e10vq
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-Q
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(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended
December 31,
2010
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OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission File Number:
001-33883
K12 Inc.
(Exact name of registrant as
specified in its charter)
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Delaware
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95-4774688
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(State or other jurisdiction of
incorporation or organization)
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(IRS Employer
Identification No.)
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2300 Corporate Park Drive
Herndon, VA
(Address of principal executive
offices)
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20171
(Zip Code)
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(703) 483-7000
(Registrant’s telephone
number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject
to such filing requirements for the past
90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
(§ 232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant
was required to submit and post such
files). Yes
o
No
o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated
filer
o
Non-accelerated
filer
o
(Do not check if a smaller
reporting company)
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Accelerated
filer
þ
Smaller reporting
company
o
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes
o
No
þ
As of February 4, 2010, the Registrant had
31,296,158 shares of Common Stock, $0.0001 par value
outstanding.
K12
Inc.
Form 10-Q
For the
Quarterly Period Ended December 31, 2010
Index
1
PART I —
FINANCIAL INFORMATION
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Item 1.
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Financial
Statements (Unaudited).
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K12
INC.
UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
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December 31,
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June 30,
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2010
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2010
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(In thousands,
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except share data)
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ASSETS
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Current assets
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Cash and cash equivalents
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$
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35,157
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$
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81,751
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Restricted cash and cash equivalents
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1,500
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3,343
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Accounts receivable, net of allowance of $2,552 and $1,363 at
December 31, 2010 and June 30, 2010, respectively
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142,486
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71,184
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Inventories, net
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16,906
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26,193
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Current portion of deferred tax asset
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4,678
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4,672
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Prepaid expenses
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9,617
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8,849
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Other current assets
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16,105
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7,286
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Total current assets
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226,449
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203,278
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Property and equipment, net
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42,573
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24,260
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Capitalized software development costs, net
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23,910
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16,453
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Capitalized curriculum development costs, net
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50,642
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39,860
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Deferred tax asset, net of current portion
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—
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5,912
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Intangible assets
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40,005
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14,081
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Goodwill
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53,531
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1,825
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Deposits and other assets
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14,411
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2,213
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Total assets
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$
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451,521
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$
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307,882
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LIABILITIES, SERIES A SPECIAL STOCK, REDEEMABLE
NONCONTROLLING INTEREST AND EQUITY
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Current liabilities
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Accounts payable
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$
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14,825
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$
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12,691
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Accrued liabilities
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13,716
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8,840
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Accrued compensation and benefits
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7,238
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10,563
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Deferred revenue
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32,682
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9,593
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Current portion of capital lease obligations
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13,736
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10,996
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Current portion of notes payable
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974
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1,251
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Total current liabilities
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83,171
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53,934
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Deferred rent, net of current portion
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3,813
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1,782
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Line of credit
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15,000
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—
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Capital lease obligations, net of current portion
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11,745
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7,710
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Notes payable, net of current portion
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—
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655
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Deferred tax liability
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9,596
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—
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Other long term liabilities
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3,219
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435
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Total liabilities
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126,544
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64,516
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Commitments and contingencies
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Series A Special Stock
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63,112
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—
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Redeemable noncontrolling interest
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20,800
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17,374
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Equity:
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K12 Inc. stockholders’ equity
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Common stock, par value $0.0001; 100,000,000 shares
authorized; 31,121,551 and 30,441,412 shares issued and
outstanding at December 31, 2010 and June 30, 2010,
respectively
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3
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3
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Additional paid-in capital
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366,442
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361,344
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Accumulated other comprehensive income
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38
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—
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Accumulated deficit
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(129,459
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)
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(139,496
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)
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Total K12 Inc. stockholders’ equity
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237,024
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221,851
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Noncontrolling interest
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4,041
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4,141
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Total equity
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241,065
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225,992
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Total liabilities, Series A special stock, redeemable
noncontrolling interest and equity
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$
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451,521
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$
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307,882
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See notes to unaudited condensed consolidated financial
statements.
2
K12
INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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Three Months Ended
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Six Months Ended
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December 31, 2010
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December 31, 2010
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2010
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2009
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2010
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2009
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(In thousands, except share and per share data)
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Revenues
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$
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129,002
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$
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93,197
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$
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263,873
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$
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199,522
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Cost and expenses
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Instructional costs and services
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76,195
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51,589
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151,277
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109,682
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Selling, administrative, and other operating expenses
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35,177
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24,899
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85,675
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58,226
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Product development expenses
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3,435
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|
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2,415
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7,346
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4,653
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Total costs and expenses
|
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|
114,807
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78,903
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244,298
|
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172,561
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Income from operations
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14,195
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|
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14,294
|
|
|
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19,575
|
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26,961
|
|
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Interest expense, net
|
|
|
(366
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)
|
|
|
(324
|
)
|
|
|
(663
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)
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(681
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)
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Income before income tax expense and noncontrolling
interest
|
|
|
13,829
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|
|
13,970
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|
|
|
18,912
|
|
|
|
26,280
|
|
|
Income tax expense
|
|
|
(6,119
|
)
|
|
|
(4,381
|
)
|
|
|
(9,050
|
)
|
|
|
(9,749
|
)
|
|
|
|
|
|
|
|
|
|
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|
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Net income
|
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|
7,710
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|
|
9,589
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9,862
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16,531
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Add net loss attributable to noncontrolling interest
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129
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|
49
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175
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|
190
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|
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Net income — K12 Inc.
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$
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7,839
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$
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9,638
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$
|
10,037
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$
|
16,721
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Net income attributable to common stockholders per share (see
Note 3):
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Basic
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$
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0.24
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$
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0.33
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$
|
0.30
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$
|
0.57
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Diluted
|
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$
|
0.23
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$
|
0.32
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|
$
|
0.30
|
|
|
$
|
0.56
|
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|
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Weighted average shares used in computing per share
amounts:
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Basic
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30,565,683
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29,648,674
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30,454,724
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29,512,635
|
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Diluted
|
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31,128,286
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29,974,642
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31,094,840
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29,875,966
|
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|
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|
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|
|
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See notes to unaudited condensed consolidated financial
statements.
3
K12
INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
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|
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|
|
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|
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|
K12 Inc Stockholders
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Total
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Additional
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Accumulated
|
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Stockholders’
|
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Common Stock
|
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Paid-in
|
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Other
|
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Accumulated
|
|
|
Noncontrolling
|
|
|
Equity
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Income
|
|
|
Deficit
|
|
|
Interest
|
|
|
(Deficit)
|
|
|
|
|
Balances at June 30, 2010
|
|
|
30,441,412
|
|
|
$
|
3
|
|
|
$
|
361,344
|
|
|
$
|
—
|
|
|
$
|
(139,496
|
)
|
|
$
|
4,141
|
|
|
$
|
225,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss)(1)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
10,037
|
|
|
|
(100
|
)
|
|
|
9,937
|
|
|
Foreign currency translation adjustments
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
38
|
|
|
|
—
|
|
|
|
—
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
9,975
|
|
|
Stock based compensation expense
|
|
|
—
|
|
|
|
—
|
|
|
|
5,399
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,399
|
|
|
Exercise of stock options
|
|
|
308,286
|
|
|
|
—
|
|
|
|
2,911
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,911
|
|
|
Excess tax benefit from stock based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
1,308
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,308
|
|
|
Issuance of restricted stock awards
|
|
|
426,863
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Forfeitures of restricted stock awards
|
|
|
(18,416
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Accretion of redeemable noncontrolling interests to estimated
redemption value
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,500
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,500
|
)
|
|
Purchase and retirement of restricted stock for tax withholding
|
|
|
(36,594
|
)
|
|
|
—
|
|
|
|
(1,020
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at December 31, 2010
|
|
|
31,121,551
|
|
|
$
|
3
|
|
|
$
|
366,442
|
|
|
$
|
38
|
|
|
$
|
(129,459
|
)
|
|
$
|
4,041
|
|
|
$
|
241,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Net income/(loss) attributable to noncontrolling interests
excludes ($0.1) million due to the redeemable
noncontrolling interest related to Middlebury Interactive
Languages
,
which is reported outside of permanent equity
in the condensed consolidated balance sheet at December 31,
2010.
|
See notes to unaudited condensed consolidated financial
statements.
4
K12
INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(In thousands)
|
|
|
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
9,862
|
|
|
$
|
16,531
|
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense
|
|
|
19,512
|
|
|
|
12,313
|
|
|
Stock based compensation expense
|
|
|
5,399
|
|
|
|
3,478
|
|
|
Excess tax benefit from stock-based compensation
|
|
|
(1,308
|
)
|
|
|
(2,194
|
)
|
|
Deferred income taxes
|
|
|
8,027
|
|
|
|
9,243
|
|
|
Provision for doubtful accounts
|
|
|
282
|
|
|
|
178
|
|
|
Provision for inventory obsolescence
|
|
|
737
|
|
|
|
366
|
|
|
Provision for (reduction of) student computer shrinkage and
obsolescence
|
|
|
19
|
|
|
|
(244
|
)
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Restricted cash
|
|
|
1,843
|
|
|
|
—
|
|
|
Accounts receivable
|
|
|
(61,629
|
)
|
|
|
(47,741
|
)
|
|
Inventories
|
|
|
9,349
|
|
|
|
9,696
|
|
|
Prepaid expenses
|
|
|
2,971
|
|
|
|
1,330
|
|
|
Other current assets
|
|
|
(3,001
|
)
|
|
|
(2,913
|
)
|
|
Deposits and other assets
|
|
|
(20
|
)
|
|
|
(33
|
)
|
|
Accounts payable
|
|
|
(3,127
|
)
|
|
|
(2,631
|
)
|
|
Accrued liabilities
|
|
|
2,764
|
|
|
|
(1,068
|
)
|
|
Accrued compensation and benefits
|
|
|
(5,766
|
)
|
|
|
(3,167
|
)
|
|
Deferred revenue
|
|
|
18,845
|
|
|
|
16,211
|
|
|
Deferred rent
|
|
|
2,308
|
|
|
|
465
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
7,067
|
|
|
|
9,820
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(9,021
|
)
|
|
|
(596
|
)
|
|
Capitalized software development costs
|
|
|
(4,276
|
)
|
|
|
(4,518
|
)
|
|
Capitalized curriculum development costs
|
|
|
(6,961
|
)
|
|
|
(6,372
|
)
|
|
Purchase of AEC, net of cash acquired of $3,841
|
|
|
(24,542
|
)
|
|
|
—
|
|
|
Cash advanced for AEC performance escrow
|
|
|
(6,825
|
)
|
|
|
—
|
|
|
Cash paid for investment in Web
|
|
|
(10,000
|
)
|
|
|
—
|
|
|
Cash paid for other investment
|
|
|
(2,040
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(63,665
|
)
|
|
|
(11,486
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
|
Repayments on capital lease obligations
|
|
|
(7,303
|
)
|
|
|
(6,245
|
)
|
|
Repayments on notes payable
|
|
|
(930
|
)
|
|
|
(692
|
)
|
|
Borrowings from line of credit
|
|
|
15,000
|
|
|
|
—
|
|
|
Proceeds from exercise of stock options
|
|
|
2,911
|
|
|
|
4,928
|
|
|
Proceeds from exercise of stock warrants
|
|
|
—
|
|
|
|
50
|
|
|
Excess tax benefit from stock-based compensation
|
|
|
1,308
|
|
|
|
2,194
|
|
|
Repurchase of restricted stock for income tax withholding
|
|
|
(1,020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
9,966
|
|
|
|
235
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of foreign exchange rate changes on cash and cash
equivalents
|
|
|
38
|
|
|
|
—
|
|
|
Net change in cash and cash equivalents
|
|
|
(46,594
|
)
|
|
|
(1,431
|
)
|
|
Cash and cash equivalents,
beginning of period
|
|
|
81,751
|
|
|
|
49,461
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents,
end of period
|
|
$
|
35,157
|
|
|
$
|
48,030
|
|
|
|
|
|
|
|
|
|
|
|
See notes to unaudited condensed consolidated financial
statements.
