. During fiscal 1997, the Company opened 15 community centers and one KinderCare At Work(R) center. There are no planned additions to the Company's Kids' Choice(TM) format as management does not believe that the concept is meeting its full potential and needs further refinement. The Company currently anticipates that any Kid's Choice(TM) center that is underperforming when its lease expires will be closed at that time. Fiscal 1996 new center openings totaled 37 centers; consisting of 22 KinderCare community centers, six KinderCare At Work(R) centers and nine Kid's Choice(TM) centers (including the conversion of one community center to a Kid's Choice(TM)). This total compares to 45 center openings or acquisitions in fiscal 1995; consisting of 29 KinderCare community centers (including 12 acquired centers of which 10 centers were acquired in a single transaction), three KinderCare At Work(R) centers and 13 Kid's Choice(TM) centers. 32 Capital expenditures during fiscal 1997 amounted to approximately $43.7 million. Approximately $27.8 million was spent on new center development, $12.1 million was spent in renovations and improvements to existing facilities, $3.0 million was spent on corporate information systems and the remaining $0.8 million was spent on computers for children's educational programs. Capital expenditures during fiscal 1996 amounted to approximately $67.3 million. Approximately $40.0 million was spent on new center development, $14.9 million was spent in renovations and improvements to existing facilities and the remaining $12.4 million was spent on equipment purchases, including $0.5 million on computers for children's educational programs. Capital expenditures during fiscal 1995 amounted to approximately $74.4 million. During fiscal 1995, approximately $43.5 million was spent on new center development, $13.5 million was spent on renovations and improvements to existing facilities and the remaining $17.4 million was spent on equipment purchases, including $6.8 million on computers for children's educational programs. Capital expenditure limits under the Credit Facilities for fiscal years 1997 and 1998 are $95 million and $100 million, respectively. Capital expenditure limits may be increased by carryover of a portion of unused amounts from previous periods and are subject to certain exceptions. Also, the Company is permitted greater flexibility under the provisions of the indenture under which the Senior Subordinated Notes were issued (the "Indenture") and the Credit Facilities with respect to the incurrence of additional indebtedness, including through certain mortgages or sale-leaseback transactions. Management believes that cash flow generated from operations and future borrowings under the Revolving Credit Facility will adequately provide for its working capital and debt service needs and will be sufficient to fund the Company's expected capital expenditures over the next several years. Although no assurance can be given that such sources will be sufficient, the capital expenditure program has substantial flexibility and is subject to revision based on various factors, including but not limited to, business conditions, changing time constraints, cash flow requirements, debt covenants, competitive factors and seasonality of openings. If the Company experiences a lack of working capital, it may reduce its capital expenditures. In the long term, if these expenditures were substantially reduced, in management's opinion, its operations and its cash flow would be adversely impacted. Recently Issued Accounting Standards In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per Share, which requires companies to present two new measures of earnings per share, basic and diluted. If SFAS No. 128 had been adopted for all periods presented, basic and diluted earnings per share would not have materially differed from reported earnings per share. The Company will adopt SFAS No. 128 in the third quarter of fiscal year 1998 and, at that time, will restate all prior periods presented. 33 In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes requirements for disclosure of comprehensive income. The new standard becomes effective for the Company's fiscal year 1999 and requires reclassification of earlier financial statements for comparative purposes. In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for disclosure about operating segments in annual financial statements and requires disclosure of selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supercedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. The new standard becomes effective for the Company's fiscal year 1999 and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company does not believe any substantial changes to its disclosures will be made at the time SFAS No. 131 is adopted. Seasonality New enrollments are generally highest in September and January, with attendance declining 5% to 10% during the summer months and the year-end holiday period. The decreased attendance in the summer months and during the year-end holiday period may result in decreased liquidity during these periods. Governmental Law & Regulations There are certain tax incentives for child care programs. Section 21 of the Internal Revenue Code of 1986, as amended (the "Code"), provides a federal income tax credit ranging from 20% to 30% of certain child care expenses for "qualifying individuals" (as defined therein). The fees paid to the Company for child care services by eligible taxpayers qualify for the tax credit, subject to the limitations of Section 21 of the Code. During fiscal 1997, approximately 13% of the Company's net operating revenues are generated from federal and state child care assistance programs, primarily the Child Care and Development Block Grant and At-Risk Programs. These programs are designed to assist low-income families with child care expenses and are administered through various state agencies. Although under new legislation, signed by President Clinton in August 1996, additional funding for child care will be available for low income families as part of welfare reform, no assurance can be given that the Company will benefit from any such additional funding. Inflation and Wage Increases Management does not believe that the effect of inflation on the results of the Company's operations has been significant in recent periods. Approximately 55% of operating expenses during fiscal 1997 consisted of salary, wages and benefits. At May 30, 1997, the Company's average wage rate for hourly employees was $6.45 per hour, compared to the current federal minimum wage rate of $4.75 per hour. During 1996, Congress enacted an increase in the minimum hourly wage from 34 $4.25 to $4.75 effective October 1, 1996, with an additional increase to $5.15 to be effective on September 1, 1997. Management currently believes that the increase to the $4.75 minimum wage rate, including the effects of wage compression (commensurate wage increase granted to certain hourly employees (with two or more years experience at KinderCare at the time of such increase) earning more than minimum wage), resulted in increased expenses of approximately $0.3 million in fiscal 1997 and, in fiscal year 1998, will add an additional $0.2 million in increased expenses. Management currently believes that the increase to the $5.15 minimum wage rate, including the effects of wage compression, will result in increased expenses of approximately $0.7 million in fiscal year 1998. The Company believes that, through increases in its tuition rates, it can recover any increase in expenses caused by the 1996 to 1997 wage adjustments and additional compensation adjustments necessitated by such increases in the minimum wage rate. However, there can be no assurance that the Company will be able to increase its rates sufficiently to offset such increased costs. The Company continually evaluates its wage structure and may implement further changes in addition to those discussed above. 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
KinderCare Learning Centers, Inc. and Subsidiaries Consolidated Balance Sheets (Dollars in thousands, except share amounts) May 30, 1997 May 31, 1996 ------------ ------------ Assets: Current assets: Cash and cash equivalents $ 24,150 $ 15,597 Receivables 13,649 15,129 Prepaid expenses and supplies 6,114 9,116 Deferred income taxes 14,127 6,664 ------------ ------------ Total current assets 58,040 46,506 Property and equipment, net 471,558 468,525 Deferred income taxes 11,621 4,422 Deferred financing costs and other assets 28,659 8,023 ------------ ------------ $ 569,878 $ 527,476 ============ ============ Liabilities and Shareholders' Equity: Current liabilities: Accounts payable $ 10,746 $ 14,330 Bank overdrafts 5,357 9,768 Current portion of long-term debt 1,760 853 Accrued expenses and other liabilities 69,056 56,186 ------------ ------------ Total current liabilities 86,919 81,137 Long-term debt 393,129 145,764 Self insurance liabilities 21,880 17,652 Other noncurrent liabilities 40,243 20,488 -------------- ------------ Total liabilities 542,171 265,041 -------------- ------------ Commitments and contingencies (Note 12) Shareholders' equity: Preferred stock, $.01 par value; authorized 10,000,000 shares; none outstanding -- -- Common stock, $.01 par value; authorized 40,000,000 shares; Issued 9,368,421 shares at May 30, 1997 and 19,981,807 shares at May 31, 1996; outstanding 9,368,421 shares at May 30, 1997 and 19,946,807 shares at May 31, 1996 94 199 Additional paid-in capital -- 200,980 Retained earnings 27,753 61,799 Cumulative translation adjustment (140) (20) -------------- ------------ 27,707 262,958 Treasury stock, at cost; 35,000 shares at May 31, 1996 -- (523) -------------- ------------ Total shareholders' equity 27,707 262,435 ============== ============ $ 569,878 $ 527,476 ============== ============ See accompanying notes to consolidated financial statements.
36
KinderCare Learning Centers, Inc. and Subsidiaries Consolidated Statements of Operations (Dollars in thousands, except share and per share amounts) Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended May 30, 1997 May 31, 1996 June 2, 1995 ------------ ------------ ------------ Operating revenues, net $ 563,135 $ 541,264 $ 506,505 ------------ ------------ ------------ Operating expenses: Salaries, wages and benefits 300,580 284,115 263,527 Depreciation 34,253 33,972 28,071 Rent 28,140 26,515 26,099 Provision for doubtful accounts 4,697 3,908 3,612 Other 147,811 139,561 135,298 Recapitalization expenses 17,277 -- -- Restructuring and other charges (income), net 10,275 1,484 (888) ------------ ------------ ------------ Total operating expenses 543,033 489,555 455,719 ------------ ------------ ------------ Operating income 20,102 51,709 50,786 Investment income, net 232 250 2,635 Interest expense 22,394 16,727 17,318 ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item (2,060) 35,232 36,103 Income tax expense 3,375 13,549 14,037 ------------ ------------ ------------ Income (loss) before extraordinary item (5,435) 21,683 22,066 Extraordinary item - loss on early retirement of debt, net of income taxes of $4,815 (7,532) -- -- ------------ ------------ ------------ Net income (loss) $ (12,967) $ 21,683 $ 22,066 ============ ============ ============ Primary income (loss) per common share: Income (loss) before extraordinary item $ (0.33) $ 1.10 $ 1.07 Extraordinary item - loss on early retirement of debt, net of income taxes (0.46) -- -- ------------ ------------ ------------ Net income (loss) $ (0.79) $ 1.10 $ 1.07 ============ ============ ============ Weighted average common and common equivalent shares outstanding 16,479,000 19,752,000 20,683,000 ============ ============ ============ Fully-diluted income per common share: Net income $ 1.05 =========== Weighted average common and common equivalent shares outstanding 20,683,000 =========== See accompanying notes to consolidated financial statements.
37
KinderCare Learning Centers, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity (Dollars in thousands, except share amounts) Common Stock Additional Cumulative --------------------------- Paid-in Retained Translation Treasury Shares Amount Capital Earnings Adjustment Stock Total ------------ ------------ -------------- ------------ ------------ ---------- ------------ Balance at June 3, 1994, as previously presented 20,009,517 $ 200 $ 188,655 $ 18,050 $ -- $ -- $ 206,905 Prior period adjustment -- -- (3,023) -- -- -- (3,023) ------------ ------------ -------------- ------------ ------------ ---------- ------------ Balance at June 3, 1994, as restated 20,009,517 200 185,632 18,050 -- -- 203,882 Net income -- -- -- 22,066 -- -- 22,066 Tax benefits of the valuation allowance for deferred tax assets -- -- 13,932 -- -- -- 13,932 Cumulative translation adjustment -- -- -- -- 32 -- 32 Exercise of stock options and warrants 110,301 1 1,303 -- -- -- 1,304 ------------ ------------ -------------- ------------ ------------ ---------- ------------ Balance at June 2, 1995 20,119,818 201 200,867 40,116 32 -- 241,216 Net income -- -- -- 21,683 -- -- 21,683 Tax benefits of the valuation allowance for deferred tax assets -- -- 4,121 -- -- -- 4,121 Cumulative translation adjustment -- -- -- -- (52) -- (52) Repurchase and retirement of stock and warrants (969,883) (10) (13,477) -- -- (523) (14,010) Exercise of stock options and warrants 831,872 8 8,476 -- -- -- 8,484 Tax benefit of option exercises -- -- 993 -- -- -- 993 ------------ ------------ -------------- ------------ ------------ ---------- ------------ Balance at May 31, 1996 19,981,807 199 200,980 61,799 (20) (523) 262,435 Net loss -- -- -- (12,967) -- -- (12,967) Cumulative translation adjustment -- -- -- -- (120) -- (120) Issuance of common stock 7,986,842 80 151,670 -- -- -- 151,750 Purchase and retirement of common stock (20,217,416) (201) (361,685) (21,079) -- 523 (382,442) Purchase of outstanding -- -- (11,143) -- -- -- (11,143) warrants Exercise of stock options and warrants 1,617,188 16 19,735 -- -- -- 19,751 Tax benefit of option exercises -- -- 443 -- -- -- 443 ------------ ------------ -------------- ------------ ------------ ---------- ------------ Balance at May 30, 1997 9,368,421 $ 94 $ -- $ 27,753 $ (140) $ -- $ 27,707 ============ ============ ============== ============ ============ ========== ============ See accompanying notes to consolidated financial statements.
38
KinderCare Learning Centers, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Dollars in thousands) Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended May 30, 1997 May 31, 1996 June 2, 1995 -------------- -------------- --------------- Cash flows from operations: Net income (loss) $ (12,967) $ 21,683 $ 22,066 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 34,253 33,972 28,071 Write-down of property and equipment 6,300 5,312 -- Amortization of deferred financing costs and intangibles 1,822 1,533 1,681 Gain on sales and disposals of property and equipment, net (12) (1,684) -- Deferred tax expense 1,982 12,285 9,862 Extraordinary item - loss on early retirement of 7,532 -- -- debt, net of income taxes Changes in operating assets and liabilities: Decrease (increase) in receivables 1,616 (2,473) 4,440 Decrease (increase) in prepaid expenses 3,002 (1,354) 2,900 and supplies Decrease (increase) in other assets 2,604 116 (978) Increase in accounts payable, accrued expenses and other liabilities 4,418 7,735 7,813 Other, net (313) (1,228) (2,892) -------------- -------------- --------------- Net cash provided by operating activities 50,237 75,897 72,963 -------------- -------------- --------------- Cash flows from investing activities: Purchases of property and equipment (43,748) (67,304) (74,376) Proceeds from sales of property and equipment 12,438 3,883 12,454 Proceeds from sales or redemption of investments -- 3,396 2,211 Proceeds from collection of notes receivable and other 396 2,042 82 -------------- -------------- --------------- Net cash used by investing activities (30,914) (57,983) (59,629) -------------- -------------- --------------- Cash flows from financing activities: Proceeds from long-term borrowings 350,000 -- -- Deferred financing costs (27,160) -- -- Proceeds from issuance of common stock 151,750 -- -- Exercise of stock options and warrants 20,194 8,484 1,303 Purchase and retirement of common stock (382,442) -- -- Payments on long-term borrowings (107,558) (13,777) (18,298) Purchases of treasury stock and warrants (11,143) (14,010) -- Bank overdrafts (4,411) 2,753 5,931 -------------- -------------- --------------- Net cash used by financing activities (10,770) (16,550) (11,064) -------------- -------------- --------------- Increase in cash and cash equivalents 8,553 1,364 2,270 Cash and cash equivalents at the beginning of the fiscal year 15,597 14,233 11,963 -------------- -------------- --------------- Cash and cash equivalents at the end of the fiscal year $ 24,150 $ 15,597 $ 14,233 ============== ============== =============== Supplemental cash flow information: Interest paid $ 14,325 $ 8,944 $ 14,850 Income taxes paid, net of refunds received 3,160 3,795 2,551 See accompanying notes to consolidated financial statements.
