UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| þ | ||
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
OR
| ¨ | ||
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the transition period from to
Commission File Number:001-33883
K12 Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 95-4774688 | ||
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | ||
2300 Corporate Park Drive Herndon, VA | 20171 | ||
| (Address of principal executive offices) | (Zip Code) | ||
(703) 483-7000
(Registrant’s telephone number, including area code)
N/A
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 ofRegulation 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 oþ 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” inRule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | Accelerated filer ¨ | |
Non-accelerated filer |
|
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o¨ No þ
As of May 5,November 7, 2011 the Registrant had 35,704,29836,364,429 shares of Common Stock, $0.0001 par value outstanding.
Form 10-Q
For the Quarterly Period Ended March 31,September 30, 2011
Index
| Page Number | ||||||||
| PART I. | 1 | |||||||
| Item | ||||||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 19 | |||||||
| Item 3. | ||||||||
| Item 4. | 28 | |||||||
| PART II. | 30 | |||||||
| Item 1. | 30 | |||||||
| Item 1A. | 30 | |||||||
| 30 | ||||||||
| Item 3. | 30 | |||||||
| Item 4. | 30 | |||||||
| Item 5. | 30 | |||||||
| Item 6. | 31 | |||||||
| 32 | ||||||||
1
| Item 1. |
K12 INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
| March 31, | June 30, | |||||||
| 2011 | 2010 | |||||||
| (In thousands, | ||||||||
| except share and per share data) | ||||||||
ASSETS | ||||||||
Current assets | ||||||||
| Cash and cash equivalents | $ | 40,080 | $ | 81,751 | ||||
| Restricted cash | 1,500 | 3,343 | ||||||
| Accounts receivable, net of allowance of $2,839 and $1,363 at March 31, 2011 and June 30, 2010, respectively | 134,048 | 71,184 | ||||||
| Inventories, net | 19,028 | 26,193 | ||||||
| Current portion of deferred tax asset | 4,768 | 4,672 | ||||||
| Prepaid expenses | 10,246 | 8,849 | ||||||
| Other current assets | 9,280 | 7,286 | ||||||
Total current assets | 218,950 | 203,278 | ||||||
| Property and equipment, net | 44,377 | 24,260 | ||||||
| Capitalized software development costs, net | 24,342 | 16,453 | ||||||
| Capitalized curriculum development costs, net | 52,643 | 39,860 | ||||||
| Deferred tax asset, net of current portion | — | 5,912 | ||||||
| Intangible assets | 39,148 | 14,081 | ||||||
| Goodwill | 53,580 | 1,825 | ||||||
| Investment in Web International | 10,000 | — | ||||||
| Deposits and other assets | 4,625 | 2,213 | ||||||
Total assets | $ | 447,665 | $ | 307,882 | ||||
| LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND EQUITY | ||||||||
Current liabilities | ||||||||
| Accounts payable | $ | 13,773 | $ | 12,691 | ||||
| Accrued liabilities | 12,468 | 8,840 | ||||||
| Accrued compensation and benefits | 8,627 | 10,563 | ||||||
| Deferred revenue | 28,315 | 9,593 | ||||||
| Current portion of capital lease obligations | 13,371 | 10,996 | ||||||
| Current portion of notes payable | 654 | 1,251 | ||||||
Total current liabilities | 77,208 | 53,934 | ||||||
| Deferred rent, net of current portion | 3,886 | 1,782 | ||||||
| Capital lease obligations, net of current portion | 11,015 | 7,710 | ||||||
| Notes payable, net of current portion | — | 655 | ||||||
| Deferred tax liability | 10,899 | — | ||||||
| Other long term liabilities | 3,323 | 435 | ||||||
Total liabilities | 106,331 | 64,516 | ||||||
Commitments and contingencies | ||||||||
Redeemable noncontrolling interest | 19,040 | 17,374 | ||||||
Equity: | ||||||||
| K12 Inc. stockholders’ equity | ||||||||
| Common stock, par value $0.0001; 100,000,000 shares authorized; 31,556,283 and 30,441,412 shares issued and outstanding at March 31, 2011 and June 30, 2010, respectively | 3 | 3 | ||||||
| Additional paid-in capital | 378,799 | 361,344 | ||||||
| Series A Special Stock, par value $0.0001; 2,750,000 and 0 shares issued and outstanding at March 31, 2011 and June 30, 2010, respectively | 63,112 | — | ||||||
| Accumulated other comprehensive income | 176 | — | ||||||
| Accumulated deficit | (123,860 | ) | (139,496 | ) | ||||
| Total K12 Inc. stockholders’ equity | 318,230 | 221,851 | ||||||
| Noncontrolling interest | 4,064 | 4,141 | ||||||
Total equity | 322,294 | 225,992 | ||||||
Total liabilities, redeemable noncontrolling interest and equity | $ | 447,665 | $ | 307,882 | ||||
| September 30, 2011 | June 30, 2011 | |||||||
(In thousands, except share and per share data) | ||||||||
| ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 133,472 | $ | 193,099 | ||||
Restricted cash and cash equivalents | 1,501 | 1,501 | ||||||
Accounts receivable, net of allowance of $1,983 and $1,777 at September 30, 2011 and June 30, 2011, respectively | 214,388 | 96,235 | ||||||
Inventories, net | 18,427 | 30,554 | ||||||
Current portion of deferred tax asset | 7,799 | 7,175 | ||||||
Prepaid expenses | 13,232 | 10,424 | ||||||
Other current assets | 17,899 | 9,111 | ||||||
|
|
|
| |||||
Total current assets | 406.718 | 348,099 | ||||||
Property and equipment, net | 58,148 | 46,625 | ||||||
Capitalized software development costs, net | 24,408 | 24,386 | ||||||
Capitalized curriculum development costs, net | 56,424 | 55,619 | ||||||
Deferred tax asset, net of current portion | — | — | ||||||
Intangible assets, net | 37,435 | 38,291 | ||||||
Goodwill | 66,668 | 55,627 | ||||||
Investment in Web International | 10,000 | 10,000 | ||||||
Deposits and other assets | 2,515 | 3,448 | ||||||
|
|
|
| |||||
Total assets | $ | 662,316 | $ | 582,095 | ||||
|
|
|
| |||||
| LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND EQUITY | ||||||||
Current liabilities | ||||||||
Accounts payable | $ | 31,850 | $ | 21,176 | ||||
Accrued liabilities | 19,025 | 14,126 | ||||||
Accrued compensation and benefits | 16,474 | 13,086 | ||||||
Deferred revenue | 63,257 | 21,907 | ||||||
Current portion of capital lease obligations | 15,101 | 11,914 | ||||||
Current portion of notes payable | 1,116 | 1,443 | ||||||
|
|
|
| |||||
Total current liabilities | 146,823 | 83,652 | ||||||
Deferred rent, net of current portion | 5,056 | 4,698 | ||||||
Capital lease obligations, net of current portion | 15,710 | 8,552 | ||||||
Notes payable, net of current portion | 1,923 | 2,299 | ||||||
Deferred tax liability | 11,818 | 9,604 | ||||||
Other long term liabilities | 3,242 | 3,343 | ||||||
|
|
|
| |||||
Total liabilities | 184,572 | 112,148 | ||||||
|
|
|
| |||||
Commitments and contingencies | — | — | ||||||
Redeemable noncontrolling interest | 17,200 | 17,200 | ||||||
|
|
|
| |||||
Equity: | ||||||||
K12 Inc. stockholders’ equity | ||||||||
Common stock, par value $0.0001; 100,000,000 shares authorized; 36,277,533 and 35,927,452 shares issued and outstanding at September 30, 2011 and June 30, 2011, respectively | 4 | 4 | ||||||
Additional paid-in capital | 515,330 | 512,181 | ||||||
Series A Special Stock, par value $0.0001; 2,750,000 issued and outstanding at September 30, 2011 and June 30, 2011 | 63,112 | 63,112 | ||||||
Accumulated other comprehensive income | 110 | 28 | ||||||
Accumulated deficit | (122,104 | ) | (126,704 | ) | ||||
|
|
|
| |||||
Total K12 Inc. stockholders’ equity | 456,452 | 448,621 | ||||||
Noncontrolling interest | 4,092 | 4,126 | ||||||
|
|
|
| |||||
Total equity | 460,544 | 452,747 | ||||||
|
|
|
| |||||
Total liabilities, redeemable noncontrolling interest and equity | $ | 662,316 | $ | 582,095 | ||||
|
|
|
| |||||
See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.
2
1
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months Ended | Nine Months Ended | |||||||||||||||
| March 31, 2011 | March 31, 2011 | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||
Revenues | $ | 130,293 | $ | 96,627 | $ | 394,167 | $ | 296,149 | ||||||||
Cost and expenses | ||||||||||||||||
| Instructional costs and services | 77,727 | 56,479 | 229,004 | 166,161 | ||||||||||||
| Selling, administrative, and other operating expenses | 36,763 | 26,843 | 122,438 | 85,069 | ||||||||||||
| Product development expenses | 4,972 | 2,924 | 12,318 | 7,577 | ||||||||||||
Total costs and expenses | 119,462 | 86,246 | 363,760 | 258,807 | ||||||||||||
Income from operations | 10,831 | 10,381 | 30,407 | 37,342 | ||||||||||||
Interest expense, net | (307 | ) | (361 | ) | (970 | ) | (1,042 | ) | ||||||||
Income before income tax expense and noncontrolling interest | 10,524 | 10,020 | 29,437 | 36,300 | ||||||||||||
Income tax expense | (5,260 | ) | (3,927 | ) | (14,310 | ) | (13,676 | ) | ||||||||
Net income | 5,264 | 6,093 | 15,127 | 22,624 | ||||||||||||
Add net loss attributable to noncontrolling interest | 335 | 36 | 509 | 226 | ||||||||||||
Net income — K12 Inc. | $ | 5,599 | $ | 6,129 | $ | 15,636 | $ | 22,850 | ||||||||
Net income attributable to common stockholders per share (see Note 3): | ||||||||||||||||
| Basic | $ | 0.17 | $ | 0.20 | $ | 0.47 | $ | 0.77 | ||||||||
| Diluted | $ | 0.16 | $ | 0.20 | $ | 0.46 | $ | 0.76 | ||||||||
Weighted average shares used in computing per share amounts: | ||||||||||||||||
| Basic | 30,958,807 | 29,951,327 | 30,620,330 | 29,658,076 | ||||||||||||
| Diluted | 31,758,313 | 30,352,974 | 31,327,544 | 30,023,341 | ||||||||||||
| Three Months Ended September 30, | ||||||||
| 2011 | 2010 | |||||||
| (In thousands, except share and per share data) | ||||||||
Revenues | $ | 193,330 | $ | 134,871 | ||||
|
|
|
| |||||
Cost and expenses | ||||||||
Instructional costs and services | 107,579 | 75,082 | ||||||
Selling, administrative, and other operating expenses | 71,260 | 50,498 | ||||||
Product development expenses | 6,224 | 3,911 | ||||||
|
|
|
| |||||
Total costs and expenses | 185,063 | 129,491 | ||||||
|
|
|
| |||||
Income from operations | 8,267 | 5,380 | ||||||
Interest expense, net | (221 | ) | (297 | ) | ||||
|
|
|
| |||||
Income before income tax expense and noncontrolling interest | 8,046 | 5,083 | ||||||
Income tax expense | (3,697 | ) | (2,931 | ) | ||||
|
|
|
| |||||
Net income — K12 Inc. | 4,349 | 2,152 | ||||||
Add net loss attributable to noncontrolling interest | 251 | 46 | ||||||
|
|
|
| |||||
Net income attributable to common stockholders, including Series A stockholders | $ | 4,600 | $ | 2,198 | ||||
|
|
|
| |||||
Net income attributable to common stockholders per share, excluding Series A stockholders: | ||||||||
Basic | $ | 0.12 | $ | 0.07 | ||||
|
|
|
| |||||
Diluted | $ | 0.12 | $ | 0.07 | ||||
|
|
|
| |||||
Weighted average shares used in computing per share amounts: | ||||||||
Basic | 35,629,836 | 30,343,696 | ||||||
|
|
|
| |||||
Diluted | 35,954,075 | 30,805,106 | ||||||
|
|
|
| |||||
See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.
