SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-KSB

[X]      Annual Report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934 for the fiscal year ended September 29, 1996.

[ ]      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 1-14052

                       KIDDIE ACADEMY INTERNATIONAL, INC.
       (Exact name of small business issuer as specified in its charter)


         Delaware                                               52-1938283
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                              Identification No.)

                    108 Wheel Road, Bel Air, Maryland 21015
             (Address of principal executive offices)   (Zip Code)

Issuer's telephone number, including area code:  (410) 515-0788

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 per share
           (Title of Class)

Check  whether  the issuer  (1) has filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Securities  Exchange  Act of 1934 during the past 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 [ ]

Check if disclosure  of delinquent  filers in response to Item 405 of Regulation
S-B is not contained herein, and no disclosure will 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-KSB or any  amendment to
this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year:  $4,791,698.

The aggregate market value of voting Common Stock held by  non-affiliates of the
registrant as of December 11, 1996, computed by reference to the last sale price
for such stock on that date as reported on the Nasdaq SmallCap Stock Market, was
approximately $4,125,000.

At December  11,  1996,  the number of shares  outstanding  of the  registrant's
Common Stock, with $0.01 par value, was 2,025,000.

Portions of the  registrant's  Proxy  Statement  for its 1997 Annual  Meeting of
Shareholders  have been  incorporated  by  reference  in Part III of this Annual
Report on Form 10-KSB.

Transitional Small Business Disclosure Format     YES [   ]            NO  [ X ]


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                                     Part I

ITEM 1.           BUSINESS

General

         Kiddie  Academy  International,   Inc.,  a  Delaware  corporation  (the
"Company"),  was incorporated on June 28, 1995 as a parent company to succeed to
the ownership and operation of the Company's  three  wholly-owned  subsidiaries:
Kiddie Academy Child Care Learning  Centers,  Inc.,  incorporated in Maryland in
1981,  which  operates  Company-owned   education-based  commercial  child  care
centers;  Kiddie Academy Franchising Systems, Inc.,  incorporated in Maryland in
1992,  which  operates the Company's  child care franchise  business;  and Kid's
Craft,  Inc.,  incorporated  in Maryland in 1989,  which  operates the Company's
school supply and equipment distribution  business.  During the last four years,
the  Company  has  experienced  rapid and  substantial  growth in the  number of
centers  opened and under  development.  As of September  29,  1996,  the Kiddie
Academy(R) system consisted of 49 centers, 17 of which were Company-owned and 32
of which were franchised, with an additional 64 franchised centers under various
stages  of  development  (23  centers  under  lease and 41  centers  in the site
selection stage).  Overall, Kiddie Academy centers are open or under development
in 15 states.

         The Company began  utilizing in fiscal year 1996 a 52 to 53 week fiscal
year  (comprised  of 13  four-week  periods),  ending on the  Sunday  closest to
September  30.  All  references  to fiscal  year 1996 are to the 52 weeks  ended
September 29, 1996.

         The Company  believes that it has  benefited  from a number of national
demographic trends including an increased birth rate through the early 1990s, an
increase in working mothers  employed outside the home and a growing emphasis by
employers on providing  child care  benefits  for  employees.  According to U.S.
Government  statistics,  births in 1989  exceeded  4,000,000  for the first time
since 1964, and continued to exceed that number in each of 1990,  1991 and 1992.
Furthermore,  the percentage of all American children under age six with mothers
in the labor force grew from 39% in 1975 to 58% in 1990,  and the  percentage of
children  receiving  center-based  child  care  increased  from 13% of the total
number of children receiving child care in 1977 to 28% in 1990. In addition, the
number of children who are ages five to 12 increased to approximately 34 million
in 1995 and is projected to increase to in excess of 36 million by 2000.

         The Company has developed a  comprehensive  education-based  child care
program   for  its   centers.   Each  Kiddie   Academy   center   utilizes   its
age-appropriate,  education-based  curriculum  designed to promote  each child's
intellectual,  social,  physical  and  emotional  growth.  In  addition  to  the
traditional areas of language arts, mathematics,  science and creative arts, the
Kiddie Academy  curriculum  and services  include a preschool  computer  science
program and a foreign  language  program.  Many Kiddie Academy  centers offer to
their  enrollees,  for an additional  fee, the  opportunity  to  participate  in
COMPUTERTOTS(R),   an  educational  computer  enrichment  program  designed  for
preschoolers.  Kiddie Academy centers  incorporate a number of features designed
to

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promote child safety and to support the Kiddie Academy curriculum.  For example,
many Kiddie Academy centers have "low walls" (i.e.,  interior walls of four feet
in height) which allow for greater visibility  throughout the center,  resulting
in enhanced security for the children.  In addition to interactive learning aids
and  educational  toys,  many Kiddie Academy centers also include an area called
"Kid's Towne USA," which is a miniature town comprised of child-sized  buildings
such as a post office,  grocery store, library and restaurant,  built inside the
center.  The Kiddie Academy  program also  emphasizes  continuous  communication
between  teachers  and parents  concerning  each child's  development  which the
Company believes is critical to maintaining  high levels of parental  confidence
and satisfaction.

         The  Company  has  developed  a   comprehensive   set  of  systems  and
methodologies  with respect to its  operating,  accounting  and quality  control
procedures which enable it to maintain uniform high quality standards throughout
its Company-owned and franchised centers. These systems and methodologies, which
are compiled in a series of manuals,  were  developed by the Company  based upon
its 15 years of  experience  in the  child  care  industry  and are  continually
revised and updated.

         The  Company  provides  a full  range of  services  in  support  of its
franchisees to develop and open their centers. These services include assistance
in  site  selection,  assistance  in  center  design,  training,  assistance  in
obtaining regulatory  approvals,  assistance  throughout the construction phase,
assistance  relating to the  center's  grand  opening  and  ongoing  operational
support,   including  providing  systems  to  process  each  center's  financial
information  at  the  Company's  corporate  headquarters.  The  Company  creates
economies of scale by using the same staff and  resources to develop and support
both Company-owned and franchised centers.

         Kid's Craft is a retail  distributor  of school  supplies,  educational
toys and equipment  currently serving both Company-owned and franchised centers.
Currently  operating from a retail/warehouse  in Bel Air, Maryland,  Kid's Craft
offers Company-owned and franchised centers the opportunity to purchase start-up
equipment,  supplies and ongoing consumables at competitive prices. All supplies
sold by Kid's Craft meet the Company's standards for safety and quality. Centers
typically  purchase  a  portion  of  their  start-up  equipment  and  continuing
requirements of consumable supplies from Kid's Craft.  Therefore,  as the number
of Company-owned and franchised  centers grow, Kid's Craft revenues are expected
to increase.  Plans for Kid's Craft also include expansion of its customer base,
which  currently  includes  the  general  public,  through  retail  sales and by
marketing to other child care centers and public and private  schools  through a
mail order  catalogue.  See  "Management's  Discussion and Analysis of Financial
Condition and Results of Operations -- Forward Looking Statements."

Business Strategy

         The Company is engaged in a dual growth strategy to increase its market
penetration, consisting of a strategic balance of Company-operated center growth
and  franchised-center  growth. By using the same corporate staff which develops
the new Company centers to assist  franchisees in locating and developing  their
new centers, the Company can achieve certain economies of scale,

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expanded expertise and efficiencies in the new center development process.

         Whether franchised or Company-operated, each Kiddie Academy center must
meet or exceed certain physical, trade area, location and demographic standards.
Each  location  for  a  potential   Kiddie  Academy  center  is  reviewed  by  a
multi-disciplinary  committee of the Company's key  executives  for adherence to
these  standards.  The Company limits its site selection  activities to selected
metropolitan areas which meet its standards and show potential for growth.

         The Company  continually  evaluates  its  strategy  with respect to the
balance  of  its  franchised-center growth and  Company-operated  center growth.
Given  the  number  of  franchised  centers  currently  under  development,  the
Company's  current plans are to focus on the "ramp-up" to profitable  enrollment
levels through  Company-operated  center growth and the  advancement of existing
franchised centers under development.

Products and Services

         Child Care Services

         Management  seeks to have each Kiddie Academy center  conveniently  and
attractively located in economically and demographically-appealing  communities,
having an above average  concentration  of dual-income,  young families.  Kiddie
Academy  facilities  are  typically  leased  for a 10-year  term  (with  renewal
options) from commercial real estate developers who meet the Company's  criteria
for quality,  resources,  and experience.  Developers  construct and fund Kiddie
Academy specified tenant  improvements.  The Company enjoys favorable  relations
with such  developers  and many are seeking to build  additional  Kiddie Academy
centers.  A  prototypical  Kiddie  Academy  center is a  one-story  building  of
approximately  7,500  square  feet  located  on  approximately  1 acre  of  land
constructed in accordance with specified designs  developed by the Company.  The
prototypical  center  is  designed  to  accommodate  approximately  125  to  200
children.  The  centers  generally  contain a broad  array of  specified  design
features,  such as a  combination  of high and low walls to allow  for  enhanced
visibility throughout the facility. The Company utilizes a computer-aided design
and drafting (CADD) system to design unit floor plans for both Company-owned and
franchised  centers  in an effort to  maximize  safety  and  revenue  generation
through optimum utilization of floor space.

         Each  center is  equipped  with a variety  of audio  and  visual  aids,
educational  toys, games,  puzzles and supplies and has an adjacent  playground,
many of which are divided  into  separate  areas for  different  age groups with
age-appropriate  equipment and toys. In addition, many centers contain a feature
called  "Kid's  Towne  USA," which is a  miniature  town made up of  child-sized
buildings such as a post office,  grocery store,  library and restaurant,  built
inside the center.  This area is used to enhance  skills such as language  arts,
math and large muscle development, and for role-playing activities.

         The various classrooms within a center are decorated with a variety of
colorful pictures,

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nursery rhyme depictions, seasonal pictures, maps, bilingual calendars and color
charts, and other age-appropriate materials designed to stimulate the children's
curiosity and to support the Kiddie  Academy  curriculum.  Colorful  educational
carpets display themes  appropriate for various age groups such as the alphabet,
numbers,  time and  educational  board games.  Decorative  wall hangings in each
classroom correlate to the Kiddie Academy curriculum's monthly and weekly themes
and provide other learning supplements.

         Company-owned and franchised centers are open throughout the year, five
days per week,  from 6:30 AM to at least 6:00 PM. Certain  centers have extended
hours depending on local conditions such as the length of the typical commute of
the parents.  Each center provides those children attending on a full-time basis
with a hot  lunch and two  snacks,  all of which are  prepared  on the  center's
premises.

         Children may be enrolled on a full-time or part-time basis. Tuition for
the programs  varies  depending  on the  location of the center,  the age of the
child and whether the child attends on a full-time or part-time  basis.  Tuition
is generally higher for infants than it is for older children,  due, in part, to
the lower  child/staff  member ratio required by most licensing  authorities for
the care of infants.  Tuition is proportionally higher for students attending on
a part-time basis.  Tuition is typically paid on a weekly basis and must be paid
in advance.  Tuition for full-time  enrollment at  Company-owned  and franchised
centers  ranges from $95 to $210 per week, and for part-time  enrollment  ranges
from $25 to $70 per week. Kiddie Academy systemwide  enrollment at September 29,
1996 was 3,872 children.

         Educational Program

         Throughout  the  year,  monthly  themes  are  introduced  in a  child's
classroom and divided into specific weekly  programs and daily projects.  During
the  school-year  months  (September  through  June) the  curriculum  focuses on
traditional  structured academics.  In the summer months, the emphasis shifts to
recreation and socialization  through athletic  activities and field trips. As a
child advances through Kiddie Academy, the specific skills learned at each level
serve as a foundation for learning at the next level.  The different  levels are
as follows:

INFANT   PROGRAM  -  Infants  are  in  the  midst  of   undergoing   a  dramatic
transformation  from a  dependent  newborn  to an active and  responsive  infant
during  their first year.  Staff work  closely with parents to customize a daily
routine that will fit family needs.  Kiddie  Academy's  care is centered  around
keeping each child  comfortable,  stimulated and healthy overall,  while working
hand in hand with parents.

TODDLER  PROGRAM - Toddlers  are very busy and need a broad range of  activities
from which to choose.  Kiddie  Academy's  toddler  activities  are plentiful and
chosen  to keep the child  engaged,  active  and  stimulated.  Kiddie  Academy's
toddler  program   promotes   intellectual,   social,   emotional  and  physical
development.  A  stimulating  environment  is created to nurture  curiosity  and
motivate each child to explore, experiment, and problem solve.

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TWO YEAR OLD PROGRAM - Kiddie Academy's  preschool  program is designed to guide
the  tremendous  intellectual,  social and emotional  growth  expected  during a
child's  second  year.  The Kiddie  Academy  curriculum  enriches  each  child's
vocabulary  and  language  skills  by  making  reading  a part of the  every day
routine.  Two-year olds are given the freedom to test by trial and error. Kiddie
Academy's staff are trained to encourage each child to take on new challenges.

THREE YEAR OLD PROGRAM - With the third  birthday  comes the beginning of a time
when the world is filled  with  imagination.  At Kiddie  Academy  having  fun is
usually also a well orchestrated  learning  experience.  Language and vocabulary
development  and other more  traditional  academic areas are fun for children in
Kiddie Academy's program. As with each of the age groups, parents are encouraged
to become involved and to contribute to design the appropriate program for their
child.