39 KinderCare Learning Centers, Inc. and Subsidiaries Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Nature of Business and Basis of Presentation KinderCare Learning Centers, Inc. ("KinderCare" or the "Company") is the largest provider of for-profit preschool educational and child care services in the United States. At the end of fiscal 1997, KinderCare operated 1,142 centers in 38 states in the United States and two centers are located in the United Kingdom. The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries: Mini-Skools Limited; KinderCare Development Corporation; KinderCare Real Estate; KinderCare Learning Centres, Limited and KinderCare Properties, Limited. All significant intercompany balances and transactions have been eliminated in consolidation. Fiscal Year The Company's fiscal year ends on the Friday closest to May 31. The first quarter is 16 weeks long and the second, third and fourth quarters are each twelve weeks long. The fiscal years ended May 30, 1997 ("fiscal 1997"), May 31, 1996 ("fiscal 1996") and June 2, 1995 ("fiscal 1995") were 52-week fiscal years. Revenue Recognition The Company recognizes revenue for child care services as earned. Cash and Cash Equivalents Cash and cash equivalents consist of cash held in banks and liquid investments with original maturities not exceeding 90 days. Property and Equipment Property and equipment are stated at cost. Depreciation on buildings and equipment is provided on the straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful life of the improvements or the lease term, including expected lease renewal options where the Company has the unqualified right to exercise the option. The Company's property and equipment is depreciated using the following estimated useful lives:
Life ----------- Buildings 10-40 years Building renovations 5-10 years Leasehold improvements 5-10 years Computer equipment 3 years All other equipment 5-10 years
40 Asset Impairments Effective June 3, 1995, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company has evaluated all its assets based upon SFAS No. 121 and has recorded all material adjustments as required. Deferred Financing Costs Deferred financing costs are amortized on a straight-line basis over the lives of the related debt facilities. Pre-Opening Costs Pre-opening costs include training salaries, grand opening and promotion expenses and the initial purchase of forms and supplies needed to operate the center. During fiscal 1997, the Company changed its method of accounting for pre-opening costs to the direct write-off method, resulting in expense of approximately $0.7 million (see Note 3). Prior to fiscal 1997, pre-opening costs were deferred and amortized over one year. Self-Insurance Programs The Company is self-insured for certain levels of general liability, workers' compensation, property and employee medical coverage. Estimated costs of these self-insurance programs are accrued at the undiscounted value of projected settlements for known and anticipated claims. Income Taxes Income taxes are accounted for under the provisions of SFAS No. 109, Accounting for Income Taxes. Stock-Based Compensation The Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, effective June 1, 1996. The Company will continue to measure compensation expense for its stock-based employee compensation plans using the method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and will, if material, provide pro forma disclosures of net income and earnings per share as if the method prescribed by SFAS No. 123 had been applied in measuring compensation expense. Net Income (Loss) Per Share Net income (loss) per share is computed on the basis of the weighted average number of common and common equivalent shares outstanding. Outstanding options for common stock, if 41 dilutive to earnings per share, have been included in the calculation of common and common equivalent shares outstanding using the treasury stock method. Recently Issued Accounting Pronouncements In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, Earnings per Share, which requires companies to present two new measures of earnings per share, basic and diluted. If SFAS No. 128 had been adopted for all periods presented, basic and diluted earnings per share would not have materially differed from reported earnings per share. The Company will adopt SFAS No. 128 in the third quarter of fiscal year 1998 and, at that time, will restate all prior periods presented. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes requirements for disclosure of comprehensive income. The new standard becomes effective for the Company's fiscal year 1999 and requires reclassification of earlier financial statements for comparative purposes. In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for disclosure about operating segments in annual financial statements and requires disclosure of selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supercedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. The new standard becomes effective for the Company's fiscal year 1999 and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company does not believe any substantial changes to its disclosures will be made at the time SFAS No. 131 is adopted. Use of Estimates The preparation of 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. Reclassifications Certain prior period amounts have been reclassified to conform to the current year's presentation. 2. Recapitalization On October 3, 1996, the Company and KCLC Acquisition Corp. ("KCLC") entered into an Agreement and Plan of Merger (the "Merger Agreement"). KCLC was a wholly owned subsidiary of KLC Associates, L.P. (the "Partnership"), a partnership formed at the direction of Kohlberg Kravis Roberts & Co., a private investment firm ("KKR"). Pursuant to the Merger Agreement, on February 13, 1997, KCLC was merged with and into the Company (the 42 "Merger"), with the Company continuing as the surviving corporation. Upon completion of the Merger, affiliates of KKR owned 7,828,947 shares, or approximately 83.6% of the Company's common stock outstanding after the Merger. Subject to certain provisions of the Merger Agreement, each issued and outstanding share of common stock was converted, at the election of the holder, into either the right to receive $19.00 in cash or the right to retain one share of common stock, subject to proration. In connection with the Merger, the Company repaid the outstanding $91.6 million balance on the Company's previous $150.0 million credit facility and paid $382.4 million to redeem common stock, warrants and options. In order to fund the transactions contemplated by the Merger (the "Recapitalization"), the Company issued $300.0 million 9 1/2% senior subordinated notes, executed a revolving credit facility of $300.0 million, executed a term loan facility of $90.0 million, against which $50.0 million was immediately drawn, and issued 7,828,947 shares of common stock to KKR affiliates for $148.8 million. During fiscal 1997, non-recurring costs in connection with the Recapitalization of approximately $17.3 million were incurred and expensed. Additionally, financing costs of approximately $27.2 million have been deferred and classified as other assets and will be amortized over the lives of the new debt facilities (see Note 8). 3. Restructuring and Other Charges (Income), Net During the fourth quarter of fiscal 1997, the Company decided to relocate its corporate offices from Montgomery, Alabama to Portland, Oregon in fiscal year 1998. In connection with the relocation, the Company recognized $3.4 million in restructuring costs, primarily severance related, and recorded a $5.0 million charge to write-down its Montgomery, Alabama headquarters facility to net realizable value. During fiscal 1997, $0.2 million was paid in relation to the relocation. The Company anticipates incurring an additional $5.8 million in restructuring charges related to the relocation in fiscal year 1998. Additionally, the Company recorded impairment losses of $1.9 million comprised of $1.3 million with respect to a certain long-lived assets and $0.6 million related to Kids Choice(TM) anticipated lease termination costs. The Company also recorded charges of approximately $1.5 million to write-off marketing materials and deferred pre-opening costs on new centers. Finally, in the second quarter of fiscal 1997, the Company received a $1.5 million interest payment from Enstar Group, Inc. ("Enstar"), the Company's former parent, in connection with a settlement of the Company's claim against Enstar in the U.S. Bankruptcy Court in Montgomery, Alabama. During the first quarter of fiscal 1996, the Company received a cash distribution of $11.3 million from Enstar in connection with the Company's claim against Enstar referred to above, the Company limited the development of its Kid's Choice(TM) centers to contracts in process until the concept is more fully developed and recorded an impairment loss of $6.3 million, consisting of a writedown of $5.3 million for the recoverability of certain long lived assets, primarily leasehold improvements (which were valued based on anticipated discounted cash flows), and $1.0 million for anticipated lease termination costs. Additionally, during fiscal 1996, the Company made substantial changes to its field operations and facilities management and to its support functions. As a result of these changes, the Company provided $6.5 million for restructuring costs, primarily to cover severance arrangements for the approximately 100 positions which were eliminated. Currently, the Company is in the process of evaluating these 43 operational changes and certain other support functions and systems in an effort to improve the quality of services and future operating effectiveness and efficiency. In the third quarter of 1995, the Company received approximately $0.9 million in connection with litigation settlements with Enstar and KinderCare's former Chairman of the Board. 4. Receivables Receivables consist of the following (dollars in thousands):
May 30, 1997 May 31, 1996 ----------------- ----------------- Tuition $15,383 $16,450 Allowance for doubtful accounts (2,133) (1,884) ----------------- ----------------- 13,250 14,566 Other 399 563 ----------------- ----------------- $13,649 $15,129 ================= =================
5. Prepaid Expenses and Supplies Prepaid expenses and supplies consist of the following (dollars in thousands):
May 30, 1997 May 31, 1996 ----------------- ----------------- Prepaid rent $ 3,233 $ 3,676 Inventories 1,862 2,491 Other 1,019 2,949 ----------------- ----------------- $ 6,114 $ 9,116 ================= =================
6. Property and Equipment Property and equipment, at cost, consist of the following (dollars in thousands):
May 30, 1997 May 31, 1996 ----------------- ----------------- Land $ 139,481 $ 142,856 Buildings and leasehold improvements 337,010 305,292 Equipment 91,354 82,594 Construction in progress 7,947 16,825 ----------------- ---------------- 575,792 547,567 Accumulated depreciation and amortization (104,234) (79,042) ----------------- ---------------- $ 471,558 $ 468,525 ================= ================
44 7. Accrued Expenses and Other Liabilities Accrued expenses and other liabilities consist of the following (dollars in thousands):
May 30, 1997 May 31, 1996 -------------- -------------- Accrued compensation and related taxes $ 22,481 $ 22,305 Accrued interest 8,902 5,585 Deferred revenue 8,704 6,451 Accrued property taxes 6,622 5,633 Accrued restructuring and lease termination 7,320 3,091 Self insurance 5,707 6,707 Accrued income taxes 3,136 2,402 Other 6,184 4,012 -------------- -------------- $ 69,056 $ 56,186 ============== =============
8. Long-Term Debt Long-term debt consists of the following (dollars in thousands):
May 30, 1997 May 31, 1996 ----------------- ----------------- Secured: Borrowings under term loan facility, interest at adjusted LIBOR plus 3.00% (8.69% at May 30, 1997) $ 50,000 $ -- Industrial refunding revenue bonds at variable rates of interest from 4.15% to 5.79% at May 30, 1997 and 3.85% to 5.57% at May 30, 1996; supported by letters of credit, maturing 33,025 33,025 1999 to 2009 Real and personal property mortgages payable in monthly installments through 2004, interest rates of 8.75% to 12.25% 6,161 7,854 Industrial revenue bonds secured by real property with maturities to 2005 at interest rates of 4.20% to 12.75% 5,492 5,738 Unsecured: Senior subordinated notes due 2009, interest at 9-1/2%, payable semi-annually 300,000 -- Senior subordinated notes due 2001, interest at 10-3/8%, payable semi-annually 211 100,000 ------------- ------------- 394,889 146,617 Less current portion of long-term debt 1,760 853 ------------- ------------- $ 393,129 $ 145,764 ============= =============
Credit Facilities The Company has credit facilities which are provided by a syndicate of financial institutions and include a Term Loan Facility of up to $90.0 million and a Revolving Credit Facility of $300.0 million (the "Credit Facilities"). The Company must pay an annual commitment fee equal to 1/2 of 1% per annum of the undrawn portion of the commitments in respect of the Credit Facilities, subject to reduction under a performance-based pricing grid, and a letter of credit fee based on the aggregate face value of the outstanding letters of credit under the Revolving Credit Facility. The Term Loan Facility will mature on February 13, 2006 and provides for $0.5 million annual interim amortization. The initial interest rate, at the option of the Company, is adjusted LIBOR (as defined) plus 3.00% or ABR (as defined) plus 1.75%, subject to reduction under a 45 performance-based pricing grid. The Company drew $50.0 million under the Term Loan Facility and the availability of the remaining $40.0 million expired on August 13, 1997. The Term Loan Facility is subject to mandatory prepayment from (i) 100% of the net cash proceeds on the sale of certain non-ordinary-course assets, (ii) 100% of the net cash proceeds from certain sale/leaseback transactions, (iii) 50% of excess cash flow (as defined) and (iv) 100% of the net proceeds from the issuance of certain debt obligations. The Revolving Credit Facility commitment will mature February 13, 2004. The initial interest rate, at the option of the Company, is adjusted LIBOR plus 2.5% or ABR plus 1.25%, subject to reduction under a performance-based pricing grid. At May 30, 1997, of the $300.0 million available under the Revolving Credit Facility, the Company had approximately $42.2 million utilized by outstanding letters of credit. The Company's obligations under the Credit Facilities are secured by a perfected first priority pledge of and security interest in the common stock of each existing and subsequently acquired direct domestic subsidiary of the Company and 65% of the common stock of each existing and subsequently acquired direct foreign subsidiary and, in certain circumstances, non-cash consideration received for certain sales of assets. The Credit Facilities contain customary covenants and restrictions on the Company's ability to engage in certain activities and include customary events of default. In addition, the Credit Facilities provide that the Company must meet or exceed defined interest coverage ratios and must not exceed defined leverage ratios. The Company was in compliance with such covenants at May 30, 1997. Industrial Revenue Bonds Series A Through E Industrial Revenue Bonds - The Company is obligated to various issuers of industrial revenue bonds (the "Refunded IRBs") in an amount totaling approximately $33.0 million outstanding at May 30, 1997 and May 31, 1996. The Refunded IRBs were issued to provide funds for refunding an equal principal amount of industrial revenue bonds which were used to finance the cost of acquiring, constructing and equipping certain facilities of the Company. The Refunded IRBs bear interest at variable rates from 4.15% to 5.79% and each is secured by a letter of credit under the Revolving Credit Facility. Other IRBs - The Company also is obligated to various issuers of other industrial revenue bonds (the "IRBs") in the aggregate principal amount of approximately $5.5 million and $5.7 million at May 30, 1997 and May 31, 1996, respectively. The principal amount of such IRBs was used to finance the cost of acquiring, constructing and equipping certain child care facilities and the IRBs are secured by these facilities. The IRBs bear interest at rates of 4.20% to 12.75%. Senior Subordinated Notes In fiscal 1997, the Company issued $300.0 million in unsecured senior subordinated notes due February 15, 2009 (the "9-1/2% Senior Subordinated Notes") under an indenture (the "Indenture") between the Company and Marine Midland Bank, as trustee. The 9-1/2% Senior Subordinated Notes bear interest at the fixed rate of 9-1/2% per annum, payable semi-annually 46 on February 15 and August 15 of each year, and are effectively subordinated to the secured indebtedness of the Company, including indebtedness under the Credit Facilities. The 9-1/2% Senior Subordinated Notes are callable by the Company at 104.750% of par from February 15, 2002 through February 15, 2003. The redemption price is reduced to 103.167% of par on February 15, 2003, to 101.583% of par on February 15, 2004 and on February 15, 2005, until maturity, the notes may be redeemed at par. Upon a change of control, as defined in the Indenture, each holder of the 9-1/2% Senior Subordinated Notes may require the Company to repurchase all or a portion of such holder's notes for a cash purchase price equal to 101% of par, together with accrued and unpaid interest to the date of repurchase. The 9-1/2% Senior Subordinated Notes contain a number of covenants similar to those of the Credit Facilities and include certain limitations with respect to payment of dividends, incurrence of additional indebtedness, creation of liens, asset or subsidiary sales, transactions with affiliates, investments and guarantees, all of which are described in the Indenture. In fiscal 1994, the Company issued $100.0 million in unsecured senior subordinated notes due June 1, 2001, which bear interest at a fixed rate of 10-3/8% per annum, payable semi-annually on December 1 and June 1 of each year ("the 10-3/8% Senior Subordinated Notes"). The 10-3/8% Senior Subordinated Notes were issued under an indenture between the Company and AmSouth Bank N.A. as trustee (the "AmSouth Indenture") and are effectively subordinated to the secured indebtedness of the Company, including indebtedness under the Credit Facilities. The 10-3/8% Senior Subordinated Notes are callable by the Company at 105.1875% of par from June 1, 1998 through June 1, 1999. On June 1, 1999, the redemption price is reduced to 102.5940% of par, and on June 1, 2000, until maturity, the notes may be redeemed at par. Upon a change of control, as defined in the AmSouth Indenture, each holder of the 10-3/8% Senior Subordinated Notes may require the Company to repurchase all or a portion of such holder's notes at a purchase price in cash equal to 101% of par, together with accrued and unpaid interest to the date of repurchase. In a series of transactions preceding and in contemplation of the Merger, the Company retired 99.7% of the 10-3/8% Senior Subordinated Notes. Principal Payments The aggregate minimum annual maturities of long-term debt for the five fiscal years subsequent to May 30, 1997 are as follows (dollars in thousands): Fiscal Year: 1998 $ 1,760 1999 1,853 2000 11,646 2001 14,786 2002 822 Thereafter 364,022 ---------------- Total $394,889 ================ 47 9. Income Taxes The provision (benefit) for income taxes attributable to income (loss) before income taxes and extraordinary items consists of the following (dollars in thousands):
Fiscal Years Ended ----------------------------------------------------- May 30, 1997 May 31, 1996 June 2, 1995 --------------- ---------------- ---------------- Current: Federal $ 3,980 $ 832 $ 2,909 State 815 (132) 662 Foreign 562 564 604 --------------- ---------------- ---------------- 5,357 1,264 4,175 --------------- ---------------- ---------------- Deferred: Federal (1,390) 10,292 8,293 State (530) 2,137 1,859 Foreign (62) (144) (290) --------------- ---------------- ---------------- (1,982) 12,285 9,862 --------------- ---------------- ---------------- $ 3,375 $ 13,549 $ 14,037 =============== ================ ================
A reconciliation between the statutory federal income tax rate and the effective income tax rates on income (loss) before income taxes and extraordinary items is as follows:
Fiscal Years Ended --------------------------------------------------- May 30, 1997 May 31, 1996 June 2, 1995 --------------- --------------- --------------- Expected tax provision (benefit) on income (loss) before income taxes and extraordinary item at federal rate - 35% $ (721) $12,334 $12,636 State income taxes, net of federal tax (235) (1,303) 1,639 benefit Non-deductible recapitalization 4,594 -- -- expenses Tax credits (620) (465) (508) Other, net 357 377 270 --------------- --------------- --------------- $3,375 $13,549 $14,037 =============== =============== ===============
48 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at May 30, 1997 and May 31, 1996 are summarized as follows (dollars in thousands):
May 30, 1997 May 31, 1996 ----------------- ---------------- Deferred tax assets: Self-insurance reserves $ 11,282 $ 9,099 Net operating loss carryforwards 4,760 7,895 Capital loss carryforwards 4,818 4,818 Tax credits 6,547 3,172 Property and equipment, basis differences 1,355 2,458 Other 13,058 8,098 ----------------- ---------------- Total gross deferred tax assets 41,820 35,540 Less valuation allowance (7,050) (10,310) ----------------- ---------------- Net deferred tax assets 34,770 25,230 ----------------- ---------------- Deferred tax liabilities: Property and equipment, basis differences of foreign subsidiary (8,944) (9,088) Stock basis of foreign subsidiary (3,622) (3,622) Other (2,056) (1,434) ----------------- ---------------- Total gross deferred tax liabilities (14,622) (14,144) ================= ================ Financial statement net deferred tax assets $ 20,148 $ 11,086 ================= ================
The valuation allowance decreased by $3.3 million during fiscal 1997. Deferred tax assets have been recognized to the extent of existing deferred tax liabilities and income taxes paid that are subject to recovery through carryback. Future recognized tax benefits relating to the valuation allowance of $7.1 million, which was created in fiscal year 1993, will be recorded as direct additions to additional paid-in capital. At May 30, 1997, the Company had $12.1 million of net operating losses available for carryforward which expire in 2008. Utilization of the net operating losses is subject to an annual limitation of $9.6 million. The Company also has capital losses of $8.7 million, which are available to offset future capital gains, and expire in varying amounts through 2000. Additionally, the Company has tax credits available for carryforward for federal income tax purposes of $6.5 million, which are available to offset future federal income taxes through 2010. 10. Employee Benefit Plans Stock Option Plans During 1993, the Company adopted the KinderCare Learning Centers, Inc. 1993 Stock Option and Incentive Plan (the "1993 Plan"). Prior to the Merger, this plan authorized a committee of the Board of Directors of the Company to grant or award to eligible employees of the Company and its subsidiaries and affiliates, stock options and restricted stock and related warrants of the Company beginning on March 31, 1993. In connection with the 1993 Plan, the Company reserved approximately 1.9 million shares of common stock for issuance to employees of the Company upon exercise of options available for grants made by the Board of Directors of the Company. At the effective time of the Merger, all stock options granted by the Company under the 1993 Plan were cancelled and each option was exchanged for a payment from the Company 49 after the Merger (subject to any applicable withholding taxes) equal to the product of (i) the total number of shares of common stock previously subject to such stock option and (ii) the excess of $19.00 over the exercise price per share of the common stock previously subject to such stock option. The cancellation of the stock options resulted in payments of approximately $3.8 million. The 1993 Plan was terminated at the effective time of the Merger. During the fiscal year ended May 30, 1997, the Company adopted the 1997 Stock Purchase and Option Plan for Key Employees of KinderCare Learning Centers, Inc. and Subsidiaries (the "1997 Plan"), subject to stockholder approval. The 1997 Plan authorizes grants of stock or stock options covering 2,500,000 shares of the Company's common stock. Grants or awards under the 1997 Plan may take the form of purchased stock, restricted stock, incentive or nonqualified stock options or other types of rights specified in the 1997 Plan. During fiscal 1997, the Board of Directors granted 421,053 stock options under the 1997 Plan, all of which were nonqualified options. Each of such options had a weighted average fair value, calculated using the Black Scholes option pricing model, of approximately $8.35 on the date of grant. All of the stock options granted vest 20% per year over a five-year period. No other options were outstanding at May 30, 1997. Grants or awards under the 1997 Plan are made at prices determined by the Board of Directors. All options granted under the 1997 Plan during the fiscal year ended May 30, 1997 have an exercise price of $19.00 per share. A summary of options outstanding is as follows:
Weighted Number of Average Shares Exercise Price ------------- ---------------- Outstanding June 3, 1994 1,295,008 $ 9.74 Granted 196,500 12.66 Exercised (108,110) 10.02 Canceled (75,760) 10.57 -------------- ---------------- Outstanding June 2, 1995 1,307,638 10.11 Granted 256,700 13.03 Exercised (746,560) 9.60 Canceled (73,640) 11.62 -------------- ---------------- Outstanding May 31, 1996 744,138 11.48 Granted 460,053 18.60 Exercised (596,058) 11.70 Canceled (187,080) 11.36 -------------- ---------------- Outstanding May 30, 1997 421,053 $ 19.00 ============== ================
