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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-K



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(Mark One)

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended July 1, 2006

or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from                     
to

Commission file number 1-10031



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NOBEL LEARNING COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 22-2465204                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|1615 West Chester Pike, Suite 200 West Chester, PA             |  | 19382                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code: (484) 947-2000

Securities registered pursuant to Section 12(b) of the Act:



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of Each Class |  | Name of Each Exchange on Which
Registered
|None                |  | None                                     

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.001 per share

(Title of each class)



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act Yes ̈No  x

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ̈No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act).

|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated filer ̈ |  | Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the
Act).    Yes ̈No  x

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of December 31, 2005 (the last
business day of the registrants most recently completed second fiscal quarter) was approximately $39,887,870 (based upon the closing sale price of these shares on such date as reported by the Nasdaq National Market). Calculation of the number
of shares held by non-affiliates is based on the assumption that the affiliates of the Company include the directors, executive officers and stockholders who have filed a Schedule 13D or 13G with the Company which reflects ownership of at least 5%
of the outstanding common stock or have the right to designate a member of the Board of Directors, and no other persons. The information provided shall in no way be construed as an admission that any person whose holdings are excluded from the
figure is an affiliate or that any person whose holdings are included is not an affiliate and any such admission is hereby disclaimed. The information provided is included solely for record keeping purposes of the Securities and Exchange Commission.

The number of shares of the registrants common stock, $0.001 par value per share, outstanding at September 12, 2006, was
8,092,776.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on November 8, 2006 (the Proxy Statement) and to be filed within 120 days after the registrants
fiscal year ended July 1, 2006 are incorporated by reference in Part III.



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TABLE OF CONTENTS



|         |  |                                                                                       |  |     
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|Item No. |  |                                                                                       |  | Page
|         |  | PART I                                                                                |  |     
|         |  |                                                                                      
|1.       |  | Business                                                                              |  | 1   
|1A.      |  | Risk Factors                                                                          |  | 8   
|1B.      |  | Unresolved SEC Comments                                                               |  | 11  
|2.       |  | Properties                                                                            |  | 11  
|3.       |  | Legal Proceedings                                                                     |  | 12  
|4.       |  | Submission of Matters to a Vote of Security Holders                                   |  | 12  
|         |  |                                                                                      
|         |  | PART II                                                                               |  |     
|         |  |                                                                                      
|5.       |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  | 13  
|6.       |  | Selected Financial Data                                                               |  | 14  
|7.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 16  
|7A.      |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 39  
|8.       |  | Financial Statements and Supplementary Data                                           |  | 40  
|9.       |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 40  
|9A.      |  | Controls and Procedures                                                               |  | 40  
|9B.      |  | Other Information                                                                     |  | 40  
|         |  |                                                                                      
|         |  | PART III                                                                              |  |     
|         |  |                                                                                      
|10.      |  | Directors and Executive Officers of the Registrant                                    |  | 41  
|11.      |  | Executive Compensation                                                                |  | 41  
|12.      |  | Security Ownership of Certain Owners and Management                                   |  | 41  
|13.      |  | Certain Relationships and Related Transactions                                        |  | 41  
|14.      |  | Principal Accountant Fees and Services                                                |  | 41  
|         |  |                                                                                      
|         |  | PART IV                                                                               |  |     
|         |  |                                                                                      
|15.      |  | Exhibits and Financial Statement Schedules                                            |  | 42  



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CAUTIONARY STATEMENTS ABOUT
FORWARD-LOOKING INFORMATION

Statements included or incorporated herein which are not
historical facts are forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When the Company uses words such as believes, expects, anticipates,
plans, estimates, projects, may, intends, seeks or similar expressions, the Company is making forward-looking statements, but these terms are not the exclusive means of
identifying forward-looking statements.

Forward-looking statements reflect managements current views with respect to future events
and financial performance, and are based on currently available competitive, financial and economic data and managements assumptions regarding future events. While management believes that its assumptions are reasonable, forward-looking
statements are subject to various known and unknown risks and uncertainties, and actual results may differ materially from those expressed or implied herein. In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company notes that certain factors, among others, which could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein are discussed in
greater detail under Managements Discussion and Analysis and Item 1A Risk Factors. In addition, the Companys results may be affected by general factors, such as economic conditions, political developments,
interest and inflation rates, accounting standards, taxes, and laws and regulations affecting it in markets where it competes.

Readers are
cautioned that the forward-looking statements reflect managements analysis only as of the date hereof, and the Company assumes no obligation to update or revise these statements or to update the reasons why actual results could differ from
those projected in the forward-looking statements, whether as a result of new information, future developments or otherwise.



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PART I



|ITEM1. | BUSINESS.
|------ | ---------

General

Nobel Learning Communities, Inc. (we, us, our, NLCI or the Company) is a leading
non-sectarian, for-profit provider of private pay education and services for education entities serving the preschool through 12thgrade market. Our programs are offered through a network of general education preschools, elementary, and middle schools, programs for learning challenged students, and special purpose high schools. Our schools may also provide
enrichment programs, summer camps and before- and after-school programs. We operate schools in California, Florida, Illinois, Maryland, Nevada, New Jersey, North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia and Washington. The
schools operate under various well-known local trade names, including but not limited to Chesterbrook Academy®, Merryhill School, Evergreen Academy, Paladin Academy® (for learning challenged students)and Houston Learning Academy (special purpose high schools). As of September 12, 2006, we
operated 151 schools in 13 states, with an aggregate capacity of approximately 24,000 children.

We have registered various service marks
in the United States Patent and Trademark Office, including, but not limited to Chesterbrook Academy®, Merryhill Country School®, Paladin Academy®, Camp Zone®, Rocking
Horse Child Care Centers®, and Houston Learning
Academy®. We believe that certain of our service
marks have substantial value in our marketing in the respective areas in which our schools operate.

Our corporate office is located at
1615 West Chester Pike, Suite 200, West Chester, PA 19382-6223. Our telephone number is (484) 947-2000. Nobel Learning Communities Inc., a Delaware corporation, was formed on March 30, 1983.

Educational Philosophy and Implementation

Our
educational philosophy is based on a foundation of sound research and innovative instructional techniques, along with quality practices and curricula developed by experienced educators. Our programs stress the development of the whole child and are
based on concepts of multi-sensory, integrated and age-appropriate learning. Our curricula are designed to allow each child to develop according to his or her own abilities and timetable, but also seek to prepare every student for achievement in
accordance with national content standards and goals. Each childs individual educational needs and skills are considered upon entrance into one of our schools. Our schools monitor student progress against curriculum objectives, as well as the
development of cognitive, social, emotional and physical skills. The result is the opportunity for each of our students to develop a strong foundation in academic learning, positive self-esteem and emotional and physical well-being.

We have created developmental goals and curriculum guidelines for each age level, grade level and content area to assist principals and teachers in
planning their daily and weekly programs. We maintain that small schools, small classes, clearly articulated curricular guidelines and excellent educational materials, delivered by qualified, innovative and enthusiastic teachers comprise the basic
ingredients of a quality education. Our philosophy is based on personalized instruction that leads to a students active involvement in learning and understanding. The programs for our schools are skills-based and delivered through
developmentally appropriate comprehensive curriculum in each developmental program or grade level. We implement the curriculum in ways that stimulate the learners curiosity, support the students individual learning style and by employing
processes that contribute to lifelong achievement. Academic areas addressed include reading, writing, spelling, mathematics, science, social studies, visual and graphic arts, music, physical education/wellness and world language. Additionally,
non-cognitive skills, such as perseverance, self-confidence, self-discipline, communication, social responsibility, teamwork, and conflict resolution skills are continuously reinforced through curriculum infusion and meta-cognitive dialogue. The
critical areas of technology literacy and study skills are integrated into the programs, as appropriate, in most content areas through the use of classroom-based technologies, media centers, and computer labs.



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We offer athletic activities and supplemental programs, which include day field trips coordinated with
curriculum to zoos, libraries, museums and theaters and, at the middle schools, overnight trips to such places as Yosemite National Park and Washington, D.C. Schools arrange classroom presentations by parents, community leaders and other volunteers
to supplement instruction. We also organize programs that allow students to present to community groups and organizations. To enhance the childs physical, social, emotional and intellectual growth, schools may provide extra-curricular
experiences (some fee-based) tailored to particular families interests. These activities include but are not limited to dance, gymnastics and instrumental music lessons. Additionally, students expand their horizons through participation in
science fairs, drama clubs, and local and regional academic competitions.

We recognize that maintaining the quality of our teachers
capabilities and professionalism is essential to sustaining our students high level of academic achievement and our profitability. We sponsor professional development days covering various aspects of teaching and education, using both internal
trainers and external consultants. Our educators serve on Company task forces and committees that review and revise curricular guidelines, programs, tools and current teaching methods.

School-based leadership teams (principals and assistant principals) also actively engage in professional development and self-improvement. Staff training
is provided by our education department and other experts within the educational industry. Through participation in NLCI Academy programs and the annual national Principals Conference seasoned administrators as well as new
recruits are kept abreast of up-to-date research, changing trends and sound pedagogical practices.

We seek to ensure that our schools meet
or exceed the standards of appropriate accrediting agencies through an internal quality assurance program. Although not mandated by any governmental or regulatory authority, many of our schools are accredited, or are currently seeking accreditation
through the Commission on International and Trans-Regional Accreditation (CITA) with various regional accreditation agencies throughout the United States. Regional accreditation agencies include:

Middle States Association of Colleges and Schools

North Central Association of Colleges and Schools

Northwest Association of Accredited Schools

Western Association of Schools and Colleges

Southern Association of Colleges and Schools

School Operations

In order to maintain appropriate standards, our schools share consistent educational goals and operating
procedures. While we have a national curriculum, principals may tailor curricula, within the standards of Nobel Learning Communities, to meet local and state requirements. Members of our management team visit schools and centers on a regular basis
to review program, facility and staff quality. Hiring and retaining quality personnel at our schools and in operational management positions is a critical success factor in driving excellence in both operational and financial performance.

Our school Principals and Assistant Principals are responsible for all facets of school operations including curriculum implementation,
ensuring student achievement and success, personnel and financial management, community outreach, student discipline, and implementing local sales and marketing strategies. We treat each school as a separate cost center, holding each school
accountable for its academic and financial performance. Each school has an annual budget and submits weekly financial data to the corporate office and to the appropriate Executive Director. Total revenue, tuition revenue, certain operating costs and
student census are monitored, with each school measured periodically in relation to our objectives.

Executive Directors oversee the
Principals and schools, and report to either a Division Vice President or a Regional Manager. Executive Directors are responsible for ensuring the qualifications of Principals and Assistant



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Principals, as well as training and development. School Principals and Executive Directors work closely with regional and corporate management,
particularly in the regular assessment of program quality and school performance.

We hire qualified candidates and attempt to promote from
within whenever possible. Candidate credentials are reviewed through employment references, criminal background checks and appropriate education verification in order to establish an understanding of the candidates skills, professionalism and
character. After hiring, it is our policy that employees receive regular performance feedback including a formal annual performance evaluation. All of our Principals and Executive Directors are eligible for incentive compensation based on the
performance of their schools.

Private Pay Schools

General Education Schools.Our preschool and elementary/middle school strategy is based on clustering a number of preschools around an elementary school in order to provide a continuum of education and
consistent curriculum for children from infancy through 5thand, in some cases, 8thgrade. Through the use of demographic drivers we place clusters of schools in geographic markets. We seek to increase market awareness, achieve
operating efficiencies, and provide cross-marketing opportunities in those clusters. Students from our preschools can move into our elementary/middle schools. In addition, we can potentially convert students from our other specialty programs to our
general education programs.

A minority of the schools we operate are not aligned with our demographic model. We also operate schools which
are not part of a complete geographic cluster. The majority of these schools were built or purchased prior to the implementation of our cluster strategy or may be the initial school in a new market. In some cases these schools may become part of a
cluster if we determine the demographic drivers in the market provide a growth opportunity.

We distinguish our schools from our
competition with our qualitative and quantitative program outcomes, which also span a broader range of ages and grades than many of our competitors. At each age and grade level, we support a childs development with appropriate curriculum-based
programs. During the fiscal year ended July 1, 2006 (Fiscal 2006), we introduced a new national preschool curriculum for children between six months and five years of age. We foster an individualized approach to learning through
small schools and small classes and by using multi-sensory, integrated curricula that blend each of the core subjects (e.g., reading, language arts, mathematics, science, and social studies) with special areas of study such as art, music,
technology, physical education/wellness, and world language. Further, in certain locations, we provide programs and schools for the learning challenged as well as special purpose high schools. We believe that empirical as well as quantitative
results support the quality of our programs. Standardized test results have consistently shown that our students perform at or above national grade performance norms in reading and mathematics.

Many of our preschools and elementary schools allow for early drop-off and late pick-up to accommodate parent schedules. In most preschool locations,
programs are available for children starting at six weeks of age. Parents can feel comfortable leaving their children at one of our schools knowing the children will receive both a quality education and engage in well-supervised developmental and
recreational activities.

Most of our preschools and elementary schools complement their educational programs with enrichment programs,
arts programs, before- and after-school programs and summer programs or camps. In addition to those revenue generating programs, our schools seek to improve margins by providing ancillary services and products, such as photo portraits, book, and
uniform sales.

During Fiscal 2006, the Company entered into a franchise agreement with CTWorkshop Licensing USA, Inc. to have the
exclusive rights to offer Childrens Technology Workshop products in several of the geographic markets in which the Company operates private schools. The Childrens Technology Workshop operates a



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childrens education and recreation business specializing in the delivery of interactive, applied technology programs and workshops that operate
pursuant to a distinctive proprietary system and proprietary trademarks. The Company intends to offer summer camp, after school enrichment, and other Childrens Technology Workshop programs through some of its schools. The Company currently
operates these programs in parts of California, Virginia, and Pennsylvania. Additionally, the Company has the right to execute franchise agreements in other markets including markets located in parts of North Carolina, Nevada, and Illinois.

Paladin Academy®.Our Paladin Academy® school and programs serve the needs of children with mild to moderate learning challenges from kindergarten through high school. Our mission is to
improve the learning process and achievement levels of children with dyslexia, attention deficit disorder, dysgraphia and other mild learning difficulties through stand-alone schools and school-based programs. We offer developmental testing,
full-day clinics and summer programs. The primary goals of our Paladin Academy® programs are to enable students to mainstream back into the general school population.

As of
September 12, 2006, we operated one stand-alone Paladin Academy® school and 10 school-based programs or clinics integrated within our elementary schools. Paladin Academy® schools and/or programs are now located in California, Florida, Nevada, New Jersey, North Carolina, Pennsylvania, and Virginia.

Houston Learning Academy®. Houston Learning Academy® (HLA), operates five special purpose high schools and one special purpose high school program in the Houston metropolitan marketplace. HLA
schools, which are fully accredited by the Southern Association of Colleges and Schools, offer a half-day high school program, as well as evening and summer school programs. HLA also provides tutors and special education classes to residential
hospitals. HLA schools and programs feature individualized attention, primarily for those students who are at risk of not completing their high school requirements in a more traditional setting, and/or are attracted to the schools program and
flexible hours of service. We continue to evaluate HLAs business to determine its long-term strategic fit within our private pay school business.

Charter School Management Services

We currently have multi-year contracts providing limited management services to three
charter schools in Philadelphia, Pennsylvania. The holders of the charters are non-profit entities managed by a board of directors or trustees. In two cases, we lease the charter school premises from a third party and sublease the premises to the
non-profit entity.

While we do not currently expect to own and operate charter schools directly, we may pursue growth in the charter
school management business by competing for contracts at charter schools owned and operated by others. Since the charter schools for which we provide services operate under a charter granted by a state or school board authority, we would lose the
right to provide those services if the charter authority were to withdraw the charter. As such, the charter authority could base such withdrawal on actions of the charter holder, which are outside of our control. Also, many state charter school
statutes require periodic reauthorization. If state charter school legislation in such states were not reauthorized or were substantially altered, our management service opportunities in the charter school market could be materially adversely
affected.

Marketing

We generate new
enrollments primarily from word-of-mouth recommendations from parents, direct mail campaigns, internet advertising, yellow pages listings, print advertisements and public relations programs. We also market to our own database of inquirers with
ongoing direct mail and email communications.

Marketing efforts are directed by a central marketing team, who work with operations
management, and the education team to develop consistent brand positioning and communication strategies, with the goal of continuously improving customer acquisition and retention. Our marketing team conducts enrollment marketing



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campaigns throughout the year in each of our geographic areas. These major campaigns are supplemented by community-based activities conducted by our local
Executive Directors and principals.

Our annual marketing calendar is synchronized to the typical customer demand cycle for enrollment. We
direct marketing resources towards our preschool enrollments during spring and summer and towards our elementary/middle schools during fall and winter. To a lesser degree, there is enrollment activity in the other seasonal periods for all schools.

During Fiscal 2006, the Company implemented a number of marketing communication tools to strengthen our communications with existing
customers and increase customer retention and length of stay. These tools include, but are not limited to, e-mail based newsletters and school specific websites.

Corporate Development  Strategy and Implementation

Our growth strategy in the private education market includes
internal growth of our enrollment at existing schools, expansion of current facilities, new school development in both existing and new markets, and strategic acquisitions.

Our recent emphasis has been on increasing occupancy and ancillary program revenue in our existing schools and leveraging the investment in those assets.
Management has implemented new training programs designed to strengthen Principals and Executive Directors sales and customer service skills. In addition, to broaden the potential career path opportunities for employees we have provided
employees the ability to move between locations as appropriate opportunities arise. The similar economic and business model our schools operate under permits the Company to execute on this career path strategy.

While a significant portion of our efforts have focused on improving the performance of existing schools, the Company expects to increase its effort to
identify opportunities to develop and open new schools and to acquire schools in support of our demographically driven geographic market cluster strategy, in both existing and new markets. To that end, during Fiscal 2006, the Company hired a Senior
Vice President for Corporate Development to lead the Companys new school development and acquisition strategy and implementation.

In
June, 2006, the Company acquired The Honor Roll School located in Sugar Land, Texas. This acquisition adds two schools to the Companys portfolio, a preschool and an elementary/middle school. This was the first acquisition for the Company in
over three years.

During the first quarter of Fiscal 2007, the Company entered into additional franchise agreements with CTWorkshop
Licensing USA, Inc. to have the exclusive rights to offer Childrens Technology Workshop products in parts of the North Carolina, Nevada, and Illinois markets in which the Company operates private schools. The Childrens Technology
Workshop operates a childrens education and recreation business specializing in the delivery of interactive, applied technology programs and workshops that operate pursuant to a distinctive proprietary system and proprietary trademarks. The
Company intends to offer summer camp, after school enrichment, and other Childrens Technology Workshop programs through some of its schools. The Company currently operates these programs in California, Virginia, and Pennsylvania.

In August, 2006 the Company entered into an agreement to manage an onsite child development program servicing the employees and children of a
department of the federal government. This contract begins on October 1, 2006 and has a multi-year term. This marks the first time in recent history that the Company has operated a child development facility under a management agreement.

While we do not currently anticipate exiting any of our geographic markets, we regularly analyze the profitability of our existing school
and real estate portfolio to identify schools that are underperforming and/or do not fit our business model or demographic cluster strategies. We then develop plans either to improve these



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schools or remove them from our portfolio. This represents an important activity in reallocating capital to the balance of our schools in order to ensure the
continued improvement of our program offerings and overall company performance.

New School Development

During Fiscal 2006, we opened one preschool. From the period beginning July 2, 2006 through September 12, 2006, we opened one preschool. The
Company anticipates opening additional preschools during Fiscal 2007. Additionally, the Company has signed a contract to manage a child development center for the benefit of employees of a federal agency in Washington D.C. We will continue to look
for available opportunities that may result in our ability to add new schools at any time.

Typically for new school development we engage
a developer or contractor to build a facility to our specifications. Alternatively, we may purchase land, construct the building with our own or borrowed funds and then seek to enter into a sale and lease-back transaction with an investor. We also
look to occupy existing buildings that are appropriate for our schools and that are located in growth areas that meet our demographic requirements.

Acquisitions

We expect to use strategic acquisitions to expand our business. Key acquisition criteria include reputation,
location in markets with excellent demographics, growth prospects, quality of personnel and the ability to integrate into existing market clusters, or become the foundation for new market clusters. We expect to focus any near-term acquisitions on
schools that fit our demographic and cluster strategy and which serve the preschool and/or elementary market either directly serving the consumer or supporting a corporation or other entity in providing preschool and other related services to their
employees. The Company seeks to identify acquisition opportunities at appropriate prices. Due to a variety of factors we cannot be certain acquisition targets will be available on terms or conditions acceptable to the Company. During Fiscal 2006,
the Company hired a Senior Vice President for Corporate Development to lead the Companys new school development and acquisition strategy implementation.

On June 29, 2006, the Company acquired certain net assets of The Honor Roll School in Sugar Land, Texas. The Honor Roll School serves students from age two through eighth grade. This acquisition adds two schools to
the Companys portfolio, a preschool and an elementary/middle school. This was the first acquisition for the Company in over three years.

Seasonality

Our elementary/middle schools historically have lower operating revenues in the summer due to the end of the
traditional academic year and seasonally lower enrollment in summer programs. Summer revenues of preschools are, to a lesser degree, subject to the same seasonality. Management seeks to reduce the seasonal fluctuations of the Companys revenue
stream by adding to the school a mix of products and services in the lower revenue seasons. The success of these offerings depends primarily on customer acceptance and available disposable income.

Industry and Competition

Education reform movements
in the United States are providing new alternatives to the public schools. These reforms include charter schools, private management of public schools, home schooling, private schools, virtual schools and voucher programs. Our strategy is to provide
parents a quality alternative to public schools through our privately owned and operated schools, utilizing proven curriculum in a safe and challenging environment. While our schools do not currently reside in any school voucher markets, we believe
voucher



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programs would be a positive development for our schools. We consider each of these alternatives to be competition for our schools and the expansion or
contraction of funding and/or public support of these alternatives may impact the demand for our product, available real estate and our ability to increase or maintain our operating margins.

We compete with other for-profit private schools, charter schools, non-profit schools, sectarian schools and home schooling. We also face competition
with respect to preschool services and before- and after-school programs from public schools, government-based providers, and religiously affiliated, community-based or other non-profit programs that may offer such services at little or no cost to
parents. We anticipate that, given the perceived potential of the education market, well-financed competition may emerge, including possible competition from the large for-profit child care companies. We believe the only large for-profit competitors
that integrate preschool and elementary education and that currently compete beyond a regional level are Knowledge Learning Corp. and Bright Horizons Family Solutions, Inc. We also face competition in each of our demographic markets from local
operators of individually owned private schools. Finally, public school systems may become stronger competitors at the preschool level if additional states pass or expand universal pre-K legislation that provides public funds for preschool for three
and four year olds and do not allow for-profit preschool operators to participate in these programs, or fund payments to for-profit operators at lower than market prices or costs.

While price is an important factor in competing in both the preschool and elementary school markets, we believe that other competitive factors also are
important, including professionally developed educational programs, qualified and trained school administrators, well-equipped facilities, trained teachers and a broad range of ancillary services, including before- and after- school programs,
transportation and infant care. Some of these services are not offered by some of our competitors. We believe we are competitively priced in each of our markets.

Regulation

Our schools are subject to state and local regulations and licensing requirements. We have policies and
procedures in place to assist in complying with such regulations and requirements. These regulations and the administrative bodies in charge of these regulations vary from jurisdiction to jurisdiction, and may apply differently within the same
jurisdiction to a preschool, elementary or middle school. Although the regulatory and licensing requirements tend to be more stringent with respect to preschool, government agencies generally review the fitness and adequacy of buildings and
equipment, the ratio of staff personnel to enrolled children, staff training, record keeping, childrens dietary program, daily curriculum, and compliance with health and safety standards. In most jurisdictions, these agencies conduct scheduled
and unscheduled inspections of the schools and licenses must be renewed periodically. Most jurisdictions establish requirements for background checks or other clearance procedures for new employees of schools. Repeated failures of a school to comply
with applicable regulations can subject the school to sanctions, which might include probation or, in more serious cases, suspension or revocation of the schools license to operate, and could also lead to investigations of our other schools
located in the same jurisdiction. In addition, this type of action could lead to negative publicity extending beyond that jurisdiction and potentially affecting our other locations.

We believe that our operations are in substantial compliance with all material regulations applicable to our business. However, there is no assurance
that a licensing authority will not determine a particular school to be in violation of applicable regulations and take action against that school and possibly other schools 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 that could have a material adverse effect on our operations. States in which we operate routinely review the adequacy
of regulatory and licensing requirements and implement changes which may significantly increase our costs to operate in those states.



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Environmental Compliance

We are not aware of any existing environmental conditions that currently or in the future could reasonably be expected to have a material adverse effect on our financial position, operating results or cash flows, and
we have not incurred material expenditures to address environmental conditions at any school. Although we have periodically conducted limited environmental investigations and remedial activities at some of our schools, we have not undertaken an
in-depth environmental review of all of our schools, and accordingly, there may be material environmental liabilities of which we are unaware. In addition, no assurances can be given that future laws or regulations will not impose any material
environmental liability.

Insurance

We
currently maintain comprehensive general liability, workers compensation, automobile liability, property, excess umbrella liability, student accident insurance and directors and officers liability insurance. The policies provide a
variety of coverages and limits. Companies involved in the education and care of children, however, may not be able to obtain insurance for the total risks inherent in their operations. In particular, general liability coverage can have sublimits
per claim for child abuse. Although we believe we have adequate insurance coverage at this time, claims in excess of, or not included within, our coverage may be asserted. In addition, there can be no assurance that in future years we will not
become subject to lower limits or substantial increase in insurance premiums.

Employees

On September 12, 2006, we employed approximately 4,166 persons. None of the Companys employees are represented by a labor union. We believe
that our relationship with our employees is satisfactory.

Available Information

We file electronically with the Securities and Exchange Commission (the SEC) our annual reports on Form 10-K, quarterly reports on Form 10-Q,
and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read or copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington,
DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

A free copy of our annual reports
on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports may be obtained (as soon as reasonably practicable after we file or furnish such reports with the SEC) on our website at
http://www.nobellearning.com. The information on our website is not and should not be considered part of this Annual Report on Form 10-K and is not incorporated by reference in this report. This website is and is only intended to be an inactive
textual reference.



|ITEM1A. | RISK FACTORS.
|------- | -------------

Each
of the following risks, individually or in a group, could have a material adverse affect on the Companys business, results of operations, financial condition or cash flows.

Changing Economic Conditions

The Companys revenue and net income are subject to general
economic conditions. The Companys revenues depend, in part, on the number of dual income families and working single parents who require child development, child care, or educational services. A deterioration of general economic conditions may
adversely impact the Company because of the tendency of out-of-work parents to diminish or discontinue utilization of these services. In addition, the Company may not be able to increase tuition at a rate consistent with increases in wages, health
insurance, and other operating costs or continue tuition increases at historical rates experienced in the industry.



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##### Table of Contents

Execution of Growth Strategy.

The Companys ability to grow in the future will depend upon a number of factors, including the expansion of services and programs offered by the Company, the maintenance of high quality services and programs,
the hiring and training of qualified personnel, and the availability of appropriately located and economically feasible real estate and/or buildings. Sustaining growth may require further enhancements to operational and financial systems and will
also depend on the Companys ability to expand its management and operational workforce. There can be no assurance that the Company will be able to manage its expanding operations effectively or that it will be able to maintain or accelerate
its growth.

Competition

The Company
competes for individual enrollment in a highly fragmented market. For enrollment, the Company competes with residential based child care (operated out of the caregivers home) and center-based child care which may include work-site child care
centers, full and part-time child care centers and preschools, private and public elementary schools and church-affiliated and other not-for-profit providers. In addition, substitutes for organized preschool, child care, and educational services,
such as relatives and others caring for a child or home schooling, can represent lower cost alternatives to the Companys services. Management believes the Companys ability to compete successfully depends on a number of factors, including
qualifications of principals and teachers, quality of care, site convenience and cost. The Company often is at a price disadvantage with respect to these alternative providers, who operate with little or no rental expense and generally do not comply
or are not required to comply with the same health, safety, insurance and operational regulations as the Company. Many of its competitors in the private pay education service segment also offer similar or competing services at a substantially lower
price than the Company and some may have access to greater financial resources than the Company or have greater name recognition. The Company also competes with many not-for-profit providers of child care and preschools, as well as elementary
schools, some of which are able to offer lower pricing than the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors.

Risks Associated with Acquisitions

Acquisitions are
an ongoing part of the Companys growth strategy. Acquisitions involve numerous risks, including potential difficulties in the assimilation of acquired operations, not meeting financial objectives, additional need for capital investment,
undisclosed liabilities not covered by insurance or terms of acquisition, diversion of managements attention in connection with an acquisition and potential loss of key employees of the acquired operation. No assurance can be given as to the
success of the Company in identifying, executing and assimilating acquisitions in the future or the ability to identify satisfactory acquisition targets and successfully complete any acquisition.

Dependence on Key Management Personnel

The success
of the Company is highly dependent on the efforts, abilities, and continued services of its executive officers and other key employees. The Company believes that its future success will depend upon its ability to continue to attract, motivate and
retain highly-skilled key managers in a number of areas including, education, operations, finance, human resources, information technology, and marketing.

Hiring and Retaining Qualified Principals and Teachers

The Company may experience difficulty in attracting and retaining
qualified personnel in various markets necessary to meet growth opportunities. Hiring and retaining qualified personnel may require increased salaries and enhanced benefits in more competitive markets. In addition, difficulties in hiring and
retaining qualified personnel may also impact the Companys ability to obtain additional enrollment at its preschools and elementary schools.



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Ability to Maintain Effective Internal Controls Over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. A control system can only
provide reasonable, not absolute, assurance that misstatements in financial reporting will be detected or prevented. The effectiveness of a system of internal controls may deteriorate if controls become inadequate due to changes in conditions, or if
compliance with the policies or procedures declines. The key element to a system of internal control is competent personnel implementing the controls; the company may not be able to hire enough competent personnel.

Ability to Obtain and Maintain Insurance

The Company
currently maintains the following major types of insurance policies: workers compensation, commercial general liability, including coverage for child abuse and molestation, automobile liability, commercial property coverage, student accident
coverage, directors and officers liability coverage, professional liability and excess umbrella liability. These policies provide for a variety of coverages and are subject to various limitations, exclusions and deductibles.
To date, the Company has been able to obtain insurance in amounts it believes to be appropriate. There can be no assurance that such insurance will continue to be readily available to the Company or that the Companys insurance premiums will
not materially increase in the future as a consequence of conditions in the insurance business or private pay education and service market generally or the Companys experience in particular.

Adverse Publicity

Any adverse publicity concerning
reported incidents of alleged violations of licensing or regulatory requirements, neglect, or child abuse at any of the Companys locations, whether or not directly relating to or involving the Company, could result in decreased enrollment at
the Companys locations, an inability to attract new enrollments, and inability to expand in certain markets, as well as increased insurance costs.

Litigation

Because of the nature of its business, the Company is and expects that in the future it may be subject to claims
and litigation alleging negligence, inadequate supervision and other grounds for liability arising from injuries or other harm to the people it serves, primarily children. In addition, claimants may seek damages from the Company for child abuse,
sexual abuse and other acts allegedly committed by Company employees. There can be no assurance that additional lawsuits will not be filed, that the Companys insurance will be adequate to cover liabilities resulting from any claim or that any
such claim or the publicity resulting from it will not have a material adverse effect on the Companys business, results of operations, and financial condition including, without limitation, adverse effects caused by increased cost or decreased
availability of insurance and decreased demand for the Companys services.