FOUR YEAR OLD  PROGRAM - Kiddie  Academy's  curriculum  prepares  each child for
school intellectually,  as well as socially and emotionally. This program builds
an academic foundation,  including the essential ideas of counting, alphabet and
size  relationships,  and there is a strong focus on the language arts. Teachers
meet  with  parents  throughout  the year to keep  them up to date on all of the
wonderful new  developmental  milestones  four-year  olds will reach during this
year.

FIVE YEAR OLD  PROGRAM - Kiddie  Academy's  kindergarten  program is designed to
provide each child with  individualized  academic content.  The academic program
includes  organized daily  activities in language arts,  math,  science,  social
studies,  drama,  creative  arts,  music and  construction.  Parental  input and
involvement  are  encouraged  at  Kiddie  Academy.  Teachers  are  available  to
conference  and parents are welcome to visit while  classroom  activities are in
progress.

SCHOOL-AGE  PROGRAM - For  parents  seeking  before  and after  school  care for
children  ages  five  through  12,  Kiddie  Academy  offers a safe,  secure  and
stimulating  environment.  Activities  such  as arts  and  crafts,  science  and
discovery,  dramatic play and  constructive  building are designed to complement
daily school  activities  and, at the same time,  promote  further  learning and
development.  Children may also receive assistance with school assignments. Most
importantly,  each child is given the  opportunity  to choose  from a variety of
individual or group activities.

SUMMER FUN PROGRAM - During the summer  months,  classes  continue but with more
emphasis  on  socialization,  recreation  and outdoor  experiences.  Parents are
invited to join the many fun,  educational field trips which enhance the overall
summer program.

         Franchise Services

         The  Company  offers  and  sells  franchises   nationally  through  its
subsidiary,   Kiddie  Academy  Franchising  Systems,   Inc.,  and  is  currently
authorized to offer and sell franchises in 48 states.  As of September 29, 1996,
the Company was a party to 62 franchise agreements ("Franchise  Agreements") and
41  preliminary  agreements  ("Preliminary  Agreements")  (in which a  potential
franchisee  enters into an agreement to select a site for its center and becomes
an applicant for a franchise). As of September 29, 1996, franchisees operated 32
of the 49 Kiddie Academy centers

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and 23 of the 27  centers  under  lease  but  not  yet  operational  were  being
developed by franchisees of the Company.

         The Company's franchise program is subject to regulation by the Federal
Trade  Commission  ("FTC")  with  respect  to  the  information  required  to be
disclosed to prospective  franchisees  prior to their investment in a franchise.
The Company's  franchise program is subject to additional  disclosure rules in a
number of states in which the Company has, in the past,  and intends to continue
to offer franchises.  The Company distributes to each prospective  franchisee an
offering  circular  which  has been  prepared  to  conform  with the  disclosure
requirements of the FTC and applicable state authorities.

         Franchisees receive support and assistance from the Company through all
stages  of  their  business  development,   including  assistance  in  obtaining
third-party financing, site selection, lease negotiations, regulatory approvals,
facility design and construction specifications,  state child care licensing and
start-up operations.  A prospective franchisee commences the franchising process
by  executing  a  Preliminary  Agreement  with the  Company and paying a $12,500
Preliminary  Agreement fee.  Those who complete the site  selection  process and
enter into a Franchise Agreement,  pay an additional $17,500 franchise fee for a
total of $30,000,  and, upon the opening of the center, an ongoing royalty equal
to 7% of gross revenues as well as a weekly  administrative  fee.  During fiscal
year 1997,  the initial  fees are  expected to  increase  for all new  franchise
applicants to $40,000, consisting of a $30,000 franchise fee, plus an additional
$10,000  Preliminary  Agreement fee. A prospective  franchisee  will pay $20,000
upon  executing a Preliminary  Agreement  consisting of the $10,000  Preliminary
Agreement  fee,  plus  $10,000 to be applied  against  the  franchise  fee.  The
remainder  of the  franchise  fee will be paid after the  franchisee  executes a
Franchise Agreement. The regulations of four states require the Company to place
funds received from potential  franchisees  into an escrow account until certain
performance milestones are met.

         Franchise applicants who are parties to a Preliminary Agreement are not
deemed to be franchisees  until they enter into a Franchise  Agreement,  and may
terminate  their  Preliminary  Agreement  with the  Company at any time prior to
entry into a Franchise  Agreement.  The form of Preliminary  Agreement currently
entered into by the Company with new franchise  applicants  provides that,  upon
termination  by the applicant,  the Company must refund the $12,500  Preliminary
Agreement fee less (i) a $7,500 lost opportunity  charge, plus (ii) any expenses
incurred by the  Company in  assisting  the  applicant  with the site  selection
process. The Company may, at its option,  terminate the Preliminary Agreement at
any time and, in such case,  must  refund the full  Preliminary  Agreement  fee.
During fiscal year 1997, the Company's form of Preliminary Agreement is expected
to be  revised  to  provide  that in the  event  the  Preliminary  Agreement  is
terminated by the applicant, the Company will retain $15,000 of the initial fees
paid by the applicant,  but must refund $5,000, less the Company's expenses. The
Company has experienced some attrition of franchise  applicants  during the site
development  process and believes  that such  attrition is to be expected in the
ordinary course of business.

         The Company assists the prospective franchisee in securing financing
which is typically

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arranged  through  national  lenders  specializing  in granting  Small  Business
Administration  franchise  loans  and  other  small  business  loans.  Once  the
appropriate financing is obtained,  the Company assists the potential franchisee
in selecting a location for a proposed  center.  The  Company's  site  selection
assistance  includes an initial  consultation  with the  prospective  franchisee
regarding  the site  selection  process,  the loaning of various site  selection
resource  materials,  the  screening  of sites  proposed  by the  applicant  and
assistance with the negotiation of the applicant's  lease or purchase  contract.
The Kiddie  Academy  staff is also involved in  coordinating  local and regional
governmental authorities in an effort to obtain all required approvals, licenses
and permits required to construct and operate a child care center. See "Business
-- Regulation."

         During the construction phase,  franchisees participate in two weeks of
a  full-time  training  program,  which  is  divided  between  formal  classroom
exercises  and hands-on  experiences  in operating  child care  facilities.  The
Kiddie Academy staff is available to assist in recruiting, hiring and training a
Center Director for each facility.  Each initial center director  attends a week
of Kiddie Academy training.

         Franchisees  utilize the localized marketing system developed by Kiddie
Academy to obtain initial enrollment and to build and maintain enrollment levels
of the center. The Company's  mandatory  business  management system enables the
Company to monitor  certain  financial  activities  of  franchised  centers on a
weekly basis.  Franchisees  are supplied  detailed  weekly and monthly  reports,
including  profit and loss  statements,  which  assist  them in  evaluating  the
financial  performance  of their child care business and help them control costs
and improve operations.

         Each  Kiddie  Academy  franchised  center is  required  to utilize  the
procedures set forth in the Company's  operating manuals which govern marketing,
finance,  administration,  curriculum and safety  procedures.  Kiddie  Academy's
service  support  team  provides  ongoing  guidance  in all areas of  operations
through  on-site visits and frequent  telephone  conferences.  In addition,  the
Company  monitors  each  franchised  center to ensure high quality  standardized
services and to enforce  compliance with both governmental  requirements and the
operating standards required of all Kiddie Academy centers.

Quality Assurance

         The Company employs a number of initiatives, both periodic and ongoing,
to assure that the highest levels of quality  services are maintained in each of
its corporate and franchised centers. Center service visits,  conducted by field
managers,  are comprehensive and include a review of each classroom,  curriculum
activities,  the food  service  program,  staff  performance  as well as  safety
guidelines.  Field management staff  periodically  meet directly with parents to
determine  parental  satisfaction  levels.  Additionally,  parents who  withdraw
children are given a confidential  survey to determine if the  withdrawal  could
have been prevented by an improvement  in service  quality.  Data collected from
these  sources are  reviewed by all staff to foster a  continuing  open forum in
which  all  service   providers   strive  to  offer  the  highest   quality  and
customer-service oriented care.


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 Marketing

         Child Care Services

         The Company's marketing efforts,  which are designed to build awareness
of Kiddie  Academy  centers,  consist of  advertising  and  promotion  of Kiddie
Academy  centers and the  marketing  of franchise  opportunities  to attract new
franchisees.  The Company's marketing  campaigns include a targeted  direct-mail
program,  a  toll-free  customer  hotline,  advertising  placement  in  regional
newspapers, grand opening activities, yellow-page listing and signage (including
billboards).  Professional  marketing  videos  which  discuss  the  benefits  to
children of attending a Kiddie  Academy  center are shown to parents  expressing
interest in a center.

         In addition to broad-based marketing methods, the Company also strongly
emphasizes a number of interpersonal  marketing techniques.  For example, center
directors are trained to solicit  parents via  telephone and personal  contacts.
Facility  tours and "meet the teacher"  interviews are included in the marketing
efforts at each  Kiddie  Academy  center.  Franchisees  are  required to spend a
certain portion of their gross revenues towards the marketing of their centers.

         Prior to its opening,  every Kiddie  Academy center hosts an open house
for the local  community.  This event is  preceded by  advertising.  At the open
house,  parents  watch a  marketing  video,  tour  the  facility  and  have  the
opportunity   to  talk  with  the  staff  while  the  children   enjoy   ongoing
entertainment,  visit classrooms and play with educational  toys. At this event,
the Company is able to build  awareness in the community of Kiddie Academy while
enrolling new children.

         Franchise Development

         The  Company's  marketing  efforts to solicit  franchisee  applications
include advertisements of its franchising  opportunities in publications such as
the Wall Street  Journal,  USA Today,  regional  newspapers,  trade journals and
national magazines.  The Company's franchise development staff conduct in-person
interviews with qualified franchise applicants. New franchise sales also include
several franchisees which have either opened additional centers or have executed
agreements to open additional  franchised centers. The Company has a reduced fee
franchise program to encourage  multiple-center  operators within its system. As
set forth in  "Business--Strategy,"  the Company's current plans are to focus on
the "ramp-up" to profitable  enrollment  levels through Company-operated  center
growth and the advancement of existing franchised centers under development.

Seasonality

         Due to the annual  seasonal  reduction in enrollment  during the summer
months,   which  occurs   throughout  the  child  care  industry,   the  Company
historically  has  experienced a decrease in tuition  revenues during the fourth
quarter of each fiscal year (July  through  September).  The Company  expects to
continue to  experience  such a decrease in tuition  revenues  during the fourth
quarter of its fiscal year. As a result, the Company's annual earnings have been
and will continue to be heavily

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dependent on the results of operations during the first three quarters of each
year.

Competition

         The child care industry is highly  fragmented and competitive.  Many of
the Company's  competitors  have greater  financial and other resources than the
Company. The Company experiences competition from large national chains, such as
KinderCare  Learning  Centers Inc., which operates sites throughout the country.
The  Company  competes  with the  large  national  chains  by  offering  unique,
professional  services at highly  competitive  prices,  thus providing  families
value.

         Additionally,  the Company  experiences  competition from smaller local
nursery  schools  and  child-care  centers,  some of  which  are  not-for-profit
(including  religion-affiliated  centers), and from providers of "in-home" child
care, including, inter alia, child supervision services and nannies. The typical
fees and  charges  for  "in-home"  child  care and  local  nursery  schools  are
generally lower than those charged by the Company. Many  religion-affiliated and
other  not-for-profit child care centers have no or minimal rental costs and may
receive  donations or other funding to cover operating  expenses,  allowing such
centers  to  charge  less for  tuition  than the  Company-owned  and  franchised
centers.  The Company competes against this segment of the market by offering an
education-based  child care program  centered  around a  professionally  planned
curriculum which is periodically reviewed and updated by its curriculum advisory
council,  well-equipped,  clean and safe  facilities,  and trained and qualified
personnel.

Personnel

         At September  29, 1996,  the Company  employed 238 persons,  29 of whom
were employed at the corporate  headquarters.  Of the Company's total employees,
163 were employed on a full-time basis and 75 were employed on a part-time basis
as of September 29, 1996.  The Company has hired and trained  district  managers
responsible  for center  performance of Company and franchised  units over broad
geographic regions. At the center unit level, management is provided by a center
director and an assistant  director.  Center employees include regular full-time
and part-time  caregivers,  substitute  caregivers  and aides,  and other staff,
including cooks and van drivers.  Center directors are required to have either a
college degree with  concentrations  in early  childhood  education or a college
degree in any discipline along with prior experience in the child care industry.
Requirements as to the specific  qualifications of center directors are mandated
by state  licensing  authorities  and vary from  state to state.  Each  center's
initial  center  director  also  must  successfully  complete  Kiddie  Academy's
week-long  training program.  The Company assists center directors and owners of
franchised  centers  with the  training  of other  center  personnel.  It is the
Company's policy that all Company-owned and franchised centers must comply with,
and in some cases exceed,  states'  recommendations and guidelines pertaining to
teacher-to-child staffing ratios. None of the Company's employees is represented
by any labor  union or  covered  by any  collective  bargaining  agreement.  The
Company believes its relations with the employees are good.