3
2
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS STATEMENT
OF EQUITY (DEFICIT)
| K12 Inc Stockholders | ||||||||||||||||||||||||||||||||||||
| Additional | ||||||||||||||||||||||||||||||||||||
| Accumulated | ||||||||||||||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||||||||||||||
| Common Stock | Series A Common Stock | Paid-in | Comprehensive | Accumulated | Noncontrolling | Stockholders’ | ||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Income | Deficit | Interest | Equity | ||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||
| Balances at June 30, 2010 | 30,441,412 | $ | 3 | — | — | $ | 361,344 | $ | — | $ | (139,496 | ) | $ | 4,141 | $ | 225,992 | ||||||||||||||||||||
| Net Income/(Loss)(1) | 15,636 | (77 | ) | 15,559 | ||||||||||||||||||||||||||||||||
| Foreign currency translation adjustments | $ | 176 | 176 | |||||||||||||||||||||||||||||||||
| Comprehensive Income | 15,735 | |||||||||||||||||||||||||||||||||||
| Stock based compensation expense | 7,453 | 7,453 | ||||||||||||||||||||||||||||||||||
| Exercise of stock options | 755,797 | — | 8,252 | 8,252 | ||||||||||||||||||||||||||||||||
| Excess tax benefit from stock based compensation | 5,443 | 5,443 | ||||||||||||||||||||||||||||||||||
| Issuance of restricted stock awards | 451,143 | — | — | — | ||||||||||||||||||||||||||||||||
| Forfeitures of restricted stock awards | (37,030 | ) | — | — | ||||||||||||||||||||||||||||||||
| Series A removal of redemption provision and approval of conversion right | 2,750,000 | 63,112 | 63,112 | |||||||||||||||||||||||||||||||||
| Accretion of redeemable noncontrolling interests to estimated redemption value | (2,098 | ) | (2,098 | ) | ||||||||||||||||||||||||||||||||
| Retirement of restricted stock for tax withholding | (55,039 | ) | — | (1,595 | ) | (1,595 | ) | |||||||||||||||||||||||||||||
| Balances at March 31, 2011 | 31,556,283 | $ | 3 | 2,750,000 | $ | 63,112 | $ | 378,799 | $ | 176 | $ | (123,860 | ) | $ | 4,064 | $ | 322,294 | |||||||||||||||||||
| K12 Inc Stockholders | ||||||||||||||||||||||||||||||||||||
| Common Stock | Common Stock - Series A | Additional Paid-in Capital | Accumulated Other Comprehensive Income | Accumulated Deficit | Noncontrolling Interest | Total | ||||||||||||||||||||||||||||||
| (In thousands, except share data) | Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||
Balance, June 30, 2011 | 35,927,452 | $ | 4 | 2,750,000 | $ | 63,112 | $ | 512,181 | $ | 28 | $ | (126,704 | ) | $ | 4,126 | $ | 452,747 | |||||||||||||||||||
Net income (loss)(1) | 4,600 | (34 | ) | 4,566 | ||||||||||||||||||||||||||||||||
Foreign currency translation adjustments | 82 | 82 | ||||||||||||||||||||||||||||||||||
|
| |||||||||||||||||||||||||||||||||||
Comprehensive Income | 4,648 | |||||||||||||||||||||||||||||||||||
Stock based compensation expense | 2,194 | 2,194 | ||||||||||||||||||||||||||||||||||
Exercise of stock options | 63,631 | — | 1,042 | 1,042 | ||||||||||||||||||||||||||||||||
Excess tax benefit from stock-based compensation | 711 | 711 | ||||||||||||||||||||||||||||||||||
Issuance of restricted stock awards | 309,227 | — | — | — | ||||||||||||||||||||||||||||||||
Forfeiture of restricted stock awards | (4,315 | ) | — | — | — | |||||||||||||||||||||||||||||||
Accretion of redeemable noncontrolling interests to estimated redemption value | (217 | ) | (217 | ) | ||||||||||||||||||||||||||||||||
Retirement of restricted stock for tax withholding | (18,462 | ) | — | — | — | (581 | ) | — | — | — | (581 | ) | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Balance, September 30, 2011 | 36,277,533 | $ | 4 | 2,750,000 | $ | 63,112 | $ | 515,330 | $ | 110 | $ | (122,104 | ) | $ | 4,092 | $ | 460,544 | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
| (1) | Net |
See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.
4
3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| Nine Months Ended | ||||||||
| March 31, | ||||||||
| 2011 | 2010 | |||||||
| (In thousands) | ||||||||
Cash flows from operating activities | ||||||||
| Net income | $ | 15,127 | $ | 22,624 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation and amortization expense | 30,463 | 18,365 | ||||||
| Stock based compensation expense | 7,453 | 4,547 | ||||||
| Excess tax benefit from stock-based compensation | (5,443 | ) | (4,204 | ) | ||||
| Deferred income taxes | 13,329 | 13,741 | ||||||
| Provision for doubtful accounts | 569 | 353 | ||||||
| Provision for inventory obsolescence | 729 | 558 | ||||||
| Provision for (reduction of) student computer shrinkage and obsolescence | 182 | (217 | ) | |||||
| Changes in assets and liabilities: | ||||||||
| Restricted cash | 1,712 | — | ||||||
| Accounts receivable | (52,728 | ) | (41,234 | ) | ||||
| Inventories | 7,235 | 8,673 | ||||||
| Prepaid expenses | 545 | (826 | ) | |||||
| Other current assets | (1,994 | ) | (2,914 | ) | ||||
| Deposits and other assets | (105 | ) | 262 | |||||
| Accounts payable | (4,150 | ) | 1,741 | |||||
| Accrued liabilities | 1,516 | (1,419 | ) | |||||
| Accrued compensation and benefits | (4,377 | ) | 1,651 | |||||
| Deferred revenue | 14,478 | 11,813 | ||||||
| Deferred rent | 2,483 | 544 | ||||||
Net cash provided by operating activities | 27,024 | 34,058 | ||||||
Cash flows from investing activities | ||||||||
| Purchase of property and equipment | (13,400 | ) | (898 | ) | ||||
| Capitalized software development costs | (6,895 | ) | (6,589 | ) | ||||
| Capitalized curriculum development costs | (11,728 | ) | (9,305 | ) | ||||
| Purchase of AEC, net of cash acquired of $3,841 | (24,544 | ) | — | |||||
| Cash advanced for AEC performance escrow | (6,825 | ) | — | |||||
| Cash returned from AEC performance escrow | 6,825 | — | ||||||
| Cash paid for investment in Web | (10,000 | ) | — | |||||
| Cash paid for other investment | (2,040 | ) | (842 | ) | ||||
Net cash used in investing activities | (68,607 | ) | (17,634 | ) | ||||
Cash flows from financing activities | ||||||||
| Repayments on capital lease obligations | (11,113 | ) | (9,575 | ) | ||||
| Repayments on notes payable | (1,251 | ) | (1,011 | ) | ||||
| Borrowings from line of credit | 15,000 | — | ||||||
| Repayments under line of credit | (15,000 | ) | — | |||||
| Proceeds from exercise of stock options | 8,252 | 6,938 | ||||||
| Proceeds from exercise of stock warrants | — | 50 | ||||||
| Excess tax benefit from stock-based compensation | 5,443 | 4,204 | ||||||
| Repurchase of restricted stock for income tax withholding | (1,595 | ) | — | |||||
Net cash (used in) provided by financing activities | (264 | ) | 606 | |||||
Effect of foreign exchange rate changes on cash and cash equivalents | 176 | — | ||||||
Net change in cash and cash equivalents | (41,671 | ) | 17,030 | |||||
Cash and cash equivalents, beginning of period | 81,751 | 49,461 | ||||||
Cash and cash equivalents, end of period | $ | 40,080 | $ | 66,491 | ||||
| Three Months Ended September 30, | ||||||||
| 2011 | 2010 | |||||||
| (In thousands) | ||||||||
Cash flows from operating activities | ||||||||
Net income | $ | 4,349 | $ | 2,152 | ||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||
Depreciation and amortization expense | 12,992 | 9,392 | ||||||
Stock based compensation expense | 2,194 | 3,413 | ||||||
Excess tax benefit from stock based compensation | (711 | ) | (122 | ) | ||||
Deferred income taxes | 2,301 | 2,358 | ||||||
Provision for (reduction of) doubtful accounts | 201 | (82 | ) | |||||
Provision for inventory obsolescence | 39 | 664 | ||||||
Provision for student computer shrinkage and obsolescence | 377 | 71 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (118,354 | ) | (69,741 | ) | ||||
Inventories | 12,088 | 9,760 | ||||||
Prepaid expenses | (2,808 | ) | 2,764 | |||||
Other current assets | (8,788 | ) | (4,267 | ) | ||||
Deposits and other assets | 933 | 148 | ||||||
Accounts payable | 10,673 | 12,866 | ||||||
Accrued liabilities | 4,899 | 1,680 | ||||||
Accrued compensation and benefits | 3,388 | (5,915 | ) | |||||
Deferred revenue | 41,008 | 25,987 | ||||||
Cash invested in restricted cash and cash equivalents | — | 1,843 | ||||||
Deferred rent | 258 | 2,190 | ||||||
|
|
|
| |||||
Net cash used in operating activities | (34,961 | ) | (4,839 | ) | ||||
|
|
|
| |||||
Cash flows from investing activities | ||||||||
Purchase of property, equipment and software development costs | (4,911 | ) | (8,561 | ) | ||||
Capitalized curriculum development costs | (3,706 | ) | (3,208 | ) | ||||
Purchase of assets | (12,641 | ) | — | |||||
|
|
|
| |||||
Net cash used in investing activities | (21,258 | ) | (11,769 | ) | ||||
|
|
|
| |||||
Cash flows from financing activities | ||||||||
Repayments on capital lease obligations | (3,959 | ) | (3,720 | ) | ||||
Repayments on notes payable | (703 | ) | (306 | ) | ||||
Proceeds from exercise of stock options | 1,042 | 1,109 | ||||||
Excess tax benefit from stock based compensation | 711 | 122 | ||||||
Repurchase of restricted stock for income tax withholding | (581 | ) | — | |||||
|
|
|
| |||||
Net cash used in financing activities | (3,490 | ) | (2,795 | ) | ||||
|
|
|
| |||||
Effect of foreign exchange rate changes on cash and cash equivalents | 82 | — | ||||||
|
|
|
| |||||
Net change in cash and cash equivalents | (59,627 | ) | (19,403 | ) | ||||
Cash and cash equivalents, beginning of period | 193,099 | 81,751 | ||||||
|
|
|
| |||||
Cash and cash equivalents, end of period | $ | 133,472 | $ | 62,348 | ||||
|
|
|
| |||||
See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.
5
4
Notes to Unaudited Condensed Consolidated Financial Statements
| 1. | |
Description of the Business |
K12 Inc., and its subsidiaries (K12(K12 or the Company), is a technology-based education company. The Company offers proprietary curriculum, software systems and educational services created fordesigned to facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12. The K12 proprietary curriculumCompany’s mission is research-basedto maximize a child’s potential by providing access to an engaging 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. Since the Company’s inception, we have invested more than $240 million to develop and to a lesser extent, acquire curriculum and online learning platforms that promote mastery of core concepts and skills for students of all abilities. This learning system combines a cognitive research-basedour curriculum and offerings with an individualized learning approach well-suited for virtual public schools, onlinehybrid schools, school district-widedistrict online programs, public charter schools hybrid programs and private schools that combineutilize varying degrees of online and traditional classroom instruction, and other educational applications.
| 2. | |
Basis of Presentation |
The accompanying condensed consolidated balance sheetssheet as of March 31,September 30, 2011, and June 30, 2010, the condensed consolidated statements of operations for the three and nine months ended March 31,September 30, 2011 and 2010, the condensed consolidated statements of cash flows for the ninethree months ended March 31,September 30, 2011 and 2010, and the condensed consolidated statementsstatement of equity (deficit) for the ninethree months ended March 31,September 30, 2011 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 March 31,September 30, 2011, and June 30, 2010, the results of operations for the three and nine months ended March 31,September 30, 2011 and 2010, cash flows for the ninethree months ended March 31,September 30, 2011 and 2010 and the condensed consolidated statementsstatement of equity (deficit) for the ninethree months ended March 31,September 30, 2011. The results of the three and nine month period ended March 31,September 30, 2011 are not necessarily indicative of the results to be expected for the year ending June 30, 20112012 or for any other interim period or for any other future fiscal year. The consolidated balance sheet as of June 30, 20102011 has been derived from the audited consolidated financial statements at that date.
