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Recipient _____________________________________
CONFIDENTIAL
Private Placement Memorandum
Dated September 27, 2006
$1,000,000,000
KNOWLEDGE UNIVERSE EDUCATION L.P.
KUE Management Inc.
Investment Units consisting of Common Limited Partner Units of
Knowledge Universe Education LP and Class A Ordinary Shares of
KUE Management Inc.
Knowledge Universe Education L.P. ("KUE," and, together with its subsidiaries, the "Company") is a
Cayman Islands exempted limited partnership. KUE Management Inc. is a Cayman Islands exempted
company and the sole general partner of KUE (the "General Partner"). KUE is the indirect controlling
stockholder of Knowledge Learning Corporation ("KLC"), the largest for-profit early childhood care and
education company in the U.S., which operates approximately 2,500 locations in 39 states.
We are offering investment units (the "Units"), each comprised of one Common limited partner unit
("Common LP Unit") in KUE and one Class A ordinary share of the General Partner ("Class A Share"), for
$1,000 per Unit. We are offering the Units on a strictly confidential basis pursuant to a private placement
with Goldman, Sachs & Co. and Credit Suisse acting as placement agents (the "Agents"), subject to
various conditions, exclusively to accredited investors. We intend to use the net proceeds from the sale
of the Units to expand operations, including through strategic acquisitions in the U.S. and internationally,
to develop new products and services, to repay certain existing indebtedness and for other corporate
purposes. We reserve the right to withdraw, cancel or modify the offer and to reject orders in whole or in
part. The offering is expected to be completed in one or more closings on or prior to March 31, 2007.
The Units and the underlying Common LP Units and Class A Shares have not been, nor will they
be, registered under the U.S. Securities Act of 1933, as amended (the "Securities Act"), or
qualified under any applicable U.S. state statutes or laws of any non-U.S. jurisdiction. The Units
will be offered and sold under the exemption from registration provided by Section 4(2) of the
Securities Act and Regulation D and Regulation S promulgated under the Securities Act, and
other similar exemptions available pursuant to the laws of the states and other jurisdictions where
the offering will be made.
There is no public market for the Units and no such market is expected to develop in the future. There is
no obligation on the part of any person to register the Units or the underlying Common LP Units or Class
A Shares under the Securities Act or any state or non-U.S. securities laws other than in the limited
circumstances described in this Private Placement Memorandum.
Investing in the Units involves risks. You should read the section entitled "Risk Factors"
beginning on page 44 for a discussion of certain risk factors that you should consider before
investing in the Units.
Placement Agents
Goldman, Sachs & Co. Credit Suisse
Private Placement Memorandum dated September 27, 2006.
Table of Contents
1.   EXECUTIVE SUMMARY   19
2.   SUMMARY TERMS OF THE TRANSACTION   27
3.   USE OF PROCEEDS   39
4.   CAPITALIZATION   40
5.   SUMMARY FINANCIAL DATA   42
6.   RISK FACTORS   44
7.   DISTRIBUTION POLICY   60
8.   INDUSTRY OVERVIEW   61
9.   KNOWLEDGE UNIVERSE EDUCATION ("KUE")   73
10.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF KLC's PRO FORMA RESULTS OF
OPERATIONS   75
11.   THE OPERATING COMPANY ("KLC OPCO")   82
12.   THE REAL ESTATE COMPANY ("KLC PROPCO")   100
13.   k12 INC. ("k12")   106
14.   THE STRUCTURE OF KUE AND THE GENERAL PARTNER   115
15.   MANAGEMENT INCENTIVE PLANS AND EMPLOYMENT AGREEMENTS   131
16.   RELATED PARTY TRANSACTIONS   133
17.   ELIGIBLE INVESTORS   136
18.   CERTAIN INCOME TAX CONSEQUENCES   140
19.   APPENDICES   146
You should rely only on the information contained in this Private Placement Memorandum (this
"Memorandum") or to which we have referred you. We have not authorized anyone to provide you
with information that is different. This Memorandum may only be used where it is legal to sell the
Units. The information in this Memorandum may only be accurate on the date of this
Memorandum. No person has any obligation to update the statements and information contained
in this Memorandum.
NOTICE TO INVESTORS
THIS CONFIDENTIAL MEMORANDUM IS BEING FURNISHED ON A STRICTLY CONFIDENTIAL BASIS
SOLELY TO A LIMITED NUMBER OF SOPHISTICATED PROSPECTIVE INVESTORS FOR THE
PURPOSE OF PROVIDING CERTAIN INFORMATION REGARDING THE OFFERING OF THE UNITS. A
PROSPECTIVE INVESTOR MAY NOT DISTRIBUTE OR REPRODUCE THIS MEMORANDUM, OR
DISCLOSE ITS CONTENTS, TO ANY PERSON OTHER THAN PROFESSIONAL REPRESENTATIVES
OF THE INVESTOR IN CONNECTION WITH ITS CONSIDERATION OF THIS INVESTMENT. AS
CONTEMPLATED BY THE CONFIDENTIALITY AGREEMENTS BETWEEN THE INVESTORS AND
KUE, THIS MEMORANDUM AND ANY INFORMATION FURNISHED IN CONNECTION HEREWITH
(COLLECTIVELY, THE "COMPANY INFORMATION"), YOU ACKNOWLEDGE AND AGREE THAT (I) ALL
COMPANY INFORMATION IS CONFIDENTIAL; (II) YOU WILL NOT DISTRIBUTE OR REPRODUCE
THE COMPANY INFORMATION IN WHOLE OR IN PART AND WILL USE THE COMPANY
INFORMATION SOLELY TO EVALUATE AN INVESTMENT IN THE UNITS AND NOT FOR ANY OTHER
PURPOSE; (III) IN THE EVENT THAT YOU HAVE NO FURTHER INTEREST IN PARTICIPATING IN
THIS OFFERING, OR IF AT ANY TIME THE COMPANY SO REQUESTS (AT ITS DISCRETION), YOU
WILL PROMPTLY RETURN, DESTROY OR DELETE ALL COMPANY INFORMATION THAT YOU HAVE
RECEIVED AT THE EARLIEST OPPORTUNITY AS REQUESTED BY THE COMPANY; AND (IV) YOU
WILL NOT DISCLOSE TO ANY THIRD PARTY THE COMPANY INFORMATION THAT HAS BEEN
PROVIDED TO YOU. EACH PROSPECTIVE INVESTOR IS RESPONSIBLE FOR THE FEES OF ITS
OWN COUNSEL, ACCOUNTANTS AND OTHER ADVISORS.
THE UNITS OFFERED HEREBY AND THE COMMON LP UNITS AND CLASS A SHARES
REPRESENTED THEREBY ARE SUBJECT TO RESTRICTIONS ON TRANSFERABILITY AND RESALE
AND MAY NOT BE TRANSFERRED OR RESOLD EXCEPT AS PERMITTED UNDER THE SECURITIES
ACT AND THE APPLICABLE STATE AND NON-U.S. SECURITIES LAWS PURSUANT TO
REGISTRATION OR AN EXEMPTION THEREFROM, AND THEN ONLY TO THE EXTENT PERMITTED
BY THE LIMITED PARTNERSHIP AGREEMENT OF KUE AND THE GOVERNING DOCUMENTS AND
AGREEMENT AMONG MEMBERS OF THE GENERAL PARTNER. ACCORDINGLY, INVESTORS
SHOULD BE AWARE THAT THEY WILL BE REQUIRED TO BEAR THE FINANCIAL RISKS OF AN
INVESTMENT IN THE UNITS OFFERED HEREBY FOR AN INDEFINITE PERIOD OF TIME.
THE STATEMENTS AND INFORMATION CONTAINED IN THIS MEMORANDUM HAVE BEEN
COMPILED AS OF THE DATE HEREOF (UNLESS OTHERWISE STATED HEREIN) FROM THE
COMPANY AND FROM OTHER SOURCES. NEITHER THE DELIVERY OF THIS MEMORANDUM NOR
ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES IMPLY THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION SET FORTH
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. NO PERSON HAS
ANY OBLIGATION TO UPDATE THE STATEMENTS AND INFORMATION CONTAINED HEREIN.
IN MAKING AN INVESTMENT DECISION, INVESTORS MUST RELY ON THEIR OWN EXAMINATION
OF THE COMPANY, THE GENERAL PARTNER AND THE TERMS OF THE OFFERING, INCLUDING
THE MERITS AND RISKS INVOLVED. YOU ACKNOWLEDGE THAT (A) YOU HAVE NOT RELIED ON
THE AGENTS OR ANY PERSON AFFILIATED WITH THE AGENTS IN CONNECTION WITH YOUR
INVESTIGATION OF THE ACCURACY OF THE INFORMATION PROVIDED HEREIN OR YOUR
INVESTMENT DECISION AND (B) NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION
OR TO MAKE ANY REPRESENTATION CONCERNING THE COMPANY, THE GENERAL PARTNER OR
THE OFFERING OTHER THAN AS CONTAINED IN THIS MEMORANDUM AND INFORMATION GIVEN
BY DULY AUTHORIZED OFFICERS AND EMPLOYEES OF THE COMPANY IN CONNECTION WITH
YOUR EXAMINATION OF THE COMPANY, THE GENERAL PARTNER AND THE TERMS OF THIS
OFFERING, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
SHOULD NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE GENERAL
PARTNER OR THE AGENTS.
THIS MEMORANDUM DOES NOT CONSTITUTE AN OFFER BY ANY PERSON TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, ANY UNITS OR COMPONENTS THEREOF IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFER OR
SOLICITATION.
THE UNITS AND COMPONENT SECURITIES OFFERED HEREBY HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OR THE SECURITIES LAWS OF THE STATES OR ANY NON-U.S.
JURISDICTION AND ARE BEING OFFERED AND SOLD IN RELIANCE ON EXEMPTIONS FROM THE
REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND SUCH STATE AND NON-U.S.
LAWS. THE UNITS HAVE NOT BEEN RECOMMENDED, APPROVED OR DISAPPROVED BY THE
U.S. SECURITIES AND EXCHANGE COMMISSION OR ANY OTHER FEDERAL, STATE OR NON-U.S.
SECURITIES COMMISSION OR REGULATORY AUTHORITY, NOR HAVE ANY OF THE FOREGOING
AUTHORITIES PASSED UPON OR ENDORSED THE MERITS OF THIS OFFERING OR THE
ACCURACY OR ADEQUACY OF THIS MEMORANDUM. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
NEITHER THE GENERAL PARTNER NOR THE COMPANY IS REQUIRED TO REGISTER OR BE
REGULATED AS A MUTUAL FUND UNDER THE MUTUAL FUNDS LAW (2003 REVISION) OF THE
CAYMAN ISLANDS. NEITHER THE CAYMAN ISLANDS MONETARY AUTHORITY NOR ANY OTHER
GOVERNMENTAL AUTHORITY IN THE CAYMAN ISLANDS HAS PASSED JUDGMENT UPON OR
APPROVED THE TERMS OR MERITS OF THIS DOCUMENT. THERE IS NO INVESTMENT
COMPENSATION SCHEME AVAILABLE TO INVESTORS IN THE CAYMAN ISLANDS.
PROSPECTIVE INVESTORS SHOULD READ THIS ENTIRE MEMORANDUM CAREFULLY BEFORE
DECIDING WHETHER TO PURCHASE THE UNITS, AND PROSPECTIVE INVESTORS SHOULD
MAKE THEIR OWN INVESTIGATION OF THE INVESTMENT DESCRIBED HEREIN, INCLUDING THE
MERITS AND RISKS INVOLVED AND THE LEGALITY AND TAX CONSEQUENCES OF SUCH AN
INVESTMENT. PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THIS MEMORANDUM OR ITS
CONTENTS AS LEGAL, TAX, INVESTMENT OR OTHER ADVICE. PROSPECTIVE INVESTORS WILL
HAVE THE OPPORTUNITY TO ASK QUESTIONS AND RECEIVE ANSWERS AND ADDITIONAL
INFORMATION ABOUT THE COMPANY, THE GENERAL PARTNER AND THE UNITS TO VERIFY THE
INFORMATION CONTAINED HEREIN TO THE EXTENT REPRESENTATIVES OF THE COMPANY
POSSESS SUCH INFORMATION. EACH INVESTOR SHOULD MAKE ITS OWN INQUIRIES AND
CONSULT ITS OWN ADVISORS CONCERNING THE VARIOUS LEGAL, TAX AND ECONOMIC
CONSIDERATIONS RELATING TO ITS INVESTMENT.
THIS MEMORANDUM DOES NOT CONTAIN THE INFORMATION, INCLUDING FINANCIAL
STATEMENTS, THAT WOULD BE INCLUDED IN A REGISTRATION STATEMENT FILED WITH THE
U.S. SECURITIES AND EXCHANGE COMMISSION.
THIS MEMORANDUM CONTAINS PROJECTIONS FOR KLC AND K12 INC. THAT ARE BASED UPON
A NUMBER OF ASSUMPTIONS AND ESTIMATES THAT, WHILE PRESENTED WITH NUMERICAL
SPECIFICITY AND CONSIDERED REASONABLE BY MANAGEMENT WHEN TAKEN AS A WHOLE,
INHERENTLY ARE SUBJECT TO SIGNIFICANT BUSINESS, ECONOMIC, COMPETITIVE AND OTHER
RISKS, UNCERTAINTIES AND CONTINGENCIES, MANY OF WHICH ARE BEYOND THE CONTROL
OF THE COMPANY, AND ARE BASED UPON SPECIFIC ASSUMPTIONS WITH RESPECT TO FUTURE
BUSINESS DECISIONS, SOME OR ALL OF WHICH WILL CHANGE. PROJECTIONS ARE
NECESSARILY SPECULATIVE IN NATURE AND IT CAN BE EXPECTED THAT ASSUMPTIONS
UNDERLYING THE PROJECTIONS WILL NOT PROVE TO BE VALID OR WILL VARY FROM ACTUAL
RESULTS. ACCORDINGLY, THE PROJECTIONS ARE ONLY AN ESTIMATE. ACTUAL RESULTS WILL
VARY FROM THE PROJECTIONS AND THE VARIATIONS MAY BE MATERIAL. CONSEQUENTLY,
YOUR RECEIPT OF THE PROJECTIONS SHOULD NOT BE REGARDED AS A REPRESENTATION BY
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THE COMPANY, ITS ADVISORS, THE AGENTS, OR ANY OTHER PERSON OF RESULTS THAT WILL
ACTUALLY BE ACHIEVED. PROSPECTIVE PURCHASERS OF THE UNITS ARE CAUTIONED NOT
TO PLACE UNDUE RELIANCE ON THESE PROJECTIONS.
THE INFORMATION PRESENTED HEREIN WAS PREPARED OR OBTAINED BY KUE AND IS BEING
FURNISHED SOLELY FOR USE BY PROSPECTIVE INVESTORS IN CONNECTION WITH THE
OFFERING. THE AGENTS HAVE NOT ASSUMED ANY RESPONSIBILITY FOR INDEPENDENT
VERIFICATION OF THE INFORMATION CONTAINED HEREIN OR OTHERWISE MADE AVAILABLE IN
CONNECTION WITH THE OFFERING OF SECURITIES AND MAKE NO REPRESENTATIONS OR
WARRANTIES AS TO THE ACCURACY OR COMPLETENESS OF SUCH INFORMATION. NOTHING
CONTAINED HEREIN IS, OR SHOULD BE RELIED ON AS, A PROMISE OR REPRESENTATION AS TO
THE FUTURE PERFORMANCE OF KUE.
NOTICE TO NON-U.S. INVESTORS
NOTICE TO RESIDENTS OF ARGENTINA
THIS MEMORANDUM HAS NOT BEEN APPROVED BY ANY SECURITIES REGULATOR IN
ARGENTINA AND DOES NOT ENABLE KUE, THE GENERAL PARTNER, OR ANY OTHER PARTY TO
MAKE A PUBLIC OFFERING OF THE UNITS. THIS MEMORANDUM HAS ONLY BEEN ADDRESSED
DIRECTLY TO THE PROSPECTIVE INVESTORS DESIGNATED AND IS INTENDED TO PROVIDE
INFORMATION AT THEIR REQUEST THIS MEMORANDUM SHOULD NOT BE CIRCULATED OR
MADE PUBLIC IN ANY WAY. INVESTORS PARTICIPATING IN THIS ISSUANCE FULLY
ACKNOWLEDGE THAT THEY HAVE BEEN INVITED PERSONALLY AND IN CONSIDERATION OF
THEIR SPECIAL POSITION AS SOPHISTICATED INVESTORS AND THAT THEY HAVE HAD ALL
PROPER AND DUE PERSONAL COUNSELING TO ADOPT ANY DECISION RELATED TO THIS
ISSUANCE. THE UNITS ARE NOT AUTHORIZED TO BE OFFERED PUBLICLY IN THE
ARGENTINEAN MARKET OR TO BE SOLD TO ANY INVESTOR IN ARGENTINA.
NOTICE TO RESIDENTS OF AUSTRALIA
THIS MEMORANDUM HAS NOT BEEN AND WILL NOT BE LODGED WITH THE AUSTRALIAN
SECURITIES AND INVESTMENTS COMMISSION. THE OFFER IS ONLY MADE TO THOSE
PERSONS TO WHOM DISCLOSURE IS NOT REQUIRED UNDER DIVISION 2 OF PART 6D.2 OR
PART 7.9 OF THE CORPORATIONS ACT 2001 AND DOES NOT PURPORT TO BE AN OFFER OF
INTERESTS FOR WHICH DISCLOSURE IS REQUIRED. IN ADDITION, KUE IS NOT A REGISTERED
SCHEME AS DEFINED IN THE CORPORATIONS ACT 2001. RESALE OF THE UNITS IN AUSTRALIA
WITHIN 12 MONTHS OF THE DATE OF ISSUE MAY REQUIRE THE SELLER TO COMPLY WITH THE
DISCLOSURE REQUIREMENTS OF DIVISION 2 OF PART 6D.2 OR PART 7.9 OF THE
CORPORATIONS ACT 2001.
NOTICE TO RESIDENTS OF BRAZIL
KUE IS NOT A PUBLICLY-HELD CORPORATION AND IS NOT LISTED WITH ANY STOCK
EXCHANGE, ORGANIZED OVER THE COUNTER MARKET OR ELECTRONIC SYSTEM OF
SECURITIES TRADING. LIKEWISE, THE UNITS HAVE NOT BEEN AND WILL NOT BE REGISTERED
WITH ANY SECURITIES EXCHANGE COMMISSION OR OTHER SIMILAR AUTHORITY, INCLUDING
THE BRAZILIAN SECURITIES AND EXCHANGE COMMISSION (COMISSAO DE VALORES
MOBILARIOS-"CVM"). ANY PUBLIC OFFERING, AS DEFINED UNDER BRAZILIAN LAWS AND
REGULATIONS, OF THE UNITS IN BRAZIL IS NOT LEGAL WITHOUT SUCH PRIOR REGISTRATION
UNDER LAW NR. 6.385/76. SUBSEQUENT TRADING OF THE UNITS IN BRAZIL IS ALLOWED ONLY
BY MEANS OF PRIVATE TRANSACTIONS AND IS NOT SUBJECT TO REGISTRATION WITH THE
CVM TO THE EXTENT THAT SUCH TRADING DOES NOT QUALIFY AS A PUBLIC OFFERING. IT
SHOULD BE NOTED THAT A SELLER OF THE UNITS, HOWEVER, MAY BE ASKED BY THE
PURCHASER TO COMPLY WITH PROCEDURAL REQUIREMENTS TO EVIDENCE PREVIOUS TITLE
TO THE UNITS, AND MAY BE SUBJECT TO BRAZILIAN TAX ON CAPITAL GAINS WHICH MAY BE
WITHHELD FROM THE SALE PRICE. PERSONS WISHING TO OFFER OR ACQUIRE THE UNITS
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WITHIN BRAZIL SHOULD CONSULT WITH THEIR OWN COUNSEL AS TO THE APPLICABILITY OF
THESE REGISTRATION REQUIREMENTS OR ANY EXEMPTION THEREFROM.
THIS MEMORANDUM IS CONFIDENTIAL AND INTENDED SOLELY FOR THE USE OF THE
ADDRESSEE AND CANNOT BE DELIVERED OR DISCLOSED IN ANY MANNER WHATSOEVER TO
ANY PERSON OR ENTITY OTHER THAN THE ADDRESSEE.
NOTICE TO RESIDENTS OF CANADA
THIS MEMORANDUM CONSTITUTES AN OFFERING OF THE UNITS DESCRIBED HEREIN ONLY IN
THOSE JURISDICTIONS IN CANADA AND TO THOSE PERSONS WHERE AND TO WHOM THEY MAY
BE LAWFULLY OFFERED FOR SALE AND THEREIN ONLY BY PERSONS PERMITTED TO SELL
SUCH SECURITIES. THIS MEMORANDUM IS NOT, AND UNDER NO CIRCUMSTANCES IS TO BE
CONSTRUED AS, AN ADVERTISEMENT OR A PUBLIC OFFERING OF THE UNITS IN CANADA. NO
SECURITIES COMMISSION OR SIMILAR REGULATORY AUTHORITY IN CANADA HAS REVIEWED
OR IN ANY WAY PASSED UPON THIS MEMORANDUM OR THE MERIT OF THE UNITS AND ANY
REPRESENTATION TO THE CONTRARY IS AN OFFENCE UNDER APPLICABLE SECURITIES LAWS.
No dealer, salespersons or other individual has been authorized to give any information or to
make any representations not contained in this Memorandum in connection with the offer made
by this Memorandum and, if given or made, such information or representations must not be
relied upon as having been authorized by KUE or by the General Partner or by any placement
agent Neither the delivery of this Memorandum nor any sale made hereunder shall, under any
circumstances, create an implication that there has not been any change in the facts as set forth
in this Memorandum or in the affairs of KUE or the General Partner since the date hereof.
Resale Restrictions in Canada. THE DISTRIBUTION OF THE UNITS IN CANADA IS BEING MADE ON
A PRIVATE PLACEMENT BASIS. ACCORDINGLY, ANY RESALE OF THE UNITS MUST BE MADE IN
ACCORDANCE WITH AN EXEMPTION FROM THE REGISTRATION AND PROSPECTUS
REQUIREMENTS OF APPLICABLE SECURITIES LAWS. NEITHER KUE NOR THE GENERAL
PARTNER IS A REPORTING ISSUER IN ANY PROVINCE OR TERRITORY OF CANADA.
PURCHASERS OF THE UNITS ARE ADVISED TO SEEK LEGAL ADVICE PRIOR TO ANY RESALE OF
THE UNITS.
Enforcement of Legal Rights. THE GENERAL PARTNER IS A CAYMAN ISLANDS EXEMPTED
COMPANY AND KUE IS A CAYMAN ISLANDS EXEMPTED LIMITED PARTNERSHIP. THE
DIRECTORS, OFFICERS AND REPRESENTATIVES OF THE GENERAL PARTNER AND KUE MAY BE
LOCATED OUTSIDE CANADA AND, AS A RESULT, IT MAY NOT BE POSSIBLE FOR CANADIAN
PURCHASERS TO EFFECT SERVICE OF PROCESS WITHIN CANADA UPON THE GENERAL
PARTNER, KUE, OR THEIR DIRECTORS, OFFICERS OR REPRESENTATIVES. ALL OR A
SUBSTANTIAL PORTION OF THE ASSETS OF KUE, THE GENERAL PARTNER AND THEIR
DIRECTORS, OFFICERS OR REPRESENTATIVES MAY BE LOCATED OUTSIDE OF CANADA AND,
AS A RESULT, IT MAY NOT BE POSSIBLE TO SATISFY A JUDGMENT AGAINST SUCH PERSONS IN
CANADA OR TO ENFORCE A JUDGMENT OBTAINED IN CANADIAN COURTS AGAINST SUCH
PERSONS OUTSIDE OF CANADA.
Right of Action for Damages or Rescission. THE FOLLOWING SUMMARY IS SUBJECT TO THE
EXPRESS PROVISIONS OF THE SECURITIES ACT (ONTARIO), THE SECURITIES ACT (NEW
BRUNSWICK) AND THE SECURITIES ACT (NOVA SCOTIA) AND THE RULES AND REGULATIONS
THEREUNDER AND REFERENCE IS MADE THERETO FOR THE COMPLETE TEXT OF SUCH
PROVISIONS. THE SECURITIES ACT (ONTARIO) AND THE SECURITIES ACT (NEW BRUNSWICK)
PROVIDE CERTAIN PURCHASERS IN ONTARIO AND NEW BRUNSWICK, RESPECTIVELY, WITH A
STATUTORY RIGHT OF ACTION FOR DAMAGES OR RESCISSION AGAINST THE ISSUER WHERE
AN OFFERING MEMORANDUM CONTAINS A MISREPRESENTATION. THE SECURITIES ACT (NOVA
SCOTIA) PROVIDES PURCHASERS IN NOVA SCOTIA WITH A STATUTORY RIGHT OF ACTION FOR
DAMAGES AGAINST EVERY SELLER, EVERY DIRECTOR OF THE SELLER AT THE DATE OF THIS
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MEMORANDUM AND EVERY PERSON WHO SIGNED THE OFFERING MEMORANDUM OR A RIGHT
OF RESCISSION AGAINST EVERY SELLER WHERE AN OFFERING MEMORANDUM CONTAINS A
MISREPRESENTATION. SUCH PURCHASERS WHO PURCHASE A SECURITY OFFERED BY THE
OFFERING MEMORANDUM DURING THE PERIOD OF DISTRIBUTION ARE DEEMED TO HAVE
RELIED ON SUCH MISREPRESENTATION IF IT WAS A MISREPRESENTATION AT THE TIME OF
PURCHASE.
FOR PURCHASERS IN ONTARIO AND NOVA SCOTIA, THESE STATUTORY RIGHTS ARE
EXERCISABLE, IN THE CASE OF AN ACTION FOR RESCISSION, 180 DAYS AFTER THE DATE OF
THE TRANSACTION THAT GAVE RISE TO THE CAUSE OF ACTION OR, IN THE CASE OF ANY
ACTION, OTHER THAN AN ACTION FOR RESCISSION, THE EARLIER OF (I) 180 DAYS AFTER THE
PLAINTIFF FIRST HAD KNOWLEDGE OF THE FACTS GIVING RISE TO THE CAUSE OF ACTION AND
(II) THREE YEARS AFTER THE DATE OF THE TRANSACTION THAT GAVE RISE TO THE CAUSE OF
ACTION. NOTWITHSTANDING THE FOREGOING, IN NOVA SCOTIA, NO ACTION MAY BE
COMMENCED MORE THAN 120 DAYS AFTER THE DATE ON WHICH PAYMENT WAS MADE FOR
THE SECURITIES OR AFTER THE DATE ON WHICH THE INITIAL PAYMENT FOR THE SECURITIES
WAS MADE WHERE PAYMENTS SUBSEQUENT TO THE INITIAL PAYMENT ARE MADE PURSUANT
TO A CONTRACTUAL COMMITMENT ASSUMED PRIOR TO, OR CONCURRENTLY WITH, THE
INITIAL PAYMENT
FOR PURCHASERS IN NEW BRUNSWICK, THESE STATUTORY RIGHTS ARE EXERCISABLE, IN
THE CASE OF AN ACTION FOR RESCISSION, 180 DAYS AFTER THE DATE OF THE TRANSACTION
THAT GAVE RISE TO THE CAUSE OF ACTION OR, IN THE CASE OF ANY ACTION, OTHER THAN AN
ACTION FOR RESCISSION, THE EARLIER OF (I) ONE YEAR AFTER THE PLAINTIFF FIRST HAD
KNOWLEDGE OF THE FACTS GIVING RISE TO THE CAUSE OF ACTION AND (II) 6 YEARS AFTER
THE DATE OF THE TRANSACTION THAT GAVE RISE TO THE CAUSE OF THE ACTION.
THE RIGHTS DISCUSSED ABOVE ARE IN ADDITION TO AND WITHOUT DEROGATION FROM ANY
OTHER RIGHT OR REMEDY WHICH PURCHASERS MAY HAVE AT LAW AND ARE INTENDED TO
CORRESPOND TO THE PROVISIONS OF THE RELEVANT SECURITIES LEGISLATION AND ARE
SUBJECT TO THE DEFENCES CONTAINED THEREIN.
Canadian Federal Income Tax Considerations. THIS MEMORANDUM DOES NOT DISCUSS THE
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS RELEVANT TO A HOLDER OF THE UNITS
RESIDENT IN CANADA FOR PURPOSES OF THE INCOME TAX ACT (CANADA) (THE "ITA"). THE
RULES FOR THE TAXATION OF PARTNERS AND PARTNERSHIPS UNDER THE ITA ARE
EXTREMELY COMPLEX AND, ACCORDINGLY, PROSPECTIVE PURCHASERS OF THE UNITS WHO
ARE RESIDENT IN CANADA ARE STRONGLY ADVISED TO CONSULT WITH THEIR OWN TAX
ADVISORS PRIOR TO PURCHASING ANY UNITS.
Forward Looking Statements. CERTAIN STATEMENTS IN THIS MEMORANDUM CONSTITUTE
"FORWARD-LOOKING STATEMENTS." FORWARD-LOOKING STATEMENTS INCLUDE
STATEMENTS CONCERNING THE PLANS, OBJECTIVES, GOALS, STRATEGIES AND FUTURE
OPERATIONS AND PERFORMANCE OF KUE AND THE GENERAL PARTNER AND THE
ASSUMPTIONS UNDERLYING THESE FORWARD-LOOKING STATEMENTS. KUE AND THE
GENERAL PARTNER USE THE WORDS "ANTICIPATES," "ESTIMATES," EXPECTS," "BELIEVES,"
"INTENDS," "PLANS," "MAY," "WILL," "SHOULD," AND ANY SIMILAR EXPRESSIONS TO IDENTIFY
FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS INVOLVE
KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER IMPORTANT FACTORS THAT
COULD CAUSE ACTUAL RESULTS, PERFORMANCE AND ACHIEVEMENTS TO BE MATERIALLY
DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED
OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING
STATEMENTS ARE BASED ON NUMEROUS ASSUMPTIONS REGARDING PRESENT AND FUTURE
BUSINESS STRATEGIES AND THE ENVIRONMENT IN WHICH KUE AND THE GENERAL PARTNER
WILL OPERATE IN THE FUTURE. AS A RESULT OF THESE RISK, UNCERTAINTIES AND
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ASSUMPTIONS, A PROSPECTIVE INVESTOR SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS. SEE "RISK FACTORS" IN THIS MEMORANDUM.
THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF THIS
MEMORANDUM. NEITHER KUE NOR THE GENERAL PARTNER IS OBLIGED, AND DOES NOT
INTEND, TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. ALL SUBSEQUENT
WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO KUE, THE GENERAL
PARTNER, OR PERSONS ACTING ON THEIR BEHALF, ARE EXPRESSLY QUALIFIED IN THEIR
ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED THROUGHOUT THIS MEMORANDUM.
Financial information. FINANCIAL INFORMATION CONTAINED IN THIS MEMORANDUM HAVE NOT
BEEN PREPARED IN ACCORDANCE WITH U.S. GENERALLY ACCEPTED ACCOUNTING
PRACTICES, AND MAY DIFFER IN CERTAIN RESPECTS FROM THOSE ACCOUNTING PRINCIPLES
USED IN OTHER JURISDICTIONS, INCLUDING CANADA. PROSPECTIVE PURCHASERS SHOULD
CONDUCT THEIR OWN INVESTIGATION AND ANALYSIS OF THE BUSINESS, DATA AND
TRANSACTION DESCRIBED HEREIN AND CONSULT THEIR OWN FINANCIAL ADVISORS. SEE
"NON-GAAP FINANCIAL MEASURES" BELOW IN THIS MEMORANDUM.
Representations of Canadian Purchasers. EACH PURCHASER OF THE UNITS RESIDENT IN A
CANADIAN JURISDICTION WILL BE DEEMED TO HAVE REPRESENTED TO KUE AND THE
GENERAL PARTNER AND THE AGENTS WHO SELLS THE UNITS TO SUCH PURCHASER THAT: (A)
THE OFFER AND SALE OF THE UNITS WAS MADE EXCLUSIVELY THROUGH THIS MEMORANDUM
AND WAS NOT MADE THROUGH AN ADVERTISEMENT OF THE UNITS IN ANY PRINTED MEDIA OF
GENERAL AND REGULAR PAID CIRCULATION, RADIO, TELEVISION OR TELECOMMUNICATIONS,
INCLUDING ELECTRONIC DISPLAY, OR ANY OTHER FORM OF ADVERTISING IN CANADA; (B)
SUCH PURCHASER HAS REVIEWED AND ACKNOWLEDGES THE TERMS REFERRED TO ABOVE
UNDER "RESALE RESTRICTIONS IN CANADA"; (C) WHERE REQUIRED BY LAW, SUCH
PURCHASER IS PURCHASING AS PRINCIPAL FOR ITS OWN ACCOUNT AND NOT AS AGENT; AND
(D) SUCH PURCHASER OR ANY ULTIMATE PURCHASER FOR WHICH SUCH PURCHASER IS
ACTING AS AGENT IS ENTITLED UNDER APPLICABLE CANADIAN SECURITIES LAWS TO
PURCHASE SUCH UNITS WITHOUT THE BENEFIT OF A PROSPECTUS QUALIFIED UNDER SUCH
SECURITIES LAWS, AND WITHOUT LIMITING THE GENERALITY OF THE FOREGOING: (I) SUCH
PURCHASER IS AN "ACCREDITED INVESTOR" AS DEFINED IN SECTION 1.1 OF NATIONAL
INSTRUMENT 45-106 ("NI 45-106"), OR FULFILLS THE REQUIREMENTS OF SECTION 2.10 OF NI 45-
106 (A "$150K PURCHASER") AND (II) IN THE CASE OF A PURCHASER RESIDENT IN ONTARIO,
SUCH PURCHASER, OR ANY ULTIMATE PURCHASER FOR WHICH SUCH PURCHASER IS ACTING
AS AGENT, IS AN "ACCREDITED INVESTOR" AS DEFINED IN NI 45-106, OR A $150K PURCHASER
WHO IS PURCHASING THE UNITS FROM A REGISTERED INVESTMENT DEALER WITHIN THE
MEANING OF SECTION 98 OF THE REGULATION TO THE SECURITIES ACT (ONTARIO).
IN ADDITION, EACH PURCHASER OF THE UNITS RESIDENT IN CANADA WILL BE DEEMED TO
HAVE REPRESENTED TO KUE, THE GENERAL PARTNER AND THE AGENTS FROM WHOM A
PURCHASE CONFIRMATION WAS RECEIVED, THAT SUCH PURCHASER: (A) HAS BEEN NOTIFIED
BY KUE AND THE GENERAL PARTNER (I) THAT KUE AND THE GENERAL PARTNER ARE
REQUIRED TO PROVIDE INFORMATION ("PERSONAL INFORMATION") PERTAINING TO THE
PURCHASER AS REQUIRED TO BE DISCLOSED IN SCHEDULE I OF FORM 45-106F1 UNDER NI 45-
106 (INCLUDING ITS NAME, ADDRESS, TELEPHONE NUMBER AND THE NUMBER AND VALUE OF
ANY UNITS PURCHASED), WHICH FORM 45-106F1 IS REQUIRED TO BE FILED BY KUE AND THE
GENERAL PARTNER UNDER NI 45-106; (II) THAT SUCH PERSONAL INFORMATION WILL BE
DELIVERED TO THE ONTARIO SECURITIES COMMISSION (THE "OSC") IN ACCORDANCE WITH NI
45-106; (III) THAT SUCH PERSONAL INFORMATION IS BEING COLLECTED INDIRECTLY BY THE
OSC UNDER THE AUTHORITY GRANTED TO IT UNDER THE SECURITIES LEGISLATION OF
ONTARIO; (IV) THAT SUCH PERSONAL INFORMATION IS BEING COLLECTED FOR THE
PURPOSES OF THE ADMINISTRATION AND ENFORCEMENT OF THE SECURITIES LEGISLATION
OF ONTARIO; AND (V) THAT THE PUBLIC OFFICIAL IN ONTARIO WHO CAN ANSWER QUESTIONS
6
ABOUT THE OSC'S INDIRECT COLLECTION OF SUCH PERSONAL INFORMATION IS THE
ADMINISTRATIVE ASSISTANT TO THE DIRECTOR OF CORPORATE FINANCE AT THE OSC, SUITE
1903, BOX 5520 QUEEN STREET WEST, TORONTO, ONTARIO M5H 3S8, TELEPHONE: (416) 593-
8086; AND (B) HAS AUTHORIZED THE INDIRECT COLLECTION OF THE PERSONAL INFORMATION
BY THE OSC. FURTHER, THE PURCHASER ACKNOWLEDGES THAT ITS NAME, ADDRESS,
TELEPHONE NUMBER AND OTHER SPECIFIED INFORMATION, INCLUDING THE NUMBER OF
UNITS IT HAS PURCHASED AND THE AGGREGATE PURCHASE PRICE PAID BY PURCHASER,
MAY BE DISCLOSED TO OTHER CANADIAN SECURITIES REGULATORY AUTHORITIES AND MAY
BECOME AVAILABLE TO THE PUBLIC IN ACCORDANCE WITH THE REQUIREMENTS OF
APPLICABLE LAWS. BY PURCHASING UNITS, THE PURCHASER CONSENTS TO THE
DISCLOSURE OF SUCH INFORMATION.
Language of documents if7 Canada. UPON RECEIPT OF THIS MEMORANDUM, EACH INVESTOR IN
CANADA HEREBY CONFIRMS THAT IT HAS EXPRESSLY REQUESTED THAT ALL DOCUMENTS
EVIDENCING OR RELATING IN ANY WAY TO THE SALE OF THE UNITS (INCLUDING FOR GREATER
CERTAINTY ANY PURCHASE CONFIRMATION OR ANY NOTICE) BE DRAWN UP IN THE ENGLISH
LANGUAGE ONLY. PAR LA RECEPTION DE CE DOCUMENT CHAQUE INVESTISSEUR CANADIEN
CONFIRME PAR LES PRESENTES QU'IL A E_XPRESSEMENT EXIGE QUE TOUS LES DOCUMENTS
FAISANT FOI OU SE RAPPORTANT DE QUELQUE MANIERE QUE CE SOIT A LA VENTE DES
VALEURS MOBILIERES DECRITES AUX PRESENTES (INCLUANT, POUR PLUS DE CERTITUDE,
TOUTE CONFIRMATION D'ACHAT OU TOUT AVIS) SOIENT REDIGES EN ANGLAIS SEULEMENT.
NOTICE TO RESIDENTS OF THE CAYMAN ISLANDS
CLASS A SHARES IN THE GENERAL PARTNER AND COMMON LP UNITS IN KUE MAY BE
BENEFICIALLY OWNED BY PERSONS RESIDENT, DOMICILED, ESTABLISHED, INCORPORATED
OR REGISTERED IN THE CAYMAN ISLANDS PURSUANT TO THE LAWS OF THE CAYMAN
ISLANDS. THE GENERAL PARTNER AND KUE, HOWEVER, WILL NOT UNDERTAKE BUSINESS
WITH THE PUBLIC IN THE CAYMAN ISLANDS OTHER THAN SO FAR AS MAY BE NECESSARY FOR
THE CARRYING ON OF THE BUSINESS OF, AS APPLICABLE THE GENERAL PARTNER OR KUE
EXTERIOR TO THE ISLANDS. "PUBLIC" FOR THESE PURPOSES DOES NOT INCLUDE ANY
EXEMPTED OR ORDINARY NON-RESIDENT COMPANY REGISTERED UNDER THE COMPANIES
LAW OR A FOREIGN COMPANY REGISTERED PURSUANT TO PART IX OF THE COMPANIES LAW
OR ANY SUCH COMPANY ACTING AS GENERAL PARTNER OF A PARTNERSHIP REGISTERED
PURSUANT TO SECTION 9(1) OF THE EXEMPTED LIMITED PARTNERSHIP LAW (2003 REVISION)
OR ANY DIRECTOR OR OFFICER OF SUCH PARTNERSHIP ACTING IN SUCH CAPACITY OR THE
TRUSTEE OF ANY TRUST REGISTERED OR CAPABLE OF REGISTRATION PURSUANT TO
SECTION 74 OF THE TRUSTS LAW (2001 REVISION).
NOTICE TO RESIDENTS OF CHINA
THE INFORMATION CONTAINED IN THIS MEMORANDUM WILL NOT CONSTITUTE AN OFFER TO
SELL ANY SECURITIES WITHIN THE PEOPLE'S REPUBLIC OF CHINA (WHICH, FOR SUCH
PURPOSES, DOES NOT INCLUDE THE HONG KONG OR MACAU SPECIAL ADMINISTRATIVE
REGIONS OR TAIWAN) (THE "PRC"). THIS MEMORANDUM AND THE INFORMATION CONTAINED
HEREIN HAVE NOT BEEN APPROVED BY ANY RELEVANT GOVERNMENTAL AUTHORITIES IN THE
PRC AND THE UNITS MAY NOT BE OFFERED FOR SALE IN THE PRC. PRC INVESTORS ARE
RESPONSIBLE FOR OBTAINING ALL RELEVANT GOVERNMENT REGULATORY
APPROVALS/LICENSES THEMSELVES, INCLUDING, BUT NOT LIMITED TO, ANY WHICH MAY BE
REQUIRED FROM THE STATE ADMINISTRATION OF FOREIGN EXCHANGE, THE CHINA BANKING
REGULATORY COMMISSION, AND/OR THE CHINA SECURITIES REGULATORY COMMISSION, AND
COMPLYING WITH ALL RELEVANT PRC REGULATIONS, INCLUDING, BUT NOT LIMITED TO, ANY
RELEVANT FOREIGN EXCHANGE REGULATIONS AND/OR FOREIGN INVESTMENT REGULATIONS.
7
NOTICE TO RESIDENTS OF FRANCE
THE COMPANY AND THE AGENTS HAVE NOT OFFERED OR SOLD AND WILL NOT OFFER OR
SELL, DIRECTLY OR INDIRECTLY, THE UNITS TO THE PUBLIC IN FRANCE, AND HAVE NOT
DISTRIBUTED OR CAUSED TO BE DISTRIBUTED AND WILL NOT DISTRIBUTE OR CAUSE TO BE
DISTRIBUTED TO THE PUBLIC IN FRANCE, THIS MEMORANDUM OR ANY OTHER OFFERING
MATERIAL RELATING TO THE UNITS. SUCH OFFERS, SALES AND DISTRIBUTIONS HAVE BEEN
AND SHALL ONLY BE MADE IN FRANCE TO (I) PROVIDERS OF INVESTMENT SERVICES RELATING
TO PORTFOLIO MANAGEMENT FOR THE ACCOUNT OF THIRD PARTIES, AND/OR (II) QUALIFIED
INVESTORS (INVESTISSEURS QUALIFIES), AND/OR (III) A RESTRICTED GROUP OF INVESTORS
(CERCLE RESTREINT D'INVESTISSEURS), ALL AS DEFINED IN, AND IN ACCORDANCE WITH,
ARTICLES L.411-1, L.411-2, D.411-1 AND D.411-2 OF THE FRENCH CODE MONETAIRE ET
FINANCIER.
NOTICE TO RESIDENTS OF GERMANY
THE UNITS HAVE NOT BEEN AND WILL NOT BE REGISTERED OR APPROVED FOR PUBLIC
OFFERING UNDER THE SECURITIES LAWS OF GERMANY. THIS MEMORANDUM HAS NOT BEEN
AND WILL NOT BE SUBMITTED TO THE FEDERAL FINANCIAL SERVICES SUPERVISORY
AUTHORITY (BUNDESANSTALT FOR FINANZDIENSTLEISTUNGSAUFSICHT) FOR APPROVAL AS A
PROSPECTUS AND NO PROSPECTUS HAS BEEN OR WILL BE PUBLISHED IN GERMANY.
THEREFORE, THE UNITS MAY BE OFFERED AND SOLD IN THE TERRITORY OF THE FEDERAL
REPUBLIC OF GERMANY ONLY IF (I) LESS THAN 20 UNITS ARE OFFERED IN GERMANY, (II) THE
PRICE PER OFFERED UNIT IS AT LEAST €200,000 FOR EACH OFFEREE, (III) THE OFFER IS TO A
"RESTRICTED CIRCLE OF PERSONS" AS THIS TERM IS INTERPRETED BY THE BAFIN AND THE
GERMAN COURTS, OR (IV) THE OFFER IS TO INVESTORS WHO PURCHASE OR SELL
SECURITIES OR INVESTMENTS (VERMOGENSANLAGEN) AS DEFINED IN THE GERMAN SALES
PROSPECTUS ACT (VERKAUFSPROSPEKTGESETZ) FOR THEIR OWN ACCOUNT OR THE
ACCOUNT OF THIRD PARTIES AS PART OF THEIR PROFESSION OR TRADE. THIS MEMORANDUM
AND ANY OTHER DOCUMENT RELATING TO THE UNITS, AS WELL AS INFORMATION CONTAINED
THEREIN, MAY NOT BE SUPPLIED TO THE PUBLIC IN GERMANY OR USED IN CONNECTION WITH
ANY OFFER FOR SUBSCRIPTION OR SALE OF THE UNITS TO THE PUBLIC IN GERMANY. THIS
MEMORANDUM AND OTHER OFFERING MATERIALS RELATING TO THE OFFER OF THE UNITS
ARE STRICTLY CONFIDENTIAL AND MAY NOT BE DISTRIBUTED TO ANY PERSON OR ENTITY
OTHER THAN THE RECIPIENTS HEREOF.
NOTICE TO RESIDENTS OF HONG KONG
WARNING
THE CONTENTS OF THIS MEMORANDUM HAVE NOT BEEN REVIEWED BY ANY REGULATORY
AUTHORITY IN HONG KONG. YOU ARE ADVISED TO EXERCISE CAUTION IN RELATION TO THE
OFFER. IF YOU ARE IN ANY DOUBT ABOUT ANY OF THE CONTENTS OF THIS MEMORANDUM,
YOU SHOULD OBTAIN INDEPENDENT PROFESSIONAL ADVICE.
NOTICE TO RESIDENTS OF ICELAND
THIS MEMORANDUM HAS BEEN ISSUED TO YOU FOR YOUR PERSONAL USE ONLY AND
EXCLUSIVELY FOR THE PURPOSES OF THE INVESTMENT SCHEME. ACCORDINGLY, THIS
MEMORANDUM MAY NOT BE USED FOR ANY OTHER PURPOSE NOR PASSED ON TO ANY OTHER
PERSON IN ICELAND. THE SECURITIES OFFERING DESCRIBED IN THIS MEMORANDUM IS AN
UNREGULATED INVESTMENT SCHEME. THE SECURITIES WHICH ARE THE OBJECT OF THIS
MEMORANDUM ARE NOT REGISTERED FOR PUBLIC DISTRIBUTION IN ICELAND WITH THE
FINANCIAL SUPERVISORY AUTHORITY PURSUANT TO THE ICELANDIC ACT ON SECURITIES
TRANSACTIONS NO. 33/2003 OR THE ICELANDIC ACT ON UCITS-FUNDS AND OTHER
INVESTMENT FUNDS NO. 30/2003 AND SUPPLEMENTARY REGULATIONS. THE UNITS MAY NOT
BE OFFERED OR SOLD BY MEANS OF THIS MEMORANDUM OR ANYWAY LATER RESOLD TO
8
OTHER THAN ENTITIES OR PERSONS DEFINED AS INSTITUTIONAL INVESTORS IN THE MEANING
OF ITEM NO. 7. IN ARTICLE 2 OF THE ICELANDIC ACT ON SECURITIES TRANSACTIONS AND THE
REGULATION OF THE TRANSACTIONS OF SECURITIES NO. 233/2003. ANY RESALE OF THE
UNITS IN ICELAND WILL NEED TO TAKE PLACE IN ACCORDANCE WITH THE PROVISIONS OF THE
ICELANDIC ACT ON SECURITIES TRANSACTIONS No. 33/2003 AS AMENDED AND ANY
APPLICABLE LAWS OR REGULATIONS OF ICELAND.
NOTICE TO RESIDENTS OF INDIA
THE ISSUANCE OF THE UNITS IS BEING MADE STRICTLY ON A PRIVATE PLACEMENT BASIS.
THIS MEMORANDUM IS NOT A PROSPECTUS OR A STATEMENT IN LIEU OF A PROSPECTUS. IT
IS NOT, AND SHOULD NOT BE DEEMED TO CONSTITUTE AN OFFER TO THE PUBLIC IN
GENERAL.
THE INFORMATION CONTAINED IN THIS MEMORANDUM IS BELIEVED BY THE COMPANY TO BE
ACCURATE IN ALL MATERIAL RESPECTS AS OF THE DATE HEREOF. THE COMPANY DOES NOT
UNDERTAKE TO UPDATE THIS MEMORANDUM TO REFLECT SUBSEQUENT EVENTS. THIS
MEMORANDUM HAS BEEN PREPARED TO PROVIDE GENERAL INFORMATION ON THE COMPANY
TO POTENTIAL INVESTORS EVALUATING THE PROPOSAL TO SUBSCRIBE FOR THE UNITS
COVERED BY THIS MEMORANDUM AND IT DOES NOT PURPORT TO CONTAIN ALL THE
INFORMATION THAT ANY SUCH POTENTIAL INVESTOR MAY REQUIRE. POTENTIAL INVESTORS
SHOULD CONDUCT THEIR OWN DUE DILIGENCE, INVESTIGATION AND ANALYSIS OF THE
COMPANY.
PRIOR TO APPLYING FOR THE UNITS, INVESTORS SHOULD VERIFY IF THEY HAVE THE
NECESSARY POWER AND COMPETENCE TO APPLY FOR THE UNITS UNDER THEIR
CONSTITUTIONAL DOCUMENTS AS WELL AS ALL RELEVANT LAWS AND REGULATIONS IN
FORCE IN INDIA. THEY SHOULD ALSO CONSULT THEIR OWN TAX ADVISORS ON THE TAX
IMPLICATIONS OF THE ACQUISITION, OWNERSHIP AND SALE OF THE UNITS, AND INCOME
ARISING THEREON.
ALTHOUGH THE INFORMATION CONTAINED HEREIN HAS BEEN OBTAINED FROM SOURCES
THAT ARE RELIABLE TO THE BEST OF THE AGENTS' KNOWLEDGE AND BELIEF, THE AGENTS
MAKES NO REPRESENTATION AS TO THE ACCURACY OR COMPLETENESS OF ANY
INFORMATION CONTAINED HEREIN OR OTHERWISE PROVIDED BY THE AGENT. NEITHER THE
AGENTS NOR ANY OFFICER OR EMPLOYEE OF THE AGENTS ACCEPT ANY LIABILITY
WHATSOEVER FOR ANY DIRECT OR CONSEQUENTIAL LOSS ARISING FROM ANY USE OF THIS
MEMORANDUM OR ITS CONTENTS.
NOTICE TO RESIDENTS OF ITALY
THE OFFERING OF THE UNITS IN THE REPUBLIC OF ITALY ("ITALY") HAS NOT BEEN
AUTHORISED BY THE COMMISSIONE NAZIONALE PER LE SOCIETA E LA BORSA ("CONSOB")
PURSUANT TO THE ITALIAN SECURITIES LEGISLATION AND, ACCORDINGLY:
(I) THE UNITS CANNOT BE OFFERED, SOLD OR DELIVERED IN ITALY IN AN INVESTMENT
SOLICITATION ("SOLLECITAZIONE ALL'INVESTIMENTO") WITHIN THE MEANING OF ARTICLE 1,
PARAGRAPH 1, LETTER (T) OF LEGISLATIVE DECREE NO. 58 OF 24 FEBRUARY 1998, AS
AMENDED ("DECREE 58/98"),
(II) THE UNITS CANNOT BE OFFERED, SOLD AND/OR DELIVERED, NOR ANY DOCUMENT
RELATING TO THE UNITS CAN BE DISTRIBUTED, EITHER IN THE PRIMARY OR SECONDARY
MARKET, TO INDIVIDUALS RESIDENT IN ITALY, AND
(III) ANY OFFER, SALE AND/OR DELIVERY OF THE UNITS AND DISTRIBUTION OF COPIES OF ANY
DOCUMENT RELATING TO THE UNITS IN ITALY WILL ONLY BE:
(A) MADE TO ITALIAN INSTITUTIONAL INVESTORS ("INVESTITORI ISTITUZIONALI"), AS
DEFINED IN ARTICLE 100 OF DECREE 58/98 BY REFERENCE TO ARTICLE 31.2 OF CONSOB
REGULATION NO. 11522 OF 1 JULY 1998, AS AMENDED ("REGULATION 11522/98");
(B) MADE IN COMPLIANCE WITH ARTICLE 129 OF THE LEGISLATIVE DECREE NO. 385 OF 1
SEPTEMBER 1993, AS AMENDED ("DECREE 385/93"), AND THE IMPLEMENTING
INSTRUCTIONS OF THE BANK OF ITALY, IF APPLICABLE, PURSUANT TO WHICH THE ISSUE
OR PLACEMENT OF SECURITIES IN ITALY IS SUBJECT TO PRIOR NOTIFICATION TO THE
BANK OF ITALY, UNLESS AN EXEMPTION, DEPENDING, INTER ALIA, ON THE AMOUNT OF
THE ISSUE AND THE CHARACTERISTICS OF THE SECURITIES, APPLIES;
(C) MADE IN COMPLIANCE WITH ANY OTHER ITALIAN SECURITIES, TAX AND EXCHANGE
CONTROL AND OTHER APPLICABLE LAWS AND REGULATIONS AND ANY OTHER
APPLICABLE REQUIREMENT OR LIMITATION WHICH MAY BE IMPOSED BY CONSOB, THE
BANK OF ITALY OR ANY OTHER COMPETENT ITALIAN AUTHORITY; AND
(D) MADE BY AN INVESTMENT FIRM, BANK OR FINANCIAL INTERMEDIARY PERMITTED TO
CONDUCT SUCH ACTIVITIES IN ITALY IN ACCORDANCE WITH DECREE 58/98, DECREE 385/93,
REGULATION 11522/98 AND ANY OTHER APPLICABLE LAWS AND REGULATIONS.
NOTICE TO RESIDENTS OF JAPAN
THE OFFERING OF THE UNITS HEREUNDER HAS NOT BEEN AND WILL NOT BE REGISTERED
UNDER THE SECURITIES AND EXCHANGE LAW OF JAPAN. CONSEQUENTLY, THE UNITS MAY
NOT BE OFFERED, SOLD, RESOLD OR OTHERWISE TRANSFERRED, DIRECTLY OR INDIRECTLY,
IN JAPAN OR TO OR FOR THE ACCOUNT OF ANY RESIDENT OF JAPAN, EXCEPT PURSUANT TO
AND IN COMPLIANCE WITH APPLICABLE JAPANESE LAWS AND REGULATIONS. THE INVESTORS
SHOULD FURTHER NOTE THAT PURSUANT TO THE PARTNERSHIP AGREEMENT THE UNITS MAY
ONLY BE TRANSFERRED IN WHOLE AND NOT IN PART AND THAT ANY SUCH TRANSFER WILL
REQUIRE A PRIOR WRITTEN CONSENT OF THE GENERAL PARTNER.