                                       9

<PAGE>



Regulation

         Child care centers are subject to numerous state and local governmental
regulations  and  licensing   requirements,   including,   without   limitation,
regulations  with regard to the fitness and adequacy of buildings and equipment,
supplies,  qualifications of staff, ratio of staff to enrolled  children,  staff
training,  record-keeping,  dietary  requirements,  daily curriculum and health,
fire and safety standards. Failure to comply with any applicable regulations can
subject a child care center to sanctions imposed by the regulating jurisdiction,
including  placement on probation or, in certain  serious  cases,  suspension or
revocation of a center's license to operate.  Construction of child care centers
must also comply with local  zoning  requirements,  health and  building  codes,
which  compliance can result in significant  delays and added expense in opening
new  centers.  Such  zoning  rules and  regulations  vary from  jurisdiction  to
jurisdiction.  Failure to continue to comply with such laws and  regulations  or
the imposition of additional  restrictions  on the centers could have a material
adverse effect on the operations of the Company and its franchisees.

Trademarks

         The Company has registered  with the United States Patent and Trademark
Office the Kiddie Academy name and logo. In addition,  the Company has trademark
applications  pending  for the Kid's Craft name and logo.  The Company  believes
that its intellectual  property rights are important to its business and intends
to  continue  to renew its  trademark  registrations  and to enforce  its rights
thereunder.

Insurance

         The Company  currently has in place (i) a commercial  liability  policy
with an aggregate policy and per occurrence limit of $1,000,000,  which includes
property,  business  interruption,  computer,  criminal,  comprehensive  general
liability  and  automobile  liability  coverage,  (ii) a  worker's  compensation
policy,  and (iii) an umbrella liability policy with an aggregate policy and per
occurrence limit of $1,000,000.

         In addition,  each Company-owned  center carries the types of insurance
required for franchised  centers,  as described below. The Company believes that
the types of insurance  and amounts of coverage it maintains  are  customary for
businesses of comparable  size in its industry.  There can be no assurance  that
the  Company's  current  insurance  program  will  continue  to be  adequate  or
available  to the Company at  reasonable  rates.  In the event that  coverage is
inadequate or becomes  unavailable,  the Company  could be materially  adversely
affected.

         The Company  requires that franchisees  procure,  no later than 30 days
before the date on which  operations of a center are commenced,  and maintain in
full force and effect at all times during the term of the  Franchise  Agreement,
the following insurance coverage:  (i) comprehensive general liability insurance
with an  aggregate  policy and per  occurrence  limit of  $1,000,000,  including
coverage  for  personal   injury,   errors  and  omissions,   products/completed
operations, contractual

                                       10

<PAGE>



liability,  professional malpractice,  products liability,  automobile liability
and property  damage  liability;  (ii) fire,  vandalism  and  extended  coverage
insurance; (iii) student accident insurance; (iv) employer's liability, workers'
compensation,  business interruption and such other insurance as may be required
by  state  and  local  laws;  and (v) such  additional  insurance  and  types of
coverages as may be required  under the terms of the lease for the center.  Each
child  enrolled  in a  Company-owned  or  franchised  center is  covered  by the
center's comprehensive general liability insurance.

Availability of Acceptable Locations

         The Company's  continued success and expansion depends,  in large part,
on the  continued  availability  of its existing  locations and on the Company's
ability to identify and secure on acceptable terms suitable additional locations
on which to construct new Company-owned or franchised  centers.  The Company, on
behalf of itself or its franchisees, is currently involved in lease negotiations
with  landlords for a number of potential  locations.  There can be no assurance
that lease  agreements  with respect to such  locations and locations for future
centers will be successfully negotiated and entered into. The rate of new center
openings is further subject to various  contingencies,  many of which are beyond
the Company's control.  These contingencies  include, among others, the progress
of  construction  of new  centers  and  the  ability  of  the  Company  and  its
franchisees  to  successfully  comply  with all  state  and  local  governmental
regulations (including zoning regulations) applicable to child care centers. See
"Business -- Regulation."  To date, the Company has  experienced no  significant
difficulties  in locating  suitable  locations for new centers or in negotiating
acceptable  lease terms.  There can be no assurance,  however,  that the Company
will be able to continue to locate a sufficient number of suitable  locations to
accommodate its expansion plans.  Selection of an unsuitable location could lead
to a center which performs  below  expectations.  Difficulty in identifying  and
negotiating  favorable lease terms for a suitable  location could lead to delays
in opening both franchised centers and Company-owned  centers,  and, in the case
of franchised  centers,  could lead to termination of the Preliminary  Agreement
and/or  Franchise  Agreement  by  the  potential   franchisee  or  the  existing
franchisee.  See  "Business -- Franchise  Services."  Further,  there can be  no
assurance that  construction  and other costs of opening new centers will not be
higher than those  anticipated by the Company,  in which case, the Company might
be required to reduce the rate at which it opens new centers.  While some of the
Company's and its  franchisees'  leases contain  provisions for renewal options,
there can be no assurance that, upon expiration of the current lease terms, such
locations will continue to be available to the Company or its franchisees, or if
available, that the terms of renewal for such locations will be acceptable.

Liability Under Leases

         In many  instances,  the Company has had to guarantee  some or all of a
franchisee's obligations under the lease for its child care center. Although the
franchisee  typically agrees to personally  guarantee the lease and to indemnify
the Company in the event the Company is required to make any payments  under its
guarantee, the franchisee may not have adequate financial resources to honor its
personal  guarantee  or  indemnification  obligations.  Most  of  the  Company's
guarantees  provide for notice of a tenant's  default and an opportunity to cure
the default, prior to landlord enforcement of any guarantee.  In addition,  most
franchise agreements require the franchisee lease

                                       11

<PAGE>



to contain a Collateral  Assignment of Lease Agreement,  which provides that, in
the event of a default which is not cured (under either the franchise  agreement
or the lease agreement),  Kiddie Academy Franchising  Systems,  Inc. may, at its
option (but not as an obligation), operate the center as a Company-owned center,
elect  to  select  a new  franchisee  to  operate  the  center  (subject  to the
landlord's  approval),  or cease the center's operations  altogether (subject to
the  obligation  of the  Company  to  continue  to pay rent if the  Company  has
guaranteed  the  franchisee's  obligations  under the lease).  While the Company
believes  that  it  may  benefit  from  these  Collateral  Assignment  of  Lease
Agreements by the receipt of income from the operation or  refranchising  of the
center in default,  the failure of one or more  franchisees to meet its or their
obligations  under its or their leases could have a material  adverse  effect on
the business, operations and financial condition of the Company.

ITEM 2.           PROPERTIES

         The Company's corporate headquarters are located in approximately 9,600
square feet of leased office space in Bel Air,  Maryland.  The Company considers
this space for its corporate  headquarters  to be in good condition and adequate
for its current needs.

         The Company leases the land and buildings for its various Company-owned
centers.  Centers leased by the Company are typically  leased under "triple net"
leases  that  require  the  Company to pay its share of  utilities,  real estate
taxes, maintenance costs and insurance premiums.

         The  following  table shows the number of  locations  of the  Company's
Centers as of  September  29,  1996,  which are either open or are under  lease,
pending opening, sorted by state.


                                       12

<PAGE>




     STATE              CENTERS OPEN            CENTERS UNDER        TOTAL
                        & OPERATIONAL          LEASE, PENDING
                                                   OPENING
----------------------------------------------------------------------------
California                    1                       3                4
Colorado                      2                       1                3
Delaware                      2                       1                3
Georgia                       0                       1                1
Illinois                      4                       1                5
Indiana                       2                       0                2
Maryland                     17                       5               22
Michigan                      0                       1                1
North Carolina                1                       1                2
New Jersey                    8                       5               13
New York                      4                       2                6
Ohio                          3                       1                4
Pennsylvania                  2                       3                5
Texas                         2                       1                3
Virginia                      1                       1                2


TOTAL                        49                      27               76

         Of the above 49 operating  centers,  17 are operated by Kiddie  Academy
Child Care Learning Centers, Inc. and the remaining balance of 32 are leased and
operated by franchisees.  All centers are leased and have terms ranging from one
year to 15 years in duration. Many leases contain options to extend the original
lease term for additional periods ranging from five to 10 years.  Certain leases
contain purchase  options and rights of first refusal,  in favor of the Company.
Typical  center  leases  have an  initial  term of 10 years  with at least  two,
five-year  renewal  options  and often  require  the  tenant to pay its share of
utilities, real estate taxes, maintenance costs and insurance premiums.

ITEM 3.           LEGAL PROCEEDINGS

         The Company is involved from time to time in routine litigation arising
out of the ordinary

                                       13

<PAGE>



course of its business,  some of which is covered by insurance.  In management's
opinion,  none of the  litigation in which the Company is currently  involved is
material to its financial condition or results of operations.

ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         Not Applicable.


                                    PART II

ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY
                  AND RELATED STOCKHOLDER MATTERS

         The  Company's  Common  Stock is traded on the  Nasdaq  SmallCap  Stock
Market under the symbol KAII and on the Boston Stock  Exchange  under the symbol
KAI.  Warrants to purchase the  Company's  Common Stock are traded on the Nasdaq
SmallCap  Stock Market  under the symbol KAIIW and on the Boston Stock  Exchange
under the symbol KAIW. The following tables set forth, for fiscal year 1996 (the
only period during which the  Company's  Common Stock and warrants were publicly
traded), the high and low sales prices from the Nasdaq SmallCap Stock Market for
the Company's Common Stock and warrants.

                              RECENT MARKET PRICES
                                  Fiscal 1996

                                  COMMON STOCK

QUARTER          4TH                3RD                2ND                 1ST*
High             4 63/64           4 3/4              6 19/64              7
Low              4 1/4             3                  3                    5 1/4


                                    WARRANTS

QUARTER          4TH                3RD                2ND                 1ST*
High             45/64              13/16              1 7/32              1 7/8
Low              13/32              3/8                3/8                 3/4

* Comprises  the period  December 18, 1996 - December 31, 1996,  the only period
during  this  quarter in which the  Company's  Common  Stock and  warrants  were
publicly traded.

                                       14

<PAGE>



         As of December 11, 1996,  there were  approximately  367 holders of the
Company's Common Stock and 276 holders of warrants.

Dividends

         The Company has not paid  dividends  on shares of Common Stock and does
not anticipate declaring or paying any cash dividends on its Common Stock in the
foreseeable future. Any future  determination as to dividend policy will be made
by the Board of Directors of the Company in its  discretion and will depend on a
number of factors,  including the future earnings, if any, capital requirements,
financial condition and business prospects of the Company and such other factors
as the Board of Directors may deem relevant.


ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

         The following  discussion  and analysis  should be read in  conjunction
with the Company's  Consolidated  Financial  Statements and Notes. The financial
information  and  percentages  set forth  below in  Results  of  Operations  and
Liquidity and Capital Resources have been rounded to the nearest  thousandth and
to the nearest whole percent, respectively.

Forward-Looking Statements

         When used in this report, press releases and elsewhere by management of
the  Company  from  time to  time,  the  words  "believes,"  "anticipates,"  and
"expects"  and similar  expressions  are  intended  to identify  forward-looking
statements  that involve certain risks and  uncertainties.  A variety of factors
could cause actual results to differ  materially  from those  anticipated in the
Company's  forward-looking  statements,  some of  which  include  the  Company's
ability to identify and secure on acceptable  terms suitable  locations on which
to construct new Company-owned or franchised  centers;  the Company's  continued
ability to compete with this segment of the market;  the relatively small number
of Company-owned and franchised  centers  currently  operating which could cause
poor operating  results at any one center or any unsuccessful new center opening
to negatively impact the Company's results to a greater result than would be the
case in a larger chain;  the Company's  dependence  on  franchisees  which could
cause the Company's  revenues from  franchise fees and royalties to be adversely
affected  if  the  Company's  franchisees  experience  business  or  operational
difficulties;  the  failure  of one or more  franchisees  to meet  its or  their
obligations  under its or their  leases  which  could have a  material,  adverse
effect on the business, operations and financial condition of the Company to the
extent such obligations have been guaranteed by the Company;  the Company's need
to comply with numerous state and local  governmental  regulations and licensing
requirements; and other risk factors that are discussed from time to time in the
Company's  SEC reports.  Readers are  cautioned  not to place undue  reliance on
these forward-looking  statements,  which speak only as of the date thereof. The
Company  undertakes no obligation to publicly  release the results of any events
or circumstances after the date hereof or to reflect the occurrence of

                                       15

<PAGE>



unanticipated events.

General

         The Company  derives  revenue from three  sources:  (i) weekly  tuition
generated  at  the  17  Company-owned  and  operated  centers;  (ii)  fees  from
franchisees,  including  franchise licensing fees currently totaling $30,000 per
new franchised center, ongoing royalties equal to 7% of each franchised center's
gross revenues, and weekly administrative fees of $52 per franchised center; and
(iii) the sale of  school  supplies,  educational  toys and  equipment  by Kid's
Craft. The Company  experienced a net increase in the number of centers from 36,
at the beginning of fiscal year 1996, to 49 at the end of fiscal year 1996.  The
Company has achieved this growth through a combination of  Company-operated  and
franchised centers.  The number of Company-owned  centers increased by 10 during
fiscal year 1996,  and the number of  franchised  centers  increased by 3 during
fiscal year 1996.  The growth of  Company-owned  centers during fiscal year 1996
included the acquisition of six centers from its franchisees.