6
5
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
| 3. | |
Summary of Significant Accounting Policies |
Revenue Recognition
Revenues are principally earned from long-term contractual agreements to provide onlineon-line curriculum, books, materials, computers and management services to virtual public schools, hybrid schools, traditional schools, school districts, public charter schools and school districts. The Company is often responsibleprivate schools. In addition to providing the curriculum, books and materials under the virtual public schoolsschool and hybrid school contracts from which most of the Company’s revenue is derived, the Company is responsible for all aspects of schoolthe management of schools, 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 isthey are the primary obligor for substantially all expenses under these contracts, itthe Company records the associated per student revenue received by the school from its state funding school district 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).Recognition. 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 and hybrid schools which include multiple elements. These elements may include:include providing each of a school’s students with access to the Company’s onlineon-line school and the onlineon-line component of lessons; offline learning kits which include books and materials designed to complement and supplement the onlineon-line lessons; the use of a personal computer and associated reclamation services; internet access and technology support services; instruction fromthe services of a state-certified teacher; andteacher and; all management and technology services required to operate a virtual public school or hybrid 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 it 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 incurred over revenues incurredearned by the virtual public schools or hybrid schools as reflected on their financial statements. The costs include Company charges to the schools. TheseThe fact that a school has an operating loss in one year does not necessarily mean the Company anticipates losing money on the entire contract, however, a school operating lossesloss may
7
On December 1, 2010, the Company acquired The American Education Corporation (AEC), a leading provider of research-based core curriculum for kindergarteners through adult learners. AEC derives revenues
6
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
from four sources: (1) annual subscription license revenues; (2) license revenues from non-cancelable perpetual license agreements; (3) related professional and support services and (4) hosting services to provide customers with access to its online courses.
We recognize revenue in accordance with ASC 605 when all of the following conditions are met: there is persuasive evidence of an arrangement; delivery has occurred or services have been rendered; the amount of fees to be paid by the customer is fixed and determinable; and the collectability of the fee is probable.
Revenue from the licensing of curriculum under subscription arrangements where AEC provides online access to curriculum is recognized on a ratable basis over the subscription period starting the later of the first day of the subscription period or when all revenue recognition criteria identified above have been met. Revenue from the licensing of curriculum under subscription and non-cancelable perpetual arrangements where AEC is not providing access via a hosting arrangement is recognized when all revenue recognition criteria have been met. Revenue from professional and support services include consulting and training services, which are deferred and recognized ratably over the service period.
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.Web site. 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 offline learning kits are recognized upon shipment.
During the three months ended September 30, 2011 and 2010, approximately 56% and 50%, respectively, of the Company’s revenues were recognized from schools we managed. During the three months ended September 30, 2011, we had contracts with two schools that represented approximately 7% and 9% of revenues. During the three months ended September 30, 2010, we had contracts with two schools that each individually represented approximately 12% of revenues. Approximately 13% and 12% of accounts receivable was attributable to a contract with one school as of September 30, 2011 and June 30, 2011.
Consolidation
The condensed consolidated financial statements include the accounts of the Company, its wholly-owned and affiliated companies either ownedthat the Company owns, directly or indirectly, and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Series A Special StockInventories
Inventories consist primarily of schoolbooks and curriculum materials, a Special Meetingmajority of Shareholderswhich are supplied to virtual public schools and hybrid schools and utilized directly by students. Inventories represent items that are purchased and held for sale and are recorded at the lower of cost (first-in, first-out method) or market value. Excess and obsolete inventory reserves are established based upon the evaluation of the quantity on January 27,hand relative to demand. The excess and obsolete inventory reserve was $3.0 million and $2.9 million at September 30, 2011 the right to convert the Series A Special Stock to common stock was approved by the shareholders. As a consequence, the right of redemption is no longer effective and those shares have been classified within stockholders’ equity in the consolidated balance sheet. The Special Stock’s carrying value was not impacted by the vote.
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
The Company issued 2,750,000 shares of Series A Special stock in connection with its acquisition of KC Distance Learning, Inc. The holders of the Series A Special stock have the right to convert those shares into
7
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
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 have no voting rights.
Noncontrolling Interest
Earnings or losses attributable to other stockholders of a consolidated affiliated company are classified separately as “noncontrolling interest” in the Company’s condensed consolidated statements of operations. Net loss attributable to noncontrolling interest reflects only its share of the after-tax earnings or losses of an affiliated company. Income taxes attributable to noncontrolling interest are determined using the applicable statutory tax rates in the jurisdictions where such operations are conducted. These rates vary from country to country. The Company’s condensed consolidated balance sheets reflect noncontrolling interest within the equity section of the condensed consolidated balance sheets rather than in the mezzanine section of the condensed consolidated balance sheets, except for redeemable noncontrolling interest. Noncontrolling interest is classified separately in the Company’s condensed consolidated statement of equity (deficit).
Redeemable Noncontrolling Interests
Noncontrolling interests in subsidiaries that are redeemable outside of the Company’s control for cash or other assets are classified outside of permanent equity at fair value. The redeemable noncontrolling interests will be adjusted to their fair value at each balance sheet date. The resulting increases or decreases in the estimated redemption amount are affected by corresponding charges against retained earnings, or in the absence of retained earnings, additional paid-in-capital.
Goodwill and Intangibles
The Company records 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 350.350 — Intangibles — Goodwill and Other. 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 Topic 360Accounting for the Impairment or Disposal of Long-Lived Assets, — Property, Plant, and Equipment, the Company reviews its recorded finite-lived intangible assets for impairment whenever events or changes in circumstances
8
ASC 350Goodwill 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 of each year.
During the first quarter of 2011, the Company’s goodwill increased by approximately $10.0 million due primarily to the acquisition of certain assets of Kaplan Virtual Education and Insight Schools (Kaplan/Insight Assets) a subsidiary of Kaplan, Inc (see Note 10). The Company did not experience a significant adverse change in its business climate and therefore does not believe a triggering event occurred that would require a detailed test of goodwill for impairment as of an interim date. Consequently, the first step of the goodwill impairment test will not be performed during the first quarter of 2012. The Company will complete its annual goodwill impairment test as of May 31, 2012.
8
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
The following table represents goodwill additions during the fiscal quarter ended September 30, 2011:
($ in millions) | Amount | |||
Rollforward of Goodwill | ||||
Balance as of June 30, 2011 | $ | 55.6 | ||
Acquisition of certain Kaplan/Insight Assets | 11.0 | |||
Other adjustments | 0.1 | |||
|
| |||
Balance as of September 30, 2011 | $ | 66.7 | ||
|
| |||
The following table represents the balance of intangible assets as of September 30, 2011 and June 30, 2011.
Intangible Assets:
| September 30, 2011 | June 30, 2011 | |||||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | |||||||||||||||||||
Trade names | $ | 23.3 | $ | (1.8 | ) | $ | 21.5 | $ | 23.3 | $ | (1.6 | ) | $ | 21.7 | ||||||||||
Customer and distributor relationships | 16.5 | (1.9 | ) | 14.6 | 16.5 | (1.3 | ) | 15.2 | ||||||||||||||||
Developed technology | 1.5 | (0.5 | ) | 1.0 | 1.5 | (0.4 | ) | 1.1 | ||||||||||||||||
Other | 0.5 | (0.2 | ) | 0.3 | 0.5 | (0.2 | ) | 0.3 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
| $ | 41.8 | $ | (4.4 | ) | $ | 37.4 | $ | 41.8 | $ | (3.5 | ) | $ | 38.3 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Impairment of Long-Lived Assets
Long-lived assets include property, equipment, capitalized curriculum and software developed or obtained for internal use. In accordance with ASC 360, the Company reviews its recorded long-lived 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. There was no impairment for the quarter ended September 30, 2011 and the year ended June 30, 2011.
Fair Value Measurements
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1: | Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date. | |
Level 2: | Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. | |
Level 3: | Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instruments valuation. | |
9
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
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, 20102011 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 in Middlebury Joint Venture | $ | 17,374 | $ | — | $ | — | $ | 17,374 | ||||||||
| Total | $ | 17,374 | $ | — | $ | — | $ | 17,374 | ||||||||
| Fair Value Measurements Using: | ||||||||||||||||
Description | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Input (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| (In thousands) | ||||||||||||||||
Redeemable Noncontrolling Interest in Middlebury Joint Venture | $ | 17,200 | $ | — | $ | — | $ | 17,200 | ||||||||
Investment in Web International Education Group | $ | 10,000 | $ | — | $ | — | $ | 10,000 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 27,200 | $ | — | $ | — | $ | 27,200 | ||||||||
|
|
|
|
|
|
|
| |||||||||
The following table summarizes certain fair value information at March 31,September 30, 2011 for assets and liabilities measured at fair value on a recurring basis.
| Fair Value Measurements Using: | ||||||||||||||||
Description | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Input (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| (In thousands) | ||||||||||||||||
Redeemable Noncontrolling Interest in Middlebury Joint Venture | $ | 17,200 | $ | — | $ | — | $ | 17,200 | ||||||||
Investment in Web International Education Group | $ | 10,000 | $ | — | $ | — | $ | 10,000 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 27,200 | $ | — | $ | — | $ | 27,200 | ||||||||
|
|
|
|
|
|
|
| |||||||||
The following table presents activity related to our fair value measurements categorized as Level 3 of the valuation hierarchy, valued on a recurring basis:
| Three Months Ended September 30, 2011 | ||||||||||||||||
Description | Fair Value June 30, 2011 | Purchases, Issuances, and Settlements | Unrealized Gains/(Losses) | Fair Value September 30, 2011 | ||||||||||||
| (In thousands) | ||||||||||||||||
Redeemable Noncontrolling Interest in Middlebury Joint Venture | $ | 17,200 | — | — | $ | 17,200 | ||||||||||
Investment in Web International Education Group | $ | 10,000 | $ | — | $ | — | $ | 10,000 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 27,200 | $ | — | $ | — | $ | 27,200 | ||||||||
|
|
|
|
|
|
|
| |||||||||
10
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
The fair value of the investment in Web International Education Group (Web) as of March 31,September 30, 2011 was estimated to be $10 million. The fair value was measured based on the initial cost of the investment and Web’s financial performance since initial investment. There was no underlying change in its estimated market value.
| 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) | ||||||||||||||||
| Investment in Web International Education Group | $ | 10,000 | $ | — | $ | — | $ | 10,000 | ||||||||
| Redeemable Noncontrolling Interest in Middlebury Joint Venture | $ | 19,040 | $ | — | $ | — | $ | 19,040 | ||||||||
| Total | $ | 29,040 | $ | — | $ | — | $ | 29,040 | ||||||||
9
| Nine Months Ended March 31, 2011 | ||||||||||||||||
| Purchases, | ||||||||||||||||
| Fair Value | Issuances, | Unrealized | Fair Value | |||||||||||||
| June 30, 2010 | and Settlements | Gains/(Losses) | March 31, 2011 | |||||||||||||
| (In thousands) | ||||||||||||||||
| Investment in Web International Education Group | $ | — | $ | 10,000 | $ | — | $ | 10,000 | ||||||||
| Redeemable Noncontrolling Interest in Middlebury Joint Venture | $ | 17,374 | $ | — | $ | 1,666 | $ | 19,040 | ||||||||
| Total | $ | 17,374 | $ | 10,000 | $ | 1,666 | $ | 29,040 | ||||||||
The fair value of the Redeemable Noncontrolling Interest in Middlebury Joint Venture was measured in accordance with ASC 480,Distinguishing Liabilities from Equity, and initial valuations were determined bywas based upon a valuation from a third party valuation firm and updated by management for the current period. In determining the fair valueas of the redeemable noncontrolling interest,June 30, 2011. As of September 30, 2011 the Company performed an internal analysis and detemined there was no underlying change in the estimated fair market value. This analysis incorporated a number of assumptions and estimates including utilizing various valuation methodologies including an income-based approach. The fair valuethe financial results of the investment in Web International Education Group (Web) as of March 31, 2011 was estimatedjoint venture to be $10 million. The fair value was measured based on the initial cost of the investment and Web’s financial performance since initial investment. There was no underlying change in its estimated market value.