5
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial Statements
|
|
|
|
1.
|
Description
of the Business
|
K12 Inc. and its subsidiaries (K12 or the Company) are
technology-based education companies. The Company offers
proprietary curriculum and educational services created for
individualized learning for students in kindergarten through
12th grade, or K-12. The K12 proprietary curriculum is
research-based and combines content with innovative technology
to allow students with a wide spectrum of learning styles to
receive an effective and engaging education regardless of
geographic location or socio-economic background. This learning
system combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual public
schools, online school district-wide programs, public charter
schools, hybrid programs and private schools that combine
varying degrees of online and traditional classroom instruction,
and other educational applications.
The Company delivers its learning system to students primarily
through virtual public schools and is building an institutional
business with sales directly to school districts. The Company
offers its proprietary curriculum, learning kits, use of a
personal computer, online learning platform and varying levels
of academic and management services, which can range from
targeted programs to complete turnkey solutions.
As of December 31, 2010, the Company served virtual public
schools or hybrid schools in 27 states and the District of
Columbia. The Company expanded into two new states in fiscal
year 2011, Massachusetts and Michigan. In addition, the Company
operates an online private school, the K12 International
Academy, and also sells access to its on-line curriculum and
learning kits directly to individual consumers.
In April 2010, the Company formed a joint venture with
Middlebury College known as Middlebury Interactive Languages LLC
(MIL) to develop online foreign language courses. This new
venture will create online language programs for pre-college
students and will leverage Middlebury’s recognized
experience in foreign language instruction and K12’s
expertise in online education. In July 2010, the Company
acquired all of the stock of KC Distance Learning, Inc. (KCDL),
a provider of online curriculum and public and private virtual
education. On December 1, 2010, the Company acquired
American Education Corporation (AEC), a leading provider of
research-based core curriculum instructional software for
kindergarten through adult learners. These acquisitions and the
formation of MIL increase K12’s portfolio of innovative,
high quality instructional and curriculum offerings.
The accompanying condensed consolidated balance sheet as of
December 31, 2010, the condensed consolidated statements of
operations for the three and six months ended December 31,
2010 and 2009, the condensed consolidated statements of cash
flows for the six months ended December 31, 2010 and 2009,
and the condensed consolidated statements of equity for the six
months ended December 31, 2010 are unaudited. The unaudited
interim financial statements have been prepared on the same
basis as the annual financial statements and in the opinion of
management, reflect all adjustments, which include only normal
recurring adjustments, necessary to present fairly the
Company’s financial position as of December 31, 2010,
the results of operations for the three and six months ended
December 31, 2010 and 2009, cash flows for the six months
ended December 31, 2010 and 2009 and the condensed
consolidated statements of equity for the six months ended
December 31, 2010. The results of the three and six month
period ended December 31, 2010 are not necessarily
indicative of the results to be expected for the year ending
June 30, 2011 or for any other interim period or for any
other future fiscal year. The consolidated balance sheet as of
June 30, 2010 has been derived from the audited
consolidated financial statements at that date.
The accompanying unaudited condensed consolidated financial
statements of the Company have been prepared in accordance with
accounting principles generally accepted in the United States of
America (“GAAP”) for interim financial information and
with the instructions to
Form 10-Q
and
Rule 10-01
of
Regulation S-X
of the Securities Exchange Act of 1934, as amended
(“Exchange Act”). Accordingly, they do not include all
of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, these
statements include all adjustments (consisting of normal
recurring adjustments) considered necessary to present a fair
statement of our consolidated results of operations, financial
position and cash flows. Preparation of the Company’s
financial
6
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts in
the financial statements and footnotes. Actual results could
differ from those estimates. This quarterly report on
Form 10-Q
should be read in conjunction with the financial statements and
the notes thereto included in the Company’s latest annual
report on
Form 10-K
filed on September 13, 2010, which contains the
Company’s audited financial statements for the fiscal year
ended June 30, 2010.
|
|
|
|
3.
|
Summary
of Significant Accounting Policies
|
Revenue
Recognition
Revenues are principally earned from long-term contractual
agreements to provide on-line curriculum, books, materials,
computers and management services to public charter schools and
school districts. In addition to providing the curriculum, books
and materials, under most contracts, the Company is responsible
to the virtual public schools for all aspects of school
management, including monitoring academic achievement, teacher
hiring and training, compensation of school personnel, financial
management, enrollment processing and procurement of curriculum,
equipment and required services. The schools generally receive
funding on a per student basis from the state in which the
public school or school district is located.
Where the Company has determined that it is the primary obligor
for substantially all expenses under these contracts, it records
the associated per student revenue received by the school from
its state funding up to the expenses incurred in accordance with
ASC 605 (formerly Emerging Issues Task Force (EITF)
99-19,
Reporting Revenue Gross as a Principal Versus Net as an
Agent
). For contracts in which the Company is not the
primary obligor, the Company records revenue based on its net
fees earned per the contractual agreement.
The Company generates revenues under contracts with virtual
public schools which include multiple elements. These elements
include: providing each of a school’s students with access
to the Company’s on-line school and the on-line component
of lessons; learning kits which include books and materials
designed to complement and supplement the on-line lessons; use
of a personal computer and associated reclamation services;
internet access and technology support services; instruction
from a state-certified teacher and; all management and
technology services required to operate a virtual public school.
The Company has determined that the elements of our contracts
are valuable to schools in combination, but do not have
standalone value. While we have sold some of these elements in
various combinations or bundles to schools and school districts,
the value of each element across these combinations is
indeterminable and we have concluded that we do not have
sufficient objective and reliable evidence of fair value for
each element. As a result, the elements within our
multiple-element contracts do not qualify for treatment as
separate units of accounting. Accordingly, the Company accounts
for revenues received under multiple element arrangements as a
single unit of accounting and recognizes the entire arrangement
based upon the approximate rate at which we incur the costs
associated with each element. In certain schools where the
Company has a direct relationship with the state funding school
district, the Company recognizes the associated per student
revenue on a pro-rata basis over the school year.
Under the contracts with the schools where the Company provides
turnkey management services, the Company has generally agreed to
absorb any operating losses of the schools in a given school
year. These school operating losses represent the excess of
costs over revenues incurred by the virtual public schools as
reflected on their financial statements. The costs include
Company charges to the schools. These school operating losses
may reduce the Company’s ability to collect invoices in
full. Accordingly, the Company’s amount of recognized
revenue reflects this reduction.
Other revenues are generated from individual customers who
prepay and have access for 12 or 24 months to curriculum
via the Company’s online learning system. The Company
recognizes these revenues pro rata over the maximum term of the
customer contract, which is either 12 or 24 months.
Revenues from associated learning kits are recognized upon
shipment.
7
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
Consolidation
The condensed consolidated financial statements include the
accounts of the Company, its wholly-owned and affiliated
companies, either owned directly or indirectly, and all
controlled subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
Reclassifications
Certain prior year amounts related to capitalized software
development costs and other long term liabilities have been
reclassified to conform to the current year presentation.
Series A
Special Stock
Equity that is redeemable upon occurrence of an event outside
the Company’s control should be classified outside of
permanent equity per ASC 480,
Distinguishing Liabilities
from Equity
. The Series A Special Stock as described
further in Note 11, is considered redeemable outside of the
Company’s control and classified separately outside of
permanent equity. At a Special Meeting of Shareholders held on
January 27, 2011, the right to convert the Series A
Special Stock to Common Stock was approved by shareholders. As a
consequence, the right of redemption is no longer effective and
the shares will be classified within stockholders’ equity
in the consolidated balance sheet in subsequent financial
statements.
Goodwill
and Intangibles
We record as goodwill the excess of purchase price over the fair
value of the identifiable net assets acquired. Finite-lived
intangible assets acquired in business combinations subject to
amortization are recorded at their fair value in accordance with
ASU Topic 350. Finite-lived intangible assets include trade
names, customer relationships and non-compete agreements. Such
intangible assets are amortized on a straight-line basis over
their estimated useful lives.
In accordance with ASC 360
Accounting for the Impairment
or Disposal of Long-Lived Assets
, the Company reviews its
recorded finite-lived intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be fully recoverable. If the total of
the expected undiscounted future cash flows is less than the
carrying amount of the asset, a loss is recognized for the
difference between fair value and the carrying value of the
asset.
ASC 350
Goodwill and Other Intangible Assets
, prescribes
a two-step process for impairment testing of goodwill and
intangibles with indefinite lives, which is performed annually,
as well as when an event triggering impairment may have
occurred. The first step tests for impairment, while the second
step, if necessary, measures the impairment. Goodwill and
intangible assets deemed to have an indefinite life are tested
for impairment on an annual basis, or earlier when events or
changes in circumstances suggest the carrying amount may not be
fully recoverable. The Company has elected to perform its annual
assessment on May 31st.
Fair
Value Measurements
The carrying values reflected in our consolidated balance sheets
for cash and cash equivalents, receivables, and short and long
term debt approximate their fair values.
The following table summarizes certain fair value information at
June 30, 2010 for assets and liabilities measured at fair
value on a recurring basis. The redeemable noncontrolling
interest is a result of the Company’s venture with
Middlebury College to form a new entity, Middlebury Interactive
Languages. Under the agreement, Middlebury College has an
irrevocable election to sell all (but not less than all) of its
Membership Interest to the
8
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
Company (“put right”) after May 1,
2015. The fair value of the redeemable noncontrolling
interest reflects management’s best estimate of the
redemption value of the put right.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using:
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Assets
|
|
|
Input
|
|
|
Inputs
|
|
|
Description
|
|
Fair Value
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
Redeemable Noncontrolling Interest
|
|
$
|
17,374
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
17,374
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
17,374
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
17,374
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes certain fair value information at
December 31, 2010 for assets and liabilities measured at
fair value on a recurring basis.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using:
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Assets
|
|
|
Input
|
|
|
Inputs
|
|
|
Description
|
|
Fair Value
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
Redeemable Noncontrolling Interest
|
|
$
|
20,800
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
20,800
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table presents activity related to our fair value
measurements categorized as Level 3 of the valuation
hierarchy, valued on a recurring basis, for the six months ended
December 31, 2010. There have been no transfers in or out
of Level 3 of the hierarchy for the period presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended December 31, 2010
|
|
|
|
|
|
|
|
Purchases,
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
|
Issuances,
|
|
|
Unrealized
|
|
|
Fair Value
|
|
|
|
|
June 30, 2010
|
|
|
and Settlements
|
|
|
Gains/(Losses)
|
|
|
December 31, 2010
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
Redeemable Noncontrolling Interest
|
|
$
|
17,374
|
|
|
$
|
—
|
|
|
$
|
3,246
|
|
|
$
|
20,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
17,374
|
|
|
$
|
—
|
|
|
$
|
3,246
|
|
|
$
|
20,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of the redeemable noncontrolling interest as of
December 31, 2010 was estimated to be $20.8 million.
The fair value was measured in accordance with ASC 480,
Distinguishing Liabilities from Equity
, and initial
valuations were determined by a third party valuation firm and
updated by management for the current period. In determining the
fair value of the redeemable noncontrolling interest, the
Company incorporated a number of assumptions and estimates
including utilizing various valuation methodologies including an
income-based approach.