NOTICE TO RESIDENTS OF JERSEY
NOTHING IN THIS MEMORANDUM, NOR ANYTHING COMMUNICATED TO HOLDERS OR
POTENTIAL HOLDERS OF SECURITIES BY THE COMPANY OR THE AGENTS IS INTENDED TO
CONSTITUTE OR SHOULD BE CONSTRUED AS ADVICE ON THE MERITS OF THE PURCHASE OF
OR SUBSCRIPTION FOR THE UNITS OR THE EXERCISE OF ANY RIGHTS ATTACHED THERETO
FOR THE PURPOSES OF THE FINANCIAL SERVICES (JERSEY) LAW 1998, AS AMENDED.
NOTICE TO RESIDENTS OF KUWAIT
THIS OFFERING HAS NOT BEEN APPROVED BY THE KUWAIT CENTRAL BANK OR THE KUWAIT
MINISTRY OF COMMERCE AND INDUSTRY, NOR HAS THE COMPANY RECEIVED AUTHORIZATION
OR LICENSING FROM THE KUWAIT CENTRAL BANK OR THE KUWAIT MINISTRY OF COMMERCE
AND INDUSTRY TO MARKET OR SELL THE UNITS WITHIN KUWAIT. FURTHERMORE, THIS
MEMORANDUM DOES NOT CONSTITUTE THE MARKETING OR OFFERING OF SECURITIES IN
KUWAIT PURSUANT TO THE KUWAITI SECURITIES LAW (LAW NO. 31 OF 1990, AS AMENDED).
NOTICE TO RESIDENTS OF MEXICO
THE UNITS HAVE NOT BEEN REGISTERED WITH THE NATIONAL REGISTRY OF SECURITIES
(REGISTRO NACIONAL DE VALORES) MAINTAINED BY THE MEXICAN NATIONAL BANKING AND
SECURITIES COMMISSION (COM/S/ON NACIONAL BANCARIA Y DE VALORES) AND MAY NOT BE
OFFERED OR SOLD PUBLICLY IN MEXICO. THIS OFFER DOES NOT CONSTITUTE A PUBLIC
OFFER UNDER THE MEXICAN SECURITIES MARKET LAW (LEY DEL MERCADO DE VALORES).
THIS PRIVATE OFFER AND ALL OTHER INFORMATION AS CONTAINED IN THIS MEMORANDUM
ARE EXCLUSIVELY FOR THE BENEFIT OF AND DISTRIBUTION TO INSTITUTIONAL OR HIGH NET
10
WORTH INVESTORS. THIS MEMORANDUM AND OTHER OFFERING MATERIALS MAY NOT BE
PUBLICLY DISTRIBUTED IN MEXICO.
NOTICE TO RESIDENTS OF MONACO
NEITHER THIS MEMORANDUM NOR ANY OTHER OFFERING MATERIAL RELATING TO THE UNITS
MAY BE AVAILABLE TO THE PUBLIC OR USED IN CONNECTION WITH ANY OTHER OFFER FOR
SUBSCRIPTION OR SALE OF THE UNITS IN THE PRINCIPALITY OF MONACO, AND THE UNITS
MAY NOT BE ISSUED, OFFERED OR OTHERWISE SOLD IN THE PRINCIPALITY OF MONACO.
NOTICE TO RESIDENTS OF THE NETHERLANDS
THE UNITS MAY ONLY BE OFFERED, DIRECTLY OR INDIRECTLY, IN THE NETHERLANDS TO
ENTITIES WHICH (i) ARE PROFESSIONAL MARKET PARTIES AS DEFINED IN ARTICLE I-C, 1ST
PARAGRAPH, UNDER A OF THE EXEMPTION REGULATION ISSUED PURSUANT TO ARTICLE 4 OF
THE ACT ON THE SUPERVISION OF SECURITIES TRADE (WET TOEZICHT EFFECTENVERKEER
1995) AND (ii) WHICH TRADE OR INVEST IN INVESTMENT OBJECTS IN THE CONDUCT OF A
PROFESSION OR BUSINESS WITHIN THE MEANING OF ARTICLE I OF THE EXEMPTION
REGULATION OF 9 OCTOBER 1990 ISSUED PURSUANT TO ARTICLE 14 OF THE INVESTMENT
INSTITUTION SUPERVISION ACT (WET TOEZICHT BELEGGINGSINSTELLINGEN OF JUNE 27,
1990). THE UNITS MAY NOT OTHERWISE BE OFFERED, DIRECTLY OR INDIRECTLY, IN THE
NETHERLANDS.
NOTICE TO RESIDENTS OF QATAR
THE UNITS HAVE NOT BEEN OFFERED, SOLD OR DELIVERED, AND WILL NOT BE OFFERED,
SOLD OR DELIVERED AT ANY TIME, DIRECTLY OR INDIRECTLY, IN THE STATE OF QATAR IN A
MANNER THAT WOULD CONSTITUTE A PUBLIC OFFERING. THIS MEMORANDUM HAS NOT BEEN
REVIEWED OR REGISTERED WITH QATARI GOVERNMENT AUTHORITIES, WHETHER UNDER
LAW. NO. 25 (2002) CONCERNING INVESTMENT FUNDS, CENTRAL BANK RESOLUTION NO. 15
(1997), AS AMENDED, OR ANY ASSOCIATED REGULATIONS. THEREFORE, THIS MEMORANDUM
IS STRICTLY PRIVATE AND CONFIDENTIAL, AND IS BEING ISSUED TO A LIMITED NUMBER OF
SOPHISTICATED INVESTORS, AND MAY NOT BE REPRODUCED OR USED FOR ANY OTHER
PURPOSE, NOR PROVIDED TO ANY PERSON OTHER THAN RECIPIENT THEREOF.
NOTICE TO RESIDENTS OF RUSSIA
UNDER RUSSIAN LAW, THE UNITS ARE SECURITIES OF A FOREIGN ISSUER. NEITHER THE
ISSUE OF THE UNITS NOR A SECURITIES PROSPECTUS IN RESPECT OF THE UNITS HAS BEEN,
OR IS INTENDED TO BE, REGISTERED WITH THE FEDERAL SERVICE FOR FINANCIAL MARKETS
OF THE RUSSIAN FEDERATION, AND HENCE THE UNITS ARE NOT ELIGIBLE FOR INITIAL
OFFERING OR PUBLIC CIRCULATION IN THE RUSSIAN FEDERATION. THE INFORMATION
PROVIDED IN THIS MEMORANDUM IS NOT AN OFFER, OR AN INVITATION TO MAKE OFFERS, TO
SELL, EXCHANGE OR OTHERWISE TRANSFER THE UNITS IN THE RUSSIAN FEDERATION OR TO
OR FOR THE BENEFIT OF ANY RUSSIAN PERSON OR ENTITY.
EACH OF THE AGENTS HAS REPRESENTED AND AGREED THAT IT HAS NOT OFFERED OR SOLD
AND WILL NOT OFFER OR SELL ANY UNITS TO OR FOR THE BENEFIT OF ANY PERSONS
RESIDENT, INCORPORATED, ESTABLISHED OR HAVING THEIR USUAL RESIDENCE IN RUSSIA OR
TO ANY PERSON LOCATED WITHIN THE TERRITORY OF RUSSIA UNLESS AND TO THE EXTENT
OTHERWISE PERMITTED UNDER RUSSIAN LAW.
NOTICE TO RESIDENTS OF SAUDI ARABIA
THIS MEMORANDUM MAY NOT BE DISTRIBUTED IN THE KINGDOM EXCEPT TO THE EXTENT
PERMITTED UNDER THE RULES GOVERNING EXEMPT OFFERS AS SET FORTH IN THE OFFERS
11
OF SECURITIES REGULATIONS (THE "REGULATIONS"). IT SHOULD NOT BE DISTRIBUTED TO
ANY OTHER PERSON, OR RELIED UPON BY ANY OTHER PERSON.
THE CAPITAL MARKET AUTHORITY DOES NOT TAKE ANY RESPONSIBILITY FOR THE CONTENTS
OF THIS MEMORANDUM, DOES NOT MAKE ANY REPRESENTATION AS TO ITS ACCURACY OR
COMPLETENESS, AND EXPRESSLY DISCLAIMS ANY LIABILITY WHATSOEVER FOR ANY LOSS
ARISING FROM, OR INCURRED IN RELIANCE UPON, ANY PART OF THIS MEMORANDUM.
PROSPECTIVE PURCHASERS OF THE SECURITIES OFFERED HEREBY SHOULD CONDUCT
THEIR OWN DUE DILIGENCE ON THE ACCURACY OF THE INFORMATION RELATING TO THE
SECURITIES. IF YOU DO NOT UNDERSTAND THE CONTENTS OF THIS DOCUMENT YOU SHOULD
CONSULT AN AUTHORIZED FINANCIAL ADVISER.
NOTICE TO RESIDENTS OF SINGAPORE
As to the Class A Shares
THIS MEMORANDUM HAS NOT BEEN REGISTERED AS A PROSPECTUS WITH THE MONETARY
AUTHORITY OF SINGAPORE. ACCORDINGLY, THIS MEMORANDUM AND ANY OTHER DOCUMENT
OR MATERIAL IN CONNECTION WITH THE OFFER OR SALE, OR INVITATION FOR SUBSCRIPTION
OR PURCHASE, OF CLASS A SHARES MAY NOT BE CIRCULATED OR DISTRIBUTED, NOR MAY
SUCH CLASS A SHARES BE OFFERED OR SOLD, OR BE MADE THE SUBJECT OF AN INVITATION
FOR SUBSCRIPTION OR PURCHASE, WHETHER DIRECTLY OR INDIRECTLY, TO PERSONS IN
SINGAPORE OTHER THAN (I) TO AN INSTITUTIONAL INVESTOR UNDER SECTION 274 OF THE
SECURITIES AND FUTURES ACT, CHAPTER 289 OF SINGAPORE (THE "SFA"), (II) TO A RELEVANT
PERSON, OR ANY PERSON PURSUANT TO SECTION 275(1A), AND IN ACCORDANCE WITH THE
CONDITIONS, SPECIFIED IN SECTION 275 OF THE SFA OR (III) OTHERWISE PURSUANT TO, AND
IN ACCORDANCE WITH THE CONDITIONS OF, ANY OTHER APPLICABLE PROVISION OF THE SFA.
WHERE SUCH CLASS A SHARES ARE SUBSCRIBED OR PURCHASED UNDER SECTION 275 BY A
RELEVANT PERSON WHICH IS:
(A) A CORPORATION (WHICH IS NOT AN ACCREDITED INVESTOR (AS DEFINED IN SECTION 4A
OF THE SFA)) THE SOLE BUSINESS OF WHICH IS TO HOLD INVESTMENTS AND THE ENTIRE
SHARE CAPITAL OF WHICH IS OWNED BY ONE OR MORE INDIVIDUALS, EACH OF WHOM IS AN
ACCREDITED INVESTOR; OR
(B) A TRUST (WHERE THE TRUSTEE IS NOT AN ACCREDITED INVESTOR) WHOSE SOLE
PURPOSE IS TO HOLD INVESTMENTS AND EACH BENEFICIARY OF THE TRUST IS AN INDIVIDUAL
WHO IS AN ACCREDITED INVESTOR,
SHARES, DEBENTURES AND UNITS OF SHARES AND DEBENTURES OF THAT CORPORATION OR
THE BENEFICIARIES' RIGHTS AND INTEREST (HOWSOEVER DESCRIBED) IN THAT TRUST SHALL
NOT BE TRANSFERRED WITHIN 6 MONTHS AFTER THAT CORPORATION OR THAT TRUST HAS
ACQUIRED SUCH CLASS A SHARES PURSUANT TO AN OFFER MADE UNDER SECTION 275
EXCEPT:
(1) TO AN INSTITUTIONAL INVESTOR (FOR CORPORATIONS, UNDER SECTION 274 OF THE SFA)
OR TO A RELEVANT PERSON DEFINED IN SECTION 275(2) OF THE SFA, OR TO ANY PERSON
PURSUANT TO AN OFFER THAT IS MADE ON TERMS THAT SUCH SHARES, DEBENTURES AND
UNITS OF SHARES AND DEBENTURES OF THAT CORPORATION OR SUCH RIGHTS AND
INTEREST IN THAT TRUST ARE ACQUIRED AT A CONSIDERATION OF NOT LESS THAN S$200,000
(OR ITS EQUIVALENT IN A FOREIGN CURRENCY) FOR EACH TRANSACTION, WHETHER SUCH
AMOUNT IS TO BE PAID FOR IN CASH OR BY EXCHANGE OF SECURITIES OR OTHER ASSETS,
AND FURTHER FOR CORPORATIONS, IN ACCORDANCE WITH THE CONDITIONS SPECIFIED IN
SECTION 275 OF THE SFA;
(2) WHERE NO CONSIDERATION IS OR WILL BE GIVEN FOR THE TRANSFER; OR
12
(3) WHERE THE TRANSFER IS BY OPERATION OF LAW.
As to the Common LP Units
THIS MEMORANDUM HAS NOT BEEN REGISTERED AS A PROSPECTUS WITH THE MONETARY
AUTHORITY OF SINGAPORE AND THIS OFFERING IS NOT REGULATED BY ANY FINANCIAL
SUPERVISORY AUTHORITY PURSUANT TO ANY LEGISLATION IN SINGAPORE. YOU SHOULD
ACCORDINGLY CONSIDER CAREFULLY WHETHER THE INVESTMENT IS SUITABLE FOR YOU.
EACH INVESTOR AGREES THAT THIS MEMORANDUM AND ANY OTHER DOCUMENT OR
MATERIAL IN CONNECTION WITH THE OFFER OR SALE, OR INVITATION FOR SUBSCRIPTION OR
PURCHASE, OF COMMON LP UNITS MAY NOT BE CIRCULATED OR DISTRIBUTED, NOR MAY
SUCH COMMON LP UNITS BE OFFERED OR SOLD, OR BE MADE THE SUBJECT OF AN
INVITATION FOR SUBSCRIPTION OR PURCHASE, WHETHER DIRECTLY OR INDIRECTLY, TO
PERSONS IN SINGAPORE OTHER THAN INSTITUTIONAL INVESTORS (AS DEFINED IN SECTION
4A OF THE SECURITIES AND FUTURES ACT, CHAPTER 289 OF SINGAPORE ("SFA")),
ACCREDITED INVESTORS (AS DEFINED IN SECTION 4A OF THE SFA) OR ANY PERSON
PURSUANT TO AN OFFER THAT IS MADE ON TERMS THAT SUCH COMMON LP UNITS ARE
ACQUIRED AT A CONSIDERATION OF NOT LESS THAN S$200,000 (OR ITS EQUIVALENT IN A
FOREIGN CURRENCY) FOR EACH TRANSACTION, WHETHER SUCH AMOUNT IS TO BE PAID FOR
IN CASH OR BY EXCHANGE OF SECURITIES OR OTHER ASSETS.
NOTICE TO RESIDENTS OF SPAIN
NO PUBLIC OFFERING OF THE COMMON LP UNITS WILL BE CARRIED OUT IN THE SPANISH
TERRITORY, PURSUANT TO THE DEFINITION OF PUBLIC OFFER CONTAINED IN ARTICLE 30 BIS
OF THE SECURITIES MARKET LAW 24/1988, OF JULY 28. CONSEQUENTLY, THIS MEMORANDUM
HAS NOT BEEN AND WILL NOT BE VERIFIED OR REGISTERED WITH THE SPANISH SECURITIES
MARKET COMMISSION (COMISION NACIONAL DEL MERCADO DE VALORES, "CNMV").
NOTICE TO RESIDENTS OF SWITZERLAND
THE UNITS ARE BEING OFFERED BY WAY OF A PRIVATE PLACEMENT TO A LIMITED NUMBER OF
INVESTORS WITHOUT ANY PUBLIC OFFERING IN OR FROM SWITZERLAND. THIS
MEMORANDUM AND ANY OTHER OFFERING MATERIAL RELATING TO THE UNITS ARE INTENDED
SOLELY FOR THE RECIPIENT; THE INFORMATION THEREIN IS STRICTLY CONFIDENTIAL AND
THEREFORE MAY NOT BE DISTRIBUTED TO ANY THIRD PARTY OR THE PUBLIC IN GENERAL.
NOTICE TO RESIDENTS OF THE UNITED ARAB EMIRATES ("UAE")
BY RECEIVING THIS MEMORANDUM, THE PERSON OR ENTITY TO WHOM IT HAS BEEN ISSUED
UNDERSTANDS, ACKNOWLEDGES AND AGREES THAT THIS MEMORANDUM HAS NOT BEEN
APPROVED BY THE UAE CENTRAL BANK, THE UAE MINISTRY OF ECONOMY OR ANY OTHER
AUTHORITY IN THE UAE, NOR ARE THE AGENTS AUTHORIZED OR LICENSED BY THE UAE
CENTRAL BANK, THE UAE MINISTRY OF ECONOMY OR ANY OTHER AUTHORITY IN THE UAE TO
MARKET OR SELL THE UNITS IN THE COMPANY WITHIN THE UAE. NO MARKETING OF ANY
FINANCIAL PRODUCTS OR SERVICES HAVE BEEN OR WILL BE MADE FROM WITHIN THE UAE
AND NO SUBSCRIPTION TO ANY SECURITIES, PRODUCTS OR FINANCIAL SERVICES MAY OR
WILL BE CONSUMMATED WITHIN THE UAE.
THE AGENTS ARE NOT LICENSED BROKERS, DEALERS, FINANCIAL ADVISORS OR INVESTMENT
ADVISORS UNDER THE LAWS APPLICABLE IN THE UAE, AND DO NOT ADVISE INDIVIDUALS
RESIDENT IN THE UAE AS TO THE APPROPRIATENESS OF INVESTING IN OR PURCHASING OR
SELLING SECURITIES OR OTHER FINANCIAL PRODUCTS, NOTHING CONTAINED IN THIS
MEMORANDUM IS INTENDED TO CONSTITUTE INVESTMENT, LEGAL, TAX, ACCOUNTING OR
OTHER PROFESSIONAL ADVICE IN, OR IN RESPECT OF, THE UAE.
13
THIS MEMORANDUM IS FOR YOUR INFORMATION ONLY AND NOTHING IN THIS MEMORANDUM
IS INTENDED TO ENDORSE OR RECOMMEND A PARTICULAR COURSE OF ACTION. YOU SHOULD
CONSULT WITH AN APPROPRIATE PROFESSIONAL FOR SPECIFIC ADVICE RENDERED ON THE
BASIS OF YOUR SITUATION.
NOTICE TO RESIDENTS OF THE UNITED KINGDOM
THE COMPANY IS AN UNREGULATED COLLECTIVE INVESTMENT SCHEME FOR THE PURPOSES
OF THE FINANCIAL SERVICES AND MARKETS ACT 2000 ("FSMA"), THE PROMOTION OF WHICH IN
THE UNITED KINGDOM IS RESTRICTED BY THE FSMA. IF MADE BY A PERSON WHO IS NOT AN
AUTHORISED PERSON UNDER FSMA, THE ISSUE OR DISTRIBUTION OF THIS DOCUMENT IN THE
UNITED KINGDOM MAY ONLY BE MADE TO AND DIRECTED AT PERSONS WHO (I) ARE
INVESTMENT PROFESSIONALS FALLING WITHIN ARTICLE 19 OF THE FINANCIAL SERVICES AND
MARKETS ACT 2000 (FINANCIAL PROMOTION) ORDER 2005; OR (II) ARE PERSONS TO WHOM
THE PROMOTION MAY OTHERWISE BE LAWFULLY MADE. IF MADE BY A PERSON WHO IS AN
AUTHORISED PERSON UNDER FSMA, THE ISSUE OR DISTRIBUTION OF THIS DOCUMENT IN THE
UNITED KINGDOM MAY ONLY BE MADE TO AND DIRECTED AT PERSONS WHO (I) ARE
INVESTMENT PROFESSIONALS WITHIN ARTICLE 14 OF THE FINANCIAL SERVICES AND
MARKETS ACT 2000 (PROMOTION OF COLLECTIVE INVESTMENT SCHEMES) (EXEMPTIONS)
ORDER 2001; OR (II) ARE PERSONS TO WHOM THE PROMOTION MAY OTHERWISE BE LAWFULLY
MADE. TRANSMISSION OF THIS DOCUMENT TO ANY OTHER PERSON IN THE UNITED KINGDOM
IS UNAUTHORISED AND MAY CONTRAVENE THE FSMA. IN THE UNITED KINGDOM,
PARTICIPATION IN THE COMPANY IS AVAILABLE ONLY TO SUCH PERSONS AND PERSONS OF
ANY OTHER DESCRIPTION SHOULD NOT RELY ON THIS DOCUMENT
14
NON-GAAP FINANCIAL MEASURES
EBITDA, Adjusted EBITDA and Adjusted EBITDAR (including pro forma presentations thereof) and the
related ratios presented in this Memorandum are supplemental measures of our performance that are not
required by, or presented in accordance with, generally accepted accounting principles in the U.S.
("GAAP"). EBITDA, Adjusted EBITDA and Adjusted EBITDAR are not measurements of our financial
performance under GAAP and should not be considered as alternatives to net income, operating income
or any other performance measures derived in accordance with GAAP, or as an alternative to cash flow
from operating activities as a measure of our liquidity.
EBITDA represents net income before net interest expense, income tax expense, depreciation (including
impairment charges) and amortization. Pro forma presentations of EBITDA have also added back
KinderCare Learning Centers, Inc.'s ("KinderCare") discontinued operations, consistent with KLC's
treatment of center closures and sales and KinderCare's historical presentation of EBITDA. Adjusted
EBITDA represents EBITDA plus (i) expenses (minus gains) that we do not consider reflective of our
ongoing operations after the KinderCare acquisition, as further described in this Memorandum and (ii)
management fees which are subordinated to our obligations on our 7%% senior subordinated notes (the
"Notes") and which are added back in measuring our performance for purposes of our ability to incur debt
under our indenture. Our actual and projected Adjusted EBITDA, where applicable, also exclude non-
cash stock-based compensation expense, which is also excluded under our indenture; accruals under our
stock appreciation rights ("SAR") plan; and accruals under our long term incentive plan, which are non-
cash at the time of award and vest and become payable in three years subject to continued employment
(with certain exceptions). Our pro forma Adjusted EBITDA for 2005 excludes restructuring and integration
charges associated with the KinderCare acquisition and the cost of operating parallel organizations during
the integration process, which management does not consider reflective of ongoing operations. Adjusted
EBITDAR is Adjusted EBITDA plus rent expense. We present EBITDA, Adjusted EBITDA and Adjusted
EBITDAR because we consider them to be important supplemental measures of our performance and
believe they are frequently used by securities analysts, investors and other interested parties in the
evaluation of issuers, many of which present EBITDA and/or Adjusted EBITDA and/or Adjusted EBITDAR
when reporting their results.
We are basing our executive incentive compensation payments in part on our performance measured
using Adjusted EBITDA including adjustments described herein. We also use financial measures similar
to Adjusted EBITDA, though subject to certain different adjustments, in the senior credit facility that we
entered into in connection with the KinderCare acquisition and the indenture governing the Notes to
measure our compliance with covenants such as interest coverage and debt incurrence. Measures
similar to Adjusted EBITDA are also widely used by us and others in our industry to evaluate and price
potential acquisition candidates. For example, we evaluated the KinderCare acquisition and our 2003
acquisition of ARAMARK Educational Resources to a significant degree based on their historical and
potential EBITDA, as adjusted for items we did not consider representative of post-acquisition operations.
We believe EBITDA and Adjusted EBITDA facilitate operating performance comparisons from period to
period and company to company by backing out potential differences caused by variations in capital
structures (affecting relative interest expense), tax positions (such as the impact on periods or companies
of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities
and equipment (affecting relative depreciation expense). We believe Adjusted EBITDAR is a useful
measure of performance independent of occupancy costs.
We calculate Adjusted EBITDA by adjusting EBITDA to eliminate the impact of a number of items we do
not consider indicative of our ongoing operations and for the other reasons noted above. For the reasons
indicated herein, you are encouraged to evaluate each adjustment and whether you consider it
appropriate. In addition, in evaluating Adjusted EBITDA and Adjusted EBITDAR, you should be aware
that in the future we may incur expenses similar to the adjustments in the presentation of Adjusted
EBITDA and Adjusted EBITDAR. Our presentation of Adjusted EBITDA and Adjusted EBITDAR should
not be construed as an inference that our future results will be unaffected by unusual or non-recurring
items.
15
EBITDA, Adjusted EBITDA and Adjusted EBITDAR have limitations as analytical tools, and you should
not consider them in isolation, or as a substitute for analysis of our results as reported under GAAP.
Some of these limitations are:
• they do not reflect our cash expenditures for capital expenditures or contractual commitments;
• they do not reflect the cost of our non-cash stock-based compensation or our SAR plan or long term
incentive plan or the expense associated with allocating Profits Participation LP Units (as defined
below) to employees;
• they do not reflect changes in, or cash requirements for, our working capital;
• they do not reflect the significant interest expense, or the cash requirements necessary to service
interest or principal payments, on our indebtedness;
• they do not reflect management fees;
• although depreciation and amortization are non-cash charges, the assets being depreciated and
amortized will often have to be replaced in the future, and our non-GAAP measures do not reflect cash
requirements for such replacements or the related expense;
• they do not reflect the impact of earnings or charges resulting from the significant costs we have
incurred in integrating KinderCare, and we are likely to incur significant integration costs in future
acquisitions;
• other companies, including other companies in our industry, may calculate these measures differently
than we do, limiting their usefulness as a comparative measure; and
• they do not comply with the requirements of Item 10(e) of Regulation S-K or Regulation G of the
Securities and Exchange Commission ("SEC").
Because of these limitations, EBITDA, Adjusted EBITDA and Adjusted EBITDAR should not be
considered as measures of discretionary cash available to us to invest in the growth of our business or
reduce our indebtedness. We compensate for these limitations by relying on our GAAP results as well as
these non-GAAP measures.
For more information, see our consolidated financial statements and the notes to those statements
included elsewhere in this Memorandum.
FORWARD-LOOKING STATEMENTS
This Memorandum contains forward-looking statements, which involve risks and uncertainties. You can
identify forward-looking statements because they contain words such as "anticipates," "expects,"
"should," 'intends," "plans," "believes," "seeks," "estimates," "will," "may," "approximately" and similar
expressions which concern, among other things, the Company's results of operations, financial condition,
liquidity, prospects, growth, strategies and the industry in which the Company operates. Examples
include statements regarding anticipated growth in revenue, net income and EBITDA, expectations
regarding the likelihood of recurrence of certain charges and gains, expectations regarding capital
investments, and expectations regarding future cash generated from operations. These forward-looking
statements are based on our management's current expectations, assumptions, estimates and
projections about us and our industry. You are cautioned that actual results could differ from those
16
anticipated by the forward-looking statements. Investors are cautioned not to place undue reliance on the
projections contained in this Memorandum or other models and forecasts they may receive or discuss in
connection with this offering.
Important factors that could cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or implied by those statements
include, but are not limited to, those discussed under "Risk Factors," elsewhere in this Memorandum.
The following list represents some, but not necessarily all, of the factors that could cause actual results to
differ from historical results or those anticipated or predicted by any forward-looking statements:
• we may be unable to identify, consummate or obtain favorable terms on acquisitions of businesses or
interests therein, which is a principal component of our growth strategy;
^ our international expansion strategy is untested, and our acquisition and development of non-U.S.
businesses may not be successful;
• the loss of any of our key management employees could adversely affect our business;
• we have a substantial level of indebtedness and plan to incur additional debt;
• we face intense competition in the early childhood care and education services industry from
numerous other types of providers;
• we may acquire companies that are not well-established or experiencing financial difficulties;
• we rely on the management teams of our subsidiaries, who may not be able to operate them in
accordance with our plans;
• we may acquire minority interests in various companies (such as k12 Inc. ("k12")) and we may not be
able to protect our interests adequately in respect of such investments;
• we or our subsidiaries may be unable to raise additional financing which may be needed to satisfy
certain of our subsidiaries' working capital requirements;
• failure to comply with present or future applicable U.S. or foreign governmental regulation and
licensing requirements could have a material adverse effect on our operations;
• activities of Knowledge Universe Learning Group LLC C'KULG), the parent entity of the General
Partner and/or its Principals may be competitive with the Company; conflicts of interest may arise with
the Principals and their affiliates; the Company may not engage in certain businesses;
• litigation and adverse publicity concerning incidents at child care centers could hurt our reputation;
• our insurance policies may prove inadequate to cover claims, and we may be unable to maintain our
existing coverage in the future at reasonable prices;
• factors beyond our control, such as economic conditions, could affect demand for our child care
services;
17
NM a loss or reduction of government funding for child care assistance programs or food reimbursement
programs could adversely affect us;
if a termination or reduction of tax credits for child care could have a material adverse effect on our
business;
si if we (or our subsidiaries) are unable to attract and retain sufficient qualified employees, if minimum
wage rates increase or if our employees (or our subsidiaries' employees) unionize, our results of
operations may be adversely affected;
12 our results of operations could be adversely affected if environmental contamination is discovered on
any of our properties; and
II material weaknesses in KLC's internal controls discovered during KLC's fiscal year 2005 audit.
BACKGROUND DATA
Industry and market data used throughout this Memorandum is based on independent industry
publications, government publications, reports by market research firms and other published independent
sources. Some data is also based on our good faith estimates, which are derived from our review of
internal surveys and independent sources. Such information necessarily incorporates significant
assumptions as to factual or other matters. Although we believe these sources are reliable, we have not
independently verified the information from third party-sources or the assumptions on which such
information is based and cannot guarantee its accuracy or completeness. Some of the industry data
contained in this Memorandum has not been updated because we have been unable to obtain more
recent data. Although we are not aware of trends contrary to those reflected in such data (except as
otherwise stated), we cannot assure you that such data are indicative of current trends.
TRADEMARKS
The intellectual property portfolio of the Company includes registered and unregistered trademarks and
service marks and collective trademarks that distinguish the services and products that it offers from
those services and products offered by other companies.
In addition, the Company has applied to register certain other trademarks, service marks and collective
trademarks in the U.S. and other countries, and likely will seek to register additional marks in the future.
A federal registration in the U.S. is effective for ten years and may be renewed for ten-year periods
perpetually, subject only to required filings based on continued use of the mark by a registrant. It is
possible that some of these applications to register additional marks will not result in registrations.
KLC's primary trademarks are "Knowledge Learning Corporation," "Children's World," "Knowledge
Beginnings," "Children's Discovery Centers" and "Medallion School Partnerships."
KinderCare owns and uses various registered and unregistered trademarks and service marks covering
the name "KinderCare," its schoolhouse logo and a number of other names, slogans and designs,
including "KinderCare at Work" and "Mulberry."
k12's primary trademarks are the k12 star logo, the word mark and design, which are licensed from an
entity controlled by the Principals.
All other product and company names referred to in this Memorandum are trademarks and registered
trademarks of their respective companies.
18
1. EXECUTIVE SUMMARY
The following summary is qualified in its entirety by the more detailed information appearing elsewhere in this
Memorandum. You should carefully consider the information set forth under "Risk Factors". The term "KUE" refers
only to Knowledge Universe Education L.P., a Cayman Islands exempted limited partnership. The terms "Knowledge
Universe Education", the "Company", "we", "us" and "our" refer to KUE and, where applicable, its subsidiaries, and
do not refer to the Agents. In November 2005, KLC separated its education operations ("KLC OpCo') from its real
estate assets ("KLC PropCo').
1.1. Company Overview
KUE is the third largest for-profit education company in the world and the largest for-profit education
company in the pre-school to 12th grade segment ("pre-K-12") in the world. While the Company's
operations are currently based within the U.S., the proceeds from this transaction will be used primarily to
expand KUE's education platform both globally and across the pre-K-12 education continuum. KUE's
existing portfolio of assets consists of:
(i)
KLC OpCo, the leading early childhood education
("ECE") company with 2,507 locations in 39 states
and the District of Columbia and nearly two and a
half times larger than its next closest competitor in
terms of revenue;
(ii) KLC PropCo, one of the largest education based
real estate portfolios in the U.S. consisting of 845
early childhood centers located in 37 states; and
Knowledge Universe
Education LP
87.6%1
KUE Management Inc.
(General Partner)
17.9% to 40.0%2
Knowledge Learning
Corporation (KLC)
k12 Inc.
(iii) A significant interest in k12, an online curriculum
provider and kindergarten through 12th grade management company, currently serving over
25,000 students as the largest operator of online virtual schools in the U.S.
The principal owners of KUE are Michael Milken, Lowell Milken and Steven Green (collectively the
"Principals"). Michael Milken and Lowell Milken each has more than two decades of experience in the
education sector through involvement in several for-profit and not-for-profit initiatives. Steven Green,
former U.S. ambassador to Singapore, has more than two decades of experience as an international
industrialist leading major corporate restructurings and expansions in manufacturing, housing, consumer
products, retail and real estate enterprises. The Company represents the Principals' sole vehicle for
equity investment opportunities in the pre-K-12 sector going forward.
The Principals founded the Company and its affiliated companies over the past decade based on their
vision of a world where competition for human capital3 is becoming the driving force of economic
prosperity. To remain competitive in the world economy, countries will be forced to invest heavily in the
development of their human capital. The Principals believe that an investment made in an individual's
education, especially at a young age, is the most effective way to build human capital and thereby
increase that individual's lifelong productivity. As the largest for-profit provider of ECE in the world, the
Company is well positioned to capitalize on these trends.
:The 12.4% minority position is held by various investors.
KUE's ownership varies depending on the liquidation value or sale value of k12 and according to the preference of the various securities KUE owns.
At higher valuations, KUE's percentage ownership is lower. See "k12 Inc. (k12) — k12 Equity."
3 The economic theory of Human Capital Policy was first published by University of Chicago professor James Heckman in Human Capital Policy, dated
August 2002.
19
Education is one of the largest sectors in the world, representing approximately 5% of global gross
national income of $48 trillion.4 In 2005 in the U.S. alone, education was a $1 trillion market.' Education
is still predominantly provided by public / governmental entities in most countries including the U.S. KUE
believes that the industry will converge towards a more balanced public / private system, similar to the
evolution observed in the 20th century in other major industries such as healthcare, infrastructure and
telecommunications.
The Company's strategy is to grow its existing platforms both domestically and internationally and to
expand its assets globally across the pre-K-12 education continuum. In addition to its current investments
in ECE and online curriculum, KUE will seek to expand by acquiring education companies offering
services or products that can complement its current offering. KUE believes that owning a diversified
portfolio of assets in the pre-K-12 education space will allow it to leverage content and best practices
across multiple constituencies and to multiple markets. KUE's strategy in U.S. ECE is to expand its
existing platform through the opening of new centers, opportunistic acquisitions of smaller competitors
and the sale of education-related products and services through existing channels. Internationally, KUE
has identified several near-term opportunities to expand into Europe, the Middle-East and Asia, with some
of these opportunities in advanced stages of preparation.
Management has a history of successfully growing through acquisitions. In May 2003, KLC acquired
Aramark Educational Resources ("AER"), a company three times its size in terms of revenue.
Management completed the integration of AER in approximately 12 months, realizing approximately $10
million in net annual synergies and improving operational performance. In January 2005, the Company
acquired KinderCare, the largest provider of ECE services in the U.S. at the time. Management achieved
approximately $25 million in net annualized synergies through the closing of under-performing centers
and the rationalization of corporate overhead. In November 2005, KLC separated its education
operations (KLC OpCo) from its real estate assets (KLC PropCo). Management believes this division
allows KLC OpCo management to focus on the core business of operating and growing the ECE
business while the maximization of the valuable educational real estate portfolio is managed and
expanded by a professional real estate firm, Greenstreet Real Estate Partners (formerly Greenstreet
Realty Partners, L.P.), and also represents management's view of KLC's component businesses.
Management believes that KUE presents an attractive financial profile with its combination of businesses:
(i) KLC OpCo, which generated $1.48 billion in pro forma revenue and $150 million in pro forma Adjusted
EBITDA6 in 2005, is projected to grow organically to $2.3 billion and $320 million by 2011, respectively
and to generate operating cash flow growing from $72 million in 2005 to $214 million in 2011; (ii) a real
estate portfolio in KLC PropCo that generated an additional $88 million in pro forma EBITDA in 2005; and
(Hi) an investment in k12, which continues to deliver top line growth in excess of 25% and has seen its
revenue grow at a 133% compounded annual growth rate over the last three fiscal years (from $6.7
million in 2002 to $85.1 million in 2005).
1.2. Investment Rationale
1.2.1 Attractive Industry Characteristics
ri The global for-profit education market is large and growing
° Source: UNESCO Institute for Statistics database.
6 Source: US Department of Education National Center for Education Statistics and Training Magazine and Harris Nesbitt research.
° Pro forma for the acquisition of KinderCare and the separation of KLC into KLC OpCo and KLC PropCo.
20
Education is one of the largest sectors in the world and represents a large portion of a country's
investments
— Represents approximately 5% of global gross national income of $48 trillion. In the U.S. alone,
education represents a $1 trillion market with for-profit education accounting for approximately $81
billion or 7.8% of the overall market.
— The pre-K-12 segment of the education market is approximately a $610 billion market, with for-
profit pre-K-12 education accounting for approximately $37.4 billion, over 6.1% of the pre-K-12
market/
The for-profit education sector is growing at an attractive rate
— U.S. education spending has grown at a stable compound annual growth rate ("CAGR") of 5.7%
since 1993. The for-profit component of this industry (pre-K-12, post secondary and corporate
training) is projected to grow faster than the overall historical industry growth rate, at a 7.4% annual
rate, reflecting the increasing importance of for-profit operations in the sector, to reach a market
size of $116 billion by 2010.7
— In addition, these estimates do not reflect the growing segment of direct to consumer educational
materials such as supplemental tutoring, which represented an estimated $20 billion of additional
spending in 2004.
• Increasing competition for human capital
To remain competitive in the global economy, countries are investing heavily in the development of their
human capital, especially at young ages
— According to the World Bank's World Education Indicators, worldwide enrollment rates in pre-
primary education increased by 37% from 1995 to 2003.8
— KUE believes that education companies will become significantly more valuable as countries
become increasingly aware of the competitive advantages afforded by education. Of the top 100
global companies by market cap, not a single education company is represented on the list.
As globalization of the economy and improving technologies flatten the playing field, demand for more
standardized education across regions increases
— KUE believes that increasingly global education standards, enhanced workforce mobility and new
technologies are catalysts of world competition for human capital.
• Several international growth opportunities
The Company is starting to execute on its international development strategy
— In the near term, the Company is focusing on opportunities identified in the United Kingdom, Saudi
Arabia, the United Arab Emirates and China. Depending on the state and organization of each
country's education sector, KUE's development will be executed through cooperation with
government authorities, outright acquisitions and/or the establishment of partnerships with key local
players.
7 Source: Harris Nesbitt, Education and Training, September 2005.
Source: Education Trends in Perspective: Analysis of the World Education Indicators, 2005.
21
— These initiatives could provide three key regional platforms for further development and
consolidation.
In the medium term, numerous opportunities for KUE should be generated by the increasing demand for
quality for-profit educational offerings by governments and citizens around the world
— Competitive pressures for development of human capital, deficiencies of national education
systems, growth of a middle-class in China, India and the Middle East, demand for English
language offerings and changing demographics are some of the primary drivers of increased
demand internationally.
— In China alone, 274 million children are under the age of 15, and 100 million are single-children
under the age of 25, as a result of the one-child policy. These demographics result in large
demand for education and increased spending capacity per child.
I• Favorable demographic trends and customer behavior in the U.S.
Growing number of working mothers
— According to the Bureau of Labor Statistics (BLS) estimates, women are expected to represent
nearly 48% of the total U.S. workforce by 2012, up from 46.6% in 2002.°
— In the U.S., approximately 60% of mothers with children under the age of six are employed.
Increasing birth rate
— There are approximately 24 million children under the age of five in the U.S. today. According to
the U.S. Census Bureau, absolute birth rates are going to continue to increase, and the population
of children in the U.S. five and under is expected to increase to approximately 27 million by 2015.10
Essential nature of the service to the consumer
— As with healthcare, parents are primarily focused on the quality of the service that their child
receives and the proximity of the center to their home or work; price is typically a secondary
consideration. By relieving parents of the requirement to stay at home with their children, ECE
allows both men and women to participate in the workforce and generate income for the
household.
1.2.2 Compelling Business Profile
• KUE presents an attractive financial profile
For the fiscal year ended December 31, 2005, KLC OpCo had operations in 39 states and Washington
D.C. and generated pro forma revenue of $1.48 billion
— With organic growth projected to be in excess of 5% per annum through 2011, geographic diversity
and double-digit Adjusted EBITDA margins, KLC OpCo can generate attractive returns.
— KLC OpCo generates strong operating cash flow (48% of 2005 pro forma Adjusted EBITDA) which
provides significant resources to fund investment and support equity return-enhancing leverage, a
° Source: Harris Nesbitt, Education and Training, September 2005.
1° Source: Population Projections Branch, U.S. Census Bureau, "US. Interim Projections by Age, Sex, Race and Hispanic Origin," May 2004.
22
capability that is expected to increase in line with the 13.5% Adjusted EBITDA CAGR projected
until 2011.
k12 continues to grow at an impressive rate, with annual enrollment growth proiected in excess of 25%
over the next two years
— Many of k12's direct costs are semi-fixed in nature (e.g., school administration) creating strong
economies of scale as this business continues to grow.
— With $70 million invested in the development of the platform for kindergarten to 9th grade classes,
extension of the offering into new states and schools is expected to be achieved at relatively low
costs.
• Leading market position in early childhood education with significant brand equity
Leading market positions in early childhood education and before and after school programs
___ Largest U.S. provider of ECE services (1,934 centers).
KLC OpCo's U.S.
Market Position
Organization
LTM
Capacity Revenue' Centers
Owner
KLC OpCo   253,000   $1,477.7'   1,934   KUE
La Petite Academy   89,000   411.1   649   JP Morgan
Bright Horizons   66,350   625.3   616   Public
ABC Learning'   69,000   220.7   460   Public
LTM revenue in millions. KLC OpCo and Bright Horizons LTM as of 12./31/05, La Petite LTM as of
2/28/06, ABC (Learning Care Group) LTM as of 10/14/05.
2 Pro forma for the effects of the acquisition of KinderCare in January 2005 and for the separation of
KLC into KLC OpCo and KLC PropCo in November 2005, as if those transactions and related
financing had occurred on January 1, 2004.
3 Represents ABC's presence within the U.S. pro forma for the acquisition of the Learning Care
Group. ABC has approximately 1,167 total centers (707 of which are located in Australia and New
Zealand) and combined LTM revenue of $441.1 million using Learning Care Group LTM revenue of
$220.7 million as of 10/14/05 and ABC LTM revenue of $292.7 million AUD as of 6/30/05, converted
at an average exchange rate of .753 AUD/USD from 6/30/04 to 6/30/05.
— Second largest U.S. provider of ECE to employers (122 centers).
— Largest U.S. for-profit provider of before and after school programs (573 sites).
High brand awareness and customer recognition
— The programs are marketed primarily under the KinderCare, Children's Discovery Centers,
Knowledge Beginnings, and Children's World brand names. KinderCare enjoyed 87% aided
awareness as of November 2005.11
• Superior competitive position of KLC OpCo as a result of proprietary curriculum, standards of
excellence and experience and scale
11 Source: Parthenon Conjoint Survey.
23
KLC OpCo has leveraged its scale and operational expertise to roll out a proprietary curriculum and to
provide enhanced corporate level services
— Curriculum has been developed, rolled out and refined over many years and provides a significant competitive advantage in an industry where small independent players do not have the resources to develop comparable programs. — Operational leverage allows for enhanced marketing, back-office, legal and compliance functions, keeping KLC OpCo at the forefront of education standards. Controls that meet or exceed requirements established by licensing authorities, state and federal
government and accrediting bodies
— Controls include rigorous and stringent hiring procedures and uniform rules for conduct. — 43% of KLC OpCo's centers, over four times the industry average of 10%, are accredited by the National Association for the Education of Young Children (referred to herein as "NAEYC"), the nation's leading accreditation body. Management believes that all the Company's centers' operations and policies meet or are substantially compliant with NAEYC accreditation requirements. • A compelling business model at k12 As the state of education across the U.S. is generating increasing concerns, k12 provides a compelling
value proposition
— Children continue to perform poorly on assessment tests geared to measure reading, writing and math skills. The passing of legislation such as the "No Child Left Behind Act of 2001" which, among other things, provides for increased funding for education and implementation of achievement level standards, demonstrates the commitment of government to address the issue. Technology and content platform easily leverageable to provide results-driven curriculum and service
— With $70 million invested in the development of the platform for kindergarten to 9th grade classes, extension of the offering into new states and schools is expected to be achieved at relatively low costs. — k12 benefits from stable demand for its curriculum and services which is reflected by current reenrollment rates of 65% to 70%. — Many of the direct costs are semi-fixed in nature (e.g., school administration) creating strong economies of scale as this business continues to grow. • Valuable real estate portfolio of centers providing solid asset base 845 owned centers recently appraised at approximately $1.25 billion12
— New organization separating management of real estate assets allows KLC OpCo education teams to focus on the core education business. — Long term partnership with Greenstreet Real Estate Partners ensuring state-of-the-art management of the real estate assets by a leader in this field.
12 Actual appraisal was for 713 out of 845 centers and the appraised value was $1.1 billion. The $1.25 billion is achieved by taking the independent appraisal valuation methodology and extrapolating it to the remaining 132 centers.
24
B Strong leadership teams
KUE
___ Strong team of highly experienced professionals at the KUE level, led by CEO Lowell Milken,
Chairman Michael Milken and Vice-Chairmen Steven Green and Ted Sanders. The team
contributes an average of more than two decades of experience in their respective fields to KUE.
___ Providing corporate headquarters support services in the areas of strategy and business
development, acquisitions, recruiting of executives, communication and government relations.
KLC OpCo
— Highly experienced management team comprised of both experts in the field of education (C00 Dr.
Elanna Yalow has substantial experience operating for-profit ECE centers), as well as business
professionals.
— Seasoned executive and middle management team with average Company tenure of ten years.
k12
— Chairman, Founder and acting CEO Ron Packard has extensive experience in the K-12 education
space and was previously with KLC before founding k12. John Baule, Executive Vice President
and CFO, served as CFO of Headstrong for five years before joining k12.
1.2.3 Value Creating Strategy
• Value is created by owning assets across the pre-K-12 education continuum
Incremental value is expected to be created from strategic and financial synergies inherent in a global
platform
— The Company can exploit the similarities in various education markets by capitalizing on the assets
it owns (e.g., using KLC's expertise to establish similar operations across geographies and across
the pre-K-12 education continuum).
— Sharing of best practices globally and ability to cross-sell products and services to the Company's
customers.
— Entry into less structured international markets early in their development cycle to establish
attractive competitive positions.
• Multiple growth opportunities at KLC and k12
Top line organic growth at KLC OpCo is expected to be driven by several factors:
___ Historically the industry has demonstrated a pattern of price increases above inflation. Historical
industry data shows an average tuition rate increase of 7% per annum.13
— Higher "Utilization"14 resulting from increased student enrollment, improved retention rates, further
network rationalization to better align supply with demand, more favorable center build rate in the
broader industry and favorable macro trends.
"Source: The National Economic Impacts of the Child Care Sector 2002.
25
— The ECE industry generates approximately $54 billion in total spending in the U.S. and has grown
at a compound annual growth rate of 10% since 1982. It is expected to grow at a 3.4%
compounded annual rate through 2010 according to Harris Nesbitt research. The ECE industry's
growth has been driven by several favorable social and demographic trends including: the increase
in working mothers and single-parent or dual-income families, historically high birth rates, and
increase in popularity of center-based care.
___ Net opening of new centers as the integration of KinderCare winds down and the number of center
openings starts exceeding the number of closures.
— Leverage of KLC OpCo's footprint to market additional educational products and services to the
more than 300,000 children KLC OpCo interacts with each year, their parents, grandparents and
other child care providers. Selected incremental revenue opportunities include: foreign language or
music lessons, educational materials and financial services (life insurance, health insurance, tuition
financing, etc.).
Growth through acquisitions and industry consolidation
— Consolidation strategy supported by the highly fragmented early childhood industry, with for-profit
chains representing only approximately 5% of the market in aggregate, and small independent
providers representing 60% of the market.15
___ Management has demonstrated an ability to grow through acquisitions, as evidenced by the three
networks acquired by KLC since inception, of sizes up to 1,000 centers.
Multiple drivers of expected double-digit growth at k12
— Existing school enrollment rates at k12 expected to continue to increase at double digit rates for at
least the next three years, as k12 further penetrates its existing markets through commercial and
marketing push.
— k12 currently operates virtual public schools in 11 states and the District of Columbia. As
legislatures in other states permit the formation of virtual public schools, k12 expects to have
opportunities to expand into new states.
"Utilization is calculated as the total actual child care revenues earned at centers that are open at the calculation date divided by the total potential
child care revenue (based upon the center's undiscounted pre-school tuition rate and the center's total licensed capacity) during the related time
period.
Source: Harris Nesbitt, Education and Training, September 2005.
26
2. SUMMARY TERMS OF THE TRANSACTION
Certain of the key terms of the offering, which are subject to and qualified in their entirety by reference to
the Limited Partnership Agreement of KUE, the organizational documents of the General Partner and
applicable Cayman Islands law, are outlined below. The terms summarized herein are set forth in detail
in the Limited Partnership Agreement of KUE, the Agreement Among Members of KUE Management, Inc.
and the Amended and Restated Memorandum and Articles of Association of KUE Management, Inc.,
copies of which have been provided or are available upon request. Such summaries are qualified in their
entirety by reference to such agreements.
Issuers:
Securities Offered:
Minimum and Maximum Investment:
Closing:
Knowledge Universe Education L.P., a Cayman Islands
exempted limited partnership ("KUE") and KUE Management
Inc., a Cayman Islands exempted company, the general
partner of KUE (the "General Partner").
Up to 1,000,000 investment units (the "Units"), each
comprised of one Common Limited Partner Unit ("Common
LP Unit") in KUE and one Class A ordinary share ("Class A
Share") of the General Partner at an offering price of U.S.
$1,000 per Unit ($999 allocated to the Common LP Unit and
$1 allocated to the Class A Share) (the "Purchase Price") for
aggregate proceeds of U.S. $1 billion (subject to increase in
the offering size by the General Partner at its sole discretion
up to an aggregate of 1,500,000 Units to Investors, with
aggregate proceeds of U.S. $1.5 billion). The offering is
expected to be completed in one or more closings on or
before March 31, 2007 (the "Offering Period").
Since the General Partner will have a nominal economic
interest in KUE, the Class A Shares are expected to have
nominal economic value. The Class A Shares are, however,
intended to provide Unit holders with certain voting and other
governance rights in the General Partner (as described
further below) which, in turn, will control KUE.
The Common LP Units and the Class A Shares comprising
the Units owned by the investors (the "Investors") will not be
separately transferable unless otherwise approved by the
Board of Directors of the General Partner and a committee
of Independent Directors (as defined below) (the
"Independent Committee").
U.S. $25 million (subject to waiver by the General Partner at
its sole discretion). At any closing after the first closing of
the offering of the Units, the maximum investment permitted
will be U.S. $185.0 million.
KUE may accept or reject subscriptions, in whole or in part,
at its sole discretion. KUE will hold one or more closings in
connection with the sale of the Units on dates specified by
KUE to the Investors. The minimum amount of subscriptions
to be accepted in the first closing of the offering (including
the amount attributable to Knowledge Universe Education
27
LLC, a Delaware limited liability company ("KUE LLC")
through conversion of its preferred limited partner units,
including accrued dividends at the option of KUE LLC, into
Common LP Units) is U.S. $280.0 million. Subscriptions
received will be promptly refunded if 280,000 Common LP
Units are not issued for $1,000 per unit (in cash or preferred
limited partner units) before the end of the Offering Period.
Subscriptions paid in any closing will not otherwise be
returned regardless of the size or occurrence of any
subsequent closing.
Investors admitted during the Offering Period after the first
closing of this offering and after September 30, 2006 will pay
an additional amount accruing at a rate of 0.67% per month
calculated from the first closing date of the offering (pro-
rated for partial periods) for each Common LP Unit
purchased, which will be distributed promptly to the holders
of Common LP Units outstanding prior to such admission in
proportion to the number of Common LP Units held by such
holders.
Use of Proceeds:
Capital Structure:
The proceeds of the offering described herein will be used:
(i) to expand operations, including through strategic
acquisitions in the U.S. and internationally, (ii) to develop
new products and services, (Hi) to repay, in whole or in part,
$150 million of existing debt plus accrued interest (including
through the application of a portion of the proceeds of the
initial closing of the offering), (iv) an estimated $50 million in
fees and expenses (including amounts payable from July 1,
2006 under a Fixed Overhead Payment Agreement (the
"Fixed Overhead Payment Agreement")), (v) in the discretion
of KUE LLC, payment at the initial closing of the offering of
approximately $7.0 million of accrued preferred return on the
preferred limited partner units of KUE being converted to
Common LP Units if such accrued preferred return is not
converted to Common LP Units and (vi) for other corporate
purposes.
Assuming that 1,000,000 Units are sold to Investors by
March 31, 2007, and that the accrued dividends on the
preferred limited partner units are paid in cash,
approximately 2,530,000 Units will be outstanding. The
Investors will own approximately 40% of KUE in the form of
Common LP Units (excluding profits participation limited
partner units of KUE, "Profits Participation LP Units") and
approximately 40% of the General Partner in the form of
Class A Shares.
The General Partner will be the sole general partner of KUE
and will hold approximately 1,000 General Partner Units
("GP Units") in KUE, representing approximately 0.04%
ownership in KUE.
The economic interest in KUE represented by the Common
28
LP Units and the GP Units will be reduced by the Profits
Participation LP Units as described below under
"Distributions."
Assuming that 1,000,000 Units are sold to Investors by
March 31, 2007, and that the accrued dividends on the
preferred limited partner units are paid in cash, KUE LLC,
controlled by the Principals, will hold approximately
1,530,000 Common LP Units representing approximately
60% ownership in KUE (excluding Profits Participation LP
Units) and 1,530,000 Class A Shares. The Common LP
Units owned by KUE LLC will not be transferable, except to
(i) the Principals; (ii) to affiliates of the Principals; and/or OD
to family members and/or charitable organizations in
connection with the Principals' estate planning, unless
combined with the corresponding percentage of Class A
Shares to form Units and transferred in the form of Units in
accordance with the Limited Partnership Agreement.
Knowledge Universe Holdings LLC, a Delaware limited
liability company ("KUH LLC") controlled by the Principals,
will hold 900 Class B ordinary shares of the General Partner
(the "Class B Shares"). The Class B Shares held by the
Principals and their affiliates will not be transferable, except
to (i) the Principals; (H) to the affiliates of the Principals;
and/or (iii) to family members and/or charitable organizations
in connection with the Principals' estate planning. The Class
B Shares will automatically convert to Class A Shares if the
Principals' aggregate direct and indirect economic interest in
KUE is less than 15% of the outstanding Partnership Units
(as defined below) of KUE.