Seasonality and Variability of Quarterly Operating Results

The Companys revenue and results of operations fluctuate with the seasonal demands for child development and educational
services. Revenue at the Companys locations which have mature operating levels typically declines during the fourth quarter of our fiscal year as a result of decreased enrollments at its locations as parents withdraw their children for summer
vacations or summer break periods normally associated with a nine or ten month academic school year. There can be no assurance that the Company will be able to adjust its expenses on a short-term basis to minimize the effect of these fluctuations in
revenue. The Companys quarterly results of operations may also fluctuate based upon the number and timing of preschool and elementary school openings and/or acquisitions, the performance of new and existing locations, competitive factors and
general economic conditions. The inability of existing locations to maintain their current enrollment levels and profitability, the failure of newly opened locations to contribute to profitability and the failure to maintain and grow the existing
services could result in additional fluctuations in the future operating results of the Company on a quarterly or annual basis.



10



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##### Table of Contents

Impact of Governmental Regulations

The Companys locations are subject to numerous national, state and local regulations and licensing requirements. Although these regulations vary greatly from jurisdiction to jurisdiction, government agencies
generally review, among other things, the adequacy of buildings and equipment, licensed capacity, the ratio of staff to children, staff training, record keeping, the dietary program, the daily curriculum, hiring practices and compliance with health
and safety standards. Failure of any location to comply with applicable regulations and requirements could subject it to governmental sanctions, which might include fines, corrective orders, probation, or, in more serious cases, suspension or
revocation of the locations license to operate or an award of damages to private litigants and could require significant expenditures by the Company to bring its location into compliance. Many government agencies may publish or publicly report
major and/or minor regulatory violations and the Company may suffer adverse publicity which could result in a loss of enrollment in a school or market.

The expansion of independent charter schools where student tuition is funded by or supported by public funds could impact consumer demand for our educational services and schools in markets where the Company operates
elementary and/or middle schools.

Finally, although the Company expects to pay employees at rates above the minimum wage, increases in the
statutory minimum wage could result in a corresponding increase in the wages paid to the Companys employees.

Impact of Governmental Universal
Child Care Benefit

National, state or local child care and early age education benefit programs relying primarily on subsidies in the
form of tax credits or other direct financial aid could provide the Company opportunities for expansion in additional markets; however, a universal benefit with governmentally mandated or provided child care could reduce the demand for educational
services at the Companys existing locations. Even in situations where the Company was allowed to provide publicly funded early age education programs, the amount of public funding could have a material adverse effect on the Companys
business and financial condition if the Company were to undertake these programs.

Possible Volatility of Stock Price

The prices at which the Companys common stock trades is determined by the marketplace and is influenced by many factors, including the liquidity of
the market for the Common Stock, investor perception of the Company and of the work/life industry generally, general economic market conditions and world events. Factors such as announcements of new services, new clients, acquisitions by the
Company, its competitors or third parties, new regulatory or licensing requirements, as well as market conditions in the Companys industry, may have a significant impact on the market price of the Common Stock. General investment market trends
and movements in prices of stocks in general may also affect the market price. In addition, awards under the Companys stock incentive plan and the issuance of additional equity securities of the Company may cause dilution to existing
stockholders.



|ITEM1B. | UNRESOLVED SEC COMMENTS.
|------- | ------------------------

None.



|ITEM2. | PROPERTIES.
|------ | -----------

At September 12,
2006, we operated 151 schools on eight owned and 143 leased properties in 13 states. Our schools are geographically distributed as follows: 30 in California, eight in Florida, 15 in Illinois, one in Maryland, six in Nevada, 10 in New Jersey, 20
in North Carolina, three in Oregon, 20 in Pennsylvania, two in South Carolina, 11 in Texas, 19 in Virginia and six in Washington. Our schools generally are located in suburban settings.



11



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##### Table of Contents

The land and buildings which we own are subject to security interests on the real property. Our leased
properties are leased under long-term leases which are typically triple-net leases requiring us to pay all applicable real estate taxes, utility expenses and insurance costs. These leases usually contain inflation related rent escalators.

From time to time, we may purchase undeveloped land for future development.

We lease 22,500 square feet of space for our corporate offices in West Chester, Pennsylvania. This space is adequate for our current needs.



|ITEM3. | LEGAL PROCEEDINGS.
|------ | ------------------

We are a party in various suits and claims that arise in the ordinary course of our business. Our management currently believes that the ultimate disposition of all such pending matters will not have a material adverse effect on our
consolidated financial position or results of operations. The significance of these pending matters on our future operating results and cash flows depends on the level of future results of operations and cash flows as well as on the timing and
amounts, if any, of the ultimate outcome.



|ITEM4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------ | ---------------------------------------------------

None.



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##### Table of Contents

PART II



|ITEM5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
|------ | -------------------------------------------------------------------------------------------------------------

Market Information

Our common stock trades on The
Nasdaq National Market under the symbol NLCI.

The table below sets forth the quarterly high and low sales prices for our common stock as
reported by Nasdaq for each quarter during the period from July 4, 2004 through July 1, 2006.



|                                           |  |      |       |     |   |     
|------------------------------------------ |  | ---- | ----- | --- | - | ----
|                                           |  | High |       | Low
|Fiscal 2005 (July 4, 2004 to July 2, 2005) |  |      |       |     |   |     
|First Quarter                              |  | $    | 7.30  |     | $ | 6.50
|Second Quarter                             |  |      | 8.00  |     |   | 6.99
|Third Quarter                              |  |      | 9.35  |     |   | 7.35
|Fourth Quarter                             |  |      | 9.40  |     |   | 6.20
|                                           |  |     
|Fiscal 2006 (July 2, 2005 to July 1, 2006) |  |      |       |     |   |     
|First Quarter                              |  | $    | 9.99  |     | $ | 8.71
|Second Quarter                             |  |      | 9.71  |     |   | 9.01
|Third Quarter                              |  |      | 9.61  |     |   | 8.70
|Fourth Quarter                             |  |      | 10.47 |     |   | 9.30

Holders

At September 12, 2006, there were approximately 325 holders of record of shares of our common stock.

Dividend
Policy

We have never paid a dividend on our common stock and do not expect to do so in the foreseeable future. Although the payment of
dividends is at the discretion of the Board of Directors, we intend to retain our earnings in order to finance our ongoing operations and to develop and expand our business. Our credit facility with our senior lender prohibits us from paying
dividends on our common stock or making other cash distributions on our common stock without the lenders consent.

As permitted and
in accordance with the provisions of its Preferred Series E and Preferred Series F stock, the Company does currently pay dividends in shares of common stock. Effective on the third anniversary for each of these classes the Company will be permitted
to pay these dividends in cash. The Company intends to begin payment of these dividends in cash as soon as it is practical to do so.



13



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##### Table of Contents

|ITEM6. | SELECTED FINANCIAL DATA.
|------ | ------------------------

The following table sets forth selected historical consolidated financial and other data, with dollars in thousands, except per share amounts. See Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data included elsewhere in this report. The historical operating results below have been restated to reflect the reclassification of
discontinued operations from continuing operations to loss from discontinued operations.



|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------- | ------- | - | ------------ | - | ------- | ------------ |  | - | ------------- | - |  | ------------- | ------- | - |  | - | ------- | -
|                                                                   |  | For the Fiscal Year Ended |        
|                                                                   |  | July 1, 2006              |         |   | July 2, 2005 |   |         | July 3, 2004 |  |   | June 30, 2003 |   |  | June 30, 2002 |        
|Operating Data:                                                    |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Revenue                                                            |  | $                         | 168,329 |   |              | $ | 164,204 |              |  | $ | 158,361       |   |  | $             | 149,753 |   |  | $ | 145,173 |  
|Cost of services                                                   |  |                           | 146,129 |   |              |   | 142,448 |              |  |   | 137,847       |   |  |               | 131,050 |   |  |   | 122,613 |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Gross profit                                                       |  |                           | 22,200  |   |              |   | 21,756  |              |  |   | 20,514        |   |  |               | 18,703  |   |  |   | 22,560  |  
|Goodwill and other asset impairments (a)                           |  |                           | 30      |   |              |   | 216     |              |  |   | 3,368         |   |  |               | 8,715   |   |  |   |        |  
|Transaction related costs (b)                                      |  |                           |        |   |              |   |        |              |  |   |              |   |  |               | 1,168   |   |  |   |        |  
|General and administrative expenses (c)                            |  |                           | 13,523  |   |              |   | 14,548  |              |  |   | 14,256        |   |  |               | 13,885  |   |  |   | 11,776  |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Operating income (loss)                                            |  |                           | 8,647   |   |              |   | 6,992   |              |  |   | 2,890         |   |  |               | (5,065  | ) |  |   | 10,784  |  
|Interest expense                                                   |  |                           | 1,469   |   |              |   | 2,692   |              |  |   | 3,632         |   |  |               | 3,740   |   |  |   | 3,637   |  
|Other income, net                                                  |  |                           | (350    | ) |              |   | (184    | )            |  |   | (45           | ) |  |               | (189    | ) |  |   | (126    | )
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Income (loss) from continuing operations before income taxes       |  |                           | 7,528   |   |              |   | 4,484   |              |  |   | (697          | ) |  |               | (8,616  | ) |  |   | 7,273   |  
|Income tax expense (benefit)                                       |  |                           | 2,943   |   |              |   | 1,677   |              |  |   | 257           |   |  |               | (2,193  | ) |  |   | 2,875   |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Income (loss) from continuing operations                           |  |                           | 4,585   |   |              |   | 2,807   |              |  |   | (954          | ) |  |               | (6,423  | ) |  |   | 4,398   |  
|(Loss) from discontinued operations, net of income tax benefit (d) |  |                           | (106    | ) |              |   | (291    | )            |  |   | (5,127        | ) |  |               | (5,111  | ) |  |   | (1,564  | )
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss)                                                  |  |                           | 4,479   |   |              |   | 2,516   |              |  |   | (6,081        | ) |  |               | (11,534 | ) |  |   | 2,834   |  
|Preferred stock dividends                                          |  |                           | 487     |   |              |   | 642     |              |  |   | 516           |   |  |               | 82      |   |  |   | 82      |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss) available for common stockholders                |  | $                         | 3,992   |   |              | $ | 1,874   |              |  | $ | (6,597        | ) |  | $             | (11,616 | ) |  | $ | 2,752   |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Basic income (loss) per share:                                     |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss) from continuing operations                       |  | $                         | 0.55    |   |              | $ | 0.31    |              |  | $ | (0.22         | ) |  | $             | (1.02   | ) |  | $ | 0.69    |  
|Discontinued operations                                            |  |                           | (0.01   | ) |              |   | (0.04   | )            |  |   | (0.79         | ) |  |               | (0.81   | ) |  |   | (0.25   | )
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss) per share                                        |  | $                         | 0.54    |   |              | $ | 0.27    |              |  | $ | (1.01         | ) |  | $             | (1.83   | ) |  | $ | 0.44    |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Diluted income (loss) per share:                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss) from continuing operations                       |  | $                         | 0.45    |   |              | $ | 0.29    |              |  | $ | (0.22         | ) |  | $             | (1.02   | ) |  | $ | 0.59    |  
|Discontinued operations                                            |  |                           | (0.01   | ) |              |   | (0.03   | )            |  |   | (0.79         | ) |  |               | (0.81   | ) |  |   | (0.21   | )
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Net income (loss) per share                                        |  | $                         | 0.44    |   |              | $ | 0.26    |              |  | $ | (1.01         | ) |  | $             | (1.83   | ) |  | $ | 0.38    |  
|                                                                   |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Weighted average common shares outstanding (in thousands):         |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Basic                                                              |  |                           | 7,473   |   |              |   | 7,064   |              |  |   | 6,512         |   |  |               | 6,336   |   |  |   | 6,198   |  
|Diluted                                                            |  |                           | 10,080  |   |              |   | 9,719   |              |  |   | 6,512         |   |  |               | 6,336   |   |  |   | 7,475   |  
|Balance Sheet Data:                                                |  |                           |         |   |              |   |         |              |  |   |               |   |  |               |         |   |  |   |         |  
|Cash and cash equivalents                                          |  | $                         | 9,837   |   |              | $ | 2,925   |              |  | $ | 2,716         |   |  | $             | 4,722   |   |  | $ | 1,787   |  
|Working capital deficit                                            |  |                           | (9,503  | ) |              |   | (15,079 | )            |  |   | (8,688        | ) |  |               | (23,095 | ) |  |   | (7,720  | )
|Goodwill and intangible assets, net                                |  |                           | 39,997  |   |              |   | 36,937  |              |  |   | 37,167        |   |  |               | 40,162  |   |  |   | 49,521  |  
|Total assets                                                       |  |                           | 86,419  |   |              |   | 78,344  |              |  |   | 85,865        |   |  |               | 97,968  |   |  |   | 102,980 |  
|Short term debt and current portion of long term debt              |  |                           | 2,180   |   |              |   | 2,281   |              |  |   | 2,405         |   |  |               | 24,860  |   |  |   | 4,488   |  
|Long term debt                                                     |  |                           | 11,000  |   |              |   | 13,180  |              |  |   | 22,931        |   |  |               | 10,605  |   |  |   | 35,729  |  
|Stockholders equity                                               |  |                           | 46,280  |   |              |   | 37,390  |              |  |   | 34,275        |   |  |               | 37,075  |   |  |   | 42,487  |  



14



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---

|(a) | During the year ended July 2, 2005 (Fiscal 2005), the Company recorded an impairment charge of $216,000 related to fixed asset impairments in accordance with SFAS
144, Accounting for Impairment or Disposal of Long-Lived Assets, (SFAS 144). During the year ended July 3, 2004 (Fiscal 2004), the Company recorded impairment of goodwill of $2,273,000 in accordance with
Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangibles and an impairment charge of $1,095,000 related to fixed asset impairments in accordance with SFAS 144. During the year ended June 30,
2003 (Fiscal 2003), the Company recorded impairment of goodwill of $7,700,000 in accordance with SFAS 142, Goodwill and Other Intangibles and an impairment charge of $1,015,000 related to intangible assets in accordance with
SFAS 144, Accounting for Impairment or Disposal of Long-Lived Assets. See notes to the financial statements for further discussion.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | During Fiscal 2003, the Company expensed approximately $1,168,000 of legal, professional and other registration fees and expenses incurred in connection with termination of a merger
agreement.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | In Fiscal 2005, general and administrative expenses include an additional charge of $1,500,000 related to the reserve of the Companys investment in Total Education Solutions.
In Fiscal 2004, general and administrative expenses includes a charge of $1,500,000 related to the present value of future payments with respect to consulting agreements with two former executives of approximately $1,290,000 and charges for future
health insurance coverage for these two individuals of approximately $210,000. In Fiscal 2003, general and administrative expenses include a charge of $1,000,000 related to the write-down of the Companys investment in Total Education
Solutions.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) | Discontinued operations contain the following (dollars in thousands):
|--- | ---------------------------------------------------------------------



|                                                            |  |                     |      |   |              |   |       |              |  |   |               |   |  |               |        |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------- | ---- | - | ------------ | - | ----- | ------------ |  | - | ------------- | - |  | ------------- | ------ | - |  | - | ------ | -
|                                                            |  | For the Years Ended |     
|                                                            |  | July 1, 2006        |      |   | July 2, 2005 |   |       | July 3, 2004 |  |   | June 30, 2003 |   |  | June 30, 2002 |       
|Revenues                                                    |  | $                   |     |   |              | $ | 384   |              |  | $ | 5,432         |   |  | $             | 11,851 |   |  | $ | 11,106 |  
|Cost of services                                            |  |                     | 402  |   |              |   | 1,131 |              |  |   | 7,714         |   |  |               | 14,481 |   |  |   | 13,577 |  
|                                                            |  |                     |      |   |              |   |       |              |  |   |               |   |  |               |        |   |  |   |        |  
|Gross loss                                                  |  |                     | (402 | ) |              |   | (747  | )            |  |   | (2,282        | ) |  |               | (2,630 | ) |  |   | (2,471 | )
|Goodwill and intangible impairment                          |  |                     |     |   |              |   |      |              |  |   | (1,052        | ) |  |               | (710   | ) |  |   |       |  
|Write down of property and equipment                        |  |                     |     |   |              |   |      |              |  |   | (1,379        | ) |  |               | (2,907 | ) |  |   |       |  
|Reduction of future lease obligations for closed schools    |  |                     | 228  |   |              |   | 277   |              |  |   | (3,556        | ) |  |               | (1,996 | ) |  |   |       |  
|                                                            |  |                     |      |   |              |   |       |              |  |   |               |   |  |               |        |   |  |   |        |  
|Loss from discontinued operations before income tax benefit |  |                     | (174 | ) |              |   | (470  | )            |  |   | (8,269        | ) |  |               | (8,243 | ) |  |   | (2,471 | )
|Income tax benefit                                          |  |                     | (68  | ) |              |   | (179  | )            |  |   | (3,142        | ) |  |               | (3,132 | ) |  |   | (907   | )
|                                                            |  |                     |      |   |              |   |       |              |  |   |               |   |  |               |        |   |  |   |        |  
|Loss from discontinued operations                           |  | $                   | (106 | ) |              | $ | (291  | )            |  | $ | (5,127        | ) |  | $             | (5,111 | ) |  | $ | (1,564 | )
|                                                            |  |                     |      |   |              |   |       |              |  |   |               |   |  |               |        |   |  |   |        |  



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##### Table of Contents

|ITEM7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
|------ | --------------------------------------------------------------------------------------

The
following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.

The Company has made statements in this report that constitute forward-looking statements as that term is defined in the federal securities laws. These forward-looking statements concern the Companys operations,
economic performance and financial condition and may include statements regarding: opportunities for growth; the number of pre-elementary and elementary schools expected to be added in future years; the profitability of newly opened schools; capital
expenditure levels; the ability to incur additional indebtedness; strategic acquisitions, investments and other transactions; and changes in operating systems and policies. The forward-looking statements are subject to various known and unknown
risks, uncertainties and other factors. When words such as believes, expects, anticipates, plans, estimates, projects or similar expressions are used in this Annual Report on
Form 10-K, the Company is making forward-looking statements.

Although the Company believes that any forward-looking statements are based
on reasonable assumptions, expected results may not be achieved. Actual results may differ materially from the Companys expectations. In addition to the risk factors described in Item IA of this document and that are discussed from time to
time in the Companys other SEC reports and filings, important factors that could cause actual results to differ from expectations include:



| |  |  | the Companys inability to successfully execute its growth strategy;
| | - |  | --------------------------------------------------------------------



| |  |  | the effects of general economic conditions, including interest and inflation rates, and world events;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | competitive conditions in the pre-elementary and elementary school education and services industry, including advertising and tuition price sensitivity;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | delays in new school openings or lower than expected enrollments;
| | - |  | -----------------------------------------------------------------



| |  |  | various factors affecting occupancy levels, including, but not limited to, the reduction in or changes to the general labor force that would reduce the need or demand for private
schools, or newly opened competitor schools;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | government regulations affecting student/teacher ratios;
| | - |  | --------------------------------------------------------



| |  |  | the availability of a qualified labor pool and the impact of government regulations concerning labor and employment issues;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | federal and state regulations regarding changes in child care assistance programs, welfare reform, minimum wages and licensing standards;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the loss of government funding for child care assistance programs;
| | - |  | ------------------------------------------------------------------



| |  |  | the establishment of governmentally mandated universal pre-K programs or benefits that do not allow for participation by for-profit operators or allows for participation at low
reimbursement rates;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the growth of competitors as possible alternatives to the public school system, such as virtual charter schools, charter schools, and magnet schools;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | decisions by local school systems which may adversely effect acceptance of course credits from our special purpose high schools;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Companys inability to defend successfully against or counter negative publicity associated with claims involving alleged incidents at its schools;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Companys inability to obtain insurance at the same levels, or at costs comparable to those incurred historically;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | the acceptance of the Companys newly developed schools and businesses and performance of acquired businesses;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | the Companys ability to successfully implement new school information systems and technology;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | new regulations or changes in accounting requirements and standards and/or new interpretations of existing regulations or standards;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | taxes, laws and regulations affecting the Company in markets where it competes;
| | - |  | -------------------------------------------------------------------------------



| |  |  | environmental related events that could affect schools in areas impacted by such events;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the Companys ability to obtain additional financing or capital required to implement fully its business and strategic plan;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | the Companys ability to defend itself in any litigation; and
| | - |  | -------------------------------------------------------------



| |  |  | the growth of competitors in our markets and their tactics to recruit our employees.
| | - |  | ------------------------------------------------------------------------------------

Negative developments in these areas could have a material adverse effect on the Companys business, financial condition and results of operations.

In addition, beginning with the Companys Annual Report on Form 10-K for the year ending June 30, 2007 or June 28, 2008 (depending on the
market capitalization test to be performed at December 31, 2006), Section 404 of the Sarbanes-Oxley Act of 2002 may require the Company to include a report of managements assessment of the effectiveness of its internal control over
financial reporting as of the end of the fiscal year. That report is also required to include a statement that the Companys independent auditors have issued an attestation report on managements assessment of the Companys internal
control over financial reporting. Risk factors associated with these new requirements include:



| |  |  | The Companys inability to complete the work necessary to issue managements attestation report in a timely manner, or to complete the extensive work that will be required
for the Company to report that its internal control over financial reporting is effective;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The inability of the Companys independent auditors to complete the work required for them to issue an attestation report on managements assessment in a timely manner;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Companys inability to ensure that no internal control deficiencies will emerge, or that any remediation efforts will be completely successful;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Companys inability to implement and integrate throughout our schools a new system in such a way that we have appropriate time to finish all the testing and documentation
associated with the system conversion and;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Substantial increase in professional fees associated with compliance requirements.
| | - |  | ----------------------------------------------------------------------------------

Readers are cautioned that these risks may not be exhaustive. The Company operates in a continually changing business and regulatory environment and new risks and requirements emerge from time to time. Readers should
not rely upon forward-looking statements except as statements of managements present intentions and expectations that may or may not occur. Readers should read these cautionary statements as being applicable to all forward-looking statements
wherever they appear. The Company assumes no obligation to update or revise the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

Introduction

The following discussion should be read
in conjunction with Item 6. Selected Historical Consolidated Financial and Other Data and the consolidated financial statements and the related notes presented in Item 8. Financial Statements and Supplementary Data included
elsewhere in this report.



17



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##### Table of Contents

Change in Fiscal Year End

Effective for the fiscal year ended July 3, 2004 (Fiscal 2004), the Company changed to a 52-53 week fiscal year ending on the Saturday closest to June 30. The fiscal years ended July 1, 2006
(Fiscal 2006), and July 2, 2005 (Fiscal 2005) each includes 52 weeks. Fiscal 2004 includes 53 weeks. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and
majority-owned subsidiaries.

Reclassifications

As a result of certain school closures in Fiscal 2005 and Fiscal 2004 and the reclassification in Fiscal 2005 of certain schools from held for sale to continuing operations, the Company has conformed amounts reported for Fiscal years 2005
and 2004 in its Annual Report on Form 10-K for the period ended July 1, 2006. Certain other prior period amounts have been reclassified to conform to the current periods presentation. All significant intercompany balances and transactions
have been eliminated.

Results of Operations

Fiscal
2006 compared to Fiscal 2005

At July 1, 2006, the Company operated 150 schools. Since July 2, 2005, the Company has acquired
one preschool and one elementary school in addition to opening one preschool. School counts for Fiscal 2006 and Fiscal 2005 are as follows:



|                                             |  |        |   |  |      |  
|-------------------------------------------- |  | ------ | - |  | ---- | -
|                                             |  | Fiscal |  
|                                             |  | 2006   |   |  | 2005 |  
|Number of schools at the beginning of period |  | 149    |   |  | 149  |  
|Acquisitions                                 |  | 2      |   |  |     |  
|Openings                                     |  | 1      |   |  | 2    |  
|Closures                                     |  | (2     | ) |  | (2   | )
|                                             |  |        |   |  |      |  
|Number of schools at the end of the period   |  | 150    |   |  | 149  |  
|                                             |  |        |   |  |      |  

The following table sets forth certain statement of operations data as a percent of revenue for
Fiscal 2006 and Fiscal 2005 (dollars in thousands):



|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  
|----------------------------------- |  | ---------- | ------- | ------------------ | ----- | - | ---------- | - | ------------------ |  | ----- | ------------------------------- |  | - | --------------- | - |  | ---- | -
|                                    |  | Fiscal2006 |         | Percent ofRevenues |       |   | Fiscal2005 |   | Percent ofRevenues |  |       | ChangeAmountIncrease/(Decrease) |  |   | PercentIncrease |  
|Revenues                            |  | $          | 168,329 |                    | 100.0 | % |            | $ | 164,204            |  | 100.0 | %                               |  | $ | 4,125           |   |  | 2.5  | %
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  
|Personnel costs                     |  |            | 79,283  |                    | 47.1  |   |            |   | 77,213             |  | 47.0  |                                 |  |   | 2,070           |   |  | 2.7  |  
|School operating costs              |  |            | 25,264  |                    | 15.0  |   |            |   | 23,917             |  | 14.6  |                                 |  |   | 1,347           |   |  | 5.6  |  
|Rent and other                      |  |            | 41,582  |                    | 24.7  |   |            |   | 41,318             |  | 25.2  |                                 |  |   | 264             |   |  | 0.6  |  
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  
|Cost of services                    |  |            | 146,129 |                    | 86.8  |   |            |   | 142,448            |  | 86.8  |                                 |  |   | 3,681           |   |  | 2.6  |  
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  
|Gross profit                        |  |            | 22,200  |                    | 13.2  |   |            |   | 21,756             |  | 13.2  |                                 |  |   | 444             |   |  | 2.0  |  
|Goodwill and other asset impairment |  |            | 30      |                    | 0.0   |   |            |   | 216                |  | 0.1   |                                 |  |   | (186            | ) |  | n/a  |  
|General and administrative expenses |  |            | 13,523  |                    | 8.0   |   |            |   | 14,548             |  | 8.9   |                                 |  |   | (1,025          | ) |  | (7.0 | )
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  
|Operating income                    |  | $          | 8,647   |                    | 5.1   | % |            | $ | 6,992              |  | 4.3   | %                               |  | $ | 1,655           |   |  | 23.7 | %
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |      |  



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##### Table of Contents

Revenue

Revenue for Fiscal 2006 increased $4,125,000 or 2.5% to $168,329,000 from $164,204,000 from Fiscal 2005. The revenue increase for Fiscal 2006 as compared to Fiscal 2005 is as follows (dollars in thousands):



|                                 |  |        |         |        |   |                     |  |   |       |  |      |  
|-------------------------------- |  | ------ | ------- | ------ | - | ------------------- |  | - | ----- |  | ---- | -
|                                 |  | Fiscal |         | Dollar |   | Percent             | 
|                                 |  | 2006   |         | 2005   |   | Increase (decrease) | 
|Schools open before July 3, 2004 |  | $      | 164,656 |        | $ | 162,426             |  | $ | 2,230 |  | 1.4  | %
|Schools opened in Fiscal 2005    |  |        | 2,372   |        |   | 1,778               |  |   | 594   |  | 33.4 |  
|One school opened in Fiscal 2006 |  |        | 1,301   |        |   |                    |  |   | 1,301 |  |     |  
|                                 |  |        |         |        |   |                     |  |   |       |  |      |  
|                                 |  | $      | 168,329 |        | $ | 164,204             |  | $ | 4,125 |  | 2.5  | %
|                                 |  |        |         |        |   |                     |  |   |       |  |      |  

Revenue for schools opened before July 3, 2004 increased $2,230,000 or 1.4% in Fiscal 2006 as
compared to the same number of days in the prior fiscal year. The revenue increases for schools opened prior to July 3, 2004 were due primarily to increases in average tuition of approximately 4.0% to 4.5% offset by a decrease in average
enrollments.

Schools that opened in Fiscal 2005 had an increase in revenue of $594,000 versus the comparable period in Fiscal 2006 due to
being open for a full year, normal ramp-up in enrollment for newer schools and the annual tuition increase of approximately 4.0% to 4.5%

The one new school that opened in Fiscal 2006 added revenue of approximately $1,301,000. The two schools that were acquired in Fiscal 2006 did not have an impact on the Companys revenues as the acquisition closed at the end of the
fiscal year.

Revenue trends

Comparable private pay schools net revenue increased 1.7% for Fiscal 2006 compared to Fiscal 2005. Comparable private pay schools gross tuition revenue increased 1.3%. Revenue increases were due primarily to average tuition increases of
approximately 4.0% to 4.5% offset by a decrease in average enrollments.

The decrease in average enrollments are primarily a result of
employee turnover at the school administrator level that occurred during or prior to the Fiscal 2006 enrollment season most of which occurred during Fiscal 2005. The vacancies among our administrators resulted in less effective new customer tours
and sales efforts, schools with a vacancy in a key administrative position, and/or reduced communications with existing customers. As the Company successfully continues to fill these positions, personnel costs have increased at a faster rate than
revenue. This negatively impacted the gross margin in Fiscal 2006. This trend may continue in the near term as we complete the upgrade of our administrative teams.

Approximately 96.4% of the Companys gross revenue comes directly from our customers. Management believes this is significantly different than many providers in the education industry where a more significant
portion of revenue is generated through government pay sources.

Management believes it is an industry practice to increase tuition
annually and that industry norms in recent years have been increases in approximately a 3% to 5% range. Management expects this will continue to be industry practice for the foreseeable future.

Personnel costs

Personnel costs primarily
include wages, payroll taxes, employee benefits and vacation costs. This category of costs is primarily affected by rate increases, staffing ratios, and enrollment changes. The category tends to be variable on a step function basis when staffing
ratios indicate additional teachers are required without full enrollment in a class. In the case of new schools, a base level of personnel and operating costs are incurred in the early years of a schools life which are leveraged in future
years as enrollments ramp up.



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##### Table of Contents

For Fiscal 2006, personnel cost increased approximately $2,070,000 or approximately 2.7% as compared to
Fiscal 2005. Personnel cost increased to approximately 47.1% of revenues for Fiscal 2006 from approximately 47.0% of revenue for Fiscal 2005. Personnel cost increased as a percent of revenue as hiring and wage increases outpaced revenue increases as
discussed in the revenue trends section above.

Total salary and wage expense increased $1,623,000 and accounted for approximately 2.1% of
the total 2.7% increase in personnel costs. Healthcare accounted for $447,000 or 0.6% of the 2.7% increase. Healthcare as a line item increased 11.8% for Fiscal 2006 compared to Fiscal 2005.

School operating costs

School operating costs
primarily include maintenance, food, supplies, utilities, transportation, school level marketing spending, ancillary programs, and bad debt. The category is partially variable with increases in revenue primarily as those revenue increases are driven
by additional enrollment. In the case of new schools a base level of costs are incurred in the early years of a schools life which are leveraged in future years as enrollments ramp up.

Management has undertaken specific initiatives discussed below in regard to certain costs in this category. These initiatives have been to both improve
operations and increase control in operating activities.

For Fiscal 2006, school operating costs increased approximately $1,347,000 or
5.6% versus Fiscal 2005. School operating cost increased to 15.0% of revenue for Fiscal 2006 from 14.6% of revenue for Fiscal 2005.

Expense increases in bad debt of $515,000, utilities of $386,000, program cost of $251,000, food of $217,000, transportation of $145,000 and maintenance of $78,000, were partially offset by lower school based marketing costs of $208,000,
and costs related to prior year operations of The Activities Club (TAC) of $182,000 (TAC was closed during Fiscal 2005). The bad debt cost increase resulted primarily from more uniform application of collection standards in certain schools, which
also may have had a negative impact on enrollment. Increased utilities and transportation costs resulted from increasing energy costs and improved services to schools as the Company-wide roll out of broadband service to its school base to support
its new information technology system efforts (see information technology below). Increased program cost resulted from the implementation of a new Spanish language curriculum. Food cost increases resulted from higher food costs and a lower number of
students qualified for agency reimbursement as well as lower federal and state program reimbursement rates in certain locations. Lower school based marketing resulted from a shift to corporate based marketing included in rent and other expense and
not an overall reduction in marketing spending.