Net Income perPer Common Share
The Company calculates net income per share in accordance with ASC 260. Under ASC 260, basic net income per common share is computedcalculated by dividing net income available to common stockholders by the weighted averageweighted-average number of shares of common stockshares outstanding during the reporting 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 unvestedand restricted stock awards and warrants.awards. The dilutive effect of stock options and restricted stock awards and warrants was determined using the treasury stock method. Under the treasury stock method, the proceeds received 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.
10
11
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 | Nine Months Ended | |||||||||||||||
| March 31, | March 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (In thousands, except share and per share data) | (In thousands, except share and per share data) | |||||||||||||||
Basic earnings per share computation: | ||||||||||||||||
| Net income — K12 Inc. | $ | 5,599 | $ | 6,129 | $ | 15,636 | $ | 22,850 | ||||||||
| Amount allocated to participating Series A stockholders | 457 | — | 1,241 | — | ||||||||||||
| Income available to common stockholders — basic | $ | 5,142 | $ | 6,129 | $ | 14,395 | $ | 22,850 | ||||||||
| Weighted average common shares — basic historical | 30,958,807 | 29,951,327 | 30,620,330 | 29,658,076 | ||||||||||||
| Basic net income per share | $ | 0.17 | $ | 0.20 | $ | 0.47 | $ | 0.77 | ||||||||
Diluted earnings per share computation: | ||||||||||||||||
| Net income — K12 Inc. | $ | 5,599 | $ | 6,129 | $ | 15,636 | $ | 22,850 | ||||||||
| Amount allocated to participating Series A stockholders | 457 | — | 1,241 | — | ||||||||||||
| Income available to common stockholders — diluted | $ | 5,142 | $ | 6,129 | $ | 14,395 | $ | 22,850 | ||||||||
| Shares computation: | ||||||||||||||||
| Weighted average common shares — basic historical | 30,958,807 | 29,951,327 | 30,620,330 | 29,658,076 | ||||||||||||
| Effect of dilutive stock options and restricted stock awards | 799,506 | 401,647 | 707,214 | 365,265 | ||||||||||||
| Weighted average common shares — diluted | 31,758,313 | 30,352,974 | 31,327,544 | 30,023,341 | ||||||||||||
| Diluted net income per share | $ | 0.16 | $ | 0.20 | $ | 0.46 | $ | 0.76 | ||||||||
| Three Months Ended September 30, | ||||||||
| 2011 | 2010 | |||||||
(In thousands except shares and per share data) | ||||||||
Basic earnings per share computation: | ||||||||
Net income — K12 | $ | 4,600 | $ | 2,198 | ||||
Amount allocated to participating Series A stockholders | $ | (330 | ) | $ | (137 | ) | ||
|
|
|
| |||||
Income available to common stockholders — basic | $ | 4,270 | $ | 2,061 | ||||
|
|
|
| |||||
Weighted average common shares — basic historical | 35,629,836 | 30,343,696 | ||||||
|
|
|
| |||||
Basic net income per share | $ | 0.12 | $ | 0.07 | ||||
|
|
|
| |||||
Dilutive earnings per share computation: | ||||||||
Net income — K12 | $ | 4,600 | $ | 2,198 | ||||
Amount allocated to participating Series A stockholders | $ | (330 | ) | $ | (137 | ) | ||
|
|
|
| |||||
Income available to common stockholders — diluted | $ | 4,270 | $ | 2,061 | ||||
|
|
|
| |||||
Share computation: | ||||||||
Weighted average common shares — basic historical | 35,629,836 | 30,343,696 | ||||||
Effect of dilutive stock options and restricted stock awards | 324,239 | 461,410 | ||||||
|
|
|
| |||||
Weighted average common shares outstanding — diluted | 35,954,075 | 30,805,106 | ||||||
|
|
|
| |||||
Diluted net income per share | $ | 0.12 | $ | 0.07 | ||||
|
|
|
| |||||
Recent Accounting Pronouncements
In January 2010, the FASB issued ASU2010-06,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. ASU2010-06 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. ASU2010-06 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.rollforward. The Company adopted the provisions of ASU2010-06 related to new disclosures and clarification as of existing disclosures was adopted by the Company beginning JanuaryJuly 1, 2010. As ASU2010-06 relates only to disclosure, the2011. The adoption of these provisionsASU 2010-06 did not have a material impact on its financial condition, results of operations, and disclosures. The provisions of ASU2010-06 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 ASU2010-06 will have on our financial condition, results of operations, and disclosures.
11
In December 2010, the FASB issued ASU 2010-29,Disclosure of Supplementary Pro Forma Information for Business Combination, which provides authoritative guidance on disclosure of supplementary pro forma information for business combinations. The new guidance requires that pro forma financial information should be prepared as if the business combination has occurred as of the beginning of the prior annual period. The guidance is effective forCompany adopted the Company for business combinations with acquisition dates beginning onprovisions of ASU 2010-29 as of July 1, 2011. The Company is currently evaluating the potential impact, if any, of the adoption of ASU2010-29 will did not have a material impact on ourits financial condition, results of operations and disclosures.
12
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
In June 2011, the FASB issues ASU 2011-05,Presentation of Comprehensive Income, which provides authoritative guidance on disclosure requirements for comprehensive income. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, the Company must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This guidance will be effective for the Company beginning on July 1, 2012. The Company does not expect the guidance to impact its financial condition and results of operations, as it only requires a change in the format of presentation.
In September 2011, the FASB issued ASU 2011-08,Testing Goodwill for Impairment, which provides authoritative guidance to simplify how entities, both public and nonpublic, test goodwill for impairment. This accounting update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This guidance will be effective for the Company beginning on July 1, 2012, with early adoption permitted. The Company does not expect the guidance to impact its consolidated financial statements.
| 4. | |
Income |
The Company accounts for income taxes in accordance with ASC 740,Income Taxes. Under ASC 740, deferred tax assets and liabilities are computed based on the difference between the financial reporting and income tax bases of assets and liabilities using the enacted marginal tax rate. ASC 740 requires that the net deferred tax asset be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the net deferred tax asset will not be realized. The provision for income taxes is based on earnings reported in the unaudited 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 or benefit is measured by the change in the deferred income tax asset or liability during the year.
| 5. | |
Long-term Obligations |
Capital Leases
As of March 31, 2011September 30 and June 30, 2010,2011, computer equipment and software under capital leases are recorded at a cost of $45.5$76.5 million and $38.8$61.2 million, respectively and accumulated depreciation of $23.8$47.5 million and $22.9$43.7 million, respectively. The Company’s equipmentBorrowings under lease line of credit with Hewlett-Packard Financial Services Company (HPFSC) for new purchases expired on August 31, 2010. Prior borrowings under the HPFSC equipment lease linelines had interest rates ranging from 4.96%2.62% to 7.0%6.40% and included a36-month payment term with a $1 purchase option at the end of the term. The Company hadhas 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. As of March 31, 2011, the Company had $9.4 million outstanding under the HPFSC equipment lease line.
12
36-month payment term with a $1 purchase option at the end of the term. The Company intends to finance new equipment purchases with either cash on hand or by obtaining additional financing. As of March 31, 2011, the Company had $13.5 million outstanding under the PNC equipment lease line.
The Company has purchased computer software licenses and maintenance services through unsecured notes payable arrangements with various vendors at interest rates ranging up to 6.1% and payment terms of three years. There are no covenants associated with these notes payable arrangements. The balance of notes payable at March 31, 2011September 30, and June 30, 20102011 was $0.7$3.0 million and $1.9$3.7 million, respectively.
13
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
The following is a summary as of March 31,September 30, 2011 of the present value of the net minimum payments on capital leases and notes payable under the Company’s commitments:
| Capital | Notes | |||||||||||
As of March 31, 2011 | Leases | Payable | Total | |||||||||
| 2011 | $ | 13,633 | $ | 670 | $ | 14,303 | ||||||
| 2012 | 8,474 | — | 8,474 | |||||||||
| 2013 | 3,241 | — | 3,241 | |||||||||
| Thereafter | — | — | — | |||||||||
| Total minimum payments | 25,348 | 670 | 26,018 | |||||||||
| Less amount representing interest (imputed average capital lease interest rate of 4.8%) | (962 | ) | (16 | ) | (978 | ) | ||||||
| Net minimum payments | 24,386 | 654 | 25,040 | |||||||||
| Less current portion | (13,371 | ) | (654 | ) | (14,025 | ) | ||||||
| Present value of minimum payments, less current portion | $ | 11,015 | $ | — | $ | 11,015 | ||||||
September 30, | Capital Leases | Notes Payable | Total | |||||||||
2012 | $ | 15,828 | $ | 1,173 | $ | 17,001 | ||||||
2013 | $ | 10,598 | $ | 1,571 | $ | 12,169 | ||||||
2014 | $ | 5,501 | $ | 393 | $ | 5,894 | ||||||
Thereafter | $ | — | $ | — | $ | — | ||||||
|
|
|
|
|
| |||||||
Total minimum payments | 31,927 | 3,137 | 35,064 | |||||||||
Less amount representing interest (imputed average capital lease interest rate of 6.1%) | (1,116 | ) | (98 | ) | $ | (1,214 | ) | |||||
|
|
|
|
|
| |||||||
Net minimum payments | 30,811 | 3,039 | 33,850 | |||||||||
Less current portion | (15,101 | ) | (1,116 | ) | $ | (16,217 | ) | |||||
|
|
|
|
|
| |||||||
Present value of minimum payments, less current portion | $ | 15,710 | $ | 1,923 | $ | 17,633 | ||||||
|
|
|
|
|
| |||||||
| 6. | |
Line of Credit |
The Company has a $35 million line of credit with PNC Bank that expires in December 2012. Borrowings underAs of September 30 and June 30, 2011, no borrowings were outstanding on the line of credit bear interest based on LIBOR rates over selected borrowing periods ranging from one to six months. Asand approximately $0.3 million was reserved for a letter of March 31, 2011 and June 30, 2010, no amounts were outstanding under the line of credit. The Company had borrowed $15 million under the line of credit as of December 31, 2010 and these amounts were paid in full during the period ended March 31, 2011.
13
| 7. | |
Stock Option Plan |
Stock Options
Stock option activity during the ninethree months ended March 31,September 30, 2011 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 | 104,500 | 30.12 | ||||||||||||||
| Exercised | (755,797 | ) | 10.95 | |||||||||||||
| Forfeited or canceled | (121,677 | ) | 21.75 | |||||||||||||
| Outstanding, March 31, 2011 | 3,140,873 | $ | 18.43 | 4.68 | $ | 47,954 | ||||||||||
| Stock options exercisable at March 31, 2011 | 1,995,989 | $ | 17.37 | 3.92 | $ | 32,588 | ||||||||||
| Shares | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Life (Years) | Aggregate Intrinsic Value | |||||||||||||
Outstanding, June 30, 2011 | 2,765,729 | $ | 19.23 | |||||||||||||
Granted | 158,486 | 26.78 | ||||||||||||||
Exercised | (63,631 | ) | 16.37 | |||||||||||||
Forfeited or canceled | (12,559 | ) | 23.25 | |||||||||||||
|
|
|
| |||||||||||||
Outstanding, September 30, 2011 | 2,848,025 | $ | 19.70 | 4.52 | $ | 16,403 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Stock options exercisable at September 30, 2011 | 1,900,577 | $ | 18.52 | 3.74 | $ | 13,181 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
The total intrinsic value of options exercised during the ninethree months ended March 31,September 30, 2011 was $14.0 million or $18.48 per share.
| Weighted Average | ||||||||||||||||
| Options | Weighted-Average | Grant-Date | Intrinsic | |||||||||||||
Grant Date | Granted | Exercise Price | Fair Value | Value | ||||||||||||
| September 2010 | 44,000 | $ | 26.23 | $ | 11.16 | $ | — | |||||||||
| February 2011 | 60,500 | $ | 32.95 | $ | 14.67 | $ | — | |||||||||
| 104,500 | ||||||||||||||||
As of March 31,September 30, 2011, there was $5.9$7.7 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 2.652.3 years. During the ninethree months ended March 31,September 30, 2011 and March 31,September 30, 2010, the Company recognized $3.9$1.1 million and $4.0$1.4 million, respectively of stock based compensation expense related to stock options.