Options outstanding at May 30, 1997 have a remaining contractual life of 9.7 years. No options were exercisable at May 30, 1997. As discussed in Note 1, the Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation cost has been recognized for stock options granted with an exercise price equal to the fair value of the underlying stock on the date of grant. Had compensation cost for the Company's stock option plans been determined based on 50 the estimated fair value of the options at the date of grant, the Company's net income (loss) and net income (loss) per share for the years ended May 30, 1997 and May 31, 1996 would not have materially differed from the amounts reported. Savings and Investment Plan The Board of Directors of the Company adopted the KinderCare Learning Centers, Inc. Savings and Investment Plan (the "Savings Plan") effective January 1, 1990. All full-time employees of the Company and its subsidiaries are eligible to participate in the Savings Plan upon completion of one year of service and the attainment of age 18. Participants may contribute, in increments of 1% up to 10% of their compensation to the Savings Plan. In accordance with the provisions of the Savings Plan, the Board of Directors has elected, since April 1, 1991, not to match employee contributions. Nonqualified Deferred Compensation Plan The Board of Directors of the Company adopted the KinderCare Learning Centers, Inc. Nonqualified Deferred Compensation Plan (the "DC Plan") effective August 1, 1996. Under the DC Plan, certain highly compensated or key management employees are provided the opportunity to defer receipt and income taxation of such employees' compensation. 11. Disclosures About Fair Value of Financial Instruments Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments at May 30, 1997 and May 31, 1996. Cash and cash equivalents, receivables and current liabilities Fair value approximates cost as reflected in the consolidated balance sheets at May 30, 1997 and May 31, 1996 because of the short-term maturity of these instruments. Long-term debt The carrying value for the Company's 9-1/2% Senior Subordinated Notes, at May 30, 1997, approximated fair value due to the recent Merger and refinancing. The carrying value of the 10-3/8% Senior Subordinated Notes, at May 30, 1997, approximated fair value based on current market activity, while the fair value, at May 31, 1996, approximated the carrying value based on market activity. The carrying values for the Company's remaining long-term debt of $94.7 million and $46.6 million at May 30, 1997, and May 31, 1996, respectively, approximated market value based on current rates that management believes could be obtained for similar debt. 12. Commitments and Contingencies The Company conducts a portion of its operations from leased or subleased day care centers. Additionally, the Company leases its fleet of vehicles. Each vehicle in the Company's fleet is leased pursuant to the terms of a 12-month non-cancelable master lease which may be renewed on a month-to-month basis after the initial 12 month lease period. Payments under the 51 vehicle leases vary with the number of vehicles leased and changes in interest rates. The vehicle leases require that the Company guarantee specified residual values upon cancellation. In most cases, management expects that substantially all of the leases will be renewed or replaced by other leases as part of the normal course of business. All such leases are classified as operating leases. Subsequent to January 1, 1993, the Company re-negotiated certain day care center leases to amend the terms to allow the Company the right to terminate the lease at any time with minimal notice. In connection with the termination option, the Company, in certain instances, prepaid up to 12 months rent. Such amounts, totaling approximately $3.2 million, will be amortized over the termination transition period or over the appropriate remaining months of the lease period. At May 30, 1997, the remaining unamortized balance of the prepaid amount was $2.3 million. In addition, several leases were re-negotiated to decrease the monthly fixed rental payments. At May 30, 1997, the Company had a Revolving Credit Facility of $300.0 million, of which $42.2 million was utilized by outstanding letters of credit. Following is a schedule of future minimum lease payments under operating leases, that have initial or remaining non-cancelable lease terms in excess of one year at May 30, 1997 (dollars in thousands): Fiscal Year: 1998 $ 17,631 1999 17,227 2000 15,255 2001 13,029 2002 11,235 Subsequent years 61,891 Expenses incurred in connection with the fleet vehicle leases were $10.1 million, $10.3 million and $10.1 million for fiscal 1997, fiscal 1996 and fiscal 1995, respectively. The Company is presently, and is from time to time, subject to claims and suits arising in the ordinary course of business, including suits alleging child abuse. In certain of such actions, plaintiffs request damages that are covered by insurance. The Company believes that none of the claims or suits of which it is aware will materially affect its financial position, operating results or cash flows, although absolute assurance cannot be given with respect to the ultimate outcome of any such actions. 13. Stock Repurchase Programs On February 15, 1995 the Board of Directors of KinderCare authorized the repurchase of up to $10 million of the Company's common stock. This repurchase was completed and all shares retired during the second quarter of fiscal 1996. On May 2, 1996, the Board of Directors authorized an additional repurchase of $10 million and increased it to $23.0 million on June 3, 1996. At May 31, 1996, under the second stock buyback program, 259,000 shares and 120,000 warrants had been repurchased for $4.2 million. At July 27, 1996, under the second stock buyback program, 1,111,500 shares and 435,000 warrants had been repurchased for $18.3 million. All shares repurchased were retired. Other than in connection with the Merger, no 52 additional shares or warrants were repurchased subsequent to July 27, 1996 and the stock buyback programs were terminated at the effective time of the Merger. 14. Extraordinary Losses During the first and second quarters of fiscal 1997, the Company purchased 99.7% of its 10-3/8% Senior Subordinated Notes for an aggregate price of $108.3 million. This transaction included the write off of deferred financing costs of $1.7 million and resulted in an extraordinary loss of $6.4 million, net of income taxes. During the third quarter of fiscal 1997, in connection with the Merger and retirement of existing debt, an extraordinary loss of $1.1 million, net of income taxes, was recognized for the write-off of deferred financing costs relating to the Company's previous credit facility. 15. Prior Period Adjustment At the Company's emergence from bankruptcy in 1993, the Company did not record a liability for accrued but untaken employee vacation. Accordingly, the accompanying financial statements for periods prior to June 1, 1996 have been restated. The net effect of the restatement on the accompanying financial statements was to decrease additional paid-in capital as of June 3, 1994 by $3.0 million reflecting the vacation accrual of $5.0 million net of the deferred tax effect of $2.0 million. The effect of the restatement is not material to the results of operations. 53 16. Quarterly Results (Unaudited) A summary of results of operations for fiscal 1997 and fiscal 1996 is as follows (dollars in thousands, except per share data):
First Second Third Fourth Quarter (a) Quarter (b) Quarter (b) Quarter(b) --------------- -------------- -------------- -------------- Fiscal year ended May 30, 1997: Operating revenues $ 171,427 $ 128,324 $ 126,657 $ 136,727 Operating income (loss) 9,751 14,366 (3,074) (941) Income (loss) before extraordinary items 2,978 6,820 (10,455) (4,778) Income (loss) before extraordinary items per share 0.15 0.33 (0.61) (0.51) Net income (loss) 1,749 1,569 (11,507) (4,778) Net income (loss) per share 0.09 0.08 (0.67) (0.51) Fiscal year ended May 31, 1996: Operating revenues $ 161,313 $ 124,079 $ 123,641 $ 132,231 Operating income 11,141 11,222 13,514 15,832 Net income 3,565 4,551 5,868 7,699 Net income per share (primary) 0.17 0.23 0.30 0.39 Net income per share (fully-diluted) N/A N/A N/A 0.37 N/A - Not applicable (a) Sixteen week quarter (b) Twelve week quarters
The computation of fully-diluted earnings per share is based on the higher of the average or year-end market price of the Company's common stock. 54 Independent Auditors' Report The Board of Directors and Shareholders KinderCare Learning Centers, Inc.: We have audited the consolidated balance sheet of KinderCare Learning Centers, Inc. and subsidiaries as of May 30, 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KinderCare Learning Centers, Inc. and subsidiaries as of May 30, 1997, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP Portland, Oregon August 15, 1997 55 Independent Auditors' Report The Board of Directors and Shareholders KinderCare Learning Centers, Inc.: We have audited the accompanying consolidated balance sheet of KinderCare Learning Centers, Inc. and subsidiaries as of May 31, 1996 and the related consolidated statements of operations, shareholders' equity, and cash flows for the years ended May 31, 1996 and June 2, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of KinderCare Learning Centers, Inc. and subsidiaries as of May 31, 1996, and the results of their operations and their cash flows for the years ended May 31, 1996 and June 2, 1995, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP Atlanta, Georgia August 9, 1996 56 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 14, 1997, the Company engaged Deloitte & Touche LLP as independent accountants to audit the Company's financial statements for the fiscal year ending May 30, 1997 and elected not to renew the engagement of the Company's previous accountants, KPMG Peat Marwick LLP. The decision was approved by the Company's Board of Directors. In connection with the audits of the fiscal years ended May 31, 1996 and June 2, 1995, and for all subsequent periods through April 14, 1997, there were no disagreements with KPMG Peat Marwick LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to their satisfaction would have caused them to make reference in connection with their opinion to the subject matter of the disagreement. No adverse opinions or disclaimers of opinions were given by KPMG Peat Marwick LLP during the fiscal years ended May 31, 1996 and June 2, 1995, and for all subsequent periods through April 14, 1997, nor were any of their opinions qualified or modified as to uncertainty, audit scope, or accounting principle during the time KPMG Peat Marwick LLP was engaged. The Company requested that KPMG Peat Marwick LLP furnish it with a letter addressed to the SEC stating whether or not it agreed with the above statements. A copy of such letter, dated April 17, 1997, was filed as Exhibit 16 to the above referenced filing on Form 8-K. 57 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Company hereby incorporates by reference the information contained under the headings "Certain Information Concerning Nominees and Directors," "Meetings of the Board of Directors and Committees" and "Beneficial Ownership Reporting--Section 16(a) Compliance" from its definitive proxy statement to be delivered to the shareholders of the Company in connection with the 1997 annual meeting of shareholders to be held on November 11, 1997. ITEM 11. EXECUTIVE COMPENSATION The Company hereby incorporates by reference the information contained under the heading "Executive Compensation" from its definitive proxy statement to be delivered to the shareholders of the Company in connection with the 1997 annual meeting of shareholders to be held on November 11, 1997. In no event shall the information contained in the proxy statement under the sections entitled "Shareholder Return Analysis" and "Compensation Committee's Report on Executive Compensation" be included in this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The Company hereby incorporates by reference the information contained under the heading "Security Ownership of Certain Beneficial Owners" from its definitive proxy statement to be delivered to the shareholders of the Company in connection with the 1997 annual meeting of shareholders to be held on November 11, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company hereby incorporates by reference the information contained under the heading "Certain Transactions" from its definitive proxy statement to be delivered to the shareholders of the Company in connection with the 1997 annual meeting of shareholders to be held on November 11, 1997. 58 PART IV ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The following is an index of the financial statements, schedules and exhibits included in this Report or incorporated herein by reference: (a)(1) Financial Statements. Page ---- Consolidated Balance Sheets as of May 30, 1997 and May 31, 1996.................................................36 Consolidated Statements of Operations for the fiscal years ended May 30, 1997, May 31, 1996 and June 2, 1995.................................................37 Consolidated Statements of Shareholders' Equity for the fiscal years ended May 30, 1997, May 31, 1996 and June 2, 1995........................................38 Consolidated Statements of Cash Flows for the fiscal years ended May 30, 1997, May 31, 1996 and June 2, 1995.................................................39 Notes to Consolidated Financial Statements....................40-54 Independent Auditors' Reports.................................55-56 (a)(2) Schedules to Financial Statements. None. (a)(3) Exhibits. The following is an index of the exhibits included in this Annual Report on Form 10-K or incorporated herein by reference. 59 Exhibit Number Description of Exhibits - ------ ----------------------- 2(a) Agreement and Plan of Merger dated as of October 3, 1996, between KinderCare Learning Centers, Inc. ("KinderCare") and KCLC Acquisition Corp. ("KCLC Acquisition") (incorporated by reference to Exhibit 2.1(a) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(b) Merger Agreement Amendment dated as of December 27, 1996 between KinderCare and KCLC Acquisition (incorporated by reference to Exhibit 2.1(b) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(c) Voting Agreement, dated as of October 3, 1996, among KCLC Acquisition and the stockholders parties thereto (incorporated by reference to Exhibit 2.2(a) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(d) Voting Agreement Amendment dated as of December 27, 1996 among KCLC Acquisition and the stockholders parties thereto (incorporated by reference to Exhibit 2.2(b) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(e) Stockholders' Agreement between KinderCare and the stockholders parties thereto (incorporated by reference from Exhibit 2.3 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 3(a) Certificate of Merger of KCLC Acquisition into KinderCare (incorporated by reference from Exhibit 3.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 3(b) By-Laws of KinderCare (incorporated by reference from Exhibit 3.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, file no. 333-23127). 4(a) Indenture dated as of February 13, 1997 between KinderCare and Marine Midland Bank, as Trustee (incorporated by reference from Exhibit 4.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 4(b) Form of 9 1/2 % Senior Subordinated Note due 2009. (incorporated by reference from Exhibit 4.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 60 4(c) Form of 9 1/2% Series B Senior Subordinated Note due 2009 (incorporated by reference from Exhibit 4.3 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(a) Credit Agreement, dated as of February 13, 1997, among KinderCare, the several lenders from time to time parties thereto, and the Chase Manhattan Bank as administrative agent (incorporated by reference from Exhibit 10.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(b) Registration Rights Agreement, dated as of February 13, 1997, among KCLC Acquisition, KLC Associated L.P. and KKR Partners II, L.P. (incorporated by reference from Exhibit 10.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(c) Registration Rights Agreement dated February 13, 1997 among KinderCare, Chase Securities, Inc., BT Securities Corporation, Salomon Brothers Inc and Smith Barney Inc. (incorporated by reference from Exhibit 4.4 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(d) Employment Agreement of Philip L. Maslowe dated May 8, 1995 (incorporated by reference from Exhibit 10(w) of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 2, 1995). 10(e) Letter Agreement relating to termination of employment of Sandra Scarr dated January 8, 1997. 10(f) Lease between 600 Holladay Limited Partnership and KinderCare Learning Centers, Inc. dated June 2, 1997. 16 Letter from KPMG Peat Marwick LLP re Change in Certifying Accountant, hereby incorporated by reference from Exhibit 16 of the Registrant's Current Report on Form 8-K dated April 17, 1997. 21 Subsidiaries of KinderCare. 27 Financial Data Schedule. 61 (b) Reports on Form 8-K. The registrant filed the no reports on Form 8-K during the fourth quarter of fiscal 1997. (c) Exhibits Required by Item 601 of Regulation S-K. The Exhibits to this Report are listed under item 14(a)(3) above. 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, on August 28, 1997. KINDERCARE LEARNING CENTERS, INC. By: /s/ DAVID J. JOHNSON ------------------------------------ David J. Johnson Chief Executive Officer and Chairman of the Board of Directors Pursuant to the requirements of the Securities Act, this Registration Statement has been signed on the 28th day of August, 1997 by the following persons in the capacities indicated: Signature Title /s/ DAVID J. JOHNSON Chief Executive Officer, and Chairman - ----------------------------------- of the Board of Directors (Principal David J. Johnson Executive Officer) /s/ DAN JACKSON Vice President, Financial Control and - ----------------------------------- Planning (Principal Financial Accounting Officer) /s/ HENRY R. KRAVIS Director - ----------------------------------- Henry R. Kravis /s/ GEORGE R. ROBERTS Director - ----------------------------------- George R. Roberts /s/ CLIFTON S. ROBBINS Director - ----------------------------------- Clifton S. Robbins /s/ NILS P. BROUS Director - ----------------------------------- Nils P. Brous /s/ SANDRA W. SCARR, Ph.D. Director - ----------------------------------- Sandra W. Scarr /s/ STEPHEN KAPLAN Director - ----------------------------------- Stephen Kaplan 63 KinderCare Learning Centers, Inc. Annual Report on Form 10-K Fiscal Year Ended May 30, 1997 Exhibit Index Exhibit Number Description of Exhibits - ------ ----------------------- 2(a) Agreement and Plan of Merger dated as of October 3, 1996, between KinderCare Learning Centers, Inc. ("KinderCare") and KCLC Acquisition Corp. ("KCLC Acquisition") (incorporated by reference to Exhibit 2.1(a) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(b) Merger Agreement Amendment dated as of December 27, 1996 between KinderCare and KCLC Acquisition (incorporated by reference to Exhibit 2.1(b) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(c) Voting Agreement, dated as of October 3, 1996, among KCLC Acquisition and the stockholders parties thereto (incorporated by reference to Exhibit 2.2(a) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(d) Voting Agreement Amendment dated as of December 27, 1996 among KCLC Acquisition and the stockholders parties thereto (incorporated by reference to Exhibit 2.2(b) to KinderCare's Form S-4, filed January 7, 1997, File no. 333-19345). 2(e) Stockholders' Agreement between KinderCare and the stockholders parties thereto (incorporated by reference from Exhibit 2.3 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 3(a) Certificate of Merger of KCLC Acquisition into KinderCare (incorporated by reference from Exhibit 3.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 3(b) By-Laws of KinderCare (incorporated by reference from Exhibit 3.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, file no. 333-23127). 4(a) Indenture dated as of February 13, 1997 between KinderCare and Marine Midland Bank, as Trustee (incorporated by reference from Exhibit 4.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 64 4(b) Form of 9 1/2 % Senior Subordinated Note due 2009. (incorporated by reference from Exhibit 4.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 4(c) Form of 9 1/2% Series B Senior Subordinated Note due 2009 (incorporated by reference from Exhibit 4.3 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(a) Credit Agreement, dated as of February 13, 1997, among KinderCare, the several lenders from time to time parties thereto, and the Chase Manhattan Bank as administrative agent (incorporated by reference from Exhibit 10.1 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(b) Registration Rights Agreement, dated as of February 13, 1997, among KCLC Acquisition, KLC Associated L.P. and KKR Partners II, L.P. (incorporated by reference from Exhibit 10.2 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(c) Registration Rights Agreement dated February 13, 1997 among KinderCare, Chase Securities, Inc., BT Securities Corporation, Salomon Brothers Inc and Smith Barney Inc. (incorporated by reference from Exhibit 4.4 of Amendment No. 1 to the Registrant's Registration Statement on Form S-4 dated April 9, 1997, File no. 333-23127). 10(d) Employment Agreement of Philip L. Maslowe dated May 8, 1995 (incorporated by reference from Exhibit 10(w) of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 2, 1995). 10(e) Letter Agreement relating to termination of employment of Sandra Scarr dated January 8, 1997. 10(f) Lease between 600 Holladay Limited Partnership and KinderCare Learning Centers, Inc. dated June 2, 1997. 16 Letter from KPMG Peat Marwick LLP re Change in Certifying Accountant, hereby incorporated by reference from Exhibit 16 of the Registrant's Current Report on Form 8-K dated April 17, 1997. 21 Subsidiaries of KinderCare. 27 Financial Data Schedule. EX-10.(E) 2 DR. SANDRA SCARR LETTER AGREEMENT January 8, 1997 Dr. Sandra Scarr 2626 Capstone Drive Montgomery, Alabama 36106 Dear Sandra: As we have discussed, in light of your announced intention to retire from KinderCare Learning Centers, Inc. (the "Company") on the date of the closing (the "Closing Date") of the merger (the "Merger") of KCLC Acquisition Corp. into the Company described in the Agreement and Plan of Merger between the Company and KCLC Acquisition Corp., dated as of October 3, 1996, the purpose of this letter is to describe various agreements that have been reached between you and the Company regarding your retirement from the Company and to further describe the ongoing relationship between you and the Company after the Closing Date. 1. For the period commencing on the Closing Date and ending December 15, 1999 (the "Additional Service Period"), and, where appropriate, for any period before the Additional Service Period, you agree to perform the following services for the Company: a. You will assist and cooperate in good faith, whether before or after the Closing Date, with (i) the meetings with potential investors in various cities throughout the United States in connection with the offering of the Company's Senior Subordinated Notes and bank loans in connection with the Merger, or any other sales or management presentations in connection therewith, including, but not limited to, sales force and rating agency presentations, (ii) the consummation of the Merger and (iii) the transition with the new Chief Executive Officer of the Company. b. You will make yourself reasonably available for consultation with the Chief Executive Officer of the Company on business matters from time to time, and in connection with any litigation and disputes arising out of actions of the Company of which you have knowledge or information and you agree that you will cooperate with the Company in supplying data, information, and expertise within your special knowledge or competence and otherwise assist the Company in a proper and inappropriate fashion in the protection of its interests. The Company will reimburse you for reasonable out-of-pocket expenses (such as hotel and travel expenses) incurred by you in providing such services, and may provide additional consulting fees to you as mutually agreed upon; c. At the Company's request you agree to serve as a member of the Company's Board of Directors (the "Board"), for which you will be entitled to receive those directors fees afforded to other outside directors of the Company. Dr. Sandra Scarr -2- January 8, 1997 Subject to paragraph 7 herein, nothing in this Agreement will be construed as preventing you from obtaining full-time employment elsewhere during the Additional Service Period. 2. As soon as practicable after the Closing Date, the Company will pay you a lump sum amount equal to the product of (i) $7,692.31 (1/52 of $400,000) and (ii) the number of weeks (including fractions thereof) from the Closing Date until June 15, 1997. 3. For a period of thirty months beginning July 15, 1997 and ending December 15, 1999 the Company will pay you $36,666.67 per month; provided, that the first payment will be made on July 15, 1997. If agreed by you and the Company, these payments may be deferred. The payments provided for in this paragraph 3 will be in consideration of (i) the services that you will be required to provide pursuant to paragraph 1.b. herein and (ii) your obligation not to compete with the Company pursuant to paragraph 7(b) herein. 4. During the period commencing on the Closing Date and ending December 15, 1998 (the "Benefits Period"), the Company will continue to provide you with medical and disability coverage, as the Company from time to time may provide, so long as you continue to contribute to the cost of coverage under such plans in the same manner and at the same level that you would be required to contribute if you had not retired; provided, however, that if you obtain employment elsewhere at any time during the Benefits Period, your benefits will be terminated and you will instead be entitled, at your cost and option, to your rights under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"); provided, further, that the COBRA period will begin on the earlier of your termination of employment or the Closing Date. In addition, during the Benefits Period, the Company will provide you with substantially similar life insurance coverage as it may from time to time provide for the executives of the Company. 5. The Company will provide the following fringe benefits and perquisites on your behalf: (a) If you so request, the Company will purchase your current residence in the Montgomery, Alabama area (the "Residence") for a total amount equal to your original purchase price plus capital improvements; provided, that such total will not exceed $360,000. The Company will not be required to purchase the residence for at least 30 days after the Closing Date or at any time after the Benefits Period has expired. (b) The Company will reimburse you for any reasonable relocation expenses that you may incur pursuant to your relocation from the Montgomery, Alabama area, up to $25,000. Dr. Sandra Scarr -3- January 8, 1997 (c) For so long as you are a member of the Board, the Company will continue to provide you with a BMW 300 series automobile under the same terms and conditions as under the employment agreement between you and the Company dated June 16, 1995 (the "Employment Agreement"). (d) The Company will allow you to retain your computer (the "Computer") subject to paragraph 7(a) herein; provided, however, that after the Closing Date, you will not be permitted to access or communicate in any way over the Company's electronic mail system or its intranet system via the Computer or by any other means unless access is requested in writing by an officer of the Company. All claims for reimbursement must be made to the Company in writing, accompanied by a bill or other appropriate documentation detailing the nature and the amount of the expense. 