Management will continue to focus its efforts on improved school operations and control.
Management believes its new school operating system will give greater visibility to school accounts receivable and will enable management to increase focus on collections which may result in a reduction in future dollar variances and lead to
reductions in actual expense year over year. Investment in school operations is critical to maintaining sound operation and education practices which attract students and their families. This may lead to additional increases in this category of
costs, beyond increases related to enrollment, in the future as these initiatives are undertaken.

Rent and other

Rent and other costs primarily include property rent and property taxes, insurance including workmens compensation and property, depreciation and
amortization, regional marketing, vehicle and equipment rent, and pre-opening costs. This category of costs is relatively fixed in nature with increases related to contractual occupancy obligations, changes in marketing initiatives, changes in
property tax rates, and/or a ramp up in school openings.

For Fiscal 2006, rent and other increased approximately $264,000 or approximately
0.6% versus Fiscal 2005. Rent and other decreased to approximately 24.7% of revenue for Fiscal 2006 from approximately 25.2% of revenue for Fiscal 2005.



20



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##### Table of Contents

Expense increases in occupancy costs of $882,000 and corporate based marketing of $412,000 were partially
offset by lower depreciation cost of $547,000, insurance of $242,000, pre-opening of $98,000, equipment lease expense of $58,000, and vehicle lease expense of $27,000. The increase in occupancy costs is due to the addition of one new school in the
period, the full period effect of two prior year openings in the period, contractual rent increases driven by the Consumer Price Index (CPI), certain lease renewals or extensions and property tax increases. Corporate based marketing increased from a
shift in school based marketing previously charged to school operating expenses described above. Lower depreciation was partially due to lower capital spending rates in the first three quarters of Fiscal 2006. Insurance expense decreased due to a
change in estimates of self insured worker compensation and property losses and the effect of a prior year worker compensation adjustment related to the Companys 2002/2003 worker compensation policy period. Pre-opening costs decreased as a
result of opening one school this period versus two in the prior period. Equipment lease expense decreased as the Company began purchasing personal computers rather than leasing them.

Gross profit

Gross profit for Fiscal 2006 increased $444,000 or 2.0% to $22,200,000 from
$21,756,000 for Fiscal 2005. Gross profit was approximately 13.2% of revenue for Fiscal 2006 and approximately 13.2% of revenue for Fiscal 2005. The change in gross profit for Fiscal 2006 as compared to the same period in the prior year is as
follows (dollars in thousands):



|                                 |  |        |        |   |        |   |        |                     |  |   |      |   |  |       |   
|-------------------------------- |  | ------ | ------ | - | ------ | - | ------ | ------------------- |  | - | ---- | - |  | ----- | --
|                                 |  | Fiscal |        |   | Dollar |   |        | Percent             | 
|                                 |  | 2006   |        |   | 2005   |   |        | Increase (decrease) | 
|Schools open before July 3, 2004 |  | $      | 21,993 |   |        | $ | 22,172 |                     |  | $ | (179 | ) |  | (0.8  | )%
|Schools opened in Fiscal 2005    |  |        | 3      |   |        |   | (377   | )                   |  |   | 380  |   |  |      |   
|One school opened in Fiscal 2006 |  |        | 332    |   |        |   |       |                     |  |   | 332  |   |  | 100.0 |   
|Pre-Opening Costs                |  |        | (128   | ) |        |   | (39    | )                   |  |   | (89  | ) |  |      |   
|                                 |  |        |        |   |        |   |        |                     |  |   |      |   |  |       |   
|                                 |  | $      | 22,200 |   |        | $ | 21,756 |                     |  | $ | 444  |   |  | 2.0   | % 
|                                 |  |        |        |   |        |   |        |                     |  |   |      |   |  |       |   

Gross profit from schools opened before July 3, 2004 decreased $179,000 or 0.8% in Fiscal
2006 versus Fiscal 2005. Gross profit as a percentage of applicable revenue for these schools decreased to 13.2% for Fiscal 2006 from 13.5% for Fiscal 2005. This decrease in gross profit as a percentage of applicable revenue is due primarily to
personnel cost increases and school operating cost increases discussed in the respective sections above along with a decrease average enrollment, partially offset by tuition increases of 4.0% to 4.5%.

Schools that opened in Fiscal 2005 had an increase in gross margin of $380,000 as compared to the same period in the prior year, primarily due to normal
ramp-up in enrollment for schools in their second year of operations and tuition increases.

One new school opened in Fiscal 2006
contributed gross profit of $247,000, net of pre-opening costs. Typically a new school has an enrollment ramp up period of two to four years, during which gross profit is expected to increase.

Pre-opening expenses were incurred for two schools totaling $128,000 in Fiscal 2006 and for one school totaling $39,000 in Fiscal 2005.

General and administrative expenses

General
and administrative expenses for Fiscal 2006 decreased $1,025,000 or 7.0% to $13,523,000 from $14,548,000 for Fiscal 2005.

The decrease in
general and administrative expenses for Fiscal 2006 was due primarily to a $1,500,000 valuation allowance related to the doubtful collection of the note receivable from Total Education Solutions, Inc. (TES) incurred in Fiscal 2005.



21



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##### Table of Contents

Corporate personnel cost decreased $285,000. This decrease was primarily a result of operating for most
of Fiscal 2006 without a senior position filled as the Company eliminated its General Counsel position in early Fiscal 2006 and did not add a Senior Corporate Development position until late in Fiscal 2006.

Total management bonus for Fiscal 2006 decreased approximately $517,000, primarily a result of Fiscal 2006 performance versus the Company objectives as
developed by the Board of Directors.

Stock compensation costs of $555,000 are included in the Companys results for the first time
during Fiscal 2006 on adoption of new accounting treatment, FASB 123(R), requiring expensing of stock based compensation. The Company expects to continue its historical practice of issuing stock options which will result in additional stock based
compensation in the future, although amounts may vary.

Total professional fees increased $254,000 primarily due to investment in
consulting support for the Companys strategic plan development and increase legal and accounting fees related to regulatory compliance and corporate governance.

Corporate depreciation increased $263,000 and information technology expense increased $161,000 due to the Companys information technology initiatives discussed below.

Operating Income

As a result of the factors
mentioned above, operating income increased $1,655,000 or 23.7% to $8,647,000 for Fiscal 2006 from $6,992,000 for Fiscal 2005. Operating income increased in Fiscal 2006 to 5.1% of revenue from 4.3% in Fiscal 2005.

Interest expense

Interest expense decreased
$1,223,000 or 45.4% to $1,469,000 for Fiscal 2006 from $2,692,000 for Fiscal 2005. The decrease in interest expense is primarily due to the retirement of $10,000,000 of 13.25% subordinated debt and reduction in average amounts outstanding under the
Companys senior bank credit facility.

Income tax expense

Income tax expense for Fiscal 2006 was $2,943,000 as compared to $1,677,000 for Fiscal 2005. The Companys effective tax rate for Fiscal 2006 was 39.1%. The income tax expense for Fiscal 2006 is greater than the
combined statutory income tax rate of 38% due to permanent differences between book and tax net income primarily consisting of prior period goodwill impairments which are not tax deductible. Income tax expense was computed by applying estimated
effective income tax rates to the income or loss before income taxes. Income tax expense varies from the statutory federal income tax rate due primarily to state income taxes and tax non-deductible expenses and credits.

At July 1, 2006 and July 2, 2005, the Company had deferred tax assets totaling $2,345,000 and $4,412,000, respectively. Deferred tax assets,
net of valuation allowances, have been recognized to the extent that their realization is more likely than not. However, the amount of the deferred tax assets considered realizable could be adjusted in the future as estimates of taxable income or
the timing thereof are revised. If the Company is unable to generate sufficient taxable income in the future through operating results, increases in the valuation allowance may be required through an increase to tax expense in future periods.
Conversely, if the Company recognizes taxable income of a suitable nature and in the appropriate periods, the deferred tax assets will more likely than not be realized.



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##### Table of Contents

Discontinued operations

The operating results for discontinued operations in the statements of operations for the periods presented, net of tax is as follows (dollars in thousands):



|                                                            |  |        |      |   |      |   |       |  
|----------------------------------------------------------- |  | ------ | ---- | - | ---- | - | ----- | -
|                                                            |  | Fiscal |     
|                                                            |  | 2006   |      |   | 2005 |  
|Revenues                                                    |  | $      |     |   |      | $ | 384   |  
|Cost of services                                            |  |        | 402  |   |      |   | 1,131 |  
|                                                            |  |        |      |   |      |   |       |  
|Gross (loss)                                                |  |        | (402 | ) |      |   | (747  | )
|Reduction of future lease obligations for closed schools    |  |        | 228  |   |      |   | 277   |  
|                                                            |  |        |      |   |      |   |       |  
|Loss from discontinued operations before income tax benefit |  |        | (174 | ) |      |   | (470  | )
|Income tax benefit                                          |  |        | (68  | ) |      |   | (179  | )
|                                                            |  |        |      |   |      |   |       |  
|Loss from discontinued operations                           |  | $      | (106 | ) |      | $ | (291  | )
|                                                            |  |        |      |   |      |   |       |  

Starting Fiscal 2005 discontinued operations consisted of eighteen schools and one undeveloped
property held for sale. Of the eighteen schools seven were subleased, six were vacant and five held for sale. The undeveloped property was sold during the second quarter of Fiscal 2005. Of the six vacant, one owned by the Company was sold in the
first quarter of Fiscal 2005, two were returned to the respective landlords and the Company has no further obligations under these leases and three remained vacant at the end of Fiscal 2005.

Of the two schools returned to the respective landlords, one was returned in September 2004 at the end of its natural lease term, there was no impact to
the accrued lease reserve for this school. One school was returned to the landlord prior to the end of the lease term and the Company was released from any future obligation for this school which resulted in a recapture of the discounted future
lease payments that were reserved during Fiscal 2004. The amount of the recapture related to this school was approximately $337,000 in the fourth quarter of Fiscal 2005. In addition, the Company during the fourth quarter of Fiscal 2005 reached
agreement with the landlord of one of the vacant properties on the buyout amount required if the landlord were able to sell the property to a third party.

Of the five operating schools included in discontinued operations at the start of Fiscal 2005, one was closed and the remaining four were evaluated by the Company to determine their future viability during the third
quarter of Fiscal 2005. Based on the absence of reasonable offers to purchase these schools, the Company determined the four schools would return to operating schools and as such, they are included in results from continuing operations as of the
third quarter of Fiscal 2005. As a result, the Company no longer holds any schools for sale.

Starting Fiscal 2006 discontinued operations
consist of ten schools, seven subleased and three vacant. During Fiscal 2006 one lease expired and two were returned to the respective landlords and the Company has no further obligations under these leases. Additionally, one property was vacated by
the sub-lessee (see discussion in lease commitments section below). At the beginning of Fiscal 2007 discontinued operations consist of seven schools, six of which are subleased, one of which is vacant.

Net Income

As a result of the above factors,
the Companys net income was approximately $4,479,000 for Fiscal 2006 as compared to $2,516,000 for Fiscal 2005.



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##### Table of Contents

Fiscal 2005 compared to Fiscal 2004

At July 2, 2005, the Company operated 149 schools. Since July 3, 2004, the Company has opened one pre-elementary school, one elementary school and closed two pre-elementary schools based on their natural
lease term end. School counts for Fiscal 2005 and Fiscal 2004 are as follows:



|                                             |  |        |   |  |      |  
|-------------------------------------------- |  | ------ | - |  | ---- | -
|                                             |  | Fiscal |  
|                                             |  | 2005   |   |  | 2004 |  
|Number of schools at the beginning of period |  | 149    |   |  | 157  |  
|Openings                                     |  | 2      |   |  | 1    |  
|Closures                                     |  | (2     | ) |  | (9   | )
|                                             |  |        |   |  |      |  
|Number of schools at the end of the period   |  | 149    |   |  | 149  |  
|                                             |  |        |   |  |      |  

Open and operating schools included in continuing operations and discontinued operations are as
follows:



|                        |  |        |  |     
|----------------------- |  | ------ |  | ----
|                        |  | Fiscal
|                        |  | 2005   |  | 2004
|Continuing operations   |  | 149    |  | 144 
|Discontinued operations |  |       |  | 5   
|                        |  |        |  |     
|                        |  | 149    |  | 149 
|                        |  |        |  |     

The following table sets forth certain statement of operations data as a percent of revenue for
Fiscal 2005 and Fiscal 2004 (dollars in thousands)



|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  
|----------------------------------- |  | ---------- | ------- | ------------------ | ----- | - | ---------- | - | ------------------ |  | ----- | ------------------------------- |  | - | --------------- | - |  | ----- | -
|                                    |  | Fiscal2005 |         | Percent ofRevenues |       |   | Fiscal2004 |   | Percent ofRevenues |  |       | ChangeAmountIncrease/(Decrease) |  |   | PercentIncrease |  
|Revenues                            |  | $          | 164,204 |                    | 100.0 | % |            | $ | 158,361            |  | 100.0 | %                               |  | $ | 5,843           |   |  | 3.7   | %
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  
|Personnel costs                     |  |            | 77,213  |                    | 47.0  |   |            |   | 75,700             |  | 47.8  |                                 |  |   | 1,513           |   |  | 2.0   |  
|School operating costs              |  |            | 23,917  |                    | 14.6  |   |            |   | 22,949             |  | 14.4  |                                 |  |   | 968             |   |  | 4.2   |  
|Rent and other                      |  |            | 41,318  |                    | 25.2  |   |            |   | 39,198             |  | 24.8  |                                 |  |   | 2,120           |   |  | 5.4   |  
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  
|Cost of services                    |  |            | 142,448 |                    | 86.8  |   |            |   | 137,847            |  | 87.0  |                                 |  |   | 4,601           |   |  | 3.3   |  
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  
|Gross profit                        |  |            | 21,756  |                    | 13.2  |   |            |   | 20,514             |  | 13.0  |                                 |  |   | 1,242           |   |  | 6.1   |  
|Goodwill and other asset impairment |  |            | 216     |                    |      |   |            |   | 3,368              |  | 2.2   |                                 |  |   | (3,152          | ) |  | n/a   |  
|General and administrative expenses |  |            | 14,548  |                    | 8.9   |   |            |   | 14,256             |  | 9.0   |                                 |  |   | 292             |   |  | 2.0   |  
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  
|Operating income                    |  | $          | 6,992   |                    | 4.3   | % |            | $ | 2,890              |  | 1.8   | %                               |  | $ | 4,102           |   |  | 141.9 | %
|                                    |  |            |         |                    |       |   |            |   |                    |  |       |                                 |  |   |                 |   |  |       |  

The reporting period for Fiscal 2005 varies from Fiscal 2004 due to the change to a 52/53 week
year at the end of Fiscal 2004. As a result, Fiscal 2004 has four extra days versus Fiscal 2005. The effects of the additional days are indicated in the respective discussions below.



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##### Table of Contents

Revenue

Revenue for Fiscal 2005 increased approximately $5,843,000 or 3.7% to $164,204,000 from $158,361,000 from Fiscal 2004. The revenue increase for Fiscal 2005 as compared to Fiscal 2004 is as follows (dollars in
thousands):



|                                  |  |        |         |        |   |                     |         |   |        |   |  |       |  
|--------------------------------- |  | ------ | ------- | ------ | - | ------------------- | ------- | - | ------ | - |  | ----- | -
|                                  |  | Fiscal |         | Dollar |   |                     | Percent |  
|                                  |  | 2005   |         | 2004   |   | Increase (decrease) |        
|Schools open before June 30, 2003 |  | $      | 161,582 |        | $ | 155,828             |         | $ | 5,754  |   |  | 3.7   | %
|Schools opened in Fiscal 2004     |  |        | 844     |        |   | 600                 |         |   | 244    |   |  | 40.7  |  
|New schools opened in Fiscal 2005 |  |        | 1,778   |        |   |                    |         |   | 1,778  |   |  | n/a   |  
|Four extra days                   |  |        |        |        |   | 1,933               |         |   | (1,933 | ) |  | 100.0 |  
|                                  |  |        |         |        |   |                     |         |   |        |   |  |       |  
|                                  |  | $      | 164,204 |        | $ | 158,361             |         | $ | 5,843  |   |  | 3.7   | %
|                                  |  |        |         |        |   |                     |         |   |        |   |  |       |  

Revenue for schools opened before June 30, 2003 increased approximately $5,754,000 or 3.7% in
Fiscal 2005 as compared to the same number of days in the prior fiscal year. The revenue increases for schools opened prior to June 30, 2003 were due primarily to increases in average tuition of approximately 3.3% and a slight increase in
average enrollments.

Schools that opened in Fiscal 2004 had an increase in revenue of approximately $244,000 versus the comparable period
in Fiscal 2005 due to normal ramp-up in enrollment for newer schools and the annual tuition increase of approximately 3.3%.

The two new
schools opened in Fiscal 2005 added revenue of approximately $1,778,000.

Included in Fiscal 2004 are four extra days which accounted for
approximately $1,933,000 of additional revenue in the 2004 period. Without the four extra days the variance would have been approximately $7,776,000 or 5.0% versus the $5,843,000 or 3.7% described above.

Revenue trends

Comparable private pay schools
net revenue increased approximately 4.0%, calculated on the same number of days, for the fifty-two week period ended July 2, 2005 over the same number of days ended July 3, 2004.

Comparable private pay schools gross tuition revenue increased 3.9% calculated on the same number of days, for the fifty-two week period ended
July 2, 2005 over the same number of days ended July 3, 2004.

Personnel costs

Personnel costs primarily include wages, payroll taxes, employee benefits and vacation costs. This category of costs is partially variable primarily
affected by rate increases, staffing ratios and enrollment changes. The category tends to be variable on a step function basis when staffing ratios indicate additional teachers are required without full enrollment in a class. In the case of new
schools, a base level of personnel and operating costs are incurred in the early years of a schools life which are leveraged in future years as enrollments ramp up.

For Fiscal 2005, personnel cost increased approximately $1,513,000 or approximately 2.0% as compared to Fiscal 2004. Personnel cost decreased to approximately 47.0% of revenues for Fiscal 2005 from approximately 47.8%
of revenue for Fiscal 2004. Personnel cost improved as a percent of revenue as revenue increases outpaced wage and benefit cost increases in total.

Total wage, payroll tax and vacation cost increases accounted for approximately $1,155,000 and amounted to approximately 1.5% of the total 2.0% increase. Wage increases were primarily a result of average rate increases. Total employee
benefits accounted for approximately $357,000 or 0.5% of the 2.0% increase. Employee benefits, primarily healthcare, increased approximately 10.4% for Fiscal 2005 as compared to Fiscal 2004.



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##### Table of Contents

Included in Fiscal 2004 are four extra days which accounted for approximately $989,000 of the personnel
cost in the period. Without the four extra days the variance would have been approximately $2,502,000 or 3.3% versus the approximately $1,513,000 or 2.0% described above.

School operating costs

School operating costs primarily include maintenance, food, supplies,
utilities, transportation, school level marketing spending and ancillary programs. The category is partially variable with increases in revenue primarily as those revenue increases are driven by additional enrollment. In the case of new schools a
base level of costs are incurred in the early years of a schools life which are leveraged in future years as enrollments ramp up.

For
Fiscal 2005, school operating costs increased approximately $968,000 or 4.2% versus Fiscal 2004. School operating cost increased to 14.6% of revenue for Fiscal 2005 from 14.4% of revenue for Fiscal 2004.

Total program expense cost increased approximately $229,000 or approximately 90.0% primarily a result of implementing a new Spanish language curriculum
which accounted for approximately $140,000 of the increase. Total school janitorial service cost increased approximately $300,000 or approximately 7.9%; upgraded services accounted for approximately $150,000 of the increase and two new schools
opened in fiscal 2005 added approximately $71,000 of the increase. Total teaching supplies cost increased approximately $94,000 or approximately 6.3% as management funded improved teacher access to classroom materials to enhance student learning
experiences.

Total bad debt costs increased approximately $72,000 or approximately 13.9% primarily related to management efforts to
tighten collection practices in certain schools and certain school closings. Operations marketing costs decreased by approximately $101,000 or approximately 19.1% as management consolidated marketing initiatives from the school level to the district
and regional level and shifted these expenses into Regional Marketing which appears in the Rent and other category discussed below.

Total
transportation costs increased approximately $93,000 or 15.2% due primarily to higher costs of fuel. Total food costs increased approximately $217,000 which is primarily a result of an increase of approximately $69,000 in North Carolina as the state
reduced reimbursement and changed qualification guidelines and approximately $65,000 of this increase is related to the opening of two new schools fiscal 2005.

Rent and other

Rent and other costs primarily include property rent and property taxes, insurance including
workmens compensation and property, depreciation and amortization, regional marketing, vehicle and equipment rent, and pre-opening costs. This category of costs is relatively fixed in nature with increases related to contractual occupancy
obligations, changes in marketing initiatives or a ramp up in school openings.

For Fiscal 2005, rent and other increased approximately
$2,120,000 or approximately 5.4% versus Fiscal 2004. Rent and other increased to approximately 25.2% of revenue for Fiscal 2005 from approximately 24.8% of revenue for Fiscal 2004.

Total occupancy related costs increased approximately $1,096,000 or approximately 3.9% due primarily to rents on two new schools opened in Fiscal 2005 of
approximately $276,000, property tax increases of approximately $158,000 and the balance of the increase is primarily related to contractual rent increases driven by the Consumer Price Index (CPI) or certain lease renewals or extensions.

Total insurance cost increased approximately $621,000 or approximately 27.5% primarily due to workmans compensation adjustments related to
audits of workmans compensation policies from fiscal years 2003 and 2004 of approximately $187,000 and an approximately $332,000 increase in workmans compensation rates based on prior years workmans compensation claims performance.
Management believes that the more visible monitoring of workmans compensation claims activity it has implemented could reduce the rate of future increases in or improve future workmans compensation rates.



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##### Table of Contents

Total depreciation and amortization increased approximately $275,000 or approximately 3.6% primarily due
to a reduction in estimated useful lives of certain curriculum related assets which accounted for approximately $329,000, additional depreciation expense of approximately $127,000 related to the three schools no longer classified as held for sale
offset by a decrease in non-compete amortization of approximately $168,000 as non-compete agreements related to purchase of certain schools came to an end.

Total centralized marketing costs increased approximately $245,000 or approximately 13.8% primarily due to management directed initiatives to more centrally control marketing spending (which reduced spending in school
operating costs as discussed above).

Total vehicle and equipment rent decreased approximately $152,000 or approximately 12.5% primarily
due to a reduction in costs of leasing copiers and personal computers for the schools.

Gross profit

Gross profit for Fiscal 2005 increased approximately $1,242,000 or approximately 6.1% to approximately $21,756,000 from approximately $20,514,000 for
Fiscal 2004. Gross profit was approximately 13.2% of revenue for Fiscal 2005 and approximately 13.0% of revenue for Fiscal 2004. The change in gross profit for Fiscal 2005 as compared to the same period in the prior year, is as follows (dollars in
thousands)



|                                  |  |        |        |   |        |   |        |                     |  |   |       |   |  |        |  
|--------------------------------- |  | ------ | ------ | - | ------ | - | ------ | ------------------- |  | - | ----- | - |  | ------ | -
|                                  |  | Fiscal |        |   | Dollar |   |        | Percent             | 
|                                  |  | 2005   |        |   | 2004   |   |        | Increase/(decrease) | 
|Schools open before June 30, 2003 |  | $      | 22,336 |   |        | $ | 20,391 |                     |  | $ | 1,945 |   |  | 9.5    | %
|Schools opened in Fiscal 2004     |  |        | (165   | ) |        |   | (295   | )                   |  |   | 130   |   |  | 44.1   |  
|New schools opened in Fiscal 2005 |  |        | (415   | ) |        |   | (150   | )                   |  |   | (265  | ) |  | (176.7 | )
|Four extra days                   |  |        |       |   |        |   | 568    |                     |  |   | (568  | ) |  | 100.0  |  
|                                  |  |        |        |   |        |   |        |                     |  |   |       |   |  |        |  
|                                  |  | $      | 21,756 |   |        | $ | 20,514 |                     |  | $ | 1,242 |   |  | 6.1    | %
|                                  |  |        |        |   |        |   |        |                     |  |   |       |   |  |        |  

Gross profit from schools opened before June 30, 2003 increased approximately $1,945,000 or
approximately 9.5% in Fiscal 2005 versus Fiscal 2004. Gross profit as a percentage of applicable revenue for these schools increased to approximately 13.8% for Fiscal 2005 from approximately 13.1% for Fiscal 2004. This increase in gross profit as a
percentage of applicable revenue is due primarily to tuition increases of approximately 3.3%, additional average enrollment increases and more efficient school labor management offset by wage increases and other expense changes discussed in the
respective sections above.

Schools that opened in Fiscal 2004 had a reduction in gross losses of approximately $130,000, as compared to
the same period in the prior year, primarily due to normal ramp-up in enrollment for schools in their second year of operations and tuition increases.

New schools opened in Fiscal 2005 had losses of approximately $415,000 in Fiscal 2005 and approximately $150,000 in Fiscal 2004 (pre-opening costs), primarily due to low enrollments associated with new schools as they
enter the normal new school enrollment ramp-up period. Pre-opening expenses for these schools was approximately $150,000 in Fiscal 2004 and approximately $144,000 in Fiscal 2005.

The four extra days provided Fiscal 2004 with additional gross profit of approximately $568,000, as compared to Fiscal 2005.

Goodwill and other asset impairment

Goodwill
and other asset impairment in Fiscal 2005 decreased approximately $3,152,000 from approximately $3,368,000 in Fiscal 2004. The decrease was due to the fact that the Companys test for goodwill did not require any impairment and asset
impairments for Fiscal 2005 were $216, 000, while the test for goodwill and asset impairment in Fiscal 2004 required the above noted impairment.



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##### Table of Contents

Asset impairments for Fiscal 2005 of $216,000 reflects managements estimate of the aggregate future
cash flows, undiscounted and without interest charges, to be generated by certain assets that are less than the carrying value of the assets. Such cash flows consider factors such as expected future operating income and historical trends, as well as
the effects of demand and competition. The loss was measured as the excess of the carrying amount of the asset over the fair value of the assets, primarily leasehold improvements and furniture and equipment. Such estimates required the use of
judgments and numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges.

General and administrative expenses

General and administrative expenses for Fiscal 2005 increased approximately
$292,000 or approximately 2.0% to approximately $14,548,000 from approximately $14,256,000 for Fiscal 2004.

The increase in general and
administrative expenses for Fiscal 2005 was due primarily to a $1,500,000 valuation allowance related to the doubtful collection of the note receivable from Total Education Solutions, Inc. (TES). During Fiscal 2003, the Company reserved $1,000,000
of the note receivable with TES. During the third quarter of Fiscal 2005, the Company continued to evaluate the financial condition of TES through TES required quarterly reporting, forecast of future performance and discussions with TES
management. TES performance and outlook suffered additional deterioration during the third quarter of Fiscal 2005. Based on the subordinated position the Company is in relative to TES senior lender, the review of TES actual results
and 3 year projection, the Company concluded that the collection of the TES debt is doubtful. Based on this, the Company reserved the remainder of the TES note of $1,500,000, which is included as a valuation allowance in the Companys general
and administrative expense. TES has received notice of default from its senior lender and is currently negotiating an extension of its senior debt.

This increase was offset by an approximately $1,500,000 charge in the first quarter of Fiscal 2004 related to the present value of the future payments to be made with respect to consulting agreements with two former executives of
approximately $1,290,000 and charges for future health insurance coverage for these two executives of approximately $210,000. Cash payments related to the consulting agreements and health insurance coverage is approximately $320,000 each fiscal
year.

Total management bonus for Fiscal 2005 increased approximately $720,000, primarily a result of Fiscal 2005 performance which
resulted in an increase in executive bonus payments of approximately $670,000. The executive bonus plan included approximately 18 participants for Fiscal 2005 versus six participants for Fiscal 2004. Total professional fees increased approximately
$342,000 primarily due to investment in consulting support for the Companys strategic plan development and increased legal and accounting fees related to regulatory compliance and corporate governance. In addition, the Company incurred
increased legal fees to support one of the charter schools for which the Company performs services.

Total travel expense decreased
approximately $161,000 primarily a result of reduced travel versus Fiscal 2004. Total telephone expense decreased approximately $384,000 primarily due to settlement of a dispute with a telecommunications vendor. During Fiscal 2004 the Company, based
on the receipt of an invoice for services rendered during the prior four years, expensed and reserved approximately $234,000 for those services based on the invoiced amount. During Fiscal 2005 the Company settled with the vendor for approximately
$71,000 and reversed the remaining approximately $163,000 of the reserve.

Total management fees decreased approximately $259,000 primarily
due to an approximately $152,000 reduction in outside consulting incurred in Fiscal 2004 for the services of a temporary Chief Financial Officer and approximately $106,000 paid on a consulting agreement with the former owner of schools the Company
acquired prior to Fiscal 2004.



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##### Table of Contents

Operating Income

As a result of the factors mentioned above, operating income increased approximately $4,102,000 or approximately 141.9% to approximately $6,992,000 for Fiscal 2005 from approximately $2,890,000 for Fiscal 2004.
Operating income increased in Fiscal 2005 to approximately 4.3% of revenue from approximately 1.8% in Fiscal 2004.

Interest expense

Interest expense decreased $940,000 or 25.9% to $2,692,000 for Fiscal 2005 from $3,632,000 for Fiscal 2004. The decrease in
interest expense is related primarily to the reduction in amounts outstanding under the Companys senior bank credit facility and fees incurred in Fiscal 2004 related to amendments to the Companys prior credit agreement with Fleet Bank.

Income tax expense

Income tax
expense for Fiscal 2005 was $1,677,000 as compared to $257,000 for Fiscal 2004. The Companys effective tax rate for Fiscal 2005 was 37.4%. The income tax expense for Fiscal 2004 is greater than the combined statutory income tax rate of 38% due
to the non-deductibility of a portion of the goodwill that was impaired in Fiscal 2004. Goodwill associated with the acquisition of the stock of a Company that is written-down is not deductible for tax purposes. Income tax expense was computed by
applying estimated effective income tax rates to the income or loss before income taxes. Income tax expense varies from the statutory federal income tax rate due primarily to state income taxes and non-deductible tax expenses and credits.

At July 2, 2005 and July 3, 2004, the Company had deferred tax assets totaling $4,412,000 and $5,415,000, respectively. Deferred
tax assets, net of valuation allowances, have been recognized to the extent that their realization is more likely than not. However, the amount of the deferred tax assets considered realizable could be adjusted in the future as estimates of taxable
income or the timing thereof are revised. If the Company is unable to generate sufficient taxable income in the future through operating results, increases in the valuation allowance may be required through an increase to tax expense in future
periods. Conversely, if the Company recognizes taxable income of a suitable nature and in the appropriate periods, the deferred tax assets will more likely than not be realized.

Discontinued operations

The operating results for discontinued operations in the statements
of operations for the periods presented, net of tax is as follows (dollars in thousands):



|                                                                    |  |        |       |   |      |   |        |  
|------------------------------------------------------------------- |  | ------ | ----- | - | ---- | - | ------ | -
|                                                                    |  | Fiscal |      
|                                                                    |  | 2005   |       |   | 2004 |  
|Revenues                                                            |  | $      | 384   |   |      | $ | 5,432  |  
|Cost of services                                                    |  |        | 1,131 |   |      |   | 7,714  |  
|                                                                    |  |        |       |   |      |   |        |  
|Gross (loss)                                                        |  |        | (747  | ) |      |   | (2,282 | )
|Goodwill and intangible impairment                                  |  |        |      |   |      |   | (1,052 | )
|Write down of property and equipment                                |  |        |      |   |      |   | (1,379 | )
|Reduction (increase) of future lease obligations for closed schools |  |        | 277   |   |      |   | (3,556 | )
|                                                                    |  |        |       |   |      |   |        |  
|Loss from discontinued operations before income tax benefit         |  |        | (470  | ) |      |   | (8,269 | )
|Income tax benefit                                                  |  |        | (179  | ) |      |   | (3,142 | )
|                                                                    |  |        |       |   |      |   |        |  
|Loss from discontinued operations                                   |  | $      | (291  | ) |      | $ | (5,127 | )
|                                                                    |  |        |       |   |      |   |        |  

During Fiscal 2004 discontinued operations consisted of twenty schools and one undeveloped
property held for sale. Of the twenty schools, nine ceased operations in Fiscal 2004, six ceased operations in Fiscal 2003 and five were held for sale.