         Additionally, the Company has entered into management arrangements with
two of its  franchisees  pursuant to which the Company has agreed to operate the
relevant  center and receive all revenues and assume  substantially  all ongoing
obligations.  Subsequent  to September  29,  1996,  the Company  franchised  one
Company-owned  center,  acquired  two  franchised  centers  and  took  over  the
management of one additional  franchised  center.  The revenues  received by the
Company from each franchised center under management by the Company are included
in the  revenues of Company-owned new  centers  as  reflected  on the  Company's
Consolidated Financial Statements.

         The  increase  in  franchised  centers  includes  the opening of 12 new
centers,  the sale of six  franchised  centers to the Company and the release of
one center from the system  following  the Company's  determination  that due to
changes in the  community  in which the center is located,  it no longer met the
Company's  minimum site criteria.  The number of franchised  centers was further
reduced  by the  two  which  are  currently  under  management  by the  Company.
Subsequent  to  September  29,  1996,  five new  franchised  centers have opened
(including one which was purchased from the Company),  two have been acquired by
the Company,  one has been  allowed to leave the system,  and one other is under
Company-management,  as described above. As set forth in "Business -- Strategy,"
the  Company's  current  plans  are to  focus  on the  "ramp-up"  to  profitable
enrollment levels through  Company-operated center growth and the advancement of
existing franchised centers under development.

         Revenue  from  Company-owned  centers is  recognized  in the period the
child care  services  are  provided.  Revenue  derived  from  franchise  fees is
recognized  when the  franchise  center  opens.  Accordingly,  the amount of the
deferred  franchise  fee  liability as shown on the  Company's  balance sheet is
directly  related to the number of centers in  development.  All franchise  fees
collected  by the Company  for centers in  development  are  accounted  for as a
current  liability  until the center  opens,  as required by generally  accepted
accounting  principles.  The  amount of the  Company's  deferred  franchise  fee
liability for the fiscal  period ended  September  29, 1996  increased  over the
comparable period in 1995 as a result of an increase in the number of centers in
development.  Royalty  income  is  recognized  in the same  period  in which the
related revenue is generated by each franchised center.

                                       16

<PAGE>



Revenue from  administrative  fees paid by franchisees for services  provided by
the Company is recognized when the Company provides such services. During fiscal
year 1997, a change in the Company's fee structure is expected to permit $10,000
of initial fees paid by each  applicant to be recognized  approximately  30 days
after the applicant executes a Preliminary Agreement with the Company.

         The  significant  growth  experienced by the Company during fiscal year
1996 contributed  significantly to the Company's  losses.  New centers typically
require up to 24 months to "ramp-up" to profitable  enrollment levels and of the
Company's  centers,  five had been  operated  by the  Company  for more  than 24
months.  In  addition,  many  of  the  centers  purchased  by the  Company  from
franchisees during fiscal year 1996 had been previously poorly managed and had a
negative  reputation in their respective  communities.  As a result, many of the
newly  acquired  centers have required a longer than average period to "ramp-up"
than that  experienced  with new centers.  Because the Company began fiscal year
1996 with very few mature Company-owned centers, the rapid expansion diluted the
profitability of those centers.

         Additionally,   the  Company  has  begun  to  increase  its   corporate
infrastructure  in anticipation of its future expansion plans.  This development
has involved the  incurrence of substantial  one-time and  continuing  expenses,
without the immediate  realization of offsetting income. The Company's expansion
also  significantly  affects the  comparability  of results of  operations  from
period to period,  in part because revenues  generated by a center are generally
significantly  lower during the first 18 to 24 months following its opening as a
result   of   lower   initial   levels   of   enrollment.   As  set   forth   in
"Business--Strategy,"  the Company's current plans are to focus on the "ramp-up"
to profitable enrollment levels through  Company-operated  center growth and the
advancement of existing franchised centers under development.

Results of Operations

         The following  table sets forth,  for the periods  indicated,  selected
information from the Company's Consolidated Statements of Operations (except for
systemwide  centers open at end of period and systemwide  revenues and financial
data  for  fiscal  year  1994),  expressed  as a  percentage  of  revenues  from
operations.


<TABLE>
<CAPTION>


                                                Twelve Months Ended
                            September 29, 1996    September 30, 1995      September 30, 1994
                            ------------------    ------------------      ------------------
Systemwide centers open             49                    36                      20
<S><C>
Systemwide revenues.......  $13,963,000           $7,325,000             $4,009,000
                            -----------           ----------             ----------
Revenues from operations
   Company-owned centers..  $3,129,000     65%    $1,418,000     58%     $2,083,000      84%
   Franchising operations.  $1,399,000     29%    $  872,000     36%     $  285,000      12%
   Product sales..........  $  264,000      6%    $  160,000      6%     $  106,000       4%
                            ----------            ----------             ----------
      Total revenues......  $4,792,000    100%    $2,450,000    100%     $2,474,000     100%
                            ----------    ---     ----------    ---      ----------     ---
Operating expenses........  $6,793,000    142%    $3,002,000    123%     $2,878,000     116%
                            -----------   ---     ----------    ---      ----------     ---
</TABLE>

                                       17

<PAGE>


<TABLE>

<S><C>
Net operating (loss)......  $(2,001,000)  (42)%   $ (552,000)   (23)%    $(404,000)    (16)%
Interest income (expense).  $    39,000      1%   $ (269,000)   (11)%    $(239,000)    (10)%
Other income..............  $    56,000      1%   $   41,000       2%    $ 359,000       15%
                            -----------   ----    ----------    ----     ---------     ----
Net loss..................  $(1,906,000)  (40)%   $ (779,000)   (32)%    $(284,000)    (11)%
                            -----------   ----    ----------    ----     ---------     ----

</TABLE>


Year Ended September 29, 1996 Compared to Year Ended September 30, 1995

         Revenues

         Systemwide  revenues  (tuition fees from  Company-owned  and franchised
centers)  for the fiscal  year ended  September  29, 1996  increased  by 91%, to
$13,963,000  from  $7,325,000 for the fiscal year ended September 30, 1995. This
increase  was due to an  increase in the total  number of centers  open to 49 at
September  29,  1996,  as  compared to 36 open at  September  30,  1995,  and an
increase  in average  enrollment  levels at centers  which were open during both
periods.

         The  Company's  revenues  from  operations  for the  fiscal  year ended
September  29, 1996  increased by 96%, to  $4,792,000  from  $2,450,000  for the
fiscal year ended  September  30, 1995.  This increase was due to an increase in
revenues  generated by an increase in the number  of Company-owned  centers,  as
well as an increase in the average  enrollment in those centers,  an increase in
revenues generated by franchising activities and increased revenues generated by
Kid's Craft.

         Aggregate  revenues  generated by Company-owned  centers for the fiscal
year  ended  September  29,  1996,  which   constituted  65%  of  revenues  from
operations, increased by 121%, to $3,129,000 from $1,418,000 for the fiscal year
ended September 30, 1995. This increase was due to the increase in the number of
Company-owned  centers owned and operated during the fiscal year ended September
29,  1996 to 17 as compared  to the fiscal  year ended  September  30, 1995 with
seven Company-owned centers. Revenues from mature centers (owned and operated by
Kiddie  Academy for at least 24 months)  showed an increase of 4% or $54,000 for
this same period but consisted of fewer centers, on average, in fiscal year 1996
than in fiscal year 1995.  During the year ended  September 29, 1996 the Company
opened three new centers,  sold an existing  center,  purchased six centers from
franchisees and entered into agreements to manage two other centers all of which
have revenue accounted for in Company-owned new centers.

         Revenues from franchising  activities  (franchising fees, royalties and
administrative  fees) for the  fiscal  year  ended  September  29,  1996,  which
constituted  29% of revenues  from  operations,  increased by 60%, to $1,399,000
from  $872,000  for the fiscal year ended  September  30,  1995.  Revenues  from
franchise fees for the fiscal year ended September 29, 1996 increased by 36%, to
$563,000 from $413,000 for the fiscal year ended  September 30, 1995.  Royalties
for the fiscal year ended  September 29, 1996 increased by 86%, to $759,000 from
$408,000 for the fiscal year ended September 30, 1995.  Administrative  fees for
the fiscal year ended  September  29,  1996  increased  by 48%, to $77,000  from
$52,000 for the fiscal year ended  September 30, 1995.  The increase in revenues
from  franchise  fees,  royalties  and  administrative  fees  resulted  from the
increase in the

                                       18

<PAGE>



number of  franchised  centers open during the fiscal year ended  September  29,
1996 to 32 (which  includes 12 new centers opened in fiscal year 1996 reduced by
the six that were sold to the  Company,  two that are  Company-managed,  and one
that was allowed to drop out of the system) from 29 during the fiscal year ended
September 30, 1995 and the increase in enrollment levels.

         Sales  revenues  generated  by Kid's  Craft for the  fiscal  year ended
September 29, 1996, which constituted 6% of revenues from operations,  increased
by 65%, to $264,000 from $160,000 for the fiscal year ended  September 30, 1995,
primarily  as a result of sales to new  franchised  centers  opened  during this
period and ongoing sales to existing franchise centers.

         Operating Expenses

         Operating  expenses include the expenses  associated with operating the
Company-owned  child care  centers  (including  payroll  and  related  expenses,
occupancy costs,  and the costs of food,  supplies,  utilities,  advertising and
insurance);  expenses associated with running the Company's franchise operations
(including   payroll,   commissions  and  related  expenses,   occupancy  costs,
advertising,  travel and utilities);  and expenses associated with the operation
of Kid's Craft (including costs of products,  freight, occupancy and utilities);
and other general and administrative expenses.

         Aggregate  operating  expenses for the fiscal year ended  September 29,
1996 increased by 126%, to $6,793,000  from  $3,002,000 in the fiscal year ended
September 30, 1995. As a percentage of operating  revenues,  operating  expenses
increased to  approximately  142% for the fiscal year ended  September  29, 1996
from  approximately  123% for the fiscal year ended  September  30, 1995.  These
increases  were due  primarily  to  increases  in expenses  associated  with the
Company's  franchising  activities and "ramp-up" expenses associated with the 10
additional centers operated by the Company during the 1996 fiscal year.

         Operating  expenses  relating to  Company-owned  centers for the fiscal
year  ended  September  29,  1996,  which  constituted  63% of  total  operating
expenses,  increased by 190%, to $4,278,000  from $1,476,000 for the fiscal year
ended  September 30, 1995.  Expenses for mature centers  increased 3% or $39,000
for this same period. Expenses for new centers were high compared to revenues as
a  result  of  centers  purchased  from  franchisees  that  required   extensive
advertising   and   re-furbishing.   These  expenses   included  many  one  time
expenditures  that should not be necessary again as the center reaches maturity.
New centers that the Company opened  experienced the normal  economic  "ramp-up"
and are  expected to reach  maturity as  anticipated.  The increase in operating
expenses for Company-owned  centers and managed centers for the 1996 fiscal year
as compared  to the 1995  fiscal year is due to the  increase in centers and the
related  increases  in rent due to lease  obligations,  payroll,  food costs and
other costs  increased  in  proportion  to the number of centers  operated.  The
Company expects that aggregate  expenses relating to Company-owned  centers will
continue to increase as the number of Company-owned centers increases.  However,
over time, as the Company  achieves and capitalizes upon economies of scale, and
as newly-opened  centers mature beyond their initial period of start-up expenses
and low  enrollment,  the Company  expects  expenses as a percentage of revenues
derived  from  Company-owned  centers to  decrease.  The Company also intends to
focus on improving

                                       19

<PAGE>



operating results at Company-owned  centers by implementing programs designed to
increase revenues such as advertising and promotion, while continuing to control
costs.

         Costs of goods sold by Kid's Craft for the fiscal year ended  September
29, 1996, which constituted 3% of total operating expenses, increased by 80%, to
$207,000  from  $115,000  for the fiscal year ended  September  30,  1995.  This
increase was primarily due to an increase in product sales and freight costs.

         General and  administrative  expenses,  which  constituted 34% of total
operating   expenses  and  which  include  the  costs  of  corporate   overhead,
franchising  operations and operating  expenses for Kid's Craft,  for the fiscal
year ended  September 29, 1996 increased by 64%, to $2,308,000  from  $1,411,000
for the fiscal year ended September 30, 1995. Increases occurred in all areas of
expense due to the growth in the corporate infrastructure undertaken in order to
support  the  Company's  expanded  efforts in  franchising  and the  substantial
increase in the number of  franchises  open and under  development.  The Company
expects that expenses related to franchising will continue to increase. However,
over time,  the Company  expects such  expenses to decrease as a  percentage  of
franchise revenues.

         Depreciation and Amortization

         Depreciation  and  amortization  expense  consist  of  depreciation  or
amortization  of  certain  equipment,   furniture  and  fixtures,  vehicles  and
leasehold improvements,  and organizational costs. Depreciation and amortization
expense,  for the fiscal year ended  September 29, 1996  decreased by $19,000 to
$83,000  from  $102,000  for the fiscal  year ended  September  30,  1995.  This
decrease was primarily due to depreciation  expense resulting from a center that
was sold in 1995,  the leases of which center had been  accounted for as capital
leases partially offset by the purchases of equipment.

         Interest

         Interest  income,  net of interest  expense,  for the fiscal year ended
September  29, 1996 was $39,000 as compared to interest  expense of $269,000 for
the fiscal year ended  September 30, 1995.  This change was  attributable to the
pay off of the line of credit in December  1995,  overnight  investments  in the
Company's  sweep  account  resulting  from the  proceeds of the  initial  public
offering, and the elimination of capital lease obligations.