Net
Income Per Common Share
Basic earnings per share is computed by dividing net income
available to common stockholders by the weighted average number
of shares of common stock outstanding during the period. The
weighted average number of shares of common stock outstanding
includes vested restricted stock awards. Diluted earnings per
share reflects the potential dilution that could occur assuming
conversion or exercise of all dilutive unexercised stock
options, unvested restricted stock awards and warrants. The
dilutive effect of stock options, restricted stock awards, and
warrants was determined using the treasury stock method. Under
the treasury stock method, the proceeds received
9
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
from the exercise of stock options and restricted stock awards,
the amount of compensation cost for future service not yet
recognized by the Company, and the amount of tax benefits that
would be recorded in additional paid-in capital when the stock
options and restricted stock awards become deductible for income
tax purposes are all assumed to be used to repurchase shares of
the Company’s common stock. Stock options and restricted
stock awards are not included in the computation of diluted
earnings per share when they are antidilutive. Common stock
outstanding reflected in our condensed consolidated balance
sheet includes restricted stock awards outstanding.
Securities that may participate in undistributed earnings with
common stock are considered participating securities. Since the
Series A Shares participate in all dividends and
distributions declared or paid on or with respect to common
stock of the Company (as if a holder of common stock), the
Series A Shares meet the definition of participating
security under ASC 260,
Participating Securities and the
Two-Class Method under FASB Statement No. 128
. All
securities that meet the definition of a participating security,
regardless of whether the securities are convertible,
non-convertible, or potential common stock securities, are
included in the computation of both basic and diluted EPS (as a
reduction of the numerator) using the two-class method. Under
the two-class method all undistributed earnings in a period are
to be allocated to common stock and participating securities to
the extent that each security may share in earnings as if all of
the earnings for the period had been distributed.
10
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
The following schedule presents the calculation of basic and
diluted net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(In thousands, except share and per share data)
|
|
|
(In thousands, except share and per share data)
|
|
|
|
|
Basic earnings per share computation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
7,839
|
|
|
$
|
9,638
|
|
|
$
|
10,037
|
|
|
$
|
16,721
|
|
|
Amount allocated to participating Series A stockholders
|
|
|
647
|
|
|
|
—
|
|
|
|
784
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common stockholders — basic
|
|
$
|
7,192
|
|
|
$
|
9,638
|
|
|
$
|
9,253
|
|
|
$
|
16,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares — basic historical
|
|
|
30,565,683
|
|
|
|
29,648,674
|
|
|
|
30,454,724
|
|
|
|
29,512,635
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$
|
0.24
|
|
|
$
|
0.33
|
|
|
$
|
0.30
|
|
|
$
|
0.57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share computation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
7,839
|
|
|
$
|
9,638
|
|
|
$
|
10,037
|
|
|
$
|
16,721
|
|
|
Amount allocated to participating Series A stockholders
|
|
|
647
|
|
|
|
—
|
|
|
|
784
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common stockholders — diluted
|
|
$
|
7,192
|
|
|
$
|
9,638
|
|
|
$
|
9,253
|
|
|
$
|
16,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares computation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares — basic historical
|
|
|
30,565,683
|
|
|
|
29,648,674
|
|
|
|
30,454,724
|
|
|
|
29,512,635
|
|
|
Effect of dilutive stock options and restricted stock awards
|
|
|
562,603
|
|
|
|
325,968
|
|
|
|
640,116
|
|
|
|
363,331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares — diluted
|
|
|
31,128,286
|
|
|
|
29,974,642
|
|
|
|
31,094,840
|
|
|
|
29,875,966
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share
|
|
$
|
0.23
|
|
|
$
|
0.32
|
|
|
$
|
0.30
|
|
|
$
|
0.56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recent
Accounting Pronouncements
In June 2009, the FASB issued an amendment to ASC 810,
Consolidation
, which modifies how a company determines
when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be
consolidated. ASC 810 clarifies that the determination of
whether a company is required to consolidate an entity is based
on, among other things, an entity’s purpose and design and
a company’s ability to direct the activities of the entity
that most significantly impact the entity’s economic
performance. ASC 810 requires an ongoing reassessment of
whether a company is the primary beneficiary of a variable
interest entity. ASC 810 also requires additional
disclosures about a company’s involvement in variable
interest entities and any significant changes in risk exposure
due to that involvement. ASC 810 is effective for fiscal
years beginning after November 15, 2009 and is effective
for the Company on July 1, 2010. The adoption of the policy
did not have a material impact on our condensed consolidated
financial statements.
In October 2009, the FASB issued ASU
2009-13,
Multiple-Deliverable Revenue Arrangements, a consensus of the
FASB Emerging Issues Task Force
. Under the new guidance,
when vendor specific objective evidence or third party evidence
for deliverables in an arrangement cannot be determined, a best
estimate of the selling price is required to separate
deliverables and allocate arrangement consideration and the use
of the relative selling price
11
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
method is required. The new guidance eliminated the residual
method of allocating arrangement consideration to deliverables
and includes new disclosure requirements on how the application
of the relative selling price method affects the timing and
amount of revenue recognition. ASU
2009-13
is
effective for revenue arrangements entered into or materially
modified in fiscal years beginning after June 15, 2010. ASU
2009-13
is
effective for the Company on July 1, 2010. The adoption did
not have a material impact on our condensed consolidated
financial statements.
In January 2010, the FASB issued ASU
2010-06,
Fair Value Measurements and Disclosures
, which requires
new disclosures for transfers in and out of Level 1 and
Level 2 and activity in Level 3 of the fair value
hierarchy. ASU
2010-06
requires separate disclosure of the amounts of significant
transfers in and out of Level 1 and Level 2 fair value
measurements and a description of the reasons for the transfers.
In the reconciliation for fair value measurements using
Level 3 inputs, a reporting entity should present
separately information about purchases, sales, issuances and
settlements. ASU
2010-06
is
effective for new disclosures and clarification of existing
disclosures for interim and annual periods beginning after
December 15, 2009 except for disclosures about purchases,
sales, issuances and settlements in the Level 3 activity
rollfoward. The provisions of ASU
2010-06
related to new disclosures and clarification of existing
disclosures was adopted by the Company beginning January 1,
2010. As ASU
2010-06
relates only to disclosure, the adoption of these provisions did
not have a material impact on its financial condition, results
of operations, and disclosures. The provisions of ASU
2010-06
related to Level 3 rollforward activity are effective for
fiscal years beginning after December 31, 2010 and will be
effective for the Company on July 1, 2011. The Company is
currently evaluating the impact that the adoption of ASU
2010-06
will
have on our financial condition, results of operations, and
disclosures.
The provision for income taxes is based on earnings reported in
the condensed consolidated financial statements. A deferred
income tax asset or liability is determined by applying
currently enacted tax laws and rates to the expected reversal of
the cumulative temporary differences between the carrying value
of assets and liabilities for financial statement and income tax
purposes. Deferred income tax expense is measured by the change
in the deferred income tax asset or liability during the year.
Capital
Leases
As of December 31 and June 30, 2010, computer equipment and
software under capital leases are recorded at a cost of
$44.3 million and $38.8 million, respectively and
accumulated depreciation of $21.6 million and
$22.9 million, respectively. The Company’s equipment
lease line of credit with Hewlett-Packard Financial Services
Company (“HPFSC”) expired on August 31, 2010.
Prior borrowings under the HPFSC equipment lease line had
interest rates ranging from 4.96% to 7.7% and included a
36-month
payment term with a $1 purchase option at the end of the term.
The Company had pledged the assets financed with the HPFSC
equipment lease line to secure the amounts outstanding. The
Company entered into a guaranty agreement with HPFSC to
guarantee the obligations under this equipment lease and
financing agreement.
The Company has an equipment lease line of credit with PNC
Equipment Finance, LLC effective August 2010 for new purchases.
Availability for additional purchases terminates on
March 31, 2011. We expect to renew this line of credit,
obtain additional financing from other providers or use cash on
hand for future purchases. The interest rate on new advances
under the PNC equipment lease line is set at the time the funds
are advanced based upon interest rates in the Federal Reserve
Statistical Release H.15. Borrowings under the equipment lease
line had interest rates of 3.0% and include a
36-month
payment term with a $1 purchase option at the end of the term.
12
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
Notes
Payable
The Company has purchased computer software licenses and
maintenance services through notes payable arrangements with
various vendors at interest rates ranging up to 6.1% and payment
terms of three years. The balance of notes payable at
December 31, and June 30, 2010 was $1.0 million
and $1.9 million, respectively.
The following is a summary as of December 31, 2010 of the
present value of the net minimum payments on capital leases and
notes payable under the Company’s commitments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
|
|
|
Notes
|
|
|
|
|
|
As of December 31, 2010
|
|
Leases
|
|
|
Payable
|
|
|
Total
|
|
|
|
|
2011
|
|
$
|
14,512
|
|
|
$
|
1,004
|
|
|
$
|
15,516
|
|
|
2012
|
|
|
8,564
|
|
|
|
—
|
|
|
|
8,564
|
|
|
2013
|
|
|
3,486
|
|
|
|
—
|
|
|
|
3,486
|
|
|
Thereafter
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum payments
|
|
|
26,562
|
|
|
|
1,004
|
|
|
|
27,566
|
|
|
Less amount representing interest (imputed average capital lease
interest rate of 5.0%)
|
|
|
(1,081
|
)
|
|
|
(30
|
)
|
|
|
(1,111
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net minimum payments
|
|
|
25,481
|
|
|
|
974
|
|
|
|
26,455
|
|
|
Less current portion
|
|
|
(13,736
|
)
|
|
|
(974
|
)
|
|
|
(14,710
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present value of minimum payments, less current portion
|
|
$
|
11,745
|
|
|
$
|
—
|
|
|
$
|
11,745
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company has a $35 million line of credit with PNC Bank
that expires in December 2012. As of December 31, 2010 and
June 30, 2010, there was $15 million and zero
outstanding on the line of credit, respectively. As of
December 31, 2010, borrowings on the line of credit had an
interest rate of 1.8%.
Stock
Options
Stock option activity during the six months ended
December 31, 2010 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
|
Shares
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Value
|
|
|
|
|
Outstanding, June 30, 2010
|
|
|
3,913,847
|
|
|
$
|
16.81
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
44,000
|
|
|
|
26.23
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(308,286
|
)
|
|
|
9.47
|
|
|
|
|
|
|
|
|
|
|
Forfeited or canceled
|
|
|
(93,794
|
)
|
|
|
21.69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2010
|
|
|
3,555,767
|
|
|
$
|
17.44
|
|
|
|
4.73
|
|
|
$
|
40,482
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable at December 31, 2010
|
|
|
1,976,236
|
|
|
$
|
14.13
|
|
|
|
4.22
|
|
|
$
|
28,713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised during the six
months ended December 31, 2010 was $5.1 million or
$16.65 per share.
13
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
The following table summarizes the option grant activity for the
six months ended December 31, 2010. There were no new
grants during the second quarter.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
|
Options
|
|
|
Weighted-Average
|
|
|
Grant-Date
|
|
|
Intrinsic
|
|
|
Grant Date
|
|
Granted
|
|
|
Exercise Price
|
|
|
Fair Value
|
|
|
Value
|
|
|
|
|
September 2010
|
|
|
44,000
|
|
|
$
|
26.23
|
|
|
$
|
11.16
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
44,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010, there was $6.4 million of
total unrecognized compensation expense related to unvested
stock options granted. The cost is expected to be recognized
over a weighted average period of 2.65 years. During the
six months ended December 31, 2010 and December 31,
2009, the Company recognized $2.6 million and
$3.1 million, respectively of stock based compensation
expense related to stock options.