6. Your Employment Agreement (including any amendment or modification thereto) will be terminated as of the Closing Date and will thereafter be of no further force or effect. 7. (a) You will not, without the prior written consent of the Company, divulge, disclose or make accessible to any other person, firm, partnership, corporation or other entity any Confidential Information pertaining to the business of the Company or any of its affiliates, except (A) while acting as a consultant for the Company, in the business of and for the benefit of the Company, or (B) when required to do so by a court of competent jurisdiction, by any governmental agency having supervisory authority over the business of the Company, or by any administrative body or legislative body (including a committee thereof) with jurisdiction to order you to divulge, disclose or make accessible such information. For purposes of this paragraph 7(a), "Confidential Information" will mean non-public, information concerning the financial data, strategic business plans, product development (or other proprietary product data), customer lists, marketing plans and other non-public proprietary and confidential information of the Company or its affiliates or customers, that, in any case, is not otherwise available to the public (other than by your breach of the terms hereof). (b) During the Additional Service Period, without the prior written consent of the Company, (A) you will not, directly or indirectly, either as a principal, manager, agent, consultant, officer, stockholder, partner, investor, lender or employee or in any other capacity, carry on, be engaged in or have any financial interest in, any business which is in competition with the business of the Company or any group, division or subsidiary of the Company and (B) you will not, on your own behalf or on behalf of any person, firm or company, directly or indirectly, hire any person, other than your Dr. Sandra Scarr -4- January 8, 1997 administrative assistance and the individual who directly provides cleaning service to you prior to your retirement date, who has been employed by the Company at any time during the 12 months immediately preceding such hiring. (c) For purposes of this paragraph 7, a business will be deemed to be in competition with the Company if it is principally involved in the purchase, sale or other dealing in any property or the rendering of any service purchased, sold, dealt in or rendered by the Company as a part of the business of the Company at the time of your resignation within the same geographic area in which the Company effects such purchases, sales or dealings or renders such services. Nothing in this paragraph 7 will be construed so as to preclude you from investing in any publicly or privately held company, provided your beneficial ownership of any class of such company's securities does not exceed 1% of the outstanding securities of such class. (d) You agree that this covenant not to compete is reasonable under the circumstances and will not interfere with your ability to earn a living or to otherwise meet your financial obligations. You and the Company agree that if in the opinion of any court of competent jurisdiction such restraint is not reasonable in any respect, such court will have the right, power and authority to excise or modify such provision or provisions of this covenant as to the court will appear not reasonable and to enforce the remainder of the covenant as so amended. You agree that any breach of the covenants contained in this paragraph 7 would irreparably injure the Company. Accordingly, you agree that the Company may, in addition to pursuing any other remedies it may have in law or in equity, cease making any payments otherwise required by this Agreement and obtain an injunction against you from any court having jurisdiction over the matter restraining any further violation of this Agreement by you. (e) The Company and you each agree that they will not (except as required by law) directly or indirectly make any statement or release any information, or encourage others to make any statement or release any information that is (i) designed to embarrass or criticize the other (or any of their respective affiliates, associates or shareholders), or (ii) intended to interfere with the merger contemplated by the Merger Agreement; provided, that it will not be a violation of this paragraph 7(e) for you to make truthful statements when required to do so by a court of law, by any governmental agency having supervisory authority over the business of the Company or by any administrative or legislative body (including a committee thereof) with jurisdiction to order you to divulge, disclose or make accessible such information. (f) (i) If you breach any of the covenants contained in this paragraph 7, the Company will have no obligation to make any further payments under this Agreement. Dr. Sandra Scarr 5 January 8, 1997 (ii) The Company and you recognize that each party will have no adequate remedy at law for breach by the other of any of the covenants set forth in this paragraph 7 and that in the event of any breach of these covenants, the Company and you hereby agree and consent that the other will be entitled to seek a decree of specific performance, mandamus or other appropriate remedy to enforce the performance of such covenants. 8. You agree, to execute a release substantially in the form attached hereto as a condition to the receipt of any payment hereof. 9. Any dispute or controversy arising under or in connection with this Agreement will be settled exclusively by arbitration, conducted before an arbitrator who is mutually agreeable to you and the Company in the Atlanta metropolitan area in accordance with the rules of the American Arbitration Association then in effect or, if you and the Company are unable to agree on an arbitrator, before an arbitrator chosen in accordance with the rules of the American Arbitration Association. Judgment may be entered on the arbitrator's award in any court having jurisdiction. 10. The Company will reimburse you for reasonable legal fees and expenses incurred by you in connection with the negotiation of this Agreement up to a maximum reimbursement of $30,000. 11. This Agreement will be construed and interpreted in accordance with the laws of the State of Delaware without regard to rules pertaining to conflict of laws. 12. You and the Company agree that this Agreement will become effective if and only if, and at such time as, the closing of the Merger occurs. 13. While this Agreement is with KCLC Acquisition Corp., upon the Closing Date this Agreement will be binding upon and inure to the benefit of the Company and any successor of the Company acquiring directly or indirectly all or substantially all of the assets of the Company whether by merger, consolidation, sale or otherwise (and such successor will thereafter be deemed embraced within the term "the company" for purposes of this Agreement) but the Agreement will not otherwise be assignable by the Company without your consent. 14. This Agreement may be executed in counterparts. Dr. Sandra Scarr -6- January 8, 1997 * * * IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. SANDRA SCARR ----------------------------------- SANDRA SCARR KCLC ACQUISITION CORP. /s/ ----------------------------------- By: EX-10.(F) 3 OFFICE LEASE OFFICE LEASE between 600 HOLLADAY LIMITED PARTNERSHIP and KINDERCARE LEARNING CENTERS, INC. Date: June 2, 1997 Floors 12 - 15 and a portion of Floor 11 Table of Contents ----------------- Article 1 Basic Lease Information Article 2 Agreement Article 3 Use Article 4 The Premises Article 5 Monthly Rent Article 6 Additional Rent for Operating Expenses Article 7 Additional Rent for Taxes Article 8 Insurance Article 9 Requirements of Law and Hazardous Materials Article 10 Assignment and Subletting Article 11 Rules and Regulations Article 12 Common Areas Article 13 Landlord's Services Article 14 Tenant's Care of the Premises Article 15 Alterations Article 16 Construction Liens Article 17 End of Term Article 18 Eminent Domain Article 19 Damage and Destruction Article 20 Subordination Article 21 Entry by Landlord Article 22 Indemnification, Waiver, and Release Article 23 Quiet Enjoyment Article 24 Effect of Sale Article 25 Default Article 26 Parking Article 27 Option to Expand Article 28 Option to Renew Article 29 Arbitration Article 30 Miscellaneous Exhibit A: The Premises Exhibit B: Legal Description of the Land Exhibit C: Rules and Regulations Exhibit D: Workletter Exhibit E: HVAC Specifications Exhibit F: Janitorial Specifications Exhibit G: Subordination, Non-Disturbance and Attornment Agreement OFFICE LEASE THIS OFFICE LEASE is entered into by Landlord and Tenant as described in the following Basic Lease Information on the date that is set forth for reference only in the following Basic Lease Information. Landlord and Tenant agree: ARTICLE 1 - BASIC LEASE INFORMATION 1.1 Basic Lease Information. The following terms are referred to in other provisions of the Lease. Each such reference shall incorporate the applicable Basic Lease Information. In the event of any conflict between the Basic Lease Information and the provisions of the Lease, the latter shall control. (a) LEASE DATE: (b) LANDLORD: 600 Holladay Limited Partnership (c) LANDLORD'S ADDRESS: c/o Ashforth Pacific, Inc. 825 NE Multnomah, Suite 1275 Portland, OR 97232 Attention: Matthew J. Klein with a copy, in the event that Tenant alleges that Landlord is in default of its obligations hereunder or if Tenant claims a right to terminate this Lease, at the same time to: The Ashforth Company, Inc. 3003 Summer Street, 5th Floor Stamford, CT 06905 Attention: Peter E. Hewitt, Esq. (d) TENANT: KinderCare Learning Centers, Inc. (e) TENANT'S ADDRESS: Until Tenant takes occupancy of its temporary space in Portland, OR: 2400 President's Drive Montgomery, AL 36116 From the time that Tenant takes occupancy of its temporary space in Portland, OR until the Commencement Date of this Lease: 825 NE Multnomah, Suite 1585 Portland, OR 97232 From and after the Commencement Date of this Lease: 650 NE Holladay Street, Suite Portland, OR 97232 Attention: Beth Ugoretz (in all cases) with a copy at the same time to: 1 Thomas R. Page Stoel Rives LLP 900 SW Fifth Avenue, Suite 2300 Portland, OR 97204-1268 (f) BUILDING ADDRESS: 650 NE Holladay Street, Portland, OR 97232. (g) PREMISES: All of floors 12 through 15 and approximately 8,500 square feet on the 11th floor. (h) USABLE AREA OF THE PREMISES: See Section 4.1. (i) RENTABLE AREA OF THE PREMISES: See Section 4.1. (j) RENTABLE AREA OF THE BUILDING: 270,728 square feet. (k) TERM: Beginning on the Commencement Date and expiring on the Expiration Date. (l) COMMENCEMENT DATE: Upon substantial completion of the Tenant's improvements, as described in the Workletter, which is anticipated to be November 1, 1997. (m) RENT COMMENCEMENT DATE: Upon the Commencement Date of the Lease. (n) EXPIRATION DATE: October 31, 2007, unless the Commencement Date is delayed as provided in Section 4.2, in which case the Expiration Date shall be the last day of the month preceding the month occurring ten (10) years after the Commencement Date. (o) SECURITY DEPOSIT: None. (p) PREPAID RENT: First month's rent. (q) MONTHLY RENT: $22.50 per rentable square foot per annum for Lease Years 1 through 5, and $26.50 per rentable square foot per annum for Lease Years 6 through 10. (r) FIRST MONTHLY RENT ADJUSTMENT DATE: January 1, 1999. (s) TENANT'S SHARE: To be determined by dividing the Rentable Area of the Premises by the Rentable Area of the Building. (t) PARKING: Up to two (2) spaces per 1,000 rentable square feet of space, subject to the provisions of Article 27. 2 (u) BROKER: Cushman & Wakefield of Oregon, Inc. (v) CONCEPTUAL PLAN SUBMISSION DATE: June 20, 1997. 1.2 Definitions: (a) ADDITIONAL RENT: Any amounts that this Lease requires Tenant to pay in addition to Monthly Rent. (b) BASE YEAR: 1998. (c) BUILDING: The office building known as Liberty Centre (d) LAND: The Land on which the Project is located and which is described on Exhibit B. (e) LEASE YEAR: The twelve month period beginning on the first day of the month in which the Commencement Date occurs and each succeeding twelve (12) month period thereafter. (f) NOTICE: Any notice, request, demand, consent, approval, or other communication required or permitted under this Lease must be in writing and will be deemed to have been given when personally delivered, sent by facsimile with receipt acknowledged, deposited with any nationally recognized overnight carrier that routinely issues receipts, or deposited in any depository regularly maintained by the United States Postal Service, postage prepaid, certified mail, return receipt requested, addressed to the party for whom it is intended at its address set forth in Section 1.1. Either Landlord or Tenant may add additional addresses or change its address for purposes of receipt of any such communication by giving ten (10) days prior Notice of such change to the other party. (g) PARKING GARAGE: The structure located on the Land, and more particularly shown on Exhibit B, designed for the parking of passenger vehicles. (h) PRIME RATE: The rate of interest from time to time announced by U.S. National Bank of Oregon ("USB"), or any successor to it, as its prime rate. If USB, or any successor to it, ceases to announce a prime rate, the Prime Rate will be a comparable interest rate designated by Landlord. (i) PROJECT: The Land and all improvements built on the Land, including without limitation the Building, Parking Garage, walkways, driveways, fences, and landscaping. (j) RENT: The Monthly Rent and Additional Rent. 3 (k) TAXES: All real and personal property taxes, school taxes, sewer rates and charges, transit taxes assessed, levied or imposed upon the Project or other Governmental assessments or charges, general, specific, ordinary or extraordinary, foreseen or unforeseen. If at any time during the Term the methods or standards of taxation prevailing at the date hereof shall be altered so that in lieu of, or as an addition to, or as a substitute for the whole or any part of the Taxes now levied, assessed or imposed, there shall be imposed (a) a tax, assessment, levy, imposition or charge based on the rents received (whether or not wholly or partially as a capital levy or otherwise), or (b) a license fee measured by the Rent, other tax, levy, imposition, charge or license fee; then all such taxes, assessments, levies, impositions, charges or license fees or the part thereof so measured or based, shall be deemed to be Taxes. (l) UNAVOIDABLE DELAYS: Delays beyond Landlord's reasonable control resulting from acts of God, governmental restrictions or guidelines enacted after the date hereof, strikes, labor disturbances, shortages of materials and supplies of which Landlord did not know or should not have known on the date hereof and from any other causes or events whatsoever beyond Landlord's reasonable control. (m) WORKLETTER: The workletter attached to this lease as Exhibit D. 1.3 Exhibits. The following addendum and exhibits are attached to this Lease and are made part of this Lease: EXHIBIT A The Premises EXHIBIT B Legal Description of the Land EXHIBIT C Rules and Regulations EXHIBIT D Workletter EXHIBIT E HVAC Specifications EXHIBIT F Janitorial Specifications EXHIBIT G Subordination, Non-Disturbance and Attornment Agreement ARTICLE 2 - AGREEMENT 2.1 Leasing. Landlord leases the Premises to Tenant, and Tenant leases the Premises from Landlord, together with the right to utilize in common with others, for ingress and egress, the common areas of the Project as described in Article 12. Nothing herein contained shall be construed to permit Tenant the use of the roof (except as provided in Section 4.4) or exterior walls of the Building, of the space above or below the Premises or of any parking or other areas adjacent to the Building, except as provided in Article 26. 4 2.2 Restrictive Covenant. Landlord agrees that so long as Tenant is not in default of any material provision of this Lease nor assigned this, Lease except as provided in Section 10.5, nor subleased more than 75% of the Premises and Tenant's corporate headquarters are located in the Premises, Landlord shall not lease space in the Building to any other tenant for the purpose of operating a child care facility nor consent to the use of any space in the Building for such purpose; provided, however, that the foregoing restriction shall not be applicable to a tenant of the Building that proposes to use a portion of its premises as a child care facility solely for its own employees. ARTICLE 3 - USE 3.1 General. The Premises shall be used for general office purposes and for no other purpose. The Premises are leased together with the appurtenances thereto, including the non-exclusive right to use the lobbies, elevators, stairways and other public portions of the Building, the non-exclusive use of any restrooms on any multi-tenant floors and the exclusive right to use any restrooms on single-tenant floors included within the Premises. Tenant shall not do, nor permit anything to be done, in or about the Premises which will in any way obstruct or interfere with the rights of other tenants of the Building, or injure or annoy them, or use or allow the Premises to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit any nuisance in, on or about the Premises or the Building, or commit or suffer to be committed any waste in, on or about the Premises or the Building. 3.2 Commercial Facility. The Premises will be used only as a commercial facility and not as a place of public accommodation as defined by the Americans with Disabilities Act of 1990, as amended ("ADA"). Tenant shall not offer its goods and services to the general public at the Premises. 3.3 Building Name. Tenant shall not be allowed to use the name of the Building for any purpose other than as the address of the business to be conducted by Tenant in the Premises. Landlord reserves the right in its sole discretion to change the name of the Building at any time. 3.4 Signs and Advertising. (a) Tenant shall not inscribe, paint, post, place, or in any manner display any sign, notice, picture, placard, poster, name or advertising matter anywhere in or about the Building or Premises at places visible (either directly or indirectly as an outline or shadow on or through a glass pane) from outside the Premises. In the event that Landlord permits any such signs or notices, upon expiration or termination of this Lease, Tenant shall, at its expense, promptly remove all such signs or advertising and shall repair any damage caused by such removal. (b) Tenant shall have the right , at its sole cost and expense, to install Building standard directory signage in the main lobby and, subject to Landlord's prior approval which shall not be unreasonably withheld or delayed, Tenant's standard signage in the elevator lobby on each floor on which the Premises are located, at each exterior entry door to the Premises, and on each side of the pylon sign to be erected by Landlord at 7th Avenue and Liberty Place. 5 3.5 Smoking Prohibited. Tenant acknowledges that smoking is not permitted within the Project (except in areas specifically designated as smoking areas) and agrees that it will not allow smoking within the Premises by employees, invitees or visitors. ARTICLE 4 - THE PREMISES 4.1 Determination of Premises.The Premises shall contain approximately 70,000 rentable square feet consisting of all of floors 12 through 15 and approximately 8,500 rentable square feet the 11th floor. Promptly after Tenant submits the Programming Information, Landlord shall calculate the usable and rentable area on the 11th floor of the Premises and all other items contained in this Lease that are dependent on either factor. The parties shall then enter into a written supplement to this Lease specifying all such items and adding a floor plan delineating the Premises as Exhibit A to this Lease . The usable area of the space on the 11th floor shall be computed by measuring from the inside finished surfaces of the dominant portion of the permanent outer Building walls to the centerline of the permanent walls separating the Premises from other tenant spaces and to the inside finished surface of the common corridor permanent walls. No deductions shall be made for columns or projections necessary to the Building. The rentable area for each single tenant floor shall be 15,722 square feet and the rentable area of space on any multi-tenant floor shall be calculated by multiplying the usable area by 1.14. Any dispute regarding the calculation of usable or rentable area shall be resolved by arbitration as provided in Article 29 and shall not render this Lease void or voidable. 4.2 Delivery of Possession. Landlord will construct or install in the Premises the improvements to be constructed or installed by Landlord according to the Workletter. Tenant acknowledges that neither Landlord nor its agents or employees have made any representations or warranties as to the suitability or fitness of the Premises for the conduct of Tenant's business or for any other purpose, nor has Landlord or its agents or employees agreed to undertake any alterations or construct any tenant improvements to the Premises, except as expressly provided in this Lease and the Workletter. If for any reason Landlord cannot deliver possession of the Premises to Tenant on the anticipated Commencement Date as stated in Section 1.1(l), this Lease will not be void or voidable, and Landlord will not be liable to Tenant for any resultant loss or damage; provided, however, in the event delivery of possession is delayed beyond the anticipated Commencement Date as stated in Section 1.1(l), then the Commencement Date and Rent Commencement Date shall be delayed on a day-by-day basis as provided in Paragraph 9 of the Workletter. Once the Commencement Date and Rent Commencement Date have been established, the parties shall execute and exchange an agreement specifying the Commencement Date and Rent Commencement Date, the Expiration Date and any other dates related thereto. If for any reason other the "Tenant Delays" as defined in Section 8 of the Workletter, Landlord has not achieved Substantial Completion as defined in Section 1(p) of the Workletter within 180 days after the anticipated Commencement Date, Tenant shall have the right to terminate this Lease by giving Landlord Notice of such election within ten (10) days after the expiration of said 180 days. 4.3 Early Entry. Tenant may be permitted early entry to the Premises by Landlord prior to the Commencement Date for the purpose of installing fixtures or any other purpose permitted by Landlord upon reasonable Notice to Landlord and provided that such entry does not interfere with or delay Landlord's completion of construction of the improvements. Any such early entry shall be at Tenant's sole risk and subject to all the terms and provisions of this Lease. 6 If at any time in Landlord's reasonable judgment such entry shall cause interference with the timely completion of the improvements to be constructed by Landlord, then said license may be withdrawn by Landlord immediately upon Notice to Tenant. 4.4 Antenna. Tenant shall have the right, at its sole cost and expense, to install a receiving dish antenna (approximately 24" in diameter) on the frame that Landlord will provide on the roof or at the mechanical penthouse of the Building and to utilize, in common with others, the conduits that Landlord shall provide for such purpose to connect its antenna to communications equipment to be installed in the Premises. Once installed, such antenna shall be maintained by Tenant in a first class condition at Tenant's sole cost and expense. If Tenant elects to install such antenna, Landlord's charge for such antenna usage shall be $200.00 per month, which charge shall be deemed additional rent pursuant to this Lease. Upon reasonable Notice to Landlord, Tenant shall be permitted access to the roof of the Building in order to maintain the antenna. 4.5 Storage Space Tenant shall have the right to lease a separate storage area of approximately 750 square feet to be constructed by Landlord in the basement of the Building. Such storage space shall be constructed of wire fencing or similar materials and not necessarily Building Standard partitioning and shall be used only for the storage of normal office documents, furniture and equipment. Such storage area may be leased by Tenant on a month to month basis during the Term of this Lease, may not be assigned or sublet by Tenant except in connection with the assignment of this Lease or a sublease of substantially all of the Premises and shall be a Landlord's standard rates in effect from time to time, which currently is $10.00 per square foot provided however that such rate shall not be increased by more than five per cent (5%) per year. ARTICLE 5 - MONTHLY RENT 5.1 Monthly Rent. Monthly Rent shall be paid beginning on the Rent Commencement Date and throughout the Term in advance on or before the first day of each calendar month of the Term except that the Prepaid Rent shall be paid upon the execution of this Lease. If the Term commences on a day other than the first day of a calendar month or ends on a day other than the last day of a calendar month, then Monthly Rent will be appropriately prorated by Landlord based on a thirty (30) day month. Monthly Rent and all Additional Rent will be paid to Landlord, without Notice or demand, and without deduction or offset, in lawful money of the United States of America at Landlord's address, or to such other address as Landlord may from time to time designate in writing. 5.2 Late Payments. Tenant recognizes that late payment of Rent or any other sum due hereunder from Tenant to Landlord will result in administrative expenses to Landlord, the extent of which are difficult and economically impractical to ascertain. Tenant therefore agrees that if Rent or any other payment due hereunder from Tenant to Landlord is not paid on the date said amount is due, then in addition to any other remedy available to Landlord, Tenant shall pay a late charge in an amount equal to the greater of (i) one percent (1%) of such delinquent Rent amount or (ii) a daily administrative charge of Twenty Five Dollars ($25.00) provided that in no event shall such late charge be greater than that permitted under the laws of the State of Oregon. The payment of such late charge shall not excuse or cure any default by Tenant under this Lease. 