A limited liability company ("KULG LLC-1"), of which
Knowledge Universe Learning Group LLC, a Delaware
limited liability company that is controlled by the Principals
("KULG"), and certain other persons designated by KULG
are members, will be the holder of the Profits Participation
LP Units (the "Profits Participation Limited Partner") with the
economic rights as set forth in "— Distributions" below. At
each closing of any sale of Units to Investors where the
aggregate purchase price of all Units acquired by Investors
to date is less than or equal to $1.5 billion (during the
Offering Period or thereafter), the Profits Participation
Limited Partner will be issued a number of Profits
Participation LP Units such that the aggregate shall equal at
least 9/11ths of the 11% of "Partnership Units" (Common LP
Units, GP Units, and Profits Participation LP Units) that may
be represented by Profits Participation LP Units. Additional
Profits Participation LP Units will be issued to the Profits
Participation Limited Partner, at such time and in such
numbers as the Profits Participation Limited Partner will
direct, based upon the issuance by the Profit Participation
Limited Partner of interests to members of the Profits
Participation Limited Partner (who may include employees,
officers, directors, consultants and agents of KUE, its
29
subsidiaries and joint ventures as designated by KULG other
than the Principals and their affiliates), the vesting schedule
of such interests, and whether certain tax elections are made
by the recipients of such interests; provided, however, the
total number of Profits Participation LP Units shall not
exceed a number equal to eleven percent (11%) of the
aggregate number of Partnership Units. Any increase in the
number of Profits Participation LP Units following the sale of
the first $1.5 billion of Common LP Units to Investors
requires a majority vote of the Independent Committee.
Subsequent to the completion of this offering, KUE may
raise additional capital through the sale of equity or debt
securities. KUE will not have any preferred limited partner
units outstanding upon completion of this offering but KUE
may issue limited partner units with preferences over the
Common LP Units in the future and may amend the Limited
Partnership Agreement accordingly.
Distributions:
First, to the Common Limited Partners and the General
Partner in proportion to and to the extent of their unreturned
Capital Contributions, but in no case may a distribution
pursuant to this paragraph exceed a Partner's positive
adjusted capital account balance;
Second, to the Common Limited Partners and the General
Partner and the Profits Participation Limited Partner (with
respect to Profits Participation Units theretofore allocated to
persons other than the Principals and their Affiliates, if
specified by the Profits Participation Limited Partner, but not
with respect to more than 2/11ths of the Profits Participation
Units) to the extent of an 8% preferred return;
Third, to the Profits Participation Limited Partner in the
additional amount the Profits Participation Limited Partner
would have received pursuant to the prior paragraph if it had
fully participated in the distribution of the 8% preferred return
with respect to all outstanding Profits Participation Units; and
Fourth, to the Common Limited Partners, the Profits
Participation Limited Partner, and the General Partner in
proportion to the number of Units held by each such Partner.
Distributions may be made in cash or in kind. Allocations of
income, gains, profits and losses are described in "The
Structure of KUE and the General Partner" in this Private
Placement Memorandum.
The Limited Partnership Agreement gives the General
Partner the authority to override the distribution provisions of
the Limited Partnership Agreement described above in order
to achieve the desired economic arrangement of KUE, which
is: (i) first, to return the Partners' Capital Contributions to
them; (ii) second, for the Common Limited Partners and the
General Partner to receive their Preferred Return while the
30
Profits Participation Limited Partner concurrently receives an
amount equal to a fraction of the amount the Common
Limited Partners and the General Partner received pursuant
to their Preferred Return (such fraction to be equal to the
portion of the Units held by the Profits Participation Limited
Partner attributable to members of the Profits Participation
Limited Partner other than the Principals), multiplied by the
number of Units held by the Profits Participation Limited
Partner divided by the number of outstanding Units other
than those Units held by the Profits Participation Limited
Partner; (iii) third, for the Profits Participation Limited Partner
to receive an amount equal to a fraction of the amount the
Common Limited Partners and the General Partner received
pursuant to their Preferred Return (such fraction to be equal
to the portion of the Units held by the Profits Participation
Limited Partner attributable to members of the Profits
Participation Limited Partner who are Principals or their
affiliates), multiplied by the number of Units held by the
Profits Participation Limited Partner divided by the number of
outstanding Units other than those Units held by the Profits
Participation Limited Partner; and (iv) finally, for all Partners
(including the Profits Participation Limited Partner) to share
in the profits of the Partnership in proportion to the number
of Units held by them.
Notwithstanding any contrary provisions below addressing
equal merger consideration, in connection with any
distribution of securities of a subsidiary entity which has high
vote and low vote (or non-voting) securities with substantially
equivalent economic rights, the Principals can receive the
high-vote securities in such a distribution while the other
holders of Common LP Units receive the low vote (or non-
voting) securities, as long as the securities otherwise have
substantially equivalent economic rights and the high-vote
securities have mandatory conversion features equivalent to
the mandatory conversion provision of the Class B Shares.
Equal Merger Consideration Provision: The Principals (through KUE LLC) and the Investors will
receive the same consideration per Common LP Unit and/or
Class A/Class B Shares in connection with a sale, merger,
recapitalization, share repurchase, dividend, or any other
transaction where all holders of Common LP Units or shares
in the General Partner receive consideration with respect to
their Common LP Units or shares, other than with respect to
corporate restructuring transactions, such as a holding
company merger, conversion of KUE from an exempted
limited partnership to a corporation or other entity, change of
domicile, or any other transaction that the Independent
Committee determines is a "corporate restructuring." In any
such corporate restructuring transaction, the Principals
(through KUE LLC) may receive securities with high-voting
rights and the Investors may receive securities with limited or
no voting rights so long as the consideration received by the
Principals (through KUE LLC) and the other Partners per
31
Common LP Unit have substantially equivalent economic
provisions.
Fixed Overhead Payment:
KUE and/or one or more of its subsidiaries will pay $20
million annually to KULG in quarterly installments beginning
July 1, 2006 pursuant to the Fixed Overhead Payment
Agreement as an agreed upon payment to provide for the
reimbursement of expenses and other costs incurred by
KULG on behalf of KUE and its subsidiaries (including, but
not limited to, salaries and bonuses of KULG employees
providing services to KUE and its subsidiaries, fees and
expenses relating to financing transactions and acquisitions,
professional fees and other administrative expenses). To
the extent that the U.S. $2,500,000 fee payable pursuant to
an existing management services agreement with
Knowledge Learning Corporation is paid to any person or
entity other than a subsidiary of KUE, the amount payable to
KULG by KUE will be reduced by the amount of such
payment to such other person or entity. The $20 million
annual fee will terminate upon the Initial Listing (as defined
below) or the sale of KUE to a person or entity that is not a
KUE LLC Entity.
Voting Rights: The General Partner will manage and operate KUE.
The Investors will have no voting rights on matters affecting
Company business with respect to their Common LP Units in
KUE because the Investors will be limited partners of KUE.
Notwithstanding the foregoing, subject to certain exceptions,
KUE must obtain the consent of (a) the holders of a majority
of the Common LP Units unaffiliated with the Principals to
amend the Limited Partnership Agreement in a manner that
is adverse to the Common LP holders and (b) the holders of
at least 90% of the Common LP Units unaffiliated with the
Principals to amend the "Equal Merger Consideration
Provision" described above. In addition, the General Partner
may not take any action to (a) alter or add to its Articles or
(b) alter or add to its Memorandum with respect to any
objects, powers or other matters specified therein that would
adversely affect the rights of holders of Class A Shares
without the affirmative vote of the holders of a majority of the
Class A Shares.
Holders of the Class A Shares of the General Partner will
have one vote per share. The holders of Class B Shares,
will have in the aggregate one more vote than the requisite
legal vote required to approve particular matters. In addition,
the Investors will have the right to elect directors to the
Board of Directors of the General Partner as set forth in
"Board of Directors" below.
The Class B Shares will automatically convert to Class A
Shares if the Principals' aggregate direct and indirect
economic interest in KUE is less than 15% of the
32
outstanding Partnership Units of KUE.
Board of Directors:
Initial Listing Process:
The General Partner will have a Board of Directors initially
consisting of up to 13 persons.
Following the first closing of the offering and prior to the
"Initial Listing" (as defined below), the outside Investor
(including its affiliates) holding the greatest number of shares
in the General Partner at the first closing of the offering will
appoint two directors of the General Partner and the holders
of the Class B Shares will appoint the remaining directors.
Following the initial appointment of the Board, the Board
may, in its sole discretion, increase the number of directors,
including to accommodate investors that invest subsequent
to the initial closing of the offering of the Units, provided that
the outside Investor appointing two directors pursuant to the
paragraph above shall have the right to appoint additional
directors as required to maintain a ratio of such Investor's
designees to total Board members of not less than 2/15ths.
"Independent Directors" of the Board of Directors of the
General Partner shall be individuals who (a) are not (i) a
Principal, (ii) a family member of a Principal, (iii) an
employee of a Principal or any entity controlled by one or
more of the Principals, and (b) meet the definition of
"independent director" set forth in Rule 303A.02 of the New
York Stock Exchange Listed Company Manual (as if the
General Partner, the Partnership and each of its Subsidiaries
were the "listed company") , including any such individuals
appointed by the Investors who otherwise satisfy the
requirements of this definition.
At the time of the final closing of this offering, the General
Partner will have at least two Independent Directors. After
the Initial Listing and so long as consistent with contractual,
listing and licensing obligations, a majority of the board of
directors of the listed company will be Independent
Directors.
"Initial Listing" means a listing on a recognized international
securities exchange with a substantially concurrent
underwritten offering generating gross proceeds of U.S.
$200 million or more. "Initial Listing" refers to the Initial
Listing of KUE or any successor or any subsidiary of KUE to
which substantially all of KUE's assets and liabilities have
been transferred or are held.
The General Partner may take and cause KUE to take such
actions as the General Partner reasonably deems necessary
to complete the Initial Listing on the recognized international
securities exchange or exchanges selected by the General
Partner, including without limitation a restructuring or
reorganization or other transaction or asset transfer between
or among KUE and any of its subsidiaries, and may require
33
Partners to exchange their interests in KUE and the General
Partner for interests in a subsidiary of KUE.
Related Party Transactions:
Related party transactions include transactions between (1)
any of the Principals or any of their affiliates or any entity
controlled by any of the Principals, and (2) KUE or any direct
or indirect subsidiary or joint venture of KUE involving more
than $1 million (including, for the avoidance of doubt, any
merger, acquisition, asset purchase or similar transaction
between KUE, its subsidiaries or joint ventures, on the one
hand, and any person of which fifteen percent (15%) or more
of the voting stock (or similar voting interests) is owned by
KUE LLC or its affiliates, on the other hand). Related party
transactions do not include (a) any transaction solely
between or among KUE and any of its direct or indirect
subsidiaries or joint ventures in which the Principals do not
have any direct or indirect ownership interest (other than as
a result of their ownership in the General Partner and KUE),
(b) reasonable and customary director, advisory board
member, or consultant compensation and benefits
(including, without limitation, retirement, health, stock option
and other benefit plans) as approved by the Independent
Committee, provided that any such compensation, benefits
and arrangements to the Principals that do not exceed $1
million in the aggregate annually shall not be subject to such
approval, and customary indemnification arrangements, (c)
transactions and arrangements pursuant to or contemplated
by express terms of the Limited Partnership Agreement of
KUE, including the "Investment in Subsidiaries" and "Co-
Invest Right" described below, and any payments pursuant
thereto, and the Fixed Overhead Payment described above,
(d) agreements, transactions and arrangements described in
"Related Party Transactions" in this Private Placement
Memorandum and any amendment thereto (so long as such
amendment is not disadvantageous to the Investors as a
whole in any material respect) or any transaction
contemplated thereby and any payments pursuant thereto,
and (e) admissions of any affiliate of the Principals to KUE
as a Limited Partner on terms substantially equivalent to
concurrent admissions of persons that are not affiliates of
the Principals.
If the size of the related party transaction is greater than $1
million and equal to or less than $50 million, then either (a)
the Independent Committee must approve the transaction or
(b) the transaction must be approved by the holders of a
majority of the Common LP Units unaffiliated with the
Principals.
If the size of the related party transaction is greater than $50
million, then the transaction must be approved by both (a)
the Independent Committee and (b) the holders of a majority
of the Common LP Units unaffiliated with the Principals.
34
Investment in Subsidiaries:
Transferability of Units:
Tag-Along Right:
Not in limitation of any commitments or restrictions the
Principals may have entered into, prior to an Initial Listing,
KUE may not permit any of its subsidiaries or controlled joint
ventures (which shall not include, for the avoidance of doubt,
certain exempt companies contemplated by the following
paragraph) to issue or grant any equity interests in such
subsidiaries or controlled joint ventures to any of the
Principals or any of their affiliates (other than KUE, its
subsidiaries and controlled joint ventures) unless (i) the
Independent Committee approves and the Investors who are
accredited investors (as such term is defined in Regulation
D) or otherwise legally eligible to participate are offered the
opportunity to participate on the same terms as the
Principals and their affiliates and in proportion to their
economic ownership of KUE or (ii) such subsidiary or joint
venture of KUE has completed an initial listing on a
recognized international securities exchange, subject to
certain limited exceptions.
The Principals intend that KUE will be their exclusive vehicle
for equity investment opportunities in and acquisitions of for-
profit companies engaged primarily in the business of pre-K
through 12th grade education of children, subject to limited
exceptions as set forth in "The Structure of KUE and the
General Partner" in this Private Placement Memorandum.
The Common LP Units and the Class A Shares comprising
the Units owned by the Investors will not be separately
transferable, and the Units are to be transferred as a whole
unless otherwise approved by the Board of Directors of the
General Partner and the Independent Committee (defined
below).
Units held by an Investor may not be sold, transferred or
assigned without the prior written consent of the General
Partner, not to be unreasonably withheld. The General
Partner intends, during the first two years after the applicable
closing of the offering, to approve transfers of the Units to an
affiliate of the Investor, in compliance with applicable law.
After such time, the General Partner intends to approve
transfers of Units to an affiliate of the Investor or to another
Investor (and affiliates thereof), in each case in compliance
with applicable law. The General Partner also intends to
approve transfers pursuant to the Tag-Along Right and Drag-
Along Right provisions described below.
Unless the Investors' Units (or securities received in
exchange for Units if the Initial Listing is of a Subsidiary of
KUE) are freely tradable without volume restrictions on the
exchange on which the Initial Listing occurred, with respect
to any proposed transfer of the Common LP Units held by
KUE LLC and its affiliates to a non-affiliate purchaser (and,
unless otherwise approved by the Board of Directors and the
Independent Committee of the General Partner, a
35
corresponding percentage of Class A Shares held by KUE
LLC), the Investors may sell a pro rata portion of their
Common LP Units and corresponding Class A Shares in the
proposed transfer on the same terms and in exchange for
the same consideration per Unit (and Class A Share)
received by KUE LLC and its affiliates.
Following the Initial Listing, the tag-along right will continue
for certain Investors with respect to transfers for value of the
Units (or units of the listed entity as the case may be) by the
Principals or their affiliates to non-affiliates (excluding
transfers on a recognized international securities exchange)
above the following thresholds in one or more transactions:
(i) 15% of the Principals' original KUE holdings to any single
buyer (or affiliates of that buyer) or (i) 33% of the Principals'
original KUE holdings in the aggregate.
Drag-Along Right:
Co-Invest Right:
Additional Listing of Investors' Units:
Prior to the Initial Listing, with respect to any proposed
transfer of a majority of the Units held by KUE LLC to a
proposed non-affiliate purchaser (and, unless otherwise
approved by the Board of Directors and the Independent
Committee of the General Partner, a corresponding
percentage of Class A Shares held by KUE LLC), the
Investors may be required to sell a pro rata portion of their
Units and corresponding Class A Shares in the proposed
transfer on the same terms and in exchange for the same
consideration received by KUE LLC.
Prior to the Initial Listing, if KUE proposes to issue for cash
any Units or securities convertible into Units after the
Offering Period (subject to certain exceptions), then KUE is
required to offer to each Investor that is an accredited
investor (as such term is defined in Regulation D) or
otherwise legally eligible to participate in the offering, the
right to purchase a pro rata portion of such securities.
Prior to the Initial Listing, the Investors have substantially
equivalent rights with respect to issuances of securities by
the General Partner.
Beginning any time after six months after the Initial Listing,
one or more holders holding an aggregate of $100 million of
more of the Units may request KUE and the General Partner
to take such action as may be necessary for their Units to be
freely tradable and not subject to volume restrictions on the
international securities exchange on which the Initial Listing
occurred; provided that no more than one such action may
be required in any 12 month period and customary cut-back
and other provisions will apply in any such listing or
underwritten transaction, as the case may be. KUE will use
its commercially reasonable efforts to cause such action to
cover such holders and the securities of any other holders
legally eligible to participate in such action.
36
Term: The term of KUE will be indefinite, unless terminated earlier
in accordance with the Limited Partnership Agreement.
Illiquidity Period:
KUE will operate for a period of seven years from the date of
the first closing of this offering. If there has not been an
Initial Listing by the end of seven years from the date of the
first closing of this offering, the Board of Directors of the
General Partner will determine whether to pursue a sale of
KUE or an Initial Listing (or a dual track process); provided,
however, in the event that not less than 75% of the value of
KUE at that time is represented by shares of securities listed
on one or more recognized international securities
exchanges and such shares have been or will be distributed
as soon as reasonably practicable thereafter to the Investors
and the Investors have received distributions of cash and/or
such securities valued at amounts equal to or in excess of
their original capital contributions, then there shall be two
extensions of one year's duration each in order for KUE to
complete either an Initial Listing or to have the remaining
value of KUE represented by shares of securities listed on a
recognized international securities exchange and to
distribute such shares to the Investors. The Board of
Directors shall approve the desired course of action.
If the Board determines to pursue a sale of KUE (or an Initial
Listing or a dual track process), then the Principals must
determine at such time whether they intend to participate as
a potential bidder in the sale process.
If the Principals elect not to participate as a potential bidder
in a sale process, then they will not be allowed to
subsequently elect to participate as a potential bidder unless
the sale process does not result in a buyer at a price the
Independent Committee deems to be "fair." If the sale
process results in a transaction that the Independent
Committee deems to be "fair", the Principals will be required
to sell their entire stake in KUE (Common LP Units and
Profits Participation LP Units on an "as converted" basis) on
the same terms as the Investors.
If the Principals elect to participate as a potential bidder in a
sale process, then the sale process will be managed by the
Independent Committee and the Principals will be precluded
from participating in Board deliberations regarding the sale
process. In addition, the Principals will be required to sell
their entire stake in KUE on the same terms as the Investors
to the winning bidder in the event the Principals do not
submit the most attractive bid.
In the event that a sale of KUE or an Initial Listing has not
occurred within nine years from the date the first Investors
are admitted to KUE, the Independent Committee shall
determine whether to pursue a sale of KUE (or an Initial
Listing or a dual track process). A majority vote of the
37
Independent Committee on this issue shall be binding on the
Board of Directors of the General Partner and will require the
Board of Directors of the General Partner to pursue such
action within ninety (90) days.
Indemnification: KUE will indemnify the General Partner and its members,
officers, directors, and employees, and at the General
Partner's discretion, any other person providing services to
KUE, its subsidiaries or joint ventures. KUE has provided a
customary indemnity to the Agents in connection with their
services.
Periodic Reporting: KUE will provide annual audited financial statements and
semi-annual reports. The General Partner will provide such
periodic reports if engaged in any business other than acting
as general partner of KUE or if it owns any material assets
other than an interest in KUE.
Certain U.S. Federal Income Tax For a discussion of certain U.S. federal income tax
Consequences: consequences that may be relevant to prospective investors,
please read "Certain Income Tax Consequences" in this
Private Placement Memorandum.
38
3. USE OF PROCEEDS
The proceeds of this offering will be used: (i) to expand operations, including through strategic
acquisitions in the U.S. and internationally, (H) to develop new products and services, (Hi) to repay, in
whole or in part, $150 million of existing debt plus accrued interest (including through application of a
portion of the proceeds of the initial closing of the offering after payment of expenses and preferred
returns), which currently bears interest at either the reserve adjusted LIBOR rate plus 0.125% or the base
rate (generally the applicable prime lending rate, as announced from time to time), (iv) to pay an
estimated $50 million in fees and expenses (including amounts payable to the Agents and including
amounts payable from July 1, 2006 under the Fixed Overhead Payment Agreement), (v) in the discretion
of KUE LLC, payment at the initial closing of the offering of approximately $7.0 million of accrued return
on the preferred limited partner units of KUE being converted to Common LP Units if such accrued return
is not converted to Common LP Units and (vi) for other corporate purposes. Until the proceeds are used,
KUE currently intends to invest the unapplied proceeds in cash-equivalents and short-term marketable
securities.
39
4. CAPITALIZATION
The following table sets forth KUE's cash, cash equivalents and senior capitalization as of December 31,
2005:
• on an actual basis; and
• on a pro forma basis to give effect to the sale of $1 billion in Units in this offering by KUE after
deducting estimated offering fees and estimated offering expenses payable by KUE.
You should read this table together with "Management's Discussion and Analysis of KLC's Pro Forma
Results of Operations" and the audited and unaudited consolidated financial statements and the related
notes appearing elsewhere in this Memorandum. See "Related Party Transactions" for more information
on related party interests.
KUE Senior Capitalization
As of April 1,2006
Actual   Adjustmentsl   Pro Forma
Cash
KUE   $9.4   $800.0   $809.4
KUE Inc.   5.4   5.4
KSI   3.0   3.0
KLC OpCo   115.4   115.4
KLC PropCo   31.8   31.8
Total Cash   $164.9   $800.0   $964.9
Debt
KUE2   $150.0   ($150.0)   $0.0
KUE Inc.3   183.9   183.9
KLC OpCo - Sr. Sub. Notes   260.0   260.0
KLC OpCo - Capital Leases   16.2   16.2
KLC PropCo - CMBS   697.7   697.7
KLC PropCo - Junior Mezzanine4   147.9   147.9
Total Debt   $1,455.7   $1,305.7
Preferred Equity
KUE5   180.0   (180.0)   0.0
Total Debt and Preferred Equity   $1,635.7   $1,305.7
Assumes $50 million of fees and expenses.
2 Upon closing, KUE LLC will contribute all of its assets to KUE. In addition, upon contribution of assets to KUE by KUE LLC, KUE will
become a co-borrower to the KUE LLC term loan which will be repaid with the proceeds of the offering.
3 Includes capitalized interest of $10.7 million.
4 Represents book value net of original issue discount plus capitalized interest. Original principal amount is $150 million.
5 Reflects the conversion of existing preferred limited partner units of KUE LLC into common limited partner units of KUE at the offering
price.
40
Organizational Structure - Pro Forma for Funding of $1 Billion. Al! figures are rounded.
Principals
100%
Investors
1,000,000
Class A
Shares
1,000,000 -----
Common
LP Units
900
Class B
Shares
KUE Management Inc., a
Cayman Islands
exempted company
"General Partner"
Approx.
1,000
General
Partner Units
Knowledge Universe Holdings LLC,
a Delaware limited liability company
"KUH"
Knowledge Universe Learning Group LLC,
a Delaware limited liability company
"KULG"
100%
Knowledge Universe Education LLC,
a Delaware limited liability company
"KUE LLC"
1,530,000
Class A
Shares
1,530,000
Common LP
Units
Knowledge Universe Education L.P., a
Cayman Islands Exempted Limited Partnership
"KUE"
100%
KU Education Inc.
"KUE Inc."
87.6%
Knowledge Schools, Inc.
"KSI"
1100%
Knowledge Learning
Corporation
"KLC"
17.9% to 40.0%'
k12 Inc.
"k12"
11% Profits
Participation
Interest
Limited
Partner'
KUE owns preferred stock that is convertible into 17.9% of k12's Common Stock. KUE's ownership varies depending on the liquidation value or
sale value of k12 and according to the preference of the various securities KUE owns. At higher valuations, KUE's percentage ownership is lower.
See "k12 Inc. (k12) — k12 Equity."
2 Of those Profits Participation LP Units outstanding immediately after the offering, 2/11ths will be allocated or held for the benefit of persons other
than the Principals or their affiliates.
41
5. SUMMARY FINANCIAL DATA
The following summary historical pro forma and projected financial data should be read in conjunction
with the financial statements and "Management's Discussion and Analysis of KLC's Pro Forma Results of
Operations" presented elsewhere in this Memorandum. See also "Non-GAAP Financial Measures"
elsewhere in this Memorandum for a discussion of the derivation and limitations of EBITDA, Adjusted
EBITDA and Adjusted EBITDAR. The historical information is pro forma for the effects of our acquisition
of KinderCare in January 2005 and for the separation of our business into operating (KLC OpCo) and
property (KLC PropCo) in November 2005, as if those transactions and related financing had occurred on
January 1, 2004. The rental income received by KLC PropCo in all periods presented is primarily
comprised of lease payments from KLC OpCo.
Our pro forma results for KLC were not prepared in conformity with Article 11 of Regulation S-X of the
SEC (which would not, among other limitations, permit a 2004 pro forma presentation after completion of
our 2005 financial statements). In addition, by presenting a pro forma comparison, this section does not
include a comparison of KLC's historical GAAP consolidated operating results or segment information that
would be required by Item 3-03 of Regulation S-X of the SEC. In addition, the non-GAAP financial
information presented below does not comply with Item 10(e) of Regulation S-K or Regulation G of the
SEC. For further information, please see KLC's GAAP financial statements and those of KinderCare
included in this Memorandum.
The pro forma presentation below is not shown with adjustments to historical financial statements.
Instead, it is based on a "ground up" combination of corporate level expenditures (overhead and capital
expenditures) and internal financial statements derived from a center-by-center build up of KLC's results.
The primary reasons for the presentation based on internal reports are different fiscal year ends and
expense classification between KLC and KinderCare.
Projected results presented below are based on assumptions management believes to be reasonable, but
which are inherently uncertain and may not be realized. For a discussion of the assumptions, see "The
Operating Company (KLC OpCo) - Summary Financial Information and Projections Discussion" and "The
Real Estate Company (KLC PropCo) - Summary Financial Information and Projections Discussion." Our
ability to perform as projected depends on a number of variables that cannot be predicted with certainty
and our performance could be adversely affected by a number of factors, including those described in
"Risk Factors" elsewhere in this Memorandum. See also "Forward-Looking Statements."
KLC Consolidated Historical Pro Forma and Projected Financial Summary
($ in millions)   Fiscal Year Ended December 31,
2004Pr   2005Pr   2006P   2007P
OPERATIONAL DATA: Revenue Revenue Growth   $1,442.2   $1,477.7 2.5%   $1,557.8 5.4%   $1,661.0 6.6%
Gross Profit   $329.6   $340.7   $387.0   $421.4
Adjusted EBITDA2   $231.4   $238.0   $249.7   $272.6
Adjusted EBITDA Margin   16.0%   16.1%   16.0%   16.4%
Adjusted EBITDAR   $344.5   $359.1   $363.1   $387.7
Adjusted EBITDAR Margin   23.9%   24.3%   23.3%   23.3%
OTHER FINANCIAL DATA:
Interest Expense   89.9   89.9   89.9   89.5
Capital Expenditures   70.6   83.1   69.9   60.2
42
KLC OpCo Historical Pro Forma and Projected Financial Summary
($ in millions, except for weekly tuition)   Fiscal Year Ended December 31,
2004PF1   2005PF1   2006P   2007P
OPERATIONAL DATA: Revenue Revenue Growth   $1,442.2   $1,477.7 2.5%   $1,557.8 5.4%   $1,656.5 6.3%
Gross Profit   $233.3   $244.4   $290.7   $320.6
Adjusted EBITDA2   $143.3   $149.9   $161.7   $179.9
Adjusted EBITDA Margin   9.9%   10.1%   10.4%   10.9%
Adjusted EBITDAR   $352.8   $367.4   $371.4   $391.4
Adjusted EBITDAR Margin   24.5%   24.9%   23.8%   23.6%
OTHER FINANCIAL DATA:
Interest Expense   $23.5   $23.5   $23.6   $23.5
Capital Expenditures   70.6   83.1   69.9   60.2
# of Centers   2,021   1,934   1,894   1,878
Average Weekly Tuition   $156.61   $167.35   $173.68   $179.99
Utilization   61.6%   61.2%   62.2%   63.0%
KLC PropCo Historical Pro Forma and Projected Financial Summary
Fiscal Year Ended December 31,
($ in millions)   2004Pr   2005Pr   2006P   2007P
OPERATIONAL DATA:
Rental Revenue From KLC OpCo   $96.3   $96.3   $96.3   $96.3
Other Rental Revenue   0.0   0.0   0.0   4.6
Total Revenue   $96.3   $96.3   $96.3   $100.9
Operating Expenses   $8.3   $8.3   $8.3   $8.3
EBITDA   $88.1   $88.1   $88.1   $92.6
OTHER FINANCIAL DATA:
Interest Expense   $66.4   $66.4   $66.3   $66.0
/r12 Historical and Projected Financial Summary
($ in millions)   Fiscal Year Ended June 30,
2004   2005   2006P   2007P
OPERATIONAL DATA:
Revenue4   $71.4   $85.3   $116.0   $132.2
Revenue Growth   19.5%   36.0%   14.0%
EBITDA   ($1.9)   $2.2   $5.7   $12.3
EBITDA Margin   (2.6)%   2.6%   4.9%   9.3%
OTHER FINANCIAL DATA:
Capital Expenditures   $4.3   $4.9   $9.4   $15.0
# of States Served   11   11   12   14
# of Students   10,811   14,144   18,267   24,000
Pro forma for the effects of the acquisition of KinderCare in January 2005 and the separation of KLC into KLC OpCo and KLC PropCo in
November 2005, as if those transactions and related financing had occurred on January 1, 2004.
2 EBITDA and EBITDAR are adjusted for restructuring charges, closed center costs, (gains) / losses on center sales, (gains) / losses on minority
investment, dividend income, IDS expenses, estimated parallel organization costs, management fees, KLC OpCo's long term incentive plan and
Knowledge School Inc.'s SAR Plan-related costs allocated to KLC. See also "Management's Discussion and Analysis of KLC's Pro Forma Results
of Operations" and "The Real Estate Company (KLC PropCo) - KLC PropCo Summary Financial Information and Projections Discussion."
3 Does not include the reinvestment of real estate revenues. Please refer to "The Real Estate Company (KLC PropCo)" for this information.
4 Includes only states in which virtual academies are operated. Includes Washington, D.C.
43
6. RISK FACTORS
Investment in the Units involves a substantial degree of risk and should be regarded as speculative. As a
result, the purchase of the Units should be considered only by persons who can reasonably afford a loss
of their entire investment. Prospective investors should carefully consider, in addition to matters set forth
elsewhere in this Memorandum, the following factors relating to the business of the Company and this
offering. The order in which risk factors appear is not intended as an indication of the relative weight or
importance thereof. Prospective investors should carefully review all risk factors. Such information is
presented as of the date hereof and is subject to change without notice. The discussion in this
Memorandum contains forward-looking statements that involve risks and uncertainties. Actual results
may differ significantly from the results discussed in the forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those discussed below. The
occurrence of any of these factors could materially and adversely affect the Company's results of
operations or cash flow. Risks described herein that could affect KLC are also likely to be similar for other
pre-K-12 businesses we may acquire or develop. Other businesses we acquire or develop in foreign
countries or in different markets, may be subject to risks in addition to those discussed below.
6.1. Risks Related to Our Business
6.1.1 Risks associated with growth through acquisitions; potential inability to
consummate transactions
A principal component of the Company's growth strategy is the acquisition of other businesses or interests
therein that will complement and/or expand the Company's businesses and the products and services that
they offer. The successful implementation of this strategy will depend upon a number of factors, including
the ability to identify attractive acquisition opportunities, consummate such transactions on favorable
terms and integrate the operations of the acquired businesses with those of the Company. Identifying,
completing and realizing on attractive acquisitions are highly competitive and involves a high degree of
uncertainty. The Company will be competing for acquisitions with other companies, private equity firms,
as well as individuals and others, which often results in increased acquisition prices. There can be no
assurance that the Company will be able to identify suitable acquisition opportunities or that if identified,
the Company will be able to consummate such transactions on suitable terms, or that acquired
businesses will perform as expected or generate returns.
In addition to risks facing education companies similar to those facing KLC as described herein,
acquisitions of businesses also involve special risks, including risks associated with unanticipated
liabilities and contingencies, diversion of Company management attention and possible adverse effects
on earnings resulting from increased amortization of goodwill, increased interest costs, the issuance of
additional securities and difficulties related to the integration of the acquired business. No assurance can
be given as to the success of the Company in executing and integrating acquisitions in the future. The
Company's failure or inability to successfully implement and manage its acquisition strategy would have a
material adverse effect on the Company's financial condition, results of operations and business.
The Company may from time to time enter into negotiations in anticipation of consummating an
acquisition transaction. However, there is no assurance that such negotiations will be successful and the
diversion of management attention on such unsuccessful transactions may adversely affect
managements ability to pursue other business opportunities.
In addition, KLC PropCo intends to acquire diversified real estate interests, including investments in non-
education related properties. The performance of this acquisition strategy in general, or of any particular
property, cannot be predicted.
44
The initial closing of this offering will require a minimum investment (including the amount attributable to
KUE LLC through conversion of its preferred limited partner units, including accrued dividends at the
option of KUE LLC, into Common LP Units) of U.S. $280.0 million. There can be no assurance of
additional closings after the initial closing of the offering, whether before the completion of the Offering
Period on March 31, 2007 or thereafter. Unless there are subsequent closings or offerings, cash
available for acquisitions and expansion would be limited to available cash of KLC and KUE and proceeds
of future financings of KLC and KUE.
6.1.2 The Company plans to acquire or invest in non-U.S. companies. This
international expansion strategy is untested, and may include acquisitions or
developments in countries where for-profit education is not well established
Foreign acquisitions involve certain risks not typically associated with U.S. acquisitions, including risks
relating to (i) currency exchange matters, including fluctuations in the rate of exchange between the U.S.
dollar and the various foreign currencies in which the Company's non-U.S. interests are denominated,
and costs associated with conversion from one currency into another; (ii) differences between the U.S.
and foreign securities markets, including potential price volatility in and relative illiquidity of some foreign
securities markets, the absence of uniform accounting and financial reporting standards and disclosure
requirements and less governmental supervision and regulation; (Hi) certain economic and political risks,
including potential restrictions on foreign acquisition and repatriation of capital, and the risks of political,
economic or social instability and the possibility of expropriation or confiscatory taxation; (iv) the possible
imposition of foreign taxes on income and gains; and (v) differences in applicable legal systems, including
the possibility that the Company may experience difficulty in asserting legal claims or obtaining legal
remedies against sellers of businesses in foreign jurisdictions.
The Company's prior operating history is limited to its U.S.-based businesses. Historical results may not
be indicative of future performance outside the U.S. The Company's non-U.S. businesses may operate in
countries in which the legal and regulatory frameworks, customary business models, education practices
and philosophies and political and social norms are substantially different from those in the U.S.
International expansion may also involve significant market risks, and opportunities to realize synergies
may be limited. There can be no assurance that the Company will be successful in its international
expansion strategy.
In addition, the Company may acquire businesses or pursue business development opportunities in
countries where for-profit education is not well-established, which may involve greater risks than those
associated with similar U.S. acquisitions and developments. For example, the performance of a for-profit
education company located in a country where for-profit education is in an embryonic stage may be
volatile. Such a company also may be unable to achieve the growth or success achieved by education
businesses in countries, such as the U.S., where for-profit education is more established. In addition,
there can be no assurance that for-profit education will ever become well-established or maintain viability
in any given country. If any of the above events occur, the Company may suffer a partial or total loss of
capital invested in that business or development.
6.1.3 The Company's success depends on its ability to attract and retain skilled
employees
The success of the Company will depend in part on continued employment of senior management and
other key personnel, particularly the Principals. See the discussion under the heading "The Company
may not engage in certain businesses" below. If one or more senior management or key personnel
become unable or unwilling to continue in their present positions, the business and operations of the
Company would be disrupted.
The success of the Company also depends on attracting and retaining highly trained financial, marketing
and other personnel. The Company will need to continue to hire additional personnel as its business
grows. The market for hiring such personnel is competitive and hiring such personnel may require
increased salaries and enhanced benefits under certain circumstances. A shortage in the number of
45
skilled personnel could limit the ability of the Company to increase sales of existing products and services
and launch new product offerings.
6.1.4 The Company has significant leverage, and expects to incur additional debt,
which could result in adverse effects on its financial condition
The Company has significant leverage and expects to incur additional debt in connection with the
acquisition and operation of its businesses. Although the Company intends to use leverage in a manner it
believes to be prudent, the leveraged capital structure the Company plans to utilize may significantly
increase the Company's exposure to adverse economic factors such as rising interest rates, downturns in
the economy or deteriorations in the condition of the businesses or their respective industries. If a
business cannot generate adequate cash flow to meet debt obligations, the Company may suffer a partial
or total loss of capital invested in such business.
The Company's ability to service its substantial indebtedness, and meet its other obligations depends on
its future performance, which will be affected by financial, business, economic and other factors, many of
which are outside the Company's control. The Company cannot be certain that its cash flow will be
sufficient for such purposes. If the Company does not have enough liquidity, it may be required to
refinance all or part of its existing debt, sell assets or borrow more money. The Company cannot
guarantee that it will be able to do so on favorable terms, if at all. In addition, the terms of existing or
future debt agreements, may restrict the Company from pursuing any of these alternatives.
The substantial level of indebtedness incurred by the Company may have the following consequences of
potential concern to investors in the Company:
• The Company must use a substantial portion of its cash flow from operations to pay interest and
principal on its indebtedness, which reduces the funds available for other business purposes such
as capital expenditures;
• The Company's ability to obtain additional financing for working capital, capital expenditures,
acquisitions or general corporate purposes may be impaired;
• The Company may be limited in its ability to borrow additional funds;
• The Company may have a higher level of indebtedness than some of its competitors, which may
put it at a competitive disadvantage and reduce its flexibility in planning for, or responding to,
changing conditions in its industry, including increased competition; and
• The Company may be more vulnerable to economic downturns and adverse developments than it
would without the leverage.
Adverse developments in the Company's financial condition would have adverse effects upon the
business and results of the Company as a whole.
6.1.5 The Company faces intense competition in the early childhood care and
education services industry from numerous other types of providers
The early childhood care and education services industry is competitive and highly fragmented. The most
important competitive factors generally are quality, convenience and, to a lesser extent, price. The
Company's, specifically KLC OpCo's, competition in this industry consists principally of:
• other for-profit, center-based child care providers, including franchise organizations;
• preschool, kindergarten and before and after school programs provided by public schools;
46
• local nursery schools and child care centers, including church-affiliated and other non-profit
centers;
• providers of child care services that operate out of homes; and
• substitutes for group child care, such as relatives, nannies and stay-at-home parents.
In many markets, the Company faces competition from preschool services and before and after school
programs offered by public schools that provide such services at little or no cost to parents. The number
of school districts offering these services is growing, and we expect increased competition from such
services in the future. In addition, local nursery schools, child care centers and in-home providers
generally charge less for their services than the Company. Many denominational and other non-profit
child care centers have lower operating expenses than the Company and may receive donations and/or
other funding to subsidize operating expenses. Consequently, operators of such centers often charge
lower tuition rates than us. Moreover, fees for home-based care are normally substantially lower than
fees for center-based care.
6.1.6 The Company may acquire companies that are not well-established or are
experiencing financial difficulties
The Company may acquire less established companies. Acquisitions of interests in such companies may
involve greater risks than are generally associated with acquisitions of more established or stable
companies. For example, such companies may have shorter operating histories on which to predict
future performance and may have negative cash flow. Their performance may be more volatile and they
may be unable to sustain the growth rates or success achieved by established companies. In the case of
start-up enterprises, such companies may not have significant or any operating revenues. Such
companies also may have a lower capitalization and fewer resources (including cash) and may be more
vulnerable to failure, resulting in the loss of the Company's entire investment in such company. In
addition, less mature companies could be more susceptible to irregular accounting or other fraudulent
practices. In such event, the Company may suffer a partial or total loss of capital invested in that
company.
The Company has invested in troubled companies in the past, and may make future investments in
companies that are experiencing, or are expected to experience, financial difficulties. If such difficulties
are not overcome, the Company may lose part or all of any equity investment in such companies.
6.1.7 KUE will rely on the management teams of its subsidiaries
While KUE will retain overall control and set the strategic direction of the Company, day-to-day operations
at the subsidiary level will be the responsibility of the management teams at the subsidiary level. There
can be no assurance that the existing management teams, or any successor, of any acquired business
will be able to operate such business in accordance with KUE's plans and/or objectives.
6.1.8 The Company has a non-controlling interest in k12 with limited rights as a
shareholder and may acquire minority interests in other entities
The Company holds a non-controlling interest in k12 and may in the future acquire minority interests in
other companies. Holding a minority interest limits the Company's ability to protect its interests in and to
influence management of k12. Any future investments in minority interests of other companies will likely
involve similar limitations.
In addition, the Company may co-acquire interests in businesses or develop businesses with third parties
through joint ventures or other entities, which may have larger or controlling ownership interests in such
companies. In such cases, the Company will rely significantly on the existing management and boards of
directors of such companies, which may include representatives of other investors with whom the
Company is not affiliated and whose interests may at times conflict with the interests of the Company.
47
Such interests may involve risks in connection with such third-party involvement, including the possibility
that a third-party may be in a position to take (or block) action in a manner contrary to the Company's
objectives or may have financial difficulties resulting in a negative impact on such interest. Acquisitions
made with third parties in joint ventures or other entities also may involve carried interests and/or other
fees payable to such third party partners or co-venturers. There can be no assurance that desirable
minority shareholder rights will be available or that such rights will provide sufficient protection of the
Company's interests.
6.1.9 Certain of the Company's businesses may require additional capital
Certain of the Company's businesses, especially those in development phases, may require additional
financing to satisfy their working capital requirements. The amount of the additional financing needed will
depend upon the maturity and objectives of the particular business. The Company may seek to raise any
required capital from different sources, and subsidiaries in foreign countries may raise capital locally. The
availability of capital is generally a function of capital market conditions that are beyond the control of the
Company. There can be no assurance that the Company will be able to predict accurately the future
capital requirements necessary for success or that additional funds will be available from any source as
needed. An inability to timely raise capital may materially and adversely affect the Company and/or its
business.
6.1.10 KUE's subsidiaries operate in regulated industries; failure to comply with
governmental regulation and licensing requirements could have a material
adverse effect on operations
The pre-K-12 education business is highly regulated and is often subsidized with government funding or
reimbursement programs. In addition, KUE and its subsidiaries may require the consent or approval of
applicable regulatory authorities in order to acquire or operate particular businesses, including in foreign
jurisdictions where the Company has limited or no experience with the regulatory framework. Failure to
comply with applicable laws or regulations, or failure or inability to obtain applicable approvals, could have
a material adverse effect on the operations of KUE and/or its subsidiaries.
For example, KLC's centers and school programs are subject to numerous state and local regulations and
licensing requirements. KLC has policies and procedures in place to assist in complying with such
regulations and requirements. Although these regulations vary from jurisdiction to jurisdiction, government
agencies generally review, among other things, the fitness and adequacy of buildings and equipment, the
ratio of staff personnel to enrolled children, staff training, record keeping, children's dietary program, the
daily curriculum, and compliance with health and safety standards and transportation safety. In most
jurisdictions, these agencies conduct scheduled and unscheduled inspections of the centers and licenses
must be renewed periodically. Most jurisdictions establish requirements for background checks or other
clearance procedures for new employees of child care centers and school programs. Repeated failures
by any of KLC's centers to comply with applicable regulations may result in sanctions against that center
or program and other centers or programs in the same jurisdiction, including probation or, in more serious
cases, suspension or revocation of a center's or program's license to operate. In addition, this type of
action could attract negative publicity extending beyond that jurisdiction.
A licensing authority may determine that a particular center or program is in violation of applicable
regulations and may take action against that center or program and possibly other centers or programs in
the same jurisdiction. For more information, see The Operating Company (KLC OpCo) — Licensing and
Government Regulation."
6.1.11 Future legislation or new regulations may place additional burdens on the
Company and have a material adverse effect on operations
Additional, different and/or more stringent regulations and licensing requirements may become applicable
in the future due to changes in laws and regulations, judicial or administrative interpretations of existing
laws and regulations, changes in the Company's business strategy or for other reasons. State authorities
48
routinely review the adequacy of regulatory and licensing requirements and may implement changes that
significantly increase operating costs. For example, a change in the required ratio of child center staff
personnel to enrolled children in a certain jurisdiction could increase KLC center or program staff
operating expenses in that jurisdiction and therefore have a material adverse effect on KLC's operations.
There can be no assurance that the Company will be able to (i) obtain all required regulatory approvals
that it does not yet have or that it may require in the future; (i) obtain any necessary modifications to
existing regulatory approvals; or (iii) maintain required regulatory approvals. Delay in obtaining or failure
to obtain and maintain in full force and effect any regulatory approvals, or amendments thereto, or delay
or failure to satisfy any regulatory conditions or other applicable requirements, could prevent operation of
the facility or sales to third parties, or could result in additional costs to the Company.
6.1.12 Conflicts of interest may arise with the Principals and their affiliates
The Principals will agree (on behalf of themselves and their affiliates) that KUE will be their exclusive
vehicle for equity investment opportunities in and acquisitions of for-profit companies engaged primarily in
the business of pre-K through 12th grade education of children (other than companies in which the
Principals or their affiliates directly or indirectly owns fifteen percent (15%) or more of the voting stock (or
similar voting interests) as of the date of the first closing of the offering, which are LeapFrog Enterprises,
Inc. and Nobel Learning Communities, Inc.). The Principals will not acquire or make an equity investment
in such companies unless such acquisition or investment opportunity has been first presented to the
Independent Committee and subsequently declined by the Independent Committee or initially pursued but
later abandoned by KUE. See "The Structure of KUE and the General Partner — Investment in
Subsidiaries and Joint Ventures." In addition, existing companies in which KULG and/or its principals are
investors along with other unrelated investors may invest in or acquire companies involved in areas
relating to education.
Following the consummation of the offering, the Principals will control the General Partner other than with
respect to certain actions requiring Investor approval as further described in "The Structure of KUE and
the General Partner." Conflicts could emerge between the Principals and the Company in the future,
including conflicts due to the other business segments in which the Principals may have interests,
separate from the Company. In addition, affiliates of the Principals will have certain financial interests in
KUE and certain of its subsidiaries as described in "Related Party Transactions" following the
consummation of the offering independent of their ownership of the Units, which may present conflicts of
interest.
Certain other potential conflicts of interest include:
• Other activities of management — the Principals and other senior management personnel of the
Company are subject to a variety of prior and continuing obligations unrelated to the Company.
Accordingly, conflicts may arise in the allocation of management time and resources.
• Lack of separate counsel for Investors — no separate counsel has been engaged by the Company
to act on behalf of Investors in the Company.
• For a description of existing arrangements between the Company and its affiliates, see "Related
Party Transactions."
• For a description of certain restrictions on one of the Principals and the Company, see "The
Company may not engage in certain businesses" below.
By acquiring an interest in the Company, each Investor will be deemed to have acknowledged the
existence of any such actual or potential conflicts of interest and to have waived any claim with respect to
any liability arising from the existence of any such conflict of interest.
49
6.1.13 The Company may not engage in certain businesses
On February 24, 1998, without admitting or denying liability, Michael R. Milken consented to the entry of a
final judgment in the U.S. District Court for the Southern District of New York in Securities and Exchange
Commission v. Michael R. Milken et al., which judgment was entered on February 26, 1998 restraining
and enjoining Michael Milken from associating with any broker, dealer, investment advisor, investment
company or municipal securities dealer, and from violating Section 15(a) of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). On March 11, 1991, in the action entitled In the Matter of
Michael R. Milken, the SEC instituted a proceeding pursuant to Section 15(b)(6) of the Exchange Act and
ordered that Michael Milken be barred from association with any broker, dealer, investment advisor,
investment company or municipal securities dealer. On April 24, 1990, concurrently with a plea agreement
covering criminal violations of federal securities laws, Michael Milken also consented, without admitting or
denying liability, to the entry of a final judgment in the U.S. District Court for the Southern District of New
York in the civil action entitled Securities and Exchange Commission v. Drexel Burnham Lambert
Incorporated, et al., restraining and enjoining Michael Milken from engaging in transactions, acts,
practices and courses of business which constitute or would constitute violations of, or which aid and abet
or would aid and abet violations of, Sections 7(c), 7(f), 9(a)(2), 10(b), 13(d), 14(e), 15(c)(3) and 17(a)(1) of
the Exchange Act, and Regulations T and X and Rules 10b-5, 10b-6, 13d-1, 13d-2, 14e-3, 15c3-1, 17a-3
and 17a-4 promulgated thereunder, and Section 17(a) of the Securities Act.
The Company cannot be in the business of or associated with a broker, dealer, investment company,
investment advisor, or municipal securities dealer (collectively, "prohibited businesses"). As a result, the
Company cannot pursue any acquisitions or investments that may have the effect of the Company being
in any prohibited business. This could adversely affect the Company's ability to make and/or hold
investments or acquisitions which may otherwise be consistent with its business objectives.
6.1.14 Litigation and adverse publicity concerning alleged incidents at KLC or other
child care centers could hurt KLC's reputation
KLC is subject to claims and litigation arising in the ordinary course of business, including claims and
litigation involving allegations of physical or sexual abuse of children. Any such allegations, claims or
lawsuits, either individually or in the aggregate, may have a material adverse effect on KLC OpCo's
financial position, operating results or cash flows.
Personal trust and parent referrals play a key role in the child care business. KLC believes its success is
directly related to its reputation and favorable brand identity. KLC is periodically subject to claims and
litigation alleging negligence, inadequate supervision and other grounds for liability arising from injuries or
other harm to children. In addition, claimants may seek damages from KLC for child abuse, sexual abuse
or other criminal acts arising out of alleged incidents at KLC's centers. There are lengthy statute of
limitations periods applicable to child abuse and personal injury claims. Such claims may typically be
brought until a number of years after a claimant reaches the age of majority. Any adverse publicity
concerning such incidents at one of KLC's child care centers, or child care centers generally, could greatly
damage KLC's reputation and could have an adverse effect on occupancy levels at KLC's centers.
6.1.15 KLC's insurance policies may be inadequate to cover claims, and KLC may be
unable to maintain existing coverage in the future at reasonable prices
Some operators of child care centers have experienced difficulty obtaining general liability insurance or
other liability insurance that covers child abuse. KLC maintains insurance policies to protect against
relevant liability exposures in amounts KLC considers to be appropriate. In addition, KLC's owned
centers are covered by blanket insurance policies, including property insurance. Although KLC has not
historically had to pay any claims exceeding its coverage, claims in excess of, or not included within, its
coverage may be asserted. To the extent that any claims are not covered by insurance, KLC will be
forced to cover the associated costs itself, which will reduce the amount of cash KLC has available for
other business purposes.
50
Insurance premiums have increased significantly in the past and may increase in the future because of
market conditions in the insurance business generally, conditions in the child care industry more
particularly or KLC's situation specifically. KLC cannot be certain of the cost or coverage it will obtain with
replacements of existing policies, which will depend on the factors described above.
6.1.16 Factors beyond the Company's control, such as economic conditions, may
adversely affect the demand for child care services
Demand for child care services is subject to fluctuations in general economic conditions, and the
Company's revenues depend, in part, on the number of working mothers and working single parents who
require child care services. Recessionary pressure on the economy, and a consequent reduction in the
general labor force, may adversely impact the Company because out-of-work parents tend to stop using
child care services. In addition, certain demographic trends which are favorable to the Company's
business, including the increasing percentage of mothers in the workforce and the growth in population of
children of the age needing child care, as well as trends in the preference of working parents and
employers for center based child care, may not continue. Other factors beyond the Company's control
could adversely affect demand, such as terrorism, natural disasters and epidemics.
Children attending KLC's facilities are generally enrolled on a weekly basis. Accordingly, any change in
economic conditions or other external factors affecting demand will impact us more quickly than
businesses with longer contractual periods.
6.1.17 A loss or reduction of government funding for child care assistance programs or
food reimbursement programs could adversely affect KLC
Federal and state child care assistance programs accounted for approximately 20% of KLC's revenues
during the one year period ended December 31, 2005. These funds are primarily from the Child Care
and Development Block Grant and At Risk Programs, which are designed to assist low-income families
with child care expenses and are administered through various state agencies. Although additional
funding for child care may be available for low income families as part of welfare reform and the
reauthorization of the Child Care and Development Block Grant and At Risk Programs, KLC may not
benefit from any such additional funding.
KLC is eligible to participate in the Child and Adult Care Food Program, or CACFP, which provides
reimbursement for meals and snacks that meet certain USDA approved nutritional guidelines. Centers
can qualify to participate in the CACFP by meeting one of two tests: 25% or more of the enrolled students
receive child care assistance funding or 25% or more of the center's customers have household incomes
that are at or below state specified income levels. Reimbursement is calculated based on the percentage
of the center's customers that fall into a "free" or "reduced" income category established by the state.
Federal or state child care assistance programs may not continue to be funded at current levels,
particularly with large budget deficits putting pressure on discretionary spending programs. In addition,
many states have recently experienced fiscal problems and have reduced or may in the future reduce
spending on social services. A termination or reduction in funding of child care assistance programs
could have a material adverse effect on KLC's business.
Adverse changes to the national or local economies may result in an increase in the number of families
eligible for child care assistance. In order to compensate for such increases, state or local governments
have in the past, and may in the future, increased parent co-payments required under such programs or
change the eligibility requirements to reduce the number of families eligible to participate in such
programs. An increase in the required parent co-payments may discourage parents from sending their
children to KLC's centers. An increase in required parent co-payments also increases KLC's exposure to
the risk of non-payment by these parents.
In addition, states which reduce funding for child care may be unable to qualify to receive funds under the
Temporary Assistance for Needy Families, or TANF, program. Such states may utilize funds under the
51
Child Care and Development Block Grant to provide child care assistance to needy families in lieu of
TANF funds, thereby reducing the amount of funds available to other families, including families that
utilize KLC's child care centers.
6.1.18 A termination or reduction of tax credits for child care could have a material
adverse effect on KLC's business
KLC may enjoy heightened demand for its services because of tax incentives for child care programs.
Section 21 of the Internal Revenue Code of 1986, as amended (referred to herein as the "Code"),
provides a federal income tax credit ranging from 20% to 35% of specified child care expenses with
maximum eligible expenses of $3,000 for one child and $6,000 for two or more children. The fees paid to
KLC by eligible taxpayers for child care services qualify for these tax credits, subject to the limitations of
Section 21 of the Code. However, these tax incentives are subject to change.
Code Section 45F provides incentives to employers to offset costs related to employer provided child care
facilities. Costs related to (a) acquiring or constructing property used as a qualified child care center, (b)
operating an existing child care center, or (c) contracting with an independent child care operator to care
for the children of the taxpayer's employees will qualify for the credit. The credit amount is 25% of the
qualified costs. An additional credit of 10% of qualified expenses for child care resource and referral
services has also been enacted. The maximum credit available for any taxpayer is $150,000 per tax year.