Restricted
Stock Awards
Restricted stock award activity during the six months ended
December 31, 2010 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
Shares
|
|
|
Fair Value
|
|
|
|
|
Nonvested, June 30, 2010
|
|
|
187,850
|
|
|
$
|
18.46
|
|
|
Granted
|
|
|
426,863
|
|
|
|
24.86
|
|
|
Vested
|
|
|
(98,252
|
)
|
|
|
22.64
|
|
|
Forfeited or canceled
|
|
|
(18,416
|
)
|
|
|
22.05
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2010
|
|
|
498,045
|
|
|
$
|
22.99
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010, there was $8.6 million of
total unrecognized compensation expense related to unvested
restricted stock awards granted. The cost is expected to be
recognized over a weighted average period of 2.79 years.
The total fair value of shares vested during the six months
ended December 31, 2010 was $2.2 million. During the
six months ended December 31, 2010 and December 31,
2009, the Company recognized $2.8 million and
$0.4 million, respectively of stock based compensation
expense related to restricted stock awards.
In the second quarter, the Company purchased services and assets
in the amount $0.4 million from Knowledge Universe
Technologies (KUT). KUT is an affiliate of the Learning Group,
LLC a related party. Additionally, KC Distance Learning has
capital leases with an outstanding balance due to KCDL Holdings
Inc. in the amount of $0.9 million as of December 31,
2010.
|
|
|
|
9.
|
Commitments
and Contingencies
|
Litigation
In the ordinary conduct of business, the Company is subject to
lawsuits, arbitrations and administrative proceedings from time
to time. The Company expenses legal costs as incurred.
Aventa
Learning
In June 2010, the shareholders of Aventa Learning, Inc. (Aventa)
filed a lawsuit against KC Distance Learning, Inc. which is
currently pending in the U.S. District Court for the
Western District of Washington,
Axtman et al. v. KC
Distance Learning, Inc.
(Case
No. 2:10-cv-01022-JLR).
The lawsuit alleges, among other things, that KCDL did not honor
the terms of an earn-out provision contained in an asset
purchase agreement after certain assets of Aventa
14
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
were acquired by KCDL in 2007. In addition, the plaintiffs
allege breach of contract and misrepresentation claims, and seek
the remedy of rescission for alleged violation of the Securities
Act of Washington. On July 23, 2010, the Company acquired
all of the shares of KCDL, which is now a wholly-owned
subsidiary. On August 31, 2010, the plaintiffs amended
their complaint to add K12 Inc. as a co-defendant in this
matter, reflecting the change in ownership. On October 4,
2010, defendants filed a motion to dismiss plaintiff’s
amended complaint. Pursuant to the Agreement and Plan of Merger
between K12 Inc. and KCDL Holdings LLC (Seller), Seller agreed
to assume responsibility to defend this lawsuit and to fully
indemnify K12 Inc. for any liability, including rescission. In
addition, K12 Inc. obtained a guarantee from Seller’s
parent company, Learning Group LLC, from any losses related to
this litigation. In our view, the outcome of this litigation
will not have a material adverse effect on the financial
condition or results of operations of K12 Inc. or any of our
subsidiaries.
During the six months ended December 31, 2010, the
Company’s goodwill increased by approximately
$51.7 million due primarily to the acquisitions of KC
Distance Learning, Inc. and American Education Corporation (see
Note 11). The Company did not experience a significant
adverse change in its business climate and therefore does not
believe a triggering event occurred that would require a
detailed test of goodwill for impairment as of an interim date.
Consequently, the first step of the goodwill impairment test
will not be performed during the second quarter of 2011. The
Company will complete its annual goodwill impairment test as of
May 31, 2011.
KC Distance Learning, Inc.
On July 23, 2010, the Company acquired all of the stock of
KCDL, a provider of online curriculum and public and private
virtual education, by issuing to its parent company, KCDL
Holdings LLC, 2,750,000 shares of a new class of stock
designated as Series A Special Stock, which had a value at
closing of $63.1 million. KCDL Holdings, Inc. is an
affiliate of the Learning Group, LLC, a related party. The
holders of the Series A Special Stock initially had no
voting rights and no rights of conversion with respect to those
shares; however, the holders had and continue to have
participating rights in all dividends and distributions declared
or paid on or with respects to common stock of the Company.
On December 23, 2010, the Company filed a definitive proxy
statement with the Securities and Exchange Commission (SEC) for
the stockholder vote. On January 27, 2011, the Company held
a Special Meeting at which the stockholders approved conversion
and voting rights for the holders of the Series A Special
Stock. The holders of the Series A Special Stock now have
the right to convert those shares into common stock on a
one-for-one
basis and for the right to vote on all matters presented to
K12 shareholders, other than for the election and removal
of directors, for which holders of the Series A Special
Stock shall have no voting rights. The redemption right of the
holders of the Series A Special Stock terminated upon
shareholder approval of their conversion and voting rights.
The KCDL businesses include: Aventa Learning (online curriculum
and instruction), the iQ Academies (statewide virtual public
charter schools for middle and high school); and The Keystone
School (international online private school). K12 believes the
acquisition of KCDL to be an important strategic step in the
Company’s efforts to expand its presence in a number of end
markets. The operating results of KCDL have been included in the
Company’s condensed consolidated financial statements
commencing as of the acquisition date of July 23, 2010. The
acquisition of KCDL has been accounted for under the acquisition
method of accounting which requires the total purchase price to
be allocated to the assets acquired and liabilities assumed
based on their estimated fair values. The fair values assigned
to the assets acquired and liabilities assumed are based on
valuations using management’s best estimates and
assumptions. The allocation of the estimated consideration to
the identifiable tangible and
15
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
intangible assets and liabilities assumed under the purchase
method of accounting, is preliminary and based on their
estimated fair values as of the acquisition date and summarized
in the following table (in thousands):
|
|
|
|
|
|
|
|
|
Amount
|
|
|
|
|
As of July 23, 2010:
|
|
|
|
|
|
Current assets
|
|
$
|
8,538
|
|
|
Property and equipment, net
|
|
|
8,654
|
|
|
Capitalized curriculum development costs, net
|
|
|
3,873
|
|
|
Intangible assets, net
|
|
|
21,900
|
|
|
Goodwill
|
|
|
35,106
|
|
|
Other noncurrent assets
|
|
|
138
|
|
|
Current liabilities
|
|
|
(5,461
|
)
|
|
Deferred tax liability
|
|
|
(6,275
|
)
|
|
Deferred revenue
|
|
|
(2,111
|
)
|
|
Other noncurrent liabilities
|
|
|
(1,250
|
)
|
|
|
|
|
|
|
|
Fair value of total consideration transferred
|
|
$
|
63,112
|
|
|
|
|
|
|
|
|
|
|
|
|
|
•
|
The intangible assets of KCDL have been increased
$21.1 million to a total value of $21.9 million to
reflect the preliminary estimate of the fair value of intangible
assets, including trade name/trademarks and customer
relationships.
|
|
|
|
|
•
|
The capitalized curriculum development costs have decreased
$0.6 million to a value of $3.9 million.
|
|
|
|
|
•
|
KCDL defers and expenses material costs over the period which
revenue is recognized. K12 expenses material cost when materials
are shipped. KCDL’s deferred material costs as of
July 23, 2010 were reduced $0.3 million to a value of
$0.
|
|
|
|
|
•
|
Deferred revenue represents advance payments from customers for
education services. The fair value was estimated based on a cost
build-up
approach. The cost
build-up
approach determines fair value by estimating the costs related
to supporting the obligation plus an assumed profit which
approximates, in theory, the amount that would be required to
pay a third party to assume the obligation. As a result, the
deferred revenues of KCDL have been decreased from
$4.2 million to $2.1 million, which represents the
estimated fair value of the contractual obligations assumed.
|
The following unaudited pro forma combined results of operations
give effect to the acquisition of KCDL as if it had occurred at
the beginning of the periods presented. The unaudited pro forma
combined results of operations are provided for informational
purposes only and do not purport to represent K12’s actual
consolidated results of operations had the acquisition occurred
on the dates assumed, nor are these financial statements
necessarily indicative of K12’s future consolidated results
of operations . K12 expects to incur costs and realize benefits
associated with integrating the operations of K12 and KCDL. The
unaudited pro forma combined results of operations do not
reflect the costs of any integration activities or any benefits
that may result from operating efficiencies or revenue synergies.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma
|
|
Three Months Ended
|
|
Six Months Ended
|
Results of
|
|
December 31,
|
|
December 31,
|
|
Operations
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
Revenues
|
|
$
|
129,002
|
|
|
$
|
105,692
|
|
|
$
|
265,195
|
|
|
$
|
220,212
|
|
|
Net Income (Loss)
|
|
$
|
7,838
|
|
|
$
|
11,965
|
|
|
$
|
8,407
|
|
|
$
|
17,224
|
|
16
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
American
Education Corporation
On December 1, 2010, the Company acquired American
Education Corporation (AEC), a leading provider of
research-based core curriculum instructional software for
kindergarten through adult learners, headquartered in Oklahoma
City, OK, for a total cash purchase price of $35.2 million,
including certain amounts held in escrow. The escrow amounts
include $6.8 million for the achievement of specified
financial targets for quarter-ended December 31, 2010. As
of the current date, the Company does not expect any of this
contingent consideration to be distributed to the selling AEC
shareholders. Consequently, this escrow amount is recorded in
other current assets. In connection with the acquisition, the
Company recorded net Working Capital accounts of
$2.9 million, net long term assets of $8.3 million,
goodwill of approximately $15.8 million, intangible assets
of approximately $4.5 million, and other long term
liabilities and taxes payable of $3.1 million. The
acquisition of AEC has been included in the Company’s
results since the acquisition date of December 1, 2010. The
allocation of the estimated consideration to the identifiable
tangible and intangible assets and liabilities assumed under the
purchase method of accounting is preliminary and based on their
estimated fair values as of the acquisition date.
An additional amount of approximately $6.8 million is held
in escrow and, if specified claims against AEC arise for which
the Company is indemnified, such amounts may be used to satisfy
those claims but not to exceed it. K12 is not entitled to any
claims against the indemnification escrow amount unless and
until the aggregate claim amount exceeds $250,000, at which time
K12 is only entitled to reimbursement for any claims exceeding
the $250,000 up to a maximum of $6.8 million. Any amounts
remaining in escrow after the satisfaction of any such claims
are to be paid to the selling AEC shareholders in two fifty
percent installments of the remaining balance of the
$6.8 million in the indemnification escrow, at 6 and
12 months after closing. At closing, the Company recognized
a liability of $1 million relating to potential claims
offset by a receivable from the escrow account of $750,000.
17
K12
Inc.
Notes to
Unaudited Condensed Consolidated Financial
Statements — (Continued)
|
|
|
|
12.
|
Supplemental
Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Cash paid for interest
|
|
$
|
517
|
|
|
$
|
665
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for taxes, net of refunds
|
|
$
|
3,631
|
|
|
$
|
589
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non-cash investing and financing
activities:
|
|
|
|
|
|
|
|
|
|
New capital lease obligations
|
|
$
|
12,897
|
|
|
$
|
10,244
|
|
|
|
|
|
|
|
|
|
|
|
|
Business Combinations:
|
|
|
|
|
|
|
|
|
|
— Current assets
|
|
$
|
17,317
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Property and equipment
|
|
$
|
4,981
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Capitalized curriculum development costs
|
|
$
|
8,073
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Capitalized software development costs
|
|
$
|
7,898
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Intangible assets
|
|
$
|
27,310
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Goodwill
|
|
$
|
51,678
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Other non-current assets
|
|
$
|
138
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Deferred tax liabilities
|
|
$
|
(8,768
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Assumed liabilities
|
|
$
|
(9,829
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Deferred revenue
|
|
$
|
(3,671
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Other noncurrent liabilities
|
|
$
|
(1,931
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Contingent consideration
|
|
$
|
1,700
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
— Issuance of Series A Special Stock
|
|
$
|
63,112
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of perpetual license agreement/accrued liabilities
|
|
$
|
1,250
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
On January 3, 2011, K12 invested $10 million in Web
International Education Group, Ltd. (Web). This strategic
investment gives the Company a 20% minority interest in Web,
with the option to acquire the remainder of Web within a period
of five years. Web is a leader in English language training for
learners of all ages throughout China, including university
students, government workers, and employees of international
companies. Web has a network of 72 learning centers in
47 cities. It currently serves more than 35,000 students.
