Payments are generally made with charge cards. For those customers electing to pay these subscription fees in their entirety upfront, we record the payment as deferred revenue and amortize the revenues over the life of the subscription. For customers paying monthly, we recognize these payments as revenues in the month earned. Revenues for offline learning kits are recognized when shipped. Within 30 days of enrollment, customers can receive a full refund, however customers terminating after 30 days will receive a pro rata refund for the unused portion of their subscription less a termination fee. Historically, the impact of refunds has been immaterial.
expenditures are expected to increase in the next several years as we invest in additional courses, new releases of existing courses and purchase computers to support increases in virtual school enrollments. We expect our capital expenditures in the next 12 months will be approximately $22 million to $30 million for curriculum development and related systems as well as computers for students. We expect to be able to fund these capital expenditures with cash generated from operations, short-term debt and capital lease financing. We lease all of our office facilities. We expect to make future payments on existing leases from cash generated from operations. In addition, our Board of Directors has approved a cash dividend on our Series C Preferred Stock, contingent upon the closing of this offering, of approximately $6.4 million. We believe that our existing cash balances and continued cash generated from operations, our revolving credit facility, and in-part, the net proceeds from this offering and from the Regulation S Transaction, will provide sufficient resources to fund the cash dividend on the Series C Preferred Stock and to meet our projected operating requirements,start-up costs to open new schools, and planned capital expenditures for at least the next 12 months. In addition, we expect that the net proceeds from this offering and from the Regulation S Transaction will allow us to meet our long-term liquidity needs and provide us with the financial flexibility to execute our strategic objectives, including the ability to make acquisitions and strategic investments. Our ability to generate cash, however, is subject to our performance, general economic conditions, industry trends and other factors. To the extent that funds from this offering and from the Regulation S Transaction, combined with existing cash and operating cash flow are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing.
Operating Activities
Net cash provided byused in operating activities during the yearthree months ended JuneSeptember 30, 2007, was $5.6$2.7 million. Net cash provided by operating activities in fiscal year 2007, 2006 and 2005 was $5.6 million, $3.6 million and $9.7 million, respectively.
The cash used in operations during the three months ended September 30, 2007 was primarily due to an increase in accounts receivable of $34.2 million, an increase in deferred tax assets of $7.1 million and a decrease in accrued compensation and benefits of $2.9 million. This was primarily offset by net income of $12.8 million, an increase in deferred revenue of $12.6 million, a decrease in inventory of $7.0 million, an increase in accounts payable and accrued liabilities totaling $6.5 million and depreciation and amortization of $2.3 million.
The cash provided by operations in thefiscal year ended June 30, 2007 was primarily due to net income of $3.9 million, depreciation and amortization of $7.4 million and increases in deferred revenue of $1.2 million and accrued compensation and benefits of $1.1 million. This was primarily offset by an increase in accounts receivable of $3.2 million, an increase in inventory of $2.8 million, a change in accounts receivable allowance of $0.9 million, and a decrease in accrued liabilities of $0.8 million. The change in accounts receivable allowance of $0.9 million was related to the write-off of accounts receivable that were fully reserved in prior years and attempts to collect were unsuccessful. Because these accounts were fully reserved in prior years, there was no impact on our results of operations for the year ended June 30, 2007.
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The cash provided by operations in fiscal year 2006 was primarily due to net income of $1.4 million, depreciation and amortization of $5.0 million, an increase in accounts payable of $1.6 million, an increase of accrued compensation and benefits of $1.8 million, and an increase in deferred rent of $1.6 million. This was primarily offset by an increase in inventory of $5.4 million and an increase of accounts receivable of $2.7 million.
The cash provided by operations in fiscal year 2005 was primarily due to depreciation and amortization of $5.5 million, a decrease in accounts receivable of $3.4 million, impairment charges of $3.3 million, an increase in accrued liabilities of $1.2 million, and an increase in accrued compensation and benefits of $1.0 million. This was primarily offset by a net loss of $3.5 million and an increase in inventories, prepaid and other assets of $1.5 million.
Investing Activities
Net cash used in investing activities for the yearthree months ended JuneSeptember 30, 2007 was $14.0$3.4 million. Net cash used in investing activities for the fiscal year 2007, 2006 and 2005 was $14.0 million, $11.5 million and $8.5 million, respectively.
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Net cash used in investing activities for the yearthree months ended JuneSeptember 30, 2007 was primarily due to capitalized curriculum of $8.7$1.6 million and purchases of property and equipment of $5.4$1.5 million. This does not include $8.1$7.0 million of student computers and other equipment and software financed with capital leases. Purchases of property and equipment for the fiscal year ended 2007, 2006 and 2005 were $5.4 million, $10.8 million and $4.7 million, respectively. In fiscal year 2007, we also financed, with capital leases, purchases of property and equipment and student computers of $8.1 million. In fiscal year 2005, we also financed with capital leases, purchases of student computers in the amount of $0.4 million. Capitalized curriculum for the fiscal year ended 2007, 2006 and 2005 were $8.7 million, $0.7 million and $3.8 million, respectively.
Financing Activities
Net cash provided by financing activities for the three months ended September 30, 2007 was $7.4 million. This was primarily due to $11.0 million in borrowings against our revolving credit facility.
Net cash provided by financing activities for the year ended June 30, 2007 was $0.7 million. This was primarily due to the release of cash from a restricted escrow account of $2.3 million, a bank overdraft of $1.6 million, and net borrowings from our revolving credit facility of $1.5 million. This was offset by a payment on a related party note payable of $4.0 million and repayments of capital lease obligations of $1.4 million. Net cash used in financing activities for fiscal year 2006 was $2.6 million primarily attributable to cash invested in a restricted escrow account of $2.2 million and repayments for capital lease obligations of $0.4 million.
Net cash provided by financing activities for the fiscal year 2005 was $2.9 million primarily due to proceeds from a related party note payable of $4.0 million and the release of cash from a restricted escrow account of $2.2 million. This was partially offset by repayments of capital lease obligations of $3.4 million.
Contractual Obligations
Our contractual obligations consist primarily of leases for office space, capital leases for equipment and other operating leases. The following summarizes our long-term contractual obligations as of JuneSeptember 30, 2007:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Twelve Months Ending June 30, | |
| | Total | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | Thereafter | |
| | (dollars in thousands) | |
|
Contractual Obligations at June 30, 2007 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Capital leases(1) | | $ | 7,531 | | | $ | 3,238 | | | $ | 2,888 | | | $ | 1,399 | | | $ | 6 | | | $ | — | | | $ | — | |
Operating leases | | | 17,221 | | | | 2,138 | | | | 2,127 | | | | 1,576 | | | | 1,386 | | | | 1,367 | | | | 8,627 | |
Line of credit(2) | | | 1,500 | | | | 1,500 | | | | | | | | | | | | | | | | | | | | | |
Long-term obligations(1) | | | 396 | | | | 193 | | | | 132 | | | | 71 | | | | | | | | | | | | | |
Other commitments(3) | | | 120 | | | | 120 | | | | — | | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 26,768 | | | $ | 7,189 | | | $ | 5,147 | | | $ | 3,046 | | | $ | 1,392 | | | $ | 1,367 | | | $ | 8,627 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Twelve Months Ending September 30, | |
| | Total | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | Thereafter | |
| | (dollars in thousands) | |
|
Contractual Obligations at September 30, 2007 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Capital leases(1) | | $ | 14,686 | | | $ | 6,105 | | | $ | 5,520 | | | $ | 3,061 | | | $ | — | | | $ | — | | | $ | — | |
Operating leases | | | 16,712 | | | | 2,126 | | | | 2,130 | | | | 1,396 | | | | 1,404 | | | | 1,376 | | | | 8,280 | |
Line of credit(2) | | | 12,500 | | | | 12,500 | | | | | | | | | | | | | | | | | | | | | |
Long-term obligations(1) | | | 335 | | | | 193 | | | | 101 | | | | 41 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 44,233 | | | $ | 20,924 | | | $ | 7,751 | | | $ | 4,498 | | | $ | 1,404 | | | $ | 1,376 | | | $ | 8,280 | |
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(1) | | Includes interest expense. |
(2) | | Pertains to revolving line of credit and excludes interest expense due to short-term repayment period. |
(3) | | For employment agreement. |
Under most contracts, we provide the virtual schools we manage with turnkey management services and take responsibility for any operating deficits that the school may incur. These deficits are recorded as a reduction in revenues, and therefore are not included as a commitment or obligation in the above table.
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In connection with our service agreement with the Northern Ozaukee School District (and the Wisconsin Virtual Academy), there is an indemnification provision which arguably could be asserted by the school district for certain expenses in the event the plaintiff prevails and the Court enjoins open enrollment payments to the district that otherwise would cover those expenses. We have assessed the likelihood of a claim as remote, and therefore it has not been included as a commitment or obligation in the table above.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Impact of Inflation
We believe that inflation has not had a material impact on our results of operations for any of the years in the three year period ended June 30, 2007. We cannot assure you that future inflation will not have an adverse impact on our operating results and financial condition.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We had unrestricted cash and cash equivalents totaling $2.9 million, $1.7 million and $9.5 million as of September 30, 2007, June 30, 2007 and June 30, 2006, respectively. Unrestricted cash and cash equivalents are maintained primarily in non-interest bearing accounts and are used for working capital purposes. Because we currently do not have balances in interest bearing accounts, fluctuations in interest rates would not have a material impact on our investment income.
Our interest rate exposure is related to short-term debt obligations under our revolving credit facility. A significant portion of our interest expense is based upon changes in the LIBOR benchmark interest rate. Due to the short-term nature of our outstanding debt subject to variable interest rates as of JuneSeptember 30, 2007 of $1.5$12.5 million, fluctuations in the LIBOR rate would not have a material impact on our interest expense.
Foreign Currency Exchange Risk
We currently do not operate in a foreign country or transact business in a foreign currency and therefore we are not subject to fluctuations due to changes in foreign currency exchange rates. However, we intend to pursue opportunities in international markets in the future. 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.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, which revised SFAS No. 123, and supersedes APB Opinion No. 25. The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25 and requires that the compensation costs relating to such transactions be recognized in the statements of operations. We adopted SFAS No. 123R for the fiscal year ended June 30, 2007.
In February 2006, FASB issued Statement of Financial Accounting Standard No. 155 (SFAS No. 155),Accounting for Certain Hybrid Financial Instruments — An Amendment of FASB Statements No. 133 and 140. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. At adoption, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative effect adjustment to beginning retained earnings. We do not believe that the adoption of SFAS No. 155 will have a material impact on our consolidated financial statements.
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In June 2006, the FASB issued FASB Interpretation (FIN) 48,Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes
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recognized in an enterprise’s financial statements in accordance with SFAS No. 109,Accounting for Income Taxes. This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 on July 1, 2007. We believedetermined the adoptionimpact of this guidanceFIN 48 will not have a material effect on our financial position and results of operations. We are currently evaluating the effect that the adoption of FIN 48 will have on our financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157 (SFAS No. 157),Fair Value Measurements,which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are in the process of evaluating the impact of this statement on our consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159 (SFAS No. 159),The Fair Value Option for Financial Assets and Financial Liabilities.This statement permits companies and not-for-profit organizations to make a one-time election to carry eligible types of financial assets and liabilities at fair value, even if fair value measurement is not required under GAAP. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted if the decision to adopt the standard is made after the issuance of this statement but within 120 days after the first day of the fiscal year of adoption, provided no financial statements have yet been issued for any interim period and provided the requirements of SFAS No. 157, Fair Value Measurements, are adopted concurrently with SFAS No. 159. The Company does not believe that it will adopt the provisions of this statement.
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Our Company
We are a technology-based education company. We offer proprietary curriculum and educational services created for online delivery to students in kindergarten through 12th grade, or K-12. Our mission is to maximize a child’s potential by providing access to an engaging and effective education, regardless of geographic location or socio-economic background. Since our inception, we have invested more than $95$100 million to develop curriculum and an online learning platform that promotes mastery of core concepts and skills for students of all abilities. This learning system combines a cognitive research-based curriculum with an individualized learning approach well-suited for a virtual schoolschools and other educational applications. From fiscal year 2004 to fiscal year 2007, we increased average enrollments in the virtual public schools we serve from approximately 11,000 students to 27,000 students, representing a compound annual growth rate of approximately 35%. For the three months ended September 30, 2007, we increased average enrollments 50% to approximately 39,500, as compared to the same period in the prior year. From fiscal year 2004 to fiscal year 2007, we increased revenues from $71.4 million to $140.6 million, representing a compound annual growth rate of approximately 25%, and improved from a net loss of $7.4 million to net income of $3.9 million. For the three months ended September 30, 2007, we increased revenues to $59.4 million, representing a growth rate of 57%, as compared to the same period in the prior year. Over the same period, we increased net income to $5.7 million (excluding an income tax benefit of $7.1 million) from $4.7 million.
We believe we are unique in the education industry because of our direct involvement in every component of the educational development and delivery process. Most educational content, software and service providers typically concentrate on only a portion of that process, such as publishing textbooks, managing schools or providing testing and assessment services. This traditional segmented approach has resulted in an uncoordinated and unsatisfactory education for many students. Unburdened by legacy, we have taken a holistic approach to the design of our learning system. We have developed an engaging curriculum which includes online lessons delivered over our proprietary school platform. We combine this with a rigorous system to test and assess students and processes to manage school performance and compliance. In addition, our professional development programs enable teachers to better utilize technology for instruction. Our end-to-end learning system is designed to maximize the performance of the schools we serve and enhance student academic achievement.
As evidence of the benefit of our holistic approach, the virtual public schools we serve generally test near, and in some cases above, state averages on standardized achievement tests. These results have been achieved despite the enrollment of a significant number of new students each school year who have had limited exposure to our learning system prior to taking these required state tests. Students using our learning system for at least three years usually perform better on standardized tests relative to state averages than students using it for one year or less. The efficacy of our learning system has also helped us achieve high levels of customer satisfaction. According to a 2006 internal survey of parents of students enrolled in virtual public schools we serve, approximately 97% of respondents stated that they were either satisfied or very satisfied with our curriculum and 95% of respondents stated that they would recommend our curriculum to other families.