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##### Table of Contents

Of the fifteen closed schools which the Company had ceased operations and closed, seven were subleased,
six were vacant, one was sold, and one was returned to the landlord under a lease buyout and early termination. Of the six vacant schools, one vacant school, owned by the Company, was sold and one vacant school reached the end of its lease term
during the first quarter of Fiscal 2005. The remaining four continue to be accounted for as discontinued operations as of July 2, 2005.

Starting Fiscal 2005 discontinued operations consisted of eighteen schools and one undeveloped property held for sale. Of the eighteen schools seven were subleased, six were vacant and five held for sale. The undeveloped property was sold
during the second quarter of Fiscal 2005 (see discussion below). Of the six vacant, one owned by the Company was sold in the first quarter of Fiscal 2005 (see discussion below), two were returned to the respective landlords and the Company has no
further obligations under these leases and three remain vacant at the end of Fiscal 2005.

Of the two schools returned to the respective
landlords, one was returned in September 2004 at the end of its natural lease term, there was no impact to the accrued lease reserve for this school. One school was returned to the landlord prior to the end of the lease term and the Company was
released from any future obligation for this school which resulted in a recapture of the discounted future lease payments which that were reserved during Fiscal 2004. The amount of the recapture related to this school was approximately $337,000 in
the fourth quarter of Fiscal 2005. In addition, the Company during the fourth quarter of Fiscal 2005 reached agreement with the landlord of one of the vacant properties on the buyout amount required if the landlord were able to sell the property to
a third party. The transaction, if it occurs, will relieve the Company of any future obligation. The amount of the buyout, if the transaction occurs would be approximately $450,000. The result of this agreement was to increase the related reserve
for future lease payments in the amount of approximately $60,000 in Fiscal 2005. The net of these reserve adjustments is included in accrual for future lease obligations.

On August 27, 2004, the Company completed the sale of a closed school with a book value of approximately $909,000. The net proceeds from the sale of this property were approximately $1,131,000 and the Company
recorded a gain on the sale of approximately $214,000 in the first quarter of Fiscal 2005. This gain is included in cost of services for discontinued operations.

On September 30, 2004, the Company sold its 19.99% interest in The Sagemont School, L.C. purchased in 1997, and received payment on notes receivable from The Sagemont School, L.C. Total proceeds from the sale of
the Companys ownership interest and collection on the notes receivable were approximately $278,000 and the Company recorded a gain on the sale of its ownership interest of approximately $29,000 in the first quarter of Fiscal 2005. This gain is
included in cost of services for discontinued operations.

On December 8, 2004, the Company completed the sale of an undeveloped
property with a book value of approximately $1,106,000. The net proceeds from the sale of this property were approximately $1,020,000 and the Company recorded a loss on the sale of approximately $86,000 in the second quarter of Fiscal 2005. The net
proceeds from the sale of these properties and ownership interest were used to pay down the Companys senior term debt. This loss is included in cost of services for discontinued operations.

Of the five held for sale (operating) schools included in discontinued operations at the start of Fiscal 2005, one was closed and the remaining four were
evaluated by the Company to determine their future viability during the third quarter of Fiscal 2005. Based on the absence of reasonable offers to purchase these schools, the Company determined the four schools would return to operating schools and
as such, they are included in results from continuing operations as of the third quarter of Fiscal 2005. As a result, the Company no longer holds any schools for sale.

Starting Fiscal 2006 discontinued operations consist of ten schools, seven subleased and three vacant.

Net Income
(Loss)

As a result of the above factors, the Companys net income was approximately $2,516,000 for Fiscal 2005 as compared to
a net loss of approximately ($6,081,000) for Fiscal 2004.



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##### Table of Contents

Liquidity and Capital Resources

Cash Flow

The Companys principal sources of liquidity are cash flow from operations and
amounts available under its Revolving Credit Commitment. During Fiscal 2006, the Company also received cash from the exercise of warrants to purchase its common stock. The Company evaluates opportunities from time to time to sell properties to third
parties. Principal uses of liquidity are debt service, capital expenditures related to the maintenance of its existing schools, and capital expenditures related to new school furniture, fixtures, and curriculum. During Fiscal 2006, the Company also
used cash in the acquisition of The Honor Roll School. At July 1, 2006 and September 12, 2006, there were no amounts outstanding under the Revolving Credit Commitment and there was $1,699,000 outstanding for letters of credit. The total
unused and available portion of the Revolving Credit Commitment, after allowance for the letters of credit, at July 1, 2006 was $8,301,000. The Companys loan covenants under its Credit Agreement limit the amount of senior debt borrowings.

Total cash and cash equivalents increased by $6,912,000 from $2,925,000 at July 2, 2005 to $9,837,000 at July 1, 2006.

Cash provided by operating activities for Fiscal 2006, 2005 and 2004 were $13,644,000, $12,389,000 and $11,056,000, respectively. The
$1,255,000 increase in Fiscal 2006 as compared to Fiscal 2005 was primarily due to an increase in net income of $1,963,000, an increase in working capital of $429,000 offset by a decrease in adjustments to net income of $1,137,000. The $1,333,000
increase in Fiscal 2005 as compared to Fiscal 2004 was primarily due to an increase in net income of $8,597,000 offset by a decrease in adjustments to net income of $4,144,000, and a decrease in working capital of $3,120,000.

Cash used in investing activities for Fiscal 2006, 2005 and 2004 were $8,244,000, $2,136,000 and $1,506,000, respectively. The $6,108,000 increase in
Fiscal 2006 as compared to Fiscal 2005 was primarily due cash used for the acquisition of The Honor Roll School of $2,639,000, increased capital improvements spending of $761,000, investments in franchises and trade names of $311,000, and a decrease
of cash proceeds from the sale of properties and the collection of a note that occurred in Fiscal 2005 totaling $2,397,000. The $630,000 increase in Fiscal 2005 as compared to Fiscal 2004 was primarily due to a reduction in proceeds from the sale of
property and equipment of $1,889,000 offset by a $1,179,000 decrease in capital improvement spending.

Cash from financing activities for
Fiscal 2006 was $1,512,000 compared to cash used in financing activities in Fiscal 2005 and 2004 of $10,044,000 and $11,556,000, respectively. Cash provided in Fiscal 2006 was primarily due to the exercise of a common stock warrant for the purchase
of 585,803 shares of the company common stock offset by repayments of senior long term debt. Cash used in Fiscal 2005 was primarily due to the retirement of $10,000,000 of 13.25% subordinated debt. Cash used in Fiscal 2004 was primarily due to the
repayment of $9,600,000 of senior long term debt.

In connection with a $10,000,000 senior subordinated note issued in July 1998, the
Company issued warrants to acquire an aggregate of 531,255 shares of the Companys common stock at $8.5625 per share. The senior subordinated note was retired February 20, 2004. In accordance with terms of the warrant the number of shares
available for purchase and the price of purchase were adjusted to prevent dilution of the ownership position at the time the warrant was issued. In addition, to accommodate a drop in the price of common stock prior to May 31, 2000 the exercise
price was adjusted to $6.85 per share. In accordance with these terms the adjusted number of common shares available for purchase increased to 585,803 at $6.21 per share.

In June 2006 the warrants were exercised for the purchase of 585,803 shares of common stock of the company at $6.21 per share for total proceeds to the company of $3,639,097. The exercise represented the purchase of
100% of the shares available under the warrant. Subsequent to the purchase no warrants are outstanding for the purchase of common shares of the company.



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Senior Debt Changes

On February 20, 2004 the Company entered into a $22,995,000 Credit Agreement with Harris Trust and Savings Bank (the Credit Agreement) which provided for a $14,995,000 term loan (the Term
Loan) and an $8,000,000 revolving credit commitment (the Revolving Credit Commitment). Proceeds from the Term Loan were used by the Company to retire approximately $15,000,000 in obligations outstanding under the Companys
previous Amended and Restated Credit Agreement with Fleet Bank. The Term Loan will mature on February 15, 2009 and provides for $2,000,000 annual amortization with the balance paid at maturity. The Revolving Credit Commitment is scheduled to
terminate on February 15, 2009. The Companys obligations under the Credit Agreement are guaranteed by subsidiaries which are 80% or more owned by the Company, and collateralized in part by a pledge of stock of the Companys
subsidiaries and liens on real and personal property. In addition, the Credit Agreement is secured by liens on all real property owned by the Company. With respect to the Term Loan, during fiscal 2006 the Company made scheduled payments in the
amount of $2,000,000. At July 1, 2006, the Company had $13,000,000 outstanding under the Term Loan and no amounts outstanding under the Revolving Credit Commitment.

In connection with the issuance of the Credit Agreement, the Company incurred $1,364,000 of cost related to legal, investment banking and commitment fees. These fees are amortized over the life of the loan to interest
expense. As of July 1, 2006 the unamortized balance of fees was $655,000. As the Company develops further its strategy of either acquiring or building additional schools it may seek new senior bank financing which may result in the remaining
unamortized fees being charged to interest expense at that time.

From Fiscal 2004 through Fiscal 2006 the Company entered into six
amendments to its Credit Agreement as follows:

Fiscal 2004

Amendment No. 1: April 2004To modify the definition of Capital Expenditures to extend the period of time the Company had to
sell a certain property, extend the period of time permitted to refinance a certain capital lease and permit the Company to change the end of its fiscal periods.

Fiscal 2005

Amendment No. 2: February 2005To place certain encumbrances on the
Revolving Credit Commitment

Amendment No. 3: April 2005To reverse the encumbrance on the Revolving Credit
Commitment placed by amendment 2 above and permit certain exclusions from defined EBITDA.

Amendment No. 4: June
2005To readvance $4,700,000 of the Term Loan in connection with retirement of the senior subordinated Notes, increase the Revolving Credit Commitment to $10,000,000, increase permitted letter of credits to $3,500,000, reduce Term Loan and
Revolving Credit Commitment pricing, permit payment of dividends on certain preferred stock in cash rather than in kind, modify certain covenants based on the change in capital structure from the retirement of the Notes and make certain other
changes in definitions.

Fiscal 2006

Amendment No. 5: May 2006To reduce and consolidate the interest rate matrix with respect to the Term Loan and the Revolving Credit Commitment.

Amendment No. 6: June 2006To consent to the acquisition of certain assets of The Honor Roll School, Inc., and THRS II, Inc. as
well as the waiver of the requirement to make a prepayment of net cash proceeds from the exercise of stock warrants and permit the Company to acquire the senior obligations of Total Education Solutions, Inc.



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As of September 12, 2006 the outstanding balance of the Term Loan was $12,500,000. Available
borrowing under the Credit Agreement at July 1, 2006 was $8,301,000.

The Credit Agreement bears interest, at the Companys
option, at either of the following rates, which may be adjusted in quarterly increments based on the achievement of performance goals. For the Term Loan and the Revolving Credit Commitment; the applicable rate is (1) an adjusted LIBOR rate plus
a debt to defined EBITDA-dependent rate ranging from 1.75% to 2.25%, or (2) base rate plus a debt to defined EBITDA-dependent rate ranging from 0.5% to 1.0%.

The Company also pays a letter of credit fee based on the face amount of each letter of credit calculated at the rate per year then applicable to loans under the Credit Agreement bearing interest based on an adjusted
LIBOR rate plus a debt to defined EBITDA-dependent rate ranging from 1.75% to 2.25%. Under the Credit Agreement, the Company may issue up to $3,500,000 in letters of credit. Any amounts outstanding reduce amounts available under the Revolving Credit
Commitment. At July 1, 2006, the Company had approximately $1,699,000, committed under outstanding letters of credit. At July 1, 2006, the letter of credit fee was 1.75%.

The Credit Agreement and the Notes contain customary covenants and provisions that restrict the Companys ability to change its business, declare
dividends, grant liens, incur additional indebtedness and make capital expenditures. In addition, the Credit Agreement and the Notes provide that the Company must meet or exceed defined amounts for EBITDA and fixed charges and must not exceed
certain leverage ratios. At July 1, 2006 the Company was in compliance with all required covenants under the Credit Agreement.

Long-Term Obligations and Commitments

The Company has certain contractual obligations and commercial commitments.
Contractual obligations are those that will require cash payments in accordance with the terms of a contract, such as a loan agreement or lease agreement. Commercial commitments represent potential obligations for performance in the event of demands
by third parties, such as letters of credit. The Companys contractual obligations and commercial commitments at July 1, 2006 were as follows: (dollars in thousands)



|                                       |  |       |         |        |      |            |      |   |        |  |      |        |  |   |        |  |   |        |  |   |       
|-------------------------------------- |  | ----- | ------- | ------ | ---- | ---------- | ---- | - | ------ |  | ---- | ------ |  | - | ------ |  | - | ------ |  | - | ------
|                                       |  | Total |         | Fiscal |      | Thereafter
|                                       |  |       | 2007    |        | 2008 |            | 2009 |   | 2010   |  | 2011 |       
|Long Term Debt Obligations (1)         |  | $     | 15,074  |        | $    | 2,904      |      | $ | 2,753  |  | $    | 9,417  |  | $ |       |  | $ |       |  | $ |      
|Operating Lease Commitments            |  |       | 218,240 |        |      | 30,721     |      |   | 29,261 |  |      | 26,782 |  |   | 25,036 |  |   | 22,197 |  |   | 84,243
|Letter Of Credit Commitments           |  |       | 1,699   |        |      | 1,699      |      |   |       |  |      |       |  |   |       |  |   |       |  |   |      
|Non-Compete and Consulting Obligations |  |       | 694     |        |      | 322        |      |   | 372    |  |      |       |  |   |       |  |   |       |  |   |      
|                                       |  |       |         |        |      |            |      |   |        |  |      |        |  |   |        |  |   |        |  |   |       
|                                       |  | $     | 235,707 |        | $    | 35,646     |      | $ | 32,386 |  | $    | 36,199 |  | $ | 25,036 |  | $ | 22,197 |  | $ | 84,243
|                                       |  |       |         |        |      |            |      |   |        |  |      |        |  |   |        |  |   |        |  |   |       

---

|(1) | The long-term debt consists of $13.0 million (principal value), which bears interest at LIBOR plus a defined EBITDA dependent rate. Amounts above include contractual interest using
applicable rate as of July 1, 2006.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Companys most significant contractual obligations are real estate leases
for its private pay schools.

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



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The table below provides the amounts for the Companys operating lease commitments and subleases and
the potential future period effected (dollars in thousands).



|                    |  |                             |       |                                                |   |                                  |  |                                |        |                                                       |   |                                                     |  |   |       |  |   |       
|------------------- |  | --------------------------- | ----- | ---------------------------------------------- | - | -------------------------------- |  | ------------------------------ | ------ | ----------------------------------------------------- | - | --------------------------------------------------- |  | - | ----- |  | - | ------
|                    |  | Operating Lease Commitments |       |                                                |   |                                 
|                    |  | Continuing Operations       |       | DiscontinuedOperations                         |   |                                  |  |                                |        |                                                      
|Fiscal Year         |  | Vehicle andCopier Leases    |       | Private Payand CharterSchool RealEstate Leases |   | Closed LocationReal EstateLeases |  | TotalOperatingLeaseCommitments |        | Closed LocationCash SubleaseAmounts Due tothe Company |   | Net Uncovered CashOn Closed SchoolLease Commitments
|2007                |  | $                           | 1,041 |                                                | $ | 27,629                           |  | $                              | 2,051  |                                                       | $ | 30,721                                              |  | $ | 890   |  | $ | 1,161 
|2008                |  |                             | 772   |                                                |   | 26,438                           |  |                                | 2,051  |                                                       |   | 29,261                                              |  |   | 926   |  |   | 1,125 
|2009                |  |                             | 264   |                                                |   | 24,467                           |  |                                | 2,051  |                                                       |   | 26,782                                              |  |   | 878   |  |   | 1,173 
|2010                |  |                             | 140   |                                                |   | 22,859                           |  |                                | 2,037  |                                                       |   | 25,036                                              |  |   | 821   |  |   | 1,216 
|2011                |  |                             | 64    |                                                |   | 20,141                           |  |                                | 1,992  |                                                       |   | 22,197                                              |  |   | 810   |  |   | 1,182 
|2012 and thereafter |  |                             | 17    |                                                |   | 78,052                           |  |                                | 6,174  |                                                       |   | 84,243                                              |  |   | 1,000 |  |   | 5,174 
|                    |  |                             |       |                                                |   |                                  |  |                                |        |                                                       |   |                                                     |  |   |       |  |   |       
|Total               |  | $                           | 2,298 |                                                | $ | 199,586                          |  | $                              | 16,356 |                                                       | $ | 218,240                                             |  | $ | 5,325 |  | $ | 11,031
|                    |  |                             |       |                                                |   |                                  |  |                                |        |                                                       |   |                                                     |  |   |       |  |   |       

Charter school related lease commitments total $1,842,000 of which 100% are covered by sublease
contracts between the Company and the charter schools to which the Company provides management services. In addition one charter school leases tenant improvements from the company in conjunction with its sublease of real estate from the Company. The
tenant improvement lease contributed rent revenue of $739,000 and related depreciation expense of $458,000 during fiscal 2006. The charter school has the right to terminate the tenant improvement lease early by satisfying its obligations thereunder.
In the event the charter school terminates the lease early there may be a gain or loss for the difference between the amount received in termination and the net book value of the tenant improvements. This tenant improvement lease terminates in
August 2008.

Net uncovered cash on closed location lease commitments are the net cash amounts due from the Company to third party
landlords not covered by underlying leases from third party sub-lessees. The amount equals closed location lease commitments less closed location cash sublease amounts due to the Company from third parties. The Companys liability with respect
to closed location lease commitments could change if a sub-lessee defaults or in any other way terminates before the end of the contract period of the sublease under their sublease with the Company or if the Company is successful in subleasing
additional closed locations or extending existing sublease agreements. Some of the closed location lease commitments extend beyond the term of the current subleases on those properties.

During Fiscal 2006, the Company received notice under a previously subleased property that the existing sub-lessee exited the sublease two years prior to
its contract termination. The annual base rents under this sublease are currently $835,000 and the lease term is through May 2015. The company believes the former sub-lessee remains obligated under the terms of the sublease, however the sub-lessee
is no longer performing under the sublease. The Company has recorded a lease reserve in the amount of $835,000 in connection with this situation; the amount reserved is based on the assumption that another tenant sublessee will be located in the
next year. In addition to the amount reserved, the Company continues to bear customary triple-net lease obligations related to this location. The Company intends to take all appropriate actions to protect its interest under the sublease, however
until agreement can be reached either through negotiation or the courts the company is obligated to continue landlord rent payments. The Company has continued to explore alternatives to sublease the location in order to mitigate the potential loss
resulting from the attempt of the previous sub-lessee to vacate the location prior to the end of their contract term. To the extent the Company is not successful in mitigating its obligations under the lease it will incur additional expense to its
statement of operations.

The Company also has the risk of future effects on its statement of operations for the closed location real
estate leases to the extent they are not mitigated by lease reserves provided for under SFAS 144 or future



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sublease receipts. The table below shows the Companys commitments for leases on closed locations, sublease amounts due the Company on those locations,
the reserves recorded for the closed location leases and the potential future expense effect on the statement of operations (dollars in thousands).



|                    |  |                                            |        |                                                       |   |                                          |  |                                              |       |  |   |      
|------------------- |  | ------------------------------------------ | ------ | ----------------------------------------------------- | - | ---------------------------------------- |  | -------------------------------------------- | ----- |  | - | -----
|Fiscal Year         |  | Closed LocationReal EstateLeaseCommitments |        | Closed LocationCash SubleaseAmounts Due tothe Company |   | Closed LocationReal EstateLease Reserves |  | Potential FutureStatement ofOperationsEffect
|2007                |  |                                            | 2,051  |                                                       |   | 890                                      |  |                                              | 278   |  |   | 883  
|2008                |  |                                            | 2,051  |                                                       |   | 926                                      |  |                                              | 980   |  |   | 145  
|2009                |  |                                            | 2,051  |                                                       |   | 878                                      |  |                                              | 119   |  |   | 1,054
|2010                |  |                                            | 2,037  |                                                       |   | 821                                      |  |                                              | 109   |  |   | 1,107
|2011                |  |                                            | 1,992  |                                                       |   | 810                                      |  |                                              | 94    |  |   | 1,088
|2012 and thereafter |  |                                            | 6,174  |                                                       |   | 1,000                                    |  |                                              | 184   |  |   | 4,990
|                    |  |                                            |        |                                                       |   |                                          |  |                                              |       |  |   |      
|Total               |  | $                                          | 16,356 |                                                       | $ | 5,325                                    |  | $                                            | 1,764 |  | $ | 9,267
|                    |  |                                            |        |                                                       |   |                                          |  |                                              |       |  |   |      

Capital Expenditures

During Fiscal 2006, the Company opened one preschool. The propertys landlord provided substantially all of the leasehold related funding and took the risk of project completion. Company funded capital
expenditures for new school development include school equipment, furniture and fixtures and curricula purchased by the Company for the operations of the school. The capital expenditure funds to open these schools were provided by cash flow from
operations. Renovations and equipment purchases are capital expenditures incurred for existing schools in order to maintain the operations and, where necessary, upgrade the school facility. The Companys current senior bank credit facility has
annual limitations on the amount of capital expenditures. For Fiscal 2006, this limitation was $7,000,000.

During Fiscal 2005, the Company
opened one preschool and one elementary school. For both schools the landlord provided substantially all of the leasehold related funding and took the risk during the construction period. The capital expenditure funds for school equipment, furniture
and fixtures and curricula to open these schools were provided by cash flow from operations. The Companys current senior bank credit facility has annual limitations on the amount of capital expenditures. For Fiscal 2005, this limitation was
$6,500,000.

In April 2001, the Company entered into a lease agreement to lease and open a school in the Atlanta, Georgia area by
October 1, 2003. The Company decided not to pursue the development of this school however, the Company was contractually required to purchase the property (including interest and development cost) and did so in October 2003 for approximately
$1,860,000. In December 2004, the Company completed the sale of this undeveloped property with a book value of $1,106,000. The net proceeds from the sale of this property were $1,020,000 and the Company recorded a loss on the sale of $86,000 in the
second quarter of Fiscal 2005. The net proceeds from the sale were used to pay down the Companys Term Loan.

Capital expenditures are
as follows: (dollars in thousands):



|                                                        |  |        |       |      |   |       |  |   |      
|------------------------------------------------------- |  | ------ | ----- | ---- | - | ----- |  | - | -----
|                                                        |  | Fiscal
|                                                        |  | 2006   |       | 2005 |   | 2004 
|New school development                                  |  | $      | 293   |      | $ | 409   |  | $ | 218  
|Fixed Assets from Acquisition of The Honor Roll Schools |  |        | 175   |      |   |      |  |   |     
|Renovations and equipment purchases                     |  |        | 2,911 |      |   | 3,293 |  |   | 3,819
|Land purchase                                           |  |        |      |      |   |      |  |   | 1,106
|Corporate and information systems                       |  |        | 2,090 |      |   | 831   |  |   | 569  
|                                                        |  |        |       |      |   |       |  |   |      
|                                                        |  | $      | 5,469 |      | $ | 4,533 |  | $ | 5,712
|                                                        |  |        |       |      |   |       |  |   |      



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Sale of Properties and Ownership Interest

On August 27, 2004, the Company completed the sale of a closed facility in Northfield, New Jersey with a book value of $909,000. The net proceeds
from the sale of this property were $1,131,000 and the Company recorded a gain on the sale of $214,000 in the first quarter of Fiscal 2005. The net proceeds were used to pay down the Companys Term Loan.

On September 30, 2004, the Company sold its 19.99% interest in The Sagemont School, L.C. purchased in 1997, and received payment on notes receivable
from The Sagemont School, L.C. Total proceeds from the sale of the Companys ownership interest and collection on the notes receivable was $278,000 and the Company recorded a gain on the sale of its ownership interest of $29,000 in the first
quarter of Fiscal 2005. The net proceeds were used to pay down the Companys Term Loan.

On December 8, 2004, the Company
completed the sale of undeveloped property in Atlanta, Georgia with a book value of $1,106,000. The net proceeds from the sale of this property were $1,020,000 and the Company recorded a loss on the sale of $86,000 in the second quarter of Fiscal
2005. The net proceeds from the sale were used to pay down the Companys Term Loan.

As a result of these events, regularly scheduled
repayments and the readvance of $4,700,000 for the retirement of the senior subordinated Notes, the total amount outstanding under the Companys senior credit facility was $12,500,000 at September 12, 2006 as compared to $13,000,000 at
July 1, 2006 and $15,000,000 at July 2, 2005, as shown below (dollars in thousands):



|                          |  |                   |        |             |   |             |  |   |       
|------------------------- |  | ----------------- | ------ | ----------- | - | ----------- |  | - | ------
|                          |  | September 12,2006 |        | July 1,2006 |   | July 2,2005
|Term Loan Facility        |  | $                 | 12,500 |             | $ | 13,000      |  | $ | 15,000
|Revolving Credit Facility |  |                   |       |             |   |            |  |   |      
|                          |  |                   |        |             |   |             |  |   |       
|                          |  | $                 | 12,500 |             | $ | 13,000      |  | $ | 15,000
|                          |  |                   |        |             |   |             |  |   |       

Information Technology

The Company completed the roll out of the NetSuite®, licensed information technology system mid-January 2006 to its preschools and elementary schools. With this installation the Company now has on-line access to school related record keeping activities from a
central database via the web-based NetSuite®
system. The Company is now working on enhanced training, metrics reporting and additional benefits expected to be available to the Company from this roll out. This roll out is part of the Companys continuing efforts to improve and enhance its
information system related processes and information gathering capabilities. The NetSuite® system provides fully integrated general ledger and ERP capabilities.

Insurance

Companies involved in the education and care of children may not be able to obtain insurance for the totality of risks inherent in their operations. In
particular, general liability coverage can have insurance sub-limits per claim for child abuse. The Company believes it has adequate insurance coverage at this time. There can be no assurance that in future years the Company will not become subject
to lower limits or substantial increases in insurance premiums.

Recently Issued Accounting Standards

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in
Income Taxes, An Interpretation of FASB Statement 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in



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accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006 and will be adopted by the
Company in the first quarter of fiscal year 2008. We are currently evaluating the effect that the adoption of FIN 48 will have on our consolidated results of operations and financial condition.

On October 2005, the FASB released FASB Staff Position (FSP) FAS 13-1, Accounting for Rental Costs Incurred during a Construction
Period. This FSP affects companies that are engaged in construction activities on buildings or grounds, which are accounted for as operating leases. The FSP requires companies to expense rental costs associated with these leases starting on
the date that the tenant is given control of the premises. As a result, companies must cease capitalizing rental costs during construction periods. The FSP is effective for the first reporting period beginning after December 15, 2005.
Retrospective application is permitted but not required. Although this pronouncement has not impacted the Companys results of operations to date, the Company will continue to assess any potential future impacts.

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 154 (SFAS 154), Accounting
Changes and Error Corrections which provides guidance on the accounting for and reporting of accounting changes and correction of errors. This statement changes the requirements for the accounting for and reporting of a change in accounting
principle and applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement
is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate a material effect upon the adoption of this statement.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-an amendment of Accounting Principles Board (APB)
Opinion No. 29, to eliminate the exception for nonmonetary exchanges of similar productive assets and replace it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in all interim periods beginning after June 15, 2005, with early application permitted for exchanges beginning after November 2004. The Company does not believe that the adoption
of this Statement will have a material impact on the Companys consolidated financial position or results of operations.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted
accounting principles requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Predicting future events is inherently an imprecise activity and as such requires the
use of judgment. Actual results may vary from estimates in amounts that may be material to the Companys consolidated financial statements.

The Companys significant accounting policies are described in note 1 to the Companys consolidated financial statements. The following accounting policies are considered critical to the preparation of the Companys
consolidated financial statements due to the estimation processes and business judgment involved in their application.

Revenue Recognition

The recognition of net revenues meets the following criteria: the existence of an arrangement through an enrollment agreement or
contract, the rendering of educational services, a specific tuition rate and/or fee and probable collection. Net revenues include tuition, fees and other income, reduced by discounts. Fees are received for registration, other educational services
and charter school management fees. Other income is primarily



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comprised of supplemental fees from summer programs, camps, and field trips. Tuition revenues, net of discounts, and other revenues are recognized as
services are performed. Any tuition payments received in advance of the time period for which service is to be performed is recorded as deferred revenue. The Company does not receive payments for services that extend beyond the current operating
cycle. Charter school management fees are recognized based on a contractual relationship with the charter school and do not include any tuition revenue received by the charter school. Certain fees may be received in advance of services being
rendered, in which case the fee revenue is deferred and recognized over the appropriate period of service.

Accounts Receivable

The Companys accounts receivable are comprised primarily of tuition due from parents and governmental agencies. Accounts receivable are presented at
estimated net realizable value. The Company uses estimates in determining the collectibility of its accounts receivable and must rely on its evaluation of historical trends, governmental funding processes, specific customer issues and current
economic trends to arrive at appropriate reserves. Material differences may result in the amount and timing of bad debt expense if actual experience differs significantly from management estimates.

The Company provides its services to the parents and guardians of the children attending its schools. The Company does not grant credit for an extended
period of time, nor does it require collateral. Exposure to losses on receivables is principally dependent on each persons financial condition. The Company monitors its exposure for credit losses and maintains allowances for anticipated
losses. The Companys schools are located in 13 states and as a result, the Company is not dependent on economic conditions in one demographic area or market.

Long-lived and Intangible Assets

Long-lived assets and certain identifiable intangibles to be held and used are reviewed
for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An assets value is impaired if managements estimate of the aggregate future cash flows, undiscounted and without interest
charges, to be generated by the asset are less than the carrying value of the asset. Such cash flows consider factors such as expected future operating income and historical trends, as well as the effects of demand and competition. To the extent
impairment has occurred, the loss will be measured as the excess of the carrying amount of the asset over the fair value of the asset. Such estimates require the use of judgment and numerous subjective assumptions, which, if actual experience
varies, could result in material differences in the requirements for impairment charges.

During Fiscal 2006, 2005, and Fiscal 2004,
impairment charges of $30,000, $216,000 and $1,095,000, respectively, included in continuing operations were recorded with respect to certain underperforming schools.

Goodwill

The Company estimates fair values for each reporting unit using discounted cash flow
projections in evaluating and measuring a potential impairment charge on an annual basis in the fourth quarter of each fiscal year. The Company engages an independent third party consultant to review its calculations required by SFAS 142 and if
necessary the level two analysis in order to determine the amount of goodwill impaired. Any impairment of goodwill resulting from the required testing by SFAS 142 is recorded as a component of income from operations.

For Fiscal 2006, the Company performed its annual impairment test as required by SFAS 142. The level one impairment test for Fiscal 2006 indicated that
no impairment existed for the Companys reporting units, as such the Company did not record goodwill impairment for Fiscal 2006; however, there can be no assurance that such a charge will not be recorded in 2007 or future periods.

For Fiscal 2005, the Company performed its annual impairment test as required by SFAS 142. The level one impairment test for Fiscal 2005 indicated
that no impairment existed for the Companys reporting units, as such the Company did not record goodwill impairment for Fiscal 2005.



38



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For Fiscal 2004, the Company performed its annual impairment test as required by SFAS 142. The level one
impairment test for Fiscal 2004 indicated that impairment existed in the Companys reporting units as a result of operating performance. The Company recorded an impairment loss related to this test of $2,273,000.