The proceeds of the investment will primarily be used to expand
Web’s learning center network into more Chinese cities. As
of December 31, 2010, the $10 million cash investment
was in transit and recorded in long-term other assets.
On January 13, 2011, K12 announced a partnership with the
George Washington University to launch an online private high
school, the George Washington University Online High School
(GWUOHS). The private school will serve students in the
U.S. and in countries around the world. The program offers
K12’s college preparatory curriculum and is designed for
high school students who are seeking a challenging academic
experience and aspire to attend top colleges and universities.
On January 27, 2011, shareholders approved the right of the
holders of the Series A Special Stock to convert those
shares into common stock on a
one-for-one
basis and for the right to vote on all matters presented to
K12 shareholders, other than for the election and removal
of directors, for which holders of the Series A Special
Stock shall have no voting rights unless converted to common. In
addition, the right of redemption is no longer effective.
18
|
|
|
|
Item 2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
|
Certain statements in Management’s Discussion and
Analysis (MD&A), other than purely historical information,
including estimates, projections, statements relating to our
business plans, objectives, and expected operating results, and
the assumptions upon which those statements are based, are
“forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995,
Section 27A of the Securities Act of 1933, as amended (the
Securities Act), and Section 21E of the Securities Exchange
Act of 1934, as amended (the Exchange Act). These
forward-looking statements generally are identified by the words
“believe,” “project,” “expect,”
“anticipate,” “estimate,”
“intend,” “strategy,” “plan,”
“may,” “should,” “will,”
“would,” “will be,” “will
continue,” “will likely result,” and similar
expressions. Historical results may not indicate future
performance. Our forward-looking statements reflect our current
views about future events, are based on assumptions and are
subject to known and unknown risks and uncertainties that could
cause actual results to differ materially from those
contemplated by these statements. Factors that may cause
differences between actual results and those contemplated by
forward-looking statements include, but are not limited to,
those discussed in “Risk Factors” in Part I,
Item 1A, of our Annual Report on
Form 10-K
(Annual Report), including any updates found in Part II,
Item 1A, “Risk Factors,” of this quarterly
report. We undertake no obligation to publicly update or revise
any forward-looking statements, including any changes that might
result from any facts, events, or circumstances after the date
hereof that may bear upon forward-looking statements.
Furthermore, we cannot guarantee future results, events, levels
of activity, performance, or achievements.
This MD&A is intended to assist in understanding and
assessing the trends and significant changes in our results of
operations and financial condition. As used in this MD&A,
the words, “we,” “our” and “us”
refer to K12 Inc. and its consolidated subsidiaries. This
MD&A should be read in conjunction with our condensed
consolidated financial statements and related notes included in
this report, as well as the consolidated financial statements
and MD&A of our Annual Report. The following overview
provides a summary of the sections included in our MD&A:
|
|
|
|
|
|
•
|
Executive Summary —
a general description of
our business and key highlights of the current period.
|
|
|
|
|
•
|
Critical Accounting Policies and Estimates —
a
discussion of critical accounting policies requiring critical
judgments and estimates.
|
|
|
|
|
•
|
Results of Operations —
an analysis of our
results of operations in our consolidated financial statements.
|
|
|
|
|
•
|
Liquidity and Capital Resources —
an analysis
of cash flows, sources and uses of cash, commitments and
contingencies, seasonality in the results of our operations, the
impact of inflation, and quantitative and qualitative
disclosures about market risk.
|
Executive
Summary
We are a technology-based education company. We offer
proprietary curriculum and educational services designed to
facilitate individualized learning for students in kindergarten
through 12th grade, or K-12. Our mission is to maximize a
child’s potential by providing access to an engaging and
effective education, regardless of geographic location or
socio-economic background. Since our inception, we have invested
more than $200 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual public
schools, online school district-wide programs, public charter
schools, hybrid programs and private schools that combine
varying degrees of online and traditional classroom instruction,
and other educational applications.
We deliver our learning system to students primarily through
virtual public schools and are building an institutional
business with sales directly to school districts. Many states
have embraced virtual public schools as a means to provide
families with a publicly funded alternative to a traditional
classroom-based education. We offer virtual schools our
proprietary curriculum, online learning platform and varying
levels of academic and management services, which can range from
targeted programs to complete turnkey solutions. Additionally,
without the requirement of a physical classroom, virtual schools
can be scaled quickly to accommodate a large dispersed student
population, and allow more capital resources to be allocated
towards teaching, curriculum and technology rather than towards
a physical infrastructure.
19
For the
2010-11
school year, we manage virtual public schools or hybrid schools
in 27 states and the District of Columbia, including new
schools in two new states, Massachusetts and Michigan. For the
most part, these schools are able to enroll students on a
statewide basis. Most of these enrollments are in virtual public
schools. We are serving a growing number of hybrid schools the
first of which opened in Chicago in 2006. A hybrid school is a
virtual public school that combines the benefits of one or two
days a week of
face-to-face
time for students and teachers in a traditional classroom
setting along with the flexibility and individualized learning
advantages of online instruction. In July 2010, we extended our
involvement with traditional classroom settings to the full
operational management of a brick and mortar school.
Specifically, the Delaware Department of Education contracted
with us to assume responsibility for all aspects of the
operation of the Moyer Charter School, and authorized us to
serve up to 460 students in grades 6-12. This contract furthers
the use of our learning systems and instructional methods in a
traditional classroom setting.
For the three months ended December 31, 2010, we served
98,296 total average enrollments, including the recently
acquired Aventa, iQ, and Keystone programs, as compared to
68,519 for the same period in the prior year, a growth rate of
43.5%. For the three months ended December 31, 2010,
excluding the newly acquired programs, total average enrollments
in K12 programs increased to 83,318, as compared to 68,519 for
the same period in the prior year, a growth rate of 21.6%. These
enrollments include public and private school enrollments as
well as those in the K12 International Academy. Enrollments from
the Aventa, iQ, and Keystone for the three months ended
December 31, 2010 were 14,978 and contributed 21.9% to
enrollment growth. Enrollments exclude students in our
direct-to-consumer
and pilot programs and enrollments acquired with AEC.
We executed on our acquisition strategy this fiscal year and
acquired KC Distance Learning and American Education Corporation
and invested in Web International. With these additions, along
with the recent formation of Middlebury Interactive Languages,
we believe we have improved our growth potential and the ability
to scale our business even further.
For the three months ended December 31, 2010, we increased
revenues to $129.0 million from $93.3 million in the
same period in the prior year, a growth rate of 38.4%. Over the
same period, operating income declined to $14.2 million
from operating income of $14.3 million, a decrease of 0.7%,
and net income to shareholders declined to $7.8 million
from net income to shareholders of $9.6 million, a decrease
of 18.7%. The decline in operating income and net income was
primarily attributable to: several new growth initiatives;
increased depreciation and amortization including the impact of
new curriculum releases, systems enhancements and the effects of
purchase accounting; merger integration, financial systems and
process improvement costs; and M&A transaction expenses.
Middlebury
Interactive languages
In April 2010, we formed a joint venture with Middlebury College
known as Middlebury Interactive Languages LLC (MIL) to
develop online foreign language courses. This new venture will
create innovative, online language programs for pre-college
students and will leverage Middlebury’s recognized
experience in foreign language instruction and K12’s
expertise in online education. Language faculty from Middlebury
will work with K12 to develop and manage the academic content of
the Web-based language courses, which K12 will offer through its
online education programs. The new courses will use features
such as animation, music, videos and other elements that immerse
students in new languages. The joint venture will also expand
the Middlebury-Monterey Language Academy (MMLA), a language
immersion summer program for middle and high school students.
Our results for the six months ending December 31, 2010
include the summer 2010 four week residential session that
offered Arabic, Chinese, French, German and Spanish at four
college campuses. MMLA intends to expand to eight campuses for
summer 2011.
Acquisition
of KC Distance Learning
On July 23, 2010, we acquired all of the stock of KCDL, a
provider of online curriculum and public and private virtual
education, by issuing to its parent company, KCDL Holdings LLC,
2,750,000 shares of a new class of stock designated as
Series A Special Stock, which had a value at closing of
$63.1 million. KCDL Holdings, Inc. is an affiliate of the
Learning Group, LLC, a related party. The holders of the
Series A Special Stock initially had no
20
voting rights and no rights of conversion with respect to those
shares; however, the holders had and still have participating
rights in all dividends and distributions declared or paid on or
with respects to our common stock.
On December 23, 2010, we filed a definitive proxy statement
with the Securities and Exchange Commission (SEC) for the
stockholder vote. On January 27, 2011, we held a Special
Meeting at which the stockholders approved conversion and voting
rights for the holders of the Series A Special Stock. The
holders of the Series A Special Stock now have the right to
convert those shares into common stock on a
one-for-one
basis and for the right to vote on all matters presented to
K12 shareholders, other than for the election and removal
of directors, for which the holders shall have no voting rights
unless converted to common.
The KCDL businesses include: Aventa Learning (online curriculum
and instruction), the iQ Academies (statewide virtual public
charter schools for middle and high school); and The Keystone
School (international online private school). Aventa Learning
offers to schools and school districts over 140 core, elective
and AP courses in grades 6-12, from credit recovery courses to
full-scale virtual school programs, as well as instructional
services. Aventa Learning is accredited by the Northwest
Association of Accredited Schools (NAAS). The Keystone School is
an online private school for middle and high school students,
which is also accredited by the NAAS. It was established in 1974
and has served over 250,000 students from 84 countries. The
school enrolls both full-time and part-time students and its
course offerings are supported by certified teachers. The iQ
Academies are statewide online public schools that partner with
school districts or public charter schools to serve middle and
high school students. iQ Academies currently operate in
California, Kansas, Minnesota, Nevada, Texas, Washington, and
Wisconsin.
Acquisition
of American Education Corporation
On December 1, 2010, we acquired the operating assets and
liabilities of American Education Corporation (AEC), a leading
provider of research-based core curriculum instructional
software for kindergarten through adult learners, headquartered
in Oklahoma City, OK, for a total cash purchase price of
$35.2 million, subject to certain adjustments. The
acquisition increases our portfolio of innovative, high quality
instructional and curriculum offerings to school districts all
over the country. The purchase price includes $6.8 million
held in escrow that selling AEC shareholders may receive based
upon achievement of specified financial targets for the three
months ended December 31, 2010. As of the current date, we
do not expect any of this contingent consideration will be
distributed to the selling AEC shareholders.
Web
International
On January 3, 2011, we invested $10 million in cash in
Web International Education Group Ltd. (“Web”). This
strategic investment gives us a 20% minority interest in Web,
with the option to acquire the remainder of the company within a
period of five years. Web is a leader in English language
training for learners of all ages throughout China, including
university students, government workers, and employees of
international companies. Web has a network of 72 learning
centers in 47 cities. It currently serves more than 35,000
students. The proceeds of the investment will primarily be used
to expand Web’s learning center network into more Chinese
cities.