Many states offer tax credits in addition to the federal credits discussed above. Credit programs vary by
state and may apply to both the individual taxpayer and the employer. A termination or reduction of such
tax credits could have a material adverse effect on KLC's business.
6.1.19 Material weaknesses in KLC's internal controls were discovered during KLC's
2005 audit
For a discussion of certain material weaknesses in KLC's internal controls discovered in KLC's 2005 audit,
see "KLC: Management's Discussion and Analysis of Financial Condition and Results of Operations for
the Fiscal Years Ended 2005, 2004 and 2003" in Appendix B. To address these issues, and as part of
the Company's growth plan, KLC is increasing expenditures on IT systems and accounting and IT
personnel.
6.1.20 If KLC is unable to attract and retain sufficient numbers of qualified employees, if
minimum wage rates increase or if KLC's employees unionize, KLC's results of
operations may be adversely affected
KLC believes that its success is largely dependent on its ability to attract and retain qualified employees.
Many of KLC's child care center staff are entry level wage earning employees, and turnover in this
industry has traditionally been significant. If KLC is unable to hire or retain sufficient numbers of qualified
employees (particularly center directors and supervising employees) or are only able to hire or retain such
employees by providing significantly greater salaries, wages and benefits than KLC currently does as a
result of increases in the federal or state minimum wage rates or other market conditions, KLC's
operations may be adversely affected.
Since early 1998, union organization efforts in the child care industry have received considerable
publicity. While union officials associated with the American Federation of State, County and Municipal
Employees and Service Employees International have repeatedly announced their intention to engage in
a nation-wide effort to organize child care workers, organization efforts have been focused on
government-funded providers. To date, efforts to organize employees of for-profit providers have been
minimal. However, organizational efforts may occur and, if successful, could have an adverse effect on
KLC's relationships with employees and KLC's labor costs. In addition, the general publicity surrounding
such efforts, even if not focused on KLC's centers, could result in increased wages for child care workers
and, as a result, increase KLC's labor costs.
52
6.1.21 Because KLC (through KLC PropCo) owns or leases a substantial number of real
properties, and expects to invest in additional properties, results of operations
could be adversely affected if environmental contamination is discovered on any
of the properties
KLC is subject to U.S. federal, state and local environmental laws, regulations and ordinances that may
impose liability for damages resulting from past spills, disposals and other releases of hazardous
substances as well as clean up costs. In particular, under applicable environmental laws, KLC may be
responsible for investigating and remediating environmental conditions and may be subject to associated
liability, including lawsuits brought by private litigants, relating to KLC's properties. These obligations
could arise whether KLC owns or leases the property at issue and regardless of whether the
environmental conditions were created by KLC or by a prior owner or tenant. Environmental conditions
unknown to KLC at this time relating to prior, existing or future properties may be discovered and may
have a material adverse effect on KLC's results of operations.
6.1.22 KUE has a limited history
While certain subsidiaries of KUE have a financial and an operating history, KUE has only recently been
organized and has relatively little financial or operating history upon which prospective investors may
evaluate its performance, and has not prepared separate or consolidated financial statements. The prior
performance of the subsidiaries of KUE described herein may not be indicative of the future results of the
Company.
6.2. Tax Risks
6.2.1 Certain tax considerations generally applicable to Investors subject to U.S. tax
liability
KUE is expected to be treated as a partnership for U.S. federal income tax purposes. Each Investor that
is subject to U.S. federal income tax liability will take into account its allocable share of items of income,
gain, loss, deduction, and credit of KUE (as determined under the Limited Partnership Agreement),
without regard to whether it has received distributions from KUE. As a result, the tax liability to an
Investor resulting from such allocation may exceed the cash distributions made by KUE to the Investor.
Further, upon the sale of its Common LP Units, an Investor may, depending on the amount of Company
debt, if any, and the Investor's adjusted tax basis, incur a tax liability in excess of the amount of cash
received.
The U.S. Internal Revenue Service (the "IRS"), or other taxing authority may challenge the manner in
which income, gains, losses and deductions are allocated to holders of Common LP Units, the General
Partner and holders of the Profits Participation LP Units under the Limited Partnership Agreement. For
U.S. federal income tax purposes, allocation of any item of income, gain, loss or deduction to a partner in
a partnership will be given effect so long as the allocation has "substantial economic effect," or is
otherwise in accordance with the partner's interest in the partnership. If an allocation of an item pursuant
to the Limited Partnership Agreement does not satisfy this standard or is deemed not to satisfy this
standard by the IRS, it will be reallocated by the IRS among the Partners on the basis of their respective
interests in KUE (as determined by the IRS), taking into account all facts and circumstances. In such a
case, Investors could have additional tax liabilities or suffer adverse tax consequences.
An investment in KUE will give rise to a variety of complex U.S. federal income tax and other tax issues
for Investors. Certain of those issues may relate to special rules applicable to certain types of Investors
subject to U.S. tax, such as tax-exempt entities, foundations, life insurance companies, banks, dealers, in
securities, U.S. persons who own 10% or more of KUE and non-U.S. persons and entities. Prospective
Investors are urged to consult their tax advisors with specific reference to their situations concerning an
investment in KUE.
53
6.2.2 Tax-Exempt and Non-U.S. Investors may become subject to U.S. Tax
KUE business activities could generate income that will be taxable to certain otherwise tax-exempt
Investors as "unrelated business taxable income." Although, under the Limited Partnership Agreement,
the General Partner is required to use its reasonable best efforts not to engage in, or invest in (other than
through an entity that is not a pass-through entity) a pass-through entity that engages in, any activity
which constitutes the conduct of a trade or business in the United States and generates income which
constitutes "effectively connected income" in the hands of the non-U.S. Investors that own Common LP
Units, it is possible that some of KUE's business activities and acquisitions could generate income that is
"effectively connected" with a U.S. trade or business which could create U.S. federal income tax reporting,
tax liability, and tax withholding for non-U.S. Investors. Additionally, KUE believes that neither KUE nor
its subsidiaries is currently a U.S. Real Property Holding Corporation ("USRPHC") for U.S. federal income
tax purposes. However, no assurances can be given in this regard. Furthermore, it is possible that in the
future KUE and/or its subsidiaries may become a USRPHC if, for example, the value of the U.S. real
estate holdings of KUE or such subsidiary increases sufficiently. A disposition of an interest in a
USRPHC could create gain for non-U.S. Investors which would be treated as if the non-U.S. Investor
were engaged in a trade or business within the U.S. and as if such gain were effectively connected with
such trade or business. This would create U.S. federal income tax reporting, tax liability and withholding
for non-U.S. Investors. Investors that are non-U.S. persons are urged to consult their tax advisors
regarding the potential application of the USRPHC rules to their investment in KUE.
6.2.3 Investors may become subject to taxation in non-U.S. jurisdictions
KUE expects to make investments in jurisdictions outside of the U.S., and KUE, its subsidiaries and/or the
Investors may be subject to income or other tax in those jurisdictions. In addition, local tax incurred in
non-U.S. jurisdictions by KUE or subsidiaries through which it invests may not entitle Investors to either (i)
a credit against tax that may be owed in the U.S. or their respective local tax jurisdictions, or (ii) a
deduction against income taxable in the U.S. or such local jurisdictions by the Investors.
6.2.4 Controlled Foreign Corporations
KUE anticipates that it and/or its subsidiaries will invest in non-U.S. operations. Depending upon the
percentage of ownership of such operations by KUE and its subsidiaries and the type of legal entity
chosen for such operations, these non-U.S. operations could be classified as a Controlled Foreign
Corporation ("CFC") for U.S. federal income tax purposes. If an entity is classified as a CFC, certain
types of income could be taxable to U.S. persons owning 10% or more of KUE for U.S. income tax
purposes, even if no distributions of cash are made from such entity, and gain from the disposition of
such entity would be taxed as if it were a dividend to the extent of such entity's earnings and profits,
rather than as a capital gain, for U.S. income tax purposes.
6.2.5 Treatment of KUE as a U.S. Entity
Under the Code, certain non-U.S corporations may be treated as U.S. corporations for U.S. federal
income tax purposes, thereby subjecting such non-U.S. corporations to U.S. federal income tax on their
income. Recently enacted U.S. tax legislation includes one such provision. Under this legislation,
referred to as the anti-inversion legislation, non-U.S. corporations that acquire interests in a U.S.
corporation or partnership and meet certain ownership, operational and other tests may be treated as U.S.
corporations for federal income tax purposes. The legislation grants broad regulatory authority to the U.S.
Secretary of Treasury to provide such regulations as may be appropriate to determine whether a non-U.S.
corporation is treated as a U.S. corporation or as are necessary to carry out the intent of the provision,
including adjusting its application as necessary to prevent the avoidance of its purpose. Recently issued
Treasury regulations provide that the anti-inversion legislation is applicable to a foreign partnership that is
or becomes a "publicly traded partnership" within two years of the acquisition by it of a U.S. corporation.
A "publicly traded partnership" is any partnership (i) interests in which are traded on an established
securities market, or (ii) interests in which are readily tradable on a secondary market (or the substantial
equivalent thereof). KUE believes that it is not currently a publicly traded partnership and does not intend
54
to become a publicly traded partnership within two years of this offering or the acquisition of KLC and k12.
As a result, KUE does not believe the anti-inversion legislation or any regulations promulgated within the
scope of the legislation's regulatory authority should apply to KUE although no assurance can be given in
this regard or with respect to any new acquisitions of or investments in U.S. corporations. In addition,
KUE does not believe that any other Code provision subjecting non-U.S. corporations to U.S. federal
income tax should apply to KUE or its subsidiaries, although no assurance can be in this regards. The
promulgation of contrary regulations or a successful challenge of either of these positions by the Internal
Revenue Service could materially reduce a holder's after-tax return and, thus, could result in a substantial
reduction of the value of the Units.
6.2.6 Currency Fluctuations
An investment in KUE is a U.S. dollar denominated investment. Contributions to and distributions from
KUE will be made in U.S. dollars. Fluctuations in value between the U.S. dollar and the Investor's
functional currency (if other than the U.S. dollar) may result in taxable income to the Investor.
6.2.7 Reporting Requirements
Investors who are U.S. Persons will be required to file an IRS Form 8865 with the Investor's U.S. federal
income tax return for the taxable year in which the Investor purchases the Common LP Units. Investors
who are U.S. Persons may, depending upon the size of their investment in the General Partner, be
required to file an IRS Form 5471 with the Investor's U.S. federal income tax return for the taxable year in
which the Investor purchases Class A ordinary shares in the General Partner. Additionally, depending on
the type of non-U.S. investments KUE makes, Investors who are U.S. Persons may be required to file
additional IRS Forms such as a Form 5471 in subsequent years.
6.3. Risks Related to Projections
6.3.1 The projections included in this Memorandum and otherwise provided to
potential Investors are subject to a number of assumptions and uncertainties;
potential Investors are cautioned not to place undue reliance on such projections
The projections included in this Memorandum and other models and forecasts that may be presented to
or discussed with Investors represent management's best estimates as of the date of this Memorandum
of KLC's, KLC OpCo's and KLC PropCo's projected results of operations for the years ended December
31, 2006 to 2011 (the "Projections"). The Projections were not prepared with a view toward compliance
with published guidelines of the SEC, the American Institute of Certified Public Accountants, or any
regulatory or professional agency or body or generally accepted accounting principles of the U.S. or any
other country. In addition, neither the Agents, Deloitte & Touche LLP, the Company's independent
auditors, nor any other independent expert, accountant or counsel has examined, reviewed or compiled
the Projections and, consequently, assume no responsibility for them. The Projections should be read
together with, and are qualified in their entirety by, the information contained in the rest of this "Risk
Factors" section, "Management's Discussion and Analysis of KLC's Pro Forma Results of Operations,"
"Business" and the financial statements and the related notes thereto included in this Memorandum.
The Projections do not include any expenses of any entity within the Company above the KLC level,
including KUE expenses ($17.5 million of the $20.0 million payable pursuant to the Fixed Overhead
Payment Agreement) that will be payable by KUE for administrative and other services. See "Related
Party Transactions." The Projections also do not include any projected expenses relating to grants of
Profits Participation Units or other equity-related grants, including for the Stock Appreciation Rights Plan
at Knowledge Schools, Inc. ("KSI"), pursuant to which payments may be made based on different
valuations of KSI stock and are based on the same multiples of Adjusted EBITDA used in 2005; actual
valuations are conducted annually and may be higher or lower. Finally, the Projections do not reflect
projected interest expenses on KUE debt.
55
The Projections do not assume that the Company will make any future material acquisitions, even though
the Company expects to use the proceeds of the sale of the Units, among other purposes, for
acquisitions, which will likely affect actual performance and cause it to differ from the Projections. The
Projections assume the success of the Company's operating strategy, although no assurance can be
given that the Company's strategy will be effective or that the anticipated benefits from the strategy will be
realized in the periods for which the Projections have been prepared. The assumptions described herein
are those that the Company believes are most significant to the Projections; however, not all assumptions
used in preparing the Projections have been set forth herein.
The Projections, in general, assume that: (i) the Company will not be negatively or positively impacted by
any material legal proceedings; (ii) there will be no material change in any of the Company's existing
contracts or leases; (iii) there will be no change in generally accepted accounting principles in the U.S.
that will have a material effect on the financial results of the Company; (iv) there will be no labor disputes,
natural disasters, acts of terrorism, epidemics (such as avian flu) or other disturbances that would
materially affect the operations or revenues of the Company; and (v) that worldwide economic conditions
and economic conditions in the U.S. remain generally favorable and consistent with those prevailing on
the date of this Memorandum.
The Projections are based upon a number of assumptions and estimates that, while considered
reasonable by management, are inherently subject to significant business, economic and competitive
risks, uncertainties and contingencies which are beyond the control of KLC, and upon assumptions with
respect to future business decisions which are subject to change. Accordingly, the Projections are only
an estimate, and actual results will vary from the Projections, and these variations may be material.
Consequently, the inclusion of the Projections herein should not be regarded as a representation of the
Company, its advisors, the Agents, or any other person of results that will actually be achieved.
Projections are necessarily speculative in nature, and it is usually the case that one or more of the
assumptions in projections do not materialize. Prospective purchasers of the Units are cautioned not to
place undue reliance on the Projections.
The limited k12 projections contained in this Memorandum were received from k12 management and
were not prepared by the Company or its management.
The Company does not intend to update or otherwise revise the Projections to reflect circumstances
existing after the date hereof or to reflect the occurrence of unanticipated events, even in the event that
any or all of the underlying assumptions do not come to fruition. Furthermore, the Company does not
intend to update or revise the Projections to reflect changes in general economic or industry conditions.
6.4. Risks Related to Investing in the Units
6.4.1 There will be significant unallocated net proceeds from the offering
If there are additional closings after the initial closing of the offering, after repayment of KUE's debt, a
significant amount of the anticipated net proceeds from the offering of the Units may not have been
designated for specific uses. Therefore, the Company's management will have broad discretion within
the business scope of the Company with respect to the use of the net proceeds of the offering. There can
be no assurance that the uses of proceeds will benefit the Company or Investors.
6.4.2 Investors will only have limited rights to receive ongoing information about the
Company
Other than as expressly provided in the Limited Partnership Agreement of KUE (the "Limited Partnership
Agreement), the Company does not expect to provide ongoing detailed information regarding its
business, financial condition or results of operations to Investors. The Limited Partnership Agreement
provides that Investors shall receive yearly audited financial statements of the Company, as well as semi-
56
annual reports on the Company's operations. In addition, Investors have the right to access certain other
information regarding the Company as provided for in the Limited Partnership Agreement. As long as the
Units are not registered under the Exchange Act, the Company will not be subject to the reporting
requirements thereunder. KLC's 2005 audit was not completed until May 2006 due to systems
conversion issues.
6.4.3 Investors may never receive cash distributions on their investment; there is no
assurance of investment return
There is no assurance that KUE will be able to generate returns for the Investors or that returns will be
commensurate with the risks of investing in KUE. There may be limited or no cash flow available to KUE
from its subsidiaries or to the Investors from KUE and there can be no assurance that KUE will make any
distributions to Investors. KUE is not obligated to declare cash distributions with respect to the Units
other than certain distributions to meet tax obligations of the Investors. Public offerings, sales or other
dispositions which may result in a return of capital or the realization of gains, if any, are not expected to
occur for a number of years. An investment in KUE should only be considered by persons who can
reasonably afford a loss of their entire investment.
6.4.4 KUE's ability to make distributions is limited by its subsidiaries' existing and
future indebtedness
KUE will not have any material assets other than its ownership of various subsidiaries (including KLC)
and investments in other companies, and will not have any material operations or revenues other than
income derived from KUE's interest in its subsidiaries and any proceeds arising from its investments in
other companies. Therefore, KUE's ability to make any distributions to Investors will be completely
dependent on the operations and business results of its subsidiaries and its investment holdings.
KLC's ability to make distributions or payments to KUE is restricted by the provisions of its various debt
agreements, including without limitation, the Indenture, dated as of February 2, 2005, by and between
KLC, the Guarantors, as defined therein, and Wells Fargo Bank, N.A., as trustee. Therefore, KLC may be
prevented from making distributions or payments to KUE as and when needed by KUE. Such restrictions
may adversely affect the business and operations of KUE as a whole and the value of any investment in
KUE. Similar restrictions may apply to future indebtedness incurred by KLC and other subsidiaries of
KUE.
6.4.5 There is no public market for, and Investors may be unable to sell, the Units
There is no public trading market for the Units and one is not expected to develop. The economic risks of
this investment must be borne for an indefinite period of time. Neither the Units nor the underlying
Common LP Units or Class A Shares will be registered under the Securities Act or under any state
securities laws (or the securities laws of any other jurisdiction). Each Investor will be required to
represent that it is purchasing the Units for its own account for investment purposes and not with a view to
resale or distribution. Although the General Partner intends to approve permitted transfers specified in
the LPA, and not to unreasonably withhold consent to transfers, all transfers require the prior approval of
the General Partner under Caymans Law, and no transfer of the Units may be made unless the transfer
complies with the terms of the Limited Partnership Agreement. Although the Limited Partnership
Agreement of KUE and the organizational documents of the General Partner permit the foregoing
transfers and the General Partner has agreed with certain Investors to approve such transfers, applicable
Cayman Islands law gives the General Partner full discretion to approve or disapprove transfers.
Each transfer must be registered under the Securities Act and applicable state securities laws or an
exemption must be available. These restrictions will be noted on a legend placed on each certificate, if
any, representing the Units. As a precondition to the effectiveness of any transfer, the Company may
require the transferor to provide an opinion of legal counsel stating that the transfer is in accordance with
the Securities Act and to pay any costs the Company incurs in connection with the transfer. It is not
currently contemplated that the Units will be registered under the Securities Act, the Exchange Act, or
57
other securities laws. In addition, certain provisions of Rule 144 under the Securities Act, which permit
the resale, subject to various terms and conditions, of restricted securities after they have been held for
one year, do not apply to the Units because the Company is not required to file and does not file, current
reports under the Exchange Act and does not, and does not intend to, make comparable information
publicly available.
6.4.6 Purchasers of the Units are subject to Dilution
Although we have not prepared a consolidated balance sheet for KUE, prior to this offering and the
conversion of $180 million of KUE's preferred limited partner units currently held by the Principals and
their affiliates into Common LP Units at the per Common LP Unit issuance price, we expect that KUE
would have negative or nominally positive common equity book value due to its historical capital structure,
including its level of indebtedness. As a result, the book value per Unit acquired in this offering will be
substantially less after this offering than the purchase price paid by the Investors. The Investors interests
are also subject to future dilution if and to the extent the Company grants options, profits interest units or
similar rights to officers, directors or employees of the Company, and will also be affected by any awards
by the Company under the Long Term Incentive Plan and the Stock Appreciation Rights Plan described
under "Management Incentive Plans and Employment Agreements." Investors will have a Co-invest Right
to purchase a pro-rata portion of certain issuances of Units by the Company for cash; however, such right
is subject to customary exceptions. See "The Structure of KUE and the General Partner."
6.4.7 KUE and the General Partner are not U.S. entities; disputes must be resolved by
binding arbitration in the United Kingdom
KUE will be a Cayman Islands exempted limited partnership. The General Partner is a Cayman Islands
exempted company. The internal governance of KUE will be pursuant to the Limited Partnership
Agreement in compliance with applicable laws of the Cayman Islands. The internal governance of the
General Partner will be pursuant to the Memorandum and Articles of Association and the agreement
among members in compliance with applicable laws of the Cayman Islands. All disputes under the
applicable agreements or related to this offering must be resolved through binding arbitration conducted
in the United Kingdom under the London Court of International Arbitration Rules. Such laws and Rules
may offer less or different protections to Investors than laws applicable to comparable U.S. entities or
laws of the Investors' home countries.
6.4.8 The Company will not be operated to optimize the investment, tax or other
objectives of any individual Investor
The Investors may have conflicting investment, tax and other interests with respect to their investments in
the Company. The conflicting interests of individual Investors may relate to or arise from, among other
things, the nature of investments made by the Company and the structuring or the acquisition of
investments. As a consequence, conflicts of interest may arise in connection with decisions made by the
General Partner, including with respect to the nature or structuring of investments, that may be more
beneficial for one Investor than for another Investor, especially with respect to Investors' individual tax
situations. In selecting and structuring investments appropriate for the Company, the General Partner will
consider the investment and tax objectives of the Company as a whole, not the investment, tax or other
objectives of any individual Investor. Investors must seek their own investment, tax and other advice
concerning an investment in the Units.
6.4.9 The Investors may not separately transfer the constituent securities underlying
the Units
The Investors may not separately transfer Common LP Units or Class A Shares (unless otherwise
approved by the Board of Directors of the General Partner and the Independent Committee), and there
may be less Investor interest in a security such as the Units than there would be in more traditional
58
corporate or partnership investments. This restriction may adversely affect an Investors' ability to transfer
the Units in the future.
6.4.10 Under certain circumstances, the General Partner may cause an Investor's
interest in KUE to be redeemed or transferred
Under circumstances where the continuing participation in KUE by an Investor would have a material
adverse effect on the Company, the General Partner may cause an Investor's interest in KUE to be
redeemed or transferred. See "Limitation of a Limited Partner's Participation" in Section 4.11 of the
Limited Partnership Agreement of KUE.
59
7. DISTRIBUTION POLICY
We intend to retain any future earnings to fund working capital, debt service, acquisitions and growth and
do not expect to make distributions for the foreseeable future. Any determination to make distributions in
the future will be at the discretion of the General Partner and will depend upon our results of operations,
financial condition and other factors, as the General Partner, in its discretion, deems relevant. Limitations
in the credit facility and indenture of KLC restrict distributions by KLC that could, in turn, be made
available for future distributions by KUE to its partners.
60
8. INDUSTRY OVERVIEW
8.1. Human Capital
Historically, the world economy has been viewed as being driven by an asset base of natural resources.
This has shifted to an economy driven by industrial and financial resources. This perception is reinforced
through the statistics and measurements used by governments, as seen in the Federal Reserve's
representation of the U.S. balance sheet. However, it is KUE's view that the real assets of a city, state,
region or country are its people (human capital) and their productive capacity. KUE believes that national
economies that fail to embrace this concept will be left behind. Nobel Prize winning economist Gary
Becker estimates that in today's service based economy, human capital accounts for 76% of the assets in
the U.S.
2005 Human Capital - $238 Trillion Market
Human and
Social Capital
74%
Source: Gary Becker
Source: U.S. Federal Reserve
US Financial
Assets
26%
2005 U.S. Balance Sheet - $62 Trillion Market
Other Financ
5%
Other Tangible
6%
Bonds
at 4%
Importantly in today's economy, the value of a company is increasingly driven by creativity, innovation
and education. Companies are recognizing that human capital is their defining asset. With the value of
education becoming apparent to government and businesses alike, the Principals believe that a
significant opportunity exists to create an education company that will promote and cultivate human
capital. Today, not a single education company ranks in the top 100 worldwide as measured by market
capitalization. Within 20 years, KUE believes that the education space will contain some of the largest
companies in the world.
8.1.1 Enhancing Human Capital through Education
Education is a primary factor in improving an individual's life-long productivity. Studies have shown that a
higher level of education leads to increased lifetime earnings, and that this is increasingly true in the new,
knowledge economy.
61
As shown below, an individual with a professional degree earns approximately 100% more than a college
graduate and an individual with a bachelor's degree earns approximately 70% more than a high school
graduate in their lifetime.
Education and Wage Disparity: Lifetime Earnings (Ages 18-64)
$6.0
$5.0
$4.0
g. $3.0
$2.0
$1.0
$0.0
$4.2
$2.3
$1.4
$5.3
$2.7
$1.6
1991 1995 1999 2003
Professional Degree -
Source: U.S. Census Bureau.
- Bachelor's Degree ______High School Diploma
Despite the results of the study shown above, 35% of Americans over the age of 18 have not graduated
high school. Only one-third of the 25% of Americans who have received a bachelor's degree, or 8%,
have received a graduate degree.16
Studies by Nobel Prize winning economist James Heckman suggest that the highest rate of return within
education is generated through an investment in early childhood programs. Heckman's study asserts,
"The rate of return to a dollar investment made while a person is young is higher than the rate of return to
the same dollar made at a later age," as illustrated below:
Return
Preschool
School
Opportunity
Cost of Funds
Job Training
School Post School
Age
Source: August 2002 study, James Heckman, University of Chicago.
Due to the high rate of return of investments in ECE and the principles underlying the theory of human
capital, KUE has made its largest initial investment in KLC, the largest company serving the ECE market
in the world.
16 Source: U.S. Census Bureau.
62
8.2. The Education Market
Education is one of the largest sectors in the world, representing approximately 5% of global gross
national income of $48 trillion.17 In 2005 in the U.S. alone, education was a $1.0 trillion market with for-
profit education accounting for $81 billion or 7.8% of this amount.18 The for-profit component of this
industry (pre-K-12, post secondary and corporate training) is projected to grow faster than the overall
historical industry growth rate, at a 7.4% annual rate, reflecting the increasing importance of for-profit
operations in the sector, to reach a market size of $116 billion by 2010.19 Education is still predominantly
provided by public / governmental entities in most countries including the U.S. KUE believes that the
industry will converge towards a more balanced public / private system, similar to the evolution observed
in the 20th century in other major industries such as healthcare, infrastructure and telecommunications.
US Education Industry: Revenues Generated by For-Profit Companies (1999-2010E)
$150 -   10.0%
$120   9.0%
8.0%
$60 -   7.0%
$30 -   6.0%
$0   5.0%
1999 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E
For-Profit Spending - _ For-Profit %
6upueds ieloi io %
Source: Harris Nesbitt estimates, U.S. Department of Education National Center for Education Statistics, Training Magazine and
Eduventures.
8.3. The U.S. Early Childcare or "pre-K" Market
The highly fragmented early childcare or "pre-K" market includes care based in homes and housed by
community organizations (e.g., churches, synagogues, YMCAs) and center based facilities. Center-
based childcare includes preschools (nurseries), workplace centers (located on-site at the company),
lease-model centers (located in a real estate developer's office building), back-up centers (a variety of on-
site and off-site back-up care programs) and family day-care facilities (located in someone's home or
center). Although childcare may evoke thoughts of a babysitting service, education has become an
increasingly important element in services to pre-K children. However, the education-focused portion of
the childcare market remains relatively small.
Since the early 1980s, center-based ECE has become the care provider of choice for families. The U.S.
ECE unit generated an estimated $54 billion in total spending in 2005, representing a 10% compound
annual growth rate since 1982.19 Approximately five million or 60% of 3 to 5-year-olds with working
mothers are enrolled in ECE centers. 9 The following growth drivers are expected to continue to fuel
growth in the early childcare market: growing importance of ECE, demographics (e.g., more children aged
five and younger), increase in families with two working parents, more educated parents, corporations
recognizing the benefits of childcare services and tax incentives and other positive legislation.
The perception of ECE as a fundamental component of child development has contributed to average
annual fee increases of roughly 7% amongst center-based facilities, reflecting the stable, relatively
inelastic nature of the demand for higher quality care.21 The number of children receiving childcare
1' Source: UNESCO Institute for Statistics Database.
18 Source: US Department of Education National Center for Education Statistics and Training Magazine and Harris Nesbitt research.
19 Source: Harris Nesbitt, Education and Training, September 2005.
2° Source: "Early Care and Education: Work Support for Families and Developmental Opportunity for Young Children," Urban Institute, September
2001.
21 Source: The National Economic Impacts of the Child Care Sector, 2002.
63
outside the home grew from 10.6 million in 1999 to an estimated 12 million in 2003, an increase of 3.1%
annually.22
8.3.1 Early Childhood Education's Role in the Economy
ECE enables people to pursue income-generating activities by allowing parents to participate in the
workforce and contribute to the economy. A recent study found that every dollar spent on the formal ECE
sector generates approximately 15 dollars worth of additional earnings by parents. 23 Furthermore,
evidence suggests that regardless of family income, children who have participated in ECE programs do
better in school than their peers who did not. ECE also reduces social and economic costs by lowering
school dropout rates, and leads to decreased levels of criminal activity. These social and demographic
forces have established ECE as a fundamental component of today's economic 'infrastructure' and a
source of economic growth.
Given these and other supporting facts, education is an industry that is of growing importance to the
economy. This growth is driven by the following factors:
M Growing public awareness of the importance of early childhood education. ECE has received
increased media and government attention as scientific research highlights the importance of
education during a child's early developmental years. Children who attend high quality ECE centers
demonstrate greater mathematical ability, thinking and attention skills, and fewer behavioral problems
throughout their educational lives, when compared with children receiving no or lower quality care.
These differences hold true for children from a range of family backgrounds.24
• Favorable demographic trends. According to the National Center for Health Statistics, the annual
number of live births in the U.S. was approximately 4.1 million in 2003, compared to approximately 3.6
million in 1980, and the U.S. Census Bureau projects the annual number of live births to increase to
approximately 4.5 million in 2015.25 The number of children aged five years or under grew from
approximately 22.5 million in 1990 to approximately 23.4 million in 2002, according to the U.S. Census
Bureau, and is projected to reach 26.8 million in 2015.22
Number of Live Births in the U.S.
(in thousands)
4,500 -
4,250 -
4,000 -
3,750 -
3,500
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007E 2009E 2011E 2013E 2015E
Source: U.S. Census Bureau.
• Changing workforce composition. A rising percentage of women participate in the workforce due to an
increasingly higher cost of living, a desire for financial independence and an elevated standard of
living preference, which necessitates two full-time wage earners for most families. Of the nearly 65
million jobs created nationally between 1964 and 1997, 40 million were occupied by women. Today,
more than 62% of mothers with children under the age of six work full-time compared to 19% in 1960.
22 Source: Harris Nesbitt, Education and Training, September 2005.
23 Source: The National Economic Impacts of the Child Care Sector, 2002.
24 Source: The Children of the Cost, Quality, and Outcomes Study Go To School, 1999.
25 Source: Population Projections Branch, U.S. Census Bureau, "U.S. Interim Projections by Age, Sex, Race and Hispanic Origin," May 2004.
64
• Highly educated parents spend more on childcare. The increasing number of college graduates in the
U.S. and abroad will support continued expenditures on ECE. In 2001, 70% of children with college-
educated mothers attended childcare programs, while only 38% of children whose mothers had less
than a high school degree attended childcare programs. A recent report by the U.S. Department of
Commerce reveals that families with college degrees spent an average of $92.67 per week (per child)
on childcare in 2000, whereas parents without a high school degree only spent an average of $59.70
per week per child.26
• Increasing demand for Employer-Sponsored Centers. With increased levels of employment,
corporations are witnessing growing demand for ECE services. Companies benefit from offering
childcare services to their employees as (i) it often reduces employee absenteeism; (ii) serves as a
perquisite, which differentiates the employer's compensation package; and (iii) tends to lower turnover
rates. ECE services contribute to a stable and consistent workforce.
• Favorable tax incentives. Certain tax incentives are available to parents utilizing childcare programs.
Specifically, Section 21 of the Internal Revenue Code provides a federal income tax credit (Child and
Dependent Care Credit) ranging from 20% to 35% (increased in 2003) of certain childcare expenses
for "qualifying individuals." The Economic Growth and Tax Relief Reconciliation Act of 2001 created a
Federal Employer Tax Credit for certain childcare expenses beginning in 2002. Employers can
receive a credit of 25% of their spending on the construction or rehabilitation of a child care facility or
on contracts with a third party child care facility to provide child care services to employees.
Corporations also benefit from tax incentives of up to $150,000 per year.
8.3.2 Industry Characteristics
The ECE sector has a number of favorable operating characteristics. First, well-run school operators
enjoy high returns on capital, predictable revenue streams and strong free cash flows, with students
generally paying in advance of services delivered. Second, industry data shows that tuition rates have
increased by approximately 7%, a rate which has exceeded inflation.27 The current outlook suggests no
change in this dynamic. Third, government regulation and licensing standards represent notable barriers
to entry.
Given that education is a universally accepted product, management believes that our business model is
highly scalable. The basic center model is expected to be essentially repeatable and transferable to new
markets and locations. With labor representing approximately 50% of the total operating cost structure,
companies within this sector tend to benefit from a variable cost structure, which allows them to reduce
costs as economic and market conditions change.
Often the demanding requirements for the selection of school directors and teachers can limit the pool of
qualified employees for the industry. Low pay also tends to result in high turnover rates of approximately
50% annually within the industry.
8.3.3 Competitive Landscape: Early Childhood Education
The ECE sector is highly fragmented with the top six providers representing approximately 5% of all
organized ECE centers. The Company's primary competitors are (i) local nursery schools and child care
centers, some of which are non-profit (including religious-affiliated centers), (H) providers of services that
operate out of their homes and (Hi) other for-profit companies which may operate a number of centers.
Local nursery schools and ECE centers generally charge less for their services. Many religious-affiliated
and other non-profit child care centers have no or lower rental costs than for-profit chains, may receive
donations or other funding to cover operating expenses and may utilize volunteers for staffing.
Consequently, tuition rates at these centers are commonly lower than the Company's rates.
20 Source: Harris Nesbitt Research, Education and Training, September 2005.
27 Source: The National Economic Impacts of the Child Care Sector, 2002.
65
There are also several national chains, such as Bright Horizons Family Solutions, La Petite Academy,
Learning Care Group (ABC Learning) and Nobel Learning Communities, or regional for-profit companies
with sizeable numbers of centers and similar economies of scale in curriculum development, marketing
and site development.
Competitive Landscape within Early Childhood Education
Churches Other
1%
5 %
For-Profit Chid
Education
5%
Public Sector
Agencies
11%
Non Profit Child
Education
18%
Family
Day Caro
Providors
60%
Source: Harris Nesbitt Research, Education and Training, September 2005 and The National Childcare Association.
KLC OpCo successfully competes against these companies, with the following differentiating factors: (i)
strong brand equity; (ii) a strong management team; (iii) grass roots level marketing; and (iv) a larger
network of community centers. KLC also has a number of employer-sponsored centers that gives the
Company greater breadth and depth. Finally, KLC is the only large competitor in the sector owned by an
education company. Following is a brief description of each of several of the national competitors.
I ABC Learning (Public, traded on the ASX)
The Learning Care Group, ABC Learning's U.S. operating segment, has over 30,000 children enrolled
(full and part-time) nationwide. Under the Childtime and Tutor Time segments, Learning Care operates
child care centers and under the Franchise segment it licenses and provides developmental and
administrative support to franchises operating under the Tutor Time brand. As of October 14, 2005,
Childtime generated LTM sales of $220.7 million across 460 childcare centers in the U.S. (328 of which
are company owned and 132 of which are franchised locations). On January 11, ABC announced it had
successfully completed the acquisition of the Learning Care Group, Inc. for $159 million in cash. In
addition to the 460 centers located in the U.S., ABC operates 707 centers in Australia and New Zealand.
• Bright Horizons (Public)
Founded in 1986, Bright Horizons Family Solutions is a leading provider of employer-sponsored child
care services. Bright Horizons operates 616 childcare and early education centers for over 600 clients.
The company serves more than 66,300 children in 39 states, the District of Columbia, Canada, Guam,
Ireland and the United Kingdom. In September of 2005, the company acquired ChildrensFirst Inc. As of
December 31, 2005, the company reported LTM sales and EBITDA of $625 million and $75 million,
respectively.
• La Petite Academy (Private)
La Petite is the third largest operator of for-profit pre-school centers in the U.S., currently serving more
than 65,000 children in 649 centers located in 36 states and the District of Columbia. The company also
66
owns 68 (included in the 649 centers) Montessori schools which cater to K-12 students. LPA's residential
Academies are typically located in residential, middle-income neighborhoods. As of February 28, 2006,
the company reported LTM sales and EBITDA of $411 million and $33 million, respectively. The
company has been owned by JP Morgan Capital since 1998.
Nobel Learning Communities (Public)
Nobel is a for-profit provider of private pay education and services for education entities for the preschool
through 12th grade market. The company's programs are offered through a network of general education
preschools, elementary and middle schools, programs for learning challenged students and special
purpose high schools. Nobel operates 150 schools in 13 states across the U.S. As of December 31,
2005, the company reported LTM sales and EBITDA of $166 million and $15 million, respectively.
Affiliates of the Principals are currently significant shareholders of the company.
8.3.4 Government's Role in Early Childhood Education
Approximately 83% of the estimated $54 billion spent on ECE is generated by private and independent
non-profit services. The government provides the remaining 17% of services through Head Start and
public schools. The government pays for public school and Head Start programs, but also subsidizes
payments of low-income families to providers of their choice through the Child Care Development Block
Grant and Temporary Assistance for Needy Families, which are blended with state dollars. About 25% of
for-profit early childhood care revenue comes from these subsidy programs.
The government is, at both the federal and state level, actively involved in expanding the availability of
early childhood care services. Federal support is delivered at the state level through government-
operated educational and financial assistance programs. Early childhood care services offered directly by
states include training, licensing and regulation for early childhood care providers and resource and
referral systems for parents seeking ECE.
The increasing importance of education is further demonstrated by the "No Child Left Behind Act of
2001," signed into law in January 2002. This Act is the most sweeping reform of the Elementary and
Secondary Education Act, or ESEA, since ESEA was enacted in 1965. To support this commitment,
President Bush requested a $54.4 billion budget for the Department of Education for fiscal 2007, a 28.9%
increase from the 2001 budget of $42.2 billion.
Certain tax incentives exist for early childhood care programs. Section 21 of the Internal Revenue Code
provides federal income tax credits ranging from 20% to 35% of certain early childhood care expenses for
qualified individuals.
8.4. The U.S. K-12 Education Market
A fundamental change has occurred in the K-12 sector in recent years, as the desire to improve school
quality has overtaken demographics as a key growth driver. Companies providing supplemental
educational services (e.g., KLC) and several school alternatives, such as charter and contract schools
(e.g., k12), are expected to be instrumental in improving K-12 student performance.
The K-12 education market in the U.S. is comprised of over 15,000 school districts including more than
90,000 K-12 public schools, approximately 3.5 million teachers, and about 54 million students according
to the National Center for Education Statistics. Total K-12 expenditures, federal, state and local, are
approximately $500 billion.
Despite the growth in spending on public education over the last decade, student achievement has shown
little progress. According to the 2005 National Assessment of Educational Progress, 32% of eighth-
graders performed below the Basic level in mathematics, and only 29% performed at or above the
Proficient level. One-third of American fourth graders are functionally illiterate. KUE believes the
following factors will present significant market opportunities in the coming years for for-profit K-12
67
education providers. According to Harris Nesbitt Research, industry experts estimate that the $21.8
billion in revenues generated by for-profit education providers in 2004 will increase to over $29.7 billion in
2010, 5.3% annual growth. 2° However, these estimates reflect only spending by institutions on
educational material and do not reflect the growing segment of direct to consumer educational materials,
which represented roughly an additional $20 billion in 2004.28
For-Profit K-12 Education 2004— 2010E
$30
$25
$20
$15
:a
$21.8
_
$23.0
$24.2
$25.5
minammsfammis
$26.8
ISSINEMEEMSIEN
$28.2
$29.7
2004 2005 2006E 2007E
2008E
2009E 2010E
- Professional Development n Print Publishing Supplemental Services Technology Assessment o School Management
Source: Harris Nesbitt estimates based on Eduventures' The Education Industry: Learning Markets and Opportunities 2004"
report (December 2004).
Standards and Accountability. Due to the unsatisfactory performance of American students in grades K-
12, parents and lawmakers are demanding increased standards and accountability in schools. This
demand has focused on establishing guidelines for every school and every subgroup of students and
then holding the school (and its staff) accountable to students' performance relative to those standards.
The Company expects continued focus on academic standards, assessments, and accountability in the
near future. Despite this increased attention on standards and accountability, many parents continue to
remain concerned with the overall effectiveness of the public school system and are increasingly relying
on for-profit education providers.
Charter Schools and Virtual Academies. There has also been a significant rise in the number of charter
schools in the U.S. in the past decade. Since Minnesota first enacted legislation in 1991, 40 states and
the District of Columbia have passed charter school legislation. Under the typical charter school statute,
an identified entity, such as the state, a state university or local school district board of education, is
authorized to grant a specified number of charters to community groups or non-profit entities to create a
public charter school. A growing number of charter boards, in turn, contract with private sector
organizations to manage the schools. In return for a large measure of autonomy from normal public
school regulation, the charter school is accountable for student academic performance. Currently, the
Company estimates that there were nearly 2,700 charter schools in operation nationwide, as of January
2003, with an estimated enrollment of over 685,000 students. Moreover, the federal No Child Left Behind
Act ("NCLB") recognizes charter schools as a viable alternative for students who want to transfer from
neighborhood schools that are failing.
To capitalize upon the increasing number of parents who are willing to educate their children at home and
still want to be part of the public system, there are a growing number of virtual schools, where much of
the learning is home-based. Most current charter school legislation either explicitly authorizes virtual
public schools or does not directly prohibit them. Because virtual schools usually offer a comprehensive
curriculum, easy-to-use learning and performance evaluation technology assistance and instructional
materials, the Company believes that a growing number of families will pursue virtual public schools as an
attractive alternative to traditional schools and a more cost-effective, better organized approach to home
schooling. The large and scalable platform that exists at k12 is designed to capitalize on this trend as the
number of charter schools has grown on average nearly 13% annually, while charter school enrollment
28 Source: Harris Nesbitt, Education and Training, September 2005.
68
has increased 20% annually, outpacing the less than 1% average K-12 enrollment growth over the same
period 29
K-12 Charter Schools and Enrollment (1995 to 2004
Charter Schools
4,000   1,000,000
3,000   - 750,000
Cl)
2,000   - 500,000 C.
7
1,000 -   - 250,000
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Schools Students
Note: Number of students in 1999-2000 school year was estimated.
Source: Harris Nesbitt, Education and Training, September 2005 and Charter School Leadership Council and Center for
Education Reform.
Supplementary Education Market. For parents who continue to enroll their children in traditional public
and private schools, there is a growing demand for supplemental education services. According to the
U.S. Department of Education, 31% of elementary school children, or more than 10 million students
nationwide, are enrolled in after-school programs. According to Eduventures, the U.S. supplementary
education market was estimated to be approximately $8.1 billion in 2003. Additionally, under the No
Child Left Behind (NCLB) Act, some children in poorly performing schools will be eligible for taxpayer-
financed supplemental educational services. These supplemental educational services can be provided
by state-approved non-profit or for-profit entities as well as private schools and public schools (including
public charter schools). More parents want to spend educational time with their children, but lack access
to high quality supplemental material that is effective and integrated into a comprehensive plan that is
easy for a parent to deliver and manage.
The virtual school market is a relatively new area within the broader K-12 education market. As a result,
there is a growing need for a high quality, trusted, national education offering for this demographic.
Furthermore, parents are seeking much more robust and comprehensive ongoing assessments than is
currently offered in the public schools, in order to assess their children's progress both on a relative and
an absolute basis.
8.5. The International Education Industry
The leading authority on the worldwide education industry, the United Nations Educational Scientific and
Cultural Organization ("UNESCO"), estimates that average public expenditures on education across the
world increased from 4.1% of GNP in 1990 to 4.5% in 2000. In developing countries the increased
government focus on education is more pronounced as public education expenditures rose to 4.1% in
2000 from 3.5% in 1990. Based on global gross national income of $48 trillion, KUE estimates that the
global education market opportunity is greater than $2.4 trillion driven by the following factors:
• Large population of school-aqed children in parts of the world. The opportunity for pre-K-12 education
is particularly strong in certain countries with high fertility rates. Examples of such opportunities
include India, where mothers give birth to an average of 2.78 children. Increases in the population of
children coupled with an increased awareness of the economic and social benefits of education are
expected to lead to significant growth in the global ECE market.
29 Source: Harris Nesbitt, Education and Training, September 2005 and Charter School Leadership Council and Center for Education Reform.
69
• Increased government focus on education. In many countries, per student public spending on
education represents a larger portion of per capita GDP than in the U.S. For example, in Australia and
the United Kingdom, the government has subsidized a large portion of ECE. Now, countries such as
Saudi Arabia are developing similar programs. The opportunity for increased government spending on
pre-K-12 education is particularly apparent in growing economies such as China and South Korea as
those countries increase their share of world GDP.
• Potential opportunities in countries with declining populations. In countries that have had low fertility
rates for several generations, such as Japan and Italy, there often exists a large family structure
supporting a single child. KUE believes that this leads to several family members (e.g., both parents
and grandparents) contributing to a single child's schooling, resulting in higher education expenditures
per child. In addition, the high cost and limited availability of quality ECE in countries such as Japan
has been identified as a contributing factor to declining birth rates in the country.
The following paragraphs provide a brief overview of some of the key markets around the world, which
KUE views as attractive. These include China, Saudi Arabia and the United Kingdom.
8.5.1 China: Market Overview
With a population of 274 million children under a9e 15, and a fertility rate of 1.73, China represents an
attractive market for early education providers.3u In China, mandatory education starts with primary
schools, at which most children enroll by age six. Currently, 24 million Chinese children are attending
kindergarten as a growing middle class and the one-child policy are driving multiple incomes to one child
and increasing the amount of capital that can be dedicated to education. These socioeconomic factors
are reflected in the increasing numbers of private kindergartens, which have grown at a rate of 13% over
the past eight years.31
Public versus Private Pre-School Education
13.7% 17.7%
0.7%
25.1% 20.1% 19.7%
180
187 183 181 181 176
I
juiLimma_m_ELJ . •
8.7% 14.7%
I112 112 116
III III III
1995 1996 1997 1998___ 1999 2000 2001 2002 2003
Private Schools Total Schools Private Growth
150 150 142
I
NA I NA JNA I NA
138
181 182
172
132
155160164177 183 187
111 I I I I
128 128
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
All Kindergartens - Private Kindergartens
Note: Private kindergarten enrollment data unavailable before 1998.
Source: Ministry of Education, China Education Industry Development Statistics Report, China Education and Research Network.
Schools tend to be concentrated in larger cities with Beijing, Shanghai, Nanjing, Qingdao and Guangzhou
being the largest pre-school markets. Kindergartens are divided into three categories: Bilingual, Foreign
language and Mandarin. Bilingual kindergartens are typically joint ventures between Chinese and foreign
entities or owned wholly by Chinese private or public entities. Tuitions for bilingual programs can reach
$15,000 per year. Foreign language kindergartens are wholly owned foreign schools that recruit only
foreign students and are typically backed by their embassies. These schools adhere to foreign
educational standards with Mandarin being taught as a second language. The tuitions of foreign
language schools range from $10,000 to $22,000 per year. Mandarin kindergartens are typically owned
by Chinese public entities.
3° Source: Central Intelligence Agency, World Factbook 2006.
31 Source: Ministry of Education, China Education Industry Development Statistics Report, China Education and Research Network.
70
Kindergartens can be set up by the Ministry of Education, private enterprises, universities, communities
and individuals. While local governments establish the minimum and maximum fees allowed to be
charged by public kindergartens, private schools are allowed to dictate "reasonable" tuition levels.
Overview of the Major Themes in Education Market in China
Tuition
No. of
Schools
Source: Enspiren.
International
"Elite- Public
"Regular" Public
8.5.2 Saudi Arabia: Market Overview
• Only accept non•PRC citizens
• Very high tuition (›US$10,000 per year)
• Free to use any curriculum
• Usually affiliated with overseas schools
• Examples: Shanghai American School, Yew Chung Shanghai
International School, British International School
• Public schools with premium facilities and teaching resources
• Very difficult to enter (usually requires "guanxi")
• Tuition itself not necessarily high, but "sponsorship fee" can be
substantial
• Examples Song Qing Lin Kindergarten, Dong Pang Kindergarten
• Increasing in numbers over the past few years
• Mostly run by locals, but foreign participation is on the rise
• Quality and tuition vary considerably
• Examples- Elizabeth Kindergarten (local), Victoria Wah Kwong
Kindergarten (Hong Kong), Kid's Castle (Taiwan)
• Essentially a public service provided by the government
• Typically low tuition (<US$5001yr), requiring substantial government
subsidies
• Basic facilities and teaching resources
• Some are closing down or switching into private hands as government
wants to reduce expenditure
Saudi Arabia's nationwide public educational system comprises eight universities and more than 24,000
schools. Open to every citizen, the system provides students with free education, books and health
services. The government allocates over 25% of the annual State budget to education.
According to the Ministry of Education, Saudi Arabia prizes education because of its critical importance in
developing the country's human potential. Education is a central aspect of family and community life.
Parents are deeply involved in their children's education, and the close links between home and school
serve to reinforce the structure of the community and the nation.
The government plans to increase the enrollment of 4 to 6-year-olds to 40% by 2014.32 Additionally, by
royal decree, education is now required for all 4-year-olds. New labor laws also necessitate that
companies employing 50 or more women provide daycare centers. Despite this new series of laws, there
still only exist 1,200 kindergarten schools in Saudi Arabia (42% private and 58% public) to support the
legislative pronouncements. The Company anticipates that, additional capacity will be needed to meet
these social objectives. These trends, as noted by the Ministry of Education in Saudi Arabia have led to
private education facilities opening all over the Kingdom.
8.5.3 United Kingdom: Market Overview
The United Kingdom stands out with consistent rises in its investment in education, not just in absolute
terms, but also relative to national income: Spending on educational institutions increased from 4.3% of
GDP in 1990 to 5.5% in 1995 and 5.9% in 2002. From 1995 to 2002, spendin9 and enrollment in primary
and secondary education has also increased by 36% and 21%, respectively.s3 Additionally, the country
invests almost twice as much as any other country at the pre-primary level. The rate of participation of 4-
32 Source: Kingdom of Saudi Arabia Ministry of Education Deputy Ministry for Planning and Administrative Development General Directorate for
Planning. "The Ministry of Education Ten-Year Plan" 2005.
33 Source: OECD, "Education at a Glance 2005."
71
year-olds and under as a percentage of the 3-to-4-year-old population has also increased from 51% in
1998 to 77% in 2002.
The U.K. government is focused on the ECE industry and expects to spend $18 billion on child care
schemes in the near future through "Sure Start", an initiative designed to encourage additional
participation in high quality childcare through extensive subsidies. The government's intention is to create
3,500 additional children's centers in un-serviced, low-income communities.
Comparison of per-child expenditure at Pre-Primary and Primary levels 2001
$200
$150 -
*.E.
$100 -
'6
12. $50 -
trk
$0 _
$172
$56
$60
$91
$104
$108
$113
Sweden Japan France Mexico Norway United States United
Kingdom
Source: UNESCO Institute for Statistics database.
Note: Calculations based on expenditure per child in U.S. dollars at purchase price parity, using full time equivalents.
'Public and private institutions only.
72
9. KNOWLEDGE UNIVERSE EDUCATION ("KUE")
KUE is the third largest for-profit education company in the world. KUE currently operates in the U.S. and
is the indirect parent company (87.6% ownerships') of KLC and also a major shareholder (owns 17.9% to
40.0%35 of equity) of k12. In November 2005, KLC divided its business, with substantially all of its real
estate owned by special purpose subsidiaries (KLC PropCo) and all of its customer contracts and
operations remaining at KLC and certain other subsidiaries (KLC OpCo).
The controlling shareholders of the General Partner are Michael Milken, Lowell Milken and Steven Green
(collectively the "Principals"). Michael Milken and Lowell Milken each has more than two decades of
experience in the education sector through involvement in several for-profit and not-for-profit initiatives.
Steven Green, a former U.S. ambassador to Singapore, has more than two decades of experience as an
international industrialist leading major corporate restructurings and expansions in manufacturing,
housing, consumer products, retail and real estate enterprises. The Principals founded KUE and its
affiliated companies over the past decade based on their vision of a world where competition for human
capital is becoming the driving force of economic prosperity. KUE represents the Principals' sole vehicle
for equity investment opportunities in the early education through secondary school sector going forward.
The Company has an accomplished and internationally recognized leadership team. Led by the
Principals, the Company has a prominent management team and advisory board with significant financial
resources and substantial experience in the fields of education and real estate management. Additionally,
through its past experiences at KLC, the Company has demonstrated the ability to acquire and integrate
education assets. The Company's management consists of people with diverse backgrounds in
operations, corporate finance, real estate, government relations and education. KUE's role will be to
oversee the portfolio of operating businesses, identify acquisition candidates, hire top level management
of the operating businesses and help the portfolio companies navigate some of the legislative and
regulatory matters that exist in K-12 education. These services will be performed for the Company by
KULG, for which KUE will pay $20.0 million annually to KULG in quarterly installments beginning July 1,
2006 pursuant to the Fixed Overhead Payment Agreement. See "Related Party Transactions."
The General Partner plans to have a Board of Directors (the "Board") with representatives from some of
the countries KUE plans to expand into, public policy experts and independent directors with
complementary backgrounds. KUE expects to benefit from the breadth and depth of the knowledge,
experience and expertise of the Board. At the final closing of this offering, at least two members of the
Board will be Independent Directors. After the Initial Listing of the Units and so long as consistent with
contractual and licensing obligations, the General Partner will have a majority independent board.
9.1. KUE Management and Advisory Board Members
The following table sets forth KUE's management and current advisory board members. Detailed
biographies can be found in Appendix A.
34 The 12.4% minority position is held by various investors.
'5 KUE's ownership varies depending on the liquidation value or sale value of k12 and according to the preference of the various securities KUE owns.
At higher valuations, KUE's percentage ownership is lower. See "k12 Inc (k12)— k12 Equity."