We deliver our learning system to students primarily through virtual public schools. As with any public school, these schools must meet state educational standards, administer proctored exams and are subject to fiscal oversight. The fundamental difference is that students attend virtual public 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 whom they interact online, telephonically, and face-to-face. Many states have embraced virtual public schools as a means to provide families with a publicly funded alternative to a traditional classroom-based education. For parents who believe their child is not thriving and for whom relocating or private school is not an option, virtual public schools can provide a compelling choice. This widespread availability makes them the “most public” of schools. From an education policy standpoint, virtual public 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 reported by the U.S. Department of Education. Finally, because parents are not required to pay tuition, virtual public schools make our learning system available to the broadest range of students.
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We offer virtual schools our proprietary curriculum, online learning platform and varying levels of academic and management services, which can range from targeted programs to complete turnkey solutions, under long-term contracts. These contracts provide the basis for a recurring revenue stream as students progress through successive grades. Additionally, without the requirement of a physical classroom, virtual schools can be scaled quickly to accommodate a large dispersed student population, and allow more capital resources to be allocated towards teaching, curriculum and technology rather than towards a physical infrastructure.
Substantially all of our enrollments are served through 25 virtual public schools to which we provide full turnkey solutions and seven virtual public schools to which we provide limited management services. With the exception of a school we manage in Chicago, these schools are able to enroll students on a statewide basis in 17 states and the District of Columbia. In contrast, a small number of enrollments are served by an additional 27 schools that only enroll students in a single school district in these and other states. The services we provide to these districts are designed to assist them in launching their own distance learning programs and vary according to the needs of the individual school districts. These services generally consist of our student account management systems, administrator and teacher training programs, and student placement support. Parents can also purchase our curriculum and online learning platform directly to facilitate or supplement their children’s education. Additionally, we have piloted our curriculum in brick and mortar classrooms with promising academic results. We also believe there is additional widespread applicability for our learning system internationally.
Families that choose our learning system for their children come from a broad range of social, economic and academic backgrounds. They share, however, the desire for an individualized learning program to maximize their children’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 concerns about their local school; (iii) students with disabilities for which traditional classrooms are problematic; (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 individual academic performance and, therefore, their chances of achieving their goals.
Our History
We were founded in 2000 to utilize the advances in technology to provide children access to a high-quality public school education regardless of their geographic location or socio-economic background. Given the geographic flexibility of technology-based education, we believed that the pursuit of this mission could help address the growing concerns regarding the regionalized disparity in the quality of public school education, both in the United States and abroad. These concerns were reflected in the passage of the No Child Left Behind (NCLB) Act in 2000, which implemented new standards and accountability requirements for public K-12 education. The convergence of these concerns and rapid advances in Internet technology created the opportunity to make a significant impact by deploying a high quality learning system on a flexible, online platform.
In September 2001, after 18 months of research and development on our curriculum, we launched our kindergarten through 2nd grade offering. We initially launched our learning system in virtual public schools in Pennsylvania and Colorado, serving approximately 900 students in the two states combined. During the2002-03 school year, we added our 3rd through 5th grade offering and entered into contracts to operate virtual public schools in California, Idaho, Ohio, Minnesota and Arkansas, increasing our average enrollment to approximately 5,900 students during the 2002-03 school year. DuringFor the2003-04 school year, we added our 6th and 7th grade offerings. During the2004-05 school years,year, we added 7thour 8th grade offering and 8th grades, respectively, and addedentered into contracts withto operate virtual public schools in Wisconsin, Arizona and Florida. By the end of the2004-05 school year, we had increased enrollment to approximately 15,100 students. In the 2005-06 school year, we added contracts to operate virtual public schools in Washington, Illinois and Texas. Additionally during the2006-07 school year, we implemented a hybrid school offering in Chicago that combines face-to-face time in the classroom with online instruction. We recently entered the virtual high school market, enrolling 9th and 10th grade students at the start of the2005-06 and2006-07 school years, respectively, and enrolling 11th and 12th grade students at the start of the2007-08 school year.
We believe we have significant growth potential. Therefore over the last three years, we have put a great deal of effort into developing the infrastructure necessary to scale our business. We further developed our logistics and
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technological infrastructure and implemented sophisticated financial systems to allow us to more effectively operate a large and growing company.
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Our Market
The U.S. market for K-12 education is large and growing. For example:
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| • | According to the National Center for Education Statistics (NCES), a division of the U.S. Department of Education, there were more than 49 million students in K-12 public schools during the 2005-06 school year. In addition, according to National Home Education Research, approximately two million students are home schooled and, according to a March 2006 NCES report, approximately five million students are enrolled in private schools. |
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| • | According to the NCES, the public school system alone encompassed more than 98,000 schools and 17,000 districts during the 2005-06 school year. |
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| • | The NCES estimates that total spending in the public K-12 market was $558 billion for the 2005-06 school year. |
Parents and lawmakers are demanding increased standards and accountability in an effort to improve academic performance in U.S. public schools. As a result, each state is now required to establish performance standards and to regularly assess student progress relative to these standards. We expect continued focus on academic standards, assessments and accountability in the near future.
Many parents and educators are also seeking alternatives to traditional classroom-based education that can help improve academic achievement. Demand for these alternatives is evident in the growing number of choices available to parents and students. For example, charter schools emerged in 1988 to provide an alternative to traditional public schools. Currently, 40 states and the District of Columbia have passed charter school legislation and there are approximately 4,000 charter schools in the U.S. with an estimated enrollment of over 1.1 million students according to the Center for Education Reform. Similarly, acceptance of online learning initiatives, including not only virtual schools but also online testing and Internet-based professional development, has become widespread. As of September 2006, 38 states had established some form of online learning initiative, and Michigan recently became the first state to pass legislation mandating that high school students take part in an “online learning experience” in order to graduate.
Virtual public schools represent one approach to online learning that is gaining acceptance. According to the Center for Education Reform, as of January 2007 there were 173 virtual schools with total enrollment exceeding 92,000 students, operating in 18 states compared to just 86 virtual schools in 13 states with total enrollment of 31,000 students in the 2004-05 school year. Virtual schools can offer a comprehensive curriculum and flexible delivery model; therefore, we believe that a growing number of families will pursue virtual public schools as an attractive public school alternative. Given these statistics and the nascence of this market, we believe there is a significant opportunity for a high-quality, trusted, national education provider to serve virtual public schools.
Our Competitive Strengths
We believe the following to be our key competitive strengths:
Proprietary Curriculum Specifically Designed for a Technology-Enabled Environment. We specifically designed our curriculum for online learning, in contrast to other online curriculum providers who often just digitize classroom textbooks for transmission over the Internet. Our lessons utilize a combination of innovative technologies, including flash animations, online interactivity and real-time individualized feedback, which we combine with textbooks and other offline course materials to create an engaging and highly effective curriculum. Our curriculum contains more than 11,000 discrete lessons, each of which addresses specific learning objectives and can be utilized in the manner most appropriate for each student. We continuously measure student performance and use this information to improve our curriculum and drive greater, more consistent academic achievement, a valuable competitive advantage we enjoy by virtue of our integration into all aspects of the educational development and
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delivery process. We believe our curriculum is the most advanced cognitive research-based curriculum inK-12 education.
Flexible, Integrated Online Learning Platform. Our online learning platform provides a highly flexible and effective means for delivering educational content to students. Our platform offers assessment capabilities to
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identify the current and targeted academic level of achievement for each individual student, and then incorporates this information into a detailed lesson plan. As students progress through their studies, our learning platform measures mastery of each learning objective to ensure that students grasp each concept prior to proceeding to the next lesson. Additionally, our learning platform updates each student’s lesson plan for completed lessons and enables us to track the effectiveness of each lesson with each student on a real-time basis. Finally, the fact that our learning system is Internet-based allows us to update our proprietary content and incorporate user feedback on a real-time basis. For example, our content for the 2006-07 school year reflected the fact that Pluto is no longer considered a planet, which was announced in August 2006.
Expertise in Opening Channels for Virtual Schooling. Our education policy experts and established relationships with key educational authorities have allowed us to participate effectively in advocating for virtual public schools. Specifically, we have demonstrated our expertise in helping individual educational policymakers understand the benefits of virtual schools and in managing the regulatory requirements once new virtual schools are opened. Since our inception, we have partnered with individual state governing bodies to establish highly effective, publicly funded education alternatives for parents and their children. Our experience in opening up these new channels gives us a valuable first-mover advantage over potential competitors.
Track Record of Student Achievement and Customer Satisfaction. The virtual public schools we serve generally test near, and in some cases above, state averages on standardized achievement tests. These results have been achieved despite the enrollment of a significant number of new students each school year who have had limited exposure to our learning system prior to taking these required state tests. Students using our learning system for at least three years usually perform better on standardized tests relative to state averages than students using it for one year or less. Additionally, in California, the virtual public schools we serve performed in the 50th to 70th percentile of all public schools in the state during the2005-06 school year. Among statewide virtual public schools, those using the K12 learning system outperform other providers in terms of academic performance. The efficacy of our learning system has also helped us achieve high levels of customer satisfaction. According to a 2006 internal survey of parents of students enrolled in virtual public schools we serve, approximately 97% of respondents stated that they were either satisfied or very satisfied with our curriculum and 95% of respondents stated that they would recommend our curriculum to other families. This high degree of customer satisfaction has been a strong contributor to our growth, helps drive new student referrals and leads to re-enrollments.
Highly Scalable Model. We have built our educational model systems and management team to successfully and efficiently serve the academic needs of a large dispersed student population. We generate high levels of recurring revenue as a result of our long-term contracts with schools (typically five years in length), the extended duration over which an individual student can utilize our learning system (kindergarten through 12th grade) and our high level of customer satisfaction. Since our inception, we have invested over $95 million to develop our learning system, incurring significant losses. Our ability to leverage this historical investment in our learning system and our ability to deliver our offering over the Internet enables us to successfully serve a greater number of students at a reduced level of capital investment.
Our Growth Strategy
We intend to pursue the following strategies to drive our future growth:
Generate Enrollment Growth at Existing Virtual Public Schools. From fiscal year 2004 to fiscal year 2007, we increased average enrollments in the virtual public schools we serve from more than 11,000 students to more than 27,000 students. In the2007-08 school year, substantially all of our enrollments are served through virtual public schools in 17 states and the District of Columbia. We intend to continue to drive increased enrollments at the virtual public schools we serve through targeted marketing and recruiting efforts as well as through referrals. Our marketing and recruiting efforts utilize both traditional and online media as well as community events to communicate the effectiveness of our solution to parents who are evaluating educational alternatives for their children. Historically, we
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have also enrolled a significant number of new students each year through referrals from families who have had a positive experience with our learning system and recommended K12 to their friends and family members.
Enhance Curriculum to Include a Complete High School Offering. We believe that serving virtual public high schools represents a significant growth opportunity for online education delivery given the increased
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independence of high school students and the wide variance in academic achievement levels and objectives of students who are entering high school.America’s Digital Schools 2006, a survey sponsored by Discovery Education and Pearson Education, projects that the percentage of U.S. high school students enrolled in online courses will increase from 3.8% in 2006 to 15.6% in 2011. We believe that our early offering of our integratedK-8 learning system and our experience serving K-8 virtual public schools positions us well for growth in serving virtual public high schools. In the 2005-06 and 2006-07 school years, we began enrolling 9th and 10th grade students, respectively, and with the launch of our 11th and 12th grades in the2007-08 school year, we are able to provide a complete high school offering. We are developing our high school curriculum to satisfy the broad range of high school student interests with a broad variety of required and elective courses, supplemented by selected courses from other content providers.
Expand Virtual Public School Presence into Additional States. We work closely with state policymakers and school districts to assist them in considering virtual public schools as an effective educational choice for parents and students. A virtual public school program can help state administrations or school districts quickly establish and offer an alternative to traditional classroom-based education, expanding the range of choices available to parents and students. The flexibility and comprehensiveness of our learning system allows us to efficiently adapt our curriculum to meet the individual educational standards of any state with minimal capital investment. We intend to continue to seek opportunities to assist states in establishing virtual public schools and to contract with them to provide our curriculum, online learning platform and related services.
Strengthen Awareness and Recognition of the K12Brand. Within the virtual public school community, we enjoy strong brand recognition among parents and students as a leading provider of virtual education. Outside of this community, however, the K12 brand is not as well recognized. We have developed a comprehensive brand strategy and intend to invest in further developing awareness of both the K12 brand and the core philosophy behind our learning system. The recent launch of our “Unleash thexPotential” campaign is a strong first step towards this goal of creating broader brand awareness. We believe that a strong and recognized brand will result in an increased presence among virtual public schools, attract more student applications and facilitate our entry into adjacent markets.
Pursue International Opportunities to Offer Our Learning System. We believe there is strong worldwide demand for high-quality, flexible education alternatives. In many countries, students seek a U.S. accredited education to gain access to higher education and improved employment opportunities. Given the highly flexible design and technology-based nature of our platform, it can be adapted to other languages and cultures efficiently and with modest capital investment. Additionally, our ability to operate virtually is not constrained by the need for a physical classroom or local teachers, which makes our learning system ideal for use internationally.
Develop Additional Channels Through Which to Deliver our Learning System. We believe there are many additional channels through which the K12 learning system can be offered. These include direct classroom instruction, hybrid models, and as a supplemental educational offering. For example, in an urban public school in Philadelphia, we piloted ourK-5 curriculum in traditional classrooms and were able to generate meaningful improvements in academic performance. Additionally, we have recently implemented a hybrid classroom offering in Chicago that combines face-to-face time in the classroom with online instruction. Outside the public school channels, the flexibility of our learning system enables us to package lessons to be sold as individual products directly to parents and students. We intend to regularly evaluate additional delivery channels and to pursue opportunities where we believe there is likely to be significant demand for our offering.