14
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
Restricted Stock Awards
Restricted stock award activity during the ninethree months ended March 31,September 30, 2011 was as follows:
| Weighted- | ||||||||
| Average | ||||||||
| Shares | Fair Value | |||||||
| Nonvested, June 30, 2010 | 187,850 | $ | 18.46 | |||||
| Granted | 451,143 | 25.19 | ||||||
| Vested | (151,314 | ) | 22.06 | |||||
| Forfeited or canceled | (36,776 | ) | 23.31 | |||||
| Nonvested, March 31, 2011 | 450,903 | $ | 23.59 | |||||
| Shares | Weighted- Average Fair Value | |||||||
Nonvested, June 30, 2011 | 444,151 | $ | 23.62 | |||||
Granted | 309,227 | 26.78 | ||||||
Vested | (61,150 | ) | 22.02 | |||||
Forfeited or canceled | (4,315 | ) | 23.44 | |||||
|
|
|
| |||||
Nonvested, September 30, 2011 | 687,913 | $ | 25.19 | |||||
|
|
|
| |||||
As of March 31,September 30, 2011, there was $7.5$12.4 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 2.632.6 years. The total fair value of shares vested during the ninethree months ended March 31,September 30, 2011 was $1.3 million. During the three months ended September 30, 2011 and September 30, 2010, was $3.3the Company recognized $1.1 million and $0.3 million, respectively. During the nine months ended March 31, 2011 and March 31, 2010, the Company
14
| 8. | |
Related Party |
For the three and nine monthsyear ended March 31,September 30, 2011, the Company purchased services and assets in the amount $0.8of $0.1 million from Knowledge Universe Technologies (KUT) pursuant to a Transition Services Agreement related to the Company’s acquisition of KCDL.KCDL as well as other administrative services. KUT is an affiliate of the Learning Group, LLC, a related party. Additionally, KCDL has capital leases with an outstanding balance due to KCDL Holdings, Inc. in the amount of $0.8$1.6 million as of March 31,September 30, 2011.
| 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 outcomeCompany expenses legal costs as incurred.
IpLearn
On October 26, 2011, IpLearn, LLC (“IpLearn”) filed an action for patent infringement against the Company in the United States District Court for the District of these proceedingsDelaware.IpLearn, LLC v. K12 Inc., C.A. No. 11-1026-UNA. IpLearn is a privately-held technology development and licensing company for web and computer-based learning technologies. In its complaint, IpLearn alleges that the Company has infringed three of its patents for various computer-aided learning methods and systems. The Company was served with the complaint on October 31, 2011, and the Company’s answer is not expected to have a material adverse effect on the financial condition or results of operations of the Company.
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.(CaseNo. 2:10-cv-01022-JLR)C10-01022-JLR (W.D. Wash). 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, the Company acquired all of the shares of
15
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
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 matterAventa et. al. v. K12 Inc., et. al. No. C10-01022-JLR (W.D. Wash), 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.or KCDL for any liability, including rescission. In addition,On November 10, 2011, the parties reached a settlement in principle, which settlement includes a full release of all claims against K12 Inc. obtained a guarantee from Seller’s parent company, Learning Group LLC, from any losses related to this litigation. In our view,, and the outcome of this litigation will not have a material adverse effect onCompany made no financial contributions towards the financial condition or results of operations of K12 Inc. or any of our subsidiaries. On March 27, 2011, the court issued an Order Denying Defendant’s Motion to Dismiss Amended Complaint.Aventa Learning, Inc. et. al, v. K12 Inc. et. al.(CaseNo. C10-1022settlement. JLR). Accordingly, the discovery process has commenced.
| 10. | |
|
|
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,
15
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 to be 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 consideration to the identifiable tangible and intangible assets and liabilities assumed under the purchase method of accounting, is based on their estimated fair values at the acquisition date and summarized in the following table (in millions):
| Amount | ||||
As of July 23, 2010 | ||||
Current assets | $ | 8.5 | ||
Property and equipment, net | 8.7 | |||
Capitalized curriculum development costs, net | 3.9 | |||
Intangible assets, net | 21.9 | |||
Goodwill | 34.5 | |||
Other noncurrent assets | 0.1 | |||
Current liabilities | (5.5 | ) | ||
Deferred tax liability | (5.7 | ) | ||
Deferred revenue | (2.1 | ) | ||
Other noncurrent liabilities | (1.2 | ) | ||
|
| |||
Fair value of total consideration transferred | $ | 63.1 | ||
|
| |||
The following unaudited pro forma combined results of operations give effect to the acquisition of KCDL, as if it had occurred on July 1, 2010. The unaudited pro forma combined results of operations are provided for informational purposes only and do not purport to represent the Company’s actual consolidated results of operations had the acquisition occurred on the dates assumed, nor are these financial statements necessarily indicative of the Company’s future consolidated results of operations. The unaudited pro forma combined results
16
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
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 results include non-recurring transaction costs of $1.9 million.
Pro forma Results of Operations | Three months ended September 30, 2010 | |||
Revenues | $ | 136,193 | ||
Net Income | $ | 568 | ||
The American Education Corporation
On December 1, 2010, the Company acquired The American Education Corporation (AEC), a leading provider of research-based core curriculum instructional software for kindergarteners through adult learners, 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 the quarter-ended December 31, 2010. In March 2011, the specified financial targets were not achieved and consequently, this escrow amount was returned to the Company. In connection with the acquisition, the Company recorded Net Working Capital accounts of $1.9 million, net long term assets of $8.3 million, goodwill of approximately $15.7 million, intangible assets of approximately $4.5 million, and other long term liabilities and taxes payable of $2.0 million. 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 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 | 35,155 | |||
| Other noncurrent assets | 138 | |||
| Current liabilities | (5,461 | ) | ||
| Deferred tax liability | (6,324 | ) | ||
| Deferred revenue | (2,111 | ) | ||
| Other noncurrent liabilities | (1,250 | ) | ||
| Fair value of total consideration transferred | $ | 63,112 | ||
16
| Pro Forma | Three Months Ended | Nine Months Ended | ||||||||||||||
| Results of | March 31, | March 31, | ||||||||||||||
Operations | 2011 | 2010 | 2011 | 2010 | ||||||||||||
| Revenues | $ | 130,293 | $ | 105,542 | $ | 395,488 | $ | 325,754 | ||||||||
| Net Income (Loss) | $ | 5,599 | $ | 5,746 | $ | 14,006 | $ | 22,695 | ||||||||
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 foror 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 percent50% installments of the remaining balance of the $6.8 million in the indemnification escrow on June 1, 2011 and December 1, 2011. At closing,September 30, 2011, the Company recognized a liability of $1 million$830,000 relating to potential claims offset by a receivable from the escrow account of $750,000. As of March 31, 2011, the$580,000. The Company has not incurred any specified claims against AEC to be withdrawn from the indemnification escrow.
Investment in Web International Education Group, Ltd.
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 purchase no less than 51% of Web before July 1, 2012, and the option to purchase all remaining equity interest between January 1, 2013 and December 31, 2015. 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 aan extensive network of 73 learning centers in 48 cities inthroughout China. The proceeds of the investment will primarily be used to expand Web’s learning
17
| Nine Months Ended | ||||||||
| March 31, | ||||||||
| 2011 | 2010 | |||||||
| Cash paid for interest | $ | 680 | $ | 989 | ||||
| Cash paid for taxes, net of refunds | $ | 4,551 | $ | 654 | ||||
| Supplemental disclosure of non-cash investing and financing activities: | ||||||||
| New capital lease obligations | $ | 15,613 | $ | 12,184 | ||||
| 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 | $ | 51,727 | $ | — | ||||
| — Other non-current assets | $ | 138 | $ | — | ||||
| — Deferred tax liabilities | $ | (8,817 | ) | $ | — | |||
| — 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 | $ | — | ||||
International School of Berne
On April 1, 2011, the Company finalized its acquisition of the operations of the International School of Berne (IS Berne), for 2 million Swiss Francs ($2.2 million). IS Berne is a private brick and mortartraditional school located in Bern,Berne, Switzerland
17
K12 Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)
serving students in grades Pre-K through 12. IS Berne is an International Baccalaureate school in its 50th50th year of operation. We paid the IS Berne Foundation approximately $2.0 million in cash for the transfer ofThe Company purchased the right to operate IS Berne and for substantially all of its assets excluding real estate.
Acquisition of Assets from Kaplan Virtual Education and Insight Schools, Inc.
On April 27,July 1, 2011, we closed athe Company acquired certain assets of Kaplan Virtual Education (Kaplan/Insight Assets) for $12.6 million. The Kaplan/Insight Assets included contracts to serve nine virtual charter schools and private placement sale of 4 million shares of restricted Common Stock at a price of $31.46 per share to Technology Crossover Ventures (TCV). The aggregate investment of $125.8 million will supportvirtual high schools throughout the United States that have been integrated into the Company’s expansion strategy. Underexisting operations. This purchase has been accounted for under the termsacquisition method of accounting and the fair values assigned to the assets acquired and liabilities assumed are based on valuations using management’s best estimates and assumptions. The acquisition of the transaction,Kaplan/Insight Assets has been included in the Company’s Boardresults of Directors (the “Board”) appointed a director nominated by TCV tooperations since July 1, 2011 and its proforma impact on the Board to hold office untilperiods presented is immaterial. The majority of the next annual meeting of stockholders. Additionally, the Company granted TCV the right to participatepurchase price has been allocated on a pro-ratapreliminary basis in any subsequent private offerings of Common Stock by the Company, subject to customary exclusions such as issuances in connection with acquisitions or employee equity plans. In addition, TCV was granted the right to demand registration of the shares of restricted Common Stock it acquired in the transaction.
| 11. | Supplemental Disclosure of Cash Flow Information |
| (In thousands) Three Months Ended September 30, | ||||||||
| 2011 | 2010 | |||||||
Cash paid for interest | $ | 230 | $ | 238 | ||||
|
|
|
| |||||
Cash paid for taxes, net of refunds | $ | 9 | $ | 1,461 | ||||
|
|
|
| |||||
Supplemental disclosure of non-cash investing and financing activities: | ||||||||
New capital lease obligations | $ | 14,305 | $ | 10,385 | ||||
|
|
|
| |||||
Business Combinations: | ||||||||
— Current assets | $ | — | $ | 9,198 | ||||
|
|
|
| |||||
— Property and equipment | $ | 1,626 | $ | 8,800 | ||||
|
|
|
| |||||
— Capitalized curriculum development costs | $ | — | $ | 3,873 | ||||
|
|
|
| |||||
— Intangible assets | $ | — | $ | 22,810 | ||||
|
|
|
| |||||
— Goodwill | $ | 11,041 | $ | 34,704 | ||||
|
|
|
| |||||
— Other non-current assets | $ | — | $ | 138 | ||||
|
|
|
| |||||
— Deferred tax liabilities | $ | — | $ | (5,108 | ) | |||
|
|
|
| |||||
— Assumed liabilities | $ | — | $ | (5,708 | ) | |||
|
|
|
| |||||
— Deferred revenue | $ | (85 | ) | $ | (2,111 | ) | ||
|
|
|
| |||||
— Other noncurrent liabilities | $ | — | $ | (1,250 | ) | |||
|
|
|
| |||||
— Contingent consideration | $ | — | $ | 1,700 | ||||
|
|
|
| |||||
— Issuance of Series A Special Stock | $ | — | $ | 63,112 | ||||
|
|
|
| |||||
Purchase of perpetual license agreement/accrued liabilities | $ | — | $ | 250 | ||||
|
|
|
| |||||
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 onForm 10-K (Annual Report), including any updates found in Part II, Item 1A, “Risk Factors,” of this Quarterly Report onForm 10-Q.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 — | ||
| • | Critical Accounting Policies and Estimates — | ||
| • | Results of Operations — | ||
| • | Liquidity and Capital Resources — |
Executive Summary
We are a technology-based education company. We offer proprietary curriculum, software systems and educational services designed to facilitate individualized learning for students primarily 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 $225$240 million to develop and, to a lesser extent, acquire curriculum and an online learning platformplatforms that promote mastery of core concepts and skills for students of all abilities. This learning system combines a cognitive research-basedour curriculum and offerings with an individualized learning approach well-suited for virtual public schools, onlinehybrid schools, school district-widedistrict online programs, public charter schools hybrid programs and private schools that combineutilize varying degrees of online and traditional classroom instruction, and other educational applications.