Long Term Note Receivable

The Company has a
$2,500,000 subordinated note receivable pursuant to a Credit Agreement entered into in Fiscal 2000 with Total Education Solutions, Inc. (TES). The TES note receivable was due May 2005 and $2,250,000 of the note receivable can be
converted into 30% ownership of TES. During Fiscal 2003, the Company reserved $1,000,000 of the note receivable with TES. Due to continued performance deterioration during the second quarter of Fiscal 2005, the Company reserved the remainder of the
TES note of $1,500,000, which is included as a valuation allowance in the Companys general and administrative expense.

TES is
currently in default of its senior debt. The senior debt was acquired by the Company subsequent to the end of Fiscal 2006. The Company intends to negotiate an extension of all amounts due from TES. The outcome of that negotiation is not currently
known.

Income Taxes

The Company
accounts for income taxes using the asset and liability method, in accordance with FAS 109, Accounting for Income Taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes
of a change in tax rate is recognized as income in the period of enactment. A valuation allowance is recorded based on the uncertainty regarding the ultimate realizability of deferred tax assets.

The Company files a U.S. federal income tax return and various state income tax returns, which are subject to examination by tax authorities. This
process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. The Companys estimated tax liability is subject to change as
examinations of specific tax years are completed in the respective jurisdictions including possible adjustments related to the nature and timing of deductions and the local attribution of income.



|ITEM7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Market risk represents the risk of loss that may impact the consolidated financial position, results of operations or
cash flows of the Company. The Company is exposed to market risk in the areas of interest rates and interest rate swap agreements.

Interest Rates

The Companys exposure to market risk for changes in interest rates relate primarily to debt obligations. The Company has no cash
flow exposure on notes payable of $180,000 and $461,000 at July 1, 2006 and July 2, 2005, respectively. However, the Company does have cash flow exposure on its Credit Agreement, since the Revolving Credit Commitment and the Term Loan are
subject to variable prime base rate pricing. Accordingly, a 1.0% change in the LIBOR rate and the prime rate would have resulted in interest expense changing by approximately $92,000 and $51,000 in Fiscal 2006 and Fiscal 2005, respectively.



39



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##### Table of Contents

Interest Rate Swap Agreement

The Company does not enter into derivative transactions for trading purposes. The Company had an interest rate swap with Harris Trust and Savings Bank. Under the swap, $9,643,000 of the Companys term loan was
allocated to the swap agreement. The Company used this derivative financial instrument to manage its exposure to fluctuations in interest rates. The instrument involved, to varying degrees, market risk, as the instrument was subject to rate and
price fluctuations, and elements of credit risk in the event the counterparty should default. At July 1, 2006, the interest rate swap agreement has expired and no further obligation remains. At July 2, 2005, the Companys interest
rate swap contract outstanding had a total notional amount of $5,892,000. Under the interest rate swap contract, the Company agreed to pay a fixed rate of 5.46% and the counterparty agreed to make payments based on 3-month LIBOR. There was no gain
or loss realized at the time the swap contract was terminated. The market value of the interest rate swap agreement at July 2, 2005 resulted in a liability of $76,000 and is included as a component of Accumulated Other Comprehensive Loss of
$47,000, net of taxes.



|I
TEM8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
|------- | --------------------------------------------

Financial statements and supplementary financial information specified by this Item, together with the Reports of the Companys independent
registered public accounting firm thereon, are included in this Annual Report on Form 10-K on pages F-1 through F- 28 below.



|I
TEM9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
|------- | -------------------------------------------------------------------------------------

Not Applicable



|I
TEM9A. | CONTROLS AND PROCEDURES.
|-------- | ------------------------

Disclosure Controls and Procedures

The Companys management has evaluated, with the participation of its Chief
Executive Officer and Chief Financial Officer, the effectiveness of the Companys disclosure controls and procedures as of July 1, 2006. The Companys disclosure controls and procedures are designed to provide reasonable assurance
that the information required to be disclosed in this Annual Report on Form 10-K has been appropriately recorded, processed, summarized and reported within the time periods specified in the Commissions rules and forms. The Companys disclosure
controls and procedures are also designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls
were effective as of the end of the period covered by this Annual Report on Form 10-K.

Internal Control Over Financial Reporting

There has been no change in the Companys internal control over financial reporting that occurred during the quarter ended July 1, 2006 that has
materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



|I
TEM9B. | OTHER INFORMATION
|-------- | -----------------

None



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##### Table of Contents

PART III



|ITEM10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
|------- | ---------------------------------------------------

The information required by this Item is incorporated herein by reference to the information set forth in the Proxy
Statement.



|ITEM11. | EXECUTIVE COMPENSATION.
|------- | -----------------------

The information required by this Item is incorporated herein by reference to the information set forth in the Proxy Statement.



|ITEM12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
|------- | --------------------------------------------------------------

The information required by this Item is incorporated herein by reference to the information
set forth in the Proxy Statement.



|ITEM13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
|------- | -----------------------------------------------

The information required by this Item is incorporated herein by reference to the information set forth in the Proxy Statement.



|ITEM14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES.
|------- | ---------------------------------------

The information required by this Item is incorporated herein by reference to the information set forth in the Proxy Statement.



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PART IV



|ITEM15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|------- | ------------------------------------------



| | (a) | Documents filed as a part of this Report:
| | --- | -----------------------------------------



|                                                                                |  |     
|------------------------------------------------------------------------------- |  | ----
|                                                                                |  | Page
|(1)    Financial Statements.                                                    |  |     
|                                                                                | 
|Report of Independent Registered Public Accounting Firm                         |  | F-1 
|Consolidated Balance Sheets                                                     |  | F-2 
|Consolidated Statements of Operations                                           |  | F-3 
|Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) |  | F-4 
|Consolidated Statements of Cash Flows                                           |  | F-5 
|Notes to Consolidated Financial Statements                                      |  | F-7 
|                                                                                | 
|(2)    Financial Statement Schedules.                                           |  |     
|                                                                                | 
|Report of Independent Registered Public Accounting Firm                         |  | S-1 
|Schedule II  Valuation and Qualifying Accounts                                 |  | S-2 

All other schedules have been omitted as not applicable or not required under the
instructions contained in Regulation S-X or the information is included elsewhere in the financial statements or notes thereto.



| | (b) | Exhibits required to be filed by Item 601 of Regulation S-K.
| | --- | ------------------------------------------------------------

The exhibits to this Annual Report on Form 10-K are listed on the accompanying index to exhibits and are incorporated herein by reference or are filed or furnished as part of the Annual Report on Form 10-K,



|              |  |                                                                                                                                                                                                                                                                                              
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                                                                                                       
|              | 
|3.1           |  | The Registrants Certificate of Incorporation, as amended and restated. (Filed as Exhibit 3 to the Registrants Quarterly Report on Form 10-Q for the quarter ended
December 31, 1998, and incorporated herein by reference.)                                                                
|              | 
|3.2           |  | The Registrants Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock. (Filed as Exhibit 3.4 to the Registrants Current Report on Form
8-K, filed on September 11, 1995, and incorporated herein by reference.)                                       
|              | 
|3.3           |  | The Registrants Amended and Restated By-laws as modified November 15, 2001. (Filed as Exhibit 3.4 to the Registrants Quarterly Report on Form 10-Q for the quarter ended December
31, 2001, and incorporated herein by reference.)                                                         
|              | 
|3.4           |  | The Registrants Certificate of Designation, Preferences and Rights of Series E Convertible Preferred Stock. (Filed as Exhibit 3.6 to the Registrants Annual Report on Form 10-K for
the fiscal year ended June 30, 2003, and incorporated herein by reference.)                            
|              | 
|3.5           |  | The Registrants Certificate of Designation, Preferences and Rights of Series F Convertible Preferred Stock. (Filed as Exhibit 3.7 to the Registrants Annual Report on Form 10-K for
the fiscal year ended June 30, 2003, and incorporated herein by reference.)                            
|              | 
|10.1          |  | Investment Agreement dated as of June 30, 1998 between the Registrant and its subsidiaries and Allied Capital Corporation. (Filed as Exhibit 4.11 to the Registrants Annual Report on
Form 10-K for the transitional fiscal year ended June 30, 1998, and incorporated herein by reference.)
|              | 
|10.2          |  | 1995 Stock Incentive Plan of the Registrant, as amended. (Filed as Exhibit 10.3 to the Registrants Annual Report on Form 10-K for the transitional fiscal year ended June 30, 1998,
and incorporated herein by reference.)                                                                  



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|              |   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------- | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |   |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10.3          |   |  | Form of Non-Qualified Stock Option Agreement, for stock option grants under 1995 Stock Incentive Plan. (Filed as Exhibit 10.4 to the Registrants Annual Report on Form 10-K for the
transitional fiscal year ended June 30, 1998, and incorporated herein by reference.)                                                                                                                                                                                                                                                  
|              |  
|10.4          |   |  | Form of Incentive Stock Option Agreement, for stock option grants under 1995 Stock Incentive Plan. (Filed as Exhibit 10.4 to the Registrants Annual Report on Form 10-K for the
transitional fiscal year ended June 30, 1998, and incorporated herein by reference.)                                                                                                                                                                                                                                                      
|              |  
|10.5          |   |  | Registration Rights Agreement between the Registrant and Edison Venture Fund II, L.P. and Edison Venture Fund II-PA, L.P. (Filed as Exhibit 4(af) to the Registrants Quarterly Report on
Form 10-Q with respect to the quarter ended June 30, 1994, and incorporated herein by reference.)                                                                                                                                                                                                                                
|              |  
|10.6          |   |  | Amendment dated February 23, 1996 to Registration Rights Agreement between the Registrant and Edison Venture Fund II, L.P. and Edison Venture Fund II-PA, L.P. (Filed as Exhibit 10.14 to the
Registrants Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference.)                                                                                                                                                                                                         
|              |  
|10.7          |   |  | Second Amendment dated as of June 17, 2003 to Registration Rights Agreement among the Registrant, Edison Venture Fund II, L.P. and A.J. Clegg. (Filed as Exhibit 10.19 to the Registrants
Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                                                                                      
|              |  
|10.8          |   |  | Third Amendment dated as of September 9, 2003 to Registration Rights Agreement among the Registrant, Edison Venture Fund II, L.P. and A.J. Clegg. (Filed as Exhibit 10.20 to the
Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                                                                                   
|              |  
|10.9          |   |  | Investment Agreement dated as of August 30, 1995 by and among the Registrant, certain subsidiaries of the Registrant and Allied Capital Corporation and its affiliated funds. (Certain
schedules (and similar attachments) to Exhibit 4.1 have not been filed. The Registrant will furnish supplementally a copy of any omitted schedules or attachments to the SEC upon request.) (Filed as Exhibit 4A to the Registrants Current Report
on Form 8-K, filed on September 11, 1995, and incorporated herein by reference.)
|              |  
|10.10         |   |  | Common Stock Purchase Warrant dated as of June 30, 1998 entitling Allied Capital Corporation to purchase up to 531,255 shares (subject to adjustment) of the common stock of the Registrant.
(Filed as Exhibit 10.13 to the Registrants Annual Report on Form 10-K for the transitional fiscal year ended June 30, 1998, and incorporated herein by reference.)                                                                                                                                                           
|              |  
|10.11         |   |  | First Amended and Restated Registration Rights Agreement dated as of June 30, 1998 by and between the Registrant and Allied Capital Corporation. (Filed as Exhibit 10.14 to the
Registrants Annual Report on Form 10-K for the transitional fiscal year ended June 30, 1998, and incorporated herein by reference.)                                                                                                                                                                                                       
|              |  
|10.12         |   |  | First Amendment dated as of June 17, 2003 to First Amended and Restated Registration Rights Agreement between the Registrant and Allied Capital Corporation. (Filed as Exhibit 10.24 to the
Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                                                                        
|              |  
|10.13         | * |  | The Registrants Senior Executive Severance Pay Plan Statement and Summary Plan Description as modified February 3, 2000 and December 21, 2001. (Filed as Exhibit 10.2 to the
Registrants Quarterly Report on Form 10-Q for the quarter ended December 31, 2001, and incorporated herein by reference.)                                                                                                                                                                                                                   
|              |  
|10.14         | * |  | The Registrants Executive Severance Pay Plan Statement and Summary Plan Description as modified February 3, 2000 and December 21, 2001. (Filed as Exhibit 10.3 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended December 31, 2001, and incorporated herein by reference.)                                                                                                                                                                                                                          



43



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|              |   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------- | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |   |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                                                         
|10.15         | * |  | Employment and Termination Agreement dated as of August 2001 between A.J. Clegg and the Registrant. (Filed as Exhibit 10.25 to the Registrants Annual Report on Form 10-K for the fiscal
year ended June 30, 2001, and incorporated herein by reference).                                                                                                                                                                     
|              |  
|10.16         | * |  | Employment and Termination Agreement dated as of August 2001 between John R. Frock and the Registrant. (Filed as Exhibit 10.26 to the Registrants Annual Report on Form 10-K for the
fiscal year ended June 30, 2001, and incorporated herein by reference).                                                                                                                                                                  
|              |  
|10.17         | * |  | Consultant Agreement dated as of July 11, 2003 among the Registrant, A.J. Clegg and Tuscan Business Solutions, Inc. (Filed as Exhibit 10.33 to the Registrants Annual Report on Form 10-K
for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                     
|              |  
|10.18         | * |  | Consultant Agreement dated as of August 29, 2003 between the Registrant and John R. Frock. (Filed as Exhibit 10.34 to the Registrants Annual Report on Form 10-K for the fiscal year
ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                                              
|              |  
|10.19         |   |  | Purchase and Sale Agreement dated as of March 21, 2003 between the Registrant and Partnership With Parents, Inc. (Filed as Exhibit 10.37 to the Registrants Annual Report on Form 10-K
for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                        
|              |  
|10.20         |   |  | Amendment dated July 9, 2003 to Purchase and Sale Agreement between the Registrant and Partnership With Parents, Inc. (Filed as Exhibit 10.38 to the Registrants Annual Report on Form
10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                   
|              |  
|10.21         |   |  | Amendment dated July 24, 2003 to Purchase and Sale Agreement between the Registrant and Partnership With Parents, Inc. (Filed as Exhibit 10.39 to the Registrants Annual Report on Form
10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                  
|              |  
|10.22         |   |  | Amendment dated August 13, 2003 to Purchase and Sale Agreement between the Registrant and Partnership With Parents, Inc. (Filed as Exhibit 10.40 to the Registrants Annual Report on Form
10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                                                                
|              |  
|10.23         |   |  | Series E Convertible Preferred Stock Purchase Agreement dated as of June 17, 2003 among the Registrant, Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P.
(Filed as Exhibit 10.43 to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                         
|              |  
|10.24         |   |  | Management Rights Letter of the Registrant dated as of June 17, 2003, issued to Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P. (Filed as Exhibit 10.45
to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                 
|              |  
|10.25         |   |  | Registration Rights Agreement dated as of June 17, 2003 among the Registrant, Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P. (Filed as Exhibit 10.46
to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                                                   
|              |  
|10.26         |   |  | First Amendment dated as of September 9, 2003 to Registration Rights Agreement among the Registrant, Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P.
(Filed as Exhibit 10.47 to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)                                                                            
|              |  
|10.27         |   |  | Series F Convertible Preferred Stock Purchase Agreement dated as of September 9, 2003 among the Registrant, Camden Partners Strategic Fund II-A, L.P., Camden Partners Strategic Fund II-B,
L.P., Allied Capital Corporation, Mollusk Holdings, L.L.C. and Blesbok, LLC. (Filed as Exhibit 10.48 to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)



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|              |   |  |                                                                                                                                                                                                                                                                                                                                                                                                      
|------------- | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |   |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                               
|10.28         |   |  | Registration Rights Agreement dated as of September 9, 2003 among the Registrant, Camden Partners Strategic Fund II-A, L.P., Camden Partners Strategic Fund II-B, L.P., Allied Capital
Corporation, Mollusk Holdings, L.L.C. and Blesbok, LLC. (Filed as Exhibit 10.50 to the Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2003, and incorporated herein by reference.)
|              |  
|10.29         | * |  | Amended Employment Agreement dated as of September 6. 2005 between the Registrant and George Bernstein. (Filed herewith.)                                                                                                                                                                                                                                                                            
|              |  
|10.30         |   |  | Credit Agreement, dated as of February 20, 2004 among the Registrant, certain of its subsidiaries as Guarantors, and Harris Trust and Savings Bank as administrative agent. (Filed as Exhibit
10.1 to the Registrants Current Report on Form 8-K, filed on February 25, 2004, and incorporated herein by reference.)                                                                                
|              |  
|10.31         |   |  | Revolving Note, dated as of February 20, 2004 in the principal amount of $8,000,000, payable to the order of Harris Trust and Savings Bank. (Filed as Exhibit 10.2 to the Registrants
Current Report on Form 8-K, filed on February 25, 2004, and incorporated herein by reference.)                                                                                                                
|              |  
|10.32         |   |  | Term Note, dated as of February 20, 2004 in the principal amount of $15,000,000, payable to the order of Harris Trust and Savings Bank. (Filed as Exhibit 10.3 to the Registrants Current
Report on Form 8-K, filed on February 25, 2004, and incorporated herein by reference.)                                                                                                                    
|              |  
|10.33         |   |  | Security Agreement, dated as of February 20, 2004 among the Registrant, certain of its subsidiaries and Harris Trust and Savings Bank as administrative agent. (Filed as Exhibit 10.4 to the
Registrants Current Report on Form 8-K, filed on February 25, 2004, and incorporated herein by reference.)                                                                                             
|              |  
|10.34         |   |  | Senior Subordinated Note, dated as of February 20, 2004 in the principal amount of $5,000,000, payable to the order of Mollusk Holdings, L.L.C. (Filed as Exhibit 10.7 to the Registrants
Current Report on Form 8-K, filed on February 25, 2004, and incorporated herein by reference.)                                                                                                            
|              |  
|10.35         |   |  | First Amendment to Credit Agreement dated as of April 19, 2004 between the Registrant and Harris Trust and Savings Bank. (Filed as Exhibit 10.1 to the Registrants Current Report on Form
8-K, filed on May 14, 2004, and incorporated herein by reference.)                                                                                                                                        
|              |  
|10.36         |   |  | Second Amendment to Credit Agreement dated as of February 11, 2005 between the Registrant and Harris Trust and Savings Bank. (Filed as Exhibit 10.1 to the Registrants Quarterly Report
on Form 10-Q dated April 1, 2005, and incorporated herein by reference.)                                                                                                                                    
|              |  
|10.37         |   |  | Third Amendment to Credit Agreement dated as of February 11, 2005 between the Registrant and Harris Trust and Savings Bank. (Filed as Exhibit 10.2 to the Registrants Quarterly Report on
Form 10-Q dated April 1, 2005, and incorporated herein by reference.)                                                                                                                                     
|              |  
|10.38         |   |  | Fourth Amendment to Credit Agreement dated as of February 11, 2005 between the Registrant and Harris, N.A. (formerly Harris Trust and Savings Bank). (Filed as Exhibit 10.1 to the
Registrants Current Report on Form 8-K, filed on June 7, 2005, and incorporated herein by reference.)                                                                                                            
|              |  
|10.39         | * |  | Separation Agreement and General Release dated as of June 28, 2005 between Kathy E. Herman and the Registrant. (Filed as Exhibit 10.1 to the Registrants Current Report on Form 8-K,
filed on June 28, 2005, and incorporated herein by reference).                                                                                                                                                 
|              |  
|10.40         | * |  | Omnibus Incentive Equity Compensation Plan of the Registrant, (Filed as Exhibit 99.1 to the Registrants Registration Statement on Form S-8 (Registration Statement No. 333-124247)
filed on April 22, 2005, and incorporated herein by reference.)                                                                                                                                                  
|              |  
|10.41         |   |  | Employment Agreement dated as of May 10, 2006 between the Registrant and Lee Bohs. (Filed as Exhibit 10.1 to the Registrants Current Report on Form 8-K, filed May 17, 2006, and
incorporated herein by reference. )                                                                                                                                                                                
|              |  
|10.42         |   |  | Fifth Amendment to Credit Agreement dated as of May 8, 2006 between the Registrant and Harris, N.A. (formerly Harris Trust and Savings Bank). (Filed herewith.)                                                                                                                                                                                                                                      



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|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|10.43         |  | Sixth Amendment to Credit Agreement dated as of June 30, 2006 between the Registrant and Harris, N.A. (formerly Harris Trust and Savings Bank. (Filed herewith.)                                                                                                                                                                                                                                                                                                                                                                               
|              | 
|10.44         |  | Form of Incentive Stock Option Certificate, for stock option grants under the Omnibus Incentive Equity Compensation Plan. (Filed as Exhibit 10.1 to the Registrants Quarterly Report on
Form 10-Q for the quarter ended, and incorporated herein by reference.)                                                                                                                                                                                                                                                                               
|              | 
|10.45         |  | Form of Non-Qualified Stock Option Agreement (Non-Employee Director), for stock option grants under the Omnibus Incentive Equity Compensation Plan. (Filed as Exhibit 10.2 to the
Registrants Quarterly Report on Form 10-Q for the quarter ended, and incorporated herein by reference.)                                                                                                                                                                                                                                                     
|              | 
|10.46         |  | Form of Non-Qualified Stock Option Agreement (Employee), for stock option grants under the Omnibus Incentive Equity Compensation Plan. (Filed as Exhibit 10.3 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended, and incorporated herein by reference.)                                                                                                                                                                                                                                                                  
|              | 
|10.47         |  | Form of Stock Award certificate, for stock option grants under the Omnibus Incentive Equity Compensation Plan. (Filed as Exhibit 10.4 to the Registrants Quarterly Report on Form 10-Q
for the quarter ended, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                          
|              | 
|14            |  | Code of Business Conduct and Ethics of the Registrant, as adopted June 3, 2004. (Filed as Exhibit 99.1 to the Registrants Current Report on Form 8-K, filed on October 5, 2004, and
incorporated herein by reference.)                                                                                                                                                                                                                                                                                                                        
|              | 
|16.1          |  | Letter from PricewaterhouseCoopers LLP to the SEC, dated April 1, 2003 regarding change in certifying accountant. (Filed as Exhibit 16.1 to the Registrants Current Report on Form 8-K,
filed on April 4, 2003, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                        
|              | 
|21            |  | List of subsidiaries of the Registrant. (Filed herewith.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|              | 
|23.1          |  | Consent of BDO Seidman, LLP. (Filed herewith.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              | 
|31.1          |  | Certifications of the Chief Executive Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (Filed herewith.)                                                                                                                                                                                                                                                                                                                                                                            
|              | 
|31.2          |  | Certifications of the Chief Financial Officer of the Registrant required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (Filed herewith.)                                                                                                                                                                                                                                                                                                                                                                            
|              | 
|32.1          |  | Certifications of the Chief Executive Officer of the Registrant required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed
filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under
the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, as amended.) (Filed herewith.)
|              | 
|32.2          |  | Certifications of the Chief Financial Officer of the Registrant required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed
filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under
the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, as amended.) (Filed herewith.)

---

|* | Each management contract or compensation plan required to be filed as an exhibit is identified by an asterisk (*)
|- | -----------------------------------------------------------------------------------------------------------------



| | (c) | Financial Statement Schedules.
| | --- | ------------------------------

Exhibits Required
by Item 601 of Regulation S-K: The exhibits to this report are listed under Item 15(a)(2) above.



46



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |  |  |                                 |  |     |  |                                            
|----------------------- |  |  |  | ------------------------------- |  | --- |  | -------------------------------------------
|Date:September 14, 2006 |  |  |  | NOBEL LEARNING COMMUNITIES, INC
|                        |  |  |  |                                
|                        |  |  |  |                                 |  | By: |  | /S/    GEORGE H.
BERNSTEIN                 
|                        |  |  |  |                                 |  |     |  | George H. Bernstein Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.



|                                                 |  |                                                                      |  |                   
|------------------------------------------------ |  | -------------------------------------------------------------------- |  | ------------------
|Signature                                        |  | Position                                                             |  | Date              
|/S/    GEORGE H.
BERNSTEIN George H. Bernstein   |  | Chief Executive Officer and Director (Principal Executive Officer)   |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    THOMAS
FRANK Thomas Frank                 |  | Chief Financial Officer (Principal Financial and Accounting Officer) |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    THERESE KREIG
CRANE Therese Kreig Crane   |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    DAVID
BEALE David Beale                   |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    STEVEN B.
FINK Steven B. Fink             |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    PETER H.
HAVENS Peter H. Havens           |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    RICHARD J.
PINOLA Richard J. Pinola       |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    MICHAEL J.
ROSENTHAL Michael J. Rosenthal |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    RALPH
SMITH Ralph Smith                   |  | Director                                                             |  | September 15, 2006
|                                                 |  |                                                                     
|/S/    DAVID L.
WARNOCK David L. Warnock         |  | Director                                                             |  | September 15, 2006



47



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of

Nobel Learning Communities, Inc.

The
audits referred to in our report dated September 12, 2006 relating to the consolidated financial statements of Nobel Learning Communities, Inc. and Subsidiaries, which is contained in Item 8 of Form 10-K, include the audit of the
accompanying financial statement schedule. This financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.

In our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.

BDO Seidman, LLP

Philadelphia, Pennsylvania

September 12, 2006



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---

##### Table of Contents

SCHEDULE II

Nobel Learning Communities, Inc.

Valuation and Qualifying Accounts.

(dollars in thousands)



|                                |  |                              |     |                  |     |            |        |   |                        |   |    
|------------------------------- |  | ---------------------------- | --- | ---------------- | --- | ---------- | ------ | - | ---------------------- | - | ---
|Column A                        |  | Column B                     |     | Column C         |     | Column D   |        |   | Column E              
|Description                     |  | Balance atbeginning ofperiod |     | Charge toexpense |     | Write-offs |        |   | Balanceat endof period
|Year ended July 1, 2006:        |  |                              |     |                  |     |            |        |   |                        |   |    
|Allowance for doubtful accounts |  | $                            | 879 |                  | 962 |            | (1,143 | ) |                        | $ | 698
|                                |  |                              |     |                 
|Year ended July 2, 2005:        |  |                              |     |                  |     |            |        |   |                        |   |    
|Allowance for doubtful accounts |  | $                            | 912 |                  | 447 |            | (480   | ) |                        | $ | 879
|                                |  |                              |     |                 
|Year ended July 3, 2004:        |  |                              |     |                  |     |            |        |   |                        |   |    
|Allowance for doubtful accounts |  | $                            | 803 |                  | 519 |            | (410   | ) |                        | $ | 912



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of
Directors of

Nobel Learning Communities, Inc.

West Chester, PA

We have audited the
accompanying consolidated balance sheets of Nobel Learning Communities, Inc. and Subsidiaries as of July 1, 2006 and July 2, 2005 and the related consolidated statements of operations, stockholders equity and comprehensive income,
and cash flows for each of the three years in the period ended July 1, 2006. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nobel
Learning Communities, Inc. and Subsidiaries as of July 1, 2006 and July 2, 2005, and the results of their operations and their cash flows for each of the three years in the period ended July 1, 2006, in conformity with accounting
principles generally accepted in the United States of America.

BDO Seidman, LLP

Philadelphia, Pennsylvania

September 12, 2006



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share amounts)



|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                                                                                                                             |  | July 1, 2006 |         |   | July 2, 2005 |  
|ASSETS                                                                                                                                                                                                                                                       |  |              |         |   |              |   |         |  
|Cash and cash equivalents                                                                                                                                                                                                                                    |  | $            | 9,837   |   |              | $ | 2,925   |  
|Accounts receivable, less allowance for doubtful accounts of $698 in 2006 and $879 in 2005                                                                                                                                                                   |  |              | 2,329   |   |              |   | 1,980   |  
|Deferred tax asset                                                                                                                                                                                                                                           |  |              | 1,479   |   |              |   | 2,200   |  
|Prepaid rent                                                                                                                                                                                                                                                 |  |              | 2,559   |   |              |   | 2,436   |  
|Prepaid insurance and other                                                                                                                                                                                                                                  |  |              | 2,836   |   |              |   | 2,479   |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Current Assets                                                                                                                                                                                                                                         |  |              | 19,040  |   |              |   | 12,020  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Property and equipment, at cost                                                                                                                                                                                                                              |  |              | 73,027  |   |              |   | 69,059  |  
|Accumulated depreciation and amortization                                                                                                                                                                                                                    |  |              | (47,415 | ) |              |   | (43,052 | )
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Property and equipment, net                                                                                                                                                                                                                                  |  |              | 25,612  |   |              |   | 26,007  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Goodwill                                                                                                                                                                                                                                                     |  |              | 38,374  |   |              |   | 36,639  |  
|Intangible assets, net                                                                                                                                                                                                                                       |  |              | 1,623   |   |              |   | 298     |  
|Deferred tax asset                                                                                                                                                                                                                                           |  |              | 866     |   |              |   | 2,212   |  
|Deposits and other assets                                                                                                                                                                                                                                    |  |              | 904     |   |              |   | 1,168   |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Assets                                                                                                                                                                                                                                                 |  | $            | 86,419  |   |              | $ | 78,344  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                         |  |              |         |   |              |   |         |  
|Current portion of long-term debt                                                                                                                                                                                                                            |  | $            | 2,180   |   |              | $ | 2,281   |  
|Accounts payable and other current liabilities                                                                                                                                                                                                               |  |              | 14,478  |   |              |   | 14,361  |  
|Deferred revenue                                                                                                                                                                                                                                             |  |              | 11,885  |   |              |   | 10,457  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Current Liabilities                                                                                                                                                                                                                                    |  |              | 28,543  |   |              |   | 27,099  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Long-term obligations                                                                                                                                                                                                                                        |  |              | 11,000  |   |              |   | 13,180  |  
|Other long term liabilities                                                                                                                                                                                                                                  |  |              | 596     |   |              |   | 675     |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Liabilities                                                                                                                                                                                                                                            |  |              | 40,139  |   |              |   | 40,954  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Commitments and Contingencies                                                                                                                                                                                                                                |  |              |         |   |              |   |         |  
|Stockholders Equity:                                                                                                                                                                                                                                        |  |              |         |   |              |   |         |  
|Preferred stock, $0.001 par value; 10,000,000 shares authorized, issued 3,283,419 in 2006 and 2005, outstanding 3,283,419 in 2006 and
3,175,837 in 2005. $12,401 and $11,979 aggregate liquidation preference at July 1, 2006 and July 2, 2005, respectively |  |              | 3       |   |              |   | 3       |  
|Common stock, $0.001 par value; 20,000,000 shares authorized; issued 8,092,776 in 2006 and 7,486,807 in 2005, outstanding 8,092,776 in 2006
and 7,450,097 in 2005                                                                                            |  |              | 8       |   |              |   | 8       |  
|Treasury stock, at cost; no shares in 2006, 36,710 shares in 2006                                                                                                                                                                                            |  |              |        |   |              |   | (375    | )
|Additional paid-in capital                                                                                                                                                                                                                                   |  |              | 55,778  |   |              |   | 51,302  |  
|Accumulated deficit                                                                                                                                                                                                                                          |  |              | (9,509  | ) |              |   | (13,501 | )
|Accumulated other comprehensive loss                                                                                                                                                                                                                         |  |              |        |   |              |   | (47     | )
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Stockholders Equity                                                                                                                                                                                                                                   |  |              | 46,280  |   |              |   | 37,390  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  
|Total Liabilities and Stockholders Equity                                                                                                                                                                                                                   |  | $            | 86,419  |   |              | $ | 78,344  |  
|                                                                                                                                                                                                                                                             |  |              |         |   |              |   |         |  