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Educational Philosophy
The design, development and delivery of our learning system is based on the following set of guiding principles:
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| • | Apply “Tried and True” Educational Approaches for Instruction. Our learning system is designed to utilize both “tried” and “true” methods to drive academic success. “True” methodologies are based on cognitive research regarding the way in which individuals learn. We also supplement our learning system with teaching tools and methodologies that have been tested, or “tried,” and proven to be effective. This “tried and |
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| | true” philosophy allows us to benefit from both decades of research about learning, and effective methods of teaching. |
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| • | Employ Technology Appropriately for Learning. While all of our courses are delivered primarily through an online platform and generally include a significant amount of online content, we employ technology only where we feel it is appropriate and can enhance the learning process. In addition to online content, our curriculum includes a rich mix of offline course materials, including engaging textbooks and hands-on materials such as phonics kits and musical instruments. We believe our balanced use of technology and offline materials helps to maximize the effectiveness of our learning system. |
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| • | Base Learning Objectives on Rich Content and “Big Ideas.” We refer to “big ideas” as the key, subconscious frameworks that serve as the foundation to a student’s future understanding of a subject matter. For example, an understanding of waves is fundamental to a physicist’s understanding of quantum mechanics; therefore, we teach 1st graders the fundamentals of waves. We use these “big ideas” to organize and provide the master objectives of every course we develop. We then utilize rich, engaging content to best communicate these concepts to students to promote mastery of the topics. |
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| • | Assess Every Objective to Ensure Mastery. Ongoing assessments are the most effective way to evaluate a student’s mastery of a lesson or concept. To facilitate effective assessment, our curriculum establishes clear objectives for each lesson. Throughout a course, each student’s progress is assessed and evaluated by a teacher at a point when each objective is expected to be mastered, providing direction for appropriate pacing. These periodic and well-timed assessments reinforce learning and promote mastery of a topic before a student moves to the next lesson or course. |
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| • | Facilitate Flexibility as the Level, Pace and Hours Spent on Each Objective Vary by Child. We believe that each student should be challenged appropriately. Generally, adequate progress for most students is to complete one academic year’s curriculum within a nine-month school year. Each individual student may take greater or fewer instructional hours and more or less effort than the average student to achieve this progress. Our learning system is designed to facilitate this flexibility in order to ensure that the appropriate amount of time and effort is allocated to each lesson. |
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| • | Prioritize Important, Complex Objectives. We have developed a clear understanding of those subjects and concepts that are difficult for students. Greater instructional effort is focused on the most important and difficult concepts and skills. We use existing research, feedback from parents and students and experienced teacher judgments to determine these priorities, and to modify our learning system to guide the allocation of each student’s time and effort. |
Products and Services
Our Products
K12 Curriculum
Our curriculum consists of the K12 online lessons, offline learning kits and teachers’ guides. We have developed an extensive catalogue of proprietary courses, consisting of more than 11,000 lessons, designed to teach concepts to students from kindergarten through 10th grade. Each lesson is designed to last approximately 45 to 60 minutes, although students are able to work at their own pace. A single course generally consists of 120 to 180 individual lessons.
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Online Lessons. Our online lessons are accessed through our Online School (OLS) platform. Each online lesson provides the roadmap for the entire lesson including direction to specific online and offline materials, online lesson content and a summary of the major objectives for the lesson. Lessons utilize a combination of innovative technologies including flash animations and online interactivity, coordinated textbooks and hands-on materials and individualized feedback to create an engaging, responsive and highly effective curriculum. Each lesson also contains an online assessment to ensure that students have mastered the material and are ready to proceed to the next lesson, allowing them to work at their own pace. Pronunciation guides for key words and references to suggested additional resources, specific to each lesson and each student’s assessment, are also included.
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Offline Learning Kits. All of our courses utilize a series of offline learning kits in conjunction with the online lessons to help maximize the effectiveness of our learning system. In addition to receiving access to our online lessons through the Internet, each student receives a shipment of offline materials, including textbooks, art supplies, laboratory supplies (e.g. microscopes and scales) and other reference materials which are incorporated throughout our curriculum. This approach is consistent with our guiding principle to utilize technology where appropriate in our learning system. Most of the textbooks we use are proprietary textbooks that are written in a way that is designed to be engaging to students and to compliment the online experience. We believe that our ability to combine online lessons and offline materials so effectively is a competitive advantage.
Teachers’ Guides. All of our courses are paired with a teacher’s guide. Each guide outlines the course objectives, refers back to all of the course content that is contained in the online and offline course materials, includes answers and explanations to the exercises that the students complete and contains suggestions for explaining difficult concepts to students.
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Courses Offered
The following table provides a list of our proprietary courses (including 11 foreign language courses the licences of which we have acquired by virtue of our recent acquisition of Power-Glide Language Courses, Inc., a third-party content provider) and selected third-party courses (shown in italics) that we are offering during the 2007-08 school year. We also offer an additional 20 third-party courses at the high school level.
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| | | | English and Language Arts | | Mathematics | | Science |
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Elementary School
Middle School
High School
Elementary School
Middle School
High School
| | Kindergarten Language Arts Kindergarten Phonics 1st Grade Language Arts 1st Grade Phonics 2nd Grade Language Arts 3rd Grade Language Skills 3rd Grade Spelling 3rd Grade Literature 4th Grade Language Skills 4th Grade Spelling 4th Grade Literature 5th Grade Language Skills 5th Grade Spelling 5th Grade Literature
Intermediate Language Skills A Intermediate Language Skills B Intermediate Literature A Intermediate Literature B Literary Analysis and Composition
Literary Analysis and Composition I Foundations Literary Analysis and Composition I Literary Analysis and Composition II American Literature AP English Literature and Composition World Literature and Language
History Kindergarten History 1st Grade History 2nd Grade History 3rd Grade History 4th Grade History American History Before 1865
American History Since 1865 Intermediate World History A Intermediate World History B
Modern World Studies World History U.S. History AP U.S. History American Government and Economics Macroeconomics
| | Kindergarten Math 1st Grade Math 2nd Grade Math 3rd Grade Math 4th Grade Math 5th Grade Math
Pre-Algebra A Pre-Algebra B Algebra I
Pre-Algebra Pre-Algebra Foundations Algebra Foundations Algebra I Geometry Algebra II
Art Kindergarten Art 1st Grade Art 2nd Grade Art 3rd Grade Art 4th Grade Art Intermediate Art: American A
Intermediate Art: American B Intermediate Art: World A Intermediate Art: World B
Art History Fine Art and Art Appreciation
| | Kindergarten Science 1st Grade Science 2nd Grade Science 3rd Grade Science 4th Grade Science 5th Grade Science Kindergarten Science (classroom) 1st Grade Science (classroom) 2nd Grade Science (classroom) 3rd Grade Science (classroom)
Earth Science Life Science Physical Science
Earth Science Foundations Physical Science Foundations Biology Foundations Earth Science Biology Physical Science
Music/Other Preparatory Music Beginning 1 Music Beginning 2 Music Introduction to Music Intermediate 1 Music Intermediate 2 Music Intermediate 3 Music Exploring Music
Music Concepts A Music Concepts B
Music Appreciation Learning Online Physical Education Spanish I, II, III French I, II, III German I, II Latin I, II Chinese I
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K-8 Courses. From kindergarten through 8th grade, our courses are categorized into six major subject areas: English and Language Arts, Mathematics, Science, History, Art and Music. Our proprietary curriculum includes all of the courses that students need to complete their core kindergarten through 8th grade education. These courses focus on developing fundamental skills and teaching the key knowledge building blocks or schemas that each student will need to master the major subject areas, meet state standards and complete more advanced coursework. Unlike a traditional classroom education, our learning system offers the flexibility for each student to take courses at different grade levels in a single academic year, providing flexibility for students to progress at their own level and pace within each subject area. In addition, the flexibility of our learning system allows us to tailor our curriculum to state specific requirements. For example, we have developed eight courses specifically for use in Texas public schools.
High School Courses. The curriculum sought by students in each of the high school grades is much broader and varies from student to student, largely as a result of the increased flexibility in course selection required for high school students. In order to offer a full suite of courses, including the many elective courses required to meet the needs of high school students, we offer a combination of proprietary courses and selected rigorously tested courses licensed from third-parties. We have 27 proprietary high school courses for the 2007-08 school year (including eight courses that have one or more lessons that remain under development for delivery prior to their first scheduled use later in the school year). The high school students we serve using our proprietary courses account for approximately 60% of the total course enrollment of our high school students in the2007-08 school year.
Online School Platform
Our Online School (OLS) platform is an intuitive, web-based software platform that provides access to our online lessons as well as our lesson planning and scheduling tools and our progress tracking tool, both of which serve a key role in assisting parents and teachers in managing each student’s progress. Because the OLS is a web-based platform, students, parents and teachers can access our online tools and lessons through the OLS from anywhere with an Internet connection at any time of the day or night.
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| • | Lesson Planning and Scheduling Tools. In a school year, a typical student will complete between 800 and 1,200 lessons across six or more subject areas. Our lesson planning and scheduling tools enable teachers and parents to establish a master plan for completing these lessons. These tools are designed to dynamically update the lesson plan as a student progresses through each lesson and course, allowing flexibility to increase or decrease the pace at which the student moves through the curriculum while ensuring that the student progresses towards completion in the desired time frame. For example, the schedule can easily be adapted to accommodate a student who desires to attend school six days a week, a student who is interested in studying during the winter holidays to take time off during the spring, or a student who chooses to take two math classes a day for the first month of the school year and delay art classes until the second month of the school year. Moreover, changes can be made to the schedule at any point during the school year and the remainder of the student’s schedule will automatically adjust in the OLS. |
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| • | Progress Tracking Tools. Once a master schedule has been established, the OLS delivers lessons based upon the specified parameters. Each day, a student is initially directed to a screen listing the syllabus for that particular day and begins the school day by selecting one of the listed lessons. As each lesson is completed, the student returns to the day’s syllabus to proceed to the next subject. If a student does not complete a lesson during the session, the lesson will be rescheduled to the next day and will resume at the point where the student left off. Our progress tracking tool allows students, parents and teachers to monitor student progress. In addition, information collected by our progress tracking tool regarding student performance, attendance and other data is transferred to our proprietary management system for use in providing administrative support services. |
Student Administration Management System
Our Student Administration Management System (SAMS) organizes, updates and reports information that is automatically collected through interfaces with our OLS and related management systems. SAMS collects and provides us with all of the information required to manage student enrollment and monitor student performance.
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SAMS is also central to collecting and managing all administrative data required to operate a virtual public school. In addition, the information provided by SAMS feeds our proprietary Order Management System (OMS) that generates orders for offline learning kits and computers to be delivered to students.
Student Community Tools
We place a strong emphasis on the importance of building a sense of community in the schools we manage. Accordingly, we offer a combination of tools that foster communication and interaction among virtual public school students and parents. Our K12 Community Chest website for virtual public school students includes discussion boards, blogs, games, competitions and other functions. Additionally, our K12 Family Directory web-based tool enables parents of virtual public school students to organize online and offline social activities for their children. Parents can run searches based on criteria such as their child’s location, age or interests (such as hobbies or sports) to locate and contact other parents of children with similar interests to facilitate student interaction.
Our Services
We provide a wide array of services to students and their families as well as directly to virtual public schools. Our services can be categorized broadly into academic support services and management and technology services.
Academic Support Services
Teachers and Related Services. Teachers are critical to the educational success of students in virtual public schools. Teachers in the virtual public schools that we serve are generally employed by the school, with the ultimate authority over these teachers residing with the school’s governing body. Under our service agreements, we recruit, train and provide management support for these teachers. Historically, we have seen significant demand for teaching positions in the virtual public schools that we serve. For example, for the virtual public schools we serve in California, we recently received approximately six applications for each teaching position filled for the2006-07 school year.
We use a rigorous evaluation program for making hiring recommendations to the virtual public schools we serve. We hire teachers who, at a minimum, are state certified and meet the federal requirements for designation as a “Highly Qualified Teacher,” and generally have at least three years of teaching experience. We also seek to recruit teachers who have the skill set necessary to be successful in a virtual public school environment. Teaching in a virtual public school is characterized by heightenedone-on-one student-teacher and parent-teacher interaction, so virtual public school teachers must have strong interpersonal communications skills. Additionally, a virtual public school teacher must be creative in finding ways to effectively connect with their students and integrate themselves into the daily lives of the students’ families.
New virtual public school teachers attend our comprehensive training program during which, among other things, they are introduced to our educational philosophy, our curriculum and our OLS and other technology applications, and are provided strategies for communicating and connecting with students and their families in a virtual public school environment. We also provide ongoing training opportunities for teachers so that they may stay abreast of changing educational standards and key learning trends, which we believe enhances their teaching abilities and effectiveness.
Gifted and Special Education Services. We believe that our individualized learning system is able to effectively address the educational needs of gifted and special education students because it is self-paced and employs flexible teaching methods. For students requiring special attention, we employ a national director who is an expert on the delivery of special education services in a virtual public school environment and who oversees and directs the special education programs at the virtual public schools we serve. We direct and facilitate the development and implementation of “individualized education plans” for students with special needs. Our special education program is compliant with the federal Individuals with Disabilities Education Act and all state special education requirements. Each special needs student is assigned a certified special education teacher who arranges for any required ancillary services, including speech and occupational therapy, and any required assistive technologies, such as special computer displays or speech recognition software.
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Student Support Services. We provide students attending virtual public schools that we serve and their families with a variety of support services to ensure that we effectively meet their educational needs and goals. Each student is assigned a guidance counselor to assist them with academic achievement planning. Additionally, we provide tutors as necessary to help students with courses that they find difficult. We also plan and coordinate social events to offer students opportunities to meet and socialize with their virtual public school peers. Finally, we offer our “K12 HUG” (Help, Understanding and Guidance) program to address any other questions or concerns that students and their parents have during the course of their matriculation.
Management Services
Under many of our contracts, we provide virtual public schools with turnkey management services. In these circumstances, we take responsibility for all aspects of the management of the 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. In 2007, the Commission on International and Trans-regional Accreditation (CITA), a leading worldwide education accreditation agency, thoroughly evaluated our school management services and we ultimately received the prestigious CITA accreditation.