19
As with a traditional public school, a virtual public school or hybrid school must comply with state education regulations. The fundamental difference between traditional public schools and virtual public schools is that students primarily throughattend virtual public schools and have an institutional businesshybrid schools primarily over the Internet instead of traveling to a physical classroom. In their online learning environment, students receive assignments, complete lessons, and obtain instruction from certified teachers with sales directly to school districts. Manywhom they interact online, telephonically, in virtual classroom environments, and sometimes face-to-face. The majority of states have embraced virtual public schools or hybrid schools as a means to provide families with a publicly fundedpublicly-funded alternative to a traditional classroom-based education. We offerFor parents who believe their child is not thriving and for whom relocating or attending a private school is not an option, virtual public schools and hybrid schools can provide a compelling choice. From an education policy standpoint, virtual public schools and hybrid schools often represent a savings to the taxpayers when compared with traditional public schools because they are generally funded at a lower per pupil level than the per pupil state average as reported by the U.S. Department of Education. Finally, because parents are generally not required to pay tuition to attend a public school, virtual public schools and hybrid schools make our learning system an attractive alternative within the public school system.
Our proprietary curriculum, online learning platform and varying levels of academic and management services, which can range from targeted programsindividual courses to complete turnkey solutions. Additionally, withoutonline schools, are offered to our charter school, school district and private school partners. Virtual public schools and hybrid schools under turnkey management contracts (Managed Schools) account for approximately 81% of our revenue. For 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
We are serving a growing number of schools and school districts enabling them to offer our course catalogue to students either full-time or on an individual course basis. We have established a dedicated sales team to focus on this sector and, through our acquisition of KCDL 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.
We manage three online private schools where parents can enroll students on a tuition basis for a full-time online education or individual courses to supplement their children’s traditional instruction. In 2008, we launched the K12 International Academy, a private school that we operate using our curriculum. This school is accredited and enables us to offer students worldwide the same full-time education programs that we provide to the virtual public schools and hybrid schools we manage, including the option to enroll in individual courses. This school is organized as a private international school and enrolled students can interact with their classmates from more than 60 countries. Through our acquisition of KCDL, we added The Keystone School, a private school that has been serving students for over 37 years and offers online and correspondence courses. In January 2011, we announced a partnership with the George Washington University to launch an online private high school, the George Washington University Online High School (GWUOHS). The program offers our 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. In April 2011, we acquired the operations of the International School of Berne and invested(IS Berne), a traditional private school located in Web International. With these additions, along with the formation of Middlebury Interactive Languages and Capital Education, we believe we have improved our growth potential and the ability to scale our business even further.
20
We made an investment for a 20% ownership interest in Web, a provider of English language training in China. This strategic investment also gives us the option to acquire the remainder of the company within a period of five years. Web serves learners of all ages including university students, government workers, and employees of international companies. Web currently has an extensive network of learning centers throughout China. The investment will primarily be used by Web to expand its learning center network into more cities in China. Web education centers are outfitted with learning labs that include modern computer terminals and internet connections. Students can access our curriculum and other electronic learning resources from the Web centers.
Across our educational programs, families come from a broad range of social, economic and academic backgrounds. They share the desire for individualized instruction so as to maximize their child’s potential. Examples include, but are not limited to, families with: (i) students seeking to learn faster or slower than they could in a “one size fits all” traditional classroom; (ii) safety, social and health concerns about their local school; (iii) students with disabilities who are underserved in traditional classrooms; (iv) students with geographic or travel constraints; and (v) student-athletes and performers who are not able to attend regularly scheduled classes. Our individualized learning approach allows students to optimize their academic performance and, therefore, their chances of achieving their goals.
For the three months ended September 30, 2011, we served total average enrollments, including the recently acquired Kaplan/Insight and IS Berne programs of 141,525 as compared to 99,611, for the same period in the prior year, a growth rate of 42.1%. These enrollments include students in Managed Schools, students in programs offered by school districts (Institutional Business), and students in our Private Schools. Enrollments exclude students in our consumer, A+, post-secondary, and classroom pilot programs.
For the three months ended September 30, 2011, we increased revenues to $193.3 million from $134.9 million in the same period in the prior year, a growth rate of 43.3%. Over the same period, operating income increased to $8.3 million from operating income of $5.4 million, an increase of 53.7%, and net income to shareholders increased to $4.6 million from net income to shareholders of $2.2 million, an increase of 109.1%. The increase in net income was primarily attributable to lower income tax expense over the same period in the prior year.
In the last two years, we completed several strategic transactions to accelerate our growth, expand our course catalogue and service offering, extend our distribution capabilities, and strengthen our balance sheet. With these initiatives and our acquisitions of the American Education Corporation and IS Berne in fiscal year 2011 and of certain assets of Kaplan Virtual Education early in fiscal year 2012, we believe we have improved our growth potential and the ability to scale our business even further
Partnership with Blackboard Inc.
In October 2010, we announced a partnership with Blackboard Inc. (Blackboard) to develop a solution that delivers our adaptive courses through Blackboard Learn, Blackboard’s leading online teaching and learning platform. The combination is intended to reduce the cost of delivering remediation instruction while enabling community colleges and higher education institutions to offer a wider range of both self-paced and teacher-led online programs.
Acquisition of The American Education Corporation
In December 1, 2010, we acquired the operating assets and liabilitiesstock of The American Education Corporation (AEC), for a total cash purchase price of $24.5 million, after certain adjustments. AEC is 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.learners. The acquisition increases our portfolio of innovative, high quality instructionalinstruction and curriculum offerings toused by school districts all over the country. The purchase price included $6.8 million held
21
Investment in escrow that would be payable to selling AEC shareholders if specified financial targets were achieved for the three months ended December 31, 2010. In March 2011, the specified financial targets were not achieved and the $6.8 million escrow amount was returned to the Company.
In 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 provider of English language training for learners of all ages throughout China, including university students, government workers, and employees of international companies. Web has aan extensive network of 73 learning centers in 48 cities inthroughout China. The proceeds of the investment will primarilyare intended to be used to expand Web’s learning center network into more Chinese cities.
TheCreation of the George Washington University Online High School
In January 13, 2011, K12we announced the creation of 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’sthe Company’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.
Acquisition of International School of Berne
In April, 1, 2011, we finalized our acquisition of the operations of the International School of Berne (IS Berne), for 2 million Swiss Francs. IS Berne is a traditional private brick and mortar school located in Bern,Berne, Switzerland serving students in grades Pre-K through 12.
21
Investment by Technology Crossover Ventures Investmentin K12 Inc.
In April 27, 2011, we closedcompleted a private placement sale of 4 million shares of restricted Common Stock at a price of $31.46 per share to Technology Crossover Ventures (TCV). The aggregate investmentproceeds of $125.8 million will support our expansion strategy.are unrestricted and may be used for acquisitions, strategic investments and general corporate purposes. Under the terms of the transaction, our Board of Directors (the “Board”)(Board) appointed a director nominated by TCV to the Board to hold office until the next annual meeting of stockholders. Additionally, we granted TCV the right to participate on a pro-rata basis in any subsequent private offerings of Common Stock by the Company, subject to customarycertain exclusions such as issuances in connection with acquisitions or employee equity plans. In addition, TCV was granted the right to demand registration of the shares of restricted Common Stock it acquired in the transaction.
DevelopmentsAcquisition of Assets from Kaplan Virtual Education
In July 2011, we completed the purchase of certain K-12 assets and Insight School management contracts (Kaplan/Insight Assets) of Kaplan Virtual Education, a subsidiary of Kaplan, Inc. The Kaplan/Insight Assets included contracts to serve online public schools in Education Funding
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
22
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 20102011 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
Our reported total average enrollments include students in Managed Schools, students taking K12 curriculum or Aventa online programs offered by school districts (Institutional Business), and students in Private Schools. Students served through our Institutional Business and Private School offerings may enroll in a single course. For better comparability, these students are converted to growthfull-time equivalents (FTEs) on a four course basis. We currently exclude selected programs from our reported enrollment. For example, we do not include students in our private school and institutional sales business, includingconsumer channel as we do not monitor the increasingprogress of these students in the same way as we do in other programs. We typically sell our A+ curriculum (acquired with AEC) as a site license. As these schools are not limited in the number of students who enroll part-time or take a single coursemay access our curriculum, we do not include these students in these programs, we are including additionalour enrollment
22
Enrollments in K12 private schoolsManaged Schools for the three months ended March 31,September 30, 2011 increased 109.9%40.9% to 2,459103,919 from 1,17273,736 for the same period in the prior year. Managed Schools include virtual public schools and hybrid schools.
Enrollments in Institutional Business for the three months ended September 30, 2011 increased 54.4% to 28,247 from 18,300 for the same period in the prior year. Our Institutional Business provides curriculum and services to schools and school districts.
Enrollments in Private Schools for the three months ended September 30, 2011 increased 23.6% to 9,359 from 7,575 for the same period in the prior year. Private schools include the K12 International Academy, as well as private brickKeystone, GWUOHS and mortar schools.IS Berne. 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).