73
Management
Name
Lowell Milken
Michael Milken
Steven Green
Ted Sanders
Stephen Goldsmith
Nina Rees
Jeffrey Safchik
Richard Sandler
Adam Cohn
Geoffrey Moore
Michael Neumann
Name
Les Biller
Ted Mitchell
Tsvi Gal
Position
Co-Founder, President and Chief Executive Officer of KUE
Co-Founder and Chairman of KUE
Vice Chairman of KUE, and Chairman and CEO of k1 Ventures
and Greenstreet Real Estate Partners
Vice Chairman of KUE
Senior Vice President of Strategic Planning and Worldwide
Government Programs
Senior Vice President, Strategic Initiatives
Chief Financial Officer
General Counsel
Senior Vice President, Business Development
Senior Vice President, Corporate Communications
Vice President, Business Development
KUE Advisory Board
Position
Retired Vice Chairman & Chief Operating Officer of Wells
Fargo and Company
CEO of the New Schools Venture Fund
Chief Technology Officer for Deutsche Bank Asset
Management
9.2. Note Payable to KULG by KU Education, Inc.
On January 6, 2005, KU Education, Inc., a Delaware corporation and subsidiary of KUE ("KUE Inc.")
executed a promissory note in favor of KULG, an entity controlled by the Principals, in the amount of
$200.0 million, the proceeds of which were used in connection with the acquisition of KinderCare by
KLC. This note has a seven year maturity and accrues interest at the "reference rate" set by Bank of
America plus 1.25% per annum. The note may be prepaid, in whole or in part, without any premium or
penalty. As of April 1, 2006, KUE Inc. owes approximately $183.9 million under the note.
9.3. Term Loan Facility
On March 29, 2006, Knowledge Universe Education LLC, a Delaware limited liability company ("KUE
LLC"), entered into a six-month $150 million term loan facility with an affiliate of Credit Suisse, one of the
Agents. The proceeds of the $150 million term loan were used to repay existing debt of KUE LLC to
entities controlled by Michael Milken.
The term loan facility is fully and unconditionally guaranteed by KUE LLC's direct and indirect parents and
the parent guaranty is several. Upon contribution of assets to KUE by KUE LLC, KUE will become a co-
borrower. It is expected that this Term Loan Facility will be repaid with the proceeds of this offering.
The term loan bears interest at either the reserve adjusted LIBOR rate plus 0.125% or the base rate
(generally the applicable prime lending rate, as announced from time to time), at KUE's option and is
secured by cash collateral. KUE is permitted to voluntarily prepay the term loan, in whole or in part,
without premium or penalty, upon the giving of proper notice.
74
10. MANAGEMENT'S DISCUSSION AND ANALYSIS OF KLC's
PRO FORMA RESULTS OF OPERATIONS
In January 2005, KLC acquired KinderCare and incurred $540 million of term debt (the "Acquisition Term
Debt") and $250 million of subordinated bridge debt to finance the acquisition. At the time of the
KinderCare acquisition, KinderCare had approximately $300 million of nonrecourse mortgage debt
outstanding (the "KinderCare CMBS Debt"). KLC refinanced the bridge debt in February 2005 with $260
million of 7-3/4% senior subordinated notes due 2015 (the "Notes"). In November 2005, KLC completed
a transaction (the "Real Estate Transaction") in which KLC divided its business, with substantially all of its
real estate owned by special purpose subsidiaries (collectively, KLC PropCo) and all of its customer
contracts and operations remaining at KLC and certain other subsidiaries (collectively, KLC OpCo).
Management believes that this division represents the best way to analyze the business going forward.
In connection with the Real Estate Transaction, KLC PropCo entities incurred $650 million of mortgage
debt, $50 million of senior mezzanine debt and $150 million of junior mezzanine debt, which
indebtedness is nonrecourse to KLC OpCo, the proceeds of which were primarily used to repay the
Acquisition Term Debt and the KinderCare CMBS Debt, and KLC PropCo leased its owned centers back
to KLC OpCo. See "KLC: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Fiscal Years Ended 2005, 2004 and 2003" in Appendix B, "KLC: Management's
Discussion and Analysis of Financial Condition and Results of Operations for the Quarterly Period Ended
April 1, 2006" in Appendix C, "KLC: Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Quarterly Period Ended July 1, 2006" in Appendix D and Notes 11 and 21 to
KLC's Financial Statements in Appendix E.
The discussion below presents the pro forma results of consolidated KLC (KLC OpCo and KLC PropCo)
as if the KinderCare acquisition and the Real Estate Transaction occurred on January 1, 2004. The pro
forma results are not adjusted for the costs of operating KLC and KinderCare in parallel for a significant
portion of 2005, or for restructuring costs incurred in combining the two businesses. These and other
items are reflected as adjustments to EBITDA in our presentation of pro forma Adjusted EBITDA.
Our pro forma results for KLC were not prepared in conformity with Article 11 of Regulation S-X of the
SEC (which would not, among other limitations, permit a 2004 pro forma presentation after completion of
our 2005 financial statements). In addition, by presenting a pro forma comparison, this discussion and
analysis does not include a comparison of KLC's historical GAAP consolidated operating results or
segment information that would be required by Item 3-03 of Regulation S-X of the SEC. The presentation
of non-GAAP information herein does not purport to comply with Item 10(e) of Regulation S-K or
Regulation G of the SEC. For further information see "KLC: Management's Discussion and Analysis of
Financial Condition and Results of Operations for the Fiscal Years Ended 2005, 2004 and 2003" in
Appendix B, "KLC: Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Quarterly Period Ended April 1, 2006" in Appendix C, "KLC: Management's Discussion
and Analysis of Financial Condition and Results of Operations for the Quarterly Period Ended July 1,
2006" in Appendix D and the KLC and KinderCare GAAP financial statements in Appendix E.
The pro forma presentation is not shown with adjustments to historical financial statements. Instead, it is
based on a "ground up" combination of corporate level expenditures (overhead and capital expenditures)
and internal financial statements derived from a center-by-center build up of KLC's results. The primary
reasons for the presentation based on internal reports instead of KLC and KinderCare financial
statements are the different fiscal year ends and expense classifications between KLC and KinderCare.
The "ground up" analysis presented is consistent with management's view of the business.
Key Operating Variables
Net Revenue Trends and Drivers
75
The vast majority of KLC's net revenues are derived from center operations. The trends and drivers
discussed below relate to such center operations.
KLC derives its net revenues primarily from the tuition it charges for attendance by children at its centers.
KLC's tuition rates and net revenues can be significantly impacted by the enrollment characteristics at its
centers. Key factors include (1) geographic location, because KLC can command higher tuition rates in
certain geographic areas; (2) the age mix of children enrolled, because tuition rates depend on the age of
the child and are generally higher for younger children; (3) the mix between full- and part-time attendance,
because KLC charges comparatively higher rates for part-time enrollment and (4) the level of participation
in government subsidy and discount programs.
KLC calculates its average weekly tuition rate as the actual tuition charged at centers that are open at the
calculation date, net of discounts, for a specified time period, divided by average "full-time equivalents," or
"FTEs" for the related time period. KLC's FTEs are calculated by dividing net revenue by the center's
undiscounted average pre-school tuition rate. FTEs do not necessarily reflect the actual number of full-
and part-time children enrolled.
Tuition rates at KLC's centers are typically adjusted once per year to coincide with the back-to-school
period. KLC typically collects tuition on a weekly basis in advance, the majority of which is paid by
individual families. KLC provides discounts to government agencies, employees, families with multiple
enrollments, referral sources and organizations KLC partners with for its employer-sponsored centers. In
its employer-sponsored centers, tuition may be partly subsidized by such employers.
Approximately 20% of KLC's net revenues are derived from tuition paid at varying levels of subsidy by
government agencies. KLC's revenues are therefore affected by changes in the levels of government
support for education, which are negatively impacted by weak economic conditions and resulting budget
pressure at federal, state and local governments.
KLC reports comparable center revenue trends based on the centers (other than the employer-sponsored
centers operated for a management fee) that were open in both periods. Comparable center net revenues
do not include revenues generated from centers that have been closed or sold.
Utilization is a measure of the utilization of center capacity. KLC calculates utilization as the total actual
child care revenues earned at centers that are open at the calculation date divided by the total potential
child care revenue (based upon the center's undiscounted pre-school tuition rate and the center's total
licensed capacity) during the related time period.
In addition to tuition charges, KLC records revenues from fees and other income in a majority of its
centers. KLC charges a reservation fee, typically at half of the normal tuition charge, for any full week that
an enrolled child is absent from its centers. KLC also collects registration fees and fees to cover
educational supplies at the time of enrollment and annually thereafter. KLC offers tutorial programs on a
supplemental fee basis in the majority of our centers in the areas of literacy and reading, foreign
language, mathematics and music. KLC also offers field trips, predominantly during the summer months,
for an additional charge. KLC's centers earn other miscellaneous revenue from various sources, including
management fees related to certain employer-sponsored centers. In addition to its child care operations,
KLC's subsidiary, KC Distance Learning, sells high school level courses via online and correspondence
formats and provides related instructional services directly to private students, as well as to cyber and
traditional schools and school districts.
Cost of Revenue — Trends and Drivers
KLC's costs of revenue include the direct costs related to the operations of its centers. Labor related costs
are the largest component of costs of revenue. KLC's time management and scheduling systems, which
enable us to adjust staffing levels for peak and reduced attendance periods, allow KLC to manage its
labor productivity without adversely impacting the quality of services within its centers.
76
Other costs recorded at the center level include rent, marketing, maintenance, utilities, transportation,
classroom and office supplies, insurance and food. KLC's management believes its large, combined
nationwide center base gives it the ability to leverage the costs of programs and services, such as
curriculum development, training programs and other management processes.
During fiscal year 2005, KLC experienced a reduction in projected claims costs for its self-insurance
programs. However, management anticipates that premium and claims costs will continue to reflect
market forces, which are beyond KLC's control.
The Real Estate Transaction did not affect consolidated rent expense, but resulted in an increase of
approximately $96.0 million in annual rent expense of KLC OpCo, which is leasing centers from KLC
PropCo which now has title to substantially all of KLC's owned real property.
Other Operating Expenses
KLC's other operating expenses include the costs associated with the field management and corporate
oversight and support of its centers and restructuring related expenses. Labor related costs are the
largest component of KLC's general and administrative expenses.
Seasonality
New enrollments are generally highest during the traditional fall "back to school" period and after the
calendar year-end holidays. KLC attempts to focus its marketing efforts to support these periods of high
reenrollments. Enrollment generally decreases somewhat during the summer months and the calendar
year-end holidays.
Results Discussion
Revenue increased to $1.48 billion in 2005, which represents an increase of $35.6 million over 2004.
Gross margin was $340.7 million during the 52 weeks ended December 31, 2005, an increase of $11.1
million, or 3.4%, compared to the same period last year. Adjusted EBITDA during the 52 weeks ended
December 31, 2005, was $238.0 million which was $6.6 million, or 2.9%, above the same period in 2004.
77
KLC Consolidated
2004PF   2005PF
Revenue   $1,442.2   $1,477.7
Revenue Growth   2.5%
Payroll and other   $725.0   $734.9
Rent   113.2   121.1
Other Operating Expenses   274.4   281.0
Gross Profit   $329.6   $340.7
Adjusted EBITDA   $231.4   $238.0
Adjusted EBITDA Margin   16.0%   16.1%
Adjusted EBITDAR   $344.5   $359.1
Adjusted EBITDAR Margin   23.9%   24.3%
Other Financial and Operating Data
Depreciation and Amortization   $97.1   $89.3
Interest Expense   89.9   89.9
Capital Expenditures   70.6   83.1
# of Centers (at year end)   2,021   1,934
Average Weekly Tuition (combined actual)   $156.61   $167.35
Utilization   61.6%   61.2%
Revenue. During the 52 weeks ended December 31, 2005, revenue increased $35.6 million, or 2.5%,
over the same period in 2004. The increase was primarily due to tuition rate increases, which took effect
in January 2005 and September 2005, offset by the impact of center closures and a slight decline in
Utilization. However, during the third quarter of 2005 Utilization levels increased versus the same period
in 2004, from 59.3% to 60.3%. This positive Utilization trend was repeated in the fourth quarter of 2005
as levels rose to 59.2% versus 58.9% in the comparable period of 2004. Management believes these
improvements reflect stronger economic conditions, strong back-to-school enrollments, marketing efforts
and other management initiatives and programs. ECE revenue increased $24.9 million, or 1.8%, in the
52 weeks ended December 31, 2005 compared to the same period of 2004. On a same center basis
(centers opened for more than one year), revenue increased 4.4% from 2004 to 2005.
KLC Consolidated Revenue
2004PF
2005PF
ECE Centers   $1,394.4   $1,419.3
School Partnerships   39.8   48.5
KCDL   8.0   10.0
Total   $1,442.2   $1,477.7
Cost of revenue and gross margin. Gross margin for the 52 weeks ended December 31, 2005 was
$340.7 million, or 23.1% as a percentage of sales, compared to $329.6 million, or 22.9% in the prior year.
Costs of revenue include the following:
78
• Salaries, wages and benefits. Salaries, wages and benefits were $734.9 million, or 49.7% as a
percentage of sales, during the 52 weeks ended December 31, 2005, compared to $725.0 million or
50.3%, for the same period in 2004.
• Rent Rent increased by $8.0 million to $121.1 million during the 52 weeks ended December 31,
2005, compared to the same period in 2004. The increase in rent was largely due to a center sale-
leaseback program conducted by KinderCare during 2004, prior to its acquisition by KLC. Pro forma
rent does not include $96.3 million of intercompany rent payable by KLC OpCo to KLC PropCo as a
result of the Real Estate Transaction.
• Other costs. Other costs include costs directly associated with the centers such as business
insurance, food, marketing, maintenance, utilities, transportation and classroom and office supplies.
Other costs were $281.0 million during the 52 weeks ended December 31, 2005, compared to $274.4
million in the same period last year. Other costs were 19.0% of revenue during both years.
General and administrative expenses. General and administrative expenses, which include costs
associated with the field and corporate oversight and support of KLC's centers, were $126.0 million during
the 52 weeks ended December 31, 2005, compared to $126.4 million for the same period in 2004.
General and administrative expenses included the substantial majority of estimated temporary parallel
organization costs of $28.1 million and $23.3 million in 2004 and 2005, respectively, as discussed below.
Adiusted EBITDA. Adjusted EBITDA was $238.0 million during the 52 weeks ended December 31, 2005
compared to $231.4 million in 2004. The increase in Adjusted EBITDA was primarily a result of slightly
higher revenue and gross margin improvements enhanced by lower general and administrative costs
before non-cash SAR accruals, net of restructuring charges and parallel organization costs. The table
summarizes KLC's calculation of Adjusted EBITDA as defined in KLC's existing revolving credit
agreement. See "Non-GAAP Financial Measures" for a discussion of our use of performance measures
and related limitations.
79
KLC Consolidated
2004PF   2005PF
EBITDA   $194.6   $174.7
Adjustments to EBITDA
Restructuring Charge Addbackl   5.1   29.4
(Gains) / Losses on Sales2   2.1   (1.3)
(Gain) / Loss on Minority Investment   (2.1)   0.0
Dividend Income3   (1.8)   (0.5)
SAR Plan4   0.0   9.9
IDS Expenses5   2.7   (0.0)
Estimated Parallel Organization Costs6   28.1   23.3
Management Fee7   2.5   2.5
Adjusted EBITDA   $231.4   $238.0
Represents one-time, non-recurring costs of integrating the AER and KinderCare acquisitions in 2004 and
2005, respectively.
2 Represents the non-cash impact of (gains)/ losses on the sales of centers.
3 Income earned as a result of ownership in a minority investment.
4 Non-cash expenses related to KSI's Stock Appreciation Rights Plan attributed to KLC's employees and payable
by KSI in cash upon settlement. $7.8 million has been paid pursuant to SARs in connection with the departure
of KLC's chief executive officer in 2006.
5 In 2004, KinderCare contemplated an offering of income deposit securities. Costs here reflect the costs
incurred as a result of the contemplated offering.
6 Result of the costs of operating duplicative infrastructure at KLC and KinderCare following the KinderCare
acquisition.
Management fee paid to affiliate entities.
Restructuring charges. Restructuring charges during the 52 weeks ended December 31, 2005, were
$29.4 million. Included in the $29.4 million of non-recurring integration costs were $11.0 million of
severance costs that resulted primarily from the closure of KLC's former corporate offices at Golden, CO.
Additional restructuring costs in 2005 were the result of consulting, temporary contract-based labor and
other charges. Restructuring charges in 2004 were $5.1 million and were related to KLC's acquisition of
AER in May 2003.
Parallel Organization Costs. For much of 2005 KLC was burdened with the central operations and
infrastructure of both KinderCare and KLC. KLC has defined parallel organization costs as the cost of
maintaining these duplicative corporate functions during the overhead rationalization associated with the
KinderCare acquisition. KLC believes that approximately 70% of parallel organization costs are related to
salaries. Remaining parallel organization costs are related to upkeep, maintenance and utilities at
corporate facilities. During the first month of 2006 parallel organization costs had been reduced to
$174,042 (annualized run-rate of $2.1 million) compared to an estimated $23.3 million in 2005.
Parallel organization costs for the 2004 fiscal year are estimated based on an annualized run-rate based
on the costs incurred during the first month following the KinderCare acquisition. During that month
(January 2005), KLC incurred approximately $2.3 million of parallel organization costs ($28.1 million on
an annualized run-rate basis).
Interest. Interest expense in 2004 and 2005 is almost identical because both years are pro forma for the
financings associated with the Real Estate Transaction, which refinanced the indebtedness incurred to
finance the KinderCare acquisition. In 2005 pro forma interest expense of $89.9 million includes $5.1
million of non-cash interest expense. Actual interest expense during the 2005 fiscal year was $80.7
million which did not include $32.2 million related to the early extinguishment of debt.
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Capital Expenditures. The following table shows the breakdown in KLC's projected capital expenditures:
KLC Consolidated
2004PF   2005PF
Maintenance   $34.4   $36.6
New Centers   26.4   32.4
IT Spending and Other Capex   9.8   14.0
Total Capital Expenditures   $70.6   $83.1
In 2004 and 2005, KLC spent $34.4 million and $36.6 million, respectively on maintenance capital
expenditures, which includes refurbishment of its existing centers and equipment and supplies
replacement costs. In addition, KLC spent $9.8 million in 2004 on corporate infrastructure improvements,
primarily IT spending compared to $14.0 million in 2005. The remainder of KLC's capital expenditures
was used to expand KLC's center base through both purchases of furniture, fixtures and equipment and
construction of new owned centers.
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11. THE OPERATING COMPANY ("KLC OPCO")
KLC's mission is to provide a quality education to children from birth to college. KLC was formed from the
combination of KLC and AER which occurred in May 2003 and the subsequent acquisition of KinderCare
in January of 2005. Based in Portland, Oregon, KLC consists of (i) KLC OpCo, a collection of operating
companies and (ii) KLC PropCo, a collection of special purpose subsidiaries owning substantially all of
KLC's real estate.
11.1. KLC OpCo
KLC OpCo is the largest for-profit provider of ECE and care services in the U.S., the second largest
provider of employer-sponsored ECE to the corporate segment in the U.S. and the largest for-profit
provider of before and after school programs in the U.S. Through one of its subsidiaries, KLC OpCo also
operates accredited high school distance learning programs that have served over 200,000 students
since 1975. On a pro forma basis for the fiscal year ended December 31, 2005, KLC OpCo generated
revenue and Adjusted EBITDA of $1,477.7 million and $149.9 million, respectively.
KLC OpCo Business Units
KLC OpCo
Early Childhood Education ("ECE")
(Community (Employer
Centers) Sponsored Centers)
1,812 centers 122 centers
90% of Pro Forma 6% of Pro Forma
Revenue Revenue
School Partnerships
(Before and after school care)
573 sites
3% of Pro Forma Revenue
Distance Learning
(Online Education)
1% of Pro Forma Revenue
11.2. Early Childhood Education Unit (96% of Pro Forma FYE December 31, 2005
Revenue)
As of FYE December 31, 2005, KLC OpCo provided ECE services through its 1,812 company-operated
community centers (90% of pro forma revenue) and 122 employer-sponsored centers (6% of pro forma
revenue). In total the ECE Unit operated 1,934 centers in 39 states and Washington D.C., offering ECE
programs primarily for children aged six weeks to five years. The programs are marketed primarily under
the KinderCare, Children's World, Children's Discovery Centers, Knowledge Beginnings and Mulberry
Child Care & Preschool brand names.
KLC OpCo's centers typically contain classrooms, recreational areas, kitchens and bathroom facilities.
The centers usually accommodate the grouping of children according to age. The centers have outdoor
playgrounds, often with separate areas designed for infants and toddlers, with the exception of some
downtown urban centers that may utilize nearby parks. Each center is equipped with a variety of audio
and visual aids, educational supplies, games, toys and indoor and outdoor play equipment. In addition,
most of the centers are equipped with personal computers with programs specifically designed for both
pre-school and school-age children. The typical center can serve between 120-140 students, although
actual enrollments can be higher as some children are enrolled on a part-time basis. Children are usually
enrolled on a weekly basis for either full-day or half-day sessions. Most centers provide enrolled children
with meals and two snacks.
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KLC OpCo provides a wide range of quality programs that are continuously updated to reflect current
thinking and to meet the needs of individual children. Programs have been developed in conjunction with
nationally recognized experts in ECE and various curricula reflect the latest research in brain
development. Programs stimulate the social, emotional, intellectual and physical needs of children and
each program is age appropriate.
KLC OpCo's ECE facilities are generally open throughout the year, usually five days a week, from 6:30
a.m. to 6:30 p.m. New enrollments are most often highest in September and January, with the largest
decrease in enrollment during holiday periods and summer months. Many centers offer summer day
camp programs for children up to the age of 12. Additionally, many centers offer "back-up" care, which is
offered in the event that the parent's primary child care arrangement is unavailable (e.g., when an in-
home provider goes on vacation). The company will provide short-term child care until the parent's child
care resumes.
Community Centers
The 1,812 community centers are located in diverse demographic locations. Newly built centers tend to
be located in the targeted demographic market of newer upper-middle class to upper income suburban
areas with high concentrations of dual income families. In a community center, the current weekly tuition
rates for full-day service range from $90 to $400 per child, depending upon the center location and the
age of the child. KLC OpCo also offers tutorial programs in areas such as literacy, reading, foreign
languages and mathematics in many of its centers for a supplemental fee and is exploring offering
additional supplemental fee programs. Tuition is generally paid in advance on a weekly basis and, to a
lesser extent, on a monthly basis. The company typically sets tuition for half-day programs at a 20% to
40% premium compared with an equal number of hours for a full-day program. Approximately 20% of
tuition is paid under state and federal subsidy programs.
Employer-Sponsored Centers
As of FYE December 31, 2005, KLC OpCo operated 122 corporate or employer-sponsored centers.
These centers are typically free-standing, and are located at or near the premises or campus of the
employer-sponsor. These sites are different from community centers in that they usually have more
square footage per child and larger staff areas. Generally, the corporate sponsor provides the
constructed building. KLC OpCo currently has relationships with a diverse group of employers, including
hospitals, health care facilities, government agencies, and private sector companies. Its corporate
relationships include, but are not limited to, the following: AOL Time Warner, TRW, Lockheed Martin, the
World Bank Group, Fox, Maytag, Northrop, TJ Maxx, the National Security Agency, the Mayo Clinic and
Stanford University.
Employer-sponsored centers are operated either on a fixed-fee basis (31 centers) or on a profit-and-loss
basis (91 centers). Under the former, KLC OpCo receives a fixed fee per month, typically irrespective of
occupancy. In these contracts, the Company collects tuition on behalf of the employer sponsor. Under a
profit-and-loss contract, KLC OpCo collects tuition for its own account, generally with no guaranteed fees
from the employer. In some cases, its operations are subsidized by the employer, typically in the form of
tuition subsidies, free or reduced rent, the provision of certain services such as maintenance, landscaping
and janitorial services or enrollment guarantees. This enables the company to utilize the subsidies for
improved staff quality and teacher / child ratios.
Contract terms typically average between one and five years. Normally the management centers are
reserved for children of the corporations' employees. Some contracts provide for accepting non-
employee children, for which the company can often charge a higher tuition.
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11.3. School Partnerships Unit (3% of Pro Forma EYE December 31, 2005 Revenue)
Through the School Partnerships Unit, KLC OpCo provides customized before and after school
educational enrichment and recreational programs for school age and preschool children in partnership
with elementary schools. KLC OpCo provides these partnership services primarily through 573 sites in 20
states. Average tuition ranges from $35—$75 per week, payable in advance. Parents account for 94% of
total tuition received, while state and grant subsidies account for the remaining 6%.
These before and after school programs are typically conducted in collaboration with public schools and
located on-site at public school campuses. The success of the programs has led to the development of
summer camps, remedial programs, and drop-in care. Programs are operated under the Champions
name. Because each program is relatively small (approximately 40 children per program), operating
costs associated with running each program are minimal. Little or no capital investment is required and
the contracting school typically provides on-site space for the program. Contract tenures range from one
year to evergreen. They often stipulate that KLC pays minimum fees to the elementary schools for use of
facilities.
KLC OpCo's November 2004 acquisition of EdSolutions, Inc. ("ESI") provided it entry into the
Supplemental Education Services ("SES") tutoring business. The SES business is part of the federal No
Child Left Behind Act's effort to improve the performance of students at failing schools. KLC OpCo
operates 72 SES sites. ESI is approved to provide SES in 19 states and our plans call for ESI to serve as
a platform for future growth for KLC.
11.4. Distance Learning (1% of Pro Forma FYE December 31, 2005 Revenue)
Through its wholly owned subsidiary, KCDL, KLC OpCo also operates accredited high school distance
learning programs that have served over 200,000 students since 1975. Based in Portland, Oregon,
KCDL operates Keystone National High School and iQ Academies. Keystone National High School is
one of the largest and most experienced accredited high school distance learning programs in the country.
Keystone is a private, diploma granting school with parents or schools paying for individual courses
and/or complete curriculum. Keystone served over 14,000 students in 2005 and offers more than 60
distance learning courses. iQ Academies develops and manages online charter schools. It currently
operates one school in Wisconsin, is working on the approval process for another charter in California,
and has plans to begin several more charters in the next 12 months. iQ Academies provides support
required to launch and operate an online high school including curriculum, instruction, technology,
marketing and support. Though only 1% of KLC OpCo's pro forma revenues, KCDL is highly profitable
and accounts for almost 2% of KLC OpCo's pro forma Adjusted EBITDA.
11.5. Business Strategy
KLC OpCo's strategy is to drive revenue growth and enhance profitability through a combination of the
following initiatives:
• Expansion of existing business lines. Management believes that the opportunity exists to significantly
expand the scope of its existing business lines:
— Community centers. KLC OpCo has substantial experience in selecting and opening new
community centers. Over the next six years KLC OpCo plans to open 195 new centers which are
expected to generate approximately $200 million of gross revenue.
Employer-sponsored centers. KLC OpCo expects to continue the expansion of its employer-
sponsored centers. Over the next six years KLC OpCo plans to open 124 new centers with gross
revenue of approximately $120 million.
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• Rationalize centers to improve overall strategy and quality of network Management closely monitors
underperforming centers and looks to rationalization opportunities which generally lead to improved
Utilization and higher EBITDA generation.
— As part of its rationalization, KLC OpCo has identified 50 centers which it intends to close and will
continue to evaluate underperforming centers. As a result, over the next six years KLC OpCo
expects to close approximately 250 centers with a decrease in revenues of approximately $120
million. While the closure of underperforming centers decreases KLC OpCo's revenue,
rationalization is expected to increase both EBITDA and Adjusted EBITDA margins.
• Strategic acquisitions. The childcare market remains highly fragmented with for-profit chains
comprising only 5% of the entire market. There are over 386,000 family-owned and operated centers,
with each providing services to fewer than 13 children. KLC OpCo believes there are many
opportunities to consolidate some of the family-run centers as well as some of the larger regional
providers.
• Offer new products and services. KLC OpCo estimates that it services more than 200,000 families in
a given year. KLC OpCo's scope of operations makes it ideally positioned to market other products
and services through its learning centers. KLC OpCo has already sold several additional lines of
educational products and services at test locations including supplemental phonics, math, Spanish
and music courses. KLC OpCo believes that product and service lines can be expanded to include
additional educational and non-educational offerings such as medical insurance and student financing
programs.
• Initiation of the Spirit of Service Program. The fundamental assumption of the Spirit of Service
program is that sales are not separate from service—both are driven by relationships. To that end, the
Spirit of Service program was designed to promote revenue growth by building a sales-oriented culture
while increasing customer / parent engagement. Currently, KLC OpCo's management team is working
with consultants from Cypress Consulting and the Gallup Organization to:
— Understand and evaluate current practices and expectations regarding sales and service;
— Provide reliable data to help grow enrollments through a better understanding of families who have
disenrolled and KLC OpCo's current customers;
— Develop the sales and coaching skill necessary to support requisite practices and behaviors; and
____ Institutionalize practices, systems and incentive plans to ensure a sustainable focus and culture
built around sales and customer service.
11.6. Sales and Marketing
Early Childhood Care and Education
Community Centers. KLC OpCo's target market is middle-class to affluent ($70,000+ household income),
highly educated parents working or residing near the center. Target parents are white-collar workers and
are usually dual-income families. KLC looks for sites where it believes the market for its services will
support tuition rates higher than current average rates.
Management believes KLC OpCo distinguishes its services by developing and introducing high quality
curricula and programs that incorporate both learning and enjoyable activities held in a safe and
child-friendly environment. KLC OpCo markets its services through online channels (including strategic
click through advertisement placements), as well as traditional methods, such as display advertisements,
listings in the yellow pages, newspaper advertisements, distribution of flyers at schools and community
functions, and center open house events. KLC OpCo spends a large portion of its advertising budget
during the summer months in anticipation of the fall enrollment period, with continued advertising
throughout the year. The primary source of new enrollments is recommendations from customers in the
communities in which KLC OpCo operates. Center directors are also involved in the marketing process
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by encouraging parental involvement in the centers through monthly newsletters and reports,
parent-teacher conferences and parental visits to, and inspections of, the centers.
Although most of the marketing efforts are performed at the field level, corporate headquarters assists
centers in developing marketing programs, designing campaigns, preparing marketing brochures,
strengthening the brand name, identifying strategic partners, and providing advice on ways to advertise
and market the programs at the local level. In addition, KLC OpCo is actively involved in teaching the
staff and directors business enhancing skills, such as cost management, local marketing and customer
relations.
Employer-Sponsored Centers. Services that KLC OpCo provides to employers include onsite and near-
site center operation, backup care, discount programs, holiday care and consulting services. KLC OpCo
has dedicated sales personnel focused on expanding its presence in this market. It also markets its
services through relationships with consultants, attendance and presentations with clients at trade shows,
networking at conferences and through industry alliances and publications. KLC OpCo responds to
requests for proposals, referrals from current clients and prospects to targeted mid-market centers for
transition opportunities through mailings and networking. It also targets Fortune 1000 companies for its
discount and nationwide backup care services which serve large distributed workforces.
Marketing to employers or corporate sponsors largely takes place at the corporate level. KLC OpCo
markets to parents through its employer sponsors and occasionally through contracted resource and
referral agencies. KLC OpCo is finding that the preferred method is through electronic brochures and
messages as well as dedicated websites for onsite centers and services. KLC OpCo provides hardcopy
materials and promotional giveaways primarily through employer-sponsored benefit fairs and events on
client campuses. The centers engage parents and potential parents through brown bag lunch seminars,
open houses, and visibility tables in client cafeterias and common areas.
School Partnerships
Champions Programs. KLC OpCo positions its Champions school age, preschool and summer programs
as exciting combinations of learning and fun. It relies primarily on a regional, direct sales force in
effecting a two tiered sales and marketing approach. The first tier consists of selling the Champions
service at the appropriate administrative level in the school. This selling generally occurs at the
superintendent or principal level. Selling to administrators is necessary since the majority of Champions'
programs rely solely on the use of existing school infrastructure. The- sales and marketing effort in this
tier involves participation in trade shows, featured articles in trade journals, trade magazine advertising
and news releases. KLC OpCo believes that these efforts have been successful in heightening brand
awareness, and as such, has enabled its sales force to gain access to entire districts versus individual
schools.
Once a Champions program receives the endorsement of the appropriate decision-maker, the second tier
of the sales and marketing effort begins, which targets the parents of children attending the sponsor
school and, in some cases, nearby schools. Marketing is conducted primarily through flyers, open
houses and school newsletters.
Supplemental Education Services. The sales and marketing process for SES tutoring involves several
steps. First, KLC OpCo must seek approval to provide services in a state through a request-for-proposal
process. This process entails detailed descriptions of the curriculum provided and how it correlates with
state standards, testing and accountability, the operational model to be provided and company
background information. Once approval is obtained at the state level, KLC OpCo contacts districts it is
interested in serving, and requests that it be added to the list of approved providers. At the same time
that it makes the initial contact with districts, it also contacts local schools, often through such schools'
SES coordinator, and subsequently with the parents at each school.
Once KLC OpCo has been approved by the state, district and the schools, it competes with multiple SES
providers selling to individual parents, who are the ultimate decision makers in terms of selecting a
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provider. Many providers are currently offering incentives to children and families to enroll with them and
some are offering incentives to schools as well. The key challenge in marketing the SES programs to
families is offering something that is appropriate and that will add educational value for families while
enticing the children to participate. KLC OpCo believes there is a much larger number of children eligible
for services than the number that attend programs and therefore an opportunity exists to improve
marketing and outreach to families.
Identifying prospects involves targeting urban areas where there is a cluster of failing schools. Failing
schools are schools that fail to meet established NCLB requirements for three years in a row. After the
second year of failure the schools have to offer several services in order to prevent being named a failing
school. This enables KLC OpCo to project the approximate number of schools that will be considered
failing in the next school year and help identify states to pursue and markets that warrant further attention.
KLC OpCo is currently authorized to provide SES in 19 states and has already begun providing SES in
five of them. KLC OpCo believes the SES business provides an opportunity for growth.
On August 29, 2006, KLC acquired 100% of the membership interests in Education Station, LLC
("Education Station") from Catapult Learning LLC ("Catapult"), a subsidiary of Educate, Inc. (together with
Catapult, "Educate") Education Station is a private provider of supplemental educational services under
the NCLB and other educational instruction and after school services. The purchase agreement provides
for an aggregate purchase price of $6.0 million with $3.0 million paid into escrow at closing, and $1.0
million payable on each of the first three anniversaries of the closing date. The amount in escrow is
payable to Educate on three specific dates during the period beginning ninety days from the closing date
and ending on July 31, 2007 upon the renewal by Education Station of certain contracts which were in
place applicable to the 2005-2006 school year. Also on August 29, 2006, KLC and Educate entered into
a technology license agreement where Educate granted a license to KLC of certain proprietary software
used in providing real-time online NCLB services. The term of the license agreement is four years and
provides for a license fee of $10 million payable in three installments of $3.0 million within 30 days
following each of the first three anniversaries of the closing date and a final installment of $1 million within
30 days following the fourth anniversary. KLC believes that the acquisition of Education Station makes it
the largest for-profit provider of supplemental education services under the NCLB in the U.S.
Distance Learning
KLC OpCo markets its distance learning products to two distinct customer groups: the home school
market and schools. Purchases made into the home school market are driven by web-based marketing
efforts and trade associations along with a direct mail campaign. Purchases made by schools are
marketed to counselors and administrators through direct mail and telemarketing efforts.
11.7. Curriculum
KLC OpCo believes that it can increase enrollment in its centers by continuing to develop and introduce
high quality curricula and programs that provide parents with meaningful reasons to choose the centers
for their children over other alternatives. It has designed research-based, proprietary curricula for age-
specific educational and recreational programs to develop a child's social, intellectual and physical skills
and distributed curriculum manuals for each age group to its centers. These programs are used as a
framework, within which individual teachers have flexibility to create daily instruction opportunities that are
tailored to the needs of each class.
The curriculum covered by the "Early Foundations" program is carefully designed to support school
readiness. Activities are developed and implemented based on an expansive, research-based framework
of educational objectives. These objectives mirror well documented early learning standards. Frequent
assessment insures both program quality and desirable child outcomes.
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The Early Foundations program focuses on providing individual learning opportunities that are flexible
and appropriate to each child's development level. KLC OpCo believes that the Early Foundations
program distinguishes the Company from other child care providers.
11.8. Management Team and Board of Directors
KLC OpCo is led by a highly experienced management team comprised of experts in the field of
education, as well as business professionals. This combination of talent is expected to drive continued
success of KLC OpCo. These individuals are also supported by a seasoned executive and middle
management team with average Company tenure of ten years. The following table sets forth KLC OpCo's
management team and the board of directors of its parent company, KSI. Detailed biographies can be
found in Appendix A.
Management of KLC
Name
Elanna Yalow
Mark Moreland
Toni Jaffe
Eva Kripalani
Marcy Suntken
Dan Frechtling
Sharon Bergen
Stephen Brown
Name
Les Biller
Position
Director, President and Chief Operating Officer
Executive Vice President & Chief Financial Officer
Senior Vice President, Human Resources
Senior Vice President, General Counsel and
Corporate Secretary
Senior Vice President, School Partnerships
Senior Vice President, Marketing and Business Development
Senior Vice President, Education and Training
President and Chief Executive Officer, KCDL
Non-Employee Directors of Knowledge Schools Inc. ("KSI")
Position
Retired Vice Chairman and Chief Operating Officer of Wells
Fargo & Company. KUE Advisory Board
Ralph Finerman President of RFG Financial Group, Inc.
Stephen Goldsmith Professor of Government at Harvard University's Kennedy
School of Government. Senior Vice President of KUE
Steven Green Chairman and CEO of kl Ventures and Greenstreet Real
Estate Partners. Vice Chairman of KUE
Stanley Maron Senior shareholder in the law firm Maron & Sandler
Lowell Milken Chairman of KSI Board, President and Chief Executive Officer
of KUE
Wendi Murdoch Advisor to News Corporation
Jeff Safchik Co-founder, Managing Director and Chief Financial Officer of
Greenstreet Real Estate Partners. Chief Financial Officer of
KUE
Richard Sandler Shareholder in the law firm Maron & Sandler. General
Counsel for KUE
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11.9. Employees
As of December 31, 2005, KLC OpCo employed approximately 40,000 non-unionized personnel. Of the
total amount, 39,639 are employed at the field level (including teachers and center staff, center directors,
facilities and field and regional staff) and 592 are employed at the corporate level. Given the seasonality
of the child care business and the regulated teacher-student ratio that varies by age with each state,
approximately 16.5% of the total field personnel are employed on a part-time basis. Teachers and
teaching assistants, which account for 93% of the total employee pool, are paid on an hourly basis. Most
of KLC OpCo's remaining employees, including District Managers as well as most corporate staff, are
salaried. KLC believes that its relations with its employees are good.
KLC OpCo's management believes that its below-industry average turnover rates are a result of its hiring
practices and closer involvement in center operations, a focus on treating teachers as educators and not
just employees, and comprehensive training programs that are designed to ensure that teachers are
successful. KLC OpCo believes that it has the opportunity to reduce employee turnover further through
improved recruiting, training and management.
The following table presents   a breakdown of employees as of December 31, 2005:
KLC Employee Breakdown
Employee Type   Number
Teachers and Center Staff   37,440
Center Directors   1,874
Corporate   592
Facilities   218
Field / Regional Staff   107
Total   40,231
11.10. Accreditation
KLC OpCo pursues accreditation of its centers by accrediting bodies, primarily the National Association for
the Education of Young Children (referred to herein as "NAEYC"), the nation's leading child care
accreditation body. NAEYC accreditation criteria cover a wide range of quantitative and qualitative factors,
including, among others, faculty qualifications and development, staffing ratios, health and safety and
physical environment. NAEYC criteria generally are more stringent than state regulatory requirements. As
of December 31, 2005, KLC OpCo had 831 or approximately 43% of its total ECE centers that were
accredited by NAEYC. Of the approximately 117,000 licensed centers in the U.S., approximately 10%
are accredited by NAEYC.
Management believes that substantially all of its centers' operations and policies adhere to or are
substantially compliant with NAEYC accreditation requirements. Since the accreditation process is
expensive, KLC OpCo intends to seek accreditation only where it believes accreditation will provide
meaningful local marketing benefits or competitive advantages.
11.11. Licensing and Government Regulation
Each early childhood care and education center and most school programs must be licensed under
applicable state or local licensing laws. Responsibility for licensing and compliance with government
regulations is at the regional and local level. Licenses are held at the center level or by the school
program and are typically good for a minimum of one year. Generally, the center or school program will
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reapply for a license on an annual basis, and that process may include a visit from the applicable state
regulator. Renewal of a license is generally a fairly routine process.
In addition, each ECE center or school program is subject to a variety of state and local regulations.
Although these regulations vary greatly from jurisdiction to jurisdiction, governmental agencies generally
review the safety, staff qualifications, fitness and adequacy of the buildings and equipment; the ratio of
staff to children; the dietary program; the daily curriculum and compliance with health and transportation
standards. In most jurisdictions, these agencies conduct scheduled and unscheduled inspections of
locations. Repeated failures by a location to comply with applicable regulations can subject it to
sanctions that might include probation or, in more serious cases, suspension or revocation of the center's
or program's license to operate and could also lead to sanctions against the Company's other centers or
programs located in the same jurisdiction. In addition, this type of action could lead to negative publicity
extending beyond that jurisdiction.
KLC OpCo generally seeks to operate centers and school programs in states with strict regulations in
order to avoid unexpected expense and market disruption that may be caused by compliance with
regulations adopted in states that previously lacked such regulations.
KLC OpCo believes that its operations are in substantial compliance with all material regulations
applicable to its business. However, a licensing authority may determine that a particular center or school
program is in violation of applicable regulations and may take action against that center or program and
possibly other centers in the same jurisdiction. In addition, there may be unforeseen changes in
regulations and licensing requirements, such as changes in the required ratio of child center staff
personnel to enrolled children, which could have a material adverse effect on KLC OpCo's operations.
States in which KLC OpCo operates routinely review the adequacy of regulatory and licensing
requirements and implement changes which may significantly increase its costs to operate in those states.
The SES programs are operated in substantial compliance with the federal No Child Left Behind Act, as
well as applicable state Department of Education regulations that vary from state to state, but generally
regulate curriculum, staff qualifications, and program quality and effectiveness. KLC OpCo must receive
approval from each state's Department of Education in order to qualify as an SES provider. The length of
approval to be an SES provider varies, but is typically from one to five years. Repeated failure by an SES
provider to comply with regulations or its request for proposal documentation may cause the provider to
lose its approval.
Federal regulations and licensing requirements require compliance with minimum standards in order to
qualify for participation in federal assistance programs. Under the Social Security Act, the U.S. federal
government has established programs to assist low-income families with early childhood care and
education expenses. These programs include the Childcare and Development Block Grant and At Risk
Program. Funding is typically provided through block grants to states and counties, which then
administer the programs through local agencies.
The federal Americans with Disabilities Act, referred to as the ADA, and similar state laws prohibit
discrimination on the basis of disability in public accommodations and employment. Compliance with the
ADA requires that public accommodations reasonably accommodate individuals with disabilities and that
new construction or alterations made to commercial facilities conform to accessibility guidelines unless
structurally impracticable for new construction or technically infeasible for alterations. Non-compliance
with the ADA could result in the imposition of injunctive relief, fines, an award of damages to private
litigants and additional capital expenditures to remedy such noncompliance. KLC OpCo has not
experienced any material adverse impact as a result of these laws.
Section 21 of the U.S. Internal Revenue Code of 1986, as amended (the "Code"), provides for an income
tax credit ranging from 20% to 35% of certain child care expenses subject to certain maximum limitations.
The fees paid to KLC OpCo for early childhood care and educational services by eligible taxpayers qualify
for the tax credit, subject to the limitations of the Code. In addition, Section 45F of the Code provides
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incentives to families and employers to offset costs related to employer-provided child care facilities.
However, these tax incentives are subject to change.
KLC OpCo is also subject to the Fair Labor Standards Act, which governs such matters as minimum
wages, overtime compensation and working conditions. All of KLC OpCo's employees are paid at rates
equal to or higher than the federal minimum wage.
KLC OpCo is also subject to laws regulating its transportation of children. In 1998, the National Highway
Traffic Safety Administration, or NHTSA, issued interpretive letters stating that automobile dealers may no
longer sell 12 to 15-passenger vans intended to be used for the transportation of children to and from
school by child care providers and that any vehicle designed to transport 11 persons or more must meet
federal school bus standards if it is likely to be used significantly to transport children to and from school
or school-related events. These interpretations and related changes in state and federal transportation
regulations have affected the type of vehicle that the company may purchase for use in transporting
children between schools and its centers and, in effect, required KLC OpCo to replace its remaining fleet
of vans with school buses over time. These changes have increased the company's costs to transport
children because school buses are more expensive to purchase and maintain and, in some jurisdictions,
require drivers with commercial licenses.
11.12. Insurance
KLC OpCo's insurance program currently includes the following types of policies: workers' compensation,
commercial general liability, automobile liability, property, excess "umbrella" liability, directors' and
officers' liability and employment practices liability. These policies provide for a variety of coverages,
which are subject to various limits, and include substantial deductibles or self-insured retentions. Special
insurance is sometimes obtained with respect to specific hazards, if deemed appropriate and available at
a reasonable cost. Claims in excess of, or not included within, KLC's coverage may be asserted or
coverage may not be available due to insurance company failures or other reasons.
KLC OpCo maintained either a self-insured retention or a deductible for a portion of its general liability,
workers' compensation, auto, property and employee medical insurance programs. It purchases stop
loss coverage in order to mitigate its potential future losses. The nature of these liabilities, which may not
fully manifest themselves for several years, requires significant judgment. KLC OpCo estimates the
obligations for liabilities incurred but not yet reported or paid based on available claims data and historical
trends and experience, as well as future projections of ultimate losses, expenses, premiums and
administrative costs. While the company believes that the amounts accrued for these obligations are
sufficient, any significant increase in the number of claims and/or costs associated with claims made
under these programs could have a material adverse effect on the consolidated financial statements.
11.13. Legal Issues
KLC OpCo does not believe that there are any pending or threatened legal proceedings that, if adversely
determined, would have a material adverse effect on its business or operations. However, it is subject to
claims and litigation arising in the ordinary course of business, including claims and litigation involving
allegations of physical or sexual abuse of children. Although KLC OpCo cannot be assured of the
ultimate outcome of the allegations, claims or lawsuits of which it is aware, it has not historically had to
pay any claims exceeding its insurance coverage, and management believes that none of these
allegations, claims or lawsuits, either individually or in the aggregate, will have a material adverse effect
on the Company's financial position, operating results or cash flows. In addition, it cannot predict the
negative impact of publicity that may be associated with any such allegation, claim or lawsuit.
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11.14. Real Estate
As a result of a November 9, 2005 Real Estate Transaction, substantially all of the real estate owned by
KLC OpCo was transferred to KLC PropCo. Although the expectation is that newly acquired real estate
will be owned by KLC PropCo and leased back to KLC OpCo, KLC OpCo continues to be actively
involved in new center design, development and management. In addition to development of new
centers, the team is responsible for maintaining existing centers. The real estate group within KLC OpCo
is headed by Wayne Pipes, Vice President.
11.15. Environmental
KLC OpCo is not aware of any existing environmental conditions that currently or in the future could
reasonably be expected to have a material adverse effect on its financial position, operating results or
cash flows. It has not incurred material expenditures to address environmental conditions at any property.
However, it has not undertaken an in-depth environmental review of all of its owned and leased centers.
Consequently, there may be material environmental liabilities of which it is unaware.
In addition, future laws, ordinances or regulations may impose material environmental liability, and the
current environmental condition of the centers may be adversely affected by conditions at locations in the
vicinity of those centers (such as the presence of leaking underground storage tanks) or by third parties
unrelated to the company.
11.16. Summary Financial Information and Projections Discussion
The following summary historical and projected financial data should be read in conjunction with the
financial statements and "Management's Discussion and Analysis of KLC's Pro Forma Results of
Operations" presented elsewhere in this Memorandum. See also "Non-GAAP Financial Measures"
elsewhere in this Memorandum for a discussion of the derivation and limitations of Adjusted EBITDA and
Adjusted EBITDAR. The historical information is pro forma for the effects of the acquisition of KinderCare
in January 2005 and the separation of KLC into KLC OpCo and KLC PropCo in November 2005, as if
those transactions and related financing had occurred on January 1, 2004.
KLC OpCo's pro forma results reflect KLC's consolidated pro forma results adjusted to include $96.3
million of rent expense payable to KLC PropCo.
Projected results presented below are based on assumptions management believes to be reasonable,
but which are inherently uncertain and may not be realized. KLC OpCo's ability to perform as projected
depends on a number of variables that cannot be predicted with certainty and actual performance could
be adversely affected by a number of factors, including those described in "Risk Factors," particularly the
risk factor related to projections elsewhere in this Memorandum. Also see "Forward-Looking Statements."
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KLC OpCo Summary Historical Pro Forma and Projected Financials
($ in millions)   Fiscal Year Ended December 31,
2004PF   2005PF   2006P   2007P   2008P   2009P   2010P   2011P
OPERATIONAL DATA
Revenue   $1,442.2   $1,477.7   $1,557.8   $1,656.5   $1,769.6   $1,919.7   $2,095.8   $2,290.8
Growth   2.5%   5.4%   6.3%   6.8%   8.5%   9.2%   9.3%
Gross Profit   $233.3   $244.4   $290.7   $320.6   $354.0   $396.2   $448.2   $501.3
Adjusted EBITDA   $143.3   $149.9   $161.7   $179.9   $204.8   $237.5   $279.0   $320.1
Margin   9.9%   10.1%   10.4%   10.9%   11.6%   12.4%   13.3%   14.0%
Adjusted EBITDAR   $352.8   $367.4   $371.4   $391.4   $419.6   $459.7   $510.8   $568.6
Margin   24.5%   24.9%   23.8%   23.6%   23.7%   23.9%   24.4%   24.8%
Operating Income   $27.1   $78.9   $101.6   $117.8   $146.9   $179.5   $212.4
Total Interest Expense   23.5   23.6   23.5   23.4   23.3   23.1   22.9
Net Income'   $1.6   $31.1   $46.0   $56.9   $77.4   $98.3   $117.9
BALANCE SHEET DATA
Cash   $118.8   $154.2   $215.8   $288.5   $373.7   $484.8   $621.2
Accounts Receivable   55.6   58.6   62.4   66.6   72.3   78.9   86.2
PP&E, Net   286.6   301.9   305.9   309.4   315.0   315.6   311.1
Accounts Payable   13.0   13.7   14.6   15.6   16.9   18.4   20.1
SELECTED CASH FLOW DATA
Net Income (Loss)1   $1.6   $31.1   $46.0   $56.9   $77.4   $98.3   $117.9
+ Depreciation   47.9   54.6   56.2   61.5   67.3   74.2   80.9
+ Amortization of Intangibles   11.6   12.8   10.0   8.8   3.6   3.5   3.5
+ Amortization of Deferred Financing Fees   0.8   0.8   0.8   0.8   0.8   0.8   0.8
+ Change in Working Capital2   0.0   2.8   3.4   3.9   5.2   6.1   6.8
+ Change in Accrued LTIP2   0.0   2.6   4.0   4.5   2.4   1.1   0.6
+ Change in Accrued SAW   9.9   2.1   3.1   3.2   3.7   4.7   5.6
+ Change in Other Assets   0.0   (0.6)   (0.8)   (0.9)   (1.2)   (1.4)   (1.5)
= Operating Cash Flow   $71.9   $106.0   $122.7   $138.7   $159.3   $187.4   $214.5
- Capital Expenditures   (83.1)   (69.9)   (60.2)   (65.0)   (72.8)   (74.8)   (76.4)
- Capitalized Lease Payments   (0.5)   (0.8)   (0.9)   (1.0)   (1.3)   (1.5)   (1.7)
= Cash for Debt Service   $(11.7)   $35.4   $61.6   $72.7   $85.2   $111.1   $137.9
CAPITALIZATION
Total Debt   $276.4   $275.6   $274.7   $273.7   $272.5   $271.0   $269.3
Shareholders' Equity'   254.1   283.1   330.1   390.7   474.8   583.6   721.1
Total Capitalization   $530.5   $558.7   $604.9   $664.4   $747.3   $854.6   $990.4
Excludes equity in earnings of unconsolidated subsidiary (KLC PropCo).
KLC has not divided change in working capital between KLC OpCo and KLC PropCo. Traditionally KLC OpCo operates with positive working capital.
3 For additional detail, see the discussion below under the heading "- Long Term Incentive Plan."
4 Non-cash expenses related to KSI's Stock Appreciation Rights Plan attributed to KLC's employees and payable by KSI in cash upon settlement.
5 Represents book value.
Revenue
Management projects revenue to increase at a 8.0% CAGR, from $1.6 billion in 2006 to $2.3 billion in
2011. Most of the projected growth stems from KLC OpCo's ECE segment which currently accounts for
approximately 96.0% of KLC OpCo's pro forma revenue. The following table shows projected revenue by
business segment:
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KLC OpCo
($ in millions)   2006P   2007P   2008P   2009P   2010P   2011P
ECE Centers   $1,488.7   $1,572.8   $1,668.4   $1,797.1   $1,947.4   $2,111.1
School Partnerships   55.5   66.6   79.9   95.9   115.1   138.1
KC Distance Learning   13.6   17.1   21.3   26.7   33.3   41.6
Total Revenue   $1,557.8   $1,656.5   $1,769.6   $1,919.7   $2,095.8   $2,290.8
Sales Growth
From 2006 to 2011 KLC OpCo projects that revenue from the ECE centers will grow at a 7.2% CAGR.
The growth forecast is based on the following assumptions:
. Tuition growth. KLC OpCo projects that tuition rates at existing centers will grow at
approximately 4% per year for the next five years. This growth is below recent experience
(6.9% in 2005). Moreover, tuition rates in the industry have been growing at average rates of
greater than 4%.
r. Utilization improvement. Management projects that recent improvements witnessed at KLC
OpCo will continue. By 2011, KLC OpCo projects Utilization will have increased to 65.2%.
Management believes these improvements in Utilization will be the result of expected
favorable demographic trends (described elsewhere in this Memorandum), new sales training
programs, re-branding efforts in selected markets combined with the opening of appropriately
sized centers.
. New centers. KLC OpCo expects a net reduction of centers in 2006 and 2007 as it
completes its integration of KinderCare and the rationalization of its properties. Beginning in
2008, KLC OpCo projects to be adding net centers.
KLC OpCo
2005PF   2006P   2007P   2008P   2009P   2010P   2011P
Utilization   61.2%   62.2%   63.0%   63.5%   63.9%   64.5%   65.2%
Average Weekly Tuition   $167.35   $173.68   $179.99   $188.37   $197.47   $206.95   $216.52
% Growth   3.7%   3.6%   4.7%   4.8%   4.8%   4.6%
Center Count
Beginning of Period   2,021   1,934   1,894   1,878   1,890   1,925   1,963
New Center Additions   10   10   24   52   75   78   80
Closures   (97)   (50)   (40)   (40)   (40)   (40)   (40)
End of Period   1,934   1,894   1,878   1,890   1,925   1,963   2,003
Additional Products and Services
KLC OpCo plans to use its footprint of approximately 2,000 centers across the U.S. as a platform to sell
additional educational (e.g., supplemental phonics, math, Spanish and music courses) and non-
educational (e.g., health insurance, childcare financing) products and services. The sale of additional
products and services is expected to generate approximately 2.2% of total revenue in 2011, which is
included in the ECE center projections.