Compliance and Tracking Services. Operating a virtual public school entails most of the compliance and regulatory requirements of a traditional public school. We have developed management systems and processes designed to ensure that schools we serve are in compliance with all applicable requirements, including tracking appropriate student information and meeting various state reporting requirements. For example, we collect enrollment related information, monitor attendance and administer proctored state tests. As we have expanded into new states, our processes have grown increasingly robust, and we believe our compliance and tracking processes provide us with a distinct competitive advantage.
Financial Support Services. We provide each school we serve with a dedicated business manager who oversees the preparation of the annual budget and coordinates with the school’s directors to determine their annual objectives. In addition, we implement an internal control framework, develop policies and procedures, provide accounting services and payroll administration, oversee all federal entitlement programs and arrange for external audits.
Facility, Operations and Technology Support Services. We operate administrative offices and all other facilities on behalf of the virtual public schools we serve. We provide these schools with a complete technology infrastructure. In addition, we provide a comprehensive student help desk solution.
Human Resources Support Services. We are actively involved in hiring virtual public school administrators, teachers and staff, through a thorough interview and orientation process. To better facilitate the hiring process, we review and analyze the profiles of teachers that have been highly effective in our learning system to identify the attributes desired in future new hires. We also negotiate and secure employment benefits for teachers on behalf of virtual public schools and administer employee benefit plans for virtual public school employees. Additionally, we assist the virtual schools we serve in drafting and implementing administrative policies and procedures.
Product Development
We develop our products and related service offerings through a highly collaborative process that blends cognitive research with an innovative development approach by utilizing best practices from the education industry and other industries. Our approach provides for effective content and rapid time to market. Unlike many traditional content companies that may take several years to develop a new course, our course development process usually takes between six and 12 months, depending upon grade and subject. Our development team includes professionals from the following disciplines:
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| • | Cognitive Scientists, Evaluation and Research Specialists — conduct and review cognitive research to determine how students master the key ideas in a subject area, the common misconceptions that present obstacles to mastery and available techniques that can effectively address common misconceptions. |
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| • | Curriculum and Teaching Specialists — bring deep subject matter knowledge and experience with a variety of pedagogical approaches to our course design process. |
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| • | Writers and Editors — script out the text of the lessons, ensuring that the information is accurate, meaningful and suitable for the age group we are trying to reach. |
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| • | Instructional Designers — weave together all elements of a lesson and determine the extent to which online, multi-media components, textbooks and other offline materials, and activities can be integrated to achieve the desired learning outcomes. |
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| • | Graphic Artists/Media Specialists/Flash Designers — ensure overall visual integrity of each lesson and build creative and interactive content. |
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| • | Print Designers — design and publish our proprietary textbooks and printed learning materials. |
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| • | User Experience Specialists — work closely with our design teams to ensure that lessons are easy for students to navigate and understand. |
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| • | Training Specialists — concurrent with the development of the courses, develop training materials and programs to support the effective delivery of our curriculum by teachers. |
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| • | Project Managers — coordinate all of the activities, including the work of the above-listed resources to develop the product as designed, on time, and on budget. |
Using these highly skilled resources, we follow a six-stage product development process beginning with idea-generation and carrying through to post-production evaluation. Our ability to continually modify our products based upon student, parent and teacher feedback and assessment data is one of the significant advantages of our online curriculum. All of our lessons contain a user feedback button that allows us to identify learning issues on a real-time basis. In a given week, we receive hundreds of feedback items from students, parents and teachers. The related descriptions below illustrate each stage in our product development process.
Blueprint Stage. During this stage of development, we gather the key requirements for a new product, which may be a new course or a group of related courses. We conduct a thorough review to identify all of the cognitive research related to learning of the subject and gain an understanding of the stages a student will go through in mastering the subject material. We also look at how experts perform in the subject. Expert-novice research has shown that an experts’ knowledge of a domain is contained in a subconscious framework, the components of which can help guide the development of a course. During this stage, we also analyze state standards to confirm that we are encompassing the elements of the nation’s highest state standards and that we are building courses which meet or surpass all state standards.
Design Stage. We begin the design stage by developing the learning environment in which the product will be used. This includes understanding the types of students that will be using the product, how the course will be taught, the learning objectives within the course and what online and offline materials can be utilized. We then produce a design document and our creative teams develop a work plan for every aspect of the product, including the look and feel of the product, level of functionality and length of the course. We produce, test and refine prototypes with focus groups of students, teachers and parents.
Pre-production Stage. With the work plan complete, a pre-production team is assembled to develop the scope and sequence of the course. The scope and sequence is an ordered collection of learning objectives based on cognitive research and state standards. These learning objectives, once organized, guide the production team in the creation of the individual course lessons. The pre-production team also creates the list of materials that will be required and provides this list to our logistics group for sourcing.
Production Stage. During this stage, the product is built in accordance with the work plan. First, manuscripts, storyboards and lesson design specifications are created. Online screens, offline materials such as textbooks, simulations, photographs, and other reference materials are then created, reviewed and refined. Rights for licensed materials are cleared at this point, if needed. Each lesson then goes through a rigorous quality review before being released.
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Support Stage. The goal during this stage is to support the initial launch and ongoing utilization of our lessons and to enhance the products during the course of their useful life. We break this stage down into three components: (i) content development, where we design and develop teacher and student training packages; (ii) alignment and standards analysis, where we examine performance on state tests to determine the extent to which we should refine or adjust the standard alignments initially developed during the blueprint stage; and (iii) long-term maintenance, where we maintain and update the online and offline materials on an ongoing basis based upon feedback from teachers, parents and students.
Evaluation Stage. The final stage of the product development cycle is the evaluation stage. During this phase, we evaluate the overall performance of our product against the original design specifications. We obtain measurement feedback from a number of sources, including:
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| • | User Feedback — we receive a substantial amount of feedback from teachers, parents and students. Some feedback is directly incorporated into course modifications. In addition, we observe students in our usability labs and visit students and parents to better understand how our products are being used; |
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| • | Progress Reports — through our OLS, we are able to monitor each student’s progress through a course. This data helps us identify portions of a course that may be especially difficult for students, and may require revision or enhancements; and |
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| • | State Test Scores — students in the virtual public schools we serve participate in proctored state exams. These tests provide an impartial assessment of how these students are performing against established benchmarks and within their state. |
Using these sources of feedback, we can revise our courses as necessary to achieve the desired learning objectives. We believe that this ability to proactively respond to feedback and other data in an efficient manner is a key competitive advantage within the educational industry.
Education Advisory Committee. To ensure the effectiveness of our learning systems, we have established an external Education Advisory Committee comprised of experienced leaders in the education industry. The members of this Committee have the responsibility to review our curriculum and instructional model, identify the needs of the growing online education market and propose solutions for consideration by our management, and discuss ways that we can better implement our guiding principles. The current members of the Committee include:
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| • | Thomas C. Boysen, Ed.D., Senior Vice President of Classroom Solutions, K12 Inc. and formerly Kentucky Commissioner of Education, Chief Operating Officer of the Los Angeles Unified School District, Senior Vice President of the Milken Family Foundation and a school district superintendent in California, Washington and New York. Mr. Boysen is also the Chair of the Education Advisory Committee. |
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| • | Barbara Byrd-Bennett, Ed.D., Executive-In-Residence, College of Education and Human Services, Cleveland State University and formerly Chief Executive Officer of the Cleveland Municipal School District and a school district superintendent for two school districts in New York City. |
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| • | Benjamin Canada, Ph.D., Associate Executive Director, District Services, Texas Association of School Boards and formerly President of the American Association of School Administrators and a school district superintendent in Georgia, Mississippi and Oregon. |
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| • | Ramon Cortines, Ed.D., Deputy Mayor for Education, Youth and Families, City of Los Angeles and formerly a school district superintendent in California and New York. |
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| • | Jo Lynne DeMary, Ed.D., Educational Leadership Director, Center for School Improvement, Virginia Commonwealth University and formerly Virginia Superintendent of Public Instruction. |
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| • | David Driscoll, Ed.D., Education Consultant and formerly President, Council of Chief State School Officers, Commissioner of Education, Commonwealth of Massachusetts and a school district superintendent in Massachusetts. Dr. Driscoll currently serves on the board of the National Assessment Governing Board. |
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| • | Chester Finn, Ed.D., President, Thomas B. Fordham Foundation and formerly Assistant Secretary for Research and Improvement & Counselor to the Secretary, U.S. Department of Education. |
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| • | Charles Fowler Ed.D., President of School Leadership, LLC, Executive Secretary of the Suburban School Superintendents, an Adjunct Professor of School Organization and Leadership, Teachers College, Columbia University and formerly Chairperson of State and National Relations for the American Association of School Administrators and a school district superintendent in Connecticut, Florida, Illinois and New York. |
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| • | Mary Futrell, Ed.D., Dean, Graduate School of Education and Human Development, George Washington University, Director, George Washington Institute for Curriculum Standards and Technology and founding President, World Confederation of the Teaching Procession and formerly President, National Education Association, President, Virginia Education Association, President, Education International and President, ERAmerica. |
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| • | Michael Kirst, Ph.D., Professor Emeritus of Education and Business, Stanford University and formerly President of the California State Board of Education. |
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| • | Dale Mann, Ph.D., Managing Director, Interactive Inc. and Professor Emeritus of Educational Administration, Teachers College, Columbia University and formerly Senior Research Associate, Institute on Education and the Economy, Teachers College, Columbia University. |
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| • | Thomas Payzant, Ed.D., Professor of Practice, Harvard Graduate School of Education and formerly Assistant Secretary for Elementary and Secondary Education, U.S. Department of Education and a school district superintendent in California, Pennsylvania, Massachusetts, Oklahoma and Oregon. |
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| • | Betty Rosa, Ed.D., Education Consultant and formerly a school district superintendent in New York City. Ms. Rosa also serves on the board of the Alumni Council of the Harvard Graduate School of Education. |
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| • | Bernice Stafford, M.A., Principal Consultant, Center for Interactive Learning and Collaboration and formerly Vice President of School Strategies and Evaluation, PLATO Learning, Inc. and a co-founder of Lightspan, Inc. |
Channel Development
K12 receives numerous inquiries from school districts, legislators, community leaders, educators and parents who express the desire to offer a virtual public school alternative. Our school development and public affairs groups work together with these interested parties to identify and pursue opportunities to expand the use of our products and services through new channels and in new jurisdictions. Where interested parties seek to offer a virtual public school alternative in their state, our public affairs group works with them to establish the legal framework, advocate for appropriate legislation and explain the educational and fiscal benefits of our learning system. Our public affairs group also seeks to increase public awareness and ensure transparency in virtual schooling by supporting accountability standards for virtual public schools.
Once there is legal and regulatory authorization for, as well as sufficient interest in, a virtual public school, our school development group engages state and school district officials, legislators, community leaders, educators and parent groups seeking to open a virtual public school, and initiates a dialog with these interested parties to explain the steps necessary to pursue this public school alternative in their jurisdiction. Our school development group works with these officials and parent groups in planning, developing and launching the virtual school. We also offer assistance to independent school boards with charter application and authorization processes.
After virtual public schools are approved and established, our school development group engages school administrators and maintains relationships with school officials in order to ensure that they are aware of our product and services offerings and that we understand their specific needs and goals.
Distribution Channels
We distribute our products and services primarily to virtual public schools and directly to consumers. We derive revenues from virtual public schools by providing access to our OLS, offline learning kits, student computers and a variety of management and academic support services, ranging from turnkey end-to-end management solutions to a single service to meet a school’s specific needs.
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In fiscal year 2007, we derived more than 10% of our revenues from each of the Ohio Virtual Academy, the Arizona Virtual Academy, the Pennsylvania Virtual Charter School and the Colorado Virtual Academy. In aggregate, these schools accounted for 49% of our total revenues. As with all of the virtual public schools we serve, each of these schools is subject to periodic audits. Two such audits of the Colorado Virtual Academy have initially resulted in the disallowance of funding with respect to approximately 63 students alleged not to have satisfied enrollment requirements and approximately 290 students alleged not to have satisfied certain other documentation requirements in the2004-05 school year and approximately 90 students alleged not to have satisfied enrollment requirements in the2005-06 school year (out of total enrollments of approximately 2,000 students in 2004-05 and approximately 2,500 students in 2005-06). Certain of these determinations are being appealed, but to the extent determined adversely to these schools, we would be obligated to reimburse these schools pursuant to our agreements with them to forgive expenses that they incur in excess of their revenues. We have not received written notice of any other claims or litigation involving these schools. We provide our full turnkey solution pursuant to our contract with the Ohio Virtual Academy, which terminates June 30, 2017 and provides for the parties to review the agreement in 2012. The agreement is renewable automatically for an additional two years unless the school notifies us one year prior to expiration that it elects to terminate the contract. We provide our full turnkey solution to the Arizona Virtual Academy, pursuant to a contract with Portable Practical Education, Inc., an Arizona not-for-profit organization holding the charter under which the school operates, that expires June 30, 2010. We provide our curriculum and online learning platform to the Pennsylvania Virtual Charter School pursuant to a contract that terminates June 30, 2009, and which automatically renews for an additional three-years unless the school notifies us one year prior to expiration that it elects to terminate the contract. We provide turnkey solution pursuant to our contract with the Colorado Virtual Academy, which terminates June 30, 2008. We are currently engaged in negotiations with the Colorado Virtual Academy for a new contract. Each of the contracts with these schools provides for termination of the agreement if the school ceases to hold a valid and effective charter from the charter-issuing authority in their respective states.
Our direct-to-consumer product is purchased through our customer call center or online by parents, who are looking either to educate their children outside the public school system or as a supplement to their child’s existing public school curriculum. The flexibility of our curriculum combined with the assessment capabilities of our online delivery platform enables us to modularize and repackage lesson modules that can be sold as individual products. For example, if a child has particular difficulties with fractions, the parent could purchase our fractions module. The ability to rebundle individual lessons is highly scalable and we believe this opportunity is significant.