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



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)



|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|----------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ------------ | - | ------- | ------------ |  | - | ------- | -
|                                                                                                |  | For the Year Ended |        
|                                                                                                |  | July 1, 2006       |         |   | July 2, 2005 |   |         | July 3, 2004 | 
|Revenues                                                                                        |  | $                  | 168,329 |   |              | $ | 164,204 |              |  | $ | 158,361 |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Operating expenses:                                                                             |  |                    |         |   |              |   |         |              |  |   |         |  
|Personnel costs                                                                                 |  |                    | 79,283  |   |              |   | 77,213  |              |  |   | 75,700  |  
|School operating costs                                                                          |  |                    | 25,264  |   |              |   | 23,917  |              |  |   | 22,949  |  
|Rent and other                                                                                  |  |                    | 41,582  |   |              |   | 41,318  |              |  |   | 39,198  |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Total Cost of Services                                                                          |  |                    | 146,129 |   |              |   | 142,448 |              |  |   | 137,847 |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Gross profit                                                                                    |  |                    | 22,200  |   |              |   | 21,756  |              |  |   | 20,514  |  
|Goodwill and other asset impairments                                                            |  |                    | 30      |   |              |   | 216     |              |  |   | 3,368   |  
|General and administrative expenses                                                             |  |                    | 13,523  |   |              |   | 14,548  |              |  |   | 14,256  |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Operating income                                                                                |  |                    | 8,647   |   |              |   | 6,992   |              |  |   | 2,890   |  
|Interest expense                                                                                |  |                    | 1,469   |   |              |   | 2,692   |              |  |   | 3,632   |  
|Other income, net                                                                               |  |                    | (350    | ) |              |   | (184    | )            |  |   | (45     | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Income (loss) from continuing operations before income taxes                                    |  |                    | 7,528   |   |              |   | 4,484   |              |  |   | (697    | )
|Income tax expense                                                                              |  |                    | 2,943   |   |              |   | 1,677   |              |  |   | 257     |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Income (loss) from continuing operations                                                        |  |                    | 4,585   |   |              |   | 2,807   |              |  |   | (954    | )
|Loss from discontinued operations, net of income tax benefit of $68; $179, $3,142, respectively |  |                    | (106    | ) |              |   | (291    | )            |  |   | (5,127  | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Net income (loss)                                                                               |  |                    | 4,479   |   |              |   | 2,516   |              |  |   | (6,081  | )
|Preferred stock dividends                                                                       |  |                    | 487     |   |              |   | 642     |              |  |   | 516     |  
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Net income (loss) available to common stockholders                                              |  | $                  | 3,992   |   |              | $ | 1,874   |              |  | $ | (6,597  | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Basic income (loss) per share:                                                                  |  |                    |         |   |              |   |         |              |  |   |         |  
|Income (loss) from continuing operations                                                        |  | $                  | 0.55    |   |              | $ | 0.31    |              |  | $ | (0.22   | )
|(Loss) from discontinued operations                                                             |  |                    | (0.01   | ) |              |   | (0.04   | )            |  |   | (0.79   | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Net income (loss) per share                                                                     |  | $                  | 0.54    |   |              | $ | 0.27    |              |  | $ | (1.01   | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Diluted income (loss) per share:                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Income (loss) from continuing operations                                                        |  | $                  | 0.45    |   |              | $ | 0.29    |              |  | $ | (0.22   | )
|Loss from discontinued operations                                                               |  |                    | (0.01   | ) |              |   | (0.03   | )            |  |   | (0.79   | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Net income (loss) per share                                                                     |  | $                  | 0.44    |   |              | $ | 0.26    |              |  | $ | (1.01   | )
|                                                                                                |  |                    |         |   |              |   |         |              |  |   |         |  
|Weighted average common stock outstanding (in thousands):                                       |  |                    |         |   |              |   |         |              |  |   |         |  
|Basic                                                                                           |  |                    | 7,473   |   |              |   | 7,064   |              |  |   | 6,512   |  
|Diluted                                                                                         |  |                    | 10,080  |   |              |   | 9,719   |              |  |   | 6,512   |  

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



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Stockholders Equity and
Comprehensive Income (Loss)

For the Years Ended July 1, 2006, July 2, 2005 and July 3, 2004

(Dollars in thousands except share data)



|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|------------------------------------------- |  | --------------- | - |  | ------------ | -- | ------------- | ------ | --------- | ------------------------ | ------ | - | ------------------------------------- |  | -- | --------------------------------- | - |  | ----- | ------ | - |  | -- | ------- | - |  | -- | ---- | - |  | - | ------ | -
|                                            |  | Preferred Stock |   |  | Common Stock |    | TreasuryStock |        |           | AdditionalPaid-InCapital |        |   | RetainedEarnings/(AccumulatedDeficit) |  |    | AccumulatedOtherComprehensiveLoss |   |  | Total |       
|                                            |  | Shares          |   |  | Amount       |    |               | Shares |           |                          | Amount |   |                                       |  |    |                                  
|June 30, 2003                               |  | 5,920,797       |   |  | $            | 6  |               |        | 6,612,109 |                          |        | $ | 6                                     |  | ($ | 1,375                             | ) |  | $     | 47,753 |   |  | ($ | 8,778   | ) |  | ($ | 537  | ) |  | $ | 37,075 |  
|Comprehensive income:                       |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Net (loss)                                  |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | (6,081  | ) |  |    |     |   |  |   | (6,081 | )
|Swap contract, net of tax                   |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    |        |   |  |    | 333  |   |  |   | 333    |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Total comprehensive loss                    |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   | (5,748 | )
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Issuance of preferred stock                 |  | 588,236         |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       | 2,894  |   |  |    |        |   |  |    |     |   |  |   | 2,894  |  
|Conversion of preferred stock               |  | (493,226        | ) |  |              |   |               |        | 127,266   |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    |        |   |  |    |     |   |  |   |       |  
|Compensation for non employee stock options |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       | 26     |   |  |    |        |   |  |    |     |   |  |   | 26     |  
|Stock options exercised                     |  |                |   |  |              |   |               |        | 103,332   |                          |        |   | 1                                     |  |    |                                  |   |  |       | 543    |   |  |    |        |   |  |    |     |   |  |   | 544    |  
|Preferred dividends                         |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | (516    | ) |  |    |     |   |  |   | (516   | )
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|July 3, 2004                                |  | 6,015,807       |   |  |              | 6  |               |        | 6,842,707 |                          |        |   | 7                                     |  |    | (1,375                            | ) |  |       | 51,216 |   |  |    | (15,375 | ) |  |    | (204 | ) |  |   | 34,275 |  
|Comprehensive income:                       |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Net income                                  |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | 2,516   |   |  |    |     |   |  |   | 2,516  |  
|Swap contract, net of tax                   |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    |        |   |  |    | 157  |   |  |   | 157    |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Total comprehensive income                  |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   | 2,673  |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Issuance of preferred stock dividends       |  | 190,438         |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       | 897    |   |  |    |        |   |  |    |     |   |  |   | 897    |  
|Conversion of preferred stock               |  | (3,030,408      | ) |  |              | (3 | )             |        | 798,700   |                          |        |   | 1                                     |  |    |                                  |   |  |       | 2      |   |  |    |        |   |  |    |     |   |  |   |       |  
|Stock options exercised                     |  |                 |   |  |              |    |               |        | 39,200    |                          |        |   |                                      |  |    |                                  |   |  |       | 187    |   |  |    |        |   |  |    |     |   |  |   | 187    |  
|Treasury shares cancelled                   |  |                |   |  |              |   |               |        | (193,800  | )                        |        |   |                                      |  |    | 1,000                             |   |  |       | (1,000 | ) |  |    |        |   |  |    |     |   |  |   |       |  
|Preferred dividends                         |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | (642    | ) |  |    |     |   |  |   | (642   | )
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|July 2, 2005                                |  | 3,175,837       |   |  |              | 3  |               |        | 7,486,807 |                          |        |   | 8                                     |  |    | (375                              | ) |  |       | 51,302 |   |  |    | (13,501 | ) |  |    | (47  | ) |  |   | 37,390 |  
|Comprehensive income:                       |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Net income                                  |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | 4,479   |   |  |    |     |   |  |   | 4,479  |  
|Swap contract, net of tax                   |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    |        |   |  |    | 47   |   |  |   | 47     |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Total comprehensive income                  |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   | 4,526  |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|Issuance of preferred stock                 |  | 107,582         |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       | 502    |   |  |    |        |   |  |    |     |   |  |   | 502    |  
|Exercise of warrants                        |  |                |   |  |              |   |               |        | 585,803   |                          |        |   |                                      |  |    |                                  |   |  |       | 3,639  |   |  |    |        |   |  |    |     |   |  |   | 3,639  |  
|Compensation for employee stock options     |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       | 555    |   |  |    |        |   |  |    |     |   |  |   | 555    |  
|Stock options exercised                     |  |                 |   |  |              |    |               |        | 20,166    |                          |        |   |                                      |  |    |                                  |   |  |       | 155    |   |  |    |        |   |  |    |     |   |  |   | 155    |  
|Treasury shares cancelled                   |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    | 375                               |   |  |       | (375   | ) |  |    |        |   |  |    |     |   |  |   |       |  
|Preferred dividends                         |  |                |   |  |              |   |               |        |          |                          |        |   |                                      |  |    |                                  |   |  |       |       |   |  |    | (487    | ) |  |    |     |   |  |   | (487   | )
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  
|July 1, 2006                                |  | 3,283,419       |   |  | $            | 3  |               |        | 8,092,776 |                          |        | $ | 8                                     |  | $  | 0                                 |   |  | $     | 55,778 |   |  | ($ | 9,509   | ) |  | $  | 0    |   |  | $ | 46,280 |  
|                                            |  |                 |   |  |              |    |               |        |           |                          |        |   |                                       |  |    |                                   |   |  |       |        |   |  |    |         |   |  |    |      |   |  |   |        |  

The accompanying notes are an integral part of the consolidated financial statements



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Cash Flow

(Dollars in thousands)



|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|---------------------------------------------------------------------------------------- |  | ----------------- | ------ | - | ------------ | - | ------- | ------------ |  | - | ------- | -
|                                                                                         |  | Fiscal Year Ended |       
|                                                                                         |  | July 1, 2006      |        |   | July 2, 2005 |   |         | July 3, 2004 | 
|Cash Flows from Operating Activities:                                                    |  |                   |        |   |              |   |         |              |  |   |         |  
|Net income (loss)                                                                        |  | $                 | 4,479  |   |              | $ | 2,516   |              |  | $ | (6,081  | )
|Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by Operating Activities: |  |                   |        |   |              |   |         |              |  |   |         |  
|Depreciation and amortization                                                            |  |                   | 5,748  |   |              |   | 6,179   |              |  |   | 7,754   |  
|Fixed asset impairments                                                                  |  |                   | 30     |   |              |   | 216     |              |  |   | 1,095   |  
|Goodwill impairment                                                                      |  |                   |       |   |              |   |        |              |  |   | 3,326   |  
|Reserve for discontinued operations                                                      |  |                   |       |   |              |   |        |              |  |   | 2,281   |  
|Valuation allowancenote receivable                                                      |  |                   |       |   |              |   | 1,500   |              |  |   |        |  
|Amortization of debt discount                                                            |  |                   |       |   |              |   |        |              |  |   | 257     |  
|Provision for losses on accounts receivable                                              |  |                   | 962    |   |              |   | 447     |              |  |   | 519     |  
|Provision for stock option compensation                                                  |  |                   | 555    |   |              |   |        |              |  |   |        |  
|Provision for deferred taxes                                                             |  |                   | 1,077  |   |              |   | 1,269   |              |  |   | (1,666  | )
|Gain on sale of fixed assets                                                             |  |                   |       |   |              |   | (133    | )            |  |   | (14     | )
|Other                                                                                    |  |                   | (49    | ) |              |   | (18     | )            |  |   | 52      |  
|Changes in Assets and Liabilities, net of acquired amounts                               |  |                   |        |   |              |   |         |              |  |   |         |  
|Accounts receivable                                                                      |  |                   | (1,311 | ) |              |   | 341     |              |  |   | 2,617   |  
|Prepaid assets                                                                           |  |                   | (384   | ) |              |   | (72     | )            |  |   | (446    | )
|Other assets and liabilities                                                             |  |                   | 1,511  |   |              |   | 415     |              |  |   | 1,267   |  
|Deferred revenue                                                                         |  |                   | 980    |   |              |   | 987     |              |  |   | (860    | )
|Accounts payable and accrued expenses                                                    |  |                   | 46     |   |              |   | (1,258  | )            |  |   | 955     |  
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Net Cash Provided by Operating Activities                                                |  |                   | 13,644 |   |              |   | 12,389  |              |  |   | 11,056  |  
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Cash Flows Used in Investing Activities:                                                 |  |                   |        |   |              |   |         |              |  |   |         |  
|Additions to fixed assets, net of acquired amounts                                       |  |                   | (5,294 | ) |              |   | (4,533  | )            |  |   | (5,712  | )
|Proceeds from sale of property and equipment                                             |  |                   |       |   |              |   | 2,168   |              |  |   | 4,057   |  
|Repayment of notes receivable                                                            |  |                   |       |   |              |   | 229     |              |  |   | 149     |  
|Acquisition of The Honor Roll Schools                                                    |  |                   | (2,639 | ) |              |   |        |              |  |   |        |  
|Investment in Product Rights and Trade Names                                             |  |                   | (311   | ) |              |   |        |              |  |   |        |  
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Net Cash Used in Investing Activities                                                    |  |                   | (8,244 | ) |              |   | (2,136  | )            |  |   | (1,506  | )
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Cash Flows from Financing Activities:                                                    |  |                   |        |   |              |   |         |              |  |   |         |  
|Proceeds from exercise of stock options and warrants                                     |  |                   | 3,793  |   |              |   | 187     |              |  |   | 544     |  
|Borrowings of long term debt                                                             |  |                   |       |   |              |   | 4,700   |              |  |   |        |  
|Repayment of long term debt                                                              |  |                   | (2,281 | ) |              |   | (4,195  | )            |  |   | (9,613  | )
|Repayment of subordinated debt                                                           |  |                   |       |   |              |   | (10,380 | )            |  |   | (523    | )
|Proceeds from the issuance of preferred stock                                            |  |                   |       |   |              |   |        |              |  |   | 2,894   |  
|Cash overdraft                                                                           |  |                   |       |   |              |   | (319    | )            |  |   | (3,110  | )
|Debt issuance cost                                                                       |  |                   |       |   |              |   |        |              |  |   | (1,364  | )
|Repayment of capital lease obligations                                                   |  |                   |       |   |              |   |        |              |  |   | (250    | )
|Dividends paid to preferred stockholders                                                 |  |                   |       |   |              |   | (37     | )            |  |   | (78     | )
|Cash distribution of minority interest                                                   |  |                   |       |   |              |   |        |              |  |   | (56     | )
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Net Cash Provided by (Used in) Financing Activities                                      |  |                   | 1,512  |   |              |   | (10,044 | )            |  |   | (11,556 | )
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                     |  |                   | 6,912  |   |              |   | 209     |              |  |   | (2,006  | )
|Cash and cash equivalents at beginning of year                                           |  |                   | 2,925  |   |              |   | 2,716   |              |  |   | 4,722   |  
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  
|Cash and cash equivalents at end of year                                                 |  | $                 | 9,837  |   |              | $ | 2,925   |              |  | $ | 2,716   |  
|                                                                                         |  |                   |        |   |              |   |         |              |  |   |         |  

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



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Consolidated Statements of Cash Flow

(Dollars in thousands)



|                                                                                                                                    |  |                   |       |              |   |              |  |   |      
|----------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ----- | ------------ | - | ------------ |  | - | -----
|                                                                                                                                    |  | Fiscal Year Ended
|                                                                                                                                    |  | July 1, 2006      |       | July 2, 2005 |   | July 3, 2004
|Supplemental Disclosures of Cash Flow Information                                                                                   |  |                   |       |              |   |              |  |   |      
|Cash paid during year for:                                                                                                          |  |                   |       |              |   |              |  |   |      
|Interest                                                                                                                            |  | $                 | 1,246 |              | $ | 2,389        |  | $ | 3,203
|Income taxes                                                                                                                        |  |                   | 99    |              |   | 104          |  |   | 66   
|Non-cash investing and financing activities:                                                                                        |  |                   |       |              |   |              |  |   |      
|Issuance of Preferred stock for dividend payments                                                                                   |  | $                 | 502   |              | $ | 897          |  | $ |     
|Paid in kind preferred stock dividends                                                                                              |  |                   | 487   |              |   | 605          |  |   | 438  
|                                                                                                                                   
|In connection with the purchase of The Honor Roll School, as discussed in Note 3, the fair value of assets acquired are as
follows:
|                                                                                                                                    |  |                   |      
|Cash paid                                                                                                                           |  | $                 | 2,639 |              | $ |             |  | $ |     
|Net liabilities assumed                                                                                                             |  |                   | 331   |              |   |             |  |   |     
|                                                                                                                                    |  |                   |       |              |   |              |  |   |      
|Fair value of assets acquired                                                                                                       |  | $                 | 2,970 |              | $ |             |  | $ |     
|                                                                                                                                    |  |                   |       |              |   |              |  |   |      

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



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies and Company Background:

Nobel Learning Communities, Inc. (collectively with its subsidiaries, the Company) is a leading non-sectarian, for-profit provider of education and educational services for the pre-elementary through
12thgrade market. The Companys programs are offered through a network of private pay general education
pre-elementary, elementary and middle schools, programs for learning challenged students and special purpose high schools. The Company also provides management services for charter schools. These schools operate under various brand names and are
located in California, Florida, Illinois, Maryland, Nevada, New Jersey, North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia and Washington.

Principles of Consolidation and Basis of Presentation:

Effective for the fiscal year ending
July 3, 2004 (Fiscal 2004), the Company changed to a 52-53 week fiscal year ending on the Saturday closest to June 30. The fiscal years ended July 1, 2006 (Fiscal 2006), July 2, 2005 (Fiscal
2005) each include 52 weeks. Fiscal 2004 includes 53 weeks. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and majority-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.

Recognition of Revenues:

The recognition of net revenues meets the following criteria: the existence of an arrangement through an enrollment agreement or contract, the rendering
of educational services, a specific tuition rate and/or fee and probable collection. Net revenues include tuition, fees and other income, reduced by discounts. Fees are received for registration, other educational services and charter school
management fees. Other income is primarily comprised of supplemental fees from summer programs or camps and field trips. Tuition revenues, net of discounts, and other revenues are recognized as services are performed. Any tuition payments received
in advance of the time period for which service is to be performed is recorded as deferred revenue. Charter school management fees are recognized based on a contractual relationship with the charter school and do not include any tuition revenue
received by the charter school. Certain fees may be received in advance of services being rendered, in which case the fee revenue is deferred and recognized over the appropriate period of service.

Cash and Cash Equivalents:

The
Company considers cash on hand, cash in banks, and cash investments with maturities of three months or less when purchased as cash and cash equivalents. The Company maintains funds in accounts in excess of FDIC insurance limits; however, the Company
minimizes this risk by maintaining deposits in high quality financial institutions.

Accounts Receivable and Credit Risk:

The Companys accounts receivable are comprised primarily of tuition due from parents and governmental agencies. Accounts
receivable are presented at estimated net realizable value. The Company uses estimates in determining the collectibility of its accounts receivable and must rely on its evaluation of historical trends, governmental funding processes, specific
customer issues and current economic trends to arrive at appropriate reserves. Material differences may result in the amount and timing of bad debt expense if actual experience differs significantly from management estimates.

The Company provides its services to the parents and guardians of the children attending the schools. The Company does not grant credit for an extended
period of time, nor does it require collateral. Exposure to losses



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



on receivables is principally dependent on each parent/guardians financial condition. The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses. The Companys schools are located in 13 states and as a result, the Company is not dependent on economic conditions in one area or market.

Property and Equipment:

Property and
equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the related assets as follows:



|                                |  |                                                   
|------------------------------- |  | --------------------------------------------------
|Buildings                       |  | 40 years                                          
|Leasehold improvements          |  | The shorter of the leasehold period or useful life
|Furniture and equipment         |  | 3 to 10 years                                     
|Computer software and equipment |  | 3 to 5 years                                      

Maintenance, repairs and minor refurbishments are expensed as incurred. Upon retirement, lease
terminations or other disposition of buildings, leasehold improvements and furniture and equipment, the cost of the items, and the related accumulated depreciation, are removed from the accounts and any gain or loss is included in operations.

Long-Lived and Intangible Assets:

Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An
assets value is impaired if managements estimate of the aggregate future cash flows, undiscounted and without interest charges, to be generated by the asset are less than the carrying value of the asset. Such cash flows consider factors
such as expected future operating income and historical trends, as well as the effects of demand and competition. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the asset over the fair value
of the asset. Such estimates require the use of judgment and numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges.

During Fiscal 2006, Fiscal 2005, and Fiscal 2004, impairment charges of $30,000, $216,000, and $1,095,000 are included in goodwill and other asset
impairments respectively, with respect to certain underperforming schools in continuing operations.

Deferred Financing Costs:

Included in deposits and other assets are deferred financing costs that are incurred by the Company in connection with the issuance of
debt. These costs are deferred and amortized to interest expense over the life of the underlying indebtedness using the interest method adjusted to reflect any early repayments. As of July 1, 2006, $655,000 in deferred financing costs was
carried on the Companys balance sheet.

Income Taxes:

The Company accounts for income taxes using the asset and liability method, in accordance with Statement of Financial Accounting Standard
(SFAS) 109, Accounting for Income Taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates
applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rate is recognized in income in the period of enactment.
A valuation allowance is recorded based on the uncertainty regarding the ultimate realizability of deferred tax assets.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The Company files a U.S. federal income tax return and various state income tax returns, which are
subject to examination by tax authorities. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. The Companys
estimated tax liability is subject to change as examinations of specific tax years are completed in the respective jurisdictions including possible adjustments related to the nature and timing of deductions and the local attribution of income.

Stock Compensation:

On October 6, 2004, the stockholders approved the 2004 Omnibus Incentive Equity Compensation Plan. The total number of shares of common stock available for issuance is 1,395,000. Under the Plan, common stock may be issued in connection
with stock grants, incentive stock options and non-qualified stock options for key employees and outside directors. The purpose of the Plan is to attract and retain quality employees. All grants to date under the Plan (other than a certain stock
grant which was terminated) have been non-qualified stock options or incentive stock options which vest over three years (except that options issued to directors vest at the end of the fiscal year in which the options were granted and options
granted to new directors upon joining the Board of Directors vest immediately).

The number of options granted under the 2004 Omnibus
Incentive Equity Compensation Plan is determined from time to time by the Compensation Committee of the Board of Directors, except for options granted to non-employee directors, which is determined by a formula set forth in the Plan. Non-qualified
stock options are granted by a formula in the 2004 Omnibus Incentive Equity Compensation Plan. All option grants to employees vest over three years. Option grants issued to directors vest at the end of the fiscal year in which the options are
granted. Options granted to new directors upon joining the Board of Directors vest immediately. Options are exercisable for up to ten years from date of grant.

Prior to July 2, 2005, the Company accounted for employee stock option grants using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25 Accounting for
Stock Issued to Employees and related interpretations. Accordingly, compensation expense, if any, was measured as the excess of the underlying stock price over the exercise price on the date of grant. The Company complied with the disclosure
provisions of Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for Stock Based Compensation, as amended by SFAS No. 148 Accounting for Stock-Based CompensationTransition and
Disclosure which required pro-forma disclosure of compensation expense associated with stock options under the fair value method.

Effective July 3, 2005, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board (FASB) SFAS Statement No. 123(R), Share-Based Payment, using modified
prospective-transition method. Under that transition method, compensation cost recognized in Fiscal 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 2, 2005, based on the
grant date fair value estimated in accordance with the original provision of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to July 3, 2005, based on the grant-date fair value estimated in accordance
with the provisions of SFAS 123(R). Results for prior periods have not been restated. For purposes of calculating grant-date fair value, the value of the options is estimated using a Black-Scholes optionpricing formula and amortized to expense
over the options vesting periods.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for grants:



|                                          |  |         |  |                |  |               
|----------------------------------------- |  | ------- |  | -------------- |  | --------------
|                                          |  | Fiscal 
|                                          |  | 2006    |  | 2005           |  | 2004          
|Expected dividend yield                   |  | 0.0%    |  | 0.0%           |  | 0.0%          
|Expected stock price volatility           |  | 36.8%   |  | 48.1%          |  | 50.4%         
|Risk-free interest rate                   |  | 4.0%    |  | 3.0% - 3.1%    |  | 3.13%         
|Weighted average expected life of options |  | 5 years |  | 4 years        |  | 4 years       
|Expected rate of forfeiture               |  | 5.6%    |  | not applicable |  | not applicable

Stock-based compensation expense included in the statement of operations for FY 2006 was
approximately $555,000. As of July 1, 2006 there was approximately $682,000 of total unrecognized stock-based compensation cost related to options granted under our plans that will be recognized over a weighted average period of 1.6 years. The
Company expects to continue its historical practice of issuing stock options which will result in additional stock based compensation in the future, although amounts may vary.

The following table illustrates the effect on net income and earnings per share for FY 2005 and FY 2004 as if the Company had applied the fair value
recognition provisions of SFAS 123 to options granted under the Companys stock option plans in all periods presented. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes optionpricing
formula and amortized to expense over the options vesting periods (dollars in thousands).



|                                                                                         |  |                   |       |   |              |   |        |  
|---------------------------------------------------------------------------------------- |  | ----------------- | ----- | - | ------------ | - | ------ | -
|                                                                                         |  | Fiscal Year Ended |      
|                                                                                         |  | July 2, 2005      |       |   | July 3, 2004 |  
|Net (loss) incomeAs reported                                                            |  | $                 | 2,516 |   |              | $ | (6,081 | )
|Add: stock based compensation included in net (loss) income as reported                  |  |                   |      |   |              |   |       |  
|Deduct stock based compensation determined under fair value based methods for all awards |  |                   | (369  | ) |              |   | (95    | )
|                                                                                         |  |                   |       |   |              |   |        |  
|Pro Forma net (loss) income                                                              |  | $                 | 2,147 |   |              | $ | (6,176 | )
|                                                                                         |  |                   |       |   |              |   |        |  
|Basic earnings (loss) per shareas reported                                              |  | $                 | 0.27  |   |              | $ | (1.01  | )
|Basic earnings (loss) per sharepro forma                                                |  | $                 | 0.21  |   |              | $ | (1.03  | )
|Diluted earnings (loss) per shareas reported                                            |  | $                 | 0.26  |   |              | $ | (1.01  | )
|Diluted earnings (loss) per sharepro forma                                              |  | $                 | 0.22  |   |              | $ | (1.03  | )

Accumulated Other Comprehensive Income (Loss);

Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are excluded from net
income as these amounts are recorded directly as an adjustment to stockholders equity. Accumulated other comprehensive loss is comprised of the cumulative effects of the Companys interest rate swap agreement which amounted to
approximately $0 at July 1, 2006, $47,000 at July 2, 2005 and $204,000 at July 3, 2004.

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different
conditions or if assumptions change. The most significant estimates underlying the accompanying consolidated financial statements include the allowance for doubtful accounts, long-lived assets and goodwill valuations and any resulting impairment,
the valuation of our investments and realization of our deferred tax assets.

Risk and Uncertainties:

Future results of operations of the Company involve a number of risks and uncertainties. Factors that could affect future operating results and cause
actual results to vary materially from historical results include, but are not limited to, consumer acceptance of the Companys business strategy with respect to expansion into new and existing markets, the Companys debt and related
financial covenants, difficulties in managing the Companys growth including attracting and retaining qualified personnel and additional enrollments, goodwill impairment, if any, asset impairment, increased competition, changes in government
policy and regulation and the ability to obtain additional bank financing or capital required to implement fully the Companys business plan.

Negative developments in these areas could have a material effect on the Companys business, financial condition and results of operations.

Accounting for Derivatives:

The Company accounts for derivatives in accordance with SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. This standard, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments, Certain Hedging Activities, an amendment of SFAS
Standard No. 133, establishes accounting and reporting standards requiring that every derivative instrument, such as interest rate swap agreements, be recorded on the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133 also requires that changes in the derivatives fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company records its derivatives at fair value within the consolidated balance
sheet and the changes in fair value of the derivatives are either reported in earnings or are reported in other comprehensive loss in stockholders equity. The fair value represents the estimated amount the Company would receive or pay to
terminate their interest rate swap agreements taking into consideration current interest rates (see Note 10). Derivatives are limited in use and are not entered into for speculative purposes.

New Accounting Pronouncements:

In
June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes, An Interpretation of FASB Statement 109. This interpretation clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006 and will be
adopted by the Company in the first quarter of fiscal year 2008. We are currently evaluating the effect that the adoption of FIN 48 will have on our consolidated results of operations and financial condition.

On October 2005, the FASB released FASB Staff Position (FSP) FAS 13-1, Accounting for Rental Costs Incurred during a Construction
Period. This FSP affects companies that are engaged in construction activities on buildings or grounds, which are accounted for as operating leases. The FSP requires companies to expense rental costs associated with these leases starting on
the date that the tenant is given control of the premises. As a result,



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



companies must cease capitalizing rental costs during construction periods. The FSP is effective for the first reporting period beginning after
December 15, 2005. Retrospective application is permitted but not required. Although this pronouncement has not impacted the Companys results of operations to date, the Company will continue to assess any potential future impacts.

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 154 (SFAS 154),
Accounting Changes and Error Corrections which provides guidance on the accounting for and reporting of accounting changes and correction of errors. This statement changes the requirements for the accounting for and reporting of a change
in accounting principle and applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions.
This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate a material effect upon the adoption of this statement.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-an amendment of Accounting Principles Board (APB)
Opinion No. 29, to eliminate the exception for nonmonetary exchanges of similar productive assets and replace it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in all interim periods beginning after June 15, 2005, with early application permitted for exchanges beginning after November 2004. The Company does not believe that the adoption
of this Statement will have a material impact on the Companys consolidated financial position or results of operations.