7 ARTICLE 6 - ADDITIONAL RENT FOR OPERATING EXPENSES 6.1 General. (a) Whenever for any calendar year the Operating Expenses (defined below) exceed the Operating Expenses for the Base Year, then, effective January 1 of such year, Tenant shall pay as Additional Rent the product of Tenant's Share multiplied by such excess, subject to the provisions of Section 6.2. The first payment of Additional Rent for increases in Operating Expenses, if any, shall be effective on the First Monthly Rent Adjustment Date set forth in Section 1.1(r). (b) As used in this Lease, the term "Operating Expenses" means: (1) All reasonable costs paid, payable, or incurred by Landlord for the management, operation, and maintenance of the Land and Building, computed in accordance with generally accepted accounting principles, including wages, salaries, benefits and compensation of employees but not above the level of property manager; consulting, accounting, legal, janitorial, maintenance, security, window washing and other services; management fees and costs; reasonable reserves for operating expenses; that reasonable part of office rent or rental value of space in the Project used or furnished by Landlord to enhance, manage, operate, and maintain the Project; reasonable allocation of costs to provide and operate free or discounted visitor parking for the Building; power, water, waste disposal, and other utilities; consumable materials and supplies, tools, and equipment; maintenance and repairs; insurance obtained with respect to the Land and Building; depreciation or rental on personal property and equipment used in the management, operation, or maintenance of the Land and Building, except as set forth in (c) below or which is or should be capitalized on the books of Landlord; and any other costs, charges, and expenses that under generally accepted accounting principles would be regarded as management, maintenance, and operating expenses. The preceding list is for definitional purposes only and does not impose any obligation to incur such expenses or provide such services. Any services provided by Landlord or any affiliate of Landlord shall be at rates competitive with prevailing rates for comparable services and projects. (2) The cost (amortized over its useful life for federal income tax purposes) together with interest (not to exceed Landlord's cost of funds) on the unamortized balance of any capital improvements that are made to the Project by Landlord (i) for the purpose of reducing operating expenses (provided that the annual anticipated savings in the component of operating expenses that such capital improvement is intended to reduce are reasonably expected to exceed the annual amortized cost of such improvement,) or (ii) after the Lease Date and by requirement of any governmental law, code or regulation (including without limitation the ADA and any provisions of ADA applicable to the Project or any part thereof as a result of the use, occupancy, or alteration thereof by Landlord) that was not applicable to the Project at the time it was constructed and is not as a result of special requirements for any tenant's use of the Project. (c) The Operating Expenses will not include: 1. depreciation on the Project (other than depreciation on personal property, equipment used in the management, operation or maintenance of the Land and Building; 8 2. costs of alterations of space or other improvements made for tenants of the Project; 3. finders' fees and real estate brokers' commissions; 4. ground lease payments, mortgage principal or interest; 5. capital items other than those referred to in clause (b) (2) above; 6. costs of replacements to personal property and equipment for which depreciation costs are included as an operating expense; 7. costs of excess or additional services provided to any tenant in the Building that are directly billed to such tenants; 8. the cost of repairs due to condemnation or casualties that are reimbursed by third parties ; 9. any cost due to Landlord's breach of this Lease; 10 all costs, including legal fees, relating to activities for the solicitation and execution of leases of space in the Building; 11. any legal fees incurred by Landlord in enforcing its rights under other leases for space in the Building; 12. any costs incurred to correct defects in base Building construction; 13. any cost associated with in the management, operation or maintenance of the Parking Garage; and 14. Landlord's income taxes. (d) If during any calendar year at least ninety-five percent (95%) of the Building is not provided with full Building standard services or is not at least ninety-five percent (95%) occupied, in determining Operating Expenses Landlord shall compute all variable Operating Expenses for such calendar year as though ninety-five percent (95%) of the Building were provided with full Building standard services and were ninety-five percent (95%) occupied. For purposes of this Section, the term variable Operating Expenses shall mean any Operating Expense (or portion thereof) that increases or decreases with the level of occupancy of the Building. In the event that Operating Expenses do not include any specific costs billed to or otherwise incurred for the particular benefit of specific tenants of the Building, Landlord shall have the right to increase Operating Expenses by an amount equal to the cost of providing standard services similar to the services for which such excluded specific costs were billed or incurred. In no event shall Landlord receive from all tenants of the Building more than one hundred percent (100%) of the Operating Expenses for any calendar year. 9 (e) Tenant acknowledges that Landlord has not made any representation or given Tenant any assurances that any estimate of Operating Expenses will equal or approximate the actual Operating Expenses for any calendar year or partial calendar year during the Term. 6.2 Estimated Payments. (a) Commencing with the calendar year in which the First Monthly Rent Adjustment Date occurs, Landlord will give Tenant Notice of the estimated Operating Expense increase, if any, for such calendar year. On or before the first day of each month during each calendar year, Tenant shall pay to Landlord Additional Rent monthly, in advance, an amount equal to 1/12 of the product of Tenant's Share multiplied by Landlord's estimate of the excess of the Operating Expenses for such year over the Operating Expenses for the Base Year. In the month in each calendar year in which Tenant first makes a payment based upon such estimate, if not January 1st of such year, Tenant shall pay to Landlord for each month which has elapsed since January 1st the difference, if any, between the Additional Rent based upon such estimate of Operating Expenses and the Additional Rent for Operating Expenses actually paid. (b) If at any time or times it reasonably appears to Landlord that the actual Operating Expenses for any calendar year will vary substantially from the estimated Operating Expenses for such calendar year, Landlord may, by Notice to Tenant, revise the estimated Operating Expense increase for such calendar year, and subsequent Additional Rent payments by Tenant in such calendar year will be based upon such revised estimated Operating Expense increase. 6.3 Annual Settlement. Within one hundred twenty (120) days after the end of each calendar year or as soon thereafter as practicable, Landlord will deliver to Tenant a statement with reasonable detail of the actual amounts payable under Section 6.2 for the prior calendar year. Such statement will be final and binding upon Landlord and Tenant unless Tenant objects to it in writing to Landlord within two hundred ten (210) days after delivery to Tenant or October 31st of each year, whichever is later. Acceptance or resolution of the first such statement shall constitute acceptance of the Operating Expense amount for the Base Year. If such statement shows an amount owing by Tenant that is less than the estimated payments previously made by Tenant for such calendar year, the excess will be held by Landlord and credited against the next payment of Rent; however, if the Term has ended and Tenant was not in default at its end, Landlord will refund the excess to Tenant. If such statement shows an amount owing by Tenant that is more than the estimated payments previously made by Tenant for such calendar year, Tenant will pay the deficiency to Landlord within thirty (30) days after the delivery of such statement. Tenant may review Landlord's records of the operating expenses, at Tenant's sole cost and expense, at the place Landlord normally maintains such records during Landlord's normal business hours upon reasonable advance Notice. 6.4 Final Proration. If this Lease ends on a day other than the last day of a calendar year, the amount of increase (if any) in the Additional Rent payable by Tenant applicable to the calendar year in which this Lease ends will be calculated on the basis of the number of days of the Term falling within such calendar year. Tenant's obligation to pay any increase or Landlord's obligation to refund any overage shall survive the expiration or other termination of this Lease. 10 6.5 Decrease in Operating Expenses. Notwithstanding anything contained in this Article, the Monthly Rent payable by Tenant shall in no event be less than the Monthly Rent specified in Section 1.1. 6.6 Dispute Resolution. Any dispute regarding the provisions of this Article shall be resolved by arbitration as provided in Article 29. ARTICLE 7 - ADDITIONAL RENT FOR TAXES 7.1 Calculation. Tenant shall pay, as Additional Rent, an amount equal to Tenant's Share of the excess of Taxes due for each calendar year of the Term which is subsequent to the first calendar year, over the amount of such Taxes due with respect to the Base Year. The first payment of Additional Rent, if any, shall be effective on the first Monthly Rent Adjustment Date set forth in Section 1.1(r). 7.2 Adjustment of Taxes. If in the Base Year and/or any subsequent calendar year, the Project is less than fully assessed, then the Taxes for such year(s) shall be appropriately adjusted to reflect what the Taxes for such year(s) would have been had the Project been fully assessed as completed and fully occupied. In the event that there are tenants in the Building from time to time that are entitled to exemptions from Taxes, Taxes for such year(s) shall be appropriately adjusted to reflect Landlord's estimate of full assessment. 7.3 Tax Appeal. If, by virtue of any application or proceeding brought by or on behalf of Landlord, there shall be a reduction of the assessed valuation of the Project for any year, including the Base Year, which affects the Taxes, or part thereof, for which Additional Rent has been paid by Tenant pursuant to this Article, such Additional Rent payment shall be recomputed on the basis of any such reduction and Landlord will credit against the next accruing installment of Monthly Rent due under this Lease, after receipt by Landlord of a tax refund or credit, any sums paid by Tenant in excess of the recomputed amounts, less a sum equal to Tenant's Share of all costs, expenses, and fees, including reasonable attorney's fees incurred by Landlord in connection with such application or proceeding. 7.4 Estimated Payments and Annual Settlement. Commencing with the calendar year in which the First Monthly Rent Adjustment Date occurs, Landlord will give Tenant Notice of the estimated Additional Rent for Taxes, if any, for such calendar year. On or before the first day of each month during each such calendar year, Tenant shall pay to Landlord Additional Rent of one-twelfth (1/12) of such estimated increase. In the month in each calendar year in which Tenant first makes a payment based upon such estimate, if not January 1st of such year, Tenant shall pay to Landlord for each month which has elapsed since January 1st the difference, if any, between the Additional Rent based upon such estimate and the Additional Rent for Taxes actually paid. After the end of each calendar year, there shall be a reconciliation of the Additional Rent for Taxes actually due and the total of estimated payments for such Additional Rent, as provided in Section 6.3. 7.5 Final Proration. Any Additional Rent payable pursuant to this Article for any partial year shall be adjusted in proportion to the number of days in such partial year during which this Lease is in effect. The obligation of Tenant with respect to any Additional Rent pursuant to 11 this Article applicable to the last fiscal or calendar year of the Term shall survive the expiration or termination of this Lease. 7.6 Decrease in Taxes. Notwithstanding anything contained in this Article, the Monthly Rent payable by Tenant shall in no event be less than the Monthly Rent specified in Section 1.1. 7.7 Dispute Resolution. Any dispute regarding the provisions of this Article shall be resolved by arbitration as provided in Article 29. ARTICLE 8 - INSURANCE 8.1 Landlord's Insurance. At all times during the Term, Landlord will carry insurance coverages and amounts reasonably determined by Landlord, based on coverages carried by prudent owners of comparable buildings in the vicinity of the Project. 8.2 Certain Insurance Risks. Tenant will not do or permit to be done any act or thing upon the Premises or the Project which would jeopardize or be in conflict with casualty insurance policies covering the Project or increase the rate of fire or any other insurance applicable to the Project of which Tenant has knowledge or reasonably should have known. 8.3 Tenant's Insurance. (a) During the entire Term, and for so long thereafter as Tenant shall occupy any portion of the Premises, Tenant shall keep in full force and effect, at its own expense, a policy or policies of: (i) Commercial General Liability insurance, in occurrence form, covering bodily injury or death to persons and damage to or destruction of property, and including contractual liability coverage for Tenant's indemnity obligations required by this Lease to afford protection of not less than $2,000,000 per occurrence and $2,000,000 combined single limit in the aggregate for any one accident and coverage for child abuse claims. Provided, however, that Tenant shall be permitted to maintain a self-insured retention. Tenant represents that its current self-insurane retention is $500,000. Tenant shall be permitted to increase the amount of its self-insured retention to $1,000,000. Any increase in such self-insured retention in excesss of $1,000,000 shall be subject to Landlord's consent, which shall not be unreasonably withheld or delayed. (ii) Worker's Compensation insurance as required by all state and/or federal laws. (b) Such policies will be maintained with companies having a "General Policyholders Rating" of at least A:IX as set forth in the most current issue of "Best's Insurance Guide," and will be written as primary policy coverage and not contributing with, or in excess of, any insurance coverage which Landlord may carry. Tenant shall have the right to provide the coverages required herein under blanket policies provided that the coverage afforded Landlord shall not be diminished by reason thereof. 12 8.4 Certificates of Insurance.Tenant shall, prior to the Commencement Date, cause to be delivered to Landlord an original certificate of insurance providing a minimum of thirty (30) days prior notice of cancellation or reduction in coverage. Renewal certificates shall be furnished to Landlord at least ten (10) days prior to the expiration date of each policy. All such certificates shall indicate that Landlord is an additional insured with respect to the Commercial General Liability coverage. 8.5 Waiver of Subrogation. All insurance policies required by this Article shall contain a waiver by the insurer of any rights of subrogation to any cause of action (including negligent acts) against the Tenant or Landlord (as the case may be) and their officers, directors, and employees. Further, each party waives any claim or cause of action against the other party hereto arising from any loss or damage which is by such insurance or which could be covered by such insurance if Tenant self-insures but only insofar as such party is compensated by such insurance for such loss or damage. 8.6 Tenant's Property. All furnishings, fixtures, equipment and property of every kind and description of Tenant and of persons claiming by or through Tenant which may be on the Premises shall be at the sole risk and hazard of Tenant and no part of loss or damage thereto for whatever cause is to be charged to or borne by Landlord. ARTICLE 9 - REQUIREMENTS OF LAW AND HAZARDOUS MATERIALS 9.1 General. At its sole cost and expense, Tenant shall in its use of the Premises promptly comply with: (i) all laws, statutes, ordinances, and governmental rules, regulations, or requirements now in force or in force after the Lease Date, (ii) the requirements of any fire or casualty insurance policy applicable to the Project now or after the Lease Date known to Tenant, and (iii) any direction or certificate of occupancy issued pursuant to any law by any public officer or officers, as well as with the provisions of all recorded documents affecting the Premises in each case, insofar as they relate to the condition, use, or occupancy of the Premises, excluding requirements of structural changes to the Premises or the Building, unless required by the unique nature of Tenant's use or occupancy of the Premises. Tenant shall participate in all Building practice fire drills and Building evacuations and shall prepare and maintain a Fire and Life Safety Plan for its employees and guests. Landlord shall comply with all laws, statutes, ordinances and governmental rules, regulations or requirements now in force or in force after the Lease Date affecting the Project, excluding Tenant's obligations hereunder. 9.2 Americans with Disabilities Act. Tenant shall be responsible for all modifications to the Premises required for compliance with ADA. Landlord shall be responsible for insuring that the common areas of the Building and the Base Building elements are in compliance with ADA on the Commencement Date. 9.3 Hazardous Materials. (a) For purposes of this Lease, "Hazardous Materials" means any explosives, radioactive materials, hazardous wastes, or hazardous substances, including without limitation substances defined as "hazardous substances" in the Comprehensive Environmental Response, 13 Compensation and Liability Act of 1980, as amended, 42 U.S.C. Sections 9601-9657; the Hazardous Materials Transportation Act of 1975, 49 U.S.C. Sections 1801-1812; the Resource Conservation and Recovery Act of 1976, 42 U.S.C. Sections 6901-6987; or any other federal, state, or local statute, law, ordinance, code, rule, regulation, order, or decree regulating, relating to, or imposing liability or standards of conduct concerning Hazardous Materials, waste, or substances now or at any time hereafter in effect (collectively, "Hazardous Materials Laws"). (b) Tenant will not directly or indirectly cause or permit the storage, use, generation, or disposition of any Hazardous Materials in, on, or about the Premises or the Project by Tenant, its agents, employees, or contractors other than customary office supplies in such quantities and used in such manner as is consistent with normal office uses. Tenant will not directly or indirectly use or permit the Premises to be used or operated in a manner that may cause the Premises or the Project to be contaminated by any Hazardous Materials in violation of any Hazardous Materials Laws. In the event of the violation of the foregoing by Tenant, in addition to all other rights and remedies of Landlord under this Lease, regardless of when the existence of the Hazardous Materials or violation of any Hazardous Materials Laws is determined, and whether during the Term or after the Expiration Date, Tenant shall, immediately upon notice from Landlord, at Tenant's sole cost and expense, at Landlord's option, either (i) take all action necessary to test, identify and monitor the Hazardous Materials and to remove the Hazardous Materials from the Project or Premises and dispose of the same and restore the Project or Premises to the condition existing prior to such removal, and/or to remedy any violation of any Hazardous Materials Laws, all in accordance with applicable federal, state and local statutes, laws, codes, rules, regulations or orders; or (ii) reimburse Landlord for all costs and expenses incurred by Landlord for engineering or environmental consultant or laboratory services) in testing, investigating, identifying and monitoring the Hazardous Materials and in removing and disposing of the Hazardous Materials and in restoring the Project or Premises, and/or in remedying any violation of any Hazardous Materials Laws to the extent that Tenant is responsible for such violation. Tenant shall defend with legal counsel acceptable to Landlord, indemnify and save harmless Landlord and Landlord's managing agent against and from all liabilities, obligations, damages, penalties, claims, costs, charges and expenses, including architects' and attorneys' fees and disbursements which may be imposed upon or incurred by or asserted against Landlord or Landlord's managing agent, whether by any governmental authority, Tenant or other third party, by reason of any violation or alleged violation of any of the foregoing provisions of this Section by Tenant. Without Landlord's prior written consent, Tenant will not take any remedial action or enter into any agreements or settlements in response to the presence of any Hazardous Materials in, on, or about the Project or the Premises. (c) Landlord represents, to the best of its knowledge, and warrants as of the date of this Lease and the Commencement Date that there are no Hazardous Materials in or on the Premises or the Project except for equipment and supplies in such quantities and used in such manner as is consistent with the operation and maintenance of a first-class office building. 14 ARTICLE 10 - ASSIGNMENT AND SUBLETTING 10.1 General. Tenant shall not assign or transfer this Lease, or any interest therein, by operation of law or otherwise, and shall not sublet the Premises or any part thereof, or any right or privilege appurtenant thereto, or suffer any other person to occupy or use the Premises, or any portion thereof, or agree to any of the foregoing, without in each case first obtaining the written consent of Landlord in accordance with the provisions of this Article, except as provided in Section 10.5. Any such assignment, transfer, pledge, hypothecation, encumbrance, sublease or occupation or use of the Premises by any other person without such consent, shall be void and shall constitute a default under this Lease. Any consent to any assignment, transfer, pledge, hypothecation, encumbrance, sublease or occupation or use of the Premises by any other person which may be given by Landlord shall not constitute a waiver of the provisions of this Article or a release of Tenant from the full performance of the covenants herein contained. 10.2 Consent. (a) If Tenant desires at any time to assign this Lease or sublet all or any portion of the Premises, Tenant shall give Landlord Notice of its desire to do so, which Notice shall contain: (i) the name of the proposed subtenant or assignee; (ii) the nature of the proposed subtenant's or assignee's business to be carried on in the Premises; (iii) a copy of the final form of the proposed sublease or assignment; (iv) financial statements, either audited independently or signed by an authorized officer or principal, for the two most recent completed fiscal years of the proposed subtenant or assignee (financial statements furnished to Landlord which are not independently audited must be in accordance with generally accepted accounting principles ("GAAP"), and must include all four (4) GAAP financial statements); (v) bank references for the proposed subtenant or assignee; and (vi) such supplemental information as Landlord may reasonably request concerning the proposed subtenant or assignee. (b) Within twenty (20) days after Landlord's receipt of all of the above information, Landlord shall, by Notice to Tenant, elect to: (I) terminate this Lease as to the portion of the Premises so proposed to be assigned or subleased, effective as of the date of such proposed assignment or sublease with a proportionate abatement in Rent payable hereunder in the event that (i) Tenant proposes to assign the Lease except as provided in Section 10.5, or (ii) Tenant proposes to sublease space for more than five (5) years, or (iii) Tenant has subleased or would with the inclusion of the proposed sublease have subleased 15,722 or more rentable square feet. (II) consent to the sublease or assignment pursuant to Landlord's standard form; or (III) reject the sublease or assignment for any of the following reasons: (i) in Landlord's reasonable estimate, the proposed subtenant 15 or assignee has a financial standing, is of a character, is engaged in business, is of a reputation, or proposes to use any part of the Premises in a manner, not in keeping with the standards of a first-class office building; (ii) the sublease or assignment is not expressly subject to all of the obligations of Tenant pursuant to this Lease and does not specifically provide that there shall be no further subletting or assignment of the Premises without the prior written consent of Landlord and that the subtenant or assignee shall provide Landlord with an insurance certificate verifying the same coverages as required by Article 8; (iii) such subletting or assignment shall result in there being more than five occupants per floor (who are not employed, associated with or subject to Tenant's control) other than Tenant in the Premises; (iv) the proposed subtenant or assignee is a person then negotiating with Landlord for the rental of any space in the Building. Immediately prior to the time that Tenant lists any space as available for sublease, it may request from Landlord a list of parties with which Landlord is engaged in active negotiations for space in the Building. Tenant shall be free to negotiate with any party not on such list for the subleasing of such space. (c) If Landlord has available for rent comparable or similar space in the Building, Tenant shall not solicit any other occupant of the Building. 10.3 Obligation and Liability. Each permitted assignee, shall, in writing, assume and be deemed to have assumed this Lease and shall be and remain liable jointly and severally with Tenant for the payment of Rent and for the due performance or satisfaction of all the provisions, covenants, conditions and agreements herein contained on Tenant's part to be performed or satisfied. No permitted assignment shall be binding on Landlord unless such assignee or Tenant shall deliver to Landlord a counterpart of such assignment which contains a covenant of assumption by the assignee, but the failure or refusal of the assignee to execute such instrument of assumption shall not release or discharge the assignee from its liability as set forth above. No such assumption by an assignee or subtenant shall relieve Tenant of Tenant's obligation and liabilities under this Lease. 10.4 ADA Compliance. As a condition to its consent required by this Article, Landlord may require Tenant, its assignee, or its subtenant, to make such alterations to the Premises as required in order to comply with ADA as it applies to the use, occupancy, or alteration of the Premises. 