In addition to these primary distribution channels, we are continuously pursuing additional channels through which to offer our learning system, including direct classroom instruction and hybrid models. For example, we have piloted select grades and subjects of our curriculum in classrooms in 11 states. Although our in-class offering business is at a nascent stage, we believe that this distribution channel offers significant potential. Additionally, we have recently implemented a hybrid offering in Chicago that combines some face-to-face time for students and teachers in a traditional classroom setting along with online instruction. In addition to expanding our offering to additional jurisdictions within the United States, we intend to pursue international opportunities where we believe there is significant demand for a quality online education.
Student Recruitment and Marketing
Our student recruitment and marketing team consisted of 4449 employees as of JuneSeptember 30, 2007, and is responsible for promoting our corporate brand, generating new student enrollments and enhancing the experience of students and families enrolled in the virtual public schools we serve. This team employs a variety of strategies designed to better understand and address the requirements of our target markets. First, this team is responsible for defining our brand image and associating our brand with the many positive attributes of our learning system. We believe that a strong brand provides the basis for our expansion into new states and other markets.
Second, our student recruitment and marketing team generates new enrollments in the virtual public schools we serve through targeted recruiting programs, which utilize coordinated direct mailings, email marketing, print and radio advertising and search engine marketing. In addition, our marketing team conducts information sessions and workshops that provide teachers and parents with the opportunity to learn about K12 and the products and services that we offer. We conducted more than 2,500 such events during fiscal year 2007. We have found that
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effectively communicating the details and benefits of our learning system is an important first step towards building a core group of interested parties. Additionally, we believe that our consistently high customer satisfaction rates serve as the foundation for word-of-mouth referrals which supplement our other recruiting efforts.
Finally, this team is responsible for enhancing our relationship with students enrolled in the virtual public schools that we serve to complement the relationship that these students have with their teachers and school. In order to maintain a sense of community, we host the K12 Community Chest website for students to interact online with our Chief Learning Officer and with each other. We also send welcome packages, conduct art contests, survey parents and provide support to students through assigned support counselors under our K12 HUG program.
Technology
As of JuneSeptember 30, 2007, we employed 5970 employees in our technology department. Our learning system, along with our back office systems supporting order management, logistics ande-commerce, are built on our proprietary Service Oriented Architecture, or SOA, to ensure high availability and redundancy and allow flexibility and security to be core principles of our systems’ foundation.
Service Oriented Architecture. All of our systems leverage our SOA built on top of Enterprise Java that separates an implemented capability from a request flow that utilizes those capabilities. This leverage provides us with the ability to deliver different presentations against a single request workflow. Additionally, this flexibility allows iterative solutions to be developed expeditiously to meet both present and future market needs. Our high availability and scalability are also facilitated by this architecture. The SOA also enables seamless integration with third-party solutions in our platform with ease and efficiency.
Availability and Redundancy. Our SOA allows for a hardware topology where primary and secondary equipment can be utilized at all network and application tiers. Each application layer is load balanced across multiple servers, which, along with our sophisticated state management capabilities, allows for additional hardware to be inserted into our network providing us with impressive scalability and availability as evidenced by our greater than 99.9999% uptime with our ever growing user base. We regularly backup critical data and store this backup data at an offsite location.
Security. Our security measures and policies include dividing application layers into multiple zones controlled by firewall technology. Sensitive communications are encrypted between client and server and our server-to-server accessibility is strictly controlled and monitored.
Physical Infrastructure. We utilize the best of breed hardware from industry leading vendors including Cisco, F5, Oracle, Sun, Microsoft, Dell, Intel, and NetApp to provide a foundation for our SOA. Our systems are housed offsite in a state of the art data center that provides robust, redundant network backbone and power. We vigilantly monitor our physical infrastructure for security, availability, and performance.
Competition
We face varying degrees of competition from a variety of education companies because our learning system encompasses many components of the educational development and delivery process. We compete primarily with companies that provide online curriculum and school support services toK-12 virtual public schools. These companies include Connections Academy, LLC, White Hat Management, LLC and National Network of Digital Schools. We also face competition from curriculum developers, including traditional textbook publishers such as the McGraw-Hill Companies, Harcourt, Inc., Pearson plc and Houghton Mifflin Riverdeep Group plc. Additionally, we expect increased competition from post-secondary and supplementary education providers that have begun to establish a presence in theK-12 virtual school sector, including Apollo Group, Pearson plc and Kaplan, Inc.
We believe that the primary factors on which we compete are:
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| • | track record of academic results and customer satisfaction; |
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| • | quality of curriculum and online delivery platform; |
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| • | qualifications and experience of teachers; |
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| • | comprehensiveness of school management and student support services; and |
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| • | cost of the solution. |
We are unable to provide meaningful data with respect to our market share. WeAt a minimum, we believe that we serve the market for public education, and in any jurisdiction in which we operate, we serve far less than 1% of the public school students in the geographic area in which virtual school enrollments are drawn. Defining a more precise relevant market upon which to base a share estimate would not be meaningful due to significant limitations on the comparability of data among jurisdictions. For example, some providers to K-12 virtual schools serve only the high school segment, others serve the elementary and middle school segment, and a few serve both. Furthermore, some school districts offer their own virtual programs. Parents in search of an alternative to their local public school also have a number of substitutable choices beyond virtual schools including private schools, charter schools, home schooling, and blended public schools. In addition, our integrated learning system consists of components that face competition from many different education industry segments, such as traditional textbook publishers, test and assessment firms and private education management companies. Finally, our learning system is designed to operate domestically and internationally over the Internet, and thus the geographic addressable market is global and indeterminate in size.
Intellectual Property
Since our inception, we have invested more than $95 million to develop our proprietary curriculum and OLS. We continue to invest in our intellectual property as we develop more courses for new grades and expand into adjacent education markets, both in the U.S. and overseas. These intellectual property assets are critical to our success and we avail ourselves of the full protections provided under the patent, copyright, trademark and trade secrets laws. We also routinely utilize confidentiality and licensing agreements with our employees, students, the virtual public schools that we serve, direct-to-consumer customers, independent contractors and other businesses and persons with which we have commercial relationships.
On May 1, 2007, the United States Patent and Trademark Office (USPTO) granted us the patent for our “System and Method of Virtual Schooling” (Patent No. 7,210,938), which provides us with a period of exclusive use until January 26, 2024. In general terms, this patent covers the hardware and network infrastructure of our online school, including the system components for creating and administering assessment tests, the planner, lesson progress tracker and instructional sequencer. We also have four additional international and five additional U.S. patents pending, and several pending provisional U.S. patent applications.
We own the copyright in over 11,000 lessons contained in 87 courses that make up our proprietary curriculum, including our online lessons and offline learning kits, and we register this growing lesson portfolio with the U.S. Copyright Office as each new course is completed or updated. We own and use the domain names K12 (.com, .org) andK-12 (.com, .net, .org) as well as the trademark and service mark, K12. In addition, we have applied to the USPTO to register the trademark “Unleash thexPotential.”
Students who enroll in the virtual public schools we serve are granted a license to use our software in order to access our learning system. Similarly, virtual public schools are granted a license to use our learning system in order to access SAMS and our other systems. These licenses are intended to protect our ownership and the confidentiality of the embedded information and technology contained in our software and systems. We also own the trademarks and service marks that we use as part of the student recruitment and branding services we provide to virtual public schools. Those marks are licensed to the schools for use during the term of the products and services agreements.
Our employees, contractors and other parties with access to our confidential information sign agreements that prohibit the unauthorized use or disclosure of our proprietary rights, information and technology.
Operations
An essential component of the K12 courses are the offline learning kits that accompany our online lessons. A student enrolling in one of our courses receives multiple textbooks, art supplies, laboratory supplies (e.g. microscopes and scales) and other reference materials designed to enhance the learning experience. We package these books and materials into course-specific learning kits. Because each student’s curriculum is customized, the
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combination of kits for each student must also be customized. In fiscal year 2007, we assembled approximately 2.5 million items into more than 200,000 kits.
Over our six years of operation, we believe that we have gained significant experience in the fulfillment of offline materials and that this experience provides us with an advantage over many of our current and potential future competitors. We have developed strong relationships with partners allowing us to source goods at favorable
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price, quality and service levels. Through our fulfillment partner located in Harrisonburg, Virginia, we store our inventory, build our learning kits and ship the kits to students throughout the United States. We have invested in systems including our Order Management System (OMS), to automatically translate the curriculum selected by each enrolled student into an order to build the corresponding learning kit. In 2008, we plan to establish a second logistics and fulfillment center in the western portion of the United States to support our growth and to mitigate single-location fulfillment risk.
For many of our virtual public school customers, we attempt to reclaim any materials that are not consumed during the course of the school year. These items, once returned to our fulfillment center, are refurbished and included in future learning kits. This reclamation process allows us to maintain lower materials costs.
In order to ensure that students in virtual public schools have access to our OLS, we often provide students with a computer and all necessary support. We source computers and ship them to students when they enroll and reclaim the computers at the end of a school year or upon termination of their enrollment or withdrawal from the virtual public school in which they are enrolled. As of June 30, 2007, we had approximately 20,370 personal computers deployed for use by students.
Our fulfillment activities are highly seasonal, and are centered around the start of school in August or September. Accordingly, approximately 70% of our annual materials receiving occurs between March and May, approximately 75% of our annual offline learning kit assembly is accomplished between May and July, and approximately 75% of customer item fulfillment and shipping occurs between July and October.
Properties
The Company’s headquarters are located in approximately 70,000 square feet of office space in Herndon, Virginia under a lease that expires in April 2013 and a sublease that expires in September 2009.
Employees
As of JuneSeptember 30, 2007, we had 557636 employees. In addition, there are more than 650 teachers who are employed by virtual schools we serve, but who we manage under turnkey solution contracts with those schools. No K12 employees are union employees; however, certain virtual public schools we serve employ unionized teachers. We believe that our employee relations are good.
We have an agreement with a professional employer organization (PEO), to manage all payroll processing, workers’ compensation, health insurance, and other employment-related benefits for our employees. The PEO is a co-employer of our employees along with us. Although the PEO processes our payroll and pays our workers’ compensation, health insurance and other employment-related benefits, we are ultimately responsible for such payments and are responsible for complying with state and federal employment regulations. We pay the PEO a fee based on the number of employees we have.
Legal Proceedings
In the ordinary conduct of our business, we are subject to lawsuits and other legal proceedings from time to time. There are currently two significant pending lawsuits in which we are involved,involved;Johnson v. Burmaster andIllinois v. Chicago Virtual Charter School that, in each case, have been brought by teachers’ unions seeking the closure of the virtual public schools we serve in Wisconsin and Illinois, respectively.
While we prevailed on summary judgment at the circuit court level inJohnson v. Burmaster, and recently won a preliminary motion inIllinois v. Chicago Virtual Charter School, it is not possible to predict the final outcome of these matters with any degree of certainty. Even so, we do not believe at this time that a loss in either case would
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have a material adverse impact on our future results of operations, financial position or cash flows. Depending on the legal theory advanced by the plaintiffs, however, there is a risk that a loss in these cases could have a negative precedential effect if like claims were to be advanced and succeed under similar laws in other states where we operate. The cumulative effect under those circumstances could be material.
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Johnson v. Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the State of Wisconsin established a virtual public school, the Wisconsin Virtual Academy (WIVA), and entered into a service agreement with us for online curriculum and school management services. On January 6, 2004, Stan Johnson, et al., and the Wisconsin Education Association Council (WEAC) filed suit in the Circuit Court of Ozaukee County against the Superintendent of the Department of Public Instruction (DPI), Elizabeth Burmaster, the NOSD and K12 Inc. The plaintiffs alleged that the NOSD violated the state charter school, open enrollment and teacher-licensure statutes when it authorized WIVA.
On March 16, 2006, the Circuit Court issued a Decision and Order upholding on Summary Judgment that WIVA complies with applicable law(No. 04-CV-12 ). WEAC and DPI filed an appeal in the Wisconsin Court of Appeals, District II(No. 2006-AP/01380). Should the plaintiff prevail and state funding of open enrollment payments to the NOSD are enjoined, a claim could be made that the Company must indemnify the NOSD for expenses approximating $2.5 million.
Illinois v. Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed a citizen taxpayers lawsuit in the Circuit Court of Cook County challenging the decision of the Illinois State Board of Education to certify the Chicago Virtual Charter School (CVCS) and to enjoin the disbursement of state funds to the Chicago Board of Education under its contract with the CVCS. Specifically, the CTU alleges that the Illinois charter school law prohibits any “home-based” charter schools and that CVCS does not provide sufficient “direct instruction” by certified teachers of at least five clock hours per day to qualify for funding. K12 Inc. and K12 Illinois LLC were also named as defendants. On May 16, 2007, the Court dismissed K12 Inc. and K12 Illinois LLC from the case and on June 15, 2007, the plaintiffs filed a second amended complaint.complaint which the court dismissed on October 30, 2007 with leave to re-plead. We continue to participate in the defense of CVCS under an indemnity obligation in our service agreement with that school, which requires us to indemnify CVCS against certain liabilities arising out of the performance of the service agreement and certain other claims and liabilities, including liabilities arising out of challenges to the validity of the virtual school charter.
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We and the virtual public schools that purchase our curriculum and management services are subject to regulation by each of the states in which we operate, including Colorado, Arizona, Idaho, Florida, Wisconsin, Arkansas, Texas, Illinois, Minnesota, Kansas, Utah, Nevada, California, Georgia, Ohio, Pennsylvania, Washington and the District of Columbia. The state laws and regulations that directly impact our business are those that authorize or restrict our ability to operate virtual public schools, and those that restrict virtual public school growth and funding. In addition, there are state laws and regulations that are applicable to virtual public schools that indirectly affect our business insofar as they affect these virtual public schools’schools��� ability to operate and receive funding. Finally, to the extent a virtual school obtains federal funds, such as through a grant program or financial support dedicated for the education of low-income families, these schools then become subject to additional federal regulation. These federal regulations have not had a material impact on our business.