         Other Income

         For the fiscal year ended  September  29,  1996,  the Company  recorded
other  income of  $56,000,  and in the fiscal  year ended  September  30,  1995,
$41,000.  This increase is attributable to the sale of one Company-owned  center
to a franchisee and the gain on sale of asset that was realized.

         As a result of the foregoing,  the Company  recorded a net loss for the
fiscal year ended  September 29, 1996 of $1,907,000 as compared to a net loss of
$779,000 for the fiscal year ended

                                       20

<PAGE>



September 30, 1995.

Year Ended September 30, 1995 Compared to Year Ended September 30, 1994

         Revenues

         Systemwide  revenues  for the fiscal  year  ended  September  30,  1995
increased by  $3,316,000,  or 83% to $7,325,000  from  $4,009,000 for the fiscal
year ended  September  30,  1994.  This  increase  was due to an increase in the
number  of  franchised  centers  open at the end of  fiscal  year  1995 to 36 as
compared  to 20 open at the end of fiscal  year 1994 and an  increase in average
enrollment  levels in fiscal  year 1995 as  compared  with  fiscal  year 1994 at
centers which were open during both fiscal years.

         The Company's  revenues from  operations for fiscal year 1995 decreased
by $24,000,  or 1%, to $2,450,000  from  $2,474,000  for fiscal year 1994.  This
decrease was due primarily to a decrease in revenues  generated by Company-owned
centers  which  was  offset,  to a large  extent,  by an  increase  in  revenues
generated by franchising  activities and increased  revenues  generated by Kid's
Craft.

         Aggregate revenues  generated by Company-owned  centers for fiscal year
1995, which constituted 58% of revenues from operations,  decreased by $665,000,
or 32%, to $1,418,000  from  $2,083,000 for fiscal year 1994.  This decrease was
due to the reduction in the  number  of Company-owned  centers owned  throughout
the entire fiscal year 1995 to four as compared to eight  throughout  the entire
fiscal  year  1994.  During  the first  four  months of fiscal  year  1995,  one
Company-owned  center  was sold and two  others  were  converted  to  franchised
centers (the "Center Conversions"). The decrease in revenues was offset slightly
by revenues generated by three centers purchased by the Company from franchisees
in the last two months of fiscal year 1995 and revenues  received by the Company
in consideration of its management of one franchised center,  which commenced in
July  1995  (the  "Purchased  Centers").   The  net  proceeds  from  the  Center
Conversions  were  used  to  fund  the  expansion  of  the  Company's  franchise
operations.  Revenues from the four  Company-owned  centers owned throughout all
four  quarters of fiscal year 1995  increased by $257,000,  or 27% to $1,200,000
for fiscal year 1995 from  $943,000  for fiscal  year 1994.  This  increase  was
primarily   due  to  a   substantial   increase  in  enrollment  at  the  newest
Company-owned center, which opened in May 1994.

         Revenues from  franchising  activities  (site selection and franchising
fees, royalties and administrative fees) for fiscal year 1995, which constituted
36% of revenues  from  operations,  increased by $587,000,  or 206%, to $872,000
from $285,000 for fiscal year 1994.  Revenues from site  selection and franchise
fees for fiscal year 1995  increased  by  $281,000,  or 213%,  to $413,000  from
$132,000  for fiscal  year 1994.  Royalties  for fiscal year 1995  increased  by
$273,000,   or  202%,   to  $408,000   from   $135,000  for  fiscal  year  1994.
Administrative  fees for fiscal  year 1995  increased  by $34,000,  or 189%,  to
$52,000  from $18,000 for fiscal year 1994.  The increase in revenues  from site
selection and franchise fees,  royalties and  administrative  fees resulted from
the substantial  increase in the number of franchised centers open during fiscal
year 1995 to 29 from 13 during fiscal

                                       21

<PAGE>



year 1994.

         Sales  revenues  generated  by Kid's Craft for fiscal year 1995,  which
constituted  6% of revenues from  operations,  increased by $54,000,  or 51%, to
$160,000 from  $106,000 for fiscal year 1994,  primarily as a result of sales to
the 16 new franchised centers opened during this period.

         Operating Expenses

         Operating  expenses include the expenses  associated with operating the
Company-owned  child care  centers  (including  payroll  and  related  expenses,
occupancy costs,  and the costs of food,  supplies,  utilities,  advertising and
insurance);  expenses associated with running the Company's franchise operations
(including   payroll,   commissions  and  related  expenses,   occupancy  costs,
advertising,  travel and utilities);  and expenses associated with the operation
of Kid's Craft (including costs of products,  freight, occupancy and utilities);
and other general and administrative expenses.

         Aggregate   operating  expenses  for  fiscal  year  1995  increased  by
$124,000,  or 4%, to  $3,002,000  from  $2,878,000  in fiscal  year  1994.  As a
percentage  of  operating   revenues,   operating  expenses  also  increased  to
approximately  123% for fiscal year 1995 from approximately 116% for fiscal year
1994.  These  increases  were due primarily to increases in expenses  associated
with the  Company's  franchising  activities  and expenses  associated  with the
Purchased  Centers,  which  increases  were  partially  offset by  reductions in
expenses for Company-owned centers as a result of the Center Conversions.

         Operating  expenses  relating to Company-owned  centers for fiscal year
1995, which constituted 49% of total operating expenses,  decreased by $348,000,
or 19%, to $1,476,000 from $1,824,000 for fiscal year 1994.  Reductions occurred
in all categories of expense due to the Center  Conversions.  Such reductions in
expenses were  partially  offset by increases in expenses for the four remaining
centers primarily  reflecting  expenses related to one center which was open for
the full  fiscal  year 1995 which had been open only for the last five months of
fiscal year 1994 and an increase  in  expenses of $174,000  attributable  to the
Purchased  Centers.  The Company  expects that  aggregate  expenses  relating to
Company-owned  centers will continue to increase as the number of  Company-owned
centers increases.  However,  over time, as the Company achieves and capitalizes
upon economies of scale, and as newly-opened centers mature beyond their initial
period  of high  start-up  expenses  and low  enrollment,  the  Company  expects
expenses as a  percentage  of revenues  derived  from  Company-owned  centers to
decrease.  The Company also intends to focus on improving  operating  results at
Company-owned  centers by implementing  programs  designed to increase  revenues
while continuing to control costs.

         General and  administrative  expenses,  which  constituted 47% of total
operating   expenses  and  which  include  the  costs  of  corporate   overhead,
franchising  operations and operating  expenses for Kid's Craft, for fiscal year
1995 increased by $420,000,  or 42%, to $1,411,000 from $991,000 for fiscal year
1994.  Increases  occurred  in all  areas of  expense  due to the  growth in the
corporate  infrastructure  undertaken in order to support the Company's expanded
efforts in franchising and the

                                       22

<PAGE>



substantial increase in the number of franchises open and under development. The
Company expects that expenses relating to franchising will continue to increase.
However,  over  time,  the  Company  expects  such  expenses  to  decrease  as a
percentage of franchise revenues.

         Costs  of  goods  sold by Kid's  Craft  for  fiscal  year  1995,  which
constituted 4% of total  operating  expenses,  increased by $51,000,  or 80%, to
$115,000  from $64,000 for fiscal year 1994.  This increase was primarily due to
an increase in product sales and freight costs.

         Depreciation and Amortization

         Depreciation  and  amortization  expense  consist  of  depreciation  or
amortization  of  certain  equipment,   furniture  and  fixtures,  vehicles  and
leasehold   improvements,   capitalized   leases   and   organizational   costs.
Depreciation and amortization  expense for fiscal year 1995 decreased by $12,000
to $102,000 from $114,000 for fiscal year 1994.  This decrease was primarily due
to a decrease in depreciation expense resulting from the Center Conversions, the
leases of which  centers had been  accounted  for as capital  leases,  partially
offset by increases in  depreciation  expense due to the purchase of  additional
playground  equipment,  food service equipment and computer and office equipment
for the corporate office.

         Interest

         Interest expense for fiscal year 1995 increased by $30,000,  or 13%, to
$269,000  from  $239,000 for fiscal year 1994.  Of these  amounts,  $166,000 and
$234,000  for fiscal  years 1995 and 1994,  respectively,  was  attributable  to
interest  expense   associated  with  capitalized   lease   obligations,   which
obligations  have been  eliminated  as a result of the release of the Company as
co-borrower or guarantor under certain loan  agreements  secured by mortgages in
connection  with the  refinancing of such loans in September 1995. This increase
was due to an increase in interest  expense  resulting  from a bridge  financing
(the  "Bridge  Financing")  offset  in part by a  decline  in  interest  expense
associated  with the  conversion  of two  Company-owned  centers  to  franchised
centers as part of the Center Conversions,  the leases of which centers had been
categorized  as capital  leases.  The  balance of interest  expense  during both
periods was due to borrowings on the Company's line of credit.

         Other Income

         For fiscal year 1995,  the Company  realized  other  income of $41,000,
consisting primarily of consideration  received from the sale of a Company-owned
center as part of the Center Conversions during the first quarter of fiscal year
1995 and interest income.

         As a result  of the  foregoing,  the  Company  recorded  a net loss for
fiscal year 1995 of  $779,000  as compared to a net loss of $284,000  for fiscal
year 1994.




                                       23

<PAGE>



Liquidity and Capital Resources

         During the past two fiscal  years,  the Company has  satisfied its cash
requirements  from  cash  flow from  operations,  the sale of one  Company-owned
center,  the  conversion of four Company-owned  centers  to franchised  centers,
borrowing   under  its  line  of  credit,   advances   from  certain   principal
stockholders, and the initial public offering which amounted to approximately $4
million.  The primary uses of cash have been for the pay-off of borrowings under
the  line of  credit,  purchase  of  supplies,  financing  the  start-up  of new
Company-owned  centers,  the purchase of seven centers from  franchisees and the
repurchase  of one  previously  Company-owned  center  which  had been sold to a
franchisee,  capital expenditures,  and expenditures relating to the development
of the Company's franchising business, including hiring of necessary sales, real
estate,  legal and operations  personnel,  legal  requirements  associated  with
obtaining  the  necessary  franchise  registrations,   production  of  operating
manuals,  purchasing  the necessary  office  equipment and  furnishings  for the
Company's  corporate  headquarters,  marketing  for new  franchisees  (including
expenses for printing,  advertising and travel) and expenses related to the site
selection   process   (including    extensive   travel).   As   set   forth   in
"Business--Strategy,"  the Company's current plans are to focus on the "ramp-up"
to profitable enrollment levels through  Company-operated  center growth and the
advancement of existing franchised centers under development.

         Net cash used in  operating  activities  for fiscal  year 1996  totaled
approximately  $1,969,000,  reflecting,  primarily,  the net loss of $1,907,000,
which included a write off of goodwill of approximately  $220,000,  increases in
notes receivable and franchise development costs offset by increases in accounts
payable,  deferred  franchise  fees and  other  liabilities.  Net  cash  used in
operating  activities  for  fiscal  year 1995  totaled  approximately  $542,000,
reflecting,  primarily,  the  net  loss  of  $779,000  and  decreases  in  other
liabilities,  offset  by net cash  provided  by  franchise  fees  over  deferred
franchise  costs.  Net cash used for investing  activities  for the fiscal years
1996  and  1995  totaled  approximately  $686,000  and  $24,000,   respectively,
reflecting the acquisition of furniture and equipment for Company-owned  centers
and the  corporate  office.  Net cash provided by financing for fiscal year 1996
totaled  $3,836,000  which  included  approximately  $4 million from the initial
public offering,  $66,000 from long-term borrowings offset by the pay off of the
line of credit of $150,000 and payment to the  shareholder for loans of $88,000.
Net  cash  provided  by  financing  activities  for  fiscal  year  1995  totaled
approximately  $479,000,  reflecting  the proceeds from the Bridge  Financing of
approximately $400,000, borrowings of $89,000 under the Company's line of credit
and $88,000 from certain  principal  stockholders  and  affiliates,  offset by a
reduction  of  $12,000 in  long-term  debt and net  payments  to  affiliates  of
$86,000.

         The  Company  has  available  a bank line of credit  which  permits the
Company to borrow up to  $200,000,  with  interest  at the rate of 1.5% over the
bank's  prime  rate.  The line of credit  is  collateralized  by all  inventory,
equipment and accounts  receivables  of Kiddie Academy  International,  Inc. and
expires on February 22,  1997.  The Company  also has  available  the ability to
borrow $500,000  against a Certificate of Deposit (CD) for the same amount.  The
interest  cost is 2% greater than the interest  earnings of the CD. This line of
credit expires on July 26, 1996. At September 29, 1996, there were no borrowings
against either of the lines of credit.

                                       24

<PAGE>



         As  of  September  29,  1996,  the  Company's  total  debt  obligations
(exclusive  of trade  credit)  consisted  of $301,346  which  included a $44,000
equipment  loan, a $14,000 vehicle loan and various notes payable as a result of
the purchase of franchisee centers.