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School Partnerships
School Partnerships is projected to grow from $48.5 million in pro forma revenues in 2005 to $138.1
million in 2011. As a percentage of revenue, School Partnerships accounts for 3.3% of total pro forma
revenue in 2005, and is projected to grow to 6.0% in 2011. KLC OpCo projects that growth in the School
Partnerships business will be primarily driven by growth in the SES market (more school districts required
to offer supplemental services), and an increase in the number of parent pay locations in the U.S.
KC Distance Learning
KCDL is projected to grow from $10.0 million in pro forma revenues in 2005 to $41.6 million in 2011. As a
percentage of revenue, KCDL accounts for 0.7% of total pro forma revenue in 2005, and is projected to
grow to 1.8% in 2011. KLC OpCo projects that growth in this line will predominantly come from the
expansion of KCDL's direct to family business (which currently accounts for approximately 90% of pro
forma revenue) and the expansion of states to digital high school courses (which KLC believes it is in a
position to provide on an outsourced basis).
Gross Margin
KLC OpCo's pro forma gross profit is projected to increase from $244.4 million in 2005 to $501.3 million
in 2011. The growth in gross profit is projected to be largely driven by increased center efficiency as a
result of improved Utilization, continued tuition increases and the closure of underperforming centers and
shift in the revenue mix to more profitable business lines (Le., more employer-sponsored centers, KCDL,
ancillary products and services). KLC OpCo's gross margin is projected to improve from approximately
16.5% of total revenues in fiscal year 2006 to 21.9% in fiscal year 2011 as a result of these factors.
Selling, General and Administrative Expenses
Due to the relatively fixed nature of KLC OpCo's selling, general and administrative (SG&A) expenses,
KLC OpCo projects that SG&A will increase at a rate of 4.5% annually after 2006. Additionally,
management estimates that there will be a one-time increase of $2.0 in SG&A related to the expansion of
the SES business in 2007.
Adjusted EBITDA and Adjusted EBITDA Margins
KLC OpCo projects improving pro forma Adjusted EBITDA from $149.9 million in fiscal year 2005 to
$320.1 million in fiscal year 2011. Pro forma Adjusted EBITDA margin is expected to improve from 10.1%
in fiscal year 2005 to 14.0% in fiscal year 2011. This projected margin improvement reflects the
combination of increasing sales and margin improvements outlined above. The table below shows the
calculation of pro forma Adjusted EBITDA.
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KLC OpCo
2007P   2008P   2009P   2010P   2011P
EBITDA   $86.6   $146.3   $167.8   $188.1   $217.8   $257.1   $296.8
Adjustments to EBITDA
Restructuring Charge Addbackl   $29.4   $6.3   $0.0   $0.0   $0.0   $0.0   $0.0
(Gains) / Losses on Sales2   (1.3)   0.0   0.0   0.0   0.0   0.0   0.0
Dividend Income3   (0.5)   0.0   0.0   0.0   0.0   0.0   0.0
SAR Plan4   9.9   2.1   3.1   3.2   3.7   4.7   5.6
Estimated Parallel Organization Costs6   23.3   2.0   0.0   0.0   0.0   0.0   0.0
Management Fee6   2.5   2.5   2.5   2.5   2.5   2.5   2.5
Long Term Incentive Plan'   0.0   2.6   6.6   11.1   13.5   14.6   15.2
Adjusted EBITDA   $149.9   $161.7   $179.9   $204.8   $237.5   $279.0   $320.1
1 Represents one-time non-recurring costs of integrating AER and KinderCare acquisitions in 2004 and 2005 respectively.
2 Represents the non-cash impact of (gains) / losses on the sale of centers.
3 Income earned as a result of ownership in a minority investment.
a Represents accruals related to KSI's SAR plan. Approximately $7.8 million has been paid pursuant to SARs in connection with the departure of KLC's chief
executive officer in 2006.
5 Result of the costs of operating duplicative infrastructure at KLC and KinderCare following the KinderCare acquisition.
6 Management fee paid to affiliate entities.
7 For more information, see the discussion below under the heading "- Long Term Incentive Plan."
Long Term Incentive Plan
Our Adjusted EBITDA projections do not include the effect of any payments that may be made pursuant to
our Long Term Incentive Compensation Plan. Under this new plan, which provides performance-based
incentive compensation awards beginning in 2006 based on our performance against specific Adjusted
EBITDA targets, we will accrue expenses ranging from $2.6 million in 2006 to $15.2 million in 2011 if our
Adjusted EBITDA meets the projections set forth in this Memorandum. Each award is payable at the end
of three years based on performance and subject to continued employment (with certain exceptions).
The accrued expenses associated with an award in each period are non-cash, subject to cash settlement
when and if the award for that period is earned at the end of the third year. The actual expenses could be
higher or lower depending on whether actual Adjusted EBITDA performance exceeds or is less than the
amounts projected herein.
Working Capital
KLC OpCo does not expect revenue or expenses to have a meaningful impact on working capital ratios in
the future.
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Capital Expenditures
The following table shows the breakdown in KLC OpCo's projected capital expenditures:
KLC OpCo
($ in millions)   2006P   2007P   2008P   2009P   2010P   2011P
Maintenance   $41.1   $40.8   $41.0   $41.8   $42.6   $43.5
New Centers (Furniture, Fixtures &Equipment)   10.1   7.2   15.6   22.5   23.4   24.0
IT Spending and Other Capex   18.6   12.2   8.4   8.6   8.8   9.0
Total Capital Expenditures   $69.9   $60.2   $65.0   $72.8   $74.8   $76.4
Between 2006 and 2011, KLC OpCo projects to spend between $41 million and $44 million annually on
maintenance capital expenditures (approximately $22,000 on a per center basis), which includes
refurbishment of its existing centers and equipment and supplies replacement costs. In addition, KLC
OpCo expects to spend approximately $19 million in 2006 on corporate infrastructure improvements,
primarily IT spending. The remainder of KLC's OpCo capital expenditures is projected to be used to
expand KLC OpCo's center base. Beginning in 2007 KLC projects that it will only open leased centers;
KLC OpCo believes that its cost of furnishing each center will be approximately $300,000 per center.
11.17. Debt Summary
The table below shows KLC OpCo's outstanding debt as of December 31, 2005.
KLC OpCo
Debt Capitalization
($ in millions)   12/31/05
Cash   $118.8
Revolverl   $0.0
Capital Leases   16.4
Senior Subordinated Notes   260.0
Total KLC OpCo Debt   $276.4
Net Debt2   $157.6
1 KLC OpCo has a $100 million revolver, primarily used to support outstanding letters of credit.
2 Represents total debt less cash.
11.18. Terms of Revolving Credit Facility
In November 2005, KLC entered into a revolving credit facility (the "Revolver") with a syndicate of
financial institutions consisting of a $100.0 million five-year revolving credit facility under which revolving
and swingline loans may be made, and letters of credit may be issued in amounts up to $75.0 million.
The Revolver is used for KLC's working capital and general corporate requirements. At December 31,
2005, KLC had no revolving loans outstanding and approximately $46.6 million in letters of credit
outstanding under the Revolver. KLC pays a commitment fee equal to 0.50% per annum on the undrawn
portion available under the Revolver and a fee of 1.25% per annum of the daily amount available to be
drawn under outstanding letters of credit.
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Borrowings under the Revolver will generally bear interest based on a margin over, at KLC OpCo's option,
either the base rate (generally the applicable prime lending rate, as announced from time to time) or the
reserve adjusted LIBOR rate. The applicable margin for revolving loans will be 0.25% for base rate loans
and 1.25% for reserve adjusted LIBOR loans. KLC is permitted to voluntarily prepay principal amounts
outstanding or reduce commitments under the Revolver at any time, in whole or in part, without premium
or penalty.
The Revolver is fully and unconditionally guaranteed by KSI and on a joint and several basis by most of
KLC's direct and indirect domestic subsidiaries within KLC OpCo. The Revolver and guarantees are
secured by first priority security interests in, and liens on, substantially all of KLC OpCo's and the
guarantors' assets and first priority pledges of all the equity interests owned by KSI in KLC and owned by
KLC in its direct and indirect domestic subsidiaries in KLC OpCo and 66% of the equity interests owned
by KLC in its non-domestic subsidiaries.
The revolving credit facility contains customary affirmative and negative covenants for financings of its
type (with customary exceptions). The financial covenants include: a minimum fixed charge coverage
ratio test; a minimum leverage ratio test; a minimum interest coverage ratio test; and a minimum EBITDA
test.
Operating covenants limit KLC's and its restricted subsidiaries, and in certain cases, KSI's ability to
(among others): incur additional debt; incur liens or other encumbrances; make investments; make
acquisitions; incur certain contingent liabilities; make certain restricted junior payments and other similar
distributions; enter into mergers, consolidations and similar combinations; sell assets or engage in similar
transfers; open new learning centers; engage in transactions with affiliates; enter into sale-leaseback
transactions; engage in businesses other than those in which KLC and its restricted subsidiaries and KSI
were engaged at the time of the closing of the Revolver and other related or ancillary businesses; amend
certain material agreements; prepay subordinated debt; sell or discount receivables; and dispose of any
equity securities in its subsidiaries.
11.19. Terms of Senior Subordinated Notes
In February 2005, KLC sold $260.0 million in aggregate principal amount of PA% Senior Subordinated
Notes due February 1, 2015 (the "Notes") in connection with the KinderCare acquisition and related
financing transactions. The Notes bear interest at the rate of VA% per year, payable semi-annually, in
arrears, on February 1 and August 1 of each year.
KLC may redeem the Notes, in whole or in part, on or after February 1, 2010 at certain pre-set
redemption prices, plus any accrued and unpaid interest. On or prior to February 1, 2010 KLC may
redeem the Notes in whole, but not in part, at a redemption price equal to 100% of the principal amount of
the Notes to be redeemed plus an applicable premium. In addition, on or prior to February 1, 2008 KLC
may redeem up to 35% of the aggregate principal amount of the Notes with the net proceeds of one or
more qualified equity offerings.
Subject to KLC's right to redeem the Notes, upon a change of control event, holders of the Notes may
require KLC to repurchase all or a portion of the Notes at a purchase price of 101% of their principal
amount, plus accrued and unpaid interest.
KLC's obligations under the Notes are fully and unconditionally, and jointly and severally, guaranteed on a
senior subordinated basis by most of KLC's domestic restricted subsidiaries within KLC OpCo.
The indenture governing the Notes contains covenants that limit KLC and its restricted subsidiaries' ability
to, among other things: (a) pay dividends, redeem capital stock and make other restricted payments and
investments; (b) incur additional debt or issue preferred stock; (c) enter into agreements that restrict KLC
subsidiaries from paying dividends or other distributions, making loans or otherwise transferring assets to
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KLC or to any other subsidiaries; (d) create liens on assets; (e) engage in transactions with affiliates; (f)
sell assets, including capital stock of subsidiaries, except permitted real estate transfers and other
permitted transfers; and (g) merge, consolidate or sell all or substantially all of KLC's assets and the
assets of KLC's subsidiaries except permitted real estate transfers and other permitted transfers.
11.20. Stockholders Agreement of Knowledge Schools, Inc.
KLC is a wholly owned subsidiary of KSI, and KSI pursues no other businesses independent of holding
KLC's stock/equity. KSI entered into a Stockholders Agreement on May 9, 2003 with Knowledge
Universe Learning Corp. (the "KSI Parent") and its minority stockholders (the "Stockholders"). The
Agreement provides (a) the KSI Parent (and/or any "Parent Entities" designated by the KSI Parent, which
include the KSI Parent and/or certain of the Principals and certain affiliates of the KSI Parent and the
Principals) with a right of first refusal over proposed transfers of other Stockholders' shares, subject to
certain exceptions; (b) Stockholders, to the extent they are accredited investors, with a right to invest in
new issuances of KSI shares; (c) Stockholders with tag-along rights in connection with a transfer of KSI
common stock by any of the Parent Entities resulting in the Parent Entities owning less than 60% of KSI
common stock then outstanding, or a transfer of securities by any of the Parent Entities resulting in the
Parent Entities owning less than a majority of KSI common stock then outstanding. Stockholders are also
subject to a drag-along provision, pursuant to which they may be required to sell a pro rata portion of their
shares in the event of a proposed transfer of a majority of KSI common stock then outstanding. Each
Stockholder and the KSI Parent are entitled to receive certain financial information from KS]. The
Agreement terminates upon a public offering of KSI, at the option of the KSI Parent upon a sale of KSI, or
by written agreement of the parties. Knowledge Universe Learning Corp. was liquidated on October 27,
2004 and the shares of KSI were distributed on that date to its sole stockholder, KUE Inc.
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12. THE REAL ESTATE COMPANY ("KLC PROPCO")
On November 9, 2005, KLC transferred ownership of 845 ECE centers into wholly owned, bankruptcy
remote subsidiaries, which are referred to as KLC PropCo. In October 2005, 713 of the centers were
independently appraised at approximately $1.1 billion.36 KLC PropCo then issued $700 million of CMBS
debt secured by the 713 appraised centers and the stock of the CMBS borrower, and $150 million of
junior mezzanine debt, the proceeds of which were used to repay KLC OpCo debt. The table below
summarizes the revised corporate structure at KLC:
KLC OpCo
• $100.0 million Revolver
• $16.4 million Capital
Leases
• $260.0 million Sr.
Subordinated Notes
Operating Company
77.--------
• 845 Properties
• $699.4 million CMBS Debt
K.... • $150.0 million Junior
Mezzanine Debt(”
KLC PropCo
Represents face value; book value is approximately $147.3 million.
Real Estate Company
With 845 ECE centers in 37 states (as of December 31, 2005), KLC PropCo believes it is the largest
private owner of education real estate assets in the world. The real estate portfolio is geographically
diversified without significant concentrations or ties to any single part of the U.S. KLC PropCo leases its
centers to KLC OpCo for an aggregate annual rent of $96.3 million. The lease agreement, which was
signed in November 2005, carries an initial term of 15 years with two extensions available for five years
each and an escalation of rent by the lesser of 7% or the CPI every fifth year. All of the properties have
been leased to KLC OpCo on a "triple-net" basis, requiring KLC OpCo to fund all property taxes,
insurance expenses related to the properties and all maintenance capital expenditures. For the fiscal
year ended December 31, 2005, KLC PropCo generated pro forma rental revenue of $96.3 million and
EBITDA of $88.1 million.
12.1. KLC PropCo Strategy
KLC PropCo was separated from KLC OpCo to create a flexible vehicle to address the growing
opportunity in education related real estate. The ongoing need for facility-based education is driving
increased demand for real estate assets that can accommodate the facilities.
3° Actual appraisal was for 713 centers and the appraised value was $1.1 billion. The $1.25 billion referred to within this Memorandum is achieved by
taking the independent appraisal valuation methodology and extrapolating it to the remaining 132 centers.
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• Leverage Greenstreet Real Estate Partners' significant expertise:
— KLC believes it is able to better maximize the potential of its real estate assets by having them
managed by a dedicated and highly experienced team at Greenstreet Real Estate Partners rather
than having them managed at the operating company level.
• Cash generated will be reinvested in acquiring more assets.
• Diversify the real estate portfolio:
— The Greenstreet Real Estate Partners team is actively looking at diversification and reinvestment
opportunities for the real estate portfolio. The diversification strategy will include some
opportunistic investments in non-education related real estate assets.
12.2. Management Team
KLC PropCo is managed by Greenstreet Real Estate Partners through a long-term agreement.
Greenstreet Real Estate Partners has a highly experienced management team to guide the continued
acquisition and diversification of the real estate portfolio. The management team includes Steven Green,
Chairman and CEO of Greenstreet Real Estate Partners, Jeffrey Safchik, COO and CFO and Steven Cox,
Executive Vice President Real Estate. Greenstreet Real Estate Partners controls a significant portfolio of
owned and self-managed real estate and has extensive experience in corporate transactions involving
owned real estate. Greenstreet Real Estate Partners operates a private real estate equity platform,
having made in excess of $850 million in acquisitions and with assets currently under management
(excluding KLC PropCo) of $540 million. It has owned and managed in excess of 10 million square feet
of shopping centers with value in excess of $1 billion. The principals of Greenstreet Real Estate Partners
each have in excess of 20 years in real estate and capital markets. Their biographies can be found in
Appendix A.
12.3. Description of the Real Estate Assets
The highly diversified portfolio includes 845 properties in 37 states. The properties are primarily one story
wood-framed buildings totaling 5,119,320 sq. ft. Some of the larger state concentrations include Texas,
California, Illinois and Virginia. No single state accounts for more than 11% of the total centers (see the
Figure below for details on the geographic distribution). The properties are single-tenant stand-alone
buildings. The average age of the properties is approximately 15 years with 22% of the portfolio built
after 1991 and approximately 6% of the facilities being constructed prior to 1979. The centers' trailing 12
month Utilization was 58.9% as of December 31, 2005.
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845 Centers in 37 States
12.4. Summary Financial Information and Projections Discussion
The table below shows KLC PropCo pro forma historical results for 2005 assuming the division of KLC
OpCo and KLC PropCo in the series of transactions completed in November 2005 (the "Real Estate
Transactions") and related financing, together with the lease of KLC PropCo-owned centers to KLC OpCo,
occurred on January 1, 2004. Projected results presented below are based on assumptions management
believes to be reasonable, but which are inherently uncertain and may not be realized. KLC PropCo's
ability to perform as projected depends on a number of variables that cannot be predicted with certainty
and actual performance could be adversely affected by a number of factors, including those described in
"Risk Factors," particularly the risk factor related to projected financial statements, elsewhere in this
Memorandum. Also see "Forward Looking Statements."
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KLC PropCo Summary Historical Pro Forma and Projected Financials
Fiscal Year Ended December 31,
($ in millions)   2005 PF   2006P   2007P   2008P   2009P   2010P   2011P
Rental Revenue from KLC OpCo   $96.3   $96.3   $96.3   $96.3   $96.3   $96.3   $103.0
Other Rental Revenue'   0.0   0.0   4.6   7.0   9.4   12.1   15.0
Total Revenue   $96.3   $96.3   $100.9   $103.3   $105.7   $108.4   $118.0
Operating Expenses   8.3   8.3   8.3   8.3   8.3   8.3   8.3
EBITDA   $88.1   $88.1   $92.6   $95.0   $97.4   $100.1   $109.8
DEPRECIATION & AMORTIZATION
Depreciation   $29.8   $27.0   $26.1   $25.0   $23.8   $22.4   $22.4
Depreciation From New Real Estate   0.0   0.0   2.8   4.2   5.7   7.3   9.1
Operating Income   $58.6   $61.1   $63.7   $65.8   $68.0   $70.4   $78.3
INTEREST EXPENSE
KLC PropCo Debt   $64.3   $64.3   $63.9   $63.5   $63.2   $62.8   $62.5
Deferred Financing Fees   2.1   2.1   2.1   2.1   2.1   2.1   2.1
Total Interest Expense   $66.4   $66.3   $66.0   $65.6   $65.2   $64.9   $64.5
Interest Income   1.1   1.1   0.2   0.2   0.2   0.2   0.2
Net Income   ($7.0)   ($4.2)   ($2.0)   $0.4   $2.9   $5.8   $14.0
BALANCE SHEET DATA
Cash and Equivalents   $24.5   $5.0   $5.0   $5.0   $5.0   $5.0   $5.0
Total Debt2   849.4   844.7   839.9   835.3   830.6   826.0   815.8
Net PP&E   687.1   715.6   715.5   715.8   718.6   724.5   740.3
SELECTED CASH FLOW DATA
Net Income (Loss) to Common   ($7.0)   ($4.2)   ($2.0)   $0.4   $2.9   $5.8   $14.0
+ Depreciation   29.8   27.0   26.1   25.0   23.8   22.4   22.4
+ Real Estate Reinvestment Depreciation   0.0   0.0   2.8   4.2   5.7   7.3   9.1
+ Amortization of Financing Fees   2.1   2.1   2.1   2.1   2.1   2.1   2.1
+ Non-Cash Interest Expense   2.3   2.3   2.3   2.3   2.4   2.4   2.4
+ Change in Working Capital   NA   0.0   0.6   0.3   0.3   0.3   1.2
+ Change in Other Assets Held for Sale   NA   15.8   0.0   0.0   0.0   0.0   0.0
+ Change in Other Assets   NA   0.0   (0.7)   (0.4)   (0.4)   (0.4)   (1.5)
+ Change in Other Liabilities   NA   0.0   4.8   2.5   2.5   2.8   10.1
= Operating Cash Flow   $27.1   $43.0   $35.9   $36.4   $39.3   $42.6   $59.8
Cash Reinvested in New Real Estate'   $0.0   $55.5   $28.9   $29.4   $32.3   $35.6   $47.2
'Assumes reinvestment of all excess cash above $5.0 million at an 8.25% cap rate.
2 Junior Mezzanine debt is recorded at face value. Book value is approximately $147.3 million.
Rental Revenue
Management projects rental revenue to increase at a 4.2% CAGR, from $96.3 million (the annual rent
payable pursuant to its leases with KLC OpCo) in 2006 to $118.0 million in 2011. The growth stems from
KLC PropCo's reinvestment of excess cash flow in additional real estate and rent increases in the
properties leased to KLC OpCo as described below:
Intercompany Rent. KLC PropCo currently leases 847 properties (845 childcare centers) to KLC for a
total annual rent payment of $96.3 million. The rent on the properties is fixed for the first five years of the
lease, at which point it increases by the lesser of the CPI growth over the five years or 7%.
Additional Real Estate. KLC PropCo has projected that it will invest all excess cash (anything over $5.0
million) in additional real estate. The additional real estate may be comprised of either educational or
non-educational assets, but will not be leased back to KLC OpCo. KLC PropCo has projected that it will
invest its capital at an 8.25% cap rate.
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Real Estate Company Operating Expenses
Greenstreet Real Estate Partners will operate all of the real estate investment functions on behalf of KLC
PropCo as detailed in the management agreement. See "Related Party Transactions."
12.5. Debt Summary
The table   below shows KLC PropCo's outstanding capitalization as of December 31, 2005.
KLC PropCo Debt Capitalization
($ in millions)   12/31/05
Cash   $ 24.5
CMBS Debt   $699.4
Junior Mezzanine Debt'   150.0
Total KLC PropCo Debt   $849.4
Net Debt2   $824.9
1 Represents face value; book value is approximately $147.3 million.
2 Represents total debt less cash.
12.6. Terms of the CMBS Debt
KLC PropCo has $699.4 million of CMBS debt which was arranged in connection with the separation from
KLC OpCo. KLC PropCo is required to pay interest in cash on a monthly basis at a rate of 5.62% and
must meet scheduled amortization requirements on a monthly basis and maturing December 1,2015.
The CMBS debt consists of a $649.5 million mortgage loan and a $50.0 million senior mezzanine loan
secured by 713 childhood education centers. The CMBS debt is nonrecourse KLC OpCo.
Each of the centers securing the mortgage loan is leased to KLC OpCo pursuant to a master lease. KLC
PropCo has entered into asset management agreements with Greenstreet Real Estate Partners (formerly
Greenstreet Realty Partners, L.P.) pursuant to which Greenstreet Real Estate Partners provides asset
management and consulting services for these centers to KLC PropCo. KLC PropCo has the right under
certain circumstances to release, substitute, sell and/or reinvest in properties securing the mortgage loan.
Prepayment of the CMBS debt is prohibited through January 1, 2007, after which prepayment is permitted
in whole or in part, subject to a prepayment premium equal to the greater of 1% or an amount obtained
based on a discount to treasury securities. After June 1, 2015, the CMBS debt may be prepaid in whole
without premium or penalty.
The CMBS debt contains provisions that require KLC PropCo to reserve with the lender of the CMBS
debt 50% of excess cash flow generated from the CMBS centers if EBITDA (as adjusted) for KLC OpCo
falls below certain levels and 100% if EBITDA (as adjusted) for KLC OpCo falls below certain other levels.
12.7. Terms of the Junior Mezzanine Debt
The Junior Mezzanine debt has a face value of $150 million (and was purchased for approximately
$147.0 million, reflecting a 2% discount to face value), substantially all of which was provided by the
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Principals and their affiliates in connection with the Real Estate Transaction. The Junior Mezzanine debt
is subordinated to the new CMBS debt. Cash interest is payable on the Junior Mezzanine debt at a rate
of 15.13% and payable in kind at a rate of 1.50%. The Junior Mezzanine debt matures in May of 2016.
Interest paid in kind may not be paid in cash until the CMBS debt is paid in full. The Junior Mezzanine
debt is nonrecourse to KLC OpCo.
Prepayment of the Junior Mezzanine debt is prohibited through November 9, 2010, after which
prepayment is permitted in whole or in part, subject to a prepayment premium equal to 8.32% for
prepayments in the first year, 6.66% for prepayments made in the second year, 4.99% for prepayments
made in the third year, 3.33% for prepayments made in the fourth year and 1.66% for prepayments made
in the fifth year. After November 9, 2015, the CMBS debt may be prepaid in whole without premium or
penalty.
12.8. Terms of the Master Lease
As part of the Real Estate Transactions, in November 2005, KLC refinanced its indebtedness and divided
KUE into KLC OpCo and KLC PropCo, and KLC OpCo entered into a Master Lease with KLC PropCo for
713 centers. The term of the Master Lease is 15 years and annual rent under the Master Lease is $91
million per year, subject to increases every five years. The Master Lease is a triple net lease that requires
KLC OpCo to pay all operational expenses, taxes, utilities, insurance and maintenance costs with respect
to the leased centers, and the Master Lease may not be terminated by KLC OpCo. KLC OpCo is
required to make certain deposits or to provide letters of credit for taxes, insurance and maintenance of
the properties. KLC is also required to deposit rent payments into a segregated deposit account
controlled by the CMBS debt lenders. KLC OpCo has the right under certain circumstances to release
and substitute properties under the Master Lease. KLC OpCo has entered into separate, substantially
smaller leases of KLC PropCo's remaining properties.
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13. k12 INC. ("k12")
k12, headquartered in McLean, Virginia, is a curriculum company and management company for
kindergarten through ninth grade (grades 10-12 currently in development). k12 is the largest operator of
K-12 virtual schools in the world. k12's mission is to enable delivery of world-class education for students
in grades K-12, consisting of comprehensive online and offline curriculum that supports numerous
applications. k12 has invested more than $70 million in building a state-of-the-art curriculum offering,
integrated assessment and the supporting technology delivery systems.
13.1. History
k12 was founded in December 1999, with the goal of leveraging technology to create the highest-quality
curriculum. k12 launched its first offering in September 2001 for students in grades K-2. This offering
was launched in conjunction with several of the world's leading education experts and included interactive
lessons in Language Arts, Math, Science, History, Art and Music. k12 launched grades 3-5 in the fall of
2002, grades 6 and 7 in the fall of 2003, grade 8 in the fall of 2004 and grade 9 in fall of 2005. k12 has
continually improved its production process and is now producing courses that are of higher quality and at
a lower cost per lesson than it originally produced. Building the service in this modular, rolling fashion
allows k12 to capture students at an early stage and to build out its product offerings in alignment with
student progress.
13.2. Current Operations
k12 provides a world-class education for its students which combines a comprehensive online and offline
curriculum with integrated assessments and supporting technology delivery systems. k12 currently
provides its education to grades K-9 through more than 7,000 interactive lessons, and is in the process of
developing content for grades 10-12. Today, k12 sells its curriculum through the following channels:
• Virtual public schools (91% of 2006E Revenue)
— k12 is the largest curriculum and management provider to virtual public schools in the U.S.
— k12 offers its curriculum directly to the rapidly growing virtual school market (projected to be offered
to 24,000 students in 2007)
• District-managed virtual programs (3% of 2006E Revenue)
— k12 sells the curriculum and technology directly to school districts who mange their own virtual
schools
— This is a fairly new initiative for k12 but is expected to be a larger part of total revenue over time
• School districts for traditional classrooms (3% of 2006E Revenue)
— k12's science curriculum has been piloted as the science curriculum in various school districts
including Philadelphia
— Initial results are promising
• Direct to consumer (3% of 2006E Revenue)
— To parents who prefer home-schooling or want to augment or enhance their children's public or
private school education
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k12 intends to expand the business to international markets and believes there is a significant worldwide
demand for high-quality online curriculum. In the near-term it can do so by serving multinational
corporations with large employee bases comprised of expatriates.
k12 generated $6 million of revenue in 2002, its first year of operations, growing to more than $116.0
million projected for FYE June 30, 2006.
13.3. Virtual Schools and District-Managed Virtual Programs (94% 2006E Revenue)
The past decade has seen an increase in the number of contracts and charters awarded to Education
Management Organizations ("EMOs"), which manage traditional K-12 public schools on behalf of a school
district ("contract schools") or manage charter schools either as the charter holder ("charter schools") or
under contract with the charter holder ("contract charters"). In the early half of the 1990's, EMOs were
mostly contract schools, managing traditional K-12 schools on behalf of school districts. Later, as public
money became available to charter schools through the use of vouchers, these organizations moved
toward charter school management and contract charter management.
A movement toward alternatives to the public school system is expected to generate substantial growth in
the for-profit EMO sector. Alternative schools and alternative management programs provide a significant
opportunity to improve the current educational "product." Furthermore, under the NCLB, growth in public
school management is expected to continue as schools that fail to achieve "Adequate Yearly Progress"
("AYP") for four consecutive years are subject to one of the following sanctions: replacement of all or most
staff including the principal, state takeover of the school, hiring an outside entity to manage the school, or
becoming a charter school. k12 is well positioned to take advantage of these trends.
To comply with NCLB, all states submitted a plan to the Department of Education indicating baseline
achievements for the 2002-03 school year and how 100% "proficiency" would be achieved by 2013-14.
The law mandates that student progress and achievement be measured ("assessed") by math and
reading tests that will be given to every child, every year, beginning in the 2005-06 school year. In
addition, a science assessment will be added beginning with the 2006-07 school year. Under Bush
administration proposals, by the 2009-10 school year, students will be tested every year from grades 3 to
11. These assessments are considered intermediate benchmarks that measure a school's ability to
demonstrate "Adequate Yearly Progress" (AYP) toward meeting its own goals.
Contract Charters. Charter schools are independent public schools, designed and operated by
community groups or non-profit entities, but sponsored by designated local or state educational
organizations that monitor their quality and integrity. In return for a large measure of autonomy and
freedom from regulation, charter schools are accountable for student academic performance.
The Center for Education Reform estimates that, in the 2004-05 school year, there were 3,345 charter
schools serving nearly 894,000 students, representing an estimated 1.6% of total K-12 students. Charter
schools now operate in 40 states and the District of Columbia, up from 38 in the 2003-04 school year. In
the 2004-05 school year, enrollment in charter schools represented 1.6% of total K-12 enrollment and
annual spending on charter schools was $7 million or 1.4% of total spending on all K-12 schools.
However, in the decade of 1995-2005 the number of charter schools had grown on average nearly 13%
annually while charter school enrollment increased over 20%, clearly outpacing the less than 1% average
K-12 enrollment growth over the same period.37
k12 participates in the charter school business by setting up virtual public schools that it manages through
a partnership with a non-profit entity. After going through the legislative process at the local or state level
and obtaining a charter for a school, k12 sets up a non-profit organization with a principal and the right
administrative team to create the school. k12 then enters into a contract with the non-profit organization
'7 Source: Harris Nesbitt, Education and Training, September 2005.
107
whereby k12 sets up and manages the "virtual public" school. k12 offers an Internet-based curriculum
(providing the computer hardware and all necessary materials) outside of the conventional brick-and-
mortar setting of traditional public and charter schools. Where legislation has enabled such schools, state
education dollars pay for children who enroll in them. Virtual schools generally generate substantially
larger profits than conventional for-profit charter schools because they receive the same amount of per-
student funding as their traditional public school counterparts despite not having to support a physical
structure. Virtual schools enable students to receive a comprehensive curriculum along with technical
assistance, teacher involvement, computer equipment, Internet access, and instructional materials,
without leaving the public education system. Virtual academies are serving a diverse mix of students.
With the same curriculum, k12 is serving both highly gifted children and children with disabilities. The
self-paced nature of k12's curriculum and its interactivity allow k12 to serve a broad array of students.
k12's students, currently in virtual schools, come from public or private schooling backgrounds, as well as
home schooling backgrounds. A summary of k12's virtual school business is as follows:
• k12 manages virtual schools for students in grades K-9 in 11 states (Arizona, Arkansas, California,
Colorado, Florida, Idaho, Minnesota, Ohio, Pennsylvania, Texas and Wisconsin) plus the District of
Columbia. In the 2006 fiscal year, these schools had a combined enrollment of approximately 18,000
children.
• k12 managed schools typically produce test score results which exceed or are equal to state averages
at a cost to the taxpayer that is approximately 70% less than what they would pay for traditional school.
• Virtual schools are funded primarily through local, state, and federal sources, which k12 expects to
receive approximately $5,300 per student per school year on average. Therefore, the virtual schools
provide access to k12's world-class service and curriculum as well as certified teachers at no cost to
the family.
• While many of k12's virtual academies are charter schools, k12 has virtual schools that are not charter
schools but are programs of school districts or other authorized school agencies, such as public
universities and federal and state agencies.
District-Managed Schools. k12's district-managed virtual programs operate under the contract schools
model. Although somewhat similar to the virtual public schools, contract schools are public schools
operated by private organizations based on management agreements with local school boards. Unlike
charter schools, contract schools do not require specific statutory authority but are created through a
contract between a school management company and a school board in accordance with existing
authority. k12 typically employs the district-managed virtual programs in states where the reimbursement
rate is low. Two states where k12 currently has district-managed virtual programs are Kansas and Utah.
The district-managed virtual programs unit is expected to grow revenue from $3 million in FY 2006 to $11
million in FY 2008.
The Pennsylvania Department of Education commissioned KPMG Consulting to study virtual education in
that state. The October 2001 study stated that the Pennsylvania Virtual Charter School (which uses the
k12 curriculum and management services) 'Was considered to be the highest quality program based on
the curriculum analysis." k12 believes that the virtual school market has powerful growth prospects which
are outlined below:
^ Strong reenrollment rates. k12 benefits from stable demand for its curriculum and services which is
reflected by current reenrollment rates of approximately 70%.
^ Increasing existing school enrollment rates. Existing school enrollments continue to increase at
double digit rates.
^ Expansion into new states. k12 is currently evaluating opportunities to start new virtual schools in
several additional states.
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• Grade expansion. k12 continues to expand its curriculum and services and plans to begin
development of grades 10-12 in the fall of 2006.
• ADA funding. The level of funding generally increases at approximately 2% per year.
With four times the number of students of its next competitor, k12 is the largest for-profit manager of
virtual schools.
Virtual Schools Managed by For-Profit Educational Management Companies
Company
k12
White Hat Management
Connections Academy
Pinnacle Education
Sequoia Charter Schools
Designs for Learning
Location
McLean, VA
Akron, OH
Baltimore, MD
Tempe, AZ
Mesa, AZ
St. Paul, MN
Public Schifolninder
Management
Number of which are Students in Virtual
Virtual Schools
15 15
38 2
10 10
9 1
11 1
10 1
Note: Schools ranked by students in 2004-05 school-year.
Source: Harris Nesbitt based on information compiled by Education Policy Studies Research Unit at Arizona State University.
Schools
14,460
3,508
1,081
212
160
50
13.4. Curriculum to School Districts of Traditional Classrooms (3% 2006E Revenue)
k12 piloted its core elementary school science program for several school districts, including Philadelphia.
The initial results of this pilot program were promising.
Case Study: William H. Hunter Elementary School
Background. In the Spring of 2004 the School District of Philadelphia wished to give a rebirth to one of its
lowest performing schools, the William H. Hunter Elementary School. k12 was selected as a partner to
provide innovative curriculum and professional development to implement a learning environment that
leverages the latest technology. As part of the k12 implementation, the District outfitted each room with
high-speed internet access, a ceiling-mounted data projection system, and interactive whiteboards. The
goal was to have Hunter become one of the District's, and the Commonwealth of Pennsylvania's, first
web-based public, traditional schools.
Of Hunter's 600 students, 95% qualify for the federal Free and Reduced Lunch program and 25% study
English as a Second Language (ESL). Therefore, the move and the District's initiative truly marked a
tremendous opportunity for both Hunter's teachers and students alike.
Scope of Services. The fall of 2004 marked the official launch of the program and the k12 curriculum was
provided for all math, science, art and history courses. This included providing all curriculum components
including text books, teacher guides, manipulatives, equipment, assessments, art supplies and all the
online lessons and teaching tools for these subjects.
The Hunter teaching staff did an impressive job of effectively implementing the program. k12 trainers
worked closely with teachers to adopt the new curriculum and to share best methods on applying the
technology. Throughout the year, k12 trainers were invited to attend and help present ongoing staff
trainings. Additionally, grade level teams and school leaders worked regularly with k12 to develop
coherent plans for boosting student achievement.
Results / Conclusions: After the first full-year of implementing the k12 program, Hunter achieved
impressive gains on the state math exams.38 In third grade, there was a 46 percentage point increase (as
38 The Pennsylvania Department of Education mandates all public schools in the Commonwealth implement its Pennsylvania System of State
Assessment (PSSA). The PSSA is a standards-based exam for measuring specific skills in math and reading, and beginning in 2006-07 science.
109
compared to a 31 point increase for the District). This was a meaningful 86% performing at or above
proficient compared to the District's 52% for 2005. In fifth grade, there was 22 percentage point gain (as
compared to a 15 point gain for the District).
As a result of these scores, the 3rd and 5th grade
students met or exceeded the absolute AYP
goals for math instruction - a first for the school.
(Note: k12 did not supply the Reading curriculum,
therefore, only Math results are applicable to the
k12 program).
These gains are an extraordinary achievement for
a school and its district. They are also difficult to
maintain over time, however this goal is shared
between the District and k12. The Hunter School
accomplished these gains through the staff's hard
work, commitment to their students and
dedication to implementing the k12 program.
Year over Year PSSA Math Gains
(2004 to 2005 % point increase)
Third Grade
Hunter
District
Fifth Grade
Hunter
District
22
31
46
New programs often take two to three years to generate similar results. While k12 and the Hunter staff
are pleased with the first year's results, it is only the beginning of a longer effort because, despite the
gains, more than half of last year's fifth graders still did not score at or above their grade level. Therefore,
although there is pride in the progress, the overall scores demonstrate how much more is to be done.
13.5. Direct to Consumer (3% of 2006E Revenue)
k12 sells its curriculum direct to consumers who either home school their children or use k12's curriculum
to supplement their child's education. k12 believes that it offers children and their parents an education
comparable to that offered in the nation's best public and private schools, utilizing optimal multimedia
methods and research-tested approaches to learning. In addition, integrated assessments allow a parent
to test his or her child's mastery of skills and enables the child to progress at the appropriate pace.
Children can move faster through lessons and address more challenging problems, while other children
can spend the additional time needed to master certain skills. With k12 's high standards and integrated
assessments, a parent can be confident that his or her child has mastered the subject. k12 considers this
market a growth area.
Educating a child at home full time or part time is a time-consuming and daunting task for parents.
Parents and caregivers spend a considerable amount of time searching for curriculum and trying to
ensure they are teaching the material adequately to their children. k12 offers a solution to this challenge
by offering a comprehensive curriculum for students in grades K-9, complete with specific daily lessons.
Parents can purchase individual or multiple courses. Although small, the home-schooling market is
growing at a healthy pace. Approximately 1.1 million students—roughly 2% of total K-12 enrollment—
were home-schooled in spring 2003, according to the National Center for Education Statistics (NCES).
This represents a roughly 30% increase from spring 1999. Most home school parents cited concerns
about the school environment (31%), interest in providing religious instruction (30%) and overall
dissatisfaction with academic instruction (16%) as their reasons for home schooling their children.39
The exam is also used in assessing performance toward No Child Left Behind guidelines for grades 3, 5, 9 and 11. The goal of the exam is for
students to score at or above proficient levels. Student results are also used to determine a school and district's performance in meeting pre-
determined goals known as Adequate Yearly Progress (AYP).
39 Source: Harris Nesbitt, Education and Training, September 2005.
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13.6. Product Offering
Comprehensive K-9 Curriculum. k12 offers a comprehensive curriculum for grades K-9 directly to the
students in its virtual academies, directly to consumers and to school districts, summer schools and after-
school programs. k12 is creating rich and challenging proprietary educational material based on existing
best-of-breed content and traditional methods enhanced by technology. Unlike most computer-based
education programs, which rely solely on computers and burden students with mechanical 'point and
click" exercises, k12 uses the computer as only one among many complementary tools to open children's
minds to the best books and educational material. k12's math, reading and writing curriculum involve a
significant amount of off-line work in the form of books, audiotapes, science equipment, art supplies and
more. k12 provides some of these materials and others will be recommended but not required.
For example, k12's comprehensive curriculum for students in grades K-9 includes lessons in the following
subjects:
• Language Arts. Progresses from a focus in the primary grades on early mastery of reading using
phonics-based curriculum reviewed and revised by a team of renowned experts, to, in later grades, a
rich program of literature, composition, and language skills;
• Math. A solid early foundation in basic math based on a highly respected math curriculum and
rigorous math standards;
• History. In grades K-4, a proprietary k12 program that offers a chronological overview of history, from
the Stone Age to the Space Age, with integrated geography and civics; in middle school, an American
History survey based on the celebrated History of the US series, and a World History survey based on
a proprietary k12 textbook;
• Science. A world-class science curriculum focused on hand-on activities and basic principles driven
by some of the most ambitious state science standards in the country;
• Visual Arts. A curriculum that combines appreciation of historical trends and masterpieces with
specific skill building and many opportunities for creative work; and
• Music. In the elementary grades, a proprietary program that engages young children in singing,
dancing and creative movement while introducing them to great works of music from around the world.
k12's curriculum and assessment are delivered, in part, through a series of proprietary course modules.
k12 delivers material over the Internet, but also through other forms of media, including traditional books,
video and learning kits. k12's course modules employ interactive text, audio, videos, CDs, and animated
graphics. The Internet-based portion of k12's courses contains the following features:
• Integration of a diverse mix of materials—visual images and concepts, audio, videos and animated
sequences, as well as high-quality written material;
• Capabilities for users to see an overview of the whole module at a glance;
• Opportunity for parents to scan and preview modules before guiding students through work;
• Integrated assessment services;
• Ability for children, parents, and teachers to follow students' progress;
• Comprehensive teaching guides with "drill down" functionality for those parents requiring more detailed
instruction; and
• Proven, standards-based, technologies that provide a satisfactory experience for the current Internet
infrastructure.
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k12 considers the majority of its entire curriculum proprietary, whether k12 is branding existing materials
with its logo and modifying the associated lesson plans or creating the entire course from scratch. k12's
K-8 curriculum includes thousands of lessons that consist primarily of existing, high-quality materials that
k12 has modified to better suit the needs of student, parent and teacher.
13.7. Management and Board of Directors
The following table sets forth certain information regarding k12's management and directors. For more
detailed biographical information, see Appendix A.
Management
Name
Ron Packard
John Baule
Bror Saxberg
Thomas Boysen
Charles Zogby
Peter Stewart
Bryan Flood
John Holdren
Name
Arthur Bilger
Steven B. Fink
Chester Finn
Lowell J. Milken
Andrew H. Tisch
Thomas Wilford
Liza Boyd
Position
Chairman and Founder / acting Chief Executive Officer and
member of the Board of Directors
Executive Vice President and Chief Financial Officer
Senior Vice President of Learning and Content
Senior Vice President and Chief School Officer
Senior Vice President of Education Policy
Vice President of the Charter School Division
Vice President of Government Relations
Senior Vice President of Curriculum
Non-Employee Directors
Position
Managing Member of Shelter Capital Partners
Chief Executive Officer of Lawrence Investments, LLC
President of the Thomas B. Fordham Foundation
President and Chief Executive Officer of KUE
Chairman of Executive Committee of Loews Corporation
Chief Executive Officer of the J.A. and Kathryn Albertson
Foundation, Inc.
Vice President Constellation Ventures / Bear Stearns Asset
Management
13.8. Summary Financial Information and Projections Discussion
The following summary historical financial data and the percentages of expected 2006 revenue presented
in the headings above are based on historical financial statements. The following projected financial data
presented below is based on assumptions management believes to be reasonable, but which are
inherently uncertain and may not be realized. k12's ability to perform as projected depends on a number
of variables that cannot be predicted with certainty and actual performance could be adversely affected
by a number of factors, including those described in "Risk Factors," particularly the risk factor related to
projections elsewhere in this Memorandum. Also see "Forward-Looking Statements."
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k12 Summary Historical and Projected Financial Information
Fiscal Year Ended June 30,
($ in millions)   2002   2003   2004   2005   2006P   2007P
Revenue   $6.7   $30.9   $71.4   $85.3   $116.0   $132.2
Growth   362.1%   131.0%   19.5%   36.0%   14.0%
Operating Income   ($30.4)   ($28.0)   ($6.9)   ($3.3)   $2.0   $6.4
Operating Income   (454.3)%   (90.4)%   (9.7)%   (3.8)%   1.7%   4.8%
Margin
EBITDA   ($28.6)   ($25.1)   ($2.0)   $2.2   $5.7   $12.3
EBITDA Margin   (427.9)%   (81.1)%   (2.8)%   2.6%   4.9%   9.3%
Net Income   ($30.4)   ($28.4)   ($7.4)   ($3.5)   $1.3   $5.2
Net Margin   (454.5)%   (91.7)%   (10.4)%   (4.1)%   1.1%   3.9%
Historically, the majority of k12's revenue has been from virtual schools and district-managed virtual
programs. Traditionally, k12's revenue growth has been driven by three major factors; (i) the addition of
grades, (ii) the addition of states and (iii) same-store growth in existing states.
In 2002 k12 began operations in two states (Colorado and Pennsylvania). In 2003 revenue grew to $30.9
million from $6.7 million during the 2002 fiscal year end. Growth was due to the addition of four new
states (Ohio, Idaho, California and Arkansas), three new grades and same store sales growth of
approximately 40%. During 2004 revenue increased by 131.0% to $71.4 million. Revenue growth during
the 2004 fiscal year was due to the addition of five new states (Minnesota, Arizona, Florida, Wisconsin
and the District of Columbia) and two new grades. During the 2005 fiscal year k12 began to concentrate
on leveraging its scale to achieve profitability by slowing down curriculum production and not aggressively
pursuing new states. Revenue grew at a slower rate, but profitability increased as the growth in the
existing states continued. Existing state growth is more profitable than new state growth because each
new state requires a significant amount of fixed overhead to be added.
The projections of financial results presented above are based on the development and expansion of
k12's operations in existing states and grades. Key growth drivers in the near term are expected to
include high same-store growth rates and k12's ability to leverage its existing infrastructure for margin
improvement. Future drivers of growth at k12 which are not included in the projections are expected to
include the addition of new states. In 2006, k12 opened in Texas, Wyoming and Washington. More
recently, the Chicago school board approved a virtual public school for the city of Chicago that will be
managed by k12. k12 also received a charter in the Sacramento area of California that will allow it to
serve a large area in California that it cannot currently serve. k12 is currently continuing to pursue
opportunities in several other states.
Under k12's current revenue recognition policy, revenues are principally earned from contractual
agreements to provide on-line curriculum, books, materials, computers and to manage and operate virtual
charter schools. In most contracts, k12 is responsible to the charter schools for all aspects of the
management of schools, including but not limited to the monitoring of the academic achievement of the
students, training, and compensation of school personnel; and procurement of curriculum and equipment
necessary for operations of the schools. The schools receive funding on a per student basis from the
state in which the charter school or school district is located. Where k12 has determined that they are the
primary obligor for substantially all expenses under these contracts, k12 records the associated per
student revenue received by the school from its state funding school district up to the expenses incurred
in accordance with Emerging Issues Task Force (EITF) 99-19, Reporting Revenue Gross as a Principal
Versus Net as an Agent. k12 has generally agreed to fund any operating losses of the schools in a given
school year; however, k12 is not entitled to any revenue in excess of expenses incurred on its contracts,
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unless k12 incurred excess losses in prior years. For contracts in which k12 is not the primary obligor,
k12 records revenue based on its net fees earned per the contractual agreement.
Under k12's current revenue recognition policy, k12 records revenue related to contracts with its virtual
academies primarily on a gross basis. As a result, k12 has recorded certain expenses of these virtual
academies in revenues and costs and expenses. These expenses were $25.4 million and $29.3 million
for the fiscal years ended June 30, 2004 and 2005 respectively.
13.9. k12 Equity
k12 has issued and outstanding approximately 45.1 million shares of Series C Preferred Stock,
approximately 51.5 million shares of Series B Preferred Stock and approximately 10.0 million shares of
Common Stock. The Series C Preferred Stock is senior to the Series B Preferred Stock and the Common
Stock and has a liquidation preference equal to the greater of (a) two times the original cost of the Series
C Preferred Stock (plus any accrued dividends) or (b) the amount which would be received upon
conversion of the Series C Preferred Stock into Common Stock. KUE owns approximately 40.0% of the
outstanding Series C Preferred Stock. The Series C Preferred Stock has a dividend rate of 10% per
annum, compounded annually with such dividends being paid in the form of additional shares of Series C
Preferred Stock.
The Series B Preferred Stock is senior to the Common Stock and has a liquidation preference equal to
the greater of (a) two times the original cost of the Series B Preferred Stock or (b) the amount which
would be received upon conversion of the Series B Preferred Stock into Common Stock. KUE owns
approximately 7.5% of the outstanding Series B Preferred Stock. The holders of the Series B Preferred
Stock do not receive dividends.
KUE does not own any shares of Common Stock. However, both the Series B Preferred Stock and the
Series C Preferred Stock are convertible into k12 Common Stock, and on an as-if-converted, fully-diluted
basis KUE owns approximately 17.9% of k12's Common Stock.
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14. THE STRUCTURE OF KUE AND THE GENERAL PARTNER
The following information is a summary of the principal terms of the organizational documents of KUE and
the General Partner. The information below is qualified in its entirety by reference to the Amended and
Restated Limited Partnership Agreement of KUE and the organizational documents of the General
Partner, including the Amended and Restated Memorandum and Articles of Association of the General
Partner and the Agreement Among Members of the General Partner (the "Organizational Documents),
copies of which have been provided or are available upon request In the event of any inconsistency
between the terms herein and the terms of the Organizational Documents, the Organizational Documents
shall control.
14.1. KUE
KUE is constituted as a Cayman Islands exempted limited partnership under the Exempted Limited
Partnership Law (2003 Revision) (the "ELP Law"). A Cayman Islands exempted limited partnership is
constituted by the signing of the relevant partnership agreement and its registration with the Registrar of
Exempted Limited Partnerships in the Cayman Islands.
Notwithstanding registration, an exempted limited partnership is not a separate legal person distinct from
its partners. Under Cayman Islands law, any property of the exempted limited partnership shall be held or
deemed to be held by the general partner, and if more than one then by the general partners jointly upon
trust, as an asset of the partnership in accordance with the terms of the partnership agreement. Similarly,
the general partner for and on behalf of the partnership incurs the debts or obligations of the exempted
limited partnership. Registration under the ELP Law entails that the partnership becomes subject to, and
the limited partners therein are afforded the limited liability and other benefits of the ELP Law.
The business of an exempted limited partnership will be conducted by its general partner(s) who will be
liable for all debts and obligations of the exempted limited partnership to the extent the partnership has
insufficient assets. As a general matter, a limited partner of an exempted limited partnership will not be
liable for the debts and obligations of the exempted limited partnership save (i) as expressed in the
partnership agreement, 00 if such limited partner becomes involved in the conduct of the partnership's
business or (Hi) if such limited partner is obliged pursuant to Section 14(1) of the ELP Law to return a
distribution made to it where the exempted limited partnership is insolvent.
The Limited Partnership Agreement of KUE limits the liability and reduces the fiduciary duties of the
General Partner to the Limited Partners of KUE (the "Limited Partners," and, together with the General
Partner, the "Partners") to the full extent of applicable law. The Limited Partnership Agreement also
restricts the remedies available to the Limited Partners for actions that might otherwise constitute a
breach of the General Partner's fiduciary duties owed to the Limited Partners. By purchasing Units,
Investors are treated as having consented to various actions contemplated in the Limited Partnership
Agreement and conflicts of interest that might otherwise be considered a breach of fiduciary or other
duties under applicable Cayman law.
14.2. The General Partner
The General Partner is incorporated in the Cayman Islands as an exempted company with limited liability
under the Companies Law (2004 Revision) (the "Companies Law"). The Memorandum and Articles of
Association comprise the constitution of General Partner. The principal business purpose of the General
Partner is to act as the general partner of KUE, to own interests in KUE and to engage in activities related
thereto (the "Business Purpose"). The General Partner will not engage in material activities (including
holding any material assets or incurring any material liabilities) unrelated to the Business Purpose. The
General Partner has no prior operating history or prior business and will not have any substantial assets or
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liabilities other than in connection with its acting as general partner of KUE and as described in this
Memorandum.
The day to day business of the General Partner will be generally be conducted by its directors, although
certain matters require the approval of its shareholders pursuant to the Companies Law and the General
Partner's Articles of Association. Under Cayman Islands law, a director of a Cayman Islands company is
obliged to comply with a number of duties, breach of which may, in certain circumstances, result in
personal liability on the part of the director. However, provided a director complies with the fiduciary
duties and the requisite duties of care, diligence and skill, the fact that a decision turns out to be wrong,
not beneficial, or causes loss, will not of itself necessarily establish personal liability.
As a general rule, in the absence of a contractual arrangement to the contrary, the liability of a
shareholder of a Cayman Islands exempted company which has been incorporated with limited liability is
limited to the amount from time to time unpaid in respect of the par value of, together with the share
premium payable on, the shares he holds; the company having a separate legal personality from that of
its shareholders, and being separately liable for its own debts due to third parties. However, although
there is no decided Cayman Islands authority on the issue, English common law authority (which would
be regarded as persuasive, though technically not binding, in the courts of the Cayman Islands), supports
the proposition that it in exceptional circumstances it is conceivable that the principle of the separate legal
personality of a company could be ignored and the court will "pierce the corporate veil." Examples might
be a company acting as the agent or nominee of its shareholder, incorporation for an illegal or improper
purpose, using a company or group of companies as a means of perpetrating a fraud, or using the
separate personality of a company to circumvent a pre-existing obligation of its proprietor.
14.3. Classes of Units; Capital Contributions
Assuming that 1,000,000 Units are sold to Investors by March 31, 2007, and that the accrued dividends
on the preferred limited partner units are paid in cash, approximately 2,530,000 Units will be outstanding.
The Investors will own approximately 40% of KUE in the form of Common LP Units and approximately
40% of the General Partner in the form of Class A Shares.
The General Partner will be the sole general partner of KUE and will hold approximately 1,000 General
Partner Units ("GP Units") in KUE, representing approximately 0.04% ownership in KUE.
The economic interest in KUE represented by the Common LP Units and the GP Units will be reduced by
the Profits Participation LP Units as described below under "Distributions."