State Laws Authorizing or Restricting Virtual Public Schools. The authority to operate a virtual public school is dependent on the laws and regulations of each state. Laws and regulations vary significantly from one state to the next and are constantly evolving. In states that have implemented specific legislation to support virtual public schools, the schools are able to operate under these statutes. Other states provide for virtual public schools under existing charter school legislation or provide that school districtsand/or state education agencies may authorize them. Some states do not currently have legislation that provides for virtual public schools or have requirements that effectively prohibit virtual public schools and, as a result, may require new legislation before virtual public schools can open in the state. We believe that new legislation would be required in only a few states to expand our ability to serve virtual public schools. According to a September 2006 review of state online learning policies by the North American Council for Online Learning (“NACOL”), there are 38 states that have either adopted legislation or formal rules or have created programs for the purpose of providing statewide online learning opportunities. We currently serve virtual schools or school district-led programs in 22 of these 38 states. NACOL also identified 12 states that do not currently have either a state-led program or significant state-level policies for online education; however, the absence of such conditions has not precluded us from applying to serve, and in certain cases serving, schools in some of those states.
Obtaining new legislation in these remaining states can be a protracted and uncertain process despite their limited number. When determining whether to pursue expansion into new states in which the laws are ambiguous, we research the relevant legislation and political climate and then make an assessment of the perceived likelihood of success before deciding to commit resources. Specifically, we take into account numerous factors including, but not limited to, the regulations of the state educational authorities, whether the overall political environment is amenable to school choice, whether current funding levels for virtual school enrollments are adequate and accessible, and the presence of non-profit and for-profit competitors in the state.
State Laws and Regulations Applicable to Virtual Public Schools. Virtual public schools that purchase our curriculum and management services are often governed and overseen by a non-profit or local or state education agency, such as an independent charter school board, local school district or state education authority. We generally receive funds for products and services rendered to operate virtual schools under detailed service agreements with that governing authority. Virtual public schools are typically funded by state or local governments on a per student basis. A virtual school that fails to comply with the state laws and regulations applicable to it may be required to repay these funds and could become ineligible for receipt of future state funds. We are not aware of any materialnon-compliance with these state regulations by the virtual public schools we serve.
To be eligible for state funding, some states require that virtual schools be organized under not-for-profit charters exempt from taxation under Section 501(c)(3) of the Internal Revenue Code. The schools must then be operated exclusively for charitable educational purposes, and not for the benefit of private, for-profit management companies. The board or governing authority of the not-for-profit virtual school must retain ultimate accountability for the school’s operations to retain its tax-exempt status. It may not delegate its responsibility and accountability for the school’s operations. Our service agreements with these virtual schools are therefore structured to ensure the full independence of the not-for-profit board and preserve its ability to exercise its fiduciary obligations to operate a virtual public school.
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Laws and regulations affect many aspects of operating a virtual public school. They can dictate the content and sequence of the curriculum, the requirements to earn a diploma, use of approved textbooks, the length of the school
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year and the school day, the assessment of student performance, and any accountability requirements. In addition, a virtual public school may be obligated to comply with state requirements to offer programs for specific populations, such as students at risk of dropping out of school, gifted and talented students, non-English speaking students, pre-kindergarten students, and students with disabilities. Tutoring services and the use of technology may also be regulated. Other state laws and regulations may affect the school’s compulsory attendance requirements, treatment of absences andmake-up work, and access by parents to student records and teaching and testing materials. Additionally, states have various requirements concerning the reporting of extensive student data that may apply to the school. A virtual public school may have to comply with state requirements that school campuses report various types of data as performance indicators of the success of the program.
States have laws and regulations concerning certification, training, experience and continued professional development of teachers and staff with which a virtual public school may be required to comply. There are also numerous laws pertaining to employee salaries and benefits, statewide teacher retirement systems, workers’ compensation, unemployment benefits, and matters related to employment agreements and procedures for termination of school employees. A virtual public school must also comply with requirements for performing criminal background checks on school staff, reporting criminal activity by school staff and reporting suspected child abuse.
As with any public school, virtual public schools must comply with state laws and regulations applicable to governmental entities, such as open meetings laws, which may require the board of trustees of a virtual public school to hold its meetings open to the public unless an exception in the law allows an executive session. Failure to comply with these requirements may lead to personal civiland/or criminal penalties for board members or officers. Virtual public schools must also comply with public information or open records laws, which require them to make school records available for public inspection, review and copying unless a specific exemption in the law applies. Additionally laws pertaining to records privacy and retention and to standards for maintenance of records apply to virtual public schools.
Other types of regulation applicable to virtual public schools include restrictions on the use of public funds, the types of investments made with public funds, the collection of and use of student fees, and controlling accounting and financial management practices.
There remains uncertainty about the extent to which we may be required to comply with state laws and regulations applicable to traditional public schools because the concept of virtual public schools is relatively new. Although we receive state funds indirectly, according to the terms of each service agreement with the local public school entity, our receipt of state funds subjects us to extensive state regulation and scrutiny. Several states have commenced audits, some of which are still pending, to verify enrollment, attendance, fiscal accountability, special education services, and other regulatory issues. While we may believe that a virtual public school we serve is compliant with state law, an agency’s different interpretation of law in a particular state could result in non-compliance, potentially affecting funding.
Regulations Restricting Virtual Public School Growth and Funding. As a new public schooling alternative, some state and regulatory authorities have elected to proceed cautiously with virtual public schools while providing opportunities for taxpayer families seeking this alternative. Regulations that control the growth of virtual public schools range from prescribing the number of schools in a state to limiting the percentage of time students may receive instruction online. Funding regulations can also have this effect.
Regulations that hinder our ability to serve certain jurisdictions include: restrictions on student eligibility, such as mandating attendance at a traditional public school prior to enrolling in a virtual public school or course completion (Arizona and Colorado); caps on the total number of students in a virtual school (Arkansas, Idaho, Wisconsin, Texas, Illinois, Florida and the District of Columbia); restrictions on grade levels served (Nevada and Arkansas); geographic limitations on enrollments (California); fixing the percentage of per pupil funding that must be paid to teachers; state-specific curriculum requirements; and limits on the number of charters that can be granted in a state.
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Funding regulations for virtual schools can take a variety of forms. These regulations include: (i) attendance — some state daily attendance rules were designed for traditional classroom procedures and applying them to track
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executives with superior ability and managerial talent and protect our intellectual capital and competitive position. These employment agreements, including the revised terms of Mr. Packard’s agreement approved by the board of directors and change in control arrangements, are further described below under the section entitled “Potential Payments Upon Termination or Change in Control.”
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Summary Compensation Table for 2007
The following table provides information regarding the compensation that we paid to our named executive officers during the fiscal year ended June 30, 2007.
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Name and Principal Position | | Year | | Salary | | Bonus(1) | | Awards(2) | | Compensation | | Compensation(3) | | Total |
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Ronald J. Packard | | | 2007 | | | $ | 410,000 | | | $ | 410,000 | | | $ | 116,436 | | | $ | — | | | $ | 2,050 | | | $ | 938,486 | |
Chief Executive Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
John F. Baule | | | 2007 | | | | 300,000 | | | | 210,000 | | | | — | | | | — | | | | 1,646 | | | | 511,646 | |
Chief Operating Officer and Chief Financial Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | 2007 | | | | 144,423 | | | | 120,000 | (5) | | | 4,791 | | | | — | | | | — | | | | 269,214 | |
Executive Vice President of School Services(4) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | | 2007 | | | | 310,000 | | | | 93,000 | | | | — | | | | — | | | | 2,713 | | | | 405,713 | |
Chief Learning Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Celia M. Stokes | | | 2007 | | | | 221,052 | | | | 80,000 | | | | — | | | | — | | | | 1,847 | | | | 302,899 | |
Chief Marketing Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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(1) | | This column represents cash awards to the named executive officers for performance with respect to fiscal year ended June 30, 2007. These awards were paid in September 2007. These awards were generally based upon corporate performance, but were not determined based upon the achievement of specific objective performance targets. |
(2) | | This column represents the dollar amount recognized by us for financial statement reporting purposes of the fair value of stock options granted in fiscal year ended June 30, 2007, and prior years in accordance with FAS 123R, assuming no forfeitures. For additional information, including information regarding the assumptions used when valuing the stock options, refer to note 9 of our consolidated financial statements filed herewith. The amounts set forth in this column reflect our accounting expense for these awards and do not correspond to the actual value that may be realized by the named executive officer receiving the awards. See the Grants of Plan-Based Awards Table for additional information on stock options granted during fiscal year ended June 30, 2007. |
(3) | | The amounts in this column consist of 401(k) matching contributions paid by us. |
(4) | | Mr. Davis commenced his employment with us on January 8, 2007. Amounts included in the table reflect Mr. Davis’ compensation from his date of hire through the end of the fiscal year ended on June 30, 2007. |
(5) | | Pursuant to the terms of his employment agreement, Mr. Davis was entitled to a guaranteed bonus of $120,000 for fiscal year 2007 which was paid on July 8, 2007. |
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Grants of Plan-Based Awards During 2007
The following table provides information regarding grants of plan-based awards to our named executive officers during the fiscal year ended June 30, 2007. The awards described in the following table were granted under our Executive Bonus Plan and stand-alone stock option agreements. The performance metrics considered when the awards were granted, if any, are described in previous subsections of the Compensation Discussion and Analysis above. No awards were granted to any named executive officer under our Amended and Restated Stock Option Plan during the fiscal year ended June 30, 2007.
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Name and Principal Position | | Date | | ($) | | (#) | | (#) | | (#) | | (#) | | Awards | | Grant(3) | | ($/Sh) |
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Ronald J. Packard | | | | | | $ | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Executive | | | 7/27/2006 | | | | | | | | — | | | | 350,000 | | | | — | | | — | | | $ | 1.50 | | | $ | 0.58 | | | $ | 14,802 | |
Officer | | | 7/27/2006 | | | | | | | | — | | | | 600,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 87,206 | |
| | | 7/27/2006 | | | | | | | | — | | | | 150,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 6,178 | |
| | | 7/27/2006 | | | | | | | | — | | | | 200,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 16,715 | |
| | | 7/27/2006 | | | | | | | | — | | | | 200,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 19,986 | |
| | | 7/27/2006 | | | | | | | | — | | | | 50,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 4,996 | |
| | | 7/27/2006 | | | | | | | | 150,000 | | | | 1,200,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 171,652 | |
| | | 7/27/2006 | | | | | | | | 75,000 | | | | 600,000 | | | | — | | | — | | | | 1.50 | | | | 0.58 | | | | 85,826 | |
| | | 7/27/2006 | | | | | | | | — | | | | 1,500,000 | | | | — | | | — | | | | 6.00 | | | | 0.58 | | | | 113,217 | |
John F. Baule | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Operating Officer and Chief Financial Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | 2/1/2007 | | | | — | | | | — | | | | — | | | | — | | | 500,000 | | | | 1.80 | | | | 0.83 | | | | 153,117 | |
Executive Vice President of School Services | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Learning Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Celia M. Stokes | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Marketing Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Estimated
| | | | | | | | | | | | | | |
| | | | Possible
| | | | | | | | All
| | | | | | |
| | | | Payouts
| | | | | | | | Other
| | | | | | Grant
|
| | | | Under
| | | | | | | | Option
| | | | | | Date
|
| | | | Nonequity
| | | | | | | | Awards:
| | | | Closing
| | Fair
|
| | | | Incentive
| | Estimated Future Payouts
| | Number of
| | Exercise or
| | Market
| | Value
|
| | | | Plan
| | Under Equity
| | Securities
| | Base
| | Price
| | of
|
| | | | Awards | | Incentive Plan Awards(1) | | Underlying
| | Price
| | on Date
| | Option
|
| | Grant
| | Target
| | Threshold
| | Target
| | Maximum
| | Options(2)
| | of Option
| | of
| | Awards
|
Name and Principal Position | | Date | | ($) | | (#) | | (#) | | (#) | | (#) | | Awards | | Grant(3) | | ($/Sh) |
|
Ronald J. Packard | | | | | | $ | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Executive | | | 7/27/2006 | | | | | | | | — | | | | 68,627 | | | | — | | | — | | | $ | 7.65 | | | $ | 2.96 | | | $ | 14,802 | |
Officer | | | 7/27/2006 | | | | | | | | — | | | | 117,645 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 87,206 | |
| | | 7/27/2006 | | | | | | | | — | | | | 29,411 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 6,178 | |
| | | 7/27/2006 | | | | | | | | — | | | | 39,215 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 16,715 | |
| | | 7/27/2006 | | | | | | | | — | | | | 39,215 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 19,986 | |
| | | 7/27/2006 | | | | | | | | — | | | | 9,803 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 4,996 | |
| | | 7/27/2006 | | | | | | | | 29,411 | | | | 235,294 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 171,652 | |
| | | 7/27/2006 | | | | | | | | 14,705 | | | | 117,647 | | | | — | | | — | | | | 7.65 | | | | 2.96 | | | | 85,826 | |
| | | 7/27/2006 | | | | | | | | — | | | | 294,117 | | | | — | | | — | | | | 30.60 | | | | 2.96 | | | | 113,217 | |
John F. Baule | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Operating Officer and Chief Financial Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | 2/1/2007 | | | | — | | | | — | | | | — | | | | — | | | 98,039 | | | | 9.18 | | | | 4.23 | | | | 153,117 | |
Executive Vice President of School Services | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Learning Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Celia M. Stokes | | | | | | | — | | | | — | | | | — | | | | — | | | — | | | | — | | | | — | | | | — | |
Chief Marketing Officer | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
(1) | | Stock options were granted pursuant to stand-alone stock option agreements with exercise prices in excess of the fair market value of a share of our common stock subject to such option on the date of grant, expire on December 31, 2012, and are subject to performance vesting schedules, as further described in the footnotes to the Outstanding Equity Awards at Fiscal Year End Table. The stock options with performance vesting schedules do not have maximum payout amounts. |
(2) | | Stock options were granted pursuant to stand-alone stock option agreements with exercise prices in excess of the fair market value of a share of our common stock subject to such option on the date of grant, expire on December 31, 2014 and are subject to a four year time-based vesting schedule. |
(3) | | The closing market price of our common stock on the date of grant is based upon our analysis of its fair market value. For a discussion of this analysis, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates — Accounting for Stock-based Compensation.” |
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Outstanding Equity Awards at Fiscal Year End for 2007
The following table provides information regarding outstanding equity awards held by our named executive officers as of June 30, 2007. All such equity awards consist of stock options granted pursuant to our Amended and Restated Stock Option Plan or stand-alone stock option agreements, and no restricted stock awards have been granted to any of the named executive officers. The section titled “Stock Options” in this Compensation Discussion and Analysis section provides additional information regarding the outstanding equity awards set forth in this table.