         The Company  believes  that the  remaining  net proceeds of the initial
public  offering,  available  cash flow from  operations  and its existing  bank
facilities  will be  sufficient  to satisfy  its capital  expenditures  and debt
obligations and will be sufficient to meet its working capital  requirements for
the ensuing fiscal year. The Company  believes that,  depending upon its success
in opening and  operating new  Company-owned  and  franchised  centers (of which
there can be no assurance),  its revenues will be sufficient to meet its working
capital requirements associated with such plans.  Additionally,  the Company may
choose to seek to raise additional  capital in the future, but no decisions have
been made in such regard. If such a plan is adopted,  there can be no assurances
that additional  financings could be consummated at all or on terms favorable to
the Company.

Effects of Inflation

         The impact of general  inflation  on the  Company's  business  has been
insignificant  to date and the  Company  believes  that it will  continue  to be
insignificant for the foreseeable future.

ITEM 7.           FINANCIAL STATEMENTS

         Information required by this Item appears on pages F1 - F16.

ITEM 8.           CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS
                  ON ACCOUNTING AND FINANCIAL DISCLOSURE

         Not Applicable.


                                    PART III

ITEM 9.           DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information  required by this Item will be  contained in the 1997 Proxy
Statement of the Company and is incorporated herein by reference.

ITEM 10.          EXECUTIVE COMPENSATION

        Information  required by this Item will be  contained  in the 1997 Proxy
Statement of the Company and is incorporated herein by reference.

ITEM 11.          SECURITY OWNERSHIP OF CERTAIN

                                       25

<PAGE>



                        BENEFICIAL OWNERS AND MANAGEMENT

        Information  required by this Item will be  contained  in the 1997 Proxy
Statement of the Company and is incorporated herein by reference.


ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Information  required by this Item will be  contained  in the 1997 Proxy
Statement and is incorporated herein by reference.


                                    PART IV

ITEM 13.          EXHIBITS AND REPORTS ON FORM 8-K

        No current reports on Form 8-K were filed by the Company during the last
quarter of the fiscal year ended September 29, 1996.

Exhibits

 3(a) Certificate of Incorporation, as amended.*
  (b) Certificate of Amendment of Certification of Incorporation.*
  (c) Amended and Restated By-laws.***
 4(a) Form of Public Warrant Certificate.*
  (b) Form of Warrant Agreement.*
  (c) Specimen certificate of Common Stock of the Company.*
 9    Voting Agreement.*
10(a) The  Company's  1995  Incentive  Compensation  Plan  (Second  Amended  and
      Restated).***
  (b) Employment  Agreement  between  the  Company  and George Miller.*
  (c) Amendment  to  George  Miller  Employment  Agreement.***
  (d) Employment  Agreement  between  the  Company  and  Michael J.  Miller.*
  (e) Amendment  to Michael J.  Miller  Employment  Agreement.***
  (f) Employment Agreement  between  the Company and Angelo D.  Bizzarro.**
  (g) Guaranty of certain leases by the Company in favor of The Sparks State
      Bank.*
  (h) Form of Preliminary Agreement (1996 Revision).***
  (i) Form of Franchise Agreement (1996 Revision).***
  (j) Form of Mutual General Release Agreement (1996 Revision).***
  (k) Form of  Collateral  Assignment  of  Lease  (1996 Revision).***
  (l) Lease  Agreement  among Penguin  Properties  Corporation ("PPC"), as
      lessor, and Kiddie Academy Child Care Learning Centers, Inc. ("Kiddie
      Centers"), Kiddie Academy Franchising Systems, Inc. ("Kiddie Franchising")
      and Kid's Craft, Inc. ("Kid's Craft"), as lessees for property located at
      108 Wheel Road, Bel Air, Maryland (the "Office Lease") dated September 25,
      1995.*
  (m) Amendment to Office Lease,  dated October 24, 1995.*
  (n) Second Amendment to Office Lease, dated October 18, 1996.***

                                       26

<PAGE>



  (o) Lease Agreement,  dated September 25, 1995,  between PPC, as lessor, and
      Kiddie Centers, as lessee, for the property located at 2235 Old Emmorton
      Road, Bel Air, Maryland, as amended (the "Old Emmorton Road Lease").*
  (p) Amendment to Old Emmorton Road Lease, dated October 24, 1995.*
  (q) Lease  Agreement,  dated  October 2, 1995,  between PPC, as lessor,  and
      Kiddie Centers, as lessee, for the property located at 3609 Milford Mill
      Road, Baltimore, Maryland.***
  (r) Lease  Agreement,  dated  September 30, 1994 (the "Kent Island  Lease"),
      between PPC, as lessor, and TAG,  Incorporated  ("TAG"),  as lessee, for
      the  property  located  at  Route  18,  Village  of  Benton's  Crossing,
      Stevensville, Maryland.***
  (s) Assignment of Lease dated November 4, 1996 between TAG, as assignor, and
      Kiddie Centers, as assignee, respecting the Kent Island Lease.***
  (t) Line of Credit  Agreement  between the  Company  and Sparks  State Bank,
      dated February 22, 1996.***
  (u) Line of Credit Agreement between the Company and Sparks State Bank dated
      July 26,  1996.***
  (v) Letter,  dated  September 27, 1995 by PPC to the Company, Kiddie Centers,
      Kiddie Franchising, Kid's Craft with respect to (i) the Office  Lease,
      (ii) the Old Emmorton Road Lease, (iii) the Lease Agreement,  dated August
      25, 1986, between Kiddie Centers and PPC and (iv) the Lease  Agreement,
      dated February 15, 1988, between Kiddie Centers and PPC.*
  (w) Line of Credit Agreement between the Company and Harford National Bank.*
21.     List of Subsidiaries of the Company*
27.     Financial Data Schedule.***



*       Incorporated by reference to the Company's Registration Statement on
        Form SB-2 (Commission File No.: 33-97282).

**      Incorporated by reference to the Company's Current Report on Form 8-K as
        filed with the Commission on October 21, 1996.

***     Filed herewith.

                                       27

<PAGE>



                                   SIGNATURES


         Pursuant  to the  requirements  of the  Securities  Act  of  1933,  the
Registrant,  Kiddie  Academy  International,  Inc., has caused this Report to be
signed  on its behalf by the undersigned, thereunto duly authorized on December
30, 1996.

                                           KIDDIE ACADEMY INTERNATIONAL, INC.


                                           By: /s/  George Miller
                                              ---------------------------------
                                               George Miller, Chairman of the
                                               Board and Chief Executive Officer


                               POWER OF ATTORNEY

         KNOW ALL MEN BY THESE  PRESENTS,  that each of the  undersigned  hereby
constitutes and appoints George Miller and Michael J. Miller, or any one of them
acting singly, his true and lawful agents and attorneys-in-fact  with full power
and authority in said agents and attorneys-in-fact,  or any of them, to sign for
the  undersigned and in his name, in the capacity  indicated  opposite his name,
this  Report of Kiddie  Academy  International,  Inc.  on Form  10-KSB  (and any
pre-effective  or  post-effective  amendment or supplement to such Report) to be
filed  under  the  Securities  Act of 1933,  with the  Securities  and  Exchange
Commission.

         Pursuant to the requirements of the Securities Act of 1933, this Report
has been  signed by the  following  persons in the  capacities  and on the dates
indicated.

         The signing  persons  include a majority of the  Registrant's  Board of
Directors.

Name                               Capacity                         Date
----                               --------                         ----
/s/ George Miller        Chairman of the Board, Chief          December 30, 1996
---------------------    Executive Officer (Principal
George Miller            Executive Officer), and Director


/s/ Michael J. Miller    President and Director                December 30, 1996
---------------------
Michael J. Miller


/s/ Guy A. Matta         Chief Financial Officer (Principal    December 30, 1996
---------------------    Financial and Accounting Officer)
Guy A. Matta



<PAGE>


                                                               December 30, 1996
/s/ Carl J. Meil, Jr.    Director
---------------------
Carl J. Meil, Jr.


/s/ Angelo D. Bizzarro   Director                              December 30, 1996
----------------------
Angelo D. Bizzarro


/s/ James A. Mitarotonda Director                              December 30, 1996
------------------------
James A. Mitarotonda


/s/ Julian R. Siegel     Director                              December 30, 1996
--------------------
Julian R. Siegel

<PAGE>

                       KIDDIE ACADEMY INTERNATIONAL, INC.

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                        Page
<S>     <C>
INDEPENDENT AUDITORS' REPORT .  . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of September 29, 1996 and September 30, 1995. . . . . .  F-3
Consolidated Statements of Operations for the Years Ended September 29, 1996
         and September 30, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
         September 29, 1996 and September 30, 1995. . . . . . . . . . . . . . . . . . . F-5
Consolidated Statements of Cash Flows for the Years Ended September 29, 1996
         and September 30, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-6
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . F-7
</TABLE>

                                      F-1

<PAGE>


INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors
Kiddie Academy International, Inc.

We have audited the accompanying  consolidated  balance sheets of Kiddie Academy
International,  Inc. and its subsidiaries (the Company) as of September 29, 1996
and September 30, 1995, and the related statements of operations,  stockholders'
equity  (deficit),  and cash flows for each of the two years in the period ended
September 29, 1996.  These financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our  opinion,  such  financial  statements  present  fairly,  in all material
respects,  the  financial  position of the Company as of September  29, 1996 and
September  30, 1995,  and the results of its  operations  and its cash flows for
each of the two years in the period ended  September 29, 1996 in conformity with
generally accepted accounting principles.

DELOITTE & TOUCHE LLP

Baltimore, Maryland
November 15, 1996

                                                        F-2

<PAGE>

                                        KIDDIE ACADEMY INTERNATIONAL, INC.
                                            CONSOLIDATED BALANCE SHEETS
                                                      ASSETS
<TABLE>
<CAPTION>
                                                                           September 29,            September 30,
                                                                               1996                     1995
                                                                           -------------            -------------
<S>     <C>
Current assets:
                    Cash and cash equivalents                                      $1,232,098                  $51,527
                    Accounts receivable                                               127,972                   75,640
                    Prepaid expenses                                                   60,024                    5,065
                    Inventories                                                        90,347                    6,498
                    Notes receivable, current                                          15,361                   21,454
                    Franchise development costs                                       699,527                  554,106
                    Deferred offering costs                                              ---                   485,837
                                                                           ------------------           --------------
                                  Total current assets                              2,225,329                1,200,127
                                                                                 ------------            -------------
Property and equipment                                                              1,057,066                  331,211
Accumulated depreciation                                                             (300,086)                (234,545)
                                                                               -------------             ------------
                                  Net property and equipment                          756,980                   96,666
                                                                                -------------            -------------
Notes receivable, long-term                                                           136,635                   85,115
Goodwill                                                                              116,910                      ---
Deposits                                                                              105,437                   16,227
                                                                                -------------           --------------
                                  Total assets                                     $3,341,291               $1,398,135
                                                                                  ===========              ===========


                                  LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
                  Notes payable                                                           ---                 $549,861
                  Accounts payable and accrued expenses                          $    787,654                  889,440
                  Deferred franchise license fees                                   1,125,002                1,065,371
                  Current portion of long-term debt                                   111,114                      291
                  Current portion of deferred rent credits                             93,992                   93,993
                                                                               --------------           --------------
                                    Total current liabilities                       2,117,762                2,598,956
Long-term debt                                                                        190,312                      ---
Stockholder notes                                                                         ---                   87,722
Deferred rent payments                                                                159,005                    3,338
Deferred rent credits                                                                 281,976                  375,968
                                                                               --------------            -------------
                                   Total liabilities                                2,749,055                3,065,984
                                                                                -------------             ------------
Commitments and contingencies
  Stockholders' equity (deficit):
                   Preferred stock, par value $0.01 per share: authorized
                      1,000,000 shares; no shares issued and outstanding                  ---                      ---
                  Common stock, par value $0.01 per share: authorized
                       10,000,000 shares; issued and outstanding shares
                       2,025,000 in 1996; 925,000 in 1995.                             20,250                    9,250
                  Additional paid-in capital                                        4,260,280                  214,505
                  Accumulated deficit                                              (3,688,294)              (1,781,604)
                  Deferred compensation                                                ---                    (110,000)
                                                                                -------------           ---------------
                            Total stockholders' equity (deficit)                      592,236               (1,667,849)
                                                                                -------------           ---------------
                            Total liabilities and stockholders'
                              equity (deficit)                                     $3,341,291               $1,398,135
                                                                                =============           ==============
</TABLE>
                See notes to consolidated financial statements.


                                      F-3

<PAGE>



                       KIDDIE ACADEMY INTERNATIONAL, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                   YEARS ENDED
                                                                  SEPTEMBER 29,                 SEPTEMBER 30,
                                                                       1996                           1995
                                                                 ----------------               --------------
<S>     <C>
REVENUES:
          Company-owned mature centers                               $1,397,502                    $1,343,224
          Company-owned new centers                                   1,731,018                        75,114
          Franchise license fees                                        563,329                       412,979
          Franchise royalties                                           758,403                       407,719
          Product sales                                                 264,442                       159,856
          Administrative fees                                            77,004                        51,520
                                                                   ------------              ----------------
                          Total revenue                               4,791,698                     2,450,412
OPERATING EXPENSES:
          Company-owned mature centers                                1,340,386                     1,301,662
          Company-owned new centers                                   2,938,072                       174,507
          Cost of product sales                                         206,835                       115,174
          General and administrative                                  2,307,745                     1,410,956
                                                                   ------------               ---------------
                          Total operating expenses                    6,793,038                     3,002,299
                                                                   ------------               ---------------
                           Loss from operations                      (2,001,340)                     (551,887)
INTEREST INCOME (EXPENSE)                                                38,996                     (269,020)
OTHER INCOME (EXPENSE), net                                              55,654                        41,460

NET LOSS                                                            ($1,906,690)                    ($779,447)
                                                                   ============            ==================
NET LOSS PER COMMON SHARE                                                ($1.06)                       ($0.81)
                                                                   ============             =================
WEIGHTED AVERAGE SHARES
OUTSTANDING                                                           1,795,833                       964,700
                                                                   ============           ===================
</TABLE>

                See notes to consolidated financial statements.