10.5 Corporate Transfers. Anything to the contrary notwithstanding, Landlord's consent shall not be required for an assignment to any entity which becomes a successor in interest to Tenant or to a transfer to an affiliate or to a transfer in connection with a merger, consolidation or sale of all or substantially all of the stock or assets of Tenant; provided, however, that Tenant shall give Landlord prompt Notice of such event. 10.6 Processing Fees. Any notice by Tenant to Landlord pursuant to this Article 10, of a proposed assignment, subletting or other transfer of any kind, shall be accompanied by a payment of Seven Hundred Fifty ($750.00) Dollars as a non-refundable fee for Landlord's time 16 and the processing of Tenant's request for Landlord's consent 10.7 Lease Termination. The voluntary or other surrender of this Lease by Tenant or a mutual cancellation thereof shall not work a merger, and shall, at the option of Landlord, terminate all or any existing subleases or subtenancies, or may, at the option of Landlord, operate as an assignment to it of any or all such subleases or subtenancies. ARTICLE 11 - RULES AND REGULATIONS Tenant and its employees, agents, licensees, and visitors will at all times observe faithfully, and comply strictly with, the rules and regulations set forth in Exhibit C. Landlord may from time to time reasonably amend, delete, or modify existing rules and regulations, or adopt reasonable new rules and regulations. In the event of any breach of any rules or regulations, Landlord will have all remedies that this Lease provides for default by Tenant, and in addition to any remedies available at law or in equity, including the right to enjoin any breach of such rules and regulations. Landlord will not be liable to Tenant for violation of such rules and regulations by any other tenant, its employees, agents, visitors, or licensees or any other person. In the event of any conflict between the provisions of this Lease and the rules and regulations, the provisions of this Lease will govern. ARTICLE 12 - COMMON AREAS As used in this Lease, the term "common areas" means the hallways, entryways, stairs, lobbies, elevators, driveways, walkways, terraces, docks, loading areas, restrooms, trash facilities, and all other areas and facilities in the Project that are provided and designated from time to time by Landlord for the general nonexclusive use and convenience of Landlord, tenants of the Project, their employees, invitees, licensees, and other visitors. Without advance Notice to Tenant, except with respect to matters covered by subsection (a) below, and without any liability to Tenant in any respect, provided Landlord will take no action permitted under this Article 12 in such a manner as to impair or adversely affect in any significant way Tenant's substantial benefit and enjoyment of the Premises, Landlord shall have the right to: (a) Close off any of the common areas to whatever extent required in the opinion of Landlord to prevent a dedication of any of the common areas or the accrual of any rights by any person or the public to the common areas; (b) Temporarily close any of the common areas for maintenance, alteration, or improvement purposes provided, however that Tenant shall at all times, except in the case of an emergency, have reasonable access to the Premises; (c) Change the size, use, shape, or nature of any such common areas, including erecting additional buildings on the common areas, expanding the existing Building or other buildings to cover a portion of the common areas, converting common areas to a portion of the Building or other buildings, or converting any portion of the Building (excluding the Premises) or other buildings to common areas. Upon erection of any additional buildings or change in common areas, the portion of the Project upon which buildings or structures have been erected will no longer be deemed to be a part of the common areas. In the event of any such changes in the size or use of the Building or common areas of the Building or Project, Landlord will make an appropriate adjustment in the rentable area of the Building or the Building's pro rata share of 17 exterior common areas of the Project, as appropriate, and a corresponding adjustment to Tenant's Share; and (d) Retain control over any common areas for the purposes of enforcing state trespass laws and shall be the "person in charge" for that purpose as that phrase is defined in ORS 164.205 (5). ARTICLE 13 - LANDLORD'S SERVICES 13.1 Landlord's Repair and Maintenance. Landlord will as a cost of operation maintain, repair and restore the common areas of the Project and public restrooms (including the restrooms on any single tenant floors included within the Premises), the exterior windows in the Building, the mechanical, plumbing and electrical equipment serving the Building, and the structure of the Building in reasonably good order and condition. Any damage occasioned by Tenant (or Tenant's employees, agents, contractors, licensees, invitees, customers or clients) shall be repaired by Landlord at Tenant's expense. Tenant agrees to notify Landlord of necessity for any repairs of which Tenant may have knowledge and for which Landlord may be responsible under the provisions of this Section. 13.2 Landlord's Other Services.Landlord shall furnish the Premises with the following services: (a) Electricity at the rate of 3.5 watts per usable square foot for Building Standard lighting and low wattage office equipment including personal computers, laser printers and copiers, and microwave ovens but excluding electrical power required for computer rooms, special lighting in excess of State of Oregon energy standards in effect on the date hereof or any other item of electrical equipment which (individually) consumes more than 1.8 kilowatts at rated capacity or which requires a voltage other than 120 volts single phase. If Tenant installs equipment requiring power in excess of that required for normal office use as determined by Landlord, Tenant shall pay to Landlord upon billing for the cost of such excess power as Additional Rent, together with the cost of installing any additional risers, submeters or other facilities that may be necessary to furnish such excess power to the Premises. Tenant shall notify Landlord in writing of any need for any excess power usage. If Tenant fails to deliver such notice to Landlord, such excess power usage shall be deemed to have commenced on the first day of occupancy of the Premises by Tenant. (b) Heat, ventilation, and air conditioning (HVAC) to the extent reasonably required to provide a standard of comfort customary in other comparable buildings in the area ("Building Standard HVAC"), during reasonable and usual business hours of 7:00 a.m. to 6:00 p.m., exclusive of Saturdays, Sundays, and state and national holidays ("Building Standard Hours"), or such shorter period specified or prescribed by any applicable policies or regulations adopted by any utility or government agency. The Building Standard HVAC shall conform to the HVAC specifications contained in Exhibit E. If Tenant desires Building Standard HVAC before or after Building Standard Hours, Tenant shall request such service in advance, and Landlord shall provide such service, at the then current hourly rate charged to other tenants in the Building, Tenant shall pay such charges as Additional Rent within ten (10) days of receipt of invoice. Landlord's initial charge for after hours HVAC shall not exceed $30 per hour per floor. If Tenant's equipment or office machines require additional air conditioning capacity above that 18 provided by Landlord as Building standard or during other than Building Standard Hours, such additional air conditioning installation and operating costs shall be paid by Tenant. Tenant shall not, without Landlord's prior written consent, use heat generating machines or equipment or lighting other than Building Standard lights and customary office equipment in the Premises which affect the temperature otherwise maintained by the Building air conditioning system. If such consent is given, Landlord shall have the right to install supplementary air conditioning units servicing the Premises, and the cost thereof, including the cost of installation and the cost of operation and maintenance thereof, shall be paid by Tenant to Landlord as Additional Rent. (c) Full passenger elevator service to all tenant floors during Building Standard Hours, and freight elevator service for deliveries of large items to and from tenant floors. At other times, elevator service may be limited as required for reasons of maintenance, repair or security provided, however, that passenger service from at least one elevator shall be available at all times, except in the case of emergencies. (d) Lighting replacement for Building standard fixtures. (e) Janitorial service in accordance with Exhibit F five (5) days per week, excluding holidays; provided, however that if Tenant improvements are not consistent in quality and/or quantity with Building standard improvements and therefore require special cleaning or janitorial services, Tenant shall pay any cleaning and janitorial costs attributable to such special services. 13.3 Manufacturer's Warranty. In the event any special equipment or appliance is installed by Landlord in the Premises, whether during initial build-out for Tenant, or at any time subsequent to the Commencement Date, such equipment or appliance shall be covered only by the manufacturer's warranty. After the original warranty period on said equipment or appliance has expired, the servicing, maintenance, repair, or replacement of said equipment or appliance shall be the sole responsibility and expense of Tenant throughout the remainder of the Term and any extensions thereof. 13.4 Limitation on Liability. Landlord shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the Rent herein reserved be abated by reason of (a) the installation, use or interruption (beyond the reasonable control of Landlord) of use of any equipment in connection with the furnishing of any of the foregoing services, (b) failure to furnish or delay in furnishing any such services when such failure or delay is caused by accident or any condition beyond the reasonable control of Landlord or by the making of necessary repairs or improvements to the Premises or to the Building, or (c) the limitation, curtailment, rationing or restrictions on use of water, electricity, gas or any other form of energy serving the Premises or the Building. Landlord shall use reasonable efforts to remedy any interruption in the furnishing of such services. 19 ARTICLE 14 - TENANT'S CARE OF THE PREMISES Tenant will maintain the Premises (including Tenant's equipment, personal property, and trade fixtures located in the Premises) in the same condition existing at the time they were delivered to Tenant, reasonable wear and tear excluded. Tenant shall also be responsible for the maintenance of any special equipment, such as supplemental air conditioning units, installed at Tenant's request. Tenant will immediately advise Landlord of any damage to the Premises or the Project. All damage or injury to the Premises, the Project, or the fixtures, appurtenances, and equipment in the Premises or the Project that is caused by Tenant, its agents, employees, or invitees may be repaired, restored, or replaced by Landlord, at the expense of Tenant. The actual out of pocket cost of any such repairs plus 12.5% of such expense for Landlord's profit, general conditions and overhead shall be Additional Rent and will be paid by Tenant within ten (10) days after delivery of a statement for such expense. Landlord has no obligation and has made no promise to alter, remodel, improve, repair, decorate or paint the Premises or any part thereof, except as may be specified in Article 4. No representations respecting the condition of the Premises or the Project have been made by or on behalf of Landlord to Tenant, except as specifically set forth in this Lease. ARTICLE 15 - ALTERATIONS 15.1 General. (a) Tenant will not after the Commencement Date make or allow to be made any alterations, additions, or improvements to or of the Premises, or attach any fixtures or equipment to the Premises (an "Alteration"), without first obtaining Landlord's written consent. Prior to commencing any Alterations, Tenant shall furnish to Landlord: (i) Copies of all governmental permits and authorizations which may be required in connection with such Alteration; (ii) A certificate evidencing that Tenant or its contractors have procured employers' general liability and worker's compensation insurance including without limitation contractors' protective, blanket contractual and completed operations coverages; (iii) Such additional bodily injury and property damage insurance (over and above the insurance required to be carried by Tenant pursuant to the provisions of Article 8) as Landlord may reasonably require because of the nature of the work to be done by Tenant; and (iv) Plans and specifications for such Alterations. (b) Landlord's consent to such Alterations shall create no responsibility or liability on the part of Landlord for the completeness, design sufficiency, or compliance with laws, rules, and regulations of governmental agencies or authorities. If Landlord determines that the services of architects or engineers or other professionals are reasonably required in order to review Tenant's plans for any Alterations, the fees charged by such professionals shall be deemed Additional Rent and shall be paid within ten (10) days of the receipt of an invoice for such 20 services. All such Alterations: (i) Will be performed by contractors approved by Landlord and subject to conditions specified by Landlord (which may include requiring the posting of a mechanic's or insurance construction lien bond); (ii) At Landlord's option and sole discretion, will be made by Landlord for Tenant's account in which case Tenant will reimburse Landlord for the cost of such Alteration plus percent 12.5% for Landlord's profit, general conditions and overhead within ten (10) days after receipt of a statement; (iii) Shall, when completed, be of such a character as not to lessen the value of the Premises; (iv) Shall conform to applicable Building codes and shall be approved by any and all governmental, quasi-governmental or utility authority having jurisdiction; (v) Shall be performed promptly in accordance with the plans and specifications, in a good workmanlike manner and in full compliance with all applicable permits, authorizations, building and zoning laws and the Building Rules in effect at such time; and (vi) Shall be performed in such a manner so as not to interfere with any other tenant in the Project or impose any additional expense upon Landlord in the maintenance or operation of the Project. (c) Subject to Tenant's rights and obligations in Article 17.1, all Alterations, whether temporary or permanent in character, made in or upon the Premises either by Tenant or Landlord, will immediately become Landlord's property and at the end of the Term will remain on the Premises without compensation to Tenant; provided, however, Landlord at its option may require Tenant to remove any or all Alterations upon expiration or earlier termination of the Lease. Notwithstanding the foregoing, Landlord shall not require the removal of the initial improvements to the Premises, except for such improvements as are in Landlord's opinion not standard office installations, such as private bathrooms, exercise facilities and internal staircases. In its approval of the plans for any Alterations, including the initial fit up of the Premises, Landlord shall indicate in writing which Alterations or improvements are to be removed. (d) Landlord shall not be liable for any failure of any Building facilities or services caused by any Alterations. Tenant shall pay the cost of correcting any such faulty installation as Additional Rent unless caused by improper or defective work performed by Landlord or its contractor. 15.2 Free-Standing Partitions. Tenant will have the right to install or relocate free-standing work station partitions, without Landlord's prior written consent, so long as no building or other governmental permit is required for their installation or relocation. However, if a permit is required, Tenant shall not install or relocate such partitions without Landlord's prior 21 written consent which shall not be unreasonably withheld. The free-standing work station partitions which are paid for by Tenant will be part of Tenant's trade fixtures for all purposes under this Lease. All other partitions installed in the Premises are and will be Landlord's property for all purposes under this Lease. ARTICLE 16 - CONSTRUCTION LIENS Tenant will pay or cause to be paid all costs and charges for work all done by Tenant or caused to be done by Tenant, in or to the Premises, and for all materials furnished for, or in connection with, such work. Tenant will indemnify Landlord against and hold Landlord harmless of and from all construction liens and claims of liens, and all other liabilities on account of such work by or on behalf of Tenant, other than work performed by Landlord. If any such lien, at any time, is filed against any part of the Project, Tenant will cause such lien to be discharged of record within ten (10) days. If Tenant fails to pay any charge for which a construction lien has been filed, or has not complied with such statutory procedures as may be available to release the lien, Landlord may, at its option, pay such charge and related costs and interest without inquiring into the validity thereof. The amount so paid, together with reasonable attorneys' fees incurred, will be immediately due from Tenant to Landlord as Additional Rent. Nothing contained in this Lease will be deemed the consent or agreement of Landlord to subject Landlord's interest in the Project to liability under any construction or other lien law. If Tenant receives Notice that a lien has been or is about to be filed against the Premises or the Project, or that any action affecting title to the Project has been commenced on account of work done by, or for, or materials furnished to, or for, Tenant, it will immediately give Landlord Notice of such lien notice. At least fifteen (15) days prior to the commencement of any work in or to the Premises, Tenant will give Landlord Notice of the proposed work and the names and addresses of the persons supplying labor and materials for the proposed work. Landlord will have the right to post notices of non-responsibility or similar notices on the Premises in order to protect the Premises against any such liens. 22 ARTICLE 17 - END OF TERM 17.1 Surrender of Premises. Upon the expiration of the Term or earlier termination of this Lease, Tenant will deliver all keys to Landlord and promptly quit and surrender the Premises broom-clean, in good order and repair, ordinary wear and tear, damage by fire and other casualty (if covered or reasonably should have been covered by insurance the premiums for which were or could have been included in Operating Expenses) excepted. Tenant, at its sole expense, shall remove such Alterations as Landlord has requested in accordance with Article 15, and all of its computer, data, telephone and security equipment including all computer, data, telephone and security wiring and cables in the plenum. Tenant will fully repair any damage occasioned by the removal of any trade fixtures, equipment, furniture or Alterations. All trade fixtures, equipment, furniture, effects and Alterations remaining on the Premises after the expiration or termination of this Lease will be deemed conclusively to have been abandoned and may be appropriated, sold, stored, destroyed, or otherwise disposed of by Landlord in a commercially reasonable manner without Notice to Tenant or any other person and without obligation to account for them. Notwithstanding the foregoing provisions of this Article, in the event that Tenant fails to comply with the preceding provisions of this Article, Landlord at its option may perform all or a portion of removals and repairs required of Tenant hereunder, for Tenant's account, and Tenant will reimburse Landlord for the costs of doing so (including 12.5% for Landlord's profit, general conditions and overhead) within ten (10) days after receipt of a statement of such cost. 17.2 Holding Over. (a) If Tenant fails to vacate the Premises after the expiration of the Term, such holding over shall be construed as a tenancy from month-to-month, subject to all the conditions, provisions and obligations of this Lease as existed during the last month of the Term hereof, so far as applicable to a month-to-month tenancy except that the Rent shall be the greater of an amount equal to one hundred twenty five percent (125%) of (i) the Rent in effect immediately prior to the expiration (or sooner termination) of the Lease, or (ii) of the current market rent. No such payment shall serve to extend or renew the Term. (b) Failure of Tenant to remove any Alterations which Tenant is required to remove pursuant to Section 15.1 or any substantial amount of furniture, furnishings, or trade fixtures which Tenant is required to remove under this Lease shall constitute a failure to vacate. (c) Notwithstanding the foregoing, Landlord may evict Tenant from the Premises and recover damages including consequential damages caused by wrongful holdover. 17.3 Survivorship. The provisions of this Article shall survive the expiration or sooner termination of this Lease. 23 ARTICLE 18 - EMINENT DOMAIN If all or any part of the Premises shall be taken or conveyed as a result of the exercise of the power of eminent domain or under threat of the exercise of such power, this Lease shall terminate as to the part so taken as of the date of taking. In the case of a partial taking, either Landlord or Tenant shall have the right to terminate this Lease as to the balance of the Premises by Notice to the other within thirty (30) days after such date; provided, however, that a condition to the exercise by Tenant of such right to terminate shall be that the portion of the Premises taken or conveyed shall be of such extent and nature as substantially to impede or impair Tenant's use of the balance of the Premises. In the event of any taking, Landlord shall be entitled to any and all compensation, damages, income, rent awards or any interest therein whatsoever which may be paid or made in connection therewith. Tenant shall have no claim against Landlord for the value of any unexpired Term of this Lease or any other value whatsoever; provided however, Tenant shall be entitled to any and all compensation, damages, income, rent or awards paid for, or on account of, Tenant's moving expenses, trade fixtures and equipment; provided same does not reduce Landlord's award. In the event of a taking of the Premises which does not result in a termination of this Lease, Rent will be abated in the proportion of the rentable area of the Premises so taken to the rentable area of the Premises immediately before such taking, and Tenant's Share will be appropriately recalculated. ARTICLE 19 - DAMAGE AND DESTRUCTION 19.1 Repair. If the Premises or the Building are damaged by fire or other casualty, Landlord shall forthwith repair the same subject to Unavoidable Delays, subject to the provisions of this Article 19, provided such repairs can, in Landlord's opinion, be made within one hundred eighty (180) days, and this Lease shall remain in full force and effect. If Landlord fails to complete such repairs within said 180 day period, Tenant shall have the right to terminate this Lease by giving Landlord Notice of its election to do so within ten (10) days after the expiration of said 180 day period, time shall be of the essence with regard to said notice period. 19.2 Option to Repair or Terminate. If such repairs cannot, in Landlord's opinion, be made within one hundred eighty (180) days, Landlord, at its option, shall, by Notice to Tenant within thirty (30) days after the date of such fire or other casualty, either (a) elect to repair or restore such damage subject to Unavoidable Delays, with this Lease continuing in full force and effect, or (b) terminate this Lease as of a date specified in the Notice. Landlord's Notice shall state Landlord's opinion as to the time period necessary to effect such repairs. If such time period exceeds 180 days, Tenant may terminate this Lease by Notice to Landlord given within thirty (30) days after receipt of Landlord's Notice, as to which date time shall be of the essence. If Tenant fails or elects not to terminate this Lease as provided in the preceding sentence and Landlord fails to substantially complete such repairs within said 180 day period, Tenant shall have the right to terminate this Lease by giving Landlord Notice within ten (10) days after the expiration of said 180 day period, time shall be of the essence with regard to such notice period. 19.3 Rent Abatement. If such fire or other casualty shall have damaged the Premises or common areas necessary to Tenant's occupancy and if such damage is not the result of the negligence or willful misconduct of Tenant or Tenant's employees or invitees, then during the period the Premises are rendered unusable by such damage, Tenant shall be entitled to a reduction in Rent in the proportion that the rentable area of the Premises rendered unusable by 24 such damage bears to the total rentable area of the Premises. ARTICLE 20 - SUBORDINATION 20.1 General.Subject to the provisions of Section 20.3, this Lease and all of Tenant's rights hereunder shall be subject and subordinate to any mortgage, deed of trust or other security instrument now or hereafter affecting all or any portion of the Project and to all renewals, modifications, consolidations, replacements and extensions thereof (herein referred to as "Security Documents") and to all of the rights of the holders of any Security Documents. The foregoing subordination shall be self-operative and no further instrument of subordination need be obtained by any holder of a Security Document; provided, however, that upon such holder's request, Tenant shall promptly execute and deliver an instrument prepared by such holder evidencing and confirming such subordination. Notwithstanding the foregoing, if the holder of a Security Document shall elect to have this Lease be superior to the lien of such Security Document, this Lease shall be deemed to be superior to such Security Document upon the giving of Notice to such effect by such holder to Tenant, irrespective of the relative dates of execution of this Lease and such Security Document or the recordation of either. 20.2. Attornment. In the event the holder of any Security Document (or any other person or entity) shall come into possession of or acquire title to the Project as a result of the enforcement or foreclosure (judicial or nonjudicial) of such Security Document, or by means of the delivery to such holder (or to such other person or entity) of a deed-in-lieu of foreclosure or as a result of any other means, or in the event that Landlord's estate in such real property is conveyed or passes to a person or entity by operation of law or any other means (a "Successor Owner"), then in any of said events Tenant shall, at the election and upon the request of such Successor Owner, attorn to such Successor Owner as its landlord under this Lease. The foregoing attornment requirement shall be self-operative upon any such request of a Successor Owner without the execution of any further instruments immediately upon the Successor Owner coming into possession of, or acquiring title to, the Project. Tenant agrees, however, upon demand of such Successor Owner, to execute an instrument in confirmation of the foregoing provisions prepared by such Successor Owner. 