| | | | | | | | | | | | | | | | | | | | |
| | Option Awards | |
| | | | | | | | Equity Incentive Plan
| | | | | | | |
| | Number of
| | | Number of
| | | Awards: Number of
| | | | | | | |
| | Securities Underlying
| | | Securities Underlying
| | | Securities Underlying
| | | Option
| | | Option
| |
| | Unexercised Options
| | | Unexercised Options
| | | Unexercised Unearned
| | | Exercise
| | | Expiration
| |
Name and Principal Position | | Exercisable | | | Unexercisable | | | Options | | | Price | | | Date | |
|
Ronald J. Packard | | | 350,000 | | | | — | | | | — | | | $ | 1.50 | | | | 7/27/2014 | |
Chief Executive Officer(1) | | | 600,000 | | | | — | | | | — | | | | 1.50 | | | | 7/27/2014 | |
| | | 150,000 | | | | — | | | | — | | | | 1.50 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 200,000 | | | | 1.50 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 200,000 | | | | 1.50 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 50,000 | | | | 1.50 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 1,200,000 | | | | 1.50 | | | | 7/27/2014 | |
| | | 300,000 | | | | — | | | | 300,000 | | | | 1.50 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 1,500,000 | | | | 6.00 | | | | 7/27/2014 | |
| | | 675,000 | | | | — | | | | — | | | | 1.34 | | | | 7/1/2011 | |
| | | 900,000 | | | | — | | | | — | | | | 1.34 | | | | 7/23/2010 | |
John F. Baule | | | 100,000 | | | | 300,000 | | | | — | | | | 1.50 | | | | 6/1/2014 | |
Chief Operating Officer | | | 450,000 | | | | 350,000 | | | | — | | | | 1.34 | | | | 3/24/2013 | |
and Chief Financial Officer(2) | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | — | | | | 500,000 | | | | — | | | | 1.80 | | | | 2/1/2015 | |
Executive Vice President of School Services(3) | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | | 75,000 | | | | 225,000 | | | | — | | | | 1.50 | | | | 4/26/2014 | |
Chief Learning Officer(4) | | | 50,625 | | | | 39,375 | | | | — | | | | 1.34 | | | | 3/1/2013 | |
Celia M. Stokes | | | 56,250 | | | | 143,750 | | | | — | | | | 1.50 | | | | 4/26/2014 | |
Chief Marketing Officer(5) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | Option Awards | |
| | | | | | | | Equity Incentive Plan
| | | | | | | |
| | Number of
| | | Number of
| | | Awards: Number of
| | | | | | | |
| | Securities Underlying
| | | Securities Underlying
| | | Securities Underlying
| | | Option
| | | Option
| |
| | Unexercised Options
| | | Unexercised Options
| | | Unexercised Unearned
| | | Exercise
| | | Expiration
| |
Name and Principal Position | | Exercisable | | | Unexercisable | | | Options | | | Price | | | Date | |
|
Ronald J. Packard | | | 68,627 | | | | — | | | | — | | | $ | 7.65 | | | | 7/27/2014 | |
Chief Executive Officer(1) | | | 117,645 | | | | — | | | | — | | | | 7.65 | | | | 7/27/2014 | |
| | | 29,411 | | | | — | | | | — | | | | 7.65 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 39,215 | | | | 7.65 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 39,215 | | | | 7.65 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 9,803 | | | | 7.65 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 235,294 | | | | 7.65 | | | | 7/27/2014 | |
| | | 58,824 | | | | — | | | | 58,824 | | | | 7.65 | | | | 7/27/2014 | |
| | | — | | | | — | | | | 294,117 | | | | 30.60 | | | | 7/27/2014 | |
| | | 132,353 | | | | — | | | | — | | | | 6.83 | | | | 7/1/2011 | |
| | | 176,469 | | | | — | | | | — | | | | 6.83 | | | | 7/23/2010 | |
John F. Baule | | | 19,607 | | | | 58,824 | | | | — | | | | 7.65 | | | | 6/1/2014 | |
Chief Operating Officer | | | 88,234 | | | | 68,628 | | | | — | | | | 6.83 | | | | 3/24/2013 | |
and Chief Financial Officer(2) | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | — | | | | 98,039 | | | | — | | | | 9.18 | | | | 2/1/2015 | |
Executive Vice President of School Services(3) | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | | 14,705 | | | | 44,118 | | | | — | | | | 7.65 | | | | 4/26/2014 | |
Chief Learning Officer(4) | | | 9,926 | | | | 7,721 | | | | — | | | | 6.83 | | | | 3/1/2013 | |
Celia M. Stokes | | | 11,028 | | | | 28,186 | | | | — | | | | 7.65 | | | | 4/26/2014 | |
Chief Marketing Officer(5) | | | | | | | | | | | | | | | | | | | | |
| | |
(1) | | Mr. Packard’s outstanding unvested options are subject to performance-based vesting. 200,00039,215 options with exercise prices of $1.50$7.65 per share will vest in each of fiscal year ending June 30, 2008 and 2009 contingent upon our attaining revenues and EBITDA goals during each of the respective preceeding fiscal years. 50,0009,803 options with exercise prices of $1.50$7.65 per share will vest in fiscal year ending June 30, 2009 contingent upon Mr. Packard attaining leadership goals during the preceeding fiscal year. 1,200,000235,294 options with exercise prices of $1.50$7.65 per share will vest on dates that jurisdictional expansion and related EBITDA goals are obtained, if any. 300,00058,824 options with exercise prices of $1.50$7.65 per share will vest on dates that jurisdictional expansion and enrollment targets are achieved. 1,500,000294,117 options with exercise prices of $6.00$30.60 per share will vest upon the fair market value of a share of our common stock equaling $6.00.$30.60. |
| | |
(2) | | Mr. Baule’s outstanding unvested options are subject to time-based vesting. 25,0004,901 options with exercise prices of $1.50$7.65 per share will vest every three months beginning on September 1, 2007 through June 1, 2010. 50,0009,803 options with exercise prices of $1.34$6.83 per share will vest every three months beginning on September 24, 2007 through March 24, 2009. |
| | |
(3) | | Mr. Davis’s outstanding unvested options are subject to time-based vesting. 125,00024,509 options will vest on February 1, 2008 and 31,2506,127 options will vest every three months thereafter beginning on May 1, 2008 through February 1, 2011. |
| | |
(4) | | Mr. Saxberg’s outstanding unvested options are subject to time-based vesting. 18,7503,676 options will vest every three months beginning on July 27, 2007 through April 27, 2010, and 5,6251,102 will vest every three months beginning on September 24, 2007 through March 24, 2009. |
| | |
(5) | | Ms. Stokes’ outstanding unvested options are subject to time-based vesting. 6,2501,225 options vest every three months beginning on July 27, 2007 through April 27, 2010, and 6,2501,225 vest every three months beginning on September 21, 2007 through March 21, 2010. |
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Option Exercises and Stock Vested
The following table provides information for the named executive officers regarding the stock options each named executive officer exercised, and the value realized, if any, during fiscal year ended June 30, 2007.
| | | | | | | | |
| | Option Awards | |
| | Number of
| | | | |
| | Shares
| | | | |
| | Acquired
| | | Value Realized
| |
Name and Principal Position | | on Exercise(1) | | | on Exercise | |
|
Ronald J. Packard | | | — | | | $ | — | |
Chief Executive Officer | | | | | | | | |
John F. Baule | | | — | | | | — | |
Chief Operating Officer and Chief Financial Officer | | | | | | | | |
Bruce J. Davis | | | — | | | | — | |
Executive Vice President of School Services | | | | | | | | |
Bror V. H. Saxberg | | | 200,000 | | | | 64,000 | (2) |
Chief Learning Officer | | | | | | | | |
Celia M. Stokes | | | — | | | | — | |
Chief Marketing Officer | | | | | | | | |
| | | | | | | | |
| | Option Awards | |
| | Number of
| | | | |
| | Shares
| | | | |
| | Acquired
| | | Value Realized
| |
Name and Principal Position | | on Exercise(1) | | | on Exercise | |
|
Ronald J. Packard | | | — | | | $ | — | |
Chief Executive Officer | | | | | | | | |
John F. Baule | | | — | | | | — | |
Chief Operating Officer and Chief Financial Officer | | | | | | | | |
Bruce J. Davis | | | — | | | | — | |
Executive Vice President of School Services | | | | | | | | |
Bror V. H. Saxberg | | | 39,215 | | | | 64,000 | (2) |
Chief Learning Officer | | | | | | | | |
Celia M. Stokes | | | — | | | | — | |
Chief Marketing Officer | | | | | | | | |
| | |
(1) | | None of the named executive officers other than Mr. Saxberg exercised any stock options during fiscal year ended June 30, 2007. |
| | |
(2) | | Represents the exercise of 200,00039,215 options on May 29, 2007, each with an exercise price of $1.34$6.83 per share. The estimated fair market value of a share of our common stock on the date of exercise was $1.66.$8,47 For a discussion of the analysis of the fair market value of our common stock, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates — Accounting for Stock-based Compensation.” |
Potential Payments Upon Termination or Change in Control
The Company has employment agreements with each of our named executive officers that provide for severance payments and, in some cases, other benefits upon certain terminations of employment.
Employment Agreements
Mr. Packard’s employment agreement, effective as of January 1, 2006, provides for a term of employment through January 1, 2009, unless terminated earlier pursuant to the terms of the agreement. Upon a termination of Mr. Packard’s employment by us without cause or due to a “constructive termination” (generally, a material reduction in Mr. Packard’s duties, responsibilities or title), Mr. Packard is entitled to salary continuation for 450 days following termination and he may exercise his outstanding vested stock options until the earlier of 90 days following the expiration of anylock-up period applicable to our initial underwritten public offering, or the expiration of the option term. Upon termination of Mr. Packard’s employment due to his death, his estate will receive salary continuation payments for 180 days following his death. The agreement also provides that Mr. Packard is subject to restrictive covenants during the term of the agreement and for certain periods following termination of employment, including confidentiality restrictive covenants during the term and for three years following termination, intellectual property restrictive covenants during the term, and nonsolicitation and noncompetition restrictive covenants during the period that Mr. Packard receives any compensation from us (including severance) and one year thereafter.
On July 12, 2007, our board of directors approved an amended and restated employment agreement for Mr. Packard. This amended and restated agreement extends the term of Mr. Packard’s employment until January 1, 2011, and provides for (i) an annual base salary of $425,000, (ii) an annual cash bonus to be awarded by the board of directors in its discretion with a target amount of 100% of base salary, (iii) additional stock option grants subject to both time-based and performance-based vesting, (iv) full vesting of all outstanding stock options upon a change in
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control of the Company, and (v) severance upon a termination of Mr. Packard’s employment without cause by us or due to “constructive termination” equal to 18 months of base salary and the extension of the exercise date for Mr. Packard’s outstanding stock options to the earlier of 90 days following expiration of anylock-up period in connection with the Company’s initial public offering and the expiration of the term of the stock options.
Mr. Baule’s employment agreement, dated March 4, 2005, provides for his employment with us on an “at-will” basis. Upon a termination of Mr. Baule’s employment for “good reason” (generally, a material reduction in Mr. Baule’s compensation, assignment of a materially different title and responsibilities effectively resulting in a demotion, relocation of Mr. Baule’s place of work more than 50 miles from our headquarters, or we otherwise materially breach the employment agreement), or by us for any reason other than cause, death or disability, Mr. Baule is entitled to severance equal to 365 days of his then-current salary, paid in six monthly installments following termination, and medical and dental benefit continuation for 365 days, or if earlier, until eligible for benefits elsewhere (or reimbursement of COBRA costs to the extent our employee benefit plans do not allow post-termination participation by Mr. Baule). The agreement also provides that Mr. Baule will be subject to the terms of the Company’s Confidentiality, Proprietary Rights and Non-Solicitation Agreement, which generally prohibits the unauthorized disclosure of our confidential information during and after the period of employment, ensures our right of ownership of any intellectual property developed during the period of employment, prohibits the solicitation of employees for one year following termination of employment and requires that any disputes regarding employment or termination of employment be subject to binding arbitration.
On July 12, 2007, our board of directors approved an amendment to Mr. Baule’s employment agreement. This amendment provides for (i) an annual base salary of $340,000, (ii) an annual cash bonus to be awarded by the board of directors in its discretion with a target amount of 70% of base salary, (iii) additional stock option grants subject to both time-based and performance-based vesting, and (iv) full vesting of all stock options upon a change in control of the company.
Mr. Davis’ employment agreement, effective as of January 3, 2007, provides for his employment with us on an “at-will” basis. Upon a termination of Mr. Davis’ employment for “good reason” (generally, a material breach of the employment agreement by us that is not cured within 60 days, a reduction in base salary, a diminution or adverse change to title or the person to whom Mr. Davis reports prior to a change in control of the Company, a material diminution in authority, responsibilities or duties, a relocation of place of employment more than 25 miles from our headquarters, a material reduction in Mr. Davis’ compensation, assignment of a materially different title and responsibilities effectively demoting Mr. Davis, or if the employment agreement is not assumed by the successor within 90 days following a change in control of the Company), or by us without cause, Mr. Davis is entitled to 180 days of salary continuation if the termination occurs prior to January 1, 2008, and 365 days of salary continuation if the termination occurs after January 1, 2008. The agreement also provides that Mr. Davis will be subject to the terms of our Confidentiality, Proprietary Rights and Non-Solicitation Agreement which generally prohibits the unauthorized disclosure of our confidential information during and after the period of employment, ensures our right of ownership of any intellectual property developed during the period of employment, prohibits the solicitation of employees for one year following termination of employment and requires that any disputes regarding employment or termination of employment be subject to binding arbitration.