The following tables settable sets forth average enrollment data by distribution channel for each of the periods indicated:
| Three months ending March 31, | Nine months ending March 31, | |||||||||||||||||||||||||||||||
| 2011 | 2010 | Change | Change % | 2011 | 2010 | Change | Change % | |||||||||||||||||||||||||
Total Average Enrollment* | ||||||||||||||||||||||||||||||||
| K12 public schools | 81,666 | 67,560 | 14,105 | 20.9 | % | 81,560 | 67,755 | 13,804 | 20.4 | % | ||||||||||||||||||||||
| K12 private schools | 2,459 | 1,172 | 1,288 | 109.9 | % | 2,337 | 1,065 | 1,273 | 119.5 | % | ||||||||||||||||||||||
K12 total | 84,125 | 68,732 | 15,393 | 22.4 | % | 83,897 | 68,820 | 15,077 | 21.9 | % | ||||||||||||||||||||||
Total acquired enrollment | 16,905 | — | 16,905 | NM | 15,758 | — | 15,758 | NM | ||||||||||||||||||||||||
Total Average Enrollment* | 101,030 | 68,732 | 32,298 | 47.0 | % | 99,655 | 68,820 | 30,835 | 44.8 | % | ||||||||||||||||||||||
Enrollment mix by sales channel for K12 programs | ||||||||||||||||||||||||||||||||
| Three months ending March 31, | Nine months ending March 31, | |||||||||||||||||||||||||||||||
| 2011 | 2010 | Change | Change % | 2011 | 2010 | Change | Change % | |||||||||||||||||||||||||
K12 Public schools* | ||||||||||||||||||||||||||||||||
| K12 managed schools | 69,154 | 57,768 | 11,386 | 19.7 | % | 69,156 | 57,805 | 11,350 | 19.6 | % | ||||||||||||||||||||||
| K12 institutional sales | 12,512 | 9,793 | 2,719 | 27.8 | % | 12,404 | 9,950 | 2,454 | 24.7 | % | ||||||||||||||||||||||
| Total K12 public | 81,666 | 67,560 | 14,105 | 20.9 | % | 81,560 | 67,755 | 13,804 | 20.4 | % | ||||||||||||||||||||||
K12 Private schools* | ||||||||||||||||||||||||||||||||
| K12 managed | 1,812 | 1,172 | 641 | 54.7 | % | 1,674 | 1,065 | 609 | 57.2 | % | ||||||||||||||||||||||
| K12 institutional sales | 647 | — | 647 | NM | 663 | — | 663 | NM | ||||||||||||||||||||||||
| Total K12 private | 2,459 | 1,172 | 1,288 | 109.9 | % | 2,337 | 1,065 | 1,273 | 119.5 | % | ||||||||||||||||||||||
Total K12 public and private schools* | 84,125 | 68,732 | 15,393 | 22.4 | % | 83,897 | 68,820 | 15,077 | 21.9 | % | ||||||||||||||||||||||
| Quarter Ending September 30, | Growth 2011 / 2010 | |||||||||||||||
| 2011 | 2010 | Change | Change % | |||||||||||||
Total Average Enrollment | ||||||||||||||||
Managed Schools | 97,209 | 73,736 | 23,473 | 31.8 | % | |||||||||||
Institutional Business | 28,247 | 18,300 | 9,947 | 54.4 | % | |||||||||||
Private Schools | 9,123 | 7,575 | 1,548 | 20.4 | % | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Average Enrollment | 134,579 | 99,611 | 34,968 | 35.1 | % | |||||||||||
Total Acquired Enrollment(IS Berne, Insight Programs) | 6,946 | — | 6,946 | NM | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Average Enrollment | 141,525 | 99,611 | 41,914 | 42.1 | % | |||||||||||
|
|
|
|
|
|
|
| |||||||||
K12 and Acquired Enrollment | ||||||||||||||||
Managed Schools | 103,919 | 73,736 | 30,183 | 40.9 | % | |||||||||||
Institutional Business | 28,247 | 18,300 | 9,947 | 54.4 | % | |||||||||||
Private Schools | 9,359 | 7,575 | 1,784 | 23.6 | % | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Average Enrollment | 141,525 | 99,611 | 41,914 | 42.1 | % | |||||||||||
|
|
|
|
|
|
|
| |||||||||
The above enrollments exclude those in our consumer A+, post-secondary, and classroom pilot programs.
23
| Three Months Ended | Nine Months Ended | |||||||||||||||
| March 31, | March 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (In thousands) | (In thousands) | |||||||||||||||
Revenues | $ | 130,293 | $ | 96,627 | $ | 394,167 | $ | 296,149 | ||||||||
Cost and expenses | ||||||||||||||||
| Instructional costs and services | 77,727 | 56,479 | 229,004 | 166,161 | ||||||||||||
| Selling, administrative, and other operating expenses | 36,763 | 26,843 | 122,438 | 85,069 | ||||||||||||
| Product development expenses | 4,972 | 2,924 | 12,318 | 7,577 | ||||||||||||
Total costs and expenses | 119,462 | 86,246 | 363,760 | 258,807 | ||||||||||||
Income from operations | 10,831 | 10,381 | 30,407 | 37,342 | ||||||||||||
Interest expense, net | (307 | ) | (361 | ) | (970 | ) | (1,042 | ) | ||||||||
Income before income taxes and noncontrolling interest | 10,524 | 10,020 | 29,437 | 36,300 | ||||||||||||
Income tax expense | (5,260 | ) | (3,927 | ) | (14,310 | ) | (13,676 | ) | ||||||||
Net income | $ | 5,264 | $ | 6,093 | $ | 15,127 | $ | 22,624 | ||||||||
Add net loss attributable to noncontrolling interest | $ | 335 | $ | 36 | $ | 509 | $ | 226 | ||||||||
Net Income — K12 Inc. | $ | 5,599 | $ | 6,129 | $ | 15,636 | $ | 22,850 | ||||||||
| September 30, | ||||||||
| 2011 | 2010 | |||||||
Revenues | $ | 193,330 | $ | 134,871 | ||||
|
|
|
| |||||
Cost and expenses | ||||||||
Instructional costs and services | 107,579 | 75,082 | ||||||
Selling, administrative, and other operating expenses | 71,260 | 50,498 | ||||||
Product development expenses | 6,224 | 3,911 | ||||||
|
|
|
| |||||
Total costs and expenses | 185,063 | 129,491 | ||||||
|
|
|
| |||||
Income from operations | 8,267 | 5,380 | ||||||
Interest expense, net | (221 | ) | (297 | ) | ||||
|
|
|
| |||||
Income before income taxes and noncontrolling interest | 8,046 | 5,083 | ||||||
Income tax expense | (3,697 | ) | (2,931 | ) | ||||
|
|
|
| |||||
Net income | 4,349 | 2,152 | ||||||
Add net loss attributable to noncontrolling interest | 251 | 46 | ||||||
|
|
|
| |||||
Net Income — K12 Inc. | $ | 4,600 | $ | 2,198 | ||||
|
|
|
| |||||
The following table sets forth statements of operations data as a percentage of revenues for each of the periods indicated:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| March 31, | March 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost and expenses | ||||||||||||||||
| Instructional costs and services | 59.7 | 58.5 | 58.1 | 56.1 | ||||||||||||
| Selling, administrative, and other operating expenses | 28.2 | 27.8 | 31.1 | 28.7 | ||||||||||||
| Product development expenses | 3.8 | 3.0 | 3.1 | 2.6 | ||||||||||||
Total costs and expenses | 91.7 | 89.3 | 92.3 | 87.4 | ||||||||||||
Income from operations | 8.3 | 10.7 | 7.7 | 12.6 | ||||||||||||
Interest expense, net | (0.2 | ) | (0.4 | ) | (0.2 | ) | (0.4 | ) | ||||||||
Income before income taxes and noncontrolling interest | 8.1 | 10.4 | 7.5 | 12.3 | ||||||||||||
Income tax expense | (4.0 | ) | (4.1 | ) | (3.6 | ) | (4.6 | ) | ||||||||
Net income | 4.0 | 6.3 | 3.8 | 7.6 | ||||||||||||
Add net loss attributable to noncontrolling interest | 0.3 | 0.0 | 0.1 | 0.1 | ||||||||||||
Net income — K12 Inc. | 4.3 | % | 6.3 | % | 4.0 | % | 7.7 | % | ||||||||
| September 30, | ||||||||
| 2011 | 2010 | |||||||
Revenues | 100.0 | % | 100.0 | % | ||||
|
|
|
| |||||
Cost and expenses | ||||||||
Instructional costs and services | 55.6 | 55.7 | ||||||
Selling, administrative, and other operating expenses | 36.9 | 37.4 | ||||||
Product development expenses | 3.2 | 2.9 | ||||||
|
|
|
| |||||
Total costs and expenses | 95.7 | 96.0 | ||||||
|
|
|
| |||||
Income from operations | 4.3 | 4.0 | ||||||
Interest expense, net | (0.1 | ) | (0.2 | ) | ||||
|
|
|
| |||||
Income before income taxes and noncontrolling interest | 4.2 | 3.8 | ||||||
Income tax expense | (1.9 | ) | (2.2 | ) | ||||
|
|
|
| |||||
Net income | 2.3 | % | 1.6 | % | ||||
Add net loss attributable to noncontrolling interest | 0.1 | — | ||||||
|
|
|
| |||||
Net income — K12 Inc. | 2.4 | % | 1.6 | % | ||||
|
|
|
| |||||
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 nine months ended March 31,September 30, 2011 as compared to the same period in the prior year.
24
Revenues. Our revenues for the three months ended March 31,September 30, 2011 were $130.3$193.3 million, representing an increase of $33.7$58.4 million, or 34.8%43.3%, as compared to revenues of $96.6$134.9 million for the same period in the prior year. This increase was primarily attributable to 22.4%42.1% increase in enrollments in K12 programs. In addition, Aventa, iQprograms from organic growth and Keystone programs obtained through our acquisitionacquisitions. The acquisitions of AEC, IS Berne, Kaplan/Insight Assets and KCDL contributed 8.4%11.7% to the revenue growth, our acquisition of AEC contributed 2.7% to revenue growth, and new business and initiatives contributed 1.0% to revenue growth.
24
Instructional costs and services expenses. Instructional costs and services expenses for the three months ended March 31,September 30, 2011 were $77.7$107.6 million, representing an increase of $21.2$32.5 million, or 37.6%43.3%, as compared to instructional costs and services expenses of $56.5$75.1 million for the same period in the prior year. This increase was primarily attributable to a $16.9$22.8 million increase in expenses to operate and manage schools including the programs acquired with KCDL.schools. In addition, amortization of curriculum and learning systems increased $3.2 million. Costscosts to supply curriculum, books, educational materials and computers to students increased $1.2 million. Included in the $21.2$4.9 million, including a $0.6 million increase in instructional coststhe provision for inventory obsolescence. Amortization of curriculum and serviceslearning systems increased $0.9 million. Enrollment operation expenses arestart-up and launch expenses of $1.8increased $3.6 million for several new businesses and initiatives.from the same period last year. As a percentage of revenues, instructional costs and services expenses increased to 59.7%56.5% for the three months ended March 31,September 30, 2011, as compared to 58.5%55.7% for the same period in the prior year. ThisThe cost increase as a percentage of revenues was primarily attributable to 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 atlower fulfillment costs for materials and 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 March 31,September 30, 2011 were $36.8$71.3 million, representing an increase of $9.9$20.8 million, or 37.0%41.2%, as compared to selling, administrative and other operating expenses of $26.8$50.5 million for the same period in the prior year. This increase iswas primarily attributable to increases in: strategic marketing including brand awareness and student recruitment; personnel costs, including those acquired with KCDLsalaries and AEC; financial systemsincentive compensation; third party commissions related to the Company’s institutional sales; accounting and process improvement costs; merger integration,audit fees related to the effects of purchase accounting;Company’s public filing and M&A transaction expenses. Included intax returns; and professional fees related to the $9.9 million increase in selling, administrative, and other operating expenses arestart-up and launch expenses of $1.8 million for several new businesses and initiatives.Oracle implementation. As a percentage of revenues, selling, administrative, and other operating expenses increased to 28.2%were consistent at 37.4% for the three months ended March 31,September 30, 2011 as compared to 27.8%37.4% for the same period in the prior year.
Product development expenses. Product development expenses for the three months ended September 30, 2011 were $6.2 million, representing an increase of $2.3 million, or 59.0% as compared to product development expenses of $3.9 million for the same period in the prior year. The increase is primarily due to new development projects. As a percentage of revenues, product development expenses increased to 3.3% for the three months ended September 30, 2011 as compared to 2.9% 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 March 31,September 30, 2011 was $0.3$0.2 million as compared to net interest expense of $0.4$0.3 million for the same period in the prior year. The slight decrease in net interest expense is primarily due to lower average interest rates paid on borrowings under our capital leases.
Income taxes. Income tax expense for the three months ended March 31,September 30, 2011 was $5.3$3.7 million, or 50.0%46.0% of income before income taxes, as compared to an income tax expense of $3.9$2.9 million, or 39.2%57.7% of income before taxes, for the same period in the prior year. The increasedecrease in the tax rate is primarily due to a decrease in non-deductible transaction expenses inand lobbying costs.
Noncontrolling interest. Noncontrolling interest for the current periodthree months ended September 30, 2011 was $0.3 million as well as the benefitcompared to noncontrolling interest of tax credits recognized ina de minimus value for the same period in the prior year.
25
26
As of March 31,September 30, 2011 and June 30, 2010,2011, we had cash and cash equivalents of $40.1$133.5 million and $81.8$193.1 million, respectively, excluding restricted cash. In addition, we have a working capital line of credit available under which we may borrow up to $35 million. There were no borrowings outstanding under the line of credit agreement as of March 31, 2011. We financed our capital expenditures and acquisitions during the ninethree months ended March 31,September 30, 2011 primarily with cash generated from operations and capital lease financing.