20.3 Subordination, Non-Disturbance and Attornment Agreement. Anything to the contrary contained in Sections 20.1 and 20.2 notwithstanding, this Lease shall be contingent for a period of five (5) business days upon Landlord obtaining from its current lender a subordination, non-disturbance and attornment agreement in substantially the same form as Exhibit G. In the event that Landlord fails to deliver an executed original of such Subordination, Non-Disturbance and Attornment Agreement within in said five (5) day period, Tenant shall have the right to terminate this Lease by giving Landlord Notice. The provisions contained in Section 20.1 shall be applicable for the benefit of the holder of any subsequent Security Documents provided that such holder enters into a subordination, non-disturbance and attornment agreement with Tenant upon such holder's standard form except that such form must contain provisions that (i) Tenant shall not be disturbed in its possession of the Premises so long as it is not in default of the provisions of this Lease; (ii) are commercially reasonable regarding any limitation of remedies against the holder of any such Security Documents; and (iii) does not provide for a period of more than 180 days for such holder to cure any of Landlord's default before Tenant can exercise any right to terminate this Lease. If Tenant fails or refuses to execute such holder's standard form of subordination, non-disturbance and attornment agreement, this Lease shall remain subordinate to 25 any such subsequent Security Documents. 20.4. Notice. Tenant shall send a copy of any notice given Landlord under this Lease which alleges that Landlord is in default of its obligations under this Lease or in which Tenant claims a right to terminate this Lease to the holder of each Security Document of which it has notice at the same time and in the same manner such notice is sent to Landlord. 20.5 Documentation. If any mortgagee, trustee or ground lessor shall, in writing, elect to have this Lease deemed subordinate or prior to the lien of its mortgage, deed of trust or ground lease, whether this Lease is dated prior or subsequent to the date of said mortgage, deed of trust or ground lease, or the date of recording thereof, Tenant agrees to execute any documents required to effectuate such subordination or to make this Lease prior to the lien of any mortgage, deed or trust or ground lease, as the case may be. ARTICLE 21 - ENTRY BY LANDLORD 21.1 Entry. Landlord, its agents, employees, and contractors may enter the Premises at any time and at reasonable hours after reasonable notice in non-emergency situations (except as provided in Section 25.2) and without notice in emergency situations and for purposes of subsection (d) hereof in order to: (a) Inspect the Premises; (b) Exhibit the Premises to prospective purchasers, lenders, or, during the last Lease Year of the Term, tenants; (c) Determine whether Tenant is complying with its Lease obligations; (d) Supply cleaning service and any other service to be provided by Landlord to Tenant according to this Lease; (e) Post notices of non-responsibility or similar notices; or (f) Make repairs required of Landlord under the terms of this Lease or make repairs to any adjoining space or utility services or make repairs, alterations, or improvements to any other portion of the Building; however, all such work will be done as promptly as reasonably possible and so as to cause as little interference to Tenant as reasonably possible. 21.2 Waiver. Tenant hereby waives any claim against Landlord, its agents, employees, or contractors for damages for any injury or inconvenience to, or interference with, Tenant's business, any loss of occupancy or quiet enjoyment of the Premises, or any other loss occasioned by any entry in accordance with this Article 21, except to the extent caused by the negligence or willful misconduct of Landlord, its agents, employees or contractors. Landlord will at all times be provided with a key with which to unlock all of the doors in, on, or about the Premises (excluding Tenant's vaults, safes, and similar areas designated in writing by Tenant in advance). Landlord will have the right to use any and all means Landlord may deem proper to open doors in and to the Premises in an emergency in order to obtain entry to the Premises, 26 provided that Landlord will promptly repair any damages caused by any forced entry. Any entry to the Premises by Landlord in accordance with this Article 21 will not be construed or deemed to be a forcible or unlawful entry into or a detainer of the Premises or an eviction, actual or constructive, of Tenant from the Premises or any portion of the Premises, nor will any such entry entitle Tenant to damages or an abatement of Rent or other charges Tenant is required to pay pursuant to this Lease. ARTICLE 22 - INDEMNIFICATION, WAIVER, AND RELEASE 22.1 Tenant's Indemnification. Except if and to the extent that Tenant is released from liability to Landlord pursuant to Section 8.5, Tenant shall indemnify and hold Landlord harmless against and from any and all loss, cost and expense arising from Tenant's use of the Premises or arising from any act, neglect, fault, or omission of the Tenant, or of its agents, employees, visitors, invitees, or licensees. In case any action or proceeding is brought against Landlord by reason of such claim, Tenant, upon notice from Landlord, shall defend same, at Tenant's expense, by counsel reasonably satisfactory to Landlord. Tenant, as a material part of the consideration to Landlord, hereby assumes all risk of damage to Tenant's property or injury to Tenant's employees, agents, visitors, invitees, and licensees in or upon the Premises and Tenant hereby waives all claims in respect thereof, from any cause whatsoever except to the extent caused by the gross negligence or willful misconduct of Landlord, its agents, employees or contractors. 22.2 Landlord's Indemnification. Except if and to the extent that Landlord is released from liability to Tenant pursuant to Section 8.5, Landlord shall indemnify and hold Tenant harmless against and from any and all loss, cost and expense arising from any act, neglect, fault, or omission of the Landlord, or of its agents, employees, visitors, invitees, or licensees. In case any action or proceeding is brought against Tenant by reason of such claim, Landlord, upon notice from Tenant, shall defend same, at Landlord's expense, by counsel reasonably satisfactory to Tenant. 22.3 Release. Landlord shall not be liable to Tenant for any entry of third parties into the Project, or for any damage to person or property, or loss of property in and about the Project by or from any unauthorized or criminal acts of third parties, regardless of any breakdown, malfunction, or insufficiency of any security measures, practices, or equipment provided by Landlord, except as provided by law. Tenant shall immediately notify Landlord in writing of any breakdown or malfunction of any security measures, practices or equipment provided by Landlord as to which Tenant has knowledge. 22.4 Limitations of Actions. In any situation in which Tenant disputes Landlord's reasonableness in exercising its judgment or withholding or delaying its consent or approval, the sole remedies available to Tenant shall be those of an equitable nature, such as an action for an injunction or specific performance. Tenant specifically waives the rights to money damages or other remedies (including the right to claim money damages by way of setoff, counterclaim or defense). The foregoing shall not be deemed to relieve Landlord from liability in the event of a judicial determination that Landlord's refusal to consent was arbitrary or capricious or that Landlord's consent was withheld in bad faith. Failure by Tenant to seek relief within thirty (30) days of the date of Landlord's decision or alleged failure to render a decision shall be deemed a waiver of any right to dispute such action. 27 22.5 Survival. The provisions of this Article 22 shall survive the expiration or earlier termination of this Lease. ARTICLE 23 - QUIET ENJOYMENT Landlord covenants and agrees with Tenant that so long as Tenant pays the Rent and observes and performs all the terms, covenants and conditions of this Lease on Tenant's part to be observed and performed, Tenant may peaceably and quietly enjoy the Premises subject, nevertheless, to the terms and conditions of this Lease, and Tenant's possession will not be disturbed by anyone claiming by, through, or under Landlord. ARTICLE 24 - EFFECT OF SALE A sale or conveyance of the Project and/or assignment by Landlord of this Lease shall operate to transfer all of Landlord's obligations under the Lease from and after the effective date of such sale, conveyance, or assignment to Landlord's successor in interest and shall release Landlord from liability for all of the covenants, terms, and conditions of this Lease, express or implied. After the effective date of such sale, conveyance, or assignment, Tenant will look solely to Landlord's successor in interest in and to this Lease. This Lease will not be affected by any such sale, conveyance, or assignment, and Tenant will attorn to Landlord's successor in interest to this Lease. ARTICLE 25 - DEFAULT 25.1 Events of Default. The occurrence of any one or more of the following events ("Events of Default") shall constitute a breach of this Lease by Tenant: (a) if Tenant shall fail to pay Monthly Rent and/or Additional Rent for increases in Operating Expenses or Taxes and such failure shall continue for more than five (5) days after receipt of Notice of non-payment; or (b) if Tenant shall fail to pay any other sum when and as the same becomes due and payable and such failure shall continue for more than ten (10) days after receipt of Notice of non-payment; or (c) if Tenant shall fail to comply with the restrictions and provisions of Article 10; or (d) if Tenant shall fail to perform or observe any other term hereof to be performed or observed by Tenant, and such failure shall continue for more than thirty (30) days after Notice thereof from Landlord provided, however that if such default is of such a nature that it cannot be remedied fully within such thirty (30) day period, the failure by Tenant to begin correction within such thirty (30) day period and thereafter proceed with diligence and in good faith to effect the remedy as soon as practicable ; or (e) if Tenant shall make a general assignment for the benefit of creditors, or shall admit in writing its inability to pay its debts as they become due or shall file a petition in 28 bankruptcy, or shall be adjudicated as bankrupt or insolvent, or shall file a petition seeking a reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation, or shall file any answer admitting or shall fail timely to contest the material allegations of a petition filed against it in any such proceeding, or shall seek or consent to or acquiesce in the appointment of any trustee, receiver or liquidator of Tenant or any material part of its properties; or (f) if any proceeding against Tenant seeking a reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation, and such proceeding shall not have been dismissed within thirty (30) days after it commenced, or if, within thirty (30) days after the appointment, without the consent or acquiescence of Tenant, of any trustee, receiver or liquidator of Tenant or of any material part of its properties, such appointment shall not have been vacated; or (g) vacation or abandonment of the Premises for a continuous period in excess of five (5) business days unless Tenant continues to pay all sums due pursuant to this Lease; or (h) if this Lease or any estate of Tenant hereunder shall be levied upon under any attachment or execution and such attachment or execution is not vacated within ten (10) days after levy thereof. 25.2 Landlord's Remedies. If an Event of Default shall occur under this Lease, then Landlord may exercise any one or more of the remedies set forth in this Section 25.2, or any other right or remedy available under applicable law or contained in this Lease: (a) Landlord may re-enter the Premises and remove all persons and property to repossess and enjoy the Premises, without any further Notice, either by summary proceedings, or by any other applicable action or proceeding, (without being liable to indictment, prosecution, or damages therefore). Landlord may use the Premises for Landlord's own purposes or relet it, without prejudice to any other remedies that Landlord may have by reason of Tenant's default. None of these actions will be deemed an acceptance of surrender by Tenant. To the extent permitted by law, Tenant expressly waives the service of any notice of intention to terminate this Lease or to retake the Premises, and waives service of any demand for payment of Rent or for possession, and of any and every other notice or demand required or permitted under applicable law. (b) Landlord, at its option, may relet the whole or any part of the Premises from time to time, either in the name of Landlord or otherwise, for terms ending before, on, or after the Expiration Date, at such rent and upon such other conditions (including concessions and free rent periods) as Landlord, may determine to be appropriate. Landlord shall have no obligation to relet the Premises or any part thereof and shall not be liable for failure to relet the Premises or, in the event of any such reletting, for failure to collect any rent due upon such reletting. No such failure shall operate to relieve Tenant of any liability under this Lease. Landlord, at its option, may make such physical changes to the Premises as it considers advisable or necessary in connection with any such reletting or proposed reletting, without relieving Tenant of any liability under this Lease. If there is other vacant space in the Building, Landlord shall have no obligation to attempt to relet the Premises prior to leasing other space in the Building. 29 (c) Whether or not Landlord retakes possession of or relets the Premises, Landlord shall have the right to recover unpaid Rent and all damages caused by the default, including attorneys' fees. Damages shall include, without limitation: (1) all past due Rent together with interest at a rate equal to five percent (5%) per annum over the Prime Rate but in no event at a rate greater than the maximum rate permitted by law, and all future Rent payable to the end of the Term; (2) all legal expenses and other related costs incurred by Landlord following Tenant's default; (3) all reasonable costs incurred by Landlord in restoring the Premises to good order and condition, or in remodeling, renovating, or otherwise preparing the Premises for reletting; and (4) all costs incurred by Landlord in reletting the Premises, including, without limitation, any brokerage commissions and the value of Landlord's time. Landlord may sue periodically for damages as they accrue without barring a later action for further damages. Landlord may in one action recover accrued damages plus damages attributable to the remaining Term equal to the difference between the Rent reserved in this Lease (including an estimated amount of Additional Rent as determined by Landlord) for the balance of the Term after the time of award, and the fair rental value of the Premises for the same period, discounted to the time of award at the Prime Rate at the time of award. If Landlord has relet the Premises for the period which otherwise would have constituted the unexpired portion of the Term, or any part thereof, the amount of Rent reserved upon such reletting shall be deemed, prima facie, to be the fair and reasonable rental value for the part or the whole of the Premises so relet during the term of the reletting. 25.3 Continuation after Default. Even though Tenant has breached this Lease and abandoned the Premises, this Lease shall continue in effect as long as Landlord does not terminate this Lease by Notice of termination to Tenant, and Landlord shall have the right to enforce all of its rights and remedies under this Lease, including the right to recover the Rent as it becomes due under this Lease. Acts of maintenance or preservation, efforts to relet the Premises or the appointment of a receiver upon initiative of Landlord to protect Landlord's interest under this Lease shall not constitute a termination of this Lease. 25.4 Other Relief. The remedies provided for in this Lease are in addition to any other remedies available to Landlord at law or in equity, by statute or otherwise. 25.5 Landlord's Right to Cure Defaults. All agreements and provisions to be performed by Tenant under any of the terms of this Lease shall be at its sole cost and expense and without any abatement of Rent. If Tenant shall fail to pay any sum of money, other than Rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder and such failure shall continue for thirty (30) days after Notice thereof by Landlord, Landlord may, but shall not be obligated to do so, and without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such other act on Tenant's part to be made or performed as provided in this Lease. All sums so paid by Landlord and all necessary incidental costs shall be deemed Additional Rent hereunder and shall be payable to Landlord on demand, together with interest thereon from the date of expenditure by Landlord to the date of repayment by Tenant at a rate of interest equal to five percent (5%) per annum over the Prime Rate from time to time, but not in any event at a rate greater than the maximum rate permitted by law. In addition to any other rights or remedies of Landlord, Landlord shall have the same rights and remedies in the event of the nonpayment of such sums and interest as in the case of default by Tenant in the payment of Rent. 30 ARTICLE 26 - PARKING 26.1 Visitor Parking. Tenant's visitors, clients, and patrons to the Premises, in common with visitors, clients, and patrons of other tenants, may use the visitors' parking area provided by Landlord in the vicinity of the Building; provided, however, that such parking may be subject to validation, charge, or other control systems which may be instituted from time to time by Landlord. As used herein, the Terms "visitors" "clients" and "patrons" shall be deemed to exclude any employee, agent, salesman, trainee, student or independent contractor of Tenant, whether employed by Tenant on a full time or part time basis. 26.2 Monthly Parking. (a) During the Term, Tenant shall have the non-exclusive right to rent up to two (2) parking spaces per 1,000 rentable square feet of Premises of which spaces twenty (20) shall be reserved. Tenant's rental and use of such parking spaces shall be pursuant to the terms, rules, and regulations provided under separate parking agreement(s). All such parking spaces will be located within the Project in the Parking Garage. The parking spaces will be unassigned, non-reserved, and non-designated, except for twenty (20) reserved spaces. (b) The parking spaces shall at all times be subject to the exclusive control and management of Landlord, and Landlord shall have the right from time to time to establish, modify, and enforce reasonable rules and regulations with respect to the parking spaces. Tenant agrees after notice thereof, to abide by such rules and regulations and to cause its employees to conform thereto. The parking spaces shall be used solely for the parking of normal sized passenger cars, sport ulitity vechicles and non-commercial vans used by Tenant's employees while they are working at the Building. No employee shall be permitted to park more than one (1) vehicle in a parking space and no storage of vehicles shall be permitted in the parking spaces. (c) Landlord reserves the right from time to time: (i) to change the area, location and arrangement of parking areas and parking spaces; (ii) to restrict parking by tenants, their officers, agents, employees, customers and invitees to designated areas; (iii) to discontinue, restrict or temporarily suspend use of all, or any portion of, the parking spaces for such period of time as may be necessary in Landlord's sole discretion to perform maintenance or repairs to the parking spaces provided, however, that Landlord shall provide temporary replacement parking or abate the parking changes for the spaces it cannot provide temporary replacements for; (iv) to limit the parking of vans, limousines and other large vehicles to specified areas provided, however that Landlord shall provide temporary replacement spaces for all such parking spaces; (v) to exclude any and all vehicles other than normal passenger cars, 31 sport utility vehicles and vans; and (vi) to designate parking areas and to modify parking lots and parking garage structures. (d) Use of the parking spaces by Tenant, its employees and visitors will be at their own risk and Landlord shall not be liable for any injury to person or property, or for loss or damage to any vehicle or its contents resulting from theft, collision, vandalism or any other cause whatsoever. (e) On or before the Commencement Date, Tenant shall give Landlord Notice of the number of parking spaces Tenant intends to rent as of the Commencement Date. If Tenant elects not to rent all or a portion of the parking spaces available to it under Section 26.2(a) above on the Commencement Date, or at any time during the Term, Landlord shall have the right to rent such spaces to others. After the Commencement Date, and throughout the Term, if Tenant later desires to rent up to its maximum number of parking spaces, including any spaces not rented on the Commencement Date (or during the Term), Tenant shall give Landlord at least thirty (30) days prior Notice of the number of parking spaces it desires to rent; provided parking spaces are available, and not contractually committed to others, or otherwise encumbered, or required for other uses, Landlord shall, subject to the provisions of Section 26.2(a), rent the desired parking spaces to Tenant. (f) Tenant shall be required to pay for parking spaces rented at prevailing market rates as determined and adjusted from time-to-time by Landlord. All parking charges are due and payable in advance at the same time and place as Monthly Rent. Landlord reserves the right to adjust the parking charges in Landlord's sole discretion at any time after thirty (30) days prior Notice. Tenant may, at its option, elect to distribute all or a portion of its maximum number of parking spaces to individual employees of Tenant who shall be responsible for paying parking charges directly to Landlord or its operator. Each employee of Tenant who will be paying directly for parking will be required to sign a separate parking agreement and abide by all of the terms, conditions, and provisions therein. 26.3 Government Regulations. If any generally applicable governmental regulation, restriction, rule or limitation (affecting parking or the availability or use of spaces within Landlord's available parking inventory) limits or reduces the number or availability of spaces within Landlord's parking inventory, then in that event Tenant's parking shall be reduced on a proportionate basis in order to spread the effects of such limitation or reduction in spaces or availability or use of spaces among all tenants in proportion to their then respective allocations. ARTICLE 27 - OPTION TO EXPAND 27.1 Option. Landlord agrees that it will not lease that portion of the 11th floor of the Building (up to 8,000 rentable square feet) not initially leased by Tenant (the "Expansion Space") for a term or terms exceeding five (5) years for the initial leases covering the Expansion Space. Landlord shall have the right to lease the Expansion Space to one or more tenants. At the time that the term of each lease for the Expansion Space expires, Tenant shall have the right to lease the Expansion Space as it becomes available. In the event that the Expansion Space is leased to more than one tenant, Tenant shall have the right to lease each 32 portion of the Expansion Space as such space becomes available. The foregoing right shall only be effective upon strict compliance with the following terms and conditions: (a) Tenant shall have the right to lease all, but not less than all, of the portion of the Expansion Space that becomes available. (b) Landlord will give Tenant no more than twelve (12) and no less than four (4) months (except in the case of any premature termination of a lease) prior Notice of the date on which each lease for all or any portion of the Expansion Space is to expire. In the event that a lease for all or a portion of the Expansion Space is terminated, Landlord shall give Tenant prompt Notice of such fact. Such notice shall specify the date on which such space is to become available, the rentable and usable area of such space, and Landlord's determination of the Fair Market Rent for such space. (c) Tenant shall have thirty (30) days after the receipt of Landlord's Notice within which to exercise its right to lease such space by giving Landlord Notice. Such Notice shall indicate whether Tenant shall (i) lease that portion of the Expansion Space described in Landlord's Notice at the rent specified in such Notice; (ii) lease that portion of the Expansion Space but elect to arbitrate the rental rate as provided in Sections 28.2 and 28.3; or (iii) elect not to lease such space. Such Notice once given shall be irrevocable. In the event that Tenant fails to give Notice within said thirty (30) day period or elects not to lease the space being offered, Landlord shall be free to lease such space upon any terms it deems acceptable in its sole and unfettered discretion. (d) In the event that Tenant properly exercises its right to lease some or all of the Expansion Space, such leasing shall be upon the same terms and conditions contained in this Lease except as follows: (i) Monthly Rent shall be $26.50 per rentable square foot. (ii) The Base Year for Operating Expenses and Taxes shall be calendar year 1998. (iii) Landlord shall deliver the Expansion Space "as is" on the date that the existing tenant vacates, broom clean and free of all of such tenant's personal property. (iv) Rent shall commence on the date such space is available to Tenant. (v) Landlord shall give Tenant a fit-up allowance of $10.00 per usable square foot of space leased for a term of five (5) years, which allowance shall be prorated on a straight line basis for terms of less than five (5) years. (e) In order for Tenant's Notice to be valid it must be in full compliance with all of the terms and conditions of this Lease on the date that it gives Notice of intent to lease the Expansion Space. (f) So long as all or any portion of the Expansion Space is available for 33 lease and/or has not been fitted out, Tenant may lease all or any portion corresponding to that which Landlord is offering for lease upon the same terms and conditions as the initial Premises except the Tenant Finish Allowance of $28.50 per usable square foot shall be prorated on a straight line basis if the term for which such space is being leased is less than ten (10) years. 