The
George Washington University Online High School
On January 13, 2011, K12 announced a partnership with the
George Washington University to launch an online private high
school, the George Washington University Online High School
(GWUOHS). The private school will serve students in the
U.S. and in countries around the world. The program offers
K12’s college preparatory curriculum and is designed for
high school students who are seeking a challenging academic
experience and aspire to attend top colleges and universities.
Developments
in Education Funding
Our annual revenue growth is impacted by changes in federal,
state and district per enrollment funding levels. Due to the
budgetary problems arising from the economic recession, many
states reduced per enrollment funding for public education
affecting many of the virtual public schools we serve. While the
American Recovery and
21
Reinvestment Act of 2009 (ARRA) has provided additional funds to
states, it has not fully offset the state funding reductions.
Thus, the net impact to funding was negative and had a negative
effect on both revenue and income for our fiscal years 2009 and
2010. Our financial results reflect these reductions, ARRA
funds, and expense reductions that we undertook in order to
mitigate the impact of the funding reductions. In August 2010,
the Education Jobs and Medicaid Assistance Act was enacted into
law, providing $10 billion in federal aid for schools. This
assistance will reach some of the schools we serve, although we
cannot be certain of the aggregate impact. At this time, many
states still have budget issues. The specific level of federal,
state and district funding for the coming years is not yet
known, and taken as a whole, it is possible the public schools
we serve could experience lower per enrollment funding in the
future.
Strategic
Marketing and Student Recruiting Initiatives
We continue to pursue opportunities to open virtual public
schools, hybrid schools, and classroom-based programs in
additional states and are marketing our post-secondary
curriculum offering under Capital Education. Our follow-on
marketing and student recruiting spending plans to support the
success of these business development efforts are based upon
historical trends. If we are more successful than anticipated,
we will invest incrementally in marketing and student recruiting
to support future revenue growth. The nature and timing of these
events may result in higher fourth fiscal quarter marketing
expenses with the corresponding increase in revenue occurring in
future periods.
Critical
Accounting Policies and Estimates
The preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions about future
events that affect the amounts reported in our consolidated
financial statements and accompanying notes. Future events and
their effects cannot be determined with certainty. Therefore,
the determination of estimates requires the exercise of
judgment. Actual results could differ from those estimates, and
any such differences may be material to our consolidated
financial statements. Critical accounting policies are disclosed
in our fiscal year 2010 audited consolidated financial
statements, which are included in our Annual Report. Other than
those described in the condensed consolidated financial
statements, there have been no significant updates to our
critical accounting policies disclosed in our Annual Report.
Results
of Operations
Enrollment
Due to growth in our private school and institutional sales
business, including the increasing number of students who enroll
part-time or take a single course in these programs, we are
including additional enrollment information for fiscal year
2011. We believe this information, combined with the existing
virtual public school enrollment data, provides a more complete
picture of the drivers of revenue.
Total average enrollments in public schools for the three months
ended December 31, 2010, the metric previously reported,
increased to 81,083, or 20.4%, as compared to 67,354 for the
same period in the prior year. High school students comprised
25.9% of public school enrollment as compared to 21.6% in the
same period in the prior year. New schools in Delaware,
Massachusetts and Michigan contributed 1.2% to total average
enrollment in public schools. With the acquisition of KCDL, we
added 14,978 enrollments to the total.
Enrollment growth in K12 managed virtual public schools was
20.0%. Enrollment growth in online curriculum sales to public
schools, school districts and other schools (institutional
sales) was 22.5%. These enrollments exclude students in our
direct-to-consumer
and pilot programs.
Enrollments in K12 private schools for the three months ended
December 31, 2010 increased 91.9% to 2,235 from 1,165 for
the same period in the prior year. Private schools include the
K12 International Academy as well as private brick and mortar
schools. These private schools offer educational services on a
full and part-time basis. For better comparability, enrollments
reported are converted to full-time equivalents (FTEs).
For the three months ended December 31, 2010, enrollments
in the Aventa, iQ, and Keystone School brands obtained through
our acquisition of KC Distance Learning were 5,830, 3,128, and
6,020, respectively. These
22
programs serve students in grades 6-12 on a full and part-time
basis. For better comparability, enrollments reported are
converted to full-time equivalents (FTEs).
The following tables set forth average enrollment data for each
of the periods indicated:
Total
Average Enrollment (FTEs)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ending December 31,
|
|
|
Six Months Ending December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
Change %
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
Change %
|
|
|
|
|
Total Average Enrollment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 public schools
|
|
|
81,083
|
|
|
|
67,354
|
|
|
|
13,729
|
|
|
|
20.4
|
%
|
|
|
81,480
|
|
|
|
67,901
|
|
|
|
13,579
|
|
|
|
20.0
|
%
|
|
K12 private schools
|
|
|
2,235
|
|
|
|
1,165
|
|
|
|
1,070
|
|
|
|
91.9
|
%
|
|
|
2,246
|
|
|
|
1,012
|
|
|
|
1,234
|
|
|
|
122.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 total
|
|
|
83,318
|
|
|
|
68,519
|
|
|
|
14,799
|
|
|
|
21.6
|
%
|
|
|
83,726
|
|
|
|
68,913
|
|
|
|
14,813
|
|
|
|
21.5
|
%
|
|
iQ
|
|
|
3,128
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
|
3,165
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
Aventa
|
|
|
5,830
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
|
5,680
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
Keystone
|
|
|
6,020
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
|
6,054
|
|
|
|
n.a.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total acquired enrollment
|
|
|
14,978
|
|
|
|
—
|
|
|
|
14,978
|
|
|
|
NM
|
|
|
|
14,899
|
|
|
|
—
|
|
|
|
14,898
|
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Average Enrollment
|
|
|
98,296
|
|
|
|
68,519
|
|
|
|
29,777
|
|
|
|
43.5
|
%
|
|
|
98,625
|
|
|
|
68,913
|
|
|
|
29,712
|
|
|
|
43.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Enrollment mix by sales channel for K12 programs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ending December 31,
|
|
|
Six Months Ending December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
Change %
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
Change %
|
|
|
|
|
K12 Public schools
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 managed schools
|
|
|
68,722
|
|
|
|
57,264
|
|
|
|
11,458
|
|
|
|
20.0
|
%
|
|
|
69,157
|
|
|
|
57,834
|
|
|
|
11,323
|
|
|
|
19.6
|
%
|
|
K12 institutional sales
|
|
|
12,361
|
|
|
|
10,090
|
|
|
|
2,271
|
|
|
|
22.5
|
%
|
|
|
12,323
|
|
|
|
10,068
|
|
|
|
2,255
|
|
|
|
22.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total K12 public
|
|
|
81,083
|
|
|
|
67,354
|
|
|
|
13,729
|
|
|
|
20.4
|
%
|
|
|
81,480
|
|
|
|
67,902
|
|
|
|
13,578
|
|
|
|
20.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 Private schools
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 managed
|
|
|
1,622
|
|
|
|
1,165
|
|
|
|
457
|
|
|
|
39.2
|
%
|
|
|
1,571
|
|
|
|
1,012
|
|
|
|
559
|
|
|
|
55.2
|
%
|
|
K12 institutional sales
|
|
|
613
|
|
|
|
—
|
|
|
|
613
|
|
|
|
NM
|
|
|
|
676
|
|
|
|
—
|
|
|
|
676
|
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total K12 private
|
|
|
2,235
|
|
|
|
1,165
|
|
|
|
1,070
|
|
|
|
91.8
|
%
|
|
|
2,247
|
|
|
|
1,012
|
|
|
|
1,235
|
|
|
|
122.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
K12 total
|
|
|
83,318
|
|
|
|
68,519
|
|
|
|
14,799
|
|
|
|
21.6
|
%
|
|
|
83,726
|
|
|
|
68,913
|
|
|
|
14,813
|
|
|
|
21.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above enrollments exclude those in our
direct-to-consumer
and pilot programs, and enrollments acquired with AEC.
23
The following table sets forth statements of operations data for
each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(In thousands)
|
|
|
(In thousands)
|
|
|
|
|
Revenues
|
|
$
|
129,002
|
|
|
$
|
93,197
|
|
|
$
|
263,873
|
|
|
$
|
199,522
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
76,195
|
|
|
|
51,589
|
|
|
|
151,277
|
|
|
|
109,682
|
|
|
Selling, administrative, and other operating expenses
|
|
|
35,177
|
|
|
|
24,899
|
|
|
|
85,675
|
|
|
|
58,226
|
|
|
Product development expenses
|
|
|
3,435
|
|
|
|
2,415
|
|
|
|
7,346
|
|
|
|
4,653
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
114,807
|
|
|
|
78,903
|
|
|
|
244,298
|
|
|
|
172,561
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
14,195
|
|
|
|
14,294
|
|
|
|
19,575
|
|
|
|
26,961
|
|
|
Interest expense, net
|
|
|
(366
|
)
|
|
|
(324
|
)
|
|
|
(663
|
)
|
|
|
(681
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and noncontrolling interest
|
|
|
13,829
|
|
|
|
13,970
|
|
|
|
18,912
|
|
|
|
26,280
|
|
|
Income tax expense
|
|
|
(6,119
|
)
|
|
|
(4,381
|
)
|
|
|
(9,050
|
)
|
|
|
(9,749
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
7,710
|
|
|
$
|
9,589
|
|
|
$
|
9,862
|
|
|
$
|
16,531
|
|
|
Add net loss attributable to noncontrolling interest
|
|
$
|
129
|
|
|
$
|
49
|
|
|
$
|
175
|
|
|
$
|
190
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income — K12 Inc.
|
|
$
|
7,839
|
|
|
$
|
9,638
|
|
|
$
|
10,037
|
|
|
$
|
16,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table sets forth statements of operations data as
a percentage of revenues for each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Revenues
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
59.1
|
|
|
|
55.4
|
|
|
|
57.3
|
|
|
|
55.0
|
|
|
Selling, administrative, and other operating expenses
|
|
|
27.3
|
|
|
|
26.7
|
|
|
|
32.5
|
|
|
|
29.2
|
|
|
Product development expenses
|
|
|
2.6
|
|
|
|
2.6
|
|
|
|
2.8
|
|
|
|
2.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
89.0
|
|
|
|
84.7
|
|
|
|
92.6
|
|
|
|
86.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
11.0
|
|
|
|
15.3
|
|
|
|
7.4
|
|
|
|
13.5
|
|
|
Interest expense, net
|
|
|
(0.3
|
)
|
|
|
(0.3
|
)
|
|
|
(0.2
|
)
|
|
|
(0.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and noncontrolling interest
|
|
|
10.7
|
|
|
|
15.0
|
|
|
|
7.2
|
|
|
|
13.2
|
|
|
Income tax expense
|
|
|
(4.7
|
)
|
|
|
(4.7
|
)
|
|
|
(3.4
|
)
|
|
|
(4.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
6.0
|
|
|
|
10.3
|
|
|
|
3.8
|
|
|
|
8.3
|
|
|
Add net loss attributable to noncontrolling interest
|
|
|
0.1
|
|
|
|
0.0
|
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income — K12 Inc.
|
|
|
6.1
|
%
|
|
|
10.3
|
%
|
|
|
3.9
|
%
|
|
|
8.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
We have included below a discussion of our operating results and
significant items which explain the material changes in our
operating results during the three and six months ended
December 31, 2010 as compared to the same period in the
prior year.
Comparison
of the Three Months Ended December 31, 2010 and Three
Months Ended December 31, 2009
Revenues.
Our revenues for the three months
ended December 31, 2010 were $129.0 million,
representing an increase of $35.8 million, or 38.4%, as
compared to revenues of $93.2 million for the same period
in the prior year. This increase was primarily attributable to
21.6% increase in enrollments in K12 programs. In addition,
Aventa, iQ and Keystone programs obtained through our
acquisition of KCDL contributed 10.5% to revenue growth.