Assuming that 1,000,000 Units are sold to Investors by March 31, 2007, and that the accrued dividends
on the preferred limited partner units are paid in cash, KUE LLC, controlled by the Principals, will hold
approximately 1,530,000 Common LP Units representing approximately 60% ownership in KUE and
1,530,000 Class A Shares. The Common LP Units owned by KUE LLC will not be transferable, except (i)
to the Principals; (ii) to affiliates of the Principals and/or (Hi) to family members and/or charitable
organizations in connection with the Principals' estate planning unless combined with the corresponding
percentage of Class A Shares to form Units and transferred in the form of Units in accordance with the
Limited Partnership Agreement.
Knowledge Universe Holdings LLC, a Delaware limited liability company ("KUH LLC") controlled by the
Principals, will hold 900 Class B ordinary shares of the General Partner (the "Class B Shares"). The
Class B Shares held by the Principals and their affiliates will not be transferable, except to (i) the
Principals; (ii) to the affiliates of the Principals; and/or (Hi) to family members and/or charitable
organizations in connection with the Principals' estate planning. The Class B Shares will automatically
convert to Class A Shares if the Principals' aggregate direct and indirect economic interest in KUE is less
than 15% of the outstanding Partnership Units (as defined below) of KUE.
A limited liability company ("KULG LLC-1"), of which Knowledge Universe Learning Group LLC, a
Delaware limited liability company that is controlled by the Principals ("KULG"), and certain other persons
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designated by KULG are members, will be the holder of the Profits Participation LP Units (the "Profits
Participation Limited Partner") with the economic rights as set forth in "— Distributions" below. KULG LLC-
1 will undertake that no more than 9% of the KUE Partnership Interests outstanding immediately after the
final closing of the offering or thereafter will be held directly or indirectly by or for the account of the
Principals and their Affiliates through the Profits Participation LP Units of KUE. At least 2/11ths of the
Profits Participation LP Units outstanding will be issued to or reserved for the benefit of members of
KULG LLC-1 that are not the Principals or their affiliates, and may include employees, officers, directors,
consultants and agents of KUE, its subsidiaries and joint ventures as designated by KULG. At each
closing of any sale of Units to Investors where the aggregate purchase price of all Units acquired by
Investors to date is less than or equal to $1.5 billion (during the Offering Period or thereafter), the Profits
Participation Limited Partner will be issued a number of Profits Participation LP Units such that the
aggregate shall equal at least 9/11ths of the 11% of "Partnership Units" (Common LP Units, GP Units,
and Profits Participation LP Units) that may be represented by Profits Participation LP Units. Additional
Profits Participation LP Units will be issued to the Profits Participation Limited Partner, at such time and in
such numbers as the Profits Participation Limited Partner will direct, based upon the issuance by the
Profit Participation Limited Partner of interests to members of the Profits Participation Limited Partner
(who may include employees, officers, directors, consultants and agents of KUE, its subsidiaries and joint
ventures as designated by KULG other than the Principals and their affiliates), the vesting schedule of
such interests, and whether certain tax elections are made by the recipients of such interests; provided,
however, the total number of Profits Participation LP Units shall not exceed a number equal to eleven
percent (11%) of the aggregate number of Partnership Units. Any increase in the number of Profits
Participation LP Units following the sale of the first $1.5 billion of Common LP Units to Investors requires
a majority vote of the Independent Committee.
Subsequent to the completion of this offering, KUE may raise additional capital through the sale of equity
or debt securities. KUE will not have any preferred limited partner units outstanding upon completion of
this offering but KUE may issue limited partner units with preferences over the Common LP Units in the
future and may amend the Limited Partnership Agreement accordingly.
Since the General Partner will have a nominal economic interest in KUE, the Class A Shares are
expected to have nominal economic value. The Class A Shares are, however, intended to provide Unit
holders with certain voting and other governance rights in the General Partner (as described further below)
which, in turn, will control KUE.
14.4. Admission of Partners to KUE
The General Partner may admit one or more Persons as additional Partners of KUE on such terms as the
General Partner will determine. Upon the admission of additional Partners, the capital accounts of the
Partners will be increased or decreased, as the case may be, to reflect the gross asset values of KUE's
assets pursuant to Regulation Section 1.704-1(b)(2)(iv)(g). The amount of any such increase or decrease
will be allocated among the Partners who were Partners immediately prior to the admission of additional
Partners as if such increase or decrease constituted income or loss, respectively, in accordance with the
allocation provisions of the Limited Partnership Agreement.
Not in limitation of the foregoing, Investors admitted during the Offering Period after the first closing of this
offering and after September 30, 2006 will pay an additional amount accruing at a rate of 0.67% per
month calculated from the first closing date of the offering (pro-rated for partial periods) for each Common
LP Units purchased, which will be distributed promptly to the holders of Common LP Units outstanding
prior to such admission in proportion to the number of Common LP Units held by such holders.
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14.5. Management of KUE and the General Partner; Voting Rights
The General Partner will manage and operate KUE. Investors will have no voting rights on matters
affecting KUE business with respect to their Common LP Units in KUE because the Investors will be
limited partners of KUE. Notwithstanding the foregoing, subject to certain exceptions set forth in the
paragraph below, KUE must obtain the consent of (a) the holders of a majority of the Common LP Units
unaffiliated with the Principals to amend the Limited Partnership Agreement in a manner that is adverse
to the Common LP Unit holders and (b) the holders of at least 90% of the Common LP Units unaffiliated
with the Principals to amend the "Equal Merger Consideration Provision" described herein. In addition,
the General Partner may not take any action to (a) alter or add to its Articles or (b) alter or add to its
Memorandum with respect to any objects, powers or other matters specified therein that would adversely
affect the rights of holders of Class A Shares without the affirmative vote of the holders of a majority of
the Class A Shares.
Notwithstanding the foregoing, the General Partner, acting reasonably and in good faith, may amend the
Limited Partnership Agreement without the consent of any Limited Partner (a) to correct any
typographical or similar ministerial errors; (b) to delete or add any provision required to be so deleted or
added by applicable law or any government official having jurisdiction over KUE; (c) to cure any mistake
or ambiguity, to correct or supplement any provision herein which may be inconsistent with any other
provision herein; (d) to take such actions as may be necessary Cif any) to ensure that KUE will be treated
as a partnership for U.S. federal income tax purposes; (e) to reflect the admission of any additional
Limited Partner and otherwise to reflect such admission or an additional investment by a Limited Partner
on the books and records of KUE pursuant to the General Partner's power of attorney; (f) to take such
actions as may be necessary (if any) to ensure that neither of KUE or the General Partner (or any
subsidiary of the foregoing) will be subject to regulation under ERISA or the Investment Company Act; (g)
to take such actions as may be necessary (if any) to ensure that the General Partner (or any Subsidiary)
will not be subject to the Investment Advisers Act; (h) to reflect any increase in the number of Profits
Participation LP Units approved by the Independent Committee and related changes in allocation and
distribution provision; CO to make changes negotiated with Limited Partners admitted in any subsequent
closing of the offering, so long as such changes do not, in the good faith determination of the General
Partner and with the approval of the Independent Committee, adversely affect the rights, obligations and
economic interests of the existing Limited Partners; and (j) to the extent necessary to give effect to
partnership interests issued to additional Limited Partners after the Offering Period. The General Partner
shall provide prompt written notice of any such amendments to the Limited Partners.
Holders of Class A Shares of the General Partner will have one vote per share. The holders of Class B
Shares will have, in the aggregate, one more vote than the requisite legal vote required to approve
particular matters. In addition, Investors will have the right to elect directors to the Board of Directors of
the General Partner as set forth in "— Board of Directors of the General Partner' below.
14.6. Board of Directors of the General Partner
The General Partner will have a Board of Directors initially consisting of up to 13 persons.
Following the first closing of the offering and prior to the "Initial Listing" (as defined below), the outside
Investor (including its affiliates) holding the greatest number of shares in the General Partner at the first
closing of the offering will appoint two directors of the General Partner and the holders of the Class B
Shares will appoint the remaining Directors.
Following the initial appointment of the Board, the Board may, in its sole discretion, increase the number
of directors, including to accommodate investors that invest subsequent to the initial closing of the
offering of the Units, provided that the outside Investor appointing two directors pursuant to the paragraph
above shall have the right to appoint additional directors as required to maintain a ratio of such Investors
designees to total Board members of not less than 2/15ths.
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"Independent Directors" of the Board of Directors of the General Partner shall be individuals who (a) are
not (i) a Principal, (ii) a family member of a Principal, (iii) an employee of a Principal or any entity
controlled by one or more of the Principals, and (b) meet the definition of "independent director" set forth
in Rule 303A.02 of the New York Stock Exchange Listed Company Manual (as if the General Partner,
KUE and each of its Subsidiaries were the "listed company") , including any such individuals appointed by
the Investors who otherwise satisfy the requirements of this definition.
At the time of the final closing of this offering, the General Partner will have at least two Independent
Directors. After the Initial Listing and so long as consistent with contractual, listing and licensing
obligations, a majority of the board of directors of the listed company will be Independent Directors.
14.7. Initial Listing; Initial Listing Process
"Initial Listing" means a listing on a recognized international securities exchange with a substantially
concurrent underwritten offering generating gross proceeds of U.S. $200 million or more. "Initial Listing"
refers to the Initial Listing of KUE or any successor or any subsidiary of KUE to which substantially all of
KUE's assets and liabilities have been transferred or are held.
The General Partner may take and cause KUE to take such actions as the General Partner reasonably
deems necessary to complete the Initial Listing on the recognized international securities exchange or
exchanges selected by the General Partner, including without limitation a restructuring or reorganization
or other transaction or asset transfer between or among KUE and any of its subsidiaries. If the Initial
Listing involves the listing of shares or other interests of a subsidiary of KUE, in the General Partner's
discretion, KUE may (i) retain some or all of KUE's interest in such subsidiary not sold in connection with
the Initial Listing, (ii) distribute some or all of KUE's interest in such subsidiary not sold in connection with
the Initial Listing to the Partners, (iii) offer Partners the opportunity to exchange their Common LP Units
and shares of the General Partner for interests in such subsidiary, (iv) require Partners to exchange their
Common LP Units and shares of the General Partner for interests in such subsidiary, or (v) any
combination of the foregoing. Each Partner shall cooperate with the General Partner in connection with
the foregoing, including, without limitation, (i) by providing any necessary approvals from such Partner for
(a) any merger or consolidation of KUE or a subsidiary then permitted by law into an entity that is eligible
to effect such Initial Listing and has no other material business, assets or liabilities, or (b) a transfer of all,
substantially all or a portion of the assets and liabilities of KUE to one or more wholly-owned subsidiaries
eligible to effect the Initial Listing; (ii) by exchanging such Partner's Common LP Units and shares of the
General Partner for shares or other interests of the entity to be listed: Op by agreeing to customary "lock-
up" (on terms no more restrictive than KUE LLC or its affiliates or any other Common Limited Partner
which provides a "lock-up") and other agreements with underwriters; and (iv) by taking such other actions
as may be reasonably requested by the General Partner, provided that, in connection with such Initial
Listing, no Partner shall be required to contribute additional capital to KUE or the entity effecting the Initial
Listing. The economic interests of the Profits Participation Limited Partner shall not be reduced as a result
of any actions taken to effect the Initial Listing.
14.8. Mandatory Conversion of Class B Ordinary Shares
The Class B Shares will automatically convert to Class A Shares if the Principals' aggregate economic
interest in KUE is less than 15% of the outstanding Partnership Units.
14.9. Distributions
Cash and other property may be distributed from KUE after payment of ordinary expenses and all
amounts currently due on KUE indebtedness, funding capital expenditures of subsidiaries and joint
venture, funding operating and other expenses of KUE, its subsidiaries and joint ventures and after the
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establishment of reasonably necessary reserves as determined by the General Partner. The General
Partner will make distributions at such times as determined by the General Partner.
Distributions will be made in the following priority:
• First, to the Common Limited Partners and the General Partner in proportion to and to the extent
of their unreturned capital contributions, but in no case may a distribution pursuant to this bullet
exceed a Partner's positive adjusted capital account balance;
• Second, pursuant to Subsections (a) and (b) in proportion as follows: (a) to the Common Limited
Partners and the General Partner in proportion to and to the extent of their undistributed
Preferred Returns; and (b) to the Profits Participation Limited Partner in an amount equal to (i) the
number of Units held by the Profits Participation Limited Partner, divided by the number of all
outstanding Units other than Units held by the Profits Participation Limited Partner, multiplied by
(H) the amount distributed pursuant to Subsection (a) of this bullet, multiplied by (Hi) a fraction to
be provided by the Profits Participation Limited Partner; provided, however, that the fraction shall
not exceed 2/11ths (unless the Independent Committee has increased the number of Profits
Participation LP Units beyond the number initially authorized, in which case the maximum fraction
authorized for this purpose would be increased appropriately);
• Third, to the Profits Participation Limited Partner in an amount equal to: (a) the number of Units
held by the Profits Participation Limited Partner, divided by the number of all outstanding Units
other than Units held by the Profits Participation Limited Partner, multiplied by (b) the amount
distributed pursuant to Subsection (a) of the above bullet from the inception of KUE, multiplied by
(c) a number (expressed as a fraction) equal to 1 minus the fraction used in clause (iii) of the prior
bullet for the same distribution (unless the Independent Committee has increased the number of
Profits Participation LP Units beyond the number initially authorized, in which case the maximum
fraction for this purpose would be modified appropriately), less (d) all amounts previously
distributed to the Profits Participation Limited Partner pursuant to this bullet; and
• Fourth, to the Common Limited Partners, the Profits Participation Limited Partner, and the
General Partner in proportion to the number of Units held by each such Partner.
"Preferred Return" means (as to a Common Limited Partner and the General Partner) an amount equal to
eight percent (8%) per annum, determined on the basis of a year of 365 or 366 days, as the case may be,
for the actual number of days in the period for which the Preferred Return is being determined and be
cumulative on the capital contributions of such Partners and shall be calculated from the date of such
Partner's capital contribution; provided however that in the case of Common LP Units issued upon the
conversion of preferred limited partner units at the initial closing of the offering, that the date of Capital
Contribution shall be deemed to be the date of the initial closing of the offering solely for purposes of
calculating the Preferred Return.
To the extent, at the time of any distribution or income or loss allocation pursuant to the Partnership
Agreement, the 2/11ths portion of the Profits Participation LP Units has not then been fully allocated by
KULG LLC-1 to employees, officers, directors, consultants and agents of KUE, its subsidiaries or joint
ventures, then the distribution or income or loss allocation that would otherwise be attributable to such
unallocated portion of the Profits Participation LP Units shall be reallocated among the Common Limited
Partners and the General Partner in proportion to their Units for purposes of such distribution or income
or loss allocation (including in connection with their Preferred Return).
Notwithstanding the foregoing, the Limited Partnership Agreement gives the General Partner the authority
to override the distribution provisions of the Limitation Partnership Agreement described above in order to
achieve the desired economic arrangement of KUE, which is: (i) first, to return the Partners' Capital
Contributions to them; (H) second, for the Common Limited Partners and the General Partner to receive
their Preferred Return while the Profits Participation Limited Partner concurrently receives an amount
equal to a fraction of the amount the Common Limited Partners and the General Partner received
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pursuant to their Preferred Return (such fraction to be equal to the portion of the Units held by the Profits
Participation Limited Partner attributable to members of the Profits Participation Limited Partner other
than the Principals), multiplied by the number of Units held by the Profits Participation Limited Partner
divided by the number of outstanding Units other than those Units held by the Profits Participation Limited
Partner; (Hi) third, for the Profits Participation Limited Partner to receive an amount equal to a fraction of
the amount the Common Limited Partners and the General Partner received pursuant to their Preferred
Return (such fraction to be equal to the portion of the Units held by the Profits Participation Limited
Partner attributable to members of the Profits Participation Limited Partner who are Principals or their
affiliates), multiplied by the number of Units held by the Profits Participation Limited Partner divided by the
number of outstanding Units other than those Units held by the Profits Participation Limited Partner; and
(iv) finally, for all Partners (including the Profits Participation Limited Partner) to share in the profits of the
Partnership in proportion to the number of Units held by them.
The General Partner may, in its discretion, when establishing the capital structure of subsidiaries or joint
ventures, provide for a capital structure which provides for high-vote and low-vote (or non-voting)
securities with substantially equivalent economic rights intended to correspond to the voting and
economic structure of KUE (taking into account differences in legal form, such that corporate subsidiaries
do not have specified distribution or liquidation rights with respect to common stock). Notwithstanding
any contrary provisions below addressing equal merger consideration, to the extent securities of an entity
corresponding to the voting structure of KUE are to be distributed to the Partners, the high-vote securities
shall be distributed to KUE LLC for purposes of maintaining the voting structure subsequent to such
distribution, as long as the securities otherwise have substantially equivalent economic rights and the
high-vote securities have mandatory conversion features equivalent to the mandatory conversion features
of the Class B Shares of the General Partner (as discussed below), it being understood that securities
with high-voting rights shall not be deemed to have a higher economic value than securities with limited or
no voting rights solely by reason of the disparity in voting rights.
14.10. Allocations of Income and Losses
In general (and subject to certain special tax and regulatory allocations), income and gains of KUE will be
allocated to the Partners in the following priority:
• First, to the General Partner in an amount equal to the losses previously allocated to the General
Partner pursuant to the third bullet in the losses allocation from the inception of KUE, less all
income previously allocated to the General Partner pursuant to this bullet;
• Second, to the Common Limited Partners and the General Partner in proportion to and to the
extent of the excess of their unreturned capital contributions over their adjusted capital account
balances;
• Third, pursuant to subsections (a) and (b) in proportion as follows: (a) to the Common Limited
Partners and the General Partner in proportion to and to the extent of the excess of: (i) the sum of
their unreturned capital contributions and their undistributed Preferred Returns; over (i) their
adjusted capital account balances; and (b) to the Profits Participation Limited Partner an amount
of income such that the amount of Income allocated pursuant to Subsections (a) and (b) of this
bullet are in the same proportions as the distributions pursuant to Subsections (a) and (b) of the
second bullet of 14.9 above would be in if cash, in the same amount as the income, were being
distributed pursuant to the second bullet of 14.9 above;
• Fourth, to the Profits Participation Limited Partner in the amount necessary to ensure, as
promptly as possible and to the extent feasible, that the cumulative net income of KUE for all
periods since its inception shall have been allocated to the Common Limited Partners, the Profits
Participation Limited Partner, and the General Partner in proportion to the number of Units held
by each such Partner; and
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• Fifth, to the Common Limited Partners, the Profits Participation Limited Partner, and the General
Partner in proportion to the number of Units held by each such Partner.
In general (and subject to certain special tax and regulatory allocations), losses and deductions of KUE
will be allocated to the Partners in the following priority:
• First, to the Common Limited Partners, the Profits Participation Limited Partner, and the General
Partner in proportion to and to the extent of their positive adjusted capital account balances;
• Second, to the Common Limited Partners, the Profits Participation Limited Partner, and the
General Partner in proportion to the number of Units held by each such Partner; and
• Third, to the General Partner.
To the extent, at the time of any distribution or income or loss allocation pursuant to the Partnership
Agreement, the 2/11ths portion of the Profits Participation LP Units has not then been fully allocated by
KULG LLC-1 to employees, officers, directors, consultants and agents of KUE, its subsidiaries or joint
ventures, then the distribution or income or loss allocation that would otherwise be attributable to such
unallocated portion of the Profits Participation LP Units shall be reallocated among the Common Limited
Partners and the General Partner in proportion to their Units for purposes of such distribution or income
or loss allocation (including in connection with their Preferred Return).
Notwithstanding the foregoing, the Limited Partnership Agreement gives the General Partner the authority
to override the distribution provisions of the Limitation Partnership Agreement described above in order to
achieve the desired economic arrangement of KUE, which is: (i) first, to return the Partners' Capital
Contributions to them; (ii) second, for the Common Limited Partners and the General Partner to receive
their Preferred Return while the Profits Participation Limited Partner concurrently receives an amount
equal to a fraction of the amount the Common Limited Partners and the General Partner received
pursuant to their Preferred Return (such fraction to be equal to the portion of the Units held by the Profits
Participation Limited Partner attributable to members of the Profits Participation Limited Partner other
than the Principals), multiplied by the number of Units held by the Profits Participation Limited Partner
divided by the number of outstanding Units other than those Units held by the Profits Participation Limited
Partner; (Hi) third, for the Profits Participation Limited Partner to receive an amount equal to a fraction of
the amount the Common Limited Partners and the General Partner received pursuant to their Preferred
Return (such fraction to be equal to the portion of the Units held by the Profits Participation Limited
Partner attributable to members of the Profits Participation Limited Partner who are Principals), multiplied
by the number of Units held by the Profits Participation Limited Partner divided by the number of
outstanding Units other than those Units held by the Profits Participation Limited Partner; and (iv) finally,
for all Partners (including the Profits Participation Limited Partner) to share in the profits of the
Partnership in proportion to the number of Units held by them.
14.11. Tax Distributions
The General Partner may decide to make a tax distribution from KUE on or before April 1st of any year
following a taxable year in which net taxable income was allocated to any Partner. If the General Partner
decides to make a tax distribution, then KUE will distribute cash available for distribution, if any, to those
Partners receiving an allocation of net taxable income, regardless of whether such net taxable income is
actually subject to tax. The amount of net taxable income upon which such a tax distribution will be made
will be based on cumulative calculation of net taxable income and net taxable loss which have been
allocated to each such Partner from the inception of KUE. Any tax distributions received by a Partner will
be treated as an advance and will offset against any other distributions such Partner is entitled to receive
from KUE.
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Certain Partners contributed appreciated property to KUE in exchange for their interests in KUE. Under
the Limited Partnership Agreement, and in accordance with Section 704(c) of the Code and the Treasury
regulations thereunder, income, gain, loss, and deduction with respect to any property contributed to KUE
must be allocated for tax purposes among the Partners in a manner that takes into account the variation
between the adjusted basis of such property to KUE and its fair market value at the time the property was
contributed to KUE. As a result of this requirement, it is possible the Partners who contributed
appreciated property to KUE will be allocated more income and gains, and therefore be entitled to receive
larger tax distributions under the Limited Partnership Agreement, than Partners who acquired their
interests in KUE pursuant to this offering.
14.12. Fixed Overhead Payment
KUE, and/or one or more of its subsidiaries will pay $20 million annually to KULG in quarterly installments
beginning July 1, 2006 pursuant to the Fixed Overhead Payment Agreement as an agreed upon payment
to provide for the reimbursement of expenses and other costs incurred by KULG on behalf of KUE and its
subsidiaries (including, but not limited to, salaries and bonuses of KULG employees providing services to
KUE and its subsidiaries, fees and expenses relating to financing transactions and acquisitions,
professional fees and other administrative expenses). To the extent that the U.S. $2,500,000 fee payable
pursuant to an existing management services agreement with Knowledge Learning Corporation is paid to
any person or entity other than a subsidiary of KUE, the amount payable to KULG by KUE will be reduced
by the amount of such payment to such other person or entity. The $20 million annual fee will terminate
upon the Initial Listing or the sale of KUE to a person or entity that is not a KUE LLC Entity.
14.13. Illiquidity Period
KUE will operate for a period of seven years from the date of the first closing of this offering. If there has
not been an Initial Listing by the end of seven years from the date of the first closing of this offering, the
Board of Directors of the General Partner will determine whether to pursue a sale of KUE or an Initial
Listing (or a dual track process); provided, however, in the event that not less than 75% of the value of
KUE at that time is represented by shares of securities listed on one or more recognized international
securities exchanges and such shares have been or will be distributed as soon as reasonably practicable
thereafter to the Investors and the Investors have received distributions of cash and/or such securities
valued at amounts equal to or in excess of their original capital contributions, then there will be two
extensions of one year's duration each (as determined by the Board of Directors of the General Partner)
in order for KUE to complete either an Initial Listing or to have the remaining value of KUE represented by
shares of securities listed on a recognized international securities exchange and to distribute such shares
to the Investors.
If the Board determines to pursue a sale of KUE (or an Initial Listing or a dual track process), then the
Principals must determine at such time whether they intend to participate as a potential bidder in the sale
process.
If the Principals elect not to participate as a potential bidder in a sale process, then they will not be
allowed to subsequently elect to participate as a potential bidder unless the sale process does not result
in a buyer at a price the Independent Committee deems to be "fair." If the sale process results in a
transaction that the Independent Committee deems to be "fair", the Principals will be required to sell their
entire stake in KUE (Common LP Units and Profits Participation LP Units on an "as converted" basis) on
the same terms as the Investors.
If the Principals elect to participate as a potential bidder in a sale process, then the sale process will be
managed by the Independent Committee and the Principals will be precluded from participating in Board
deliberations regarding the sale process. In addition, the Principals will be required to sell their entire
stake in KUE on the same terms as the Investors to the winning bidder in the event the Principals do not
submit the most attractive bid.
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In the event that a sale of KUE or an Initial Listing has not occurred within nine years from the date the
first Investors are admitted to KUE, the Independent Committee shall determine whether to pursue a sale
of KUE (or an Initial Listing or a dual track process). A majority vote of the Independent Committee on
this issue shall be binding on the Board of Directors of the General Partner and will require the Board of
Directors of the General Partner to pursue such action within ninety (90) days.
14.14. Equal Merger Consideration Provision
The Principals (through KUE LLC) and the Investors will receive the same consideration per Common LP
Unit and/or Class A/Class B Shares in connection with a sale, merger, recapitalization, share repurchase,
dividend, or any other transaction where all holders of Common LP Units or shares in the General Partner
receive consideration with respect to their Common LP Units or shares, other than with respect to
corporate restructuring transactions, such as a holding company merger, conversion of KUE from an
exempted limited partnership to a corporation or other entity, change of domicile, or any other transaction
that the Independent Committee determines is a "corporate restructuring." In any such corporate
restructuring transaction, the Principals (through KUE LLC) may receive securities with high-voting rights
and the Investors may receive securities with limited or no voting rights so long as the consideration
received by the Principals (through KUE LLC) and the other Partners per Common LP Unit have
substantially equivalent economic provisions, it being understood that securities with high-voting rights
shall not be deemed to have a higher economic value than securities with limited or no voting rights solely
by reason of the disparity in voting rights.
14.15. Related Party Transactions
Related party transactions include transactions between (1) any of the Principals or any affiliates or any
entity controlled by any of the Principals, and (2) KUE or any direct or indirect subsidiary or joint venture
of KUE involving more than $1 million (including, for the avoidance of doubt, any merger, acquisition,
asset purchase or similar transaction between KUE, its subsidiaries or joint ventures, on the one hand,
and any person of which fifteen percent (15%) or more of the voting stock (or similar voting interests) is
owned by KUE LLC or its affiliates, on the other hand). Related party transactions do not include (a) any
transaction solely between or among KUE and any of its direct or indirect subsidiaries or joint ventures in
which the Principals do not have any direct or indirect ownership interest (other than as a result of their
ownership in the General Partner and KUE), (b) reasonable and customary director, advisory board
member, or consultant compensation and benefits (including, without limitation, retirement, health, stock
option and other benefit plans) as approved by the Independent Committee, provided that any such
compensation, benefits and arrangements to the Principals that do not exceed $1 million in the aggregate
annually shall not be subject to such approval and customary indemnification arrangements, (c)
transactions and arrangements pursuant to or contemplated by express terms of the Limited Partnership
Agreement of KUE, including the "Investment in Subsidiaries" and "Co-Invest Right' described below, and
any payments pursuant thereto, (d) agreements, transactions and arrangements described in "Related
Party Transactions" in this Private Placement Memorandum (including any indemnification arrangements,
the Fixed Overhead Payment described above and other arrangements and transactions described
therein) and any amendment thereto (so long as such amendment is not disadvantageous to the
Investors as a whole in any material respect) or any transaction contemplated thereby and any payments
pursuant thereto, and (e) admissions of any affiliate of the Principals to KUE as a Limited Partner on
terms substantially equivalent to concurrent admissions of persons that are not affiliates of the Principals.
If the size of the related party transaction is greater than $1 million and equal to or less than $50 million,
then either (a) the Independent Committee must approve the transaction or (b) the transaction must be
approved by the holders of a majority of the Common LP Units unaffiliated with the Principals.
If the size of the related party transaction is greater than $50 million, then the transaction must be
approved by both (a) the Independent Committee and (b) the holders of a majority of the Common LP
Units unaffiliated with the Principals.
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14.16. Investment in Subsidiaries and Joint Ventures
The Principals will agree (on behalf of themselves and their affiliates) that KUE will be their exclusive
vehicle for equity investment opportunities in and acquisitions of for-profit companies engaged primarily in
the business of pre-K through 12th grade education of children (other than companies in which the
Principals or their affiliates directly or indirectly owns fifteen percent (15%) or more of the voting stock (or
similar voting interests) as of the date of the first closing of the offering, which are LeapFrog Enterprises,
Inc. and Nobel Learning Communities, Inc.). The Principals will not acquire or make an equity investment
in such companies unless such acquisition or investment opportunity has been first presented to the
Independent Committee and subsequently declined by the Independent Committee or initially pursued but
later abandoned by KUE. For purposes of the foregoing limitation on investment, an equity investment
shall not include equity securities that are (a) issued in respect of debt securities in connection with a
restructuring, reorganization, sale or other similar transaction in respect of a company; (b) issued in
connection with an exchange offer for debt securities; or (c) indirectly owned through a fund or other
investment vehicle managed by a person other than any Principal or affiliate of a Principal. The Principals
may co-invest with KUE in such companies, subject to the approval of the Independent Committee and
the co-investment rights of Investors in the Limited Partnership Agreement.
Not in limitation of any commitments or restrictions the Principals may have entered into, prior to an Initial
Listing, KUE may not permit any of its subsidiaries or controlled joint ventures (which shall not include, for
the avoidance of doubt, certain exempt companies contemplated by the above paragraph) to issue or
grant any equity interests in such subsidiaries or controlled joint ventures to any of the Principals or any of
their affiliates (other than KUE, its subsidiaries and controlled joint ventures) unless (i) the Independent
Committee has approved and the Investors who are accredited investors (as such term is defined in
Regulation D) or otherwise legally eligible to participate are offered the opportunity to participate on the
same terms as the Principals and their affiliates and in proportion to their economic ownership of KUE or
(ii) such subsidiary or joint venture of KUE has completed an initial listing on a recognized international
securities exchange. The foregoing restrictions will not apply to the Principals and/or their affiliates: (a)
exercising co-investment, purchase or other similar rights in respect of securities of K12 Inc. (including
warrants and options) held by them on the first closing of this offering and in respect of securities of K12
Inc. acquired pursuant to co-investment, purchase or other similar rights exercised in accordance with this
clause (a); (b) receiving securities of K12 Inc. (including warrants and options) as compensation for
services in their capacity as directors (or advisory board members) of K12 Inc.; or (c) exercising or
converting any warrants or options (or other securities) held as of the first closing of this offering or
acquired pursuant to clause (a) or (b).
The General Partner may offer co-investment opportunities to any person (except for the Principals and
their affiliates other than KUE's subsidiaries and joint ventures) to invest with KUE or to invest in a
subsidiary or joint venture of KUE.
14.17. Transferability
The Common LP Units and the Class A Shares comprising the Units owned by the Investors will not be
separately transferable, and the Units are to be transferred as a whole unless otherwise approved by the
Board of Directors of the General Partner and the Independent Committee.
Units held by an Investor may not be sold, transferred or assigned without the prior written consent of the
General Partner, not to be unreasonably withheld. During the first two years after the applicable closing
of the offering, the General Partner intends to approve transfers of Units to an affiliate of the Investor in
compliance with applicable law. After such time, the General Partner intends to approve transfers of the
Units to an affiliate of the Investor or to another Investor (and affiliates thereof), in each case in
compliance with applicable law. The General Partner also intends to approve transfers pursuant to the
Tag-Along Right and Drag-Along Right provisions described below.
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Although the Limited Partnership Agreement of KUE and the organizational documents of the General
Partner permit the foregoing transfers and the General Partner has agreed with certain investors to
approve such transfers, applicable Caymans Island law gives the General Partner full discretion to
approve or disapprove transfers of Units in KUE. Nevertheless, if the General Partner does not approve a
permitted transfer, the parties seeking to effect such transfer may have a claim against the General
Partner and KUE.
14.18. Co-Invest Right
Prior to the Initial Listing, if KUE proposes to issue for cash any Units or securities convertible into Units,
then KUE is required to offer to each Investor that is an accredited investor (as such term is defined in
Regulation D) or is otherwise legally eligible to participate in the offering the right to purchase a pro rata
portion of such securities. This purchase right does not apply to (i) the first 1.5 million Units (including
such number of Units issued at the first closing of this offering) issued by KUE to Investors through March
31, 2007, (ii) any public offering of Units or other securities by KUE; (iii) any issuance of Units in
connection with a merger, consolidation, transfer of assets or other business combination involving KUE
(or its subsidiaries or joint ventures); (iv) any issuance of Units pursuant to any unit option plan, restricted
unit plan or other benefit plan, the terms of which are approved by the General Partner, provided that the
aggregate amount of all Units issued pursuant to this clause (iv) (which does not include any Profits
Participation LP Units) shall not exceed 10% of all Units outstanding on a fully diluted basis on the date of
such issuance without the approval of the Independent Committee and shall in no event exceed 20% of
all Units outstanding on a fully diluted basis on the date of such issuance; (v) any issuance of Units in
connection with any loan transaction and/or equipment lease, the terms of which are approved by the
General Partner; (vi) any issuance of Units pursuant to any transactions, the terms of which are approved
by the General Partner primarily for the purpose of (a) joint ventures or strategic alliances, (b)
development, production or distribution of the products or services of KUE, its subsidiaries or joint
ventures, (c) purchase or licensing of technology, or (d) any other transactions that are primarily for
purposes other than raising capital, or (vii) any issuance of Units upon conversion or exercise of any Units
issued in compliance with this co-invest right provision; or (viii) any issuance of Units in connection with
Unit splits or Unit dividends or reclassifications.
Prior to the Initial Listing, Investors have substantially equivalent rights with respect to issuances of
securities by the General Partner (with the additional exemption on the issuance of up to 10,000
additional Class B Shares to the Principals or any of their Affiliates).
14.19. Tag-Along Right
A "Tag-Along Transfer" means a sale or other transfer for economic value of the Common LP Units held
by KUE LLC and its affiliates (and, unless otherwise approved by the Board of Directors and the
Independent Committee of the General Partner, a corresponding percentage of Class A Shares held by
KUE LLC) to a Person that is not KUE LLC or an affiliate ("KUE LLC Entity").
Unless an Initial Listing occurred, a Tag-Along Transfer may not be consummated unless the proposed
purchaser offers to each Investor the opportunity to include a pro rata portion of such Investor's Units in
the Tag-Along Transfer (at the same consideration per Unit received by the KUE LLC Entity). If the total
number of Units and corresponding Class A Shares proposed to be sold to the proposed purchaser
exceeds the number of Units and corresponding Class A Shares which the proposed purchaser is willing
to purchase, the number of Units and corresponding Class A Shares to be sold will be reduced pro rata
based on the total number of Units held by the transferor(s) initiating the Tag-Along Transfer and each
participating Investor.
Following the Initial Listing, the tag-along right will continue for certain Investors with respect to transfers
for value of the Units (or units of the listed entity as the case may be) by the Principals or their affiliates to
non-affiliates (excluding transfers on a recognized international securities exchange) above the following
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thresholds in one or more transactions: (i) 15% of the Principals' original KUE holdings to any single
buyer (or affiliates of that buyer) or (ii) 33% of the Principals' original KUE holdings in the aggregate.
14.20. Drag-Along Right
A "Drag-Along Transfer' means a sale or other transfer for economic value of a majority of the Common
LP Units held by KUE LLC or its affiliates (and, unless otherwise approved by the Board of Directors and
the Independent Committee of the General Partner, a corresponding percentage of Class A Shares held
by KUE LLC). Prior to the Initial Listing, in the event of a Drag-Along Transfer of Common LP Units and
corresponding Class A Shares to a proposed purchaser that is not a KUE LLC Entity (a "Proposed Drag-
Along Transfer"), KUE LLC may require Investors to sell a pro rata portion (based on the percentage of
Units held by KUE LLC being sold in the Proposed Drag-Along Transfer) of their Units and Class A
Shares in the Proposed Drag-Along Transfer to the proposed purchaser on the same terms and
conditions as KUE LLC in the Proposed Drag-Along Transfer.
14.21. Additional Listing of Investors' Units
Beginning any time after six months after the Initial Listing, one or more holders holding an aggregate of
$100 million of more of the Units (calculated based on the issue price) may request KUE and the General
Partner to take such action as may be necessary (including regulatory and legal actions) for their Units to
be freely tradable and not subject to volume restrictions on the international securities exchange on which
the Initial Listing occurred; provided that no more than one such action may be required in any 12 month
period and customary cut-back and other provisions will apply in any such listing or underwritten
transaction, as the case may be. KUE will use its commercially reasonable efforts to cause such action to
cover such holders and the securities of any other holders legally eligible to participate in such action.
14.22. Subsequent Capital Raising Activities
Subsequent to the completion of this offering, KUE may raise additional capital through the sale of equity
or debt securities. KUE will not have any preferred limited partner units outstanding upon completion of
this offering but KUE may issue limited partner units with preferences over the Common LP Units in the
future and may amend the Limited Partnership Agreement accordingly.
14.23. Periodic Reporting; Books and Records
As soon as practicable after the end of each fiscal year but in no event more than 180 days thereafter,
each Partner will be sent audited financial statements of KUE for the prior year. These financial
statements will include: (i) profit and loss statements and (ii) a balance sheet showing KUE's financial
position as of the end of that fiscal year. KUE will also provide to each Partner on a semi-annual basis a
report concerning KUE's operations. As soon as practicable after the end of each fiscal year, each
Partner will be furnished with all information necessary for the preparation of each Partner's U.S. Federal
income tax return and a copy of KUE's federal, state, and local tax or information returns for the year.
KUE will maintain at its principal place of business full and complete books and records for KUE including
the following: (1) a current list of the full name and last known business or residence address of each
Partner set forth in alphabetical order, together with the capital contribution and share of income and
losses of each Partner; (2) a copy of the Statement filed under to Section 9 of the ELP Law and all
amendments thereto; (3) copies of KUE's federal, state, and local income tax returns and reports, if any,
for the six most recent taxable years, to the extent that such exist; (4) copies of the Limited Partnership
Agreement and all amendments thereto; and (5) any other information required to be maintained by the
ELP Law. Upon the request of a Partner, the General Partner will promptly deliver to the requesting
Partner, at the expense of KUE, a copy of the information listed in the foregoing sentence.
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The General Partner will provide such periodic reports if engaged in any business other than acting as
General Partner of KUE or if it owns any material assets other than an interest in KUE.
14.24. Indemnification
KUE will indemnify, to the fullest extent permitted by applicable law, the General Partner, and its
members, officers, directors, and employees, and at the General Partner's discretion, any other person
providing services to KUE, its subsidiaries or joint ventures, (Indemnified Persons") from and against loss
because of any action performed by them on behalf of KUE or of the failure to take any action on behalf of
KUE, unless such loss resulted from the Indemnified Person acting in bad faith or the willful misconduct,
fraud or gross negligence of such Indemnified Person, or a material breach of the Limited Partnership
Agreement by such Indemnified Person. Indemnified persons may receive advances or be reimbursed
for their expenses.
14.25. Amendment of the Limited Partnership Agreement
Generally, the Limited Partnership Agreement may be amended with the consent of the General Partner.
Subject to the exceptions specified in the Limited Partnership Agreement, amendments adversely
affecting the Common LP Units may not be effected without a majority of the votes represented by Units
held by Investors.
Notwithstanding the foregoing, the General Partner, acting reasonably and in good faith, may amend the
Limited Partnership Agreement without the consent of any Limited Partner (a) to correct any typographical
or similar ministerial errors; (b) to delete or add any provision required to be so deleted or added by
applicable law or any government official having jurisdiction over KUE; (c) to cure any mistake or
ambiguity, to correct or supplement any provision herein which may be inconsistent with any other
provision herein; (d) to take such actions as may be necessary Cif any) to ensure that KUE will be treated
as a partnership for U.S. federal income tax purposes; (e) to reflect the admission of any additional
Limited Partner and otherwise to reflect such admission or an additional investment by a Limited Partner
on the books and records of KUE pursuant to the General Partner's power of attorney; (f) to take such
actions as may be necessary (if any) to ensure that neither of KUE or the General Partner (or any
subsidiary of the foregoing) will be subject to regulation under ERISA or the Investment Company Act; (g)
to take such actions as may be necessary (if any) to ensure that the General Partner (or any Subsidiary)
will not be subject to the Investment Advisers Act; (h) to reflect any increase in the number of Profits
Participation LP Units approved by the Independent Committee and related changes in allocation and
distribution provision; (i) to make changes negotiated with Limited Partners admitted in any subsequent
closing of the offering, so long as such changes do not, in the good faith determination of the General
Partner and with the approval of the Independent Committee, adversely affect the rights, obligations and
economic interests of the existing Limited Partners; and a) to the extent necessary to give effect to
partnership interests issued to additional Limited Partners after the Offering Period. The General Partner
shall provide prompt written notice of any such amendments to the Limited Partners.
14.26. Confidentiality
Each Investor is subject to an obligation to keep KUE related information confidential, subject to limited
exceptions. KUE or the General Partner will be entitled to enforce such obligations and take such actions
to maintain the confidentiality of KUE related information, including without limitation withholding any
periodic or financial reports (with the approval of the Independent Committee) from an Investor that has
violated its confidentiality obligations.
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14.27. Jurisdiction
Any actions or proceedings under the Limited Partnership Agreement or with respect to the General
Partners or this offering and the related agreements are subject to binding arbitration in London, United
Kingdom.
14.28. Limitation of Participation
Under circumstances where the continuing participation in KUE by an Investor would have a material
adverse effect on KUE or a subsidiary, the General Partner may cause an Investor's interest in KUE to be
redeemed or transferred.
14.29. United States Trade or Business
The General Partner will use its reasonable best efforts not to cause or allow KUE to engage in or invest
(other than through an entity that is not a pass-through entity) in a pass-through entity (for U.S. federal
income tax purposes) that engages in: (i) any commercial activities within the meaning of Section
892(a)(2) of the Code, or (fi) any activity which constitutes the conduct of a trade or business in the United
States and generates income which constitutes "effectively connected income" in the hands of a non-U.S.
Limited Partner. KUE will not take a position in any United States federal or state income tax return that
KUE is engaged in a trade or business in the United States that causes the non-U.S. Limited Partners to
have income which constitutes "effectively connected income" in the hands of non-U.S. Limited Partners.
In addition, the General Partner will use its reasonable best efforts to cause KUE not to invest in a U.S.
real property interest described in Section 897(c)(1 )(A)(i) or the Code.
The General Partner may, in its discretion, form a separate investment entity to pursue any investment
opportunity that is unavailable to KUE by reason of the foregoing, and may offer co-investment
opportunities to the Partners eligible to participate in such opportunities in proportion to their Units or on
such other reasonable basis as the General Partner may determine.
EACH PROSPECTIVE NON-U.S. LIMITED PARTNER SHOULD REVIEW THE SECTION ENTITLED
"CERTAIN INCOME TAX CONSEQUENCES" AND CONSULT ITS TAX AND OTHER ADVISORS IN
DETERMINING THE POSSIBLE TAX, EXCHANGE CONTROL OR OTHER CONSEQUENCES TO IT
UNDER THE LAWS OF THE U.S. AND OTHER JURISDICTIONS OF WHICH IT IS A CITIZEN,
RESIDENT OR DOMICILIARY, IN WHICH IT CONDUCTS BUSINESS OR IN WHICH IT OTHERWISE
MAY BE SUBJECT TO TAX, OF THE PURCHASE AND OWNERSHIP OF UNITS.
14.30. Term of KUE; Term of the General Partner
The term of KUE will be indefinite, unless terminated earlier as provided for below. The term of the
General Partner will be indefinite, unless terminated earlier in accordance with the Organizational
Documents.
The following events will cause the dissolution of KUE:
• The withdrawal, dissolution, bankruptcy, or resignation of a General Partner, unless the business
of KUE is continued by the election of a new General Partner by the vote of a majority in number
of the Units held by Common Limited Partners within 90 days of the happening of such event;
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• The agreement of the General Partner and the holders of a majority of the Units held by the
Limited Partners holding Common LP Units;
• The sale or distribution of all or substantially all of KUE's assets; or
• As otherwise provided by law.
If KUE is dissolved and not reconstituted and continued, the General Partner is then required to wind up
the affairs of KUE and to liquidate and sell its assets in an orderly manner. Upon the winding up and
termination of the business and affairs of KUE, its assets (other than cash) will be sold, its liabilities and
obligations to creditors and all expenses incurred in its liquidation will be paid. The net proceeds from
such sales (after deducting all selling costs and expenses in connection therewith) and any released
reserves will then be distributed to the Partners in accordance with "— Distributions" by the later of the end
of the taxable year of KUE which includes the liquidation date or the 90th day following the liquidation
date. KUE property will not be distributed in kind to the Partners upon the dissolution and termination of
KUE unless otherwise agreed by the General Partner.
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15. MANAGEMENT INCENTIVE PLANS AND EMPLOYMENT
AGREEMENTS
Certain key terms of the following incentive plans and employment agreements of the Company, which
are subject to and qualified in their entirety by reference to any underlying documentation as applicable,
are outlined below. Copies of such documentation have been provided or are available upon request and
the summaries below are qualified in their entirety by reference to such documentation.
15.1. Long Term Incentive Plan and Agreements of Knowledge Learning Corporation
Effective as of December 6, 2005, KLC put in place a long term incentive plan ("LTIP") for officers,
employees or consultants, providing for incentive compensation payments based upon the achievement
of certain performance criteria determined by KLC's Compensation Committee. Under the terms of the
long term incentive award agreements entered into with eligible recipients pursuant to the LTIP, if the
recipient is terminated by KLC without cause after the first year of any 3-year performance cycle, the first
of which begins in 2006, or upon death, permanent disability or retirement after the first 6 months of any
performance cycle, the recipient is eligible to receive a pro rata portion of any incentive award earned.
The recipient is also eligible to receive a pro rata portion of any incentive award earned in the event of a
sale of KLC or a termination of the LTIP.
15.2. Profits Interest Grants
KUE expects to grant profits interests in KUE to its (or its subsidiary's) present and future officers,
directors, employees and consultants, aggregating up to 2% of KUE's aggregate profits, subject to
increases approved by the Independent Committee. Such grants would be dilutive to the holders of Units.
15.3. Stock Appreciation Rights Plan of Knowledge Schools, Inc.
KSI established a stock appreciation rights ("SAR") plan for directors, officers, employees or consultants
of KSI and its subsidiaries on April 25, 2004, pursuant to which a maximum number of 18,410 phantom
shares (which may be converted to options) may be granted and an equivalent of 4,353.860 phantom
shares are issued and outstanding. SARs may be granted under the plan until April 24, 2014 and shall
vest and become exercisable as set forth in the holder's SAR agreement. These phantom shares will
provide the holders with the appreciation in value of the equivalent of 1.6% of KSI's equity (after payment
of $7.8 million to KLC's departing chief executive officer in settlement of his SARs, and based on
273,904.89884 shares as of April 28, 2006). Beginning in 2006, incentive compensation at the KLC level
to management will be made through the LTIP described above, while directors of KSI may continue to be
granted SAR.
15.4. Stock Option Grants by Knowledge Schools, Inc.
Les Biller and Stephen Goldsmith have been granted options to purchase an aggregate of 3,412.6 shares
of common stock of KSI. Les Biller is on the Advisory Board of KUE and a director of KSI. Stephen
Goldsmith is the Senior Vice President of Strategic Planning & Worldwide Government Programs for KUE
and a director of KS!. KSI may issue similar options from time to time.
15.5. Employment Agreements
With one exception, the Company's executives do not have long-term employment agreements. KLC
entered into an employment agreement with Elanna Yalow as of August 1, 2004 with an employment term
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of three years, unless terminated earlier. She serves as KLC's President and COO with a fixed annual
base salary of $300,000 plus bonuses, as well as stock appreciation rights. If KLC terminates Ms.
Yalow's employment at any time, other than for death, disability or cause, KLC is required to pay as
severance, Ms. Yalow's base compensation for the balance of the severance period. In case of
termination after expiration of the employment term, KLC is required to pay, in addition to the severance
pay, unpaid base compensation earned as of the date of termination.
In connection with employment arrangements for newly hired officers (including Peter Maslen, Derek
Feng and Kal Raman), the Company is providing equity-based compensation in amounts to be agreed,
which will be subject to customary terms and conditions.
15.6. KULG Arrangements
Certain of the executives providing services to KUE and its subsidiaries are employees and officers of, or
consultants to, KULG. Stephen Goldsmith, Senior Vice President of KULG, has a three-year employment
agreement beginning February 1, 2005, terminable at will by KULG or Mr. Goldsmith, subject to
severance benefits in certain circumstances and death and disability benefits. The agreement provides
for a $500,000 annual salary and targeted $250,000 discretionary bonus. Nina Rees, Vice President of
Strategic Initiatives of KULG, has an employment agreement terminable by her or KULG with 90 days'
notice and providing an annual salary of $180,000 plus a discretionary bonus. Ted Sanders has a 24-
month consulting agreement with KULG beginning March 1, 2005 pursuant to which he receives
consulting fees at a $25,000 annual rate for the first 12 months and a $35,000 annual rate for the second
12 months. All of these amounts, together with the compensation of other KULG employees providing
services to KUE will be paid from the annual overhead expense payment KUE will pay to KULG, as
described in "Related Party Transactions."
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16. RELATED PARTY TRANSACTIONS
Certain key terms of the following related party transactions of the Company, which are subject to and
qualified in their entirety by reference to their respective underlying documentation as applicable, are
outlined below. Copies of such documentation have been provided or are available upon request, and
the summaries below are qualified in their entirety by reference to such documentation.
16.1. Real Estate Support Management Agreement of Knowledge Learning Corporation
KLC entered into a Real Estate Support Management Agreement with Greenstreet Real Estate Partners
(formerly Greenstreet Realty Partners, L.P.), an entity controlled by the Principals, on January 4, 2006,
pursuant to which KLC obtains certain real property support services from Greenstreet Real Estate
Partners. The Agreement is non-exclusive and the Company may consider and solicit proposals from
other entities. Payment obligations are to be provided for in separate agreements, none of which have
been entered into as of the date of this Memorandum. The initial term of the Agreement expires on
December 31, 2016 (with automatic one-year extensions unless notice is given to the other party). The
Agreement can be terminated by either party for convenience on December 31 in any year or for breach
with prior written notice.
16.2. Fixed Overhead Payment Agreement
As reimbursement of expenses incurred by KULG, an affiliate of the Company controlled by the
Principals, on behalf of KUE and its subsidiaries (including salaries and bonuses of KULG employees
providing services to KUE and its subsidiaries, fees and expenses relating to financing transactions and
acquisitions, professional fees and other administrative expenses), KUE has an obligation to pay $20
million annually to KULG in quarterly installments beginning July 1,2006 pursuant to the Fixed Overhead
Payment Agreement. Of this amount, $2.5 million will be paid to KUE by KLC pursuant to the existing
Management Services Agreement described below.
16.3. Note Payable to KULG by KU Education, Inc.
On January 6, 2005, KUE Inc. executed a promissory note in favor of KULG, an entity controlled by the
Principals, in the amount of $200.0 million, the proceeds of which were used in connection with the
acquisition of KinderCare by KLC. This note has a seven year maturity and accrues interest at the
"reference rate" set by Bank of America plus 1.25% per annum. The note may be prepaid, in whole or in
part, without any premium or penalty. KUE Inc. currently owes approximately $183.9 million under the
note.
16.4. Asset Management Agreements with Greenstreet Real Estate Partners (formerly
Greenstreet Realty Partners, L.P.)
Greenstreet Real Estate Partners (formerly Greenstreet Realty Partners, L.P.), an entity controlled by the
Principals, entered into asset management agreements dated as of November 9, 2005 with each of KC
PropCo Holding I LLC ("PropCo Holding"), KC PropCo, LLC ("PropCo") and Mini-Skools Limited ("MSL"),
each an indirect wholly owned subsidiary of KLC, pursuant to which Greenstreet Real Estate Partners
provides asset management and consulting services to PropCo Holding, PropCo and MSL with respect to
the real property each company respectively owns, in return for a total annual fee of $8,250,000 payable
in 12 equal monthly installments starting December 1, 2005. The initial term expires on December 31,
2016 (with automatic one-year extensions unless notice is given to the other party), and the Agreement
can be terminated for breach with prior written notice.
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16.5. Management Services Agreement
KLC is a party to a management services agreement with Knowledge Universe Limited LLC, one of our
affiliates controlled by the Principals, pursuant to which Knowledge Universe Limited LLC has agreed to
provide management, consulting and financial planning services on an ongoing basis to KLC and its
subsidiaries. In consideration of these services, KLC is obligated to pay Knowledge Universe Limited
LLC an annual management fee of $2.5 million payable in equal quarterly installments on the first day of
each calendar quarter in advance, effective January 1, 2005. However, in the event of a payment default
under KLC's senior credit agreement or the indenture governing the notes, or a bankruptcy, liquidation or
winding-up of KLC, the payment of all accrued and unpaid management fees is subordinated to the prior
payment in full of all amounts due and owing under KLC's senior credit facility and the indenture
governing the Senior Subordinated Notes.
The management services agreement has a ten-year term which extends automatically on each
anniversary of the agreement for one additional year unless either party gives prior notice that the term
will not be extended. In addition, the management services agreement provides for the payment to
Knowledge Universe Limited LLC of customary fees for services provided in connection with
extraordinary services and reimbursement of reasonable out-of-pocket expenses, with limited exceptions.
16.6. KinderCare Acquisition Financing
Affiliates purchased a majority of the $250.0 million of senior subordinated bridge notes that we issued as
part of the financing of the KinderCare acquisition, which were repaid with the net proceeds of the Senior
Subordinated Notes. In connection with the KinderCare merger and related transactions, KLC paid
affiliates of KULG commitment fees, expense reimbursements and other amounts totaling approximately
$15.9 million.
16.7. Maron & Sandler
The law firm of Maron & Sandler serves as outside general counsel to us and our affiliates. Messrs.
Maron and Sandler are shareholders of Maron & Sandler. Mr. Sandler is a member of the board of
directors of KSI and is the General Counsel of KUE. Mr. Maron is a member of the board of directors of
both KLC and its parent, KS!. In addition, Mr. Maron holds an interest in an entity that holds common
stock of KSI. These shares of common stock amount to a less than 0.1% economic interest in KSI.
16.8. RFG Financial Group, Inc.
RFG Financial Group, Inc., an entity controlled by Ralph Finerman, a member of the boards of directors of
KLC and Nextera Enterprises, Inc. and an officer or director of other privately-held affiliates of KLC and
Krest LLC, periodically provides financial consulting services to KULG and its affiliates. In addition, Mr.
Finerman holds an interest in an entity that holds common stock of KSI. These shares of common stock
amount to a less than 0.1% economic interest in KSI.
16.9. Purchase of EdSolutions, Inc.
In November 2004, one of KSI's affiliates acquired ESI in a cash merger transaction for $5.5 million, of
which $2.2 million was paid to another of our affiliates in respect of its preferred stock ownership in ESI.