27.2 Failure to Vacate. In the event that a tenant fails or refuses to vacate its portion of the Expansion Space, Landlord shall have no liability or obligation except to use commercially reasonable efforts to evict such tenant from its space. 34 ARTICLE 28 - OPTION TO EXTEND 28.1 Option. Tenant shall have the option to extend the term of this Lease for an additional term of five (5) years to commence on the day following the Expiration Date and to terminate five (5) years thereafter, provided that Tenant is not in default of any provision of this Lease and has not subleased more than thirty-five percent (35%) of the area of the Premises during any portion of the two (2) Lease Years prior to the Expiration Date. Such extension shall be upon the same terms and conditions as contained in this Lease except that (i) the Monthly Rent shall be the "Fair Market Rent" as of the Expiration Date, determined pursuant to Section 28.2, but in no event less per square foot than the Monthly Rent and Additional Rent for increases in Operating Costs and Taxes Tenant is paying immediately prior to the Expiration Date; (ii) there shall be no Landlord's Work or other related concessions granted for such extension, except that Landlord shall provide Tenant with a refurbishment allowance of $10.00 per usable square foot of space occupied by Tenant at such time; (iii) the Base Year for the extension period shall be the calendar year in which such term commences; and (iv) there shall be no further option to extend. In order to exercise the option to extend, Tenant shall give notice to Landlord ("Tenant's Notice") of such exercise not later than twelve (12) months prior to the Expiration Date, time being of the essence. In order for Tenant's exercise to be effective, at the time it gives such Tenant's Notice and at the time such extension term is to commence, Tenant shall not be in default at either time of any obligation hereunder, beyond any applicable grace period. If Tenant fails to exercise its option to extend within the time period provided herein, said time being of the essence, Landlord shall be free to lease such space upon the same or different terms as set forth in the Landlord's Notice. 28.2 Determination of Rent. Following Tenant's Notice, but no later than ten (10) months prior to the Expiration Date, Landlord shall give Tenant notice ("Landlord's Notice") of Landlord's determination of the "Fair Market Rent" (as hereinafter defined) for the extension term. For the purposes of this Article, the term "Fair Market Rent" shall mean the annual fair market rent per square foot for comparable space in the Building and in other comparable first-class office buildings in the Portland, Oregon area paid by tenants pursuant to leases similar to this Lease and taking into account rent concessions then being granted, if any, for such leases, as if Landlord and Tenant were entering into a new lease for comparably improved space for a term of five (5) years. In the event that Landlord and Tenant are not able to agree upon the Fair Market Rent, after a period of thirty (30) days in which to negotiate in good faith to do so as provided in Section 28.3, Tenant shall nevertheless have the right to exercise its option to extend the term of this Lease under protest by noting its objections to such Fair Market Rent in a notice to Landlord. In the event that the determination of Fair Market Rent shall not be resolved by the date of the initial Expiration Date, Tenant shall continue to pay the Rent in effect immediate prior to such expiration date. In the event that it is determined that the Fair Market Rent is greater than the Rent Tenant has been paying, Tenant shall reimburse Landlord for the amount it has underpaid Monthly Rent plus interest at the Interest Rate 28.3 Dispute Resolution. In the event that the parties are unable to agree upon the Fair Market Rent within thirty (30) days of Tenant's receipt of Landlord's Notice, such rent shall be determined in accordance with the foregoing definition by two (2) qualified appraisers, one selected by each of the parties. Each party shall send the other Notice of its choice of appraiser within sixty (60) days of Tenant's receipt of Landlord's Notice. Failure by either party to send such notice within such sixty (60) day period shall mean that the other party's determination of 35 Fair Market Rent is accepted. If the two (2) appraisers agree upon such rent, such decision shall be conclusive and binding upon the parties. Except as hereinafter provided, if the two (2) appraisers cannot agree upon such rent within sixty (60) days after the date upon which both have been appointed, the two (2) appraisers shall then select a third appraiser within ten (10) days thereafter. The third appraiser shall within thirty (30) days select the value determined by either Landlord's or Tenant's appraiser as being in his/her professional opinion closest to the Fair Market Rent of the Premises. If the rent determined by Landlord's and Tenant's appraisers are not more than $2.00 per square foot apart, for the purposes of this Article, the Fair Market Rent shall be deemed to be the average of the two (2) rents. The appraisers shall be licensed real estate brokers or Members of the Appraisal Institute, who are disinterested and are currently practicing in Portland, Oregon with at least ten (10) years of experience in leasing or appraising properties similar to the Building. Each party shall pay the fees charged by the appraiser it selects and the fees of the third appraiser, if one is required, shall be borne equally. The foregoing agreement to arbitrate shall be specifically enforceable and shall be subject to the applicable provisions of Article 29. ARTICLE 29 - ARBITRATION 29.1 The parties have not agreed to arbitrate all disputes arising pursuant to this Lease; however, Landlord or Tenant may at any time request final and binding arbitration of any matter in dispute where arbitration is expressly provided for in this Lease (Sections 4.1, 6.6 and 7.7). Any party who fails to submit to binding arbitration following a lawful demand by the other party shall bear all costs and expenses, including reasonable attorneys' fees, (including those incurred in any trial, bankruptcy proceeding, appeal or review) incurred by the other party in obtaining a stay of any pending judicial proceeding concerning a dispute which by the terms of this Lease has been properly submitted to mandatory arbitration, and or compelling arbitration of any dispute. The party requesting arbitration shall do so by giving Notice to that effect to the other party, specifying in said Notice the nature of the dispute. All such arbitration hearings shall be held in the City of Portland, Oregon, and determined by a single arbitrator for matters up to $200,000.00 and by three arbitrators for any dispute in excess of such amount, in accordance (to the extent consistent with this Article) with the rules then pertaining to the Multnomah County Circuit Court Arbitration Program except to the extent provided otherwise under Oregon laws on arbitration and as otherwise provided herein. If such program is terminated then the rules of the American Arbitration Association shall be used. 29.2 A party demanding arbitration of a dispute shall give Notice to that effect to the other party and shall in such Notice appoint a disinterested arbitrator if a dispute is to be resolved by three (3) arbitrators. Within ten (10) business days after delivery of such Notice, the other party will also appoint a disinterested arbitrator by Notice to the original party. Within ten (10) business days after the latter appointment, the two arbitrators so appointed will appoint a third arbitrator (the "Neutral Arbitrator"). If only one arbitrator is to be used, then such arbitrator shall be selected as provided by the Rules of the Multnomah County Circuit Court Arbitration Program or American Arbitration Association, as the case may be. The Neutral Arbitrator shall conduct the arbitration. The qualification of the arbitrators will vary depending upon the nature of the matter to be resolved as follows: a real estate broker with at least ten (10) years experience in office leasing in Portland, a partner in a national accounting firm's Portland office, or a lawyer specializing in real estate matters with at least ten (10) years experience in the Portland area. Selection of the Neutral Arbitrator will be subject to the following: 36 (a) if the second arbitrator is not appointed within said ten (10) business day period, the first arbitrator will select the Neutral Arbitrator; and (b) if the two arbitrators appointed by the parties cannot agree, within ten (10) business days after the appointment of the second arbitrator, upon the appointment of the Neutral Arbitrator, they will give Notice to the parties of such failure to agree, and, if the parties fail to agree upon the selection of the Neutral Arbitrator within five (5) business days after the arbitrators appointed by the parties give such Notice, then either of the parties may apply to the Circuit Court presiding judge of Multnomah County, Oregon for a court appointment of the Neutral Arbitrator. 29.3 The arbitrator(s) shall resolve all disputes in accordance with the substantive law of the state of Oregon. The arbitrator(s) shall have no authority nor jurisdiction to award any damages or any other remedies beyond those which could have been awarded in a court of law if the parties had litigated the claims instead of arbitrating them nor to modify the provisions of this Agreement. The parties shall not assert any claim for punitive damages except to the extent such awards are specifically authorized by statute. The Federal Arbitration Act, Title 9 of the United States Code, is applicable to this Lease transaction and shall be controlling in any judicial proceedings and in the arbitration itself as to issues of arbitrability and procedure. No provision of, nor the exercise of any rights under this Article shall limit the right of the Landlord to evict the tenant, exercise self help remedies or obtain provisional or ancillary remedies such as an injunction, receivership, attachment or garnishment. Any arbitration proceeding may proceed in the absence of any party who, after Notice, fails to be present at such arbitration and, in such event, an award may be made based solely upon the evidence submitted by the party that is present. Discovery will be in accordance with the Federal Rules of Civil Procedure. The arbitrators will render a decision and award in writing, within thirty (30) days after appointment, and will deliver counterpart copies of the decision and award to each of the parties. Unless otherwise agreed in writing by the parties or unless this Agreement has been terminated, during the pendency of the arbitration, the parties will continue to comply with all the terms and provisions of this Agreement which are not the subject of the arbitration proceeding. This agreement to arbitrate will be specifically enforceable by either party. The decision or award rendered by the arbitrator(s) shall be final, non-appealable, and binding upon the parties, and judgment may be entered upon it in accordance with applicable Oregon law in a court of competent jurisdiction. 29.4 The parties shall use their best efforts to complete any arbitration within sixty (60) days of initial notice of arbitration. The arbitrator(s) shall be empowered to impose sanctions for any party's failure to do so. The provisions of this arbitration provision shall survive any termination, amendment, or expiration hereof or of the Lease. Each party agrees to keep all disputes and arbitration proceedings strictly confidential, except for the disclosure of information required in the ordinary course of business of the parties or as required by applicable law or regulation. Any time limitation (such at the statute of limitations or laches) which would bar litigation of a claim shall also bar arbitration of the claim. If any provision of this Article is declared invalid by any court, the remaining provisions shall not be affected thereby and shall remain fully enforceable. The parties understand that they have decided that upon demand of either of them, their disputes as described herein will be resolved by arbitration rather than in a court and once so decided cannot later be brought, filed or pursued in court. 37 29.5 Nothing in this Article shall limit the right of either party to obtain from any court having jurisdiction equitable, provisional or ancillary remedies such as injunctive relief, attachment, garnishment, or the appointment of a receiver. Such rights may be exercised at any time, except to the extent such action is contrary to a final award of decision in any arbitration proceeding. The institution and maintenance of such action will not constitute a waiver of the right of either party to submit any dispute under this Agreement to arbitration, nor render inapplicable the compulsory arbitration provisions hereof. 29.6 Each party will pay one-half the fees and the costs incurred by the Neutral Arbitrator, unless the Neutral Arbitrator exercises its discretion, or is required by this Article, to award fees, costs and expenses to the prevailing party. ARTICLE 30 - MISCELLANEOUS 30.1 No Offer. This Lease is submitted to Tenant on the understanding that it will not be considered an offer and will not bind Landlord in any way until Tenant has duly executed and delivered triplicate originals to Landlord and Landlord has executed and delivered one of such originals to Tenant. 30.2 No Construction Against Drafting Party. Landlord and Tenant acknowledge that each of them and their counsel have had an opportunity to review this Lease and that this Lease will not be construed against Landlord merely because Landlord has prepared it. Tenant further acknowledges that it has been represented (or has had the opportunity to be represented) in the negotiation and execution of this Lease by independent legal counsel, selected of Tenant's own free will. Tenant further acknowledges that it has read and understands the provisions, terms and conditions of this Lease. 30.3 Time of the Essence. Time is of the essence of each and every provision of this Lease. 30.4 No Recordation. Tenant's recordation of this Lease or any memorandum or short form of it will be void and a default under this Lease. 30.5 No Waiver. The failure of either party to seek redress for violation of, or to insist upon the strict performance of any covenant or condition of this Lease or any of the rules and regulations shall not prevent a subsequent act which would have originally constituted a violation, from having all the force and effect of an original violation. No provision of this Lease shall be deemed to have been waived by either party, unless such waiver be in written agreement giving such waiver. The receipt by Landlord of Rent with knowledge of the breach of any covenant of this Lease shall not be deemed a waiver of such breach. No payment by Tenant or receipt by Landlord of a lesser amount than the Monthly Rent herein stipulated shall be deemed to be other than on account of the earliest stipulated rent, nor shall any endorsement or statement on any check or any letter accompanying any check or payment as rent be deemed an accord and satisfaction. Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such Rent or pursue any other remedy in this Lease. No act by Landlord or its agent shall be deemed an acceptance of a surrender of the Premises or an agreement to accept such surrender unless in writing and signed by Landlord. No employee of Landlord or its 38 agent shall have any power to accept the keys to the Premises and the delivery of the keys shall not operate as a termination of this Lease or surrender of the Premises. The parties acknowledge that the provisions of this Section are essential and material terms of this Lease. 30.6 Estoppel Certificates. Tenant agrees that from time to time, upon not less than seven (7) days prior written request by Landlord, Tenant will, and Tenant will use reasonable effort to cause any permitted subtenant or assignee, licensee, concessionaire or other occupant of the Premises to promptly complete, execute and deliver to Landlord, or any party or parties designated by Landlord, an estoppel in the form furnished by Landlord certifying: (1) that this Lease is unmodified and in full force and effect (or if there have been modifications that the same are in full force and effect as modified and identifying the modifications); (2) the dates to which the Rent and other charges have been paid; (3) that the Premises have been unconditionally accepted by the Tenant (or if not, stating with particularity the reasons why the Premises have not been unconditionally accepted); (4) the amount of any Security Deposit held hereunder; (5) that, so far as the party making the certificate knows, Landlord is not in default under any provisions of this Lease, if such is the case, and if not, identifying all defaults with particularity; and (6) any other matter reasonably requested by Landlord. Any purchaser or mortgagee of any interest in the Building, Land or Project shall be entitled to rely on said statement. 30.7 Attorney's Fees. In the event Landlord places the collection of any Rent or other sums due or to become due hereunder, or recovery of the possession of the Premises in the hands of an attorney at law, or files suit upon the same, then the prevailing party shall be entitled to recover from the other party such sum as the court may adjudge reasonable as attorneys' fees at trial or on appeal of such suit or action, in addition to all other sums provided by law. 30.8 Severability. If any provision of this Lease proves to be illegal, invalid, or unenforceable, the remainder of this Lease will not be affected by such finding, and in lieu of each provision of this Lease that is illegal, invalid, or unenforceable a provision will be added as a part of this Lease as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and be legal, valid, and enforceable. 30.9 Written Amendment Required. No amendment, alteration, modification of, or addition to the Lease will be valid or binding unless expressed in writing and signed by Landlord and Tenant. 30.10 Entire Agreement. This Lease, the exhibits and addenda, if any, contain the entire agreement between Landlord and Tenant. No promises or representations, except as expressly contained in this Lease, have been made to Tenant respecting the condition or the manner of operating the Premises, the Building, or the Project. The taking possession of the Premises by Tenant shall be conclusive evidence that Tenant accepts the Premises and the Building and that, except to the extent set forth in a written "punchlist" or other agreement between Landlord and Tenant and except for latent defects, the same were good and satisfactory condition at the time such possession was so taken. 30.11 Captions. The captions of the various articles and sections of this Lease are for convenience only and do not necessarily define, limit, describe, or construe the contents of such articles or sections. 39 30.12 Brokers. Landlord and Tenant respectively represent and warrant to each other that neither of them has consulted or negotiated with any broker or finder with regard to the Premises except the broker named in Section 1.1(u), if any. Each of them will indemnify the other against and hold the other harmless from any claims for fees or commissions from anyone with whom either of them has consulted or negotiated with regard to the Premises except the broker. Landlord will pay any fees or commissions due the broker. 30.13 Governing Law. This Lease will be governed by and construed pursuant to the laws of the State of Oregon. 30.14 No Easements for Air or Light. Any diminution or shutting off of light, air, or view by any structure that may be erected on lands adjacent to the Building will in no way affect this Lease or impose any liability on Landlord. 30.15 Tax Credits. Landlord is entitled to claim all tax credits and depreciation attributable to leasehold improvements in the Premises for which Landlord has paid. Promptly after Landlord's demand, Landlord and Tenant will prepare a detailed list of the leasehold improvements and fixtures and their respective costs for which Landlord or Tenant has paid. Landlord will be entitled to all credits and depreciation for those items for which Landlord has paid by means of any Tenant Finish Allowance or otherwise. Tenant will be entitled to any tax credits and depreciation for all items for which Tenant has paid with funds not provided by Landlord. 30.16 Binding Effect. The covenants, conditions, and agreements contained in this Lease will bind and inure to the benefit of Landlord and Tenant and their respective heirs, executors, administrators, successors, and, except as otherwise provided in this Lease, their assigns. 30.17 Confidentiality. It is hereby agreed that the terms and provisions of this Lease are confidential and, as such, may not be disclosed to any individual or entity without the express written consent of Landlord; provided, however that Tenant may disclose the terms of this Lease to its attorneys, accountants and other advisors and as may be required by law or regulation. 30.18 Approval. Except as may be specifically otherwise provided in this Lease, reference in this Lease to "approval," "consent" "judgment" and "satisfactory" shall not be interpreted as justifying arbitrary rejection, but rather shall connote a reasonable application of judgment taking into account long-term leasing practices and commercial customs relating to major real estate transactions. 30.19 Construction of Terms. Wherever used in this Lease, unless the context clearly indicates a contrary intent or unless otherwise specifically provided herein, the word "Lease" shall mean this Lease and any schedules or supplements hereto. Whether or not specifically stated in any provision of this Lease, reference therein to (i) any law, statute, ordinance, code, rule, regulation or the like shall mean and included any and all modifications, amendments and replacements thereof, (ii) the phrase "including" shall mean "including without limitation" and (iii) any right of Landlord shall mean unless expressly provided therein to the contrary, such right without any corresponding obligation. The term "Tenant" shall mean Tenant 40 and any subsequent holder or holders of this Lease; and pronouns of any gender shall include the other gender; and either the singular or plural shall include the other. The term "Landlord" wherever used in this Lease shall be limited to mean and include only the owner or owners at the time in question of the Building or a mortgagee in possession, so that in the event of any sale, assignment or transfer of the Building, such assigning owner, or mortgagee in possession shall thereupon be released and discharged from all covenants, conditions and agreements of Landlord hereunder, but such covenants, conditions and agreements shall be binding for the time being upon each new owner, or mortgagee in possession of the Building, until again sold, assigned or transferred. 30.20 Consequential Damages. In no event shall Landlord be liable for any consequential, special, punitive or indirect loss or damage which Tenant may incur or suffer in connection with this Lease or any services to be performed or provided pursuant hereto. 30.21 Limitation of Liability. Tenant shall look solely to the estate and interest of Landlord, its successors and assigns, in the Project for the collection of a judgment (or other judicial process) requiring the payment of damages or money by Landlord, and no other property or assets of Landlord or any partner of Landlord shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies under or with respect to either this Lease, the relationship of Landlord and Tenant hereunder or Tenant's use and occupancy of the Premises. IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the day and year first above written. LANDLORD: TENANT: 600 HOLLADAY LIMITED PARTNERSHIP KINDERCARE LEARNING By Ashforth Lloyd Properties, Inc. CENTERS, INC. Its General Partner HENRY A. ASHFORTH, III BETH A. UGORETZ - --------------------------------------- ------------------------------ By Henry A. Ashforth, III By Beth A. Ugoretz Its Executive Vice President Its Executive Vice President 41 EXHIBIT A The Premises TO BE AGREED UPON AS PROVIDED IN SECTION 4.1 A-1 EXHIBIT B Legal Description of the Land All of Block 82 and Block 83, HOLLADAY'S ADDITION TO EAST PORTLAND, in the City of Portland, County of Multnomah and State of Oregon. FURTHER described as follows: A tract of land being part of the Holladay's Addition to the City of Portland, Blocks 82 and 83 and the vacated N.E. Pacific Street TOGETHER WITH portions of vacated N.E. 7th Avenue and N.E. Oregon Street, in Section 35, Township 1 North, Range 1 East, of the Willamette Meridian, in the City of Portland, County of Multnomah and State of Oregon, being more particularly described as follows: Beginning at the Northwest corner of Block 82 of the recorded plat of Holladay's Addition; thence East along the North line of Block 82 of said plat a distance of 200.00 feet to the Northeast corner of Block 82 of said plat; thence South along the East line of said Block 82 and Block 83 a distance of 450.00 feet to the Southeast corner of said Block 83, said point being in the South line of that portion vacated along the North line of N.E. Oregon Street as per vacation Ordinance No. 169326; thence West along said South line of Block 83 and the said vacated portion of N.E. Oregon Street a distance of 200.00 feet to the Southwest corner of said Block 83; thence North along the East line of N.E. 6th Avenue, a distance of 450.00 feet to the point of beginning. B-1 EX-21 4 SUBSIDIARIES OF KINDERCARE LEARNING CENTERS, INC.
SUBSIDIARIES OF KINDERCARE LEARNINGS CENTERS, INC. -------------------------------------------------- State or Jurisdiction of Approximate Percentage Name of Subsidiary Incorporation of Voting Securities Owned - ------------------ ------------------------ -------------------------- KC Development Corp. Delaware 100% KC Hedging Corp. Delaware 100% KinderCare Learning Centres Limited Delaware 100% KinderCare Properties Limited Delaware 100% KinderCare Real Estate Corp. Delaware 100% Mini-Skools, Inc. Delaware 100% Mini-Skools, Limited Manitoba, Canada 100%
EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 12-MOS MAY-30-1997 JUN-01-1996 MAY-30-1997 1 24,150 0 15,782 2,133 0 58,040 570,389 98,831 569,878 86,919 383,129 0 0 94 27,613 569,878 0 563,135 0 543,033 0 4,697 22,394 (2,060) 3,375 (5,435) 0 (7,532) 0 (12,967) (0.79) (0.79)
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