Instructional costs and services
expenses.
Instructional costs and services
expenses for the three months ended December 31, 2010 were
$76.2 million, representing an increase of
$24.6 million, or 47.7%, as compared to instructional costs
and services expenses of $51.6 million for the same period
in the prior year. This increase was primarily attributable to a
$16.9 million increase in expenses to operate and manage
schools including the programs acquired with KCDL. In addition,
costs to supply curriculum, books, educational materials and
computers to students increased $5.2 million, including
$3.3 million due to a timing difference benefiting the
prior period. Amortization of curriculum and learning systems
increased $2.5 million. Included in the $24.6 million
increase in instructional costs and services expenses are
start-up and launch expenses of $2.9 million for several
new businesses and initiatives. As a percentage of revenues,
instructional costs and services expenses increased to 59.1% for
the three months ended December 31, 2010, as compared to
55.4% for the same period in the prior year. This increase as a
percentage of revenues was primarily attributable to the benefit
of materials returns in the prior year, increased amortization
of curriculum and learning systems, and an increase in the
percentage of high school enrollments relative to total
enrollments, as high school enrollments have higher costs as a
percentage of revenues due to increased teacher and related
services costs. These increases were partially offset by
increased productivity at the schools we serve and leverage of
fixed school infrastructure costs.
Selling, administrative, and other operating
expenses.
Selling, administrative, and other
operating expenses for the three months ended December 31,
2010 were $35.2 million, representing an increase of
$10.3 million, or 41.3%, as compared to selling,
administrative and other operating expenses of
$24.9 million for the same period in the prior year. This
increase is primarily attributable to increases in: personnel
costs including those acquired with KCDL and AEC; merger
integration, financial systems and process improvement costs;
the effects of purchase accounting; and M&A transaction
expenses. Included in the $10.3 million increase in
selling, administrative, and other operating expenses are
start-up and launch expenses of $2.3 million for several
new businesses and initiatives. As a percentage of revenues,
selling, administrative, and other operating expenses increased
to 27.3% for the three months ended December 31, 2010 as
compared to 26.7% for the same period in the prior year
primarily due to the items identified above.
Product development expenses.
Product
development expenses for the three months ended
December 31, 2010 were $3.4 million, representing an
increase of $1.0 million, or 42.2%, as compared to product
development expenses of $2.4 million for the same period in
the prior year. The increase is primarily due to initiatives to
support the Aventa curriculum acquired with KCDL. As a
percentage of revenues, product development expenses increased
to 2.6% for the three months ended December 31, 2010 as
compared to 2.6% for the same period in the prior year primarily
due to the items identified above.
Interest expense, net.
Net interest expense
for the three months ended December 31, 2010 was
$0.4 million as compared to net interest expense of
$0.3 million for the same period in the prior year. The
increase in net interest expense is primarily due to borrowings
on our line of credit. In addition, balances outstanding on
capital leases increased but were offset by a decrease in
average interest rates.
Income taxes.
Income tax expense for the three
months ended December 31, 2010 was $6.1 million, or
44.2% of income before income taxes, as compared to an income
tax expense of $4.4 million, or 31.4% of income before
taxes, for the same period in the prior year. The increase in
the tax rate is primarily due to non-deductible transaction
expenses in the current period as well as the benefit of tax
credits recognized in the same period in the prior year.
25
Noncontrolling interest.
Noncontrolling
interest for the three months ended December 31, 2010 was
$0.1 million and de minimus in the same period in the
prior year. Noncontrolling interest reflects the after-tax
losses attributable to shareholders in our joint venture in the
Middle East and Middlebury Interactive Languages.
Comparison
of the Six Months Ended December 31, 2010 and Six Months
Ended December 31, 2009
Revenues.
Our revenues for the six months
ended December 31, 2010 were $263.9 million,
representing an increase of $64.4 million, or 32.3%, as
compared to revenues of $199.5 million for the same period
in the prior year. This increase was primarily attributable to
21.5% increase in enrollments in K12 programs. In addition,
Aventa, iQ and Keystone programs obtained through our
acquisition of KCDL contributed 7.7% to revenue growth.
Instructional costs and services
expenses.
Instructional costs and services
expenses for the six months ended December 31, 2010 were
$151.3 million, representing an increase of
$41.6 million, or 37.9%, as compared to instructional costs
and services expenses of $109.7 million for the same period
in the prior year. This increase was primarily attributable to a
$28.3 million increase in expenses to operate and manage
schools including the MIL summer programs and the programs
acquired with KCDL. In addition, costs to supply curriculum,
books, educational materials and computers to students increased
$8.4 million, including a $0.8 million increase in the
provision for inventory obsolescence. Included in the
$41.6 million increase in instructional costs and services
expenses were start-up and launch expenses of $5.3 million
for several new businesses and initiatives. Amortization of
curriculum and learning systems increased $5.0 million. As
a percentage of revenues, instructional costs and services
expenses increased to 57.3% for the six months ended
December 31, 2010, as compared to 55.0% for the same period
in the prior year. This increase as a percentage of revenues was
primarily attributable to increased amortization of curriculum
and learning systems, the benefit from return of instructional
materials in the prior period and an increase in the percentage
of high school enrollments relative to total enrollments, as
high school enrollments have higher costs as a percentage of
revenues due to increased teacher and related services costs. To
a lesser extent, the increase in expense as a percentage of
revenue was also impacted by the additional startup expenses
that did not have the corresponding growth in revenues in the
current period. These increases were partially offset by lower
fulfillment costs for materials and computers, increased
productivity at the schools we serve, and leverage of fixed
school infrastructure costs.
Selling, administrative, and other operating
expenses.
Selling, administrative, and other
operating expenses for the six months ended December 31,
2010 were $85.7 million, representing an increase of
$27.4 million, or 47.1%, as compared to selling,
administrative and other operating expenses of
$58.2 million for the same period in the prior year. This
increase is primarily attributable to increases in: strategic
marketing including brand awareness and student recruitment;
personnel costs including those acquired with KCDL and AEC;
merger integration, financial systems and process improvement
costs; the effects of purchase accounting; M&A transaction
expenses; one-time stock compensation expenses associated with
the execution of a new long-term employment agreement with our
CEO; and other professional services. Included in the
$27.4 million increase in selling, administrative, and
other operating expenses are start-up and launch expenses of
$3.3 million for several new businesses and initiatives. As
a percentage of revenues, selling, administrative, and other
operating expenses increased to 32.5% for the six months ended
December 31, 2010 as compared to 29.2% for the same period
in the prior year primarily due to the items identified above.
Product development expenses.
Product
development expenses for the six months ended December 31,
2010 were $7.3 million, representing an increase of
$2.7 million, or 57.9%, as compared to product development
expenses of $4.7 million for the same period in the prior
year. The increase is primarily due to initiatives to support
the Aventa curriculum acquired during the period as well as the
timing of new development projects. As a percentage of revenues,
product development expenses increased to 2.8% for the six
months ended December 31, 2010 as compared to 2.3% for the
same period in the prior year primarily due to the items
identified above.
Interest expense, net.
Net interest expense
for the six months ended December 31, 2010 and 2009 was
$0.7 million. Balances outstanding on capital leases
increased for the six months ended December 31, 2010, but
were offset by a decrease in average interest rates.
Income taxes.
Income tax expense for the six
months ended December 31, 2010 was $9.1 million, or
47.9% of income before income taxes, as compared to an income
tax expense of $9.7 million, or 37.1% of income before
26
taxes, for the same period in the prior year. The increase in
the tax rate is primarily due to non-deductible transaction
expenses in the current period as well as the benefit of tax
credits recognized in the same period in the prior year.
Noncontrolling interest.
Noncontrolling
interest for the six months ended December 31, 2010 and
2009 was $0.2 million. Noncontrolling interest reflects the
after-tax losses attributable to shareholders in our joint
venture in the Middle East and Middlebury Interactive Languages.
Liquidity
and Capital Resources
As of December 31, 2010 and June 30, 2010, we had cash
and cash equivalents of $35.2 million and
$81.8 million, respectively and excluding restricted cash.
We financed our capital expenditures during the six months ended
December 31, 2010 primarily with cash and capital lease
financing. As of December 31, 2010, our cash balance
included $11.0 million associated with our joint ventures.
Our cash requirements consist primarily of
day-to-day
operating expenses, capital expenditures and contractual
obligations with respect to facility leases, capital equipment
leases and other operating leases. We expect capital
expenditures for fiscal year 2011 of $38 million to
$40 million including expenditures for additional courses,
new releases of existing courses, foreign language courses
developed in our MIL joint venture, and internal systems
enhancements and software purchases to support our growth, the
integration of KCDL, and a second data center. We also expect
expenditures for computers provided for use by students of
approximately $14 million to support growth in virtual
school enrollments. We expect to be able to fund these capital
expenditures with cash on hand, cash generated from operations,
capital lease financing or advances under our line of credit. As
of March 31, 2011, advances for additional purchases are no
longer available under our existing capital lease line of
credit. We expect to renew this line of credit, obtain
additional financing from other providers or pay for future
purchases with cash on hand. We lease all of our office
facilities. We expect to make future payments on existing leases
from cash generated from operations.
On December 1, 2010, we closed the acquisition of AEC. We
funded the purchase price of $28.4 million plus a
contingent consideration escrow of $6.8 million, for a
total of $35.2 million with cash on hand and a
$15 million advance under our line of credit. We believe
that the contingent consideration of $6.8 million will not
be paid and that the escrowed funds will be released back to the
Company.
We believe that the combination of funds currently available and
funds to be generated from operations will be adequate to
finance our ongoing operations for the foreseeable future. In
addition, we continue to explore acquisitions, strategic
investments, and joint ventures related to our business that we
may acquire using cash, stock, debt, contribution of assets or a
combination thereof.
Redemption Right
of Middlebury College
In the formation of our joint venture with Middlebury College
(Middlebury), at any time after May 1, 2015, Middlebury may
give written notice of its irrevocable election to sell all (but
not less than all) of its Membership Interest to us (put right).
Given the put right is redeemable outside of our control it is
recorded outside of permanent equity at its estimated redemption
value. The purchase price for Middlebury’s Membership
Interest shall be its fair market value and we may, in our sole
discretion, pay the purchase price in cash or shares of our
common stock. As of December 31, 2010, the redeemable
noncontrolling interest was estimated to be $20.8 million.
Redemption Right
of Series A Special Stock
In July 2010, we acquired all of the stock of KC Distance
Learning, Inc. (KCDL), a provider of online curriculum and
public and private virtual education, by issuing to its parent
company KCDL Holdings LLC, 2.75 million shares of a new
class of stock designated as Series A Special Stock, which
had a value at closing of $63.1 million. After the approval
of shareholders on January 27, 2011, the holders of
Series A Special Stock have the right to convert those
shares into common stock on a
one-for-one
basis and for the right to vote on all matters presented to
K12 shareholders, other than for the election and removal
of directors, for which the holders shall have no voting rights
unless converted to common. The redemption right of the holders
of the Series A Special Stock terminated upon shareholder
approval of their conversion and voting rights.
27
Operating
Activities
Net cash provided by operating activities for the six months
ended December 31, 2010 and 2009 was $7.1 million and
$9.8 million, respectively.
The increase in accounts receivable was primarily attributable
to our growth in revenues including the businesses acquired with
KCDL during the period. Accounts receivable balances tend to be
at the highest levels in the first quarter as we begin billing
for students. Deferred revenues are primarily a result of
invoicing upfront fees, not cash payments. Deferred revenues
increased primarily due to growth in enrollments, and to a
lesser extent from the businesses of KCDL acquired during the
period. Deferred revenue balances tend to be highest in the
first quarter, when the majority of students enroll, and are
generally amortized over the course of the fiscal year.