2. Earnings (Loss) Per
Share:

The Company follows SFAS 128, Earnings Per Share. Under SFAS 128, companies that are publicly held or have complex
capital structures are required to present basic and diluted earnings per share on the face of the statement of operations. Earnings (loss) per share are based on the weighted average number of shares and common stock equivalents outstanding during
the period. In the calculation of diluted earnings per share, shares outstanding are adjusted to assume conversion of the Companys non-interest bearing convertible preferred stock and the exercise of options and warrants if they are dilutive.
In the calculation of basic earnings per share, the weighted average number of shares outstanding is used as the denominator. The Company sustained a loss for Fiscal 2004. As a result, the common stock equivalents of stock options, warrants and
convertible securities issued and outstanding at July 3, 2004 are not included in the computation of diluted earnings per share as they were antidilutive. Options to purchase 51,500 of common stock from $10.18 to 10.17 were outstanding during
Fiscal 2006 and 23,100 shares of common stock from $16.4375 to $7.875 were outstanding during Fiscal 2005, but these were not included in the computation of diluted earnings per share because the options exercise price was greater than the
average market price of the common shares. Earnings (loss) per share are computed as follows (dollars in thousands):



|                                             |  |                   |           |              |   |              |  |   |           |  
|-------------------------------------------- |  | ----------------- | --------- | ------------ | - | ------------ |  | - | --------- | -
|                                             |  | Fiscal Year Ended |          
|                                             |  | July 1, 2006      |           | July 2, 2005 |   | July 3, 2004 | 
|Basic income (loss) per share:               |  |                   |           |              |   |              |  |   |           |  
|                                             |  |                   |          
|Net income (loss)                            |  | $                 | 4,479     |              | $ | 2,516        |  | $ | (6,081    | )
|Less preferred dividends                     |  |                   | 487       |              |   | 642          |  |   | 516       |  
|                                             |  |                   |           |              |   |              |  |   |           |  
|Net income (loss) available for common stock |  | $                 | 3,992     |              | $ | 1,874        |  | $ | (6,597    | )
|                                             |  |                   |           |              |   |              |  |   |           |  
|Average common stock outstanding             |  |                   | 7,473,013 |              |   | 7,064,199    |  |   | 6,511,912 |  
|                                             |  |                   |           |              |   |              |  |   |           |  
|Basic income (loss) per share                |  | $                 | 0.54      |              | $ | 0.27         |  | $ | (1.01     | )
|                                             |  |                   |           |              |   |              |  |   |           |  



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



|                                                                     |  |                   |            |              |   |              |  |   |           |  
|-------------------------------------------------------------------- |  | ----------------- | ---------- | ------------ | - | ------------ |  | - | --------- | -
|                                                                     |  | Fiscal Year Ended |           
|                                                                     |  | July 1, 2006      |            | July 2, 2005 |   | July 3, 2004 | 
|Diluted income (loss) per share:                                     |  |                   |            |              |   |              |  |   |           |  
|                                                                     |  |                   |           
|Net income (loss) available for common stock and dilutive securities |  | $                 | 4,479      |              | $ | 2,516        |  | $ | (6,597    | )
|Average common stock outstanding                                     |  |                   | 7,473,013  |              |   | 7,064,199    |  |   | 6,511,912 |  
|Options, warrants and convertible preferred stock                    |  |                   | 2,606,637  |              |   | 2,654,782    |  |   |          |  
|                                                                     |  |                   |            |              |   |              |  |   |           |  
|Average common stock and dilutive securities outstanding             |  |                   | 10,079,650 |              |   | 9,718,981    |  |   | 6,511,912 |  
|                                                                     |  |                   |            |              |   |              |  |   |           |  
|Diluted income (loss) per share                                      |  | $                 | 0.44       |              | $ | 0.26         |  | $ | (1.01     | )
|                                                                     |  |                   |            |              |   |              |  |   |           |  

3. Acquisitions

On June 29, 2006 the Company completed the acquisition of certain net assets of The Honor Roll Schools. The Honor Roll Schools include both a preschool and kindergarten through eighth grade school located in
separate facilities on a single campus in Sugar Land, Texas. Cash paid by the Company was approximately $2,639,000 and was paid from existing cash resources. The purchase price has been allocated based on the estimated fair value of the assets and
liabilities acquired at the date of the acquisition, and included, among other items approximately $506,000 of net current liabilities and $175,000 of property and equipment. In addition, the Company has made allocations of $1,235,000 for intangible
assets which include $580,000 for The Honor Roll trade name and $655,000 for the acquired student roster. The remaining purchase price has been recorded as goodwill of $1,735,000. Operating results of The Honor Roll Schools did not have a material
impact on the Companys Fiscal 2006 results of operations. The purchase accounting for The Honor Roll Schools has not been finalized primarily due to a working capital settlement that is scheduled to be completed in the first quarter of Fiscal
2007. This acquisition was not material for disclosure purposes, therefore pro forma information has not been presented. The goodwill related to this will be deductible for tax purposes.

4. Discontinued Operations

The company adopted Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the Impairment or Disposal of Long Lived Assets effective August 1, 2001. Under SFAS No. 144 the results of operations of components of the entity that have either been disposed
of or are classified as held for sale are reported in discontinued operations.

During Fiscal 2004 discontinued operations consisted of
twenty schools and one undeveloped property held for sale. Of the twenty schools, the Company closed fifteen, sold one, and held four for sale. Of these fifteen closed schools, seven were subleased, six were vacant, one was sold, and one was
returned to the landlord under a lease buyout and early termination. Of the six vacant schools, one vacant school, owned by the Company, was sold and one vacant school reached the end of its lease term during the first quarter of Fiscal 2005. The
remaining four continued to be accounted for as discontinued operations through July 2, 2005.

Starting Fiscal 2005, discontinued
operations consisted of eighteen schools and one undeveloped property held for sale. Of the eighteen schools seven were subleased, six were vacant and five held for sale. The undeveloped property was sold during the second quarter of Fiscal 2005. Of
the six vacant, one owned by the Company was sold in the first quarter of Fiscal 2005, two were returned to the respective landlords and the Company has no further obligations under these leases and three remained vacant at the end of Fiscal 2005.



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Of the two schools returned to the respective landlords, one was returned in September 2004 at the
end of its natural lease term and there was no impact to the accrued lease reserve for this school. One school was returned to the landlord prior to the end of the lease term and the Company was released from any future obligation for this school
which resulted in a recapture of the discounted future lease payments that were reserved during Fiscal 2004. The amount of the recapture related to this school was approximately $337,000 in the fourth quarter of Fiscal 2005. In addition, the
Company, during the fourth quarter of Fiscal 2005, reached agreement with the landlord of one of the vacant properties on the buyout amount required if the landlord were able to sell the property to a third party.

Of the five operating schools included in discontinued operations at the start of Fiscal 2005, one was closed and the remaining four were evaluated by
the Company to determine their future viability during the third quarter of Fiscal 2005. Based on the absence of reasonable offers to purchase these schools, the Company determined the four schools would return to operating schools and as such, they
are included in results from continuing operations as of the third quarter of Fiscal 2005. As a result, the Company no longer holds any schools for sale.

Starting Fiscal 2006, discontinued operations consist of ten schools, seven subleased and three vacant. The estimate of future lease obligations for closed schools was reduced by approximately $228,000. During Fiscal
2006 one lease expired and two were returned to the respective landlords and the Company has no further obligations under these leases, accordingly the reserve for future lease obligations for closed schools was reduced by approximately $35,000.
Another property which had been vacant was subleased, reducing the reserve for future lease obligations for closed schools by approximately $900,000. A subleased property had a sublessee with questionable creditworthiness, after establishing a
favorable payment history, the Company reduced its reserve for future lease obligations by approximately $128,000. Lastly, one property was vacated by the sublessee two years prior to the contractual termination of its sublease agreement, the
reserve for future lease obligations for closed schools was increased by approximately $835,000. At the beginning of Fiscal 2007 discontinued operations consisted of seven schools, six of which are subleased, one of which is vacant.

A summary of discontinued operations is as follows (dollars in thousands):



|                                                                    |  |        |      |   |      |   |       |      |  |   |        |  
|------------------------------------------------------------------- |  | ------ | ---- | - | ---- | - | ----- | ---- |  | - | ------ | -
|                                                                    |  | Fiscal |     
|                                                                    |  | 2006   |      |   | 2005 |   |       | 2004 | 
|Revenues                                                            |  | $      |     |   |      | $ | 384   |      |  | $ | 5,432  |  
|Cost of services                                                    |  |        | 402  |   |      |   | 1,131 |      |  |   | 7,714  |  
|                                                                    |  |        |      |   |      |   |       |      |  |   |        |  
|Gross (loss)                                                        |  |        | (402 | ) |      |   | (747  | )    |  |   | (2,282 | )
|Goodwill impairment                                                 |  |        |     |   |      |   |      |      |  |   | (1,052 | )
|Write down of property and equipment                                |  |        |     |   |      |   |      |      |  |   | (1,379 | )
|Reduction (increase) of future lease obligations for closed schools |  |        | 228  |   |      |   | 277   |      |  |   | (3,556 | )
|                                                                    |  |        |      |   |      |   |       |      |  |   |        |  
|Loss from discontinued operations before income tax benefit         |  |        | (174 | ) |      |   | (470  | )    |  |   | (8,269 | )
|Income tax benefit                                                  |  |        | (68  | ) |      |   | (179  | )    |  |   | (3,142 | )
|                                                                    |  |        |      |   |      |   |       |      |  |   |        |  
|Loss from discontinued operations                                   |  | $      | (106 | ) |      | $ | (291  | )    |  | $ | (5,127 | )
|                                                                    |  |        |      |   |      |   |       |      |  |   |        |  

5. Cash Equivalents:

The Company has an agreement with its primary bank that allows the bank to act as the Companys agent in making daily investments with available funds in excess of a selected minimum account balance. This
investment amounted to approximately $8,225,000 and $248,000 at July 1, 2006 and July 2, 2005 respectively. The Companys funds were invested in money market accounts, which exceed federally insured limits. The Company



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



believes it is not exposed to any significant credit risk on cash and cash equivalents as such deposits are maintained in high quality financial
institutions.

6. Property and Equipment:

The balances of major property and equipment classes were as follows (dollars in thousands):



|                                          |  |              |         |   |              |   |         |  
|----------------------------------------- |  | ------------ | ------- | - | ------------ | - | ------- | -
|                                          |  | July 1, 2006 |         |   | July 2, 2005 |  
|Land                                      |  | $            | 2,407   |   |              | $ | 2,407   |  
|Buildings                                 |  |              | 6,390   |   |              |   | 6,222   |  
|Assets under capital lease obligations    |  |              | 884     |   |              |   | 1,224   |  
|Leasehold improvements                    |  |              | 25,351  |   |              |   | 23,956  |  
|Furniture and equipment                   |  |              | 37,474  |   |              |   | 34,305  |  
|Construction in progress                  |  |              | 521     |   |              |   | 945     |  
|                                          |  |              |         |   |              |   |         |  
|                                          |  |              | 73,027  |   |              |   | 69,059  |  
|Accumulated depreciation and amortization |  |              | (47,415 | ) |              |   | (43,052 | )
|                                          |  |              |         |   |              |   |         |  
|                                          |  | $            | 25,612  |   |              | $ | 26,007  |  
|                                          |  |              |         |   |              |   |         |  

Included in property and equipment in Fiscal 2006 is construction in progress of $521,000 for
refurbishment of one school and equipment for one new school to be opened in Fiscal 2007. The current projects are expected to be completed by the end of Fiscal 2007 at an additional cost of approximately $240,000.

Depreciation expense from continuing operations was $5,555,000, $5,880,000, and $5,526,000, for Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively.
There was no amortization of capital leases included in depreciation expense for Fiscal 2006 and Fiscal 2005, and $150,000 for Fiscal 2004. Accumulated amortization of capital leases amounted to $884,000 and $1,224,000 at July 1, 2006 and
July 2, 2005, respectively.

7. Goodwill

The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but
reviewed for impairment annually or more frequently if certain indicators arise.

The Company estimates fair values for each reporting unit
using discounted cash flow projections in evaluating and measuring a potential impairment charge on an annual basis in the fourth quarter of each fiscal year. The Company engages an independent third party consultant to review its calculations
required by SFAS 142 and if necessary the level two analysis in order to determine the amount of goodwill impaired. Any impairment of goodwill resulting from the required testing by SFAS 142 is recorded as a charge to income from operations.

During the fourth quarter of Fiscal 2006 and Fiscal 2005, the Company performed its annual impairment test as required by SFAS 142. The
level one impairment test for Fiscal 2006 and Fiscal 2005 indicated that no impairment existed for the Companys reporting units; as such the Company did not record goodwill impairment for Fiscal 2006 or Fiscal 2005.

During the fourth quarter of Fiscal 2004, the Company performed its annual impairment test as required by SFAS 142. The level one impairment test for
Fiscal 2004 indicated that impairment existed in the Companys reporting units as a result of operating performance. The Company recorded an impairment loss related to this test of $2,273,000.

In addition, goodwill specifically related to closed schools or in connection with the Companys plan to sell schools identified as under-performing
and/or which did not fit well with the Companys business or geographic strategies resulted in an impairment of $1,053,000 during Fiscal 2004. Goodwill impairment for these schools is included in loss from discontinued operations.



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



8. Intangible assets, net

Intangible assets include trade names, a franchise agreement, The Honor Roll student roster, and non-compete agreements. All intangibles except for the trade names are being amortized over their expected useful lives
which range from 3-7 years. The trade names have been determined to have an indefinite life and are not amortized. The Company will evaluate the remaining useful lives of the trade names each reporting period to determine whether events and
circumstances continue to support an indefinite useful life.

In Fiscal 2004, the Company entered into non-compete agreements with two
former executives of the Company. The total value of these non-compete agreements were $705,000 and are being amortized over a three year period.

Amortization expense for intangible assets was $223,500, $230,000, and $374,000 for Fiscal 2006, Fiscal 2005, and Fiscal 2004 respectively. At July 1, 2006, the remaining amortization of intangible assets is as follows: $198,000 in
2007, $136,000, in 2008, $126,000 in 2009, and $126,000 in 2010 through 2013.

The Companys intangible assets were as follows
(dollars in thousands):



|                             |  |                                              |  |                     |       |                         |   |                     |  |                         |       |  |   |    
|---------------------------- |  | -------------------------------------------- |  | ------------------- | ----- | ----------------------- | - | ------------------- |  | ----------------------- | ----- |  | - | ---
|                             |  |                                              |  | July 1, 2006        |       | July 2, 2005           
|                             |  | WeightedAverageAmortizationPeriod (inmonths) |  | GrossCarryingAmount |       | AccumulatedAmortization |   | GrossCarryingAmount |  | AccumulatedAmortization
|Amortized intangible assets: |  |                                              |  |                     |       |                         |   |                     |  |                         |       |  |   |    
|Franchise agreement          |  | 84                                           |  | $                   | 379   |                         | $ | 159                 |  | $                       | 151   |  | $ | 151
|Non-compete agreements       |  | 43                                           |  |                     | 405   |                         |   | 322                 |  |                         | 958   |  |   | 660
|Trade Names                  |  | indefinite                                   |  |                     | 665   |                         |   |                    |  |                         |      |  |   |   
|Honor Roll Student Roster    |  | 84                                           |  |                     | 655   |                         |   |                    |  |                         |      |  |   |   
|                             |  |                                              |  |                     |       |                         |   |                     |  |                         |       |  |   |    
|                             |  |                                              |  | $                   | 2,104 |                         | $ | 481                 |  | $                       | 1,109 |  | $ | 811
|                             |  |                                              |  |                     |       |                         |   |                     |  |                         |       |  |   |    

9. Long Term Note Receivable:

The Company has a $2,500,000 subordinated note receivable pursuant to a Credit Agreement entered into in Fiscal 2000 with Total Education Solutions, Inc. (TES). The TES note receivable was due May 2005 and
$2,250,000 of the note receivable can be converted into 30% ownership of TES. During Fiscal 2003, the Company reserved $1,000,000 of the note receivable with TES. Due to continued performance deterioration during the second quarter of Fiscal 2005,
the Company reserved the remainder of the TES note of $1,500,000, which is included as a valuation allowance in the Companys general and administrative expense.

TES is currently in default of its senior debt. The senior debt was acquired by the Company subsequent to the end of Fiscal 2006. The Company intends to negotiate an extension of all amounts due from TES. The outcome
of that negotiation is not currently known.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



10. Debt:

As of the dates indicated below debt consisted of the following (dollars in thousands):



|                                     |  |              |        |   |              |   |        |  
|------------------------------------ |  | ------------ | ------ | - | ------------ | - | ------ | -
|                                     |  | July 1, 2006 |        |   | July 2, 2005 |  
|Long Term Obligations:               |  |              |        |   |              |   |        |  
|Revolving and term credit facilities |  | $            | 13,000 |   |              | $ | 15,000 |  
|Other                                |  |              | 180    |   |              |   | 461    |  
|                                     |  |              |        |   |              |   |        |  
|                                     |  |              | 13,180 |   |              |   | 15,461 |  
|Less current portion                 |  |              | (2,180 | ) |              |   | (2,281 | )
|                                     |  |              |        |   |              |   |        |  
|                                     |  | $            | 11,000 |   |              | $ | 13,180 |  
|                                     |  |              |        |   |              |   |        |  

Senior and Senior Subordinated Debt Changes

On February 20, 2004 the Company entered into a $22,995,000 Credit Agreement with Harris Trust and Savings Bank (the Credit Agreement)
which provides for a $14,995,000 term loan (the Term Loan) and an $8,000,000 revolving credit commitment (the Revolving Credit Commitment). Proceeds from the Term Loan were used by the Company to retire approximately
$15,000,000 in obligations outstanding under the Companys previous Amended and Restated Credit Agreement with Fleet Bank. The Term Loan will mature on February 15, 2009 and provides for $2,000,000 annual amortization with the balance paid
at maturity. The Revolving Credit Commitment is scheduled to terminate on February 15, 2009. The Companys obligations under the Credit Agreement are guaranteed by subsidiaries which are 80% or more owned by the Company, and collateralized
in part by a pledge of stock of the Companys subsidiaries and liens on real and personal property. In addition, the Credit Agreement is secured by liens on all real property owned by the Company. With respect to the Term Loan, during fiscal
2006 the Company made scheduled payments in the amount of $2,000,000. The outstanding balance of the Term Loan was $13,000,000 and $15,000,000 as of July 1, 2006 and July 2, 2005 respectively. There were no amounts outstanding under the
Revolving Credit Commitment as of July 1, 2006 or July 2, 2005.

In connection with the issuance of the Credit Agreement, the
Company incurred $1,364,000 of cost related to legal, investment banking and commitment fees. These fees are amortized over the life of the loan to interest expense. As of July 1, 2006 the unamortized balance of fees was $655,000.

The Credit Agreement bears interest, at the Companys option, at either of the following rates, which may be adjusted in quarterly increments
based on the achievement of performance goals. For the Term Loan and the Revolving Credit Commitment, the applicable rate is (1) an adjusted LIBOR rate plus a debt to defined EBITDA-dependent rate ranging from 1.75% to 2.25%, or (2) base
rate plus a debt to defined EBITDA-dependent rate ranging from 0.5% to 1.0%.

The Company also pays a letter of credit fee based on the
face amount of each letter of credit calculated at the rate per year then applicable to loans under the Credit Agreement bearing interest based on an adjusted LIBOR rate plus a debt to defined EBITDA-dependent rate ranging from 1.75% to 2.25%. Under
the Credit Agreement, the Company may issue up to $3,500,000 in letters of credit. Any amounts outstanding reduce amounts available under the Revolving Credit Commitment. At July 1, 2006, the Company had approximately $1,699,000, committed
under outstanding letters of credit. At July 1, 2006, the letter of credit fee was 1.75%.

The Credit Agreement and the Notes contain
customary covenants and provisions that restrict the Companys ability to change its business, declare dividends, grant liens, incur additional indebtedness and make capital expenditures. In addition, the Credit Agreement and the Notes provide
that the Company must meet or exceed defined amounts for EBITDA and fixed charges and must not exceed certain leverage ratios. At July 1, 2006 the Company was in compliance with all required covenants under the Credit Agreement.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



From Fiscal 2004 through Fiscal 2006 the Company entered into six amendments to its Credit Agreement
as follows:

Fiscal 2004

Amendment No. 1: April 2004To modify the definition of Capital Expenditures, to extend the period of time the Company had to sell a certain property, extend the period of time permitted to refinance a
certain capital lease and permit the Company to change the end of its fiscal periods.

Fiscal 2005

Amendment No. 2: February 2005To place certain encumbrances on the Revolving Credit Commitment

Amendment No. 3: April 2005To reverse the encumbrances on the Revolving Credit Commitment placed by amendment 2 above and
permit certain exclusions from defined EBITDA.

Amendment No. 4: June 2005To readvance $4,700,000 of the Term
Loan in connection with retirement of the senior subordinated Notes described below, increase the Revolving Credit Commitment to $10,000,000, increase permitted letter of credits to $3,500,000, reduce Term Loan and Revolving Credit Commitment
pricing, permit payment of dividends on certain preferred stock in cash rather than in kind, modify certain covenants based on the change in capital structure from the retirement of the senior subordinated notes and make certain other changes in
definitions.

Fiscal 2006

Amendment No. 5: May 2006To reduce and consolidate the pricing margin with respect to the Term Loan and the Revolving Credit Commitment.

Amendment No. 6: June 2006To consent to the acquisition of certain assets of the Honor Roll School, Inc., and THRS II, Inc. as
well as the waiver of the requirement to make a prepayment of net cash proceeds from the exercise of stock warrants as well as the waiver of the requirement to make a prepayment of net cash proceeds from the exercise of stock warrants and permit the
Company to acquire the senior obligations of Total Education Solutions, Inc.

On February 20, 2004 the Company issued a $5,000,000
senior subordinated note to Blesbok LLC and a $5,000,000 senior subordinated note to Mollusk Holdings LLC (the Notes) to retire the previously outstanding $10,000,000 senior subordinated note to Allied Capital Corporation. On
June 3, 2005 the Company retired its $10,000,000 notes with $5,300,000 of cash from operations and in connection with Amendment No. 4 above, $4,700,000 from a readvance under its existing Term Loan. In addition, during fiscal 2005, the
Company expensed $28,000 of unamortized debt fees related to the retirement of the senior subordinated Notes.

Maturities of debt
obligations are as follows (dollars in thousands):



|            |  |   |       
|----------- |  | - | ------
|Fiscal Year |  |  
|2007        |  |   | 2,180 
|2008        |  |   | 2,000 
|2009        |  |   | 9,000 
|            |  |   |       
|            |  | $ | 13,180
|            |  |   |       



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Interest Rate Swap

The Company does not enter into derivative transactions for trading purposes. The Company had an interest rate swap with Harris Trust and Savings Bank. Under the swap, $9,643,000 of the Companys term loan was
allocated to the swap agreement. The Company used this derivative financial instrument to manage its exposure to fluctuations in interest rates. The instrument involved, to varying degrees, market risk, as the instrument was subject to rate and
price fluctuations, and elements of credit risk in the event the counterparty should default. The instrument expired as of July 1, 2006. At July 2, 2005, the Companys interest rate swap contract outstanding had a total notional
amount of $5,892,000. Under the interest rate swap contract, the Company agreed to pay a fixed rate of 5.46% and the counterparty agreed to make payments based on 3-month LIBOR. The market value of the interest rate swap agreement at July 2,
2005 resulted in a liability of $76,000 and is included as a component of Accumulated Other Comprehensive Loss of $47,000, net of taxes.

11. Accounts
Payable and Other Current Liabilities:

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



|                                  |  |              |        |              |   |       
|--------------------------------- |  | ------------ | ------ | ------------ | - | ------
|                                  |  | July 1, 2006 |        | July 2, 2005
|Accounts payable                  |  | $            | 3,230  |              | $ | 2,384 
|Accrued payroll and related items |  |              | 4,705  |              |   | 4,934 
|Accrued for closed schools        |  |              | 1,765  |              |   | 2,670 
|Accrued income and property taxes |  |              | 1,975  |              |   | 1,139 
|Accrued insurance                 |  |              | 321    |              |   | 398   
|Accrued rent                      |  |              | 253    |              |   | 290   
|Other accrued expenses            |  |              | 2,229  |              |   | 2,546 
|                                  |  |              |        |              |   |       
|                                  |  | $            | 14,478 |              | $ | 14,361
|                                  |  |              |        |              |   |       

12. Lease Obligations:

Future minimum lease obligations, by year and in the aggregate, for all real properties, vehicle and copier leases that the Company and its subsidiaries have entered into, consisted of the following at July 1,
2006 (dollars in thousands):



|                    |  |                             |       |                                                       |   |                                                    |  |   |        |  |   |         |  |   |       |  |   |       
|------------------- |  | --------------------------- | ----- | ----------------------------------------------------- | - | -------------------------------------------------- |  | - | ------ |  | - | ------- |  | - | ----- |  | - | ------
|                    |  | Operating Lease Commitments |       | Closed LocationCash SubleaseAmounts Dueto the Company |   | Net UncoveredCash On ClosedSchool LeaseCommitments
|                    |  | Continuing Operations       |       | DiscontinuedOperations                                |   | Total OperatingLeaseCommitments                    |  |  
|Fiscal Year         |  | Vehicle andCopier Leases    |       | Private Payand CharterSchool RealEstate Leases        |   | Closed LocationReal EstateLeases                   |  |   |       
|2007                |  | $                           | 1,041 |                                                       | $ | 27,629                                             |  | $ | 2,051  |  | $ | 30,721  |  | $ | 890   |  | $ | 1,161 
|2008                |  |                             | 772   |                                                       |   | 26,438                                             |  |   | 2,051  |  |   | 29,261  |  |   | 926   |  |   | 1,125 
|2009                |  |                             | 264   |                                                       |   | 24,467                                             |  |   | 2,051  |  |   | 26,782  |  |   | 878   |  |   | 1,173 
|2010                |  |                             | 140   |                                                       |   | 22,859                                             |  |   | 2,037  |  |   | 25,036  |  |   | 821   |  |   | 1,216 
|2011                |  |                             | 64    |                                                       |   | 20,141                                             |  |   | 1,992  |  |   | 22,197  |  |   | 810   |  |   | 1,182 
|2012 and thereafter |  |                             | 17    |                                                       |   | 78,052                                             |  |   | 6,174  |  |   | 84,243  |  |   | 1,000 |  |   | 5,174 
|                    |  |                             |       |                                                       |   |                                                    |  |   |        |  |   |         |  |   |       |  |   |       
|Total               |  | $                           | 2,298 |                                                       | $ | 199,586                                            |  | $ | 16,356 |  | $ | 218,240 |  | $ | 5,325 |  | $ | 11,031
|                    |  |                             |       |                                                       |   |                                                    |  |   |        |  |   |         |  |   |       |  |   |       



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Charter school lease commitments total $1,842,000 of which 100% are covered by sublease contracts
between the Company and the charter schools to which the Company provides management services.

Net uncovered cash on closed school lease
commitments are the net cash amounts due from the Company to third party landlords not covered by underlying leases from third party sub-tenants or assignee. The amount is the net of closed school lease commitments less closed location cash sublease
amounts due to the Company. The Companys liability with respect to closed school lease commitments could change if sublessees default under their sublease with the Company or if the Company is successful in subleasing additional closed schools
or extending existing sublease agreements. Some of the closed school lease commitments extend beyond the term of the current subleases on those properties.

Leases included in discontinued operations total seven leases, five of which are subleased, the remaining two are vacant. Additionally, the Company has ten schools for which their leases have been assigned to third
parties. In the table above, the ten assigned leases are included with closed location cash sublease amounts due to the Company. These leases are covered 100% by the assignee. If such parties under assigned or sublease agreements default, the
Company is contingently liable.

During Fiscal 2006, the Company received notice under a previously subleased property that the existing
sub-lessee exited the sublease two years prior to its contract termination. The annual base rents under this sublease are currently $835,000 and the lease term is through May 2015. The company believes the former sub-lessee remains obligated under
the terms of the sublease, however the sub-lessee is no longer performing under the sublease. The Company has recorded a lease reserve in the amount of $835,000 in connection with this situation; the amount reserved is based on the assumption that
another tenant sublessee will be located in the next year. In addition to the amount reserved, the Company continues to bear customary triple-net lease obligations related to this location. The Company intends to take all appropriate actions to
protect its interest under the sublease, however until agreement can be reached either through negotiation or the courts the company is obligated to continue landlord rent payments. The Company has continued to explore alternatives to sublease the
location in order to mitigate the potential loss resulting from the attempt of the previous sub-lessee to vacate the location prior to the end of their contract term. To the extent the Company is not successful in mitigating its obligations under
the lease it will incur additional expense to its statement of operations.

Most of the above leases contain annual rent increases based on
changes in consumer price indexes or other formulas, which are not reflected in the above schedule. Rent expense for all operating leases included in continuing operations was $28,491,000, $27,602,000, and $26,856,000 for Fiscal 2006, Fiscal 2005
and Fiscal 2004, respectively.

Rent expense and adjustments to lease reserves for all operating leases included in discontinued operations
resulted in income of $16,000, and expense of $13,000, and expense of $1,404,000 for Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively. These leases are typically triple-net leases requiring the Company to pay all applicable real estate taxes,
utility expenses, maintenance, and insurance costs.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



13. Stockholders Equity:

Preferred Stock:

A summary of the Companys convertible preferred stock is as follows:



|         |  |           |              |             |              |          
|-------- |  | --------- | ------------ | ----------- | ------------ | ---------
|         |  | Issued    |              | Outstanding
|         |  |           | July 1, 2006 |             | July 2, 2005
|Series D |  | 1,063,830 |              | 1,063,830   |              | 1,063,830
|Series E |  | 1,531,523 |              | 1,531,523   |              | 1,457,286
|Series F |  | 688,066   |              | 688,066     |              | 654,721  
|         |  |           |              |             |              |          
|         |  | 3,283,419 |              | 3,283,419   |              | 3,175,837
|         |  |           |              |             |              |          

On November 29, 2004, the Company sent redemption notices to all of the holders of its Series
A Convertible Preferred Stock and Series C Convertible Preferred Stock. Pursuant to provisions in the respective Certificates of Designation, Preferences, Rights and Limitations of the Series A Convertible Preferred Stock and the Series C
Convertible Preferred Stock, the Company had the option to redeem the Series A and Series C Convertible Preferred Stock at $1.00 per share. The Company set December 30, 2004 as the redemption date. At any time prior to the redemption date,
holders of the Series A Convertible Preferred Stock had the right to convert each of their preferred shares into 0.2940 share of Common Stock, and holders of the Series C Convertible Preferred Stock had the right to convert each of their preferred
shares into 0.25 share of Common Stock. At December 30, 2004, all holders of Series A and Series C Convertible Preferred Stock, or 3,030,408 shares of convertible preferred stock, exercised their right to convert, into an aggregate of 798,700
shares of Common Stock.As a result, at January 1, 2005, no shares of Series A or Series C Convertible Preferred Stock were outstanding.

On September 9, 2003, the Company issued in a private placement an aggregate of 588,236 shares of Series F Convertible Preferred Stock, $.001 par value, in exchange for an investment of $3,000,000, net of
expenses of $106,000. The Series F Convertible Preferred Stock is convertible into common stock at a conversion rate, subject to adjustment, of one share of common stock for each share of Series F Convertible Preferred Stock. Holders of Series F
Convertible Preferred Stock are entitled to dividends, which shall accrue and be paid quarterly in arrears at an annual rate of 5% of the Series F Purchase Price during years 1, 2 and 3. If the average stock price per share during the last 5 days of
the third year is greater than $8 per share, then the dividend rate would remain at 5% for years 4 and 5, otherwise it would increase to 8%. Under either scenario, the dividend rate would increase to 12% in year 6. In addition, if during the 12
month period ending June 2004, the Companys EBITDA, as defined, is less than $12,000,000, the dividend rate would increase to 8% until the Company achieves an EBITDA of at least $14,000,000. The dividends will be paid in kind with additional
shares of Series F Convertible Preferred Stock during the first three years, and in cash or in kind, at the option of the Company thereafter. All dividends will be paid prior to and in preference to the common stock. Upon liquidation, the holders of
Series F Convertible Preferred Stock are entitled to receive, before any distribution or payment is made upon the common stock, the Series F Purchase Price plus any unpaid dividends, plus a liquidation preference equal to the greater of 1.5 times
the Series F Purchase Price, or the amount such holders would have received if all shares of Series F Convertible Preferred Stock had been converted into common stock immediately prior to such liquidation. Each outstanding share of Series F
Convertible Preferred Stock is entitled to 0.9623 of a vote, subject to adjustment. The Company has the right to force the holders of the Series F Convertible Preferred Stock to convert their shares into common stock once certain defined conditions
are realized. The proceeds from the issuance of the Series F Convertible Preferred Stock was used for the repayment of debt, to meet certain bank



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



covenants, to meet certain requirements relating to the negotiations for the sixth amendment to the Amended and Restated Loan and Security Agreement,
requirements for working capital and other general corporate purposes. At July 1, 2006, 688,066 shares of Series F Convertible Preferred Stock are outstanding and an additional 8,597 shares of paid in kind dividends were accrued and unissued.

The Series F Convertible Preferred Stock is convertible into the Companys common stock at a conversion price that was set at a
slight discount to market at the time of issuance. The Company determined that the discount related to the issuance of the Series F Convertible Preferred Stock was immaterial. Two directors of the Company are affiliated with institutions that hold
shares of the Series F Convertible Preferred Stock. Subsequent to the issuance of the Series F Convertible Preferred Stock, NASDAQ raised a concern as to whether the Series F Convertible Preferred Stock issuance was considered compensation to a
director under its Marketplace Rules and therefore needed stockholder approval under its Marketplace Rules. In accordance with a proposal presented at the November 10, 2005 shareholder meeting, the Companys shareholders ratified the
issuance of these shares.