Following the closing, the buyer contributed the stock of ESI to KSI in exchange for $5.5 million of
preferred stock of KSI, and KSI contributed ESI to KLC. In connection with the KinderCare acquisition,
KSI redeemed the preferred stock (including accrued dividends) for $5.6 million.
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16.10. Indebtedness of KUE with affiliates
The proceeds of the $150 million term loan facility that KUE entered into on March 29, 2006 with an
affiliate of Credit Suisse, one of the Agents (as described in "Knowledge Universe Education (KUE) —
Term Loan Facility"), were used to repay existing debt of KUE to entities controlled by Michael Milken.
16.11. k12
An affiliate of Michael Milken and Lowell Milken owns the k12 trademark and related domain names, and
licenses them to k12 for $25,000 annually pursuant to a perpetual license.
An affiliate of Michael Milken and Lowell Milken owns (i) 3,106,774 shares of common stock of k12, (ii)
warrants to purchase 53,364 shares of k12 common stock at $1.60 per share and (iii) warrants to
purchase 1,164,179 shares of k12 Series B Preferred Stock at $1.34 per share.
16.12. Condors LLC
Condors LLC, substantially all of which is owned by the Principals, is the lender under the Junior
Mezzanine Loan entered into in connection with the new CMBS financing.
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17. ELIGIBLE INVESTORS
17.1. UNITED STATES SECURITIES ACT OF 1933
The Units will not be registered under the Securities Act, in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act and will not be registered under the securities laws of any
jurisdiction.
Accordingly, the Units are initially being offered and sold only to "accredited investors."
Each investor is required to enter into a Subscription Agreement to purchase the Units. In the
Subscription Agreement, it will be required to represent, among other customary private placement
representations, as follows:
• that it is an "accredited investor" (as such term is defined in Regulation D under the Securities
Act);
• that it has carefully read and understood this Memorandum and the organizational documents of
KUE in their entirety and that it has relied on such documents in making its investment decision;
• that it has had an opportunity to receive answers from KUE to its questions regarding the Units
and other matters pertaining to its investment, and it has obtained all additional information it has
requested from KUE to verify the accuracy of the information furnished to it;
• that it is capable of evaluating the merits and risks of purchasing the Units and of making an
informed investment decision with respect thereto;
• that its financial situation is such that it can afford to bear the economic risk of holding the Units
as an illiquid investment for an indefinite period of time, and it can afford to suffer the complete
loss of its investment;
• that it is acquiring the Units for its own account for investment purposes only and not with a view
to resale or distribution; and
• that it understands that it must bear the economic risk of an investment in the Units for an
indefinite period of time.
In the Subscription Agreement, each investor will be required to represent whether or not it is a U.S.
Person or non-U.S. Person (as such terms are defined in Regulation S under the Securities Act). Each
non-U.S. Person will be required to represent:
• whether it is purchasing the Units in an offshore transaction within the meaning of Regulation S;
and
• that it is eligible to purchase the Units under the laws applicable to it.
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A copy of the form of the Subscription Agreement will be provided. Each investor should carefully read
the Subscription Agreement in its entirety so as to fully understand the representations and warranties it is
required to make pursuant to the Subscription Agreement.
The Units cannot be resold or otherwise transferred unless they are subsequently registered under the
Securities Act and other applicable securities laws, or exemptions from such registration requirements are
available. It is not contemplated that registration of the Units under the Securities Act or other securities
laws will ever be effected. There is no public market for the Units, and none is expected to develop.
Therefore, an investor that purchases the Units may be required to hold the Units for an indefinite period
of time. The Units, if certificated, will bear a legend describing such transfer limitations.
17.2. United States Employment Retirement Income Security Act of 1974
An investment in the Units and the underlying Common LP Units and Class A Shares by certain U.S.
employee benefit plans is subject to additional considerations because the investments of such plans are
subject to the fiduciary responsibility and prohibited transaction provisions of the U.S. Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), and restrictions imposed by Section
4975 of the U.S. Internal Revenue Code of 1986, as amended (the "IRC"). For these purposes the term
"employee benefit plan" includes, but is not limited to, qualified pension, profit-sharing and stock bonus
plans, Keogh plans, simplified employee pension plans and tax deferred annuities or IRAs established or
maintained by an employer or employee organization. Among other things, such employee benefit plans
should give consideration to:
• whether the investment is prudent under ERISA.
• whether in making the investment, that plan will satisfy the diversification requirements of ERISA;
and
• whether the investment will result in recognition of unrelated business taxable income by the plan
and, if so, the potential after-tax investment return.
The person with investment discretion with respect to the assets of an employee benefit plan, often called
a fiduciary, should also determine whether an investment in the Units and the underlying Common LP
Units and Class A Shares is authorized by the appropriate governing instrument and is a proper
investment for the plan.
Section 406 of ERISA and Section 4975 of the IRC also prohibit employee benefit plans, and also IRAs
that are not considered part of an employee benefit plan, from engaging in specified transactions
involving "plan assets" with parties that are "parties in interest" under ERISA or "disqualified persons"
under the IRC with respect to the plan.
In addition to considering whether the purchase of Units and the Common LP Units and Class A Shares is
a prohibited transaction, a fiduciary of an employee benefit plan should consider whether the plan will, by
making such an investment, be deemed to own an undivided interest in the assets of KUE or the General
Partner, with the result that KUE or the General Partner would be subject to the regulatory restrictions of
ERISA, including its prohibited transaction rules, as well as the prohibited transaction rules of the IRC.
The U.S. Department of Labor regulations under ERISA provide guidance with respect to whether the
assets of an entity in which employee benefit plans acquire equity interests would be deemed "plan
assets" under some circumstances. Under these regulations, an entity's assets would not be considered
to be "plan assets" if, among other things:
(a) the equity interests acquired by employee benefit plans are publicly offered securities,
i.e., the equity interests are widely held by 100 or more investors independent of the
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issuer and each other, freely transferable and registered under some provisions of the
federal securities laws;
(b) the entity is an "operating company," meaning it is primarily engaged in the production or
sale of a product or service other than the investment of capital either directly or through
a majority-owned subsidiary or subsidiaries; or
(c) the entity is a "venture capital operating company," meaning that at least 50% of its
assets, determined on certain testing dates, are invested in operating companies with
respect to which the entity has contractual management rights which the entity actually
exercises in the ordinary course of its business; or
(d) there is no significant investment by benefit plan investors, which is defined to mean that
less than 25% of the value of each class of equity interest is held by the employee benefit
plans referred to above, IRAs and other employee benefit plans not subject to ERISA,
including U.S. and non-U.S. governmental plans.
The General Partner intends to operate the General Partner and KUE in such fashion that, for purposes
of the plan asset regulations, the assets of KUE and the General Partner will not be considered assets of
any plan investing in KUE and the General Partner. The Limited Partnership Agreement (and the
organizational documents of the General Partner) will confer on the General Partner (and the Principals)
the authority to take any action necessary or desirable in order to prevent Company assets and General
Partner assets from being considered to be plan assets, including the authority to restructure any aspects
of KUE and the authority to cause the redemption or sale of Units held by some or all plan investors.
KUE is considering whether and to what extent to permit plan investors to invest in the Units. Due to the
complexity of the applicable rules and the penalties imposed upon persons involved in prohibited
transactions, it is particularly important that potential purchasers that are plans consult with their counsel
regarding the consequences under ERISA of their acquisition and ownership of the Units. Employee
benefit plans that are governmental plans (as defined in Section 3(32) of ERISA) and certain church plans
(as defined in Section 3(33) of ERISA) are not subject to ERISA requirements but may be subject to
analogous provisions under applicable state, local or non-U.S. law.
17.3. Anti-Money Laundering — Cayman Islands
In order to comply with regulations aimed at the prevention of money laundering in any applicable
jurisdictions, the General Partner and KUE are required to adopt and maintain anti-money laundering
procedures, and may require prospective investors to provide evidence to verify their identity.
Accordingly, the General Partner (and its directors) reserve the right to request such information as they
consider necessary to verify the identity of a prospective investor. Where permitted, and subject to
certain conditions, the General Partner and KUE may also delegate the maintenance of its anti-money
laundering procedures (including the acquisition of due diligence information) to a suitable person. The
General Partner (and its directors) may refuse to accept any subscription application if a prospective
investor delays in producing or fails to produce any information required by the General Partner (and its
directors) for the purpose of verification and, in that event, any funds received will be returned without
interest to the account from which the moneys were originally debited.
The General Partner and KUE also reserve the right to refuse to make any redemption payment to a
shareholder of the General Partner or a partner of KUE, as applicable, if they suspect or are advised that
the payment of redemption proceeds to such person might result in a breach of applicable anti-money
laundering or other laws or regulations by any person in any relevant jurisdiction, or if such refusal is
considered necessary or appropriate to ensure the compliance by the General Partner and KUE with any
such laws or regulations in any applicable jurisdiction.
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If any person resident in the Cayman Islands knows or suspects that another person is engaged in money
laundering or is involved with terrorism or terrorist property and the information for that knowledge or
suspicion came to their attention in the course of their business the person will be required to report such
belief or suspicion to either the Financial Reporting Authority of the Cayman Islands, pursuant to the
Proceeds of Criminal Conduct Law (2005 Revision) if the disclosure relates to money laundering or to a
police officer of the rank of constable or higher if the disclosure relates to involvement with terrorism or
terrorist property, pursuant to the Terrorism Law. Such a report shall not be treated as a breach of
confidence or of any restriction upon the disclosure of information imposed by any enactment or
otherwise.
17.4. Foreign Corrupt Practices Act
The General Partner, KUE, its subsidiaries and joint ventures intend to comply with applicable provisions
of the Foreign Corrupt Practices Act ("FCPA") in connection with their business activities worldwide. The
FCPA prohibits corrupt payments to foreign officials, (including any officer or employee of a foreign
government, a public international organization, or any department or agency thereof, or any person
acting in an official capacity, regardless of rank or position), parties or candidates to obtain or retain
business or securing any improper advantage and the FCPA prohibits paying, offering, promising to pay,
directly or indirectly, money or anything of value in connection therewith.
Investors will be required to provide information on whether they are foreign officials, and confirm that
they have not paid, offered to pay or promised to pay and do not intend to pay, offer to pay or promise to
pay, directly or indirectly, money or anything of value to any foreign official, party or candidate to obtain or
retain business (whether with a government or agency or instrumentality thereof or otherwise) for or on
behalf of KUE, its subsidiaries or joint ventures or to secure an improper advantage for KUE or its
subsidiaries or joint ventures in any country.
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18. CERTAIN INCOME TAX CONSEQUENCES
The following summary of the taxation of KUE and the taxation of the Partners of KUE is based
upon current law and does not purport to be a comprehensive discussion of all the tax
considerations that may be relevant to a decision to purchase Units. Legislative, judicial or
administrative changes may be forthcoming that could affect this summary.
TO ENSURE COMPLIANCE WITH U.S. TREASURY DEPARTMENT REGULATIONS, WE
ADVISE YOU THAT: (i) ANY DISCUSSION OF U.S. FEDERAL TAX ISSUES CONTAINED
HEREIN IS NOT INTENDED OR WRITTEN TO BE RELIED UPON, AND CANNOT BE
RELIED UPON, BY INVESTORS FOR THE PURPOSE OF AVOIDING TAX-RELATED
PENALTIES UNDER THE U.S. INTERNAL REVENUE CODE OR APPLICABLE STATE OR
LOCAL TAX LAW PROVISIONS; (ii) SUCH DISCUSSION IS BEING USED IN CONNECTION
WITH THE PROMOTION OR MARKETING (WITHIN THE MEANING OF TREASURY
REGULATIONS) BY THE COMPANY OF THE TRANSACTIONS OR MATTERS
ADDRESSED HEREIN; (iii) INVESTORS SHOULD SEEK ADVICE BASED ON THEIR
PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.
PROSPECTIVE INVESTORS (INCLUDING ALL NON-U.S. PERSONS AS DEFINED BELOW)
SHOULD CONSULT THEIR TAX ADVISORS CONCERNING THE U.S. FEDERAL, STATE,
LOCAL, AND FOREIGN TAX CONSEQUENCES OF OWNING COMMON LP UNITS UNDER
THE LAWS OF THEIR COUNTRIES OF CITIZENSHIP, RESIDENCE, ORDINARY
RESIDENCE, OR DOMICILE.
18.1. Cayman Taxation
There is, at present, no direct taxation in the Cayman Islands. The Government of the Cayman Islands,
will not, under existing legislation, impose any income, corporate or capital gains tax, estate duty,
inheritance tax, gift tax, or withholding tax upon KUE, its partners, the General Partner, or its
shareholders. Similarly interest, dividends and gains payable to KUE and all distributions by KUE to its
partners will be received free of any Cayman Islands income or withholding taxes.
KUE has registered as an exempted limited partnership under Cayman Islands law and KUE has
received an undertaking from the Governor-in-Cabinet of the Cayman Islands to the effect that, for a
period of 50 years from the date of the undertaking, no law which is enacted in the Cayman Islands
imposing any tax to be levied on profits or income or gains or appreciations shall apply to KUE or to any
partner of KUE in respect of the operations or assets of KUE or the interest of a partner in KUE; and may
further provide that any such taxes or any tax in the nature of estate duty or inheritance tax shall not be
payable in respect of the obligations of KUE or the interests of the partners in KUE.
The General Partner of KUE has registered as an exempted company under Cayman Islands law and the
General Partner has received an undertaking from the Governor-in-Cabinet of the Cayman Islands that, in
accordance with section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, for a
period of 20 years from the date of the undertaking, no law which is enacted in the Cayman Islands
imposing any tax to be levied on profits, income, gains or appreciations or which is in the nature of estate
duty or inheritance tax shall be payable (i) on the shares of the General Partner or (fi) by way of the
withholding in whole or in part of a payment of dividend or other distribution of income or capital by the
General Partner to its shareholders.
The Cayman Islands does not have a double tax treaty with the United States or any other country.
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18.2. United States Federal Income Taxation
The following summary sets forth the material U.S. federal income tax considerations related to the
purchase, ownership, and disposition of Common LP Units. Unless otherwise stated, this summary deals
only with partners that are U.S. Persons (as defined below) who purchase their Common LP Units in this
offering and who hold their Common LP Units as capital assets within the meaning of Section 1221 of the
Code. The following discussion is only a discussion of the material U.S. federal income tax matters as
described herein and does not purport to address all of the U.S. federal income tax consequences that
may be relevant to a particular Limited Partner of KUE ("Limited Partner") in light of such Limited Partner's
specific circumstances. In addition, except as expressly stated, the following summary does not address
the U.S. federal income tax consequences that may be relevant to special classes of Limited Partners
who may be subject to special rules or treatment under the Code, such as financial institutions, insurance
companies, regulated investment companies, real estate investment trusts, partnerships, or other pass-
through entities, dealers or traders in securities, tax-exempt organizations, expatriates, any person who
owns or is deemed to own, for U.S. federal income tax purpose, 10% or more of the total combined voting
power of all classes of voting stock of the corporate subsidiaries of KUE, persons that have a "functional
currency" other than the United States dollar, and any individual who is a non-U.S. Person (as defined
below) and who is present in the U.S. for 183 days or more in a taxable year. This discussion does not
include any description of the tax laws of any state or local governments within the U.S. No ruling has
been or will be sought from the IRS regarding any matter discussed herein. Counsel to KUE has not
rendered any legal opinion regarding any tax consequences relating to KUE or an investment in KUE. No
assurance can be given that the IRS would not assert, or that a court would not sustain, a position
contrary to any of the positions taken by KUE as set forth below.
For purposes of this discussion, the term "U.S. Person" means (1) a citizen or resident of the U.S., (2) a
corporation created or organized in or under the laws of any State of the U.S. (including the District of
Columbia), (3) an estate the income of which is subject to U.S. federal income taxation regardless of its
source, (4) a trust if either (a) a court within the U.S. is able to exercise primary supervision over the
administration of such trust and one or more U.S. Persons have the authority to control all substantial
decisions of such trust or (b) the trust has a valid election in effect to be treated as a U.S. Person for U.S.
federal income tax purposes, or (5) any other person or entity that is treated for U.S. federal income tax
purposes as if it were one of the foregoing. The term "non-U.S. Person" means any person other than a
U.S. Person.
18.2.1 United States Federal Income Taxation of KUE and its Subsidiaries
Partnership Status of KUE. KUE believes that it should be classified as a partnership for United States
federal income tax purposes. Accordingly, KUE is not a taxable entity and incurs no U.S. federal income
tax liability. Instead, each Partner will be allocated its share of KUE's income or loss, as the case may be,
for United States federal income tax purposes as set forth in the Limited Partnership Agreement. In
addition, each U.S. Partner's share of income or loss from KUE generally will be required to be includable
in income for state and local tax purposes in the jurisdiction in which the investor is a resident and in the
jurisdictions in which KUE operates. Each U.S. Partner will be responsible for paying the income tax on
that portion of KUE's income allocated to such investor. No assurances can be given that any cash
distribution will be made from KUE to the partners to pay such income tax liabilities.
Under the Code, certain non-U.S corporations may be treated as U.S. corporations for U.S. federal
income tax purposes, thereby subjecting such non-U.S. corporations to U.S. federal income tax on their
income. Recently enacted U.S. tax legislation includes one such provision. Under this legislation,
referred to as the anti-inversion legislation, non-U.S. corporations that acquire interests in a U.S.
corporation or partnership and meet certain ownership, operational and other tests may be treated as U.S.
corporations for federal income tax purposes. The legislation grants broad regulatory authority to the U.S.
Secretary of Treasury to provide such regulations as may be appropriate to determine whether a non-U.S.
corporation is treated as a U.S. corporation or as are necessary to carry out the intent of the provision,
including adjusting its application as necessary to prevent the avoidance of its purpose. Recently issued
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Treasury regulations provide that the anti-inversion legislation is applicable to a foreign partnership that is
or becomes a "publicly traded partnership" within two years of the acquisition by it of a U.S. corporation.
A "publicly traded partnership" is any partnership (i) interests in which are traded on an established
securities market, or (ii) interests in which are readily tradable on a secondary market (or the substantial
equivalent thereof). KUE believes that it is not currently a publicly traded partnership and does not intend
to become a publicly traded partnership within two years of this offering or the acquisition of KLC and k12.
As a result, KUE does not believe the anti-inversion legislation or any regulations promulgated within the
scope of the legislation's regulatory authority should apply to KUE although no assurance can be given in
this regard or with respect to any new acquisitions of or investment in U.S. corporations. In addition, KUE
does not believe that any other Code provision subjecting non-U.S. corporations to U.S. federal income
tax should apply to KUE or its subsidiaries, although no assurance can be given in this regards. The
promulgation of contrary regulations or a successful challenge of either of these positions by the Internal
Revenue Service could materially reduce a holder's after-tax return and, thus, could result in a substantial
reduction of the value of the Units.
The remainder of this section assumes that KUE will be treated as a partnership for U.S. federal income
tax purposes.
18.2.2 United States Federal Income Taxation of Partners
U.S. Persons
Allocation of Purchase Price. You will be treated as purchasing a Unit consisting of two components, one
Common LP Unit and one GP Share. Your purchase price for each Unit will be allocated between one
Common LP Unit and one GP Share in proportion to their relative fair market values at the time of your
purchase, and this allocation will establish your initial tax basis in both your ownership interest in the
Common LP Unit and your GP Share. We will treat the fair market value of each Common LP Share at
$999 and the fair market value of each GP Share as $1.
Flow-Through of Taxable Income. KUE will not pay any U.S. federal income tax. Instead, each Partner
will be required to report on its income tax return its allocable share (as determined pursuant to the
Limited Partnership Agreement) of KUE's income, gains, losses, and deductions without regard to
whether corresponding cash distributions are made. The Limited Partnership Agreement authorizes the
General Partner to override the allocation provisions of the Limited Partnership Agreement and allocate
income, gains, losses and deductions of KUE to the Partners in a manner that achieves the desired
economic arrangement of KUE, which is to return each Partner's capital contribution and then for all
Partners (including the holder of Profits Participation LP Units) to share in the profits of KUE in proportion
to the number of Units held by them.
The IRS may challenge the manner in which income, gains, losses and deductions are allocated to
holders of Common LP Units, the General Partner and holders of the Profits Participation LP Units under
the Limited Partnership Agreement. For U.S. federal income tax purposes, allocation of any item of
income, gain, loss or deduction to a partner in a partnership will be given effect so long as the allocation
has "substantial economic effect," or is otherwise in accordance with the partner's interest in the
partnership. If an allocation of an item pursuant to the Limited Partnership Agreement does not satisfy
this standard or is deemed not to satisfy this standard by the IRS, it will be reallocated by the IRS among
the Partners on the basis of their respective interests in KUE (as determined by the IRS), taking into
account all facts and circumstances. In such a case, holders of Common LP Units could have additional
tax liabilities or suffer adverse tax consequences.
Treatment of Cash Distributions. KUE's distributions to a Partner generally will not be taxable to the
Partner for U.S. federal income tax purposes to the extent of such Partner's adjusted tax basis in its
Common LP Units immediately before the distribution. Cash distributions in excess of a Limited Partner's
adjusted tax basis generally will be considered to be gain from the sale or exchange of the Common LP
Units. Any reduction in a Limited Partner's share of KUE's liabilities, if any, for which no Partner bears the
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economic risk of loss, known as "nonrecourse liabilities," will be treated as a deemed distribution of cash
to that Partner. A decrease in a Partner's percentage interest in KUE because of KUE's issuance of
additional limited partner units ("Limited Partner Units") would decrease such Partner's share of Company
nonrecourse liabilities, if any, and thus would result in a corresponding deemed distribution of cash.
Treatment of In-Kind Distributions. KUE's distribution of property (other than cash) to a Partner generally
will not be taxable to the Partner unless the property is a "marketable security" and the exceptions to the
requirement for recognition of gain upon distributions of marketable securities do not apply. Marketable
securities, for these purposes, include actively traded securities or equity interests in another entity that
are readily convertible into or exchangeable for cash or other marketable securities. If the distributed
property constitutes a marketable security, the property would be treated as cash and the Partner would
recognize gain, but not loss, to the extent described above.
Basis of Common LP Units. A Limited Partner will have an initial tax basis for its Common LP Units equal
to the amount it paid for the Common LP Units plus its share of Company nonrecourse liabilities, if any.
That basis will be increased by the Limited Partner's share of Company income and by any increases in
its share of Company nonrecourse liabilities, if any. That basis will be decreased, but not below zero, by
distributions from KUE, by the Limited Partner's share of KUE losses, by any decrease in its share of
Company nonrecourse liabilities, if any, and by its share of Company expenditures that are not deductible
in computing KUE's taxable income and are not required to be capitalized.
Limitations on Deductibility of Company Losses. The deduction by a Limited Partner of its share of
Company losses will be limited to the adjusted tax basis in its Common LP Units. Limited Partners should
be aware that they could be subject to various other limitations on their ability to deduct their allocable
shares of Company losses (or items of deductions). Such limitations include, but are not limited to, those
relating to "investment interest" expense under Section 163(d) of the Code, "miscellaneous itemized
deductions" under Section 67 of the Code, certain other itemized deductions of high income individuals
under Section 68 of the Code, the "at risk" rules under Section 465 of the Code, and the deductibility of
capital losses under the Code. Prospective investors should consult their tax advisors with respect to the
potential application of such rules to their particular situation.
Allocation of Income, Gain, Loss, and Deduction. If KUE has a net profit or net loss, its items of income,
gain, loss, and deduction will be allocated among the Partners in accordance with the provisions of the
Limited Partnership Agreement.
Dispositions of Common LP Units — Recognition of Gain or Loss. A Limited Partner will recognize gain or
loss on a sale of Common LP Units equal to the difference between the amount realized and the Limited
Partner's adjusted tax basis for the Common LP Units sold. A Limited Partner's amount realized will be
measured by the sum of cash or the fair market value of other property received plus its share of
Company nonrecourse liabilities, if any. Generally, gain or loss recognized by a Limited Partner on the
sale or exchange of Common LP Units will be taxable as capital gain or loss and as long-term capital gain
or loss if the Common LP Units were held for more than twelve months.
Non-U.S. Persons
Withholding. Ownership of Common LP Units by non-U.S. Persons raises special U.S. federal income
tax considerations. To the extent that KUE receives dividends from a U.S. subsidiary, distributions of
such dividend income to Limited Partners who are non-U.S. Persons will be subject to U.S. withholding at
a rate of 30%. Certain countries have tax treaties with the U.S. that reduce or eliminate the withholding
requirement. To the extent that KUE receives dividends from a non-U.S. subsidiary, distributions of such
dividend income to Limited Partners who are non-U.S. Persons will not be subject to U.S. tax, unless
such income were deemed to be effectively connected with a trade or business conducted by KUE in the
U.S. KUE will be required to pay withholding tax with respect to the portion of KUE's income that is
"effectively connected" with the conduct of a U.S. trade or business and which is allocable to non-U.S.
Persons. Any amounts KUE is required to remit to taxing authorities will be treated as a distribution to the
Partner on whose behalf the withholding is being paid and will be charged against current and/or future
143
distributions such Partner would otherwise be entitled to. If KUE is required to withhold on amounts in
excess of cash distributions, Partners shall be required to contribute to KUE cash in an amount by which
such required withholding exceeds any such distributions.
Gain on Sale. A Limited Partner that is a non-U.S. Person will be subject to U.S. federal income tax upon
the sale or exchange of its Common LP Units to the extent that such Limited Partner recognizes gain
upon such sale or exchange and such gain is effectively connected with a U.S. trade or business.
U.S. Real Property Holding Corporation. If a direct U.S. subsidiary of KUE is or were to become a
"United States Real Property Holding Corporation," or "USRPHC" (as defined below), certain disposition
of Common LP Units by a Limited Partner that is a non-U.S. Person would result in such Limited Partner
being subject to U.S. federal income tax in respect of the portion of the gain recognized on such
disposition that is attributable to such subsidiary. In addition, if a direct U.S. subsidiary of KUE is or were
to become a USRPHC, certain dispositions of such subsidiary by KUE would result in Limited Partners
who are non-U.S. Persons being subject to U.S. federal income tax in respect of their allocable share of
the gain recognized by KUE on such disposition. Generally, a corporation is a USRPHC if the fair market
value of its "U.S. real property interests" equals or exceeds 50% of the sum of the fair market value of its
worldwide real property interests and its other assets used or held for use in a trade or business. KUE
believes that each of its direct U.S. subsidiaries is not currently a USRPHC for U.S. federal income tax
purposes. However, no assurances can be given in this regard. Furthermore, it is possible that in the
future one of KUE's subsidiaries may become a USRPHC if, for example, the value of the U.S. real estate
holdings of such subsidiary increases sufficiently. Limited Partners that are non-U.S. Persons are urged
to consult their tax advisors regarding the potential application of the USRPHC rules to their investment in
KUE.
Administrative Matters
Backup Withholding. For each calendar year, KUE will report to its U.S. Partners and to the Internal
Revenue Service the amount of distributions that it pays, and the amount of tax (if any) that it withholds
on these distributions. Under the backup withholding rules, a U.S. Limited Partner may be subject to
backup withholding tax with respect to distributions unless a Limited Partner: (i) is a corporation or comes
within another exempt category and demonstrates this fact when required or (U) provides a taxpayer
identification number, certifies as to no loss of exemption from backup withholding tax and otherwise
complies with the applicable requirements of the backup withholding tax rules. Exempt Limited Partners
who are U.S. Persons should indicate their exempt status on a properly completed IRS Form W-8BEN.
Backup withholding is not an additional tax, the amount of any backup withholding from a payment to a
Limited Partner will be allowed as a credit against such Limited Partner's U.S. federal income tax liability.
Nominee Reporting. Persons who hold an interest in KUE as a nominee for another Person are required
to furnish to KUE:
(a) the name, address, and taxpayer identification number of the beneficial owner and the
nominee,
(b) whether the beneficial owner is:
(1) a person that is not a U.S. Person,
(2) a foreign government, an international organization, or any wholly-owned agency
or instrumentality of either of the foregoing, or
(3) a tax-exempt entity;
(c) the amount and description of the Limited Partner Units held, acquired, or transferred for
the beneficial owner, and
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(d) specific information including the dates of acquisitions and transfers, means of
acquisitions and transfers, and acquisition cost for purchases, as well as the amount of
net proceeds from sales.
Filing Requirements. Limited Partners who are U.S. Persons will be required to file an IRS Form 8865
with the Partner's U.S. Federal Income tax return for the taxable year in which the Limited Partner
purchases the Common LP Units. Investors who are U.S. Persons may, depending upon the size of their
investment in the General Partner, be required to file an IRS Form 5471 with the investor's U.S. federal
income tax return for the taxable year in which the investor purchases Common LP ordinary shares in the
General Partner. Additionally, depending on the type of non-U.S. investments KUE makes, investors who
are U.S. Persons may be required to file additional IRS Forms such as a Form 5471 in subsequent years.
This discussion of tax consequences and tax withholding is a general discussion and is not intended to be
all inclusive nor a substitute for careful tax planning. Accordingly, each prospective purchaser of Common
LP Units is urged to consult with their own tax advisors with specific reference to their own tax situation.
145
19. APPENDICES
INDEX TO THE APPENDICES
19.1. APPENDIX A: DETAILED BIOGRAPHIES
KUE MANAGEMENT 148
KUE ADVISORY BOARD 152
KLC MANAGEMENT 153
REAL ESTATE MANAGEMENT TEAM! GREENSTREET REAL ESTATE PARTNERS 155
KSI BOARD OF DIRECTORS 156
k12 MANAGEMENT 157
19.2 APPENDIX B: KLC MD&A FOR 2005, 2004 AND 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 158
RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED DECEMBER 31,
2005, 2004 AND 2003
19.3 APPENDIX C: KLC MD&A FOR FIRST QUARTER 2006
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 179
RESULTS OF OPERATIONS FOR THE QUARTERLY PERIOD ENDED APRIL 1, 2006
19.4 APPENDIX D: KLC MD&A FOR SECOND QUARTER 2006
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 197
RESULTS OF OPERATIONS FOR THE QUARTERLY PERIOD ENDED JULY 1, 2006
19.5 APPENDIX E: FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS 222
146
19.1. Appendix A: Detailed Biographies
147
KUE Management
At the conclusion of this offering, the KUE management team will consist of the following
individuals.
Principals
Michael Milken, Co-Founder and Chairman
Mr. Milken is Co-Founder and Chairman of KUE. One of America's leading philanthropists, he was called
"The Man Who Changed Medicine" in a Fortune magazine cover story that chronicled his three decades
of efforts to accelerate medical solutions. He Co-Founded the Milken Family Foundation in 1982 to
advance programs in medical research and education. In 1993, Mr. Milken expanded his medical
philanthropy by launching the Prostate Cancer Foundation, the world's largest private source of funding
for research on that disease. A decade later, he concluded that progress wasn't coming fast enough, so
he founded FasterCures, which seeks to shorten the path to breakthroughs for all deadly diseases. Mr.
Milken also chairs the Milken Institute, a think tank who conferences feature opinion leaders and
government officials from around the world. Among the many awards Mr. Milken has received is the
Marcus Garvey Award for major contributions to the formation and inspiration of African-American
businesses. He earned his bachelor's degree at the University of California at Berkeley, and his MBA
from the University of Pennsylvania's Wharton School.
Steven Green, Vice Chairman
Steven Green, who served as the 12th U.S. Ambassador to the Republic of Singapore from 1997 to 2001,
is Vice Chairman of KUE and Chairman and CEO of Greenstreet Real Estate Partners, a professional
real estate firm. Ambassador Green previously served as Chairman and CEO of Samsonite Corporation,
which was the major operating subsidiary of Astrum International Corporation. As Chairman of Astrum,
Ambassador Green spearheaded the operating company's expansion into emerging markets in Eastern
Europe, the CIS, Asia and the Middle East In 1992, he opened the first American retailing center on Red
Square. In 1995, President Clinton appointed him to the President's Export Council, where he served on
the Executive Committee and chaired the Strategic Communications Committee. Ambassador Green is
also Chairman and Chief Executive Officer of K1 Ventures Limited, a publicly traded investment company
in Singapore, and is a board member of Greenstreet Realty, a company that manages a large portfolio of
education-related real estate. In addition to his corporate responsibilities, he has been active in U.S. civic
affairs, serving as a contributing trustee and director for a number of community and national
organizations, including the University of Miami, the U.S. Chamber of Commerce and serves as Honorary
Consul General of Singapore in Miami, Florida. The Green Family Foundation endows special projects in
community and national service.
Lowell Milken, Co-Founder, President and Chief Executive Officer
Lowell Milken is President and Chief Executive Officer of KUE. He is also Chairman of London-based
Heron International, a worldwide leader in property development and investment; Chairman of KU
Education, Inc., a leading company in ECE and K-9 educational programs and services; and Chairman
and Co-Founder of the Milken Family Foundation. Under his leadership, the Milken Family Foundation
has become one of the most innovative private foundations in the U.S., developing groundbreaking
programs in K-12 education. Mr. Milken created the Foundation's National Educator Award program,
which today is the largest teacher-recognition program in the U.S. Dubbed the "Oscars of Teaching" by
Teacher Magazine, it has awarded more than $50 million to honor more than 2,100 K-12 teachers and
principals. Mr. Milken also launched the Teacher Advancement Program ("TAP") in 1999 as a
comprehensive school reform to attract, develop, motivate and retain high quality teachers for America's
schools. Today TAP schools are operating in 12 states impacting thousands of teachers and ten of
thousands of students. Mr. Milken serves as Chairman of the Institute for Excellence in Teaching which
among its many activities is the operation of the Teacher Advancement Program. Widely known as an
educational pioneer and innovator, Mr. Milken has been recognized by numerous awards from such
148
organizations as the National Association of State Boards of Education, the Horace Mann League, and
the National Association of Secondary School Principals. Mr. Milken earned his bachelor's degree from
the University of California at Berkeley, and his law degree from the University of California, Los Angeles.
Other Executives
Ted Sanders, Vice Chairman
Ted Sanders is Vice Chairman of KUE, as well as the Executive Chairman of Cardean Learning Group,
which develops online post-secondary education and degree programs. Mr. Sanders previously served
as the President of the Education Commission of the States and as Deputy U.S. Secretary of Education
under President George H.W. Bush. He has been the Chief State School Officer in three U.S. states
(Nevada, Illinois and Ohio) and University President at Southern Illinois University. He serves as an
advisor to the School Evaluation Services Division of Standard and Poor's, the PDK Gallup Poll,
MetaMetrics Inc., and the Government Accountability Office. He holds a doctor of education degree in
educational administration and higher education from the University of Nevada at Reno.
Stephen Goldsmith, Senior Vice President, Strategic Planning and Worldwide Government
Programs
Stephen Goldsmith is the Senior Vice President of Strategic Planning & Worldwide Government Programs
for KUE. Mr. Goldsmith is also a Milken Institute Senior Fellow and the Dan Paul Professor of
Government at Harvard University's Kennedy School of Government, is a nationally recognized expert on
government management, reform and innovation. He is the author of several books, most recently,
Governing by Network: The New Face of the Public Sector, and his columns have frequently been
published in such papers as The Wall Street Journal and The New York Times. While serving two terms
as Mayor of Indianapolis, he earned a national reputation for innovations in government as he reduced
the city's bureaucracy, taxes, and counter-productive regulations, all while identifying more than $400
million in savings, which he then reinvested in a transformation of downtown Indianapolis and its urban
neighborhoods. His work in Indianapolis has been cited as a national model. Prior to his two terms as
Mayor, he was Marion County District Attorney for 12 years. Mr. Goldsmith formerly served as Special
Advisor to President Bush, and Chief Domestic Policy advisor to President Bush in the 2000 presidential
campaign.
Nina Shokraii Rees, Senior Vice President, Strategic Initiatives
Nina Rees is Senior Vice President of Strategic Initiatives for KUE, where she is responsible for furthering
the company's goals of providing the highest-quality and most effective early childhood education and on
finding innovative ways to improve K-12 educational outcomes. Before joining KUE, Ms. Rees had nearly
15 years of relevant experience in Washington, D.C., most recently as the Assistant Deputy Secretary for
Innovation and Improvement at the U.S. Department of Education. In this post, she oversaw the
administration of 28 grant programs and coordinated the implementation of several provisions of the No
Child Left Behind Act. Prior to joining the Education Department, Ms. Rees served as a Domestic-Policy
Adviser to Vice President Dick Cheney, and was involved in the effort to enact No Child Left Behind. She
also served as the Senior Education Analyst at the Heritage Foundation. Ms. Rees spent two years on
the staff of Rep. Porter Goss, R-Florida., while earning her master's degree in international transactions
from George Mason University, and received her bachelor's degree in psychology from Virginia
Polytechnic Institute and State University. Ms. Rees is fluent in French and Persian.
149
Jeffrey Safchik, Chief Financial Officer
Jeffrey Safchik is the Chief Financial Officer of KUE. Mr. Safchik is also Managing Director and Chief
Financial Officer of Greenstreet Real Estate Partners and also is one of its founders. He serves in a
similar capacity for all the Greenstreet financial companies. Mr. Safchik is also Chief Operating Officer
and Chief Financial Officer of k1Ventures, a publicly traded Singapore-based investment company.
Previously, Mr. Safchik was CFO of a real-estate company that managed more than 11 million square feet
of retail and commercial property across the U.S. He has served as CFO for a billion-dollar retailer,
where he managed the company's financial affairs and was directly involved in its restructuring and
strategic planning. Mr. Safchik graduated from Pace University in New York, received his master's
degree in taxation from St. John's University, and has attended advanced finance and real estate courses
at the Massachusetts Institute of Technology and New York University. He serves as a Trustee for the
Green Family Foundation, is Chairman of the University of Miami Department of Pediatrics Children's
Council and is active in a number of charities including the Marian Center for Under-privileged Children
and the United Way.
Richard Sandler, General Counsel
Richard Sandler is General Counsel for KUE. Mr. Sandler is also Executive Vice President of the Milken
Family Foundation and has been involved with the Foundation since its inception. A shareholder in the
law firm of Maron & Sandler, he has practiced law since 1973, and specializes in real estate transactions
and general securities and business law. He has also been involved since 1983 in consulting with
respect to business acquisitions. Mr. Sandler is a member of the State Bar of California and has served
on various boards of educational and philanthropic institutions, including the Executive Board of Heal
L.A., as a Trustee of Brentwood School, and on the Board of the Foundations of the Milken Families. Mr.
Sandler received a bachelor's degree from the University of California, Berkeley, and his juris doctorate
degree from the UCLA School of Law.
Adam Cohn, Senior Vice President, Business Development
Adam Cohn is Senior Vice President of Business Development at KUE where he is responsible for
investments, financings and business development for Knowledge Universe and its portfolio companies.
Mr. Cohn has been at KUE, or related entities, since March of 2000. He has overseen the acquisitions
and related financings of KinderCare Learning Centers Inc. and Aramark Educational Resources by
Knowledge Learning Corporation. Previously, Mr. Cohn was with Whitney & Co., a leading private equity
firm. Prior to Whitney & Co., Mr. Cohn was an investment banker in the Financial Sponsors Group at
Bankers Trust Company and Deutsche Bank. Mr. Cohn serves on several private and public company
board of directors. Mr. Cohn has a BS in Business from Skidmore College and a MBA from Columbia
University.
Geoffrey Moore, Senior Vice President, Corporate Communications
Geoffrey Moore is Senior Vice President of Communications at KUE. He has also provided
communications counsel to FasterCures, the Milken Institute, the Prostate Cancer Foundation and related
organizations for several years. Prior to joining Knowledge Universe in 1998, Mr. Moore was Senior Vice
President of Strategic Communications for Dow Jones Markets, a unit of Dow Jones, publisher of The
Wall Street Journal. He served for 22 years in a wide range of communications management and
speechwriting positions for IBM in the U.S. and Japan. Earlier, he was an Assistant to New York
Governor Nelson Rockefeller, Press Secretary to U.S. Senate Minority Leader Hugh Scott, and Director of
Public Information for the U.S. Equal Employment Opportunity Commission. His opinion articles have
been published in The New York Times and other major publications. He graduated with a degree in
political science from the University of Pennsylvania and studied law and public policy at that university's
law school.
Michael Neumann, Vice President, Business Development
Michael Neumann is a Vice President of Business Development at KUE, where he works on investments,
financings and business development for Knowledge Universe and its portfolio companies. Mr. Neumann
has been at KUE, or related entities, since 2002. He has worked on the acquisitions and related
financings of KinderCare Learning Centers Inc. and Aramark Educational Resources by Knowledge
150
Learning Corporation. Previously, Mr. Neumann was with TCW / Crescent Mezzanine where he
completed mezzanine financings primarily for leveraged buyout transactions. Prior thereto, Mr. Neumann
worked in the investment banking division of Deutsche Bank (Bankers Trust) in the Financial Sponsors
Group. Mr. Neumann earned a Bachelors of Business Administration from the University of Notre Dame.
151
KUE Advisory Board
Les Biller
Leslie Biller is retired Vice Chairman & Chief Operating Officer of Wells Fargo & Company. Mr. Biller
joined Wells Fargo in 1998, when it merged with Norwest Corporation. Prior to that, he spent nearly 11
years at Norwest, where he held various executive positions including Executive Vice President and head
of Strategic Planning and Acquisitions, Executive Vice President and head of the company's South
Central Community Banking operations, and President and Chief Operating Officer. Before joining
Norwest, he was Executive Vice President and head of Consumer Markets at Bank of America, based in
San Francisco. Mr. Biller joined Bank of America in 1985 as the Senior Vice President of International
Consumer Markets. Prior to that, he was with Citicorp for 12 years, where he was a Regional Business
Manager, U.K. Region; and Vice President and Business Manager, Italy. Mr. Biller serves on the Board of
Directors of Ecolab Inc., and is a director of the Los Angeles Urban League, the Autry Museum of
Western Heritage, and is a Founders Circle member of the Fulfillment Fund. He earned his MBA from
Xavier University in Cincinnati, Ohio, and holds a bachelor's degree in chemical engineering from City
College of New York.
Ted Mitchell
Ted Mitchell was recently named CEO of the New Schools Venture Fund after having served on the New
Schools Board of Directors for seven years. Mr. Mitchell previously served as president of Occidental
College for six years. Immediately prior to Occidental, he served as Vice President for Education and
Strategic Initiatives of the J. Paul Getty Trust. He was also the Deputy to the President at Stanford
University, Vice Chancellor at UCLA, and a Professor of Education at Dartmouth. Mr. Mitchell is an
Education Advisor to California Senator Dianne Feinstein and served as a Senior Education Advisor to
Los Angeles Mayor Richard Riordan.
Tsvi Gal
As Chief Technology Officer for Deutsche Bank Asset Management ("Deutsche Bank"), Tsvi Gal is
responsible for constructing an industry leading, state of the art, evolutionary architecture which has
competitively positioned Deutsche Bank for future growth through innovation, processing scale and
efficiency. Prior to joining Deutsche Bank, Mr. Gal was responsible for overseeing global IT operations at
Warner Music Group ("WMG"), formerly part of the Time Warner family of operations and now a privately-
held multinational music and publishing company. He lent his considerable global technical expertise to
the task of integrating WMG's global systems and exploring technological synergies, as well as
maximizing the opportunities presented by new technologies. Prior to joining WMG, Mr. Gal held the role
of president of AT&T's ATT.COM from 2000 to 2002, where he was responsible for AT&T's E*Business
and E"commerce activities. In this position, he oversaw the revitalization of AT&T's presence in the
market ensuring its transition into a modern era electronic business market leader. Earlier, Mr. Gal was
the Chief Technology Officer for Enterprise Technology services at Merrill Lynch & Company, where he
helped build the electronic trading system. From 1996 to 1999, he was Executive Vice President and CIO
of North America Applications ABN AMR() Bank, one of the world's largest global banks. Mr. Gal is a
computer-science graduate of Rutgers University, and holds an MBA from Golden Gate University.
152
KLC Management
Name   KLC Ke Mana•ement   Years with Company   Industry Exp.
Position
Elanna Yalow   President and COO   16   19
Dan Jackson   CFO   9   9
Toni Jaffe   SVP of Human Resources   1   1
Eva Kripalani   SVP & General Counsel   9   9
Marcy Suntken   SVP of School Partnerships   14   20
Dan Frechtling   SVP of Business Development   1   1
Sharon Bergen   SVP of Education and Training   18   18
Steve Brown   President, KCDL   1   1
Total   69   78
Average   8.6   9.7
Elanna Yalow, Ph.D., President and Chief Operating Officer
Dr. Yalow has been President and Chief Operating Officer of KLC since January 1996, having joined the
company in 1989 to initiate development of the employer-sponsored services division. Currently, Dr.
Yalow is responsible for supervising all center operations and support functions. Her educational degrees
include a Ph.D. in educational psychology from Stanford University School of Education in 1980 with an
emphasis on the design and evaluation of educational programs for children as well as an M.B.A. from
Stanford University's Graduate School of Business in 1989. With a background in educational research
and development, Dr. Yalow contributed to numerous statewide and national curriculum development and
assessment projects. Dr. Yalow has written extensively on matters related to the education of young
children.
Mark Moreland, Executive Vice President, Finance and Chief Financial Officer
Mr. Moreland is Executive Vice President and Chief Financial Officer of Knowledge Learning Corporation
(KLC). Mr. Moreland joined KLC during 2006. Prior to joining KLC, Mr. Moreland was Interim CFO with
Movie Gallery, Inc.; the $2.6 billion holding company of the Movie Gallery and Hollywood Video movie
rental stores with 4,700 stores nationwide. Before being appointed interim CFO, Mr. Moreland served as
Senior Vice President, Finance and Treasurer. Before joining Movie Gallery, he was with Kmart
Corporation in both merchandising finance and treasury capacities, last holding the role of Divisional Vice
President, Assistant Treasurer. Mr. Moreland has also worked with Deloitte Consulting, Blue Shield of
California and the U.S. General Accounting Office. Mr. Moreland earned an MBA from the University of
Michigan and a B.S. in Economics from the University of Texas at Arlington.
Eva Kripalani, Senior Vice President and General Counsel
Ms. Kripalani became KLC's Senior Vice President and General Counsel in January 2005. Prior to that,
Ms. Kripalani served as Senior Vice President, General Counsel and Secretary of KinderCare since July
2001. She joined KinderCare in July 1997 as Vice President, General Counsel and Secretary. Prior to
joining KinderCare, Ms. Kripalani was a partner in the law firm of Stoel Rives LLP in Portland, Oregon,
where she had worked since 1987. Ms. Kripalani received her J.D., magna cum laude, from the
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Willamette University College of Law in 1986 and her B.S. in Finance-Law, magna cum laude, from
Portland State University in 1983.
Dan Frechtling, Senior Vice President, Marketing and Business Development
Mr. Frechtling was named Senior Vice President, Marketing and Business Development in 2005. Prior to
joining KLC, Mr. Frechtling served as Vice President, Strategy and Business Development and Director,
Marketing at Mattel. He was Vice President, Corporate Development at Stamps.com and Senior
Associate at McKinsey & Company. He serves on the board for the Portland-Suzhou Sister City
Association. Mr. Frechtling graduated from Northwestern University in 1993 and earned his MBA from
Harvard Business School in 1997.
Sharon Bergen, Senior Vice President, Education and Training
Ms. Bergen joined KLC in 1997 and has held several progressively responsible positions in the Education
and Training Department until her promotion to Vice President in 2002 and her current position in 2005.
As Senior Vice President of Education and Training, Ms. Bergen oversees company-wide curriculum
program development, implementation and training activities. Ms. Bergen earned a B.S. in Child
Development from Minnesota State University and an M.A. in Early Childhood Education from Concordia
University. Her career includes a rich variety of professional experiences in the early childhood field
including prior work with several child care companies and non-profit agencies. She is a member of
numerous educational organizations, including the National Association for the Education of Young
Children (NAEYC) and the American Society of Training and Development (ASTD), and serves on a
variety of advisory councils, task forces and committees within the early childhood profession.
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Real Estate Management Team / Greenstreet Real Estate Partners
Steven Green, Chairman and Chief Executive Officer
See KUE Advisory Board section for complete biography
Jeffrey Safchik, Chief Operating Officer and Chief Financial Officer
See KUE Advisory Board section for complete biography
Steven Cox, Executive Vice President, Real Estate
Mr. Cox has over 25 years of real estate development, investment, and asset management experience.
Prior to joining Greenstreet, Mr. Cox was Managing Principal of Tishman Heskin Partners. Tishman
Heskin is a national real estate investment and asset management firm focused upon opportunistic
acquisitions of real estate and loan assets. At Tishman Heskin, Mr. Cox's activities included all aspects of
strategic direction, market analysis, acquisition, positioning / re-positioning, leasing, and disposition of
over $245 million of real estate nationwide. Since 1992, during Mr. Cox's term at Tishman Heskin
Partners, the company consistently delivered above average returns to its investors, many of whom were
offshore private clients. His experience in co-investing as a principal with globally oriented private clients
provides Mr. Cox with a firm understanding of his primary role of investment origination on behalf of GOP.
Prior associations include the Heskin Group, Towle Heskin Partners, Heskin Signet Partners and TCF
Service and Mortgage Corporation. In 1986, as a founding member and principal of the Heskin Group
(the managing member of the Towle Heskin Partners and Heskin Signet Partners), Mr. Cox oversaw the
asset management direction and disposition of over $1 billion in real estate and loan assets together with
financial and sale advisory assignments covering assets in excess of $2 billion in book value. Mr. Cox
holds a B.S.B. in Finance with additional studies in Economics from the University of Minnesota.
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KSI Board of Directors
Les Biller, Director
See KUE Advisory Board section for complete biography.
Ralph Finerman, Director
Mr. Finerman became a director of KLC in 1999. Mr. Finerman is the President of RFG Financial Group,
Inc., a position he has held since 1994. Mr. Finerman is a CPA and an attorney and practiced in New
York prior to forming RFG Financial Group, Inc. in 1994. Mr. Finerman also serves as a director of
Nextera Enterprises, Inc. and as an officer or director of other privately-held affiliates of KLC and Krest
LLC.
Stephen Goldsmith, Director
See KUE Management section for complete biography.
Steven Green, Director
See KUE Management section for complete biography.
Stanley E. Maron, Director
Mr. Maron became a director of KLC in 2004. Mr. Maron is a senior shareholder in the law firm of Maron
& Sandler, a position he has held since September 1994. Mr. Maron is also a director of LeapFrog
Enterprises, Inc. and Nextera Enterprises, Inc., and serves as an officer or director of various other
privately-held affiliates of KLC and Krest LLC.
Lowell Milken, Director
See KUE Management section for complete biography.
Wendi Murdoch, Director
Wendi Murdoch is currently an advisor to News Corporation on its business development in the Asia
Pacific region. Mrs. Murdoch is responsible for identifying and evaluating business opportunities in new
media and the Internet, managing relationships with government organizations and officials, recruiting
personnel and locating local partners. Previously, she served as the Vice President of News
Corporation's Asian satellite network, the Hong Kong based Star TV. In that capacity she was
instrumental in formulating STAR Sports and ESPN Asia. Mrs. Murdoch holds a Bachelors degree in
economics from California State University at Northridge and an MBA from Yale University.
Jeff Safchik, Director
See KUE Management section for complete biography.
Richard Sandler, Director
See KUE Management section for complete biography.
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k12 Management
Ron Packard, Chairman and Founder
Mr. Packard serves as Chairman of the Executive Committee of k12 and as acting Chief Executive Officer.
Prior to co-founding k12 and since 1997, Mr. Packard has been an executive officer of KU Schools,
whose subsidiaries and business ventures include early childhood education, charter school education,
and after school programs. From 1994 to 1997, Mr. Packard served as President of Forestal Trillium
Limitada, a South American company. Mr. Packard also has worked as a consultant for McKinsey &
Company and a mergers and acquisitions specialist at Goldman Sachs. Mr. Packard also serves on the
Advisory Board for Department of Defense Schools. Mr. Packard holds a B.S. and B.A. from the
University of California at Berkeley and an M.B.A. from the University of Chicago. He is also a Chartered
Financial Analyst.
John Baule, Executive Vice President of Operations and Chief Financial Officer
Mr. Baule previously served as CFO for Headstrong, a global consultancy based in Fairfax, Virginia, from 1999
to 2004. At Headstrong he was responsible for activities ranging from raising funds, to strategy, to daily
process improvement on a global basis. Mr. Baule acted as Mead-Johnson's CFO in their international office in
Hong Kong. Prior to Headstrong, Mr. Baule spent nine years at Bristol Myers-Squibb in a variety of
international accounting and finance roles. Mr. Baule began his career at KPMG. He holds a B.B.A. in
accounting from the College of William and Mary in Williamsburg, VA.
Bror Saxberg, Senior Vice President, Learning and Content
Bror Saxberg serves as Senior Vice President of Learning and Content of k12. From 1998 to 2000, Dr.
Saxberg served as Vice President of Operations at Knowledge Testing Enterprises, a developer of Web-
based assessments for IT skills, where he was responsible for technology, testing and operations. From
1995 to 1997, Dr. Saxberg served as Publisher and General Manager of DK Multimedia, and he has also
worked as a consultant for McKinsey & Co. Dr. Saxberg holds a B.S. from the University of Washington,
an M.A. from Oxford University, a Ph.D. from MIT and an M.D. from Harvard University.
Thomas Boysen, Senior Vice President, Chief School Officer
Mr. Boysen serves as Senior Vice President and Chief School Officer of k12. Previously, he was COO of
the Los Angeles Unified School District. Prior to this, Mr. Boysen was State Commissioner of Education
in the State of Kentucky. He has also served as superintendent of schools for the San Diego Unified and
Conejo Valley Unified school districts.
Charles Zogby, Senior Vice President, Education Policy
Mr. Zogby, serves as Senior Vice President of Education Policy. Previously, he served as Secretary of
Education for the Commonwealth of Pennsylvania, where he helped craft one of the most successful and
comprehensive education reform agendas in modern Pennsylvania history and lead the state's
development and legislative passage of the U.S.' first comprehensive cyber charter school law. Prior to
his appointment, Mr. Zogby served as Pennsylvania Gov. Ridge's policy director, where he was
responsible for coordinating policy development and initiatives across 18 executive branch agencies. Mr.
Zogby earned a bachelor's degree in economics from St. Lawrence University and his law degree, with
distinction, from George Mason University School of Law.
John Holdren, Senior Vice President, Curriculum
Mr. Holdren serves as Senior Vice President of Curriculum of k12. From 1991 to 2000, Mr. Holdren
served as Vice President and Director of Research and Publications at Core Knowledge Foundation.
While at Core Knowledge Foundation, Mr. Holdren oversaw the development of the Core Knowledge
Sequence: Content Guidelines for Grades K-8 and co-edited the Core Knowledge Series resource books.
Mr. Holdren also has taught literature and writing at the University of Virginia and Harvard University. Mr.
Holdren holds a B.A. from The Johns Hopkins University and an MA. from the University of Virginia.
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19.2. Appendix B: Knowledge Learning Corporation: Management's Discussion &
Analysis of Financial Condition and Results of Operations for the Fiscal Years
Ended December 31, 2005, 2004 and 2003
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