In addition to our cash and line of credit, we had accounts receivable of $134.0$214.4 million, and $71.2$96.2 million as of March 31,September 30, 2011 and June 30, 2010,2011, respectively. Our accounts receivable provide an additional source of
25
liquidity as cash payments are collected from customers in the normal course of business. Our accounts receivable balance fluctuates throughout the year based on the timing of customer billings and collections and accounts receivable tend to be at the highest levels in the first quarter as we begin billing for students.
We have a $35 million line of credit with PNC Bank that expires December 2012. As of September 30, 2011 no borrowings were outstanding on the line of credit and approximately $0.3 million was reserved for a letter of credit.
In August 2011, we entered intoamended our equipment lease line of credit with PNC Equipment Finance, LLC to increase the amount available for new purchases to $18 million with an agreement with Technology Crossover Ventures (TCV) for theirexpiration date of August 2012. The interest rate on the borrowings is set at the time of borrowing based upon interest rates in the Federal Reserve Statistical Release H.15.
For the quarter ended September 30, 2011, we borrowed $14.3 million to finance the purchase of 4 million shares of K12 common stock for total proceedsstudent computers and other equipment at an interest rate of approximately $125.82.6% bringing the total balance outstanding at September 30, 2011 to $30.8 million. The investment was closedThese leases include a 36-month payment term with a bargain purchase option at the end of the term. Accordingly, we include this equipment in property and funded on April 27, 2011. The proceeds are unrestrictedequipment and may be used for general corporate purposes, acquisitions, and strategic investments.
Our cash requirements consist primarily ofday-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 approximately $42 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 $15 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 and capital lease financing. As of March 31, 2011, advances for additional purchases are no longer available under our existing capital lease line of credit. We expect to use cash on hand, or renew our line of credit, to pay for future purchases. We lease all of our office facilities. We expect to make future payments on existing leases from cash generated from operations.
Redemption Right of Middlebury College
In the formation of our joint venture with Middlebury College (Middlebury), at any time after May 1, 2015,the fifth (5th) anniversary of the agreement, 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. We will record the redemption value of the redeemable noncontrolling interest on each balance sheet date in accordance with EITF Topic D-98 and any changes to the redemption value should be recognized as adjustments to retained earnings, or in the absence of retained earnings, by adjustment to additional paid-in capital. As of March 31,September 30, 2011, the redeemable noncontrolling interest was estimated to be $19.0 million.
27
one-for-one basis. On January 27, 2011, the Company’s shareholders approved the right of the holders of the Series A Special Stock to convert those shares into common stock on aone-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. Upon receiving the approval of shareholders, the redemption right of the holders of the Series A Special Stock terminated and the Series A Special Stock was reclassified to stockholders’ equity.
Net cash provided byused in operating activities for the ninethree months ended March 31,September 30, 2011 and 2010 was $27.0$35.0 million and $34.1$4.8 million, respectively.
The increase in accounts receivable was primarily attributable to our growth in revenues. Accounts receivable balances tend to be at the highest levels in ourthe first quarter as we begin billing for the school year and decrease throughout our fiscal year as cash is collected.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.enrollments. 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.
26
The net decreaseincrease in accounts payable and accrued liabilities is primarily due to the timing of payments to vendors and service providers for strategic marketing and student recruiting expenses, 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 lower accrued compensation.
Investing Activities
Net cash used in investing activities for the ninethree months ended March 31,September 30, 2011 and 2010 was $68.6$21.3 million and $17.6$11.8 million, respectively.
Net cash used in investing activities for the ninethree months ended March 31,September 30, 2011 was primarily due to acquisition activities including the acquisition of AEC for $24.5 million (net of $3.8 million acquired cash and refunded escrow amounts), a $10 million investment of a 20% interest in Web International, and approximately $2.0 million for our acquisition of the International School of Berne, which formally closed on April 1, 2011. In association with the AEC acquisition, we deposited $6.8 million into a performance escrow with payment dependent on AEC achieving specified financial targets, and we were repaid the full $6.8 million during the period. In addition, investing activities included purchases of property and equipment of $13.4$4.9 million, including $5.7 million for license and implementation of an enterprise software application, $2.2 million for expansion of our corporate offices, and $1.5 million for equipment in the build out of our second data center; investment in capitalized curriculum development of $11.7$3.7 million, primarily related to the production of high school courses and middle school math courses, and language courses; and investmentthe purchase of Kaplan/Insight Assets of $12.6 million.
In addition to the investing activities above, for the three months ended September 30, 2011, we financed through capital leases purchases of student computers and other equipment in capitalized software developmentthe amount of $6.9$14.3 million.
Net cash used in investing activities for the ninethree months ended March 31,September 30, 2010 was primarily due to purchases of property and equipment of $6.4 million including $3.8 million to license an enterprise software application, investment in capitalized curriculum development of $9.3$3.2 million, primarily related to the production of high school courses elementaryand middle school math courses,courses; and remedial reading; investment in capitalized software development of $6.6 million; and purchases of property and equipment of $0.8 million, including purchased software.
In addition to the investing activities above, for the ninethree months ended March 31, 2011 andSeptember 30, 2010, we financed through capital leases purchases of student computers and software primarily for use by studentsother equipment in the amount of $15.3 million and $12.2 million, respectively.
28
Net cash used in financing activities for the ninethree months ended March 31,September 30, 2011 and 2010 was $0.3 million. Net cash from financing activities for$3.5 million and $2.8 million, respectively.
For the ninethree months ended March 31, 2010 was $0.6 million.
For the ninethree months ended March 31,September 30, 2010, net cash provided byused in financing activities was primarily due to the exercise of stock options of $6.9 million and the excess tax benefit from stock-based compensation of $4.2 million, partially offset by payments on capital leases and notes payable of $10.6$4.0 million, partially offset by proceeds from the exercise of stock options of $1.1 million and the excess tax benefit from stock based compensation of $0.1 million. As of March 31, 2010, there were no borrowings outstanding on our $35 million line of credit.
Off Balance Sheet Arrangements, Contractual Obligations and Commitments
There were no substantial changes to our guarantee and indemnification obligations in the ninethree months ended March 31,September 30, 2011 from those disclosed in our fiscal year 20102011 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 ninethree months ended March 31,September 30, 2011 primarily due to approximately $7.2 million for operating leases, primarily for additional office space; and $5.7$10.3 million for capital leases related to student computers, net of payments.
27
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Interest Rate Risk
At March 31,September 30, 2011 and June 30, 2010,2011, we had cash and cash equivalents totaling $40.1$133.5 million and $81.8$193.1 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 March 31,September 30, 2011, a 1% gross increase in interest rates earned on cash and cash equivalents would result in an$1.3 million annualized increase of $0.4 million in interest income.
Our short-term debt obligations under our revolving credit facility are subject to interest rate exposure. As of March 31, 2011,exposure; however, as we had no amounts were outstanding balance on this facility and $15 million outstanding as of December 31, 2010 was repaid from cash generated by operating activities.
Foreign Currency Exchange Risk
We currently operate in several foreign countries. In the past,countries, but we diddo not transact a material amount of business in a foreign currency and therefore fluctuations in exchange rates didwill not have a material impact on our financial statements. However, we continue to pursueare pursuing additional opportunities in international markets.markets and expect our international presence to grow. 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 riskand/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.
29
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined inRule 13a-15(f) 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 onForm 10-K for the fiscal year ended June 30, 2010,2011, a material weakness was identified relating to project management of a new enterprise-wide financial system (“ERP”) and the resulting effects on the timeliness of our year-end close existed in our internal control over financial reporting (ICFR) relating to our accounting for complex transactionsreporting. Management assessed the processes surrounding the project management of the ERP implementation and determined that are non-routinethe ERP system implementation plan was insufficiently comprehensive which caused delays and non-recurring.ultimately prevented the year-end close from being completed in a timely manner. Rule 12b-2 andRule 1-02 ofRegulation S-X define a material weakness as a deficiency, or a combination of deficiencies, in ICFRinternal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be 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,2011, our disclosure controls and procedures were not effective at a reasonable assurance level.
28
We carried out an evaluation, required by paragraph (b) ofRule 13a-15 orRule 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 inRule 13a-15(e) orRule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report onForm 10-Q. Based on this review, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31,September 30, 2011 as the material weakness identified as of June 30, 20102011 still exists.
Changes in Internal Control over Financial Reporting
As described in Item 9Aa result of management’s evaluation of our Annual Reportinternal control over financial reporting, management identified a material weakness in our internal control. Specifically, management concluded that a material weakness relating to project management of a new enterprise-wide financial system (“ERP”) and the resulting effects onForm 10-K for the fiscal year ended June 30, 2010, management has been undertaking improvementstimeliness of our year-end and quarterly close process existed in our internal control over financial reportingreporting.
Management has assessed the processes surrounding the project management of the ERP implementation and our accounting proceduresdetermined that the ERP system implementation plan was insufficiently comprehensive which caused delays and practices generally. Specifically:
30
This control deficiency could have resulted in a material misstatement to the interim consolidated financial statements that would not be prevented or detected as of the initial filing date deadline. Accordingly, management determined that this control deficiency constituted a 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 Juneas of September 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 ninethree months ended March 31,September 30, 2011, in connection with the evaluation required by paragraph (d) ofRule 13a-15 orRule 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. On April 1, 2011, the Company completed the initial step in a multi-phased implementation of an Oracle ERP accounting system, when the system went “live”. Certain modules and functionality will be phased in over the remainder of the year. Additional business units and subsidiaries are expected to fully implement the Oracle ERP system over the next nine months, and additional modules will be implemented throughout the Company over the next nine months. Notwithstanding such efforts, the material weakness related to project management of a new enterprise-wide financial system (“ERP”) and the resulting effects on the timeliness of our accounting for complex transactions that are non-routine and non-recurringyear-end close existed in our internal control over financial reporting 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.
29
| Item 1. | Legal Proceedings. |
In the ordinary conduct of our business, we are subject to lawsuits, arbitrations and administrative proceedings from time to time.
On October 26, 2011, IpLearn, LLC (“IpLearn”) filed an action for patent infringement against the Company in the United States District Court for the District of Delaware.IpLearn, LLC v. K12 Inc., C.A. No. 11-1026-UNA. IpLearn is a privately-held technology development and licensing company for web and computer-based learning technologies. In its complaint, IpLearn alleges that the Company has infringed three of its patents for various computer-aided learning methods and systems. The outcome of these proceedingsCompany was served with the complaint on October 31, 2011, and the Company’s answer is not expected to have a material adverse effect on the financial condition or results of operation of the Company.
In June 2010, the shareholders of Aventa Learning, Inc. (Aventa) filed a lawsuit against KCDL which is currently pendingKC Distance Learning, Inc. in the U.S. District Court for the Western District of Washington,Axtman et al. v. KC Distance Learning, Inc.Inc(Case. No. 2:10-cv-01022-JLR)C10-01022-JLR (W.D. Wash). 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, wethe Company acquired all of the shares of KCDL, which is now oura wholly-owned subsidiary. On August 31, 2010, the plaintiffs amended their complaint to add K12 Inc. as aco-defendant in this matterAventa et. al. v. K12 Inc., et. al. No. C10-01022-JLR (W.D. Wash), 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 usK12 or KCDL 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. On March 27,November 10, 2011, the court issued an Order Denying Defendant’s Motion to Dismiss Amended Complaint.Aventa Learning, Inc. et. al, v.parties reached a settlement in principle, which settlement includes a full release of all claims against K12 Inc. et. al.(CaseNo. C10-1022 JLR). Accordingly,, and the discovery process has commenced.
| Item 1A. | Risk Factors |
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. | Submission of Matters to a Vote of Security Holders. |
None.
| Item 5. | Other Information. |
None.
30
| Item 6. | Exhibits. |
| (a) | Exhibits. |
| * | Filed herewith. |
31
32
K12 INC. | ||
/s/ RONALD J. PACKARD | ||
Name: | Ronald J. Packard | |
Title: | Chief Executive Officer | |
33Date: November 14, 2011
32