The increase in accounts payable and accrued liabilities is
primarily due to the timing of payments to vendors and service
providers for transaction related costs, professional services,
and equipment purchases. The decrease in inventories is
primarily due to materials shipments to students, partially
offset by purchases. The increase in cash used in accrued
compensation and benefits is primarily due to a net increase in
incentive compensation payments.
Investing
Activities
Net cash used in investing activities for the six months ended
December 31, 2010 and 2009 was $63.7 million and
$11.5 million, respectively.
Net cash used in investing activities for the six months ended
December 31, 2010 was primarily due to the purchase of AEC
for $24.5 million net of cash received of $3.8 million
and $6.8 million for the achievement of specified financial
targets for three months ended December 31, 2010. As of the
current date, we do not expect any of this contingent
consideration to be distributed to the selling AEC shareholders.
Consequently, this escrow amount is recorded in other current
assets as of December 31, 2010. We also transferred
$10 million for our investment in Web. This cash was in
transit as of December 31, 2010 and is recorded in
long-term other assets. In addition, investing activities
included purchases of property and equipment of
$9.0 million including $3.8 million to license an
enterprise software application, investment in capitalized
curriculum development of $7.0 million, primarily related
to the production of high school courses, middle school math
courses, and language courses; and investment in capitalized
software development of $4.3 million.
Net cash used in investing activities for the six months ended
December 31, 2009 was primarily due to investment in
capitalized curriculum development of $6.4 million,
primarily related to the production of high school courses,
elementary school math courses, and remedial reading; investment
in capitalized software development of $4.5 million; and
purchases of property and equipment of $0.6 million,
including purchased software.
In addition to the investing activities above, for the six
months ended December 31, 2010 and 2009, we financed
through capital leases purchases of computers and software
primarily for use by students in the amount of
$12.9 million and $10.2 million, respectively.
Financing
Activities
Net cash provided by financing activities for the six months
ended December 31, 2010 and 2009 was $10.0 million and
$0.2 million, respectively.
For the six months ended December 31, 2010, net cash
provided by financing activities was primarily due to
$15 million from our line of credit, proceeds from the
exercise of stock options of $2.9 million, and the excess
tax benefit from stock-based compensation of $1.3 million,
partially offset by payments on capital leases and notes payable
of $8.2 million. As of December 31, 2010, there was
$15 million outstanding on our $35 million line of
credit.
For the six months ended December 31, 2009, net cash
provided by financing activities was primarily due to the
exercise of stock options of $4.9 million and the excess
tax benefit from stock-based compensation of $2.2 million,
partially offset by payments on capital leases and notes payable
of $6.9 million.
28
Off
Balance Sheet Arrangements, Contractual Obligations and
Commitments
There were no substantial changes to our guarantee and
indemnification obligations in the six months ended
December 31, 2010 from those disclosed in our fiscal year
2010 audited consolidated financial statements.
Our contractual obligations consist primarily of leases for
office space, capital leases for equipment and other operating
leases. The total amount due under contractual obligations
increased during the six months ended December 31, 2010
primarily due to approximately $4.4 million for capital
leases related to student computers, net of payments.
|
|
|
|
Item 3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
Interest
Rate Risk
At December 31, 2010 and June 30, 2010, we had cash
and cash equivalents totaling $35.2 million and
$81.8 million, respectively. Our excess cash has been
invested primarily in U.S. Treasury money market funds
although we may also invest in money market accounts, government
securities, corporate debt securities and similar investments.
Future interest and investment income is subject to the impact
of interest rate changes and we may be subject to changes in the
fair value of our investment portfolio as a result of changes in
interest rates. At December 31, 2010, a 1% gross increase
in interest rates earned on cash and cash equivalents would
result in a $0.4 million annualized increase in interest
income.
Our debt obligations under our revolving credit facility are
subject to interest rate exposure. As of December 31, 2010,
$15 million was outstanding on this facility at an interest
rate of 1.8%. At December 31, 2010, a 1% gross increase in
interest rates would result in a $0.2 million annualized
increase in interest expense.
Foreign
Currency Exchange Risk
We currently operate in foreign countries. In the past, we did
not transact a material amount of business in a foreign currency
and therefore fluctuations in exchange rates did not have a
material impact on our financial statements. However, we
continue to pursue opportunities in international markets. If we
enter into any material transactions in a foreign currency or
establish or acquire any subsidiaries that measure and record
their financial condition and results of operation in a foreign
currency, we will be exposed to currency transaction risk
and/or
currency translation risk. Exchange rates between
U.S. dollars and many foreign currencies have fluctuated
significantly over the last few years and may continue to do so
in the future. Accordingly, we may decide in the future to
undertake hedging strategies to minimize the effect of currency
fluctuations on our financial condition and results of
operations.
|
|
|
|
Item 4.
|
Controls
and Procedures
|
Evaluation
of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in
Rule 13a-15(e)
of the Exchange Act) that are designed to ensure that
information required to be disclosed in our Exchange Act reports
is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange
Commission’s rules and forms and that such information is
accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls
and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired
control objectives, and management necessarily was required to
apply its judgment in evaluating the cost benefit relationship
of possible controls and procedures.
As described in Item 9A of our Annual Report on
Form 10K for the fiscal year ended June 30, 2010, a
material weakness was identified in our internal control over
financial reporting (“ICFR”) relating to our
accounting for complex transactions that are non-routine and
non-recurring.
Rule 12b-2
and
Rule 1-02
of
Regulation S-X
define a material weakness as a deficiency, or a combination of
deficiencies, in ICFR such that there is a reasonable
possibility that a material misstatement of the
registrant’s annual or interim financial statements will
not be
29
prevented or detected on a timely basis. As a result of the
material weakness, our Chief Executive Officer and Chief
Financial Officer concluded that, as of June 30, 2010, the
end of the period covered by our Annual Report, our disclosure
controls and procedures were not effective at a reasonable
assurance level.
We carried out an evaluation, required by paragraph (b) of
Rule 13a-15
or
Rule 15d-15
under the Exchange Act, under the supervision and with the
participation of management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures (as defined in
Rule 13a-15(e)
or
Rule 15d-15(e)
of the Exchange Act) as of the end of the period covered by this
Quarterly Report on Form 10Q. Based on this review, our
Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were not effective
as of December 31, 2010 as the material weakness identified
as of June 30, 2010 still exists.
Changes
in Internal Control over Financial Reporting
As described in Item 9A of our Annual Report on
Form 10K for the fiscal year ended June 30, 2010,
management has been undertaking improvements in our internal
control over financial reporting and our accounting procedures
and practices generally. Specifically, management has approved
the addition of several new positions to our finance and
accounting staff which we are in the process of filling from
internal resources and outside recruitment efforts (including
the possibility of using external staffing firms), we have
targeted potential new hires for recruitment, we have engaged a
“Big Four” accounting firm to provide consulting
services to our finance and accounting staff regarding process
improvement opportunities, best practices and relevant training,
and we are in the process of implementing an enterprise-wide
financial management solution from Oracle Corporation to improve
our overall accounting function. In addition, we are arranging
for additional internal training of our finance staff as to GAAP
requirements and SEC guidance in connection with accounting for
complex, non-routine and non-recurring transactions. Management
believes the measures that have been implemented to remediate
the material weakness in our ICFR concerning our accounting for
complex, non-routine and non-recurring transactions have had a
material impact on our internal control over financial reporting
since June 30, 2010, and anticipates that these measures
and other ongoing enhancements will continue to improve our
internal control over financial reporting in future periods.
During the six months ended December 31, 2010, in
connection with the evaluation required by paragraph (d) of
Rule 13a-15
or Rule 15d-15 under the Exchange Act, the effort to
remediate the material weakness in our internal control over
financial reporting that occurred during our last fiscal quarter
has had a positive effect on our internal control over financial
reporting. Management anticipates that these measures and other
ongoing enhancements will continue to have a positive impact on
our internal control over financial reporting in future periods.
Notwithstanding such efforts, the material weakness related to
our accounting for complex transactions that are non-routine and
non-recurring described above will not be remediated until the
new controls operate for a sufficient period of time and are
tested to enable management to conclude that the controls are
effective. Management will consider the design and operating
effectiveness of these controls and will make any additional
changes management determines appropriate.
Part II.
Other Information
|
|
|
|
Item 1.
|
Legal
Proceedings.
|
In the ordinary conduct of our business, we are subject to
lawsuits, arbitrations and administrative proceedings from time
to time.
In June 2010, the shareholders of Aventa Learning, Inc. (Aventa)
filed a lawsuit against KCDL which is currently pending in the
U.S. District Court for the Western District of Washington,
Axtman et al. v. KC Distance Learning, Inc.
(Case
No. 2:10-cv-01022-JLR).
The lawsuit alleges, among other things, that KCDL did not honor
the terms of an earn-out provision contained in an asset
purchase agreement after certain assets of Aventa were acquired
by KCDL in 2007. In addition, the plaintiffs allege breach of
contract and misrepresentation claims, and seek the remedy of
rescission for alleged violation of the Securities Act of
Washington. On July 23, 2010, we acquired all of the shares
of KCDL, which is now our wholly-owned subsidiary. On
August 31, 2010, the plaintiffs amended their complaint to
add K12 Inc. as a co-
30
defendant in this matter, reflecting the change in ownership. On
October 4, 2010, defendants filed a motion to dismiss
plaintiff’s amended complaint. Pursuant to the Agreement
and Plan of Merger between K12 Inc. and KCDL Holdings LLC
(Seller), Seller agreed to assume responsibility to defend this
lawsuit and to fully indemnify us for any liability, including
rescission. In addition, we obtained a guarantee from
Seller’s parent company, Learning Group LLC, from any
losses related to this litigation. In our view, the outcome of
this litigation will not have a material adverse effect on our
financial condition or results of operations or of any of our
subsidiaries.
There have been no material changes to the risk factors
disclosed in “Risk Factors” in Part I,
Item 1A, of our Annual Report.
|
|
|
|
Item 2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds.
|
None.
|
|
|
|
Item 3.
|
Defaults
Upon Senior Securities.
|
None.
|
|
|
|
Item 4.
|
Removed
and Reserved.
|
|
|
|
|
Item 5.
|
Other
Information.
|
None.
(a) Exhibits.
The exhibits listed on the accompanying Exhibit Index are
filed as part of this report and such Exhibit Index is
incorporated herein by reference.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
K12 INC.
Ronald J. Packard
Chief Executive Officer
Date: February 9, 2011
32
EXHIBIT INDEX
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Number
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Description
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3.1
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Third Amended and Restated Certificate of Incorporation of K12
Inc. (Incorporated by reference to Exhibit 3.1 to
K12’s Quarterly Report on Form 10-Q for the quarter
ended December 31, 2007).
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3.2
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Amended and Restated Bylaws of K12 Inc. (Incorporated by
reference to Exhibit 3.2 to K12’s Quarterly Report on
Form 10-Q for the quarter ended December 31, 2007).
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3.3
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Certificate of Designations, Preferences and Relative and Other
Special Rights of Series A Special Stock (Incorporated by
reference to Exhibit 3.1 to K12’s Current Report on
Form 8-K filed on July 26, 2010).
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10.1*
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Amendment to Amended and Restated Stock Option Agreement with
Ronald J. Packard.
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31.1*
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Certification of Principal Executive Officer Required Under
Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.
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31.2*
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Certification of Principal Financial Officer Required Under
Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.
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32.1*
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Certification of Principal Executive Officer and Principal
Financial Officer Required Under
Rule 13a-14(b)
of the Securities Exchange Act of 1934, as amended, and
18 U.S.C. Section 1350.
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33