                                      F-4

<PAGE>



                       KIDDIE ACADEMY INTERNATIONAL, INC.

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>

                                            Common Stock      Additional                                        Total
                                      ----------------------    Paid-in      Accumulated      Deferred       Stockholders'
                                          Shares      Amount    Capital        Deficit      Compensation    Equity (Deficit)
                                      ----------  ----------  -----------  --------------  --------------  -----------------
<S>     <C>
Balance at
   October 1, 1994                       925,000      $9,250      $74,505    $(1,002,157)                     $(918,402)
   Warrants issued                           ---         ---       30,000             ---                        30,000
    Deferred compensation on
      stock options                          ---         ---      110,000             ---     $(110,000)
    Net loss                                                                    (779,447)                      (779,447)
                                      ----------  ----------  -----------  --------------  -------------  --------------
Balance at
   September 30, 1995                    925,000       9,250      214,505     (1,781,604)      (110,000)     (1,667,849)
   Initial public offering             1,100,000      11,000    4,061,782             ---            ---       4,072,782
   Deferred rent credits                     ---         ---       93,993             ---            ---          93,993
   Deferred compensation on                  ---         ---                          ---
        stock options                                           (110,000)                        110,000             ---
   Net loss                                                                   (1,906,690)                    (1,906,690)
                                      ----------  ----------  -----------  --------------  -------------  --------------
Balance at
    September 29, 1996                 2,025,000     $20,250   $4,260,280    $(3,688,294)            ---        $592,236
                                      ==========  ==========  ===========  ==============  =============  ==============
</TABLE>


                See notes to consolidated financial statements.


                                      F-5

<PAGE>

                       KIDDIE ACADEMY INTERNATIONAL, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                          YEARS ENDED
                                                                         SEPTEMBER 29,                  SEPTEMBER 30,
                                                                               1996                          1995
                                                                     ---------------------          -------------------
<S>     <C>
Cash flows from operating activities:
   Net loss                                                                 ($1,906,690)                    ($779,447)
   Adjustments to reconcile net loss to net cash used in
     operating activities:
     Write-off of goodwill                                                       220,214                           ---
      Depreciation and amortization                                               82,784                       102,377
      (Gain) loss on sale of assets                                             (52,065)                        32,304
     Amortization of debt issuance costs                                          26,667                        83,333
     Changes in assets and liabilities:
        Accounts receivable                                                     (52,332)                      (24,334)
        Inventories                                                             (83,849)                         2,732
        Notes receivable                                                          14,573                        48,112
        Franchise development costs                                            (145,421)                     (230,840)
        Other assets                                                           (261,079)                         5,592
        Accounts payable and accrued expenses                                   (21,119)                        79,333
        Deferred franchise license fees                                           59,631                       277,691
        Other liabilities                                                        149,392                     (138,364)
                                                                             -----------                  ------------
        Net cash used in operating activities                                (1,969,294)                     (541,511)
                                                                             -----------                  ------------
Cash flow from investing activities:
   Acquisition of property and equipment                                       (725,855)                      (31,906)
   Proceeds from disposal of property and equipment                               40,000                         7,975

            Net cash used in investing activities                              (685,855)                      (23,931)
                                                                             -----------                  ------------
Cash flows from financing activities:
   Borrowings from (payments on) notes payable                                 (549,861)                       489,361
   Borrowings from (payments to) shareholders                                   (87,722)                        87,722
   Net proceeds from IPO                                                       4,407,391                           ---
   Payments of loans from affiliates, net                                            ---                      (86,054)
   Borrowings (payments) of long-term debt                                        65,912                      (11,909)
                                                                              ----------                  ------------
         Net cash provided by financing activities                             3,835,720                       479,120
                                                                              ----------                  ------------
         Net increase (decrease) in cash                                       1,180,571                      (86,322)


Cash, beginning of year

                                                                                  51,527                       137,849
                                                                              ----------                     ---------

Cash, end of year                                                             $1,232,098                       $51,527
                                                                              ==========                     =========
</TABLE>

                See notes to consolidated financial statements.

                                      F-6

<PAGE>


                       KIDDIE ACADEMY INTERNATIONAL, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                   SEPTEMBER 29, 1996 AND SEPTEMBER 30, 1995


1.       Summary of Significant Accounting Policies

         (a)      Description of Business
         Kiddie Academy International, Inc., a Delaware Corporation (the "Parent
Company")  (together with its  subsidiaries,  the "Company" or "Kiddie Academy")
operates and franchises education-based child care centers for children from six
weeks to 12 years of age under  the name  Kiddie  Academy  Child  Care  Learning
Centers,  Inc.  ("Kiddie  Centers"),  a  wholly-owned  subsidiary  of the Parent
Company  which was  incorporated  in Maryland in 1981 and  operates the Company-
owned centers;  Kiddie Academy Franchising Systems, Inc. ("Kiddie Franchising"),
formerly  known  as  Kiddie  Academy  International,  Inc.  and  a  wholly-owned
subsidiary of Kiddie  Centers,  which was  incorporated  in Maryland in 1992 and
operates  the  Company's  franchise  business;  and Kid's  Craft,  Inc.  ("Kid's
Craft"), a wholly-owned subsidiary of the Parent Company, which was incorporated
in  Maryland in 1989 and  operates  the  Company's  school  supply  distribution
business.

         The  Company  was  incorporated  on June  28,  1995 to  succeed  to the
ownership and operation of Kiddie Centers,  Kiddie  Franchising and Kid's Craft.
All of the shares of Kiddie  Centers and Kid's Craft were owned by the principal
stockholders  of the Parent  Company.  Each of  Pauline,  George and  Michael J.
Miller exchanged their  respective  shares of Kiddie Centers and Kid's Craft for
shares of common  stock of the  Parent  Company  at an  exchange  rate of 523.81
shares of common  stock of the Parent  Company  for one share of Kiddie  Centers
common stock and one share of Kid's Craft common stock,  resulting in a total of
1,100,000 shares of common stock of the Parent Company outstanding.

         The Company  experienced  a net  increase in the number of centers from
36, at the  beginning of fiscal year 1996,  to 49 at the end of fiscal year 1996
operating  in 15  states.  The  Company  has  achieved  this  growth  through  a
combination  of  Company-operated   and  franchised   centers.   The  number  of
Company-owned  centers  increased by ten during fiscal year 1996, and the number
of  franchised  centers  increased by 3 during  fiscal year 1996.  The growth of
Company-owned  centers  during fiscal year 1996 included the  acquisition of six
centers from its franchisees.

         (b)      Principles of Consolidation
         The consolidated financial statements include the results of operations
of the  Parent  Company  and its  wholly-owned  subsidiaries.  All  intercompany
transactions have been eliminated.


                                      F-7

<PAGE>



         (c)      Use of Estimates
         The  preparation of financial  statements in conformity  with generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

         (d)      Inventories
         Inventories,  consisting of  educational  materials,  are stated at the
lower of first-in, first-out cost or market.

         (e)      Franchise development costs
         Direct costs relating to franchise  sales for which  franchise  revenue
has not been recognized are deferred until the related revenue is recognized.

         (f)      Property and Equipment
         Property  and   equipment   are  stated  at  cost,   less   accumulated
depreciation.  Property  acquired under capital leases is stated at the lower of
the  present  value  of  future  minimum  lease  payments  or fair  value at the
inception of the lease, less accumulated amortization.

         Depreciation,  including  amortization  of assets  covered  by  capital
leases, is provided on both the  straight-line and accelerated  methods over the
estimated useful lives of the assets as follows:

             Equipment. . . . . . . . . . . . . . . . . . . . . . 5-10 years
             Furniture and fixtures. . . . . . . . . . . . . . .   5 years
             Vehicles. . . . . . . . . . . . . . . . . . . . . . . 3 years

         Amortization of leasehold  improvements  and items under capital leases
is provided  over their useful lives or the remaining  lease term,  whichever is
shorter.  Expenditures  for  maintenance  and  repairs are charged to expense as
incurred.  As  discussed  in Note 5 in 1995,  the  Company  executed  new  lease
agreements to replace the capital leases.

         (g)      Revenue Recognition
         Revenue  from  Company-owned  centers is  recognized  in the period the
child care services are provided. Revenue derived from initial franchise fees is
recognized when the franchise centers open. Royalties are recognized in the same
period  related  franchise  center  revenue  is  generated.  Revenue  from other
services  provided to  franchisees,  such as accounting,  is recognized when the
service is provided.  Certain states require the Company to place funds received
from potential  franchisees in escrow until certain  performance  milestones are
achieved.  At September 29, 1996 funds held in escrow amounted to  approximately
$60,000.

         Revenue on product sales is recognized at the time of shipment.


                                      F-8

<PAGE>



         Deferred  franchise  license  fees  represent  amounts  received by the
Company from prospective  franchisees which will be recorded as revenue when the
centers open.

         (h)      Taxes
         The Company  accounts  for income  taxes under  Statement  of Financial
Accounting  Standards  No. 109,  "Accounting  for Income Taxes" (SFAS 109) which
requires  recognition  of deferred tax assets and  liabilities  for the expected
future tax  consequences  of events  that have been  included  in the  financial
statements  or  tax  returns.  Under  this  method,   deferred  tax  assets  and
liabilities  are  determined  based  on the  difference  between  the  financial
statement  and tax bases of assets and  liabilities  using  enacted tax rates in
effect for the year in which the differences are expected to reverse.

         (i)      Net Earnings (Loss) Per Common Share
         Net earnings  (loss) per common share is determined by dividing the net
earnings  (loss) by the  weighted  average  number of common  and  common  share
equivalents outstanding.  Weighted average shares used in computing net loss per
common share for 1996 consist solely of 1,795,833  shares of common stock issued
as the effect of the warrants would be antidilutive.  Pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 83, stock options and warrants
granted  during the 12-month  period  prior to the expected  date of the initial
filing of the  Registration  Statement,  with exercise  prices below the initial
public offering price,  have been included in the calculation of the 1995 common
share equivalents,  using the treasury stock method, as if they were outstanding
for the entire year. Weighted average shares used in computing net income (loss)
per common  share for 1995  consist of 925,000  shares of common stock issued in
connection  with the  reorganization  of the  Company  and 39,700  common  stock
equivalents  (representing  employee  options and warrants  issued in connection
with the Bridge Units (see Note 4).

         (j)      Common Stock
         On October 24, 1995, the Company effected a reverse stock split (.77273
to 1) reducing the  outstanding  shares to 850,000.  On November  21, 1995,  the
Company effected a stock split (1.088236 to 1) increasing the outstanding shares
to 925,000.  The accompanying 1995 financial statements and all common stock and
per share data  included  in the  accompanying  financial  statements  and notes
thereto  have been  restated to reflect  the  reorganization  of entities  under
common  control  in a manner  similar  to a  pooling  of  interests  and to give
retroactive effect to the reverse stock split and stock split.

         As of September 29, 1996, 1,446,491 shares of common stock are reserved
for issuance in  connection  with  outstanding  offering  purchase  warrants and
bridge warrants and the Incentive Compensation Plan.

         (k)      Initial Public Offering
         In December 1995 the Company  completed an initial public offering (the
"Offering")  of  1,100,000  shares of common  stock and  1,100,000  common stock
purchase  warrants.  The warrants allow the holders to purchase 1,100,000 shares
of common stock at $7.46 per share.

                                      F-9

<PAGE>



         In February  1996,  the  underwriter  exercised  its option to purchase
165,000  warrants at an option price of $.10 per share.  Each warrant allows the
holder to purchase one share of common stock at $7.46 per share. As of September
29, 1996, there were no warrants  exercised.  These warrants expire in February,
2000.

         At September 30, 1995, in connection with the Offering, the Company had
incurred and deferred offering costs approximating  $486,000. The total offering
costs  incurred  approximated  $740,000 and were  deducted from the net proceeds
recorded of approximately $4,812,000.

         (l)      Acquisition and Goodwill
         The Company  acquired  six  centers  from  franchisees  during the 1996
fiscal year for $250,000 in cash and the issuance of notes  payable of $305,000.
The  purchase  price was  allocated  to the net  assets  acquired  (equipment  -
$147,000 and  deposits - $47,000) and the excess of the purchase  price over the
fair value of net assets  acquired  ($361,000)  has been  recorded as  goodwill.
Goodwill is amortized on a straight-line basis over a 7 - 10 year period.

         Based on an evaluation of estimated  future cash flows of these centers
by the  Company at  September  29,  1996,  it was  determined  that  goodwill of
approximately $220,000 was impaired and it was written off.

         (m)      Fiscal Year-end
         During  fiscal year 1996,  the Company  changed its fiscal year to be a
fiscal year which covers the 52 or 53 week period which ends the Sunday  nearest
to September 30.