On June 17, 2003, the Company issued in a private placement an aggregate of 1,333,333 shares of Series E
Convertible Preferred Stock, $.001 par value, for a purchase price of $6,000,000. The Series E Convertible Preferred Stock is convertible into common stock at a conversion rate, subject to adjustment, of one share of common stock for each share of
Series E Convertible Preferred Stock. Holders of Series E Convertible Preferred Stock are entitled to dividends which shall accrue and be paid quarterly in arrears at an annual rate of 5% of the Series E Purchase Price during years 1, 2 and 3. If
the average stock price per share during the last 5 days of the third year is greater than $8 per share, then the dividend rate would remain at 5% for years 4 and 5, otherwise it would increase to 8%. Under either scenario, the dividend rate would
increase to 12% in year 6. The dividends will be paid in kind with additional shares of Series E Convertible Preferred Stock during the first three years, and in cash or in kind, at the option of the Company thereafter. All dividends will be paid
prior to and in preference to the common stock. Upon liquidation, the holders of Series E Convertible Preferred Stock are entitled to receive, before any distribution or payment is made upon the common stock, the Series E Purchase Price plus any
unpaid dividends, plus a liquidation preference equal to the greater of 1.5 times the Series E Purchase Price, or the amount such holders would have received if all shares of Series E Convertible Preferred Stock had been converted into common stock
immediately prior to such liquidation. The Company has the right to force the holders of the Series E Convertible Preferred Stock to convert their shares into common stock once certain defined conditions are realized. At July 1, 2006, 1,531,523
shares of Series E Convertible Preferred Stock was outstanding and an additional 19,143 shares of paid in kind dividends were accrued and unissued.

In 1995, the Company issued 1,063,830 shares of the Companys Series D Convertible Preferred Stock for a purchase price of $2,000,000. The Series D Convertible Preferred Stock was convertible, until August 31, 2003, to common
stock at a conversion rate, subject to adjustment, of 1/4 share of common stock for each share of Series D Convertible Preferred Stock. The Series D Convertible Preferred Stock is no longer convertible. Holders of Series D Convertible Preferred
Stock are not entitled to dividends, unless dividends are declared on the Companys common stock. Upon liquidation, the holders of shares of Series D Convertible Preferred Stock are entitled to receive, before any distribution or payment is
made upon any common stock, $1.88 per share plus any unpaid dividends. At July 1, 2006, 1,063,830 shares of Series D Convertible Preferred Stock were outstanding.

Stockholder Rights Agreement:

In May 2000, the Board of Directors of the Company approved a
Stockholder Rights Agreement. Under the Stockholder Rights Agreement, preferred stock purchase rights were distributed as a dividend at the rate of one Right for each share of common stock outstanding as of the close of business on June 1,
2000. Each Right entitles the holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock of the Company at an exercise price of $18.00.



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Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The Rights will not be exercisable unless a person or group acquires, or announces the intent to
acquire beneficial ownership under certain circumstances. The Rights are redeemable for $.001 per Right at the option of the Board of Directors at any time prior to the close of business on the 10thbusiness day after the announcement of a stock acquisition event. If not redeemed, the Rights will expire on May 31, 2010. Prior to the date upon which
the rights would become exercisable under the Rights Agreement, the Companys outstanding stock certificates will represent both the shares of common stock and the Rights, and the Rights will trade only with the shares of common stock.

The Rights are designed to provide the Board of Directors sufficient time to evaluate proposed change-in-control transactions by
encouraging potential acquirers to negotiate with the Board of Directors before attempting a tender offer for the Company. The Rights are not intended to prevent transactions on terms that are fair to the Companys stockholders nor to deter any
potential acquirer who is willing to complete a transaction on such terms.

The Stockholder Rights Agreement was amended on August 4,
2002, and August 5, 2002, by Amendments No. 1 and 2, respectively, in connection with the Merger Agreement, on June 17, 2003 in connection with the issuance of the Series E Convertible Preferred Stock and September 9, 2003 in
connection with the Series F Convertible Preferred Stock.

On September 6, 2005, the Nominating and Corporate Governance Committee
recommended to the Companys full Board of Directors that the Stockholder Rights Agreement be repealed. The Board of Directors unanimously approved the Committees resolution to repeal the Stockholder Rights Agreement and instructed and
authorized the officers of the Company to take any and all actions necessary to effectuate the termination of the Stockholder Rights Agreement in due course, but in any event, to be completed no later than November 30, 2005. Subsequently all
actions necessary to effectuate the termination of the Stockholder Rights Agreement were taken and the Stockholder Rights Agreement was terminated. Redemption rights of approximately $8,000 were paid.

Common Stock Warrants:

In connection
with a $10,000,000 senior subordinated note issued in July 1998, the Company issued warrants to acquire an aggregate of 531,255 shares of the Companys common stock at $8.5625 per share. The senior subordinated note was retired
February 20, 2004. In accordance with terms of the warrant the number of shares available for purchase and the price of purchase were adjusted to prevent dilution of the ownership position at the time the warrant was issued. In addition, to
accommodate a drop in the price of common stock prior to May 31, 2000 the exercise price was adjusted to $6.85 per share. In accordance with these terms the adjusted number of common shares available for purchase increased to 585,803 at $6.21
per share.

In June 2006 the warrants were exercised for the purchase of 585,803 shares of common stock of the company at $6.21 per share
for total proceeds to the company of $3,639,097. The exercise represented the purchase of 100% of the shares available under the warrant. Subsequent to the purchase no warrants are outstanding for the purchase of common shares of the company.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Activity with respect to the Companys common stock warrants was as follows:



|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|--------------------- |  | --------------- | - |  | ------------------------ | ---- | -------------------- | -- |  | - | ---- |  | - | ----
|                      |  | Number ofshares |   |  | Range of price per share |      | WeightedAveragePrice
|                      |  |                 |   |  | (in dollars)             |      |                     
|Balance June 30, 2003 |  | 840,267         |   |  | $                        | 7.00 |                      | to |  | $ | 7.52 |  | $ | 7.19
|Granted               |  |                |   |  |                          |      |                      |    |  |   |      |  |   |     
|Terminated            |  | (309,042        | ) |  |                          | 7.52 |                      | to |  |   | 7.52 |  |   |     
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|Balance July 3, 2004  |  | 531,225         |   |  | $                        | 7.00 |                      | to |  | $ | 7.00 |  | $ | 7.00
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|Granted               |  |                |   |  |                          |      |                      |    |  |   |      |  |   |     
|Terminated            |  |                |   |  |                          |      |                      |    |  |   |      |  |   |     
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|Balance July 2, 2005  |  | 531,225         |   |  | $                        | 7.00 |                      | to |  | $ | 7.00 |  | $ | 7.00
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|Adjusted              |  | 54,578          |   |  |                          |      |                      |    |  |   |      |  |   |     
|Exercised             |  | (585,803        | ) |  |                          |      |                      |    |  |   |      |  |   |     
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     
|Balance July 1, 2006  |  |                |   |  | $                        |     |                      |    |  | $ |     |  | $ |    
|                      |  |                 |   |  |                          |      |                      |    |  |   |      |  |   |     

2004 Omnibus Incentive Equity Compensation Plan

On October 6, 2004, the stockholders approved the 2004 Omnibus Incentive Equity Compensation Plan. The total number of shares of common stock
available for issuance is 1,395,000. Under the Plan, common stock may be issued in connection with stock grants, incentive stock options and non-qualified stock options for key employees and outside directors. The purpose of the Plan is to attract
and retain quality employees. All grants to date under the Plan have been non-qualified stock options which vest over three years (except that options issued to directors vest at the end of the fiscal year in which the options were granted and
options granted to new directors upon joining the Board of Directors vest immediately).

The number of options granted under the 2004
Omnibus Incentive Equity Compensation Plan is determined from time to time by the Compensation Committee of the Board of Directors, except for options granted to non-employee directors, which is determined by a formula set forth in the Plan.
Incentive stock options are granted at market value or above, and non-qualified stock options are granted at a price fixed by the Compensation Committee at the date of grant. Options are exercisable for up to ten years from date of grant.

2000 Stock Option Plan for Consultants:

In February 2000, the Company established the 2000 Stock Option Plan for Consultants. This plan reserved up to an aggregate of 200,000 shares of common stock of the Company for issuance in connection with
non-qualified stock options for non-employee consultants. At July 1, 2006 and July 2, 2005, 60,000 options were granted under this plan.

1995 Stock Incentive Plan:

With the approval of the 2004 Omnibus Incentive Equity Compensation Plan,
the 1995 Stock Incentive Plan was terminated and the remaining shares reserved for issuance thereunder of 719,044 were cancelled.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



A summary of the status of the Companys stock option plans and other employee options as
July 1, 2006, July 2, 2005, and July 3, 2004 and changes during the years then ended is as follows:



|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|---------------------------- |  | ------------------------ | - |  | ------------------- | - | ------------------- | ------------------------- | ---- | ------ | ------- | ------------------------- | - | ----
|                             |  |                          |   |  | Options Outstanding |   | Options Exercisable
|                             |  | SharesAvailablefor Grant |   |  | Shares              |   |                     | WeightedAverageGrantPrice |      | Shares |         | WeightedAverageGrantPrice
|Balance at June 30, 2003     |  | 737,167                  |   |  | 739,843             |   |                     | $                         | 7.40 |        | 648,176 |                           | $ | 7.61
|Granted at market            |  | (221,500                 | ) |  | 221,500             |   |                     |                           | 5.44 |        |        |                           |   |    
|Cancelled outside plan       |  |                         |   |  | (95,000             | ) |                     |                           | 9.45 |        |        |                           |   |    
|Cancelled                    |  | 302,493                  |   |  | (302,493            | ) |                     |                           | 7.89 |        |        |                           |   |    
|Exercised                    |  |                         |   |  | (103,334            | ) |                     |                           | 5.25 |        |        |                           |   |    
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|Balance at July 3, 2004      |  | 818,160                  |   |  | 460,516             |   |                     | $                         | 6.09 |        | 217,350 |                           | $ | 7.04
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|Granted at market            |  | (203,932                 | ) |  | 203,932             |   |                     |                           | 7.12 |        |        |                           |   |    
|Cancelled                    |  |                         |   |  | (47,716             | ) |                     |                           | 8.12 |        |        |                           |   |    
|Exercised                    |  |                         |   |  | (39,200             | ) |                     |                           | 4.77 |        |        |                           |   |    
|Increase in shares available |  | 715,340                  |   |  |                    |   |                     |                           |     |        |        |                           |   |    
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|Balance at July 2, 2005      |  | 1,329,568                |   |  | 577,532             |   |                     | $                         | 6.38 |        | 344,265 |                           | $ | 6.68
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|Granted at market            |  | (200,100                 | ) |  | 200,100             |   |                     |                           | 9.68 |        |        |                           |   |    
|Cancelled                    |  | 9,334                    |   |  | (12,784             | ) |                     |                           | 8.35 |        |        |                           |   |    
|Exercised                    |  |                         |   |  | (20,166             | ) |                     |                           | 7.64 |        |        |                           |   |    
|Increase in shares available |  |                         |   |  |                    |   |                     |                           |     |        |        |                           |   |    
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     
|Balance at July 1, 2006      |  | 1,138,802                |   |  | 744,682             |   |                     | $                         | 7.20 |        | 445,549 |                           | $ | 6.42
|                             |  |                          |   |  |                     |   |                     |                           |      |        |         |                           |   |     

The following table summarizes information about stock options outstanding at July 1, 2006:



|                         |  |                     |  |                                                 |  |                           |      |                   |         |                           |   |     
|------------------------ |  | ------------------- |  | ----------------------------------------------- |  | ------------------------- | ---- | ----------------- | ------- | ------------------------- | - | ----
|                         |  | Options Outstanding |  | Options Exercisable                            
|Range of Exercise Prices |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife (years) |  | WeightedAverageGrantPrice |      | NumberExercisable |         | WeightedAverageGrantPrice
|$  4.69    to    $  6.63 |  | 293,500             |  | 6.32                                            |  | $                         | 5.32 |                   | 219,667 |                           | $ | 5.37
|7.03    to        8.88   |  | 226,082             |  | 7.40                                            |  |                           | 7.23 |                   | 200,882 |                           |   | 7.22
|9.13    to      10.21    |  | 225,100             |  | 8.93                                            |  |                           | 9.62 |                   | 25,000  |                           |   | 9.13
|                         |  |                     |  |                                                 |  |                           |      |                   |         |                           |   |     
|$  4.69    to    $10.21  |  | 744,682             |  | 7.44                                            |  | $                         | 7.20 |                   | 445,549 |                           | $ | 6.42
|                         |  |                     |  |                                                 |  |                           |      |                   |         |                           |   |     

The aggregate intrinsic value for options outstanding and options exercisable at July 1, 2006 were
approximately $2,204,000 and $1,668,000 respectively.



F-25



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



14. Other (Income) Expense:

Other (income) expense consists of the following (dollars in thousands):



|                                          |  |        |      |   |      |   |      |      |  |   |      |  
|----------------------------------------- |  | ------ | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                          |  | Fiscal |     
|                                          |  | 2006   |      |   | 2005 |   |      | 2004 | 
|Interest income                           |  | $      | (376 | ) |      | $ | (149 | )    |  | $ | (197 | )
|Rental (income) expense                   |  |        | (31  | ) |      |   | (17  | )    |  |   | 19   |  
|Depreciation related to rental properties |  |        |     |   |      |   |     |      |  |   | 105  |  
|Minority interest in income               |  |        |     |   |      |   | (18  | )    |  |   | 28   |  
|Other                                     |  |        | 57   |   |      |   |     |      |  |   |     |  
|                                          |  |        |      |   |      |   |      |      |  |   |      |  
|                                          |  | $      | (350 | ) |      | $ | (184 | )    |  | $ | (45  | )
|                                          |  |        |      |   |      |   |      |      |  |   |      |  

15. Income Taxes:

The provision for income taxes attributable to income (loss) before income taxes consisted of the following (dollars in thousands):



|                                                             |  |        |       |   |      |   |       |      |  |   |        |  
|------------------------------------------------------------ |  | ------ | ----- | - | ---- | - | ----- | ---- |  | - | ------ | -
|                                                             |  | Fiscal |      
|                                                             |  | 2006   |       |   | 2005 |   |       | 2004 | 
|Current:                                                     |  |        |       |   |      |   |       |      |  |   |        |  
|Federal                                                      |  | $      | 1,568 |   |      | $ | 205   |      |  | $ | (1,124 | )
|State                                                        |  |        | 230   |   |      |   | 24    |      |  |   | (96    | )
|                                                             |  |        |       |   |      |   |       |      |  |   |        |  
|Total Current                                                |  |        | 1,798 |   |      |   | 229   |      |  |   | (1,220 | )
|Deferred tax expense (benefit)                               |  |        | 1,077 |   |      |   | 1,269 |      |  |   | (1,665 | )
|                                                             |  |        |       |   |      |   |       |      |  |   |        |  
|Income tax expense (benefit), net of discontinued operations |  |        | 2,875 |   |      |   | 1,498 |      |  |   | (2,885 | )
|Income tax benefit related to discontinued operations        |  |        | (68   | ) |      |   | (179  | )    |  |   | (3,142 | )
|                                                             |  |        |       |   |      |   |       |      |  |   |        |  
|Income tax expense                                           |  | $      | 2,943 |   |      | $ | 1,677 |      |  | $ | 257    |  
|                                                             |  |        |       |   |      |   |       |      |  |   |        |  

Reconciliation between the statutory federal income tax rate and the effective income tax rates on
income before income taxes is as follows (dollars in thousands):



|                                           |  |        |       |      |   |       |      |  |   |      |  
|------------------------------------------ |  | ------ | ----- | ---- | - | ----- | ---- |  | - | ---- | -
|                                           |  | Fiscal |      
|                                           |  | 2006   |       | 2005 |   |       | 2004 | 
|U.S. federal statutory rate                |  | $      | 2,560 |      | $ | 1,524 |      |  | $ | (236 | )
|State taxes, net of federal tax benefit    |  |        | 376   |      |   | 179   |      |  |   | (28  | )
|Goodwill and other non deductible expenses |  |        | 7     |      |   | (26   | )    |  |   | 267  |  
|Prior year over accrual                    |  |        |      |      |   |      |      |  |   | 192  |  
|Other                                      |  |        |      |      |   |      |      |  |   | 62   |  
|                                           |  |        |       |      |   |       |      |  |   |      |  
|                                           |  | $      | 2,943 |      | $ | 1,677 |      |  | $ | 257  |  
|                                           |  |        |       |      |   |       |      |  |   |      |  



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Deferred income taxes reflect the impact of temporary differences between amounts of assets and
liabilities for financial reporting purposes and such amounts as measured by tax laws. Temporary differences and carry-forwards that give rise to a significant portion of deferred tax assets and (liabilities) are as follows (dollars in thousands):



|                                                       |  |              |        |   |              |   |        |  
|------------------------------------------------------ |  | ------------ | ------ | - | ------------ | - | ------ | -
|                                                       |  | July 1, 2006 |        |   | July 2, 2005 |  
|Goodwill amortization and impairment                   |  | $            | (3,113 | ) |              | $ | (2,077 | )
|Fixed asset related to depreciation                    |  |              | 2,720  |   |              |   | 1,901  |  
|Fixed asset related to impairment                      |  |              | 511    |   |              |   | 522    |  
|Accrued school closings and restructuring              |  |              | 688    |   |              |   | 1,015  |  
|Federal net operating losses and credit carry forwards |  |              |       |   |              |   | 930    |  
|State net operating losses                             |  |              | 1,891  |   |              |   | 1,336  |  
|Swap contract                                          |  |              |       |   |              |   | 29     |  
|Accruals and reserves                                  |  |              | 1,253  |   |              |   | 1,672  |  
|Other                                                  |  |              | 261    |   |              |   | 395    |  
|                                                       |  |              |        |   |              |   |        |  
|                                                       |  |              | 4,211  |   |              |   | 5,723  |  
|                                                       |  |              |        |   |              |   |        |  
|Valuation allowance                                    |  |              | (1,866 | ) |              |   | (1,311 | )
|                                                       |  |              |        |   |              |   |        |  
|Net deferred tax asset                                 |  | $            | 2,345  |   |              | $ | 4,412  |  
|                                                       |  |              |        |   |              |   |        |  

Certain of the Companys subsidiaries have state net operating loss carry-forwards ranging
from approximately $37,000 to $6,114,000 as of July 1, 2006, which can be carried forward from five to 20 years depending on the state and will expire between 2006 and 2021, if not utilized. A valuation allowance was established against loss
carry-forwards due to the uncertainty of their realization as well as a lack of earnings history of certain of the Companys subsidiaries in those states. The Company has utilized all previously generated federal net operating loss
carry-forwards.

16. Employee Benefit Plans:

The Company has a 401(k) Plan in which eligible employees may elect to enroll after six months of service on scheduled enrollment dates. The Company matches 25% of an employees contribution to the Plan, up to 6% of the employees
salary. The Companys matching contributions under the Plan were $324,000, $327,000, and $312,000 for Fiscal 2006, Fiscal 2005, and Fiscal 2004, respectively.

17. Fair Value of Financial Instruments:

Fair value estimates, methods and assumptions are set forth below for the
Companys financial instruments at July 1, 2006 and July 2, 2005.

Cash and cash equivalents, receivables, investments and
current liabilities: Fair value approximates the carrying value of cash and cash equivalents, receivables and current liabilities as reflected in the consolidated balance sheets at July 1, 2006 and July 2, 2005 because of the short-term
maturity of these instruments.

The TES note receivable of $2,500,000 reflects a valuation allowance of $2,500,000 (see Note 9). This note
is fully reserved.

Long-term debt: The carrying values for the Companys long-term debt of $13,000,000 and $15,461,000 at
July 1, 2006 and July 2, 2005, respectively, approximated market value based on current rates that management believes could be obtained for similar debt.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



18. Commitments and Contingencies:

The Company is engaged in legal actions arising in the ordinary course of its business. The Company currently believes that the ultimate outcome of all
such pending matters will not have a material adverse effect on the Companys consolidated financial position. The significance of these pending matters on the Companys future operating results and cash flows depends on the level of
future results of operations and cash flows as well as on the timing and amounts, if any, of the ultimate outcome.

The Company carries
fire and other casualty insurance on its schools and liability insurance in amounts which management believes is adequate for its operations. As is the case with other entities in the education and preschool industry, the Company cannot effectively
insure itself against certain risks inherent in its operations. Some forms of child abuse have insurance sublimits per claim in the general liability coverage.

19. Related Party Transactions:

In June 1998, the Company issued a $10,000,000 10% senior subordinated note (the
Allied Note) to Allied Capital Corporation, of which Daniel L. Russell, who served as a director of the Company until July 2004, is a Principal. Payments on the Allied Note were subordinate to the Companys senior bank debt. In
connection with this financing transaction, the Company also issued warrants to acquire 531,255 shares of Common Stock and granted certain rights to require the Company to register for resale by the holder of the Common Stock issuable upon exercise
of the warrants under the Securities Act of 1933.

On February 20, 2004, the Company retired the Allied Note by issuing a $5,000,000
senior subordinated note to Blesbok LLC (Blesbok) and a $5,000,000 senior subordinated note to Mollusk Holdings LLC (Mollusk). Steven B. Fink, who serves as a director of the Company, is Chief Executive Officer of
Mollusks member, Lawrence Investments, L.L.C. The senior subordinated notes issued to Blesbok and Mollusk were due August 15, 2009 with an interest rate of 13.25%. The senior subordinated notes were paid in full on June 3, 2005.

In September 2004, the Company entered into a License Agreement with NetSuite, Inc. for the license of an online business application
known as NetSuite for approximately $600,000. One of the Companys directors, Mr. Fink, also serves as a director of NetSuite, Inc.

On June 17, 2003, the Company issued an aggregate of 1,333,333 shares of its Series E Preferred Stock, $.001 par value, in exchange for an investment of $6,000,000 pursuant to a Series E Convertible Preferred Stock Purchase Agreement
dated as of June 17, 2003 by and among the Company, Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P. David L. Warnock, who serves as a director of the Company, is a managing member of the sole general
partner of Camden Partners Strategic Fund II-A, L.P. and Camden Partners Strategic Fund II-B, L.P.

On September 9, 2003, the Company
issued an aggregate of 588,236 shares of its Series F Convertible Preferred Stock, $.001 par value, in exchange for an investment of $3 million pursuant to that certain Series F Convertible Preferred Stock Purchase Agreement. Proceeds were used to
repay debt, and to meet certain bank covenants for working capital and other general corporate purposes. Because the proposed equity infusion involved parties affiliated with members of the Companys Board, the Companys Board of Directors
approved the formation of a special committee of the Board, comprised of two independent and disinterested directors, Messrs. Havens and Monaco, to examine and evaluate the merits of the proposed Series F Convertible Preferred Stock transaction, and
to approve any such transaction which it deemed to be appropriate. This special committee unanimously approved the transaction.



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



20. Segment Information:

In accordance with SFAS 131, Disclosures about Segments of an Enterprise and Related Information, the private pay schools are disclosed as a segment. The Company primarily manages the same type of business
in its private pay schools. The Company also performs back office services for three charter schools and through most of Fiscal 2005 operated The Activities Club. In accordance with SFAS 131, the Company discloses the charter schools and The
Activities Club as separate segment information in the other category. The Activities Club was closed during Fiscal 2005.



F-29



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The table below presents information about the reported operating income of the Company for Fiscal
2006, Fiscal 2005 and Fiscal 2004 (dollars in thousands):



|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|----------------------------------- |  | -------------- | ------- | ----- | - | --------- |  | ----- | ----- |  | - | -------
|                                    |  | PrivateSchools |         | Other |   | Corporate |  | Total
|Fiscal 2006                         |  |                |         |       |   |           |  |       |       |  |   |        
|Revenues                            |  | $              | 166,182 |       | $ | 2,147     |  | $     |      |  | $ | 168,329
|Gross profit                        |  |                | 21,315  |       |   | 885       |  |       |      |  |   | 22,200 
|Depreciation and amortization:      |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 4,287   |       | $ |          |  | $     | 1,028 |  | $ | 5,315  
|Discontinued operations             |  |                | 463     |       |   |          |  |       |      |  |   | 463    
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total depreciation and amortization |  | $              | 4,750   |       | $ |          |  | $     | 1,028 |  | $ | 5,778  
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Goodwill                            |  |                | 38,374  |       |   |          |  |       |      |  |   | 38,374 
|Segment assets                      |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 82,304  |       | $ | 1,080     |  | $     | 3,035 |  | $ | 86,419 
|Discontinued operations             |  |                |        |       |   |          |  |       |      |  | $ |       
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total assets                        |  | $              | 82,304  |       | $ | 1,080     |  | $     | 3,035 |  | $ | 86,419 
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Fiscal 2005                         |  |                |         |       |   |           |  |       |       |  |   |        
|Revenues                            |  | $              | 161,964 |       | $ | 2,240     |  | $     |      |  | $ | 164,204
|Gross profit                        |  |                | 21,029  |       |   | 727       |  |       |      |  |   | 21,756 
|Depreciation and amortization:      |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 5,105   |       | $ | 463       |  | $     | 542   |  | $ | 6,110  
|Discontinued operations             |  |                | 69      |       |   |          |  |       |      |  |   | 69     
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total depreciation and amortization |  | $              | 5,174   |       | $ | 463       |  | $     | 542   |  | $ | 6,179  
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Goodwill                            |  |                | 36,639  |       |   |          |  |       |      |  |   | 36,639 
|Segment assets                      |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 73,387  |       | $ | 1,762     |  | $     | 2,732 |  | $ | 77,881 
|Discontinued operations             |  |                | 463     |       |   |          |  |       |      |  |   | 463    
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total assets                        |  | $              | 73,850  |       | $ | 1,762     |  | $     | 2,732 |  | $ | 78,344 
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Fiscal 2004                         |  |                |         |       |   |           |  |       |       |  |   |        
|Revenues                            |  | $              | 156,024 |       | $ | 2,337     |  | $     |      |  | $ | 158,361
|Gross Profit                        |  |                | 19,773  |       |   | 741       |  |       |      |  |   | 20,514 
|Depreciation and amortization       |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 4,795   |       | $ | 498       |  | $     | 606   |  | $ | 5,899  
|Discontinued operations             |  |                | 1,292   |       |   | 563       |  |       |      |  |   | 1,855  
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total depreciation and amortization |  | $              | 6,087   |       | $ | 1,061     |  | $     | 606   |  | $ | 7,754  
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Goodwill                            |  |                | 36,639  |       |   |          |  |       |      |  |   | 36,639 
|Segment assets                      |  |                |         |       |   |           |  |       |       |  |   |        
|Continuing operations               |  | $              | 74,358  |       | $ | 3,571     |  | $     | 5,472 |  | $ | 83,401 
|Discontinued operations             |  |                | 2,287   |       |   | 177       |  |       |      |  |   | 2,464  
|                                    |  |                |         |       |   |           |  |       |       |  |   |        
|Total assets                        |  | $              | 76,645  |       | $ | 3,748     |  | $     | 5,472 |  | $ | 85,865 
|                                    |  |                |         |       |   |           |  |       |       |  |   |        



F-30



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##### Table of Contents

Nobel Learning Communities, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



21. Quarterly Results of Operations (unaudited):

(In thousands, except per share data)

The
following table shows certain unaudited financial information for the Company for the interim periods indicated. The unaudited financial information has been prepared by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Companys financial position. Quarterly results may vary from year to year depending on
the timing and amount of revenues and costs associated with new school development and acquisitions.



|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|------------------------------------------------------ |  | ------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | -------------- | - |  | ---- | ------ | - | ---- | - | ------ | ---- |  | ---- | ------ | - |  | - | ------ |  | - | ------
|Quarterly Results Adjusted For Discontinued
Operations |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |     
|                                                       |  | First Quarter |        |   | Second Quarter |   |        | Third Quarter |  |   | Fourth Quarter
|                                                       |  | 2006          |        |   | 2005           |   |        | 2006          |  |   | 2005           |   |  | 2006 |        |   | 2005 |   |        | 2006 |  | 2005
|Revenues                                               |  | $             | 37,502 |   |                | $ | 36,277 |               |  | $ | 42,299         |   |  | $    | 41,288 |   |      | $ | 43,934 |      |  | $    | 43,156 |   |  | $ | 44,594 |  | $ | 43,483
|Gross profit                                           |  |               | 2,809  |   |                |   | 2,419  |               |  |   | 6,109          |   |  |      | 5,670  |   |      |   | 6,390  |      |  |      | 6,337  |   |  |   | 6,892  |  |   | 7,330 
|Income (loss) from continuing operations               |  |               | (647   | ) |                |   | (941   | )             |  |   | 1,302          |   |  |      | 1,133  |   |      |   | 1,758  |      |  |      | 712    |   |  |   | 2,172  |  |   | 1,903 
|Income (loss) from discontinued operations             |  |               | (66    | ) |                |   | (99    | )             |  |   | (68            | ) |  |      | (134   | ) |      |   | (6     | )    |  |      | (116   | ) |  |   | 34     |  |   | 58    
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Net income (loss)                                      |  | $             | (713   | ) |                | $ | (1,040 | )             |  | $ | 1,234          |   |  | $    | 999    |   |      | $ | 1,752  |      |  | $    | 596    |   |  | $ | 2,206  |  | $ | 1,961 
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Basic income (loss) per share:                         |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Continuing operations                                  |  | $             | (0.10  | ) |                | $ | (0.17  | )             |  | $ | 0.16           |   |  | $    | 0.14   |   |      | $ | 0.22   |      |  | $    | 0.08   |   |  | $ | 0.27   |  | $ | 0.23  
|Discontinued operations, net of tax                    |  |               | (0.01  | ) |                |   | (0.01  | )             |  |   | (0.01          | ) |  |      | (0.02  | ) |      |   |       |      |  |      | (0.02  | ) |  |   | 0.01   |  |   | 0.01  
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Net income (loss)                                      |  | $             | (0.11  | ) |                | $ | (0.18  | )             |  | $ | 0.15           |   |  | $    | 0.12   |   |      | $ | 0.22   |      |  | $    | 0.06   |   |  | $ | 0.28   |  | $ | 0.24  
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Diluted income (loss) per share:                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Continuing operations                                  |  | $             | (0.10  | ) |                | $ | (0.17  | )             |  | $ | 0.13           |   |  | $    | 0.11   |   |      | $ | 0.18   |      |  | $    | 0.07   |   |  | $ | 0.22   |  | $ | 0.19  
|Discontinued operations, net of tax                    |  |               | (0.01  | ) |                |   | (0.01  | )             |  |   | (0.01          | ) |  |      | (0.01  | ) |      |   |       |      |  |      | (0.01  | ) |  |   |       |  |   | 0.01  
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       
|Net income (loss)                                      |  | $             | (0.11  | ) |                | $ | (0.18  | )             |  | $ | 0.12           |   |  | $    | 0.10   |   |      | $ | 0.18   |      |  | $    | 0.06   |   |  | $ | 0.22   |  | $ | 0.20  
|                                                       |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |      |        |   |  |   |        |  |   |       

During the fourth quarters of Fiscal 2006, Fiscal 2005 and Fiscal 2004, the Company recorded
certain adjustments that impacted net income. These adjustments predominantly relate to goodwill impairments, reserves and impairments related to assets included in discontinued operations, and a note receivable valuation allowance and are
summarized below.



|                                                                                             |  |                |      |   |      |   |      |  |   |      
|-------------------------------------------------------------------------------------------- |  | -------------- | ---- | - | ---- | - | ---- |  | - | -----
|                                                                                             |  | Fourth Quarter
|                                                                                             |  | 2006           |      |   | 2005 |   | 2004
|Goodwill impairment related to continuing operations                                         |  | $              |     |   |      | $ |     |  | $ | 2,273
|Impairment of assets related to continuing operations                                        |  |                | 30   |   |      |   | 216  |  |   | 1,095
|Increase (reduction) of reserves and impairment of assets related to discontinued operations |  |                | (138 | ) |      |   |     |  |   | 4,601



F-31