         (n)      Fair Value of Financial Instruments
         The  following  methods  and  assumptions  were used by the  Company in
estimating its fair value disclosures for financial instruments:

         Cash  and cash  equivalents  - The  carrying  amounts  reported  in the
         balance sheets for cash approximates fair value.

         Accounts  Receivable  and  Accounts  Payable  -  The  carrying  amounts
         reported in the balance  sheets for  accounts  receivable  and accounts
         payable approximate fair value.

         Notes  Receivable - The carrying amounts reported in the balance sheets
         for the current and long-term portions of notes receivable  approximate
         fair value as the interest rates are comparable to current rates.

         Long-term  Debt - The carrying  amounts  reported in the balance sheets
         for the current and long-term  portions of long-term  debt  approximate
         fair value as the notes were executed in the current year and were done
         so at current rates for any agreement with an original maturity greater
         than 12 months.


                                      F-10

<PAGE>



2.       Notes Receivable
         Notes  receivable  at September 29, 1996 and September 30, 1995 consist
of installment notes due from franchisees as follows:

<TABLE>
<CAPTION>
                                                                                September 29,       September 30,
                                                                                    1996                1995
                                                                                -------------       -------------
<S>     <C>
Collateralized notes receivable in monthly installments of $1,868,
     including interest at 8% to 10% through February 2006                         $146,983           $101,069
Collateralized note receivable due December 1996 including interest at 12%            5,013              5,500
                                                                                   --------           --------
Total notes receivable                                                              151,996            106,569
Current portion                                                                      15,361             21,454
                                                                                   --------           --------
Long-term portion                                                                  $136,635           $ 85,115
                                                                                   ========           ========
</TABLE>

3.       Property and Equipment
         Property and  equipment at September  29, 1996 and  September  30, 1995
consist of:

<TABLE>
<CAPTION>
                                                    September 29,   September 30,
                                                         1996           1995
                                                    -------------   -------------
<S>     <C>
Equipment                                             $ 797,326       $173,370
Furniture and fixtures                                   69,635         36,286
Vehicles                                                 16,648            ---
Leasehold Improvements                                  173,457        121,555
                                                     -----------      ---------
                                                      1,057,066        331,211
   Less accumulated depreciation and amortization      (300,086)      (234,545)
                                                     -----------      ---------
                                                       $756,980        $96,666
                                                     ===========      =========
</TABLE>

4.       Indebtedness
         (a) Notes Payable
         The  Company  has  available  a bank line of credit  which  permits the
Company to borrow up to $200,000 at 1.5% over the Bank's prime rate.  Borrowings
under the agreement  are  collateralized  by  inventory,  equipment and accounts
receivable.  The line of credit  expires on February 22, 1997.  At September 30,
1995, $149,861 was outstanding on a previous line of credit that expired on June
30, 1996.  The Company also has available a $500,000 line of credit secured by a
$500,000  Certificate  of Deposit (CD) which permits the Company to borrow at 2%
above the CD rate of 4.95%.  The line expires on July 26, 1997. At September 29,
1996, there were no borrowings on either lines of credit.


                                      F-11

<PAGE>

         (b) Long-Term Debt
         Long-term debt at September 29, 1996 and September 30, 1995 consists of
the following:

<TABLE>
<CAPTION>
                                                                               September 29,    September 30,
                                                                                   1996              1995
                                                                               -------------    -------------
<S>    <C>
Equipment loan, bearing interest at 7.5% per annum, maturing in 1995            $     ---           $  291
Equipment loans bearing interest at 1.5% above prime, and 8.5% maturing
     in February 1999 and May 1999, respectively, collateralized by equipment
     and a vehicle                                                                 58,492              ---
Various notes payables, bearing interest at 0% to 8%, maturing at various
     dates through 2002, issued in connection with the purchase of centers        242,934              ---
Less current maturities of long-term debt                                        (111,114)            (291)
                                                                                 ---------       ----------

Long-term debt                                                                    $190,312       $      ---
                                                                                  ========       ===========
</TABLE>

         (c)      Bridge Loan
         On August 8, 1995,  the Company  sold four units (the  "Bridge  Units")
each  consisting of a Bridge Note for $100,000 and a Bridge  Warrant to purchase
21,023 shares of common stock. The net proceeds received by the Company from the
sale of the  Bridge  Units  were  approximately  $320,000  and were used to fund
expenses of the Company in  connection  with the Offering,  for working  capital
requirements and for other corporate purposes prior to the Offering.  The Bridge
Notes  bore  interest  at a rate of 10% per  annum  and  were  paid off with the
proceeds of the Offering.  The Bridge  Warrants  entitle the holders  thereof to
purchase,  in the aggregate,  up to 84,091 shares of common stock at an exercise
price of $3.38 per share.  The Bridge  Warrants may be exercised at any time and
expire on August 8, 2000.  Debt issuance costs  associated  with the bridge loan
were being amortized over the period the Bridge Notes were outstanding.  Through
September  30, 1995,  the Company  amortized  $30,000  relating to the estimated
value  ascribed to the Bridge  Warrants  by the Company and $53,000  relating to
costs associated with the sale of the Bridge Units. For the year ended September
29,  1996,  the  Company  amortized  the  remaining  $27,000  relating  to costs
associated with the sale of the Bridge Units.

5.       Capital Leases and Commitments
         (a)      Capital Leases
         During  1993,  the  Company  leased  three  child care  centers and its
corporate  headquarters from Penguin Properties  Corporation  ("PPC"), an entity
owned by certain  officers,  directors  and  shareholders  of the  Company.  The
Company also guaranteed the debt of PPC relating to these buildings. The initial
terms of the  respective  leases  were for five  years  with a series of renewal
options. Because of the debt guarantee, the lease term was considered to include
all renewals during which the debt guarantee was expected to be in effect.  As a
result, the leases were capital leases for financial reporting purposes.

         During  September 1995, the Company  entered into new lease  agreements
for the remaining  capital  leases with PPC and PPC refinanced its existing debt
on all of these buildings.  As a result of the refinancing  discussed above, the
debt was no longer  guaranteed by the Company and capitalized  lease obligations
and related accrued interest were removed from the balance sheet. The

                                      F-12

<PAGE>

resulting  gain has been  deferred and will be amortized to  additional  paid-in
capital over the term of the new lease.  The new lease  agreements with PPC have
an initial term of five years and contain renewal options.

         (b)      Operating Leases
         The  Company   leases  certain   facilities  in  connection   with  its
Company-owned  centers as well as its  corporate  headquarters.  The  negotiated
leases  contain  rental  abatements and scheduled  payment  increases  which are
amortized on a straight-line basis over the terms of the leases.

         Future minimum rentals under non-cancelable operating leases, including
the leases with PPC, are as follows:


                     Year Ending September
                     1997                     $1,578,000
                     1998                      1,592,000
                     1999                      1,631,000
                     2000                      1,650,000
                     2001                      1,224,000
                     Thereafter                5,579,000

         Rent expense for the years ended  September  29, 1996 and September 30,
1995 was $1,257,000 and $414,000, respectively.

         (c)      Commitments and Contingencies
         In  September  1995,  the Company  entered into  three-year  employment
agreements  with each of George  Miller and Michael J.  Miller.  The  agreements
provide for a minimum  salary level as well as bonuses  based on a percentage of
pre-tax profits.

         Also, in September 1995 the Company entered into a two-year  employment
agreement with a chief operating officer who subsequently  resigned his position
in January  1996. In connection  with the  agreement,  the Company had agreed to
grant an option to purchase  40,000  shares of the  Company's  common stock at a
price below par value.  At September 30, 1995,  $110,000 of  compensation  costs
related to the option grant was deferred and to be amortized. As a result of the
resignation,  the  options  expired  and the  deferred  compensation  amount was
reversed.

         In October 1996, the Company entered into a three-year agreement with a
new chief executive  officer.  The agreement calls for a minimum salary level, a
bonus  based on a  percentage  of pre-tax  profits and  various  stock  options,
including 75,000 non-qualified stock options (at an exercise price of $3.64) and
25,000 incentive stock options (at an exercise price equal to the per share fair
market  value on the date he  commences  employment).  The new  Chief  Executive
Officer  will  further be  entitled to an  additional  100,000  incentive  stock
options if the stockholders of the

                                      F-13

<PAGE>



Company approve a proposed  increase in the number of shares available under the
Company's  1995 Incentive  Compensation  Plan (see Note 9). Also in October 1996
the  agreements  with the  Millers  were  extended  to expire  in  approximately
February 2000.

         In  many  instances,  the  Company  has  guaranteed  some  or  all of a
franchisee's obligations under the lease for the franchisee's child care center.
In addition,  the Company has entered into a management  agreements  with two of
its franchisees,  pursuant to which the Company has agreed to operate the center
and assume certain long-term commitments.

         The Company is subject to complaints and claims arising in the ordinary
course of business, including its business as a franchisor. The Company believes
that none of the current  claims or  complaints  are  material to the  Company's
consolidated financial position.

6.       Income Taxes

         Due to the Company's operating losses, a provision for income taxes has
not been necessary.

         The  components of the net deferred tax assets as of September 29, 1996
and September 30, 1995 are as follows:


                                                    1996              1995
                                                -----------       ----------
Deferred tax assets:
     Financial statement accruals, net          $    44,000         $ 12,000
     Deferred franchisee fee, net of costs          170,000          185,000
     Differences in bases of assets                  88,000              ---
     Net operating loss carryforwards               966,000          309,000
     Valuation allowance                         (1,257,000)        (506,000)
                                                -----------      -----------
                                                     11,000              ---
Deferred tax liabilities:
     Depreciation                                   (11,000)             ---
                                                -----------      -----------
Net deferred tax asset                            $     ---         $    ---
                                                ===========      ===========

The corporate  reorganization and offering,  as discussed in Note 1, will result
in an  annual  limitation  of the  Company's  utilization  of its net  operating
losses.  There is no assurance  that the Company will  generate  future  taxable
income  sufficient to allow for such utilization.  Accordingly,  the Company has
fully reserved all tax assets.

         At September 29, 1996, NOL  carryforwards of  approximately  $2,415,000
were available to reduce future taxable income. The NOL carryforwards  expire in
varying amounts from 2007 to 2011.



                                      F-14

<PAGE>

7.       Supplementary Cash Flow Information
         For the years ended September 29, 1996 and September 30, 1995,  certain
supplementary cash flow information follows:

<TABLE>
<CAPTION>
                                                                         Years Ended
                                                               September 29,        September 30,
                                                                   1996                 1995
                                                                   ----                 ----
<S>     <C>
Cash paid for interest                                          $   54,000          $    220,892
Non-cash financing activities:
     -- reduction of capital lease obligation (see Note 5)             ---             1,013,298
     -- deferred offering costs included in accounts
         payable                                                    75,000               460,000
Notes payable issued on acquisition of centers                     305,000
Non-cash investing activities, note received on sale of
   fixed assets                                                     60,000                   ---
</TABLE>

8.       Related Party Transactions
         From time to time from 1991 to 1995,  PPC advanced  certain  amounts to
Kiddie Centers and Kiddie Centers  advanced certain amounts to PPC. In addition,
the  stockholders  advanced certain amounts to Kiddie Centers and Kiddie Centers
advanced  certain  amounts  to its  principal  stockholders.  These did not bear
interest.  As of September  30, 1995,  Kiddie  Centers  wrote off the  remaining
balance  of its loans of  $39,630  to the  principal  stockholders  which was in
excess of its payable to PPC. As a result, there was no net balance in affiliate
loans at September 30, 1995.

         From January 1995 through  September 1995,  Kiddie Centers  borrowed an
aggregate  of  $63,895  from  George  Miller,  Chief  Executive  Officer  and  a
stockholder of the Company,  and an aggregate of $21,700 from Michael J. Miller,
President  and a  stockholder  of the Company,  to fund certain of the Company's
working capital needs and expenses related to the bridge financing (see Note 4).
Each of these loans bears interest at the rate of 8% per annum.  As of September
30, 1995, $87,772 in principal plus accrued interest remained  outstanding under
these loans.  A portion of the proceeds of the Offering (see Note 1) was used to
repay these loans.

         The Company also leases  certain  property  from PPC.  Such leases were
accounted for as capital leases until September 1995 (see Note 5).

9.       Incentive Compensation Plan
         The Company has  established a 1995  Incentive  Compensation  Plan (the
"Plan")  which is designed to provide  additional  incentives  for  officers and
other key employees of the Company to promote the success of the business and to
enhance the  Company's  ability to attract and retain the  services of qualified
persons.  The  Plan  will be  administered  by the  Board of  Directors  or by a
compensation committee of the Board of Directors (the "Committee") which will be
authorized  to grant to key employees  (including  officers)  restricted  stock,
incentive stock options and  non-qualified  stock options.  A maximum of 100,000
shares of common stock was reserved  for issuance  under the Plan.  The Board of
Directors has approved an increase in the number of shares reserved for issuance
under the plan to  300,000,  which  increase  is subject to the  approval of the
Company's  stockholders.  The Plan will  expire on, and no awards may be granted
thereunder after, the tenth anniversary of the adoption of the Plan,  subject to
the right of the Board of  Directors  to  terminate  the Plan at any time  prior
thereto.  The Board of Directors may amend the Plan at any time,  except no such
amendment may impair the rights of recipients  of previous  grants  without such
grantees' consent.  At September 29, 1996 no options have been granted under the
Plan.


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