Mr. Saxberg’s employment agreement, dated June 1, 2006, provides for his employment with us on an “at-will” basis. Upon a termination of Mr. Saxberg’s employment for “good reason” (Mr. Saxberg’s resignation within 40 days after his discovery of a material breach of the agreement by us which is not cured within 30 days after written notice from Mr. Saxberg), or by us without “cause,” Mr. Saxberg is entitled to 180 days of salary continuation, reduced by any compensation resulting from new employment. The agreement also provides that Mr. Saxberg will be subject to the terms of our Confidentiality, Proprietary Rights and Non-Solicitation Agreement which generally prohibits the unauthorized disclosure of our confidential information during and after the period of employment, ensures our right of ownership of any intellectual property developed during the period of employment, prohibits the solicitation of employees for one year following termination of employment and requires that any disputes regarding employment or termination of employment be subject to binding arbitration.
Ms. Stokes’ employment agreement, dated March 10, 2006, provides for her employment with us on an“at-will” basis. Upon a termination of Ms. Stokes’ employment for “good reason” (Ms. Stokes’ resignation within
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40 days after her discovery of a material breach of the agreement by us which is not cured within 30 days after written notice from Ms. Stokes), or by us without “cause,” Ms. Stokes is entitled to 180 days of salary continuation, reduced by any compensation resulting from new employment. The agreement also provides that Ms. Stokes will be subject to the terms of our Confidentiality, Proprietary Rights and Non-Solicitation Agreement which generally prohibits the unauthorized disclosure of our confidential information during and after the period of employment, ensures our right of ownership of any intellectual property developed during the period of employment, prohibits the solicitation of employees for one year following termination of employment and requires that any disputes regarding employment or termination of employment be subject to binding arbitration.
Change in Control Arrangements
Except for certain stock options granted to Mr. Packard and Mr. Baule during our fiscal year ending in 2007, the stock option agreements for outstanding stock options generally provide for accelerated and full vesting of unvested stock options upon certain corporate events. As described above, on July 12, 2007, our board of directors approved an amended and restated employment agreement for Mr. Packard, which provides that all of his outstanding options will become fully vested upon a change in control of the Company. Additionally, on July 12, 2007, our board of directors also approved the terms of a new option agreement for Mr. Baule, which provides that all of his outstanding options will become fully vested upon a change in control of the Company. Those events include a sale of all or substantially all of our assets, a merger or consolidation which results in the Company’s stockholders immediately prior to the transaction owning less than 50% of our voting stock immediately after the transaction, and a sale of our outstanding securities (other than in connection with an initial public offering) which results in our stockholders immediately prior to the transaction owning less than 50% of our voting stock immediately after the transaction.
In addition, as described above, Mr. Davis is entitled to voluntarily terminate his employment and receive the severance payments described above if his employment agreement is not assumed by the successor entity within 90 days following a change in control of the Company. Other than the foregoing, none of the named executive officers is entitled to any additional payments upon a change in control of the Company.
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Potential Value of Termination and Change in Control Benefits
The following table provides the dollar value of potential payments and benefits that each named executive officer would be entitled to receive upon certain terminations of employment and upon a change in control of the Company, assuming that the termination or change in control occurred on June 30, 2007, and the price per share of our common stock subject to the stock options equaled $1.82, the value of a share on June 30, 2007. For a discussion of our analysis of the fair market value of our common stock, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates — Accounting for Stock-based Compensation.”
| | | | | | | | | | | | | | | | | | |
| | | | | | | Without
| | | Good
| | | Change in
| |
Name | | Payment | | Death | | | Cause | | | Reason | | | Control | |
|
Ronald J. Packard(1) | | Salary continuation | | $ | 202,192 | | | $ | 505,479 | | | $ | 505,479 | | | $ | — | |
| | Benefit continuation | | | — | | | | — | | | | — | | | | — | |
| | Option vesting | | | — | | | | — | | | | — | | | | 624,000 | |
| | | | | | | | | | | | | | | | | | |
John F. Baule(2) | | Salary continuation | | | — | | | | 300,000 | | | | 300,000 | | | | — | |
| | Benefit continuation | | | — | | | | 16,734 | | | | 16,734 | | | | — | |
| | Option vesting | | | — | | | | — | | | | — | | | | 264,000 | |
| | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | Salary continuation | | | — | | | | 147,945 | | | | 147,945 | | | | — | |
| | Benefit continuation | | | — | | | | — | | | | — | | | | — | |
| | Option vesting | | | — | | | | — | | | | — | | | | 10,000 | |
| | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg | | Salary continuation | | | — | | | | 152,877 | | | | 152,877 | | | | — | |
| | Benefit continuation | | | — | | | | — | | | | — | | | | — | |
| | Option vesting | | | — | | | | — | | | | — | | | | 90,900 | |
| | | | | | | | | | | | | | | | | | |
Celia M. Stokes | | Salary continuation | | | — | | | | 109,012 | | | | 109,012 | | | | — | |
| | Benefit continuation | | | — | | | | — | | | | — | | | | — | |
| | Option vesting | | | — | | | | — | | | | — | | | | 46,000 | |
| | |
(1) | | Amounts do not reflect the terms of Mr. Packard’s amended and restated employment agreement effective July 12, 2007. If Mr. Packard’s amended and restated employment agreement was in effect as of June 30, 2007, Mr. Packard’s salary continuation upon death, termination without cause or termination for good reason would have been $209,589, $637,500 and $637,500, respectively. The value of Mr. Packard’s option vesting would not have changed because the exercise price of the new stock options would have exceeded the value of a share of our common stock on such date. |
(2) | | Amounts do not reflect the terms of Mr. Baule’s amended employment agreement or stock option agreement effective July 12, 2007. If Mr. Baule’s amended employment agreement and option agreement were in effect as of June 30, 2007, Mr. Baule’s salary continuation upon termination without cause or termination for good reason would have been $340,000. The value of Mr. Baule’s option vesting would not have changed because the exercise price of the new stock options would have exceeded the value of a share of our common stock on such date. The value of the benefit continuation would not have changed. |
Director Compensation
For fiscal year ended June 30, 2007, and prior fiscal years, we compensated our nonemployee directors solely through grants of stock options. None of our nonemployee directors received any other form of compensation for service during fiscal year ended June 30, 2007, such as cash fees for retainer, committee service, service as chairman of the board of directors or meeting attendance. For service during fiscal year ended June 30, 2007, each nonemployee director received options to purchase 25,0004,901 shares of our common stock. In addition, members of the Executive Committee of the board during fiscal year ended June 30, 2007, which included Messrs. Tisch, Milken, Fink and Ms. Boyd, received options to purchase an additional 25,0004,901 shares of our common stock in compensation
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for their increased time commitments with respect to serving on the Executive Committee. Directors who are also our employees receive no additional compensation for serving on the board or its committees.
| | | | | | | | |
| | Option
| | | | |
Name | | Awards(1) | | | Total(1) | |
|
Andrew H. Tisch | | $ | 708(2) | | | $ | 708 | |
Arthur H. Bilger | | | 354(3) | | | | 354 | |
Chester E. Finn Jr. | | | 354(4) | | | | 354 | |
Liza A. Boyd | | | 708(5) | | | | 708 | |
Lowell J. Milken | | | 708(6) | | | | 708 | |
Steven B. Fink | | | 708(7) | | | | 708 | |
Thomas J. Wilford | | | 354(8) | | | | 354 | |
| | |
(1) | | This column represents the dollar amount recognized by us for financial statement reporting purposes of the fair value of stock options granted in fiscal year ended June 30, 2007, and prior years under our Amended and Restated Stock Option Plan in accordance with FAS 123R, assuming no forfeitures. For additional information, including information regarding the assumptions used when valuing the stock options, refer to note 9 of our consolidated financial statements filed herewith. The amounts set forth in this column reflect our accounting expense for these awards and do not correspond to the actual value that may be realized by the directors receiving the awards. |
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(2) | | During fiscal year ended June 30, 2007, Mr. Tisch was granted 50,0009,803 options on May 17, 2007 with a fair value of $33,975. As of June 30, 2007, Mr. Tisch held options to purchase 275,00053,916 shares of common stock, consisting of 50,0009,803 granted on May 17, 2007; 50,0009,803 granted on April 27, 2006; 50,0009,803 granted on March 24, 2005; 50,0009,803 granted on March 31, 2004; 50,0009,803 granted on February 10, 2003; and 25,0004,901 granted on July 23, 2002. |
| | |
(3) | | During fiscal year ended June 30, 2007, Mr. Bilger was granted 25,0004,901 options on May 17, 2007 with a fair value of $16,988. As of June 30, 2007, Mr. Bilger held options to purchase 150,00029,406 shares of common stock, consisting of 25,0004,901 granted on May 17, 2007; 25,0004,901 granted on April 27, 2006; 25,0004,901 granted on March 24, 2005; 25,0004,901 granted on March 31, 2004; 25,0004,901 granted on February 10, 2003; and 25,0004,901 granted on July 23, 2002. Mr. Bilger resigned from the board of directors on June 29, 2007. |
| | |
(4) | | During fiscal year ended June 30, 2007, Mr. Finn was granted 25,0004,901 options on May 17, 2007 with a fair value of $16,988. As of June 30, 2007, Mr. Finn held options to purchase 210,00041,170 shares of common stock, consisting of 25,0004,901 granted on May 17, 2007; 25,0004,901 granted on April 27, 2006; 25,0004,901 granted on March 24, 2005; 25,0004,901 granted on March 31, 2004; 25,0004,901 granted on February 10, 2003; 25,0004,901 granted on July 23, 2002; and 60,00011,764 granted on August 31, 2000. Mr. Finn resigned from the board of directors on July 19, 2007. |
| | |
(5) | | Ms. Boyd serves as a director on behalf of certain funds managed by Constellation Ventures. During fiscal year ended June 30, 2007, Ms. Boyd was granted 50,0009,803 options on May 17, 2007 with a fair value of $33,975, which have been assigned to these funds. The options granted to the director serving on behalf of these funds in prior years have also been assigned to these funds. As of June 30, 2007, these funds held options to purchase 237,50046,564 shares of common stock, consisting of 50,0009,803 granted on May 17, 2007; 50,0009,803 granted on April 27, 2006; 50,0009,803 granted on March 24, 2005; 50,0009,803 granted on March 31, 2004; and 37,5007,352 granted on February 10, 2003. |
| | |
(6) | | During fiscal year ended June 30, 2007, Mr. Milken was granted 50,0009,803 options on May 17, 2007 with a fair value of $33,975. As of June 30, 2007, Mr. Milken held options to purchase 275,00053,916 shares of common stock, consisting of 50,0009,803 granted on May 17, 2007; 50,0009,803 granted on April 27, 2006; 50,0009,803 granted on March 24, 2005; 50,0009,803 granted on March 31, 2004; 50,0009,803 granted on February 10, 2003; and 25,0004,901 granted on July 23, 2002. Mr. Milken resigned from the board of directors on July 11, 2007. |
| | |
(7) | | During fiscal year ended June 30, 2007, Mr. Fink was granted 50,0009,803 options on May 17, 2007 with a fair value of $33,975. As of June 30, 2007, Mr. Fink held options to purchase 205,68540,326 shares of common stock, consisting of 50,0009,803 granted on May 17, 2007; 50,0009,803 granted on April 27, 2006; 50,0009,803 granted on March 24, 2005; 50,0009,803 granted on March 31, 2004; 959188 granted on December 18, 2003; and 4,726926 granted on October 24, 2003. |
| | |
(8) | | During fiscal year ended June 30, 2007, Mr. Wilford was granted 25,0004,901 options on May 17, 2007 with a fair value of $16,988. As of June 30, 2007, Mr. Wilford held options to purchase 125,00024,505 shares of common stock, consisting of 25,0004,901 granted on May 17, 2007; 25,0004,901 granted on April 27, 2006; 25,0004,901 granted on March 24, 2005; 25,0004,901 granted on March 31, 2004; and 25,0004,901 granted on February 10, 2003. |
Employee Equity Incentive Plans
Amended and Restated Stock Option Plan
Our Board of Directors has adopted our Amended and Restated Stock Option Plan, or the Existing Plan, which was approved by our stockholders in December 2003. The Board of Directors subsequently amended the Existing Plan which was approved by our stockholders in November 2007. Pursuant to that amendment, we have reserved an aggregate of 3,921,568 shares of our common stock for issuance under the Existing Plan. The aggregate number of shares subject to outstanding awards under the Existing Plan is 3,429,608 shares of our common stock. We do not intend to grant any additional options under the Existing Plan after the completion of this offering.
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2007 Equity Incentive Award Plan
Our Board of Directors has adopted our 2007 Equity Incentive Award Plan, or the 2007 Plan, which will be submitted to our shareholders for their approval within twelve months from the date our Board of Directors approved the 2007 Plan. The 2007 Plan will become effective on the day prior to the effective date of this offering.
We have initially reserved 784,313 shares of our common stock for issuance under the 2007 Plan. In addition, the number of shares initially reserved under the 2007 Plan will be increased by the number of shares of common stock related to awards granted under our Existing Plan that are repurchased, forfeited, expired or are cancelled on or after the effective date of the 2007 Plan. The 2007 Plan contains an “evergreen provision” that allows for an annual increase in the number of shares available for issuance under the 2007 Plan on July 1 of each year during the ten-year term of the 2007 Plan, beginning on July 1, 2008. The annual increase in the number of shares shall be equal to the least of:
| | |
| • | 4% of our outstanding common stock on the applicable July 1; |
| | |
| • | a lesser number of shares as determined by our Board of Directors. |
Therefore, the 2007 Plan provides for an aggregate limit of 4,213,921 shares of common stock plus the increases in the shares of stock pursuant to the “evergreen provision” that may be issued under the 2007 Plan over the course of its ten-year term. The material terms of the 2007 Plan are summarized below. The 2007 Plan is filed as an exhibit to the registration statement of which this prospectus is a part.
Administration
The Compensation Committee of our Board of Directors will administer the 2007 Plan (except with respect to any award granted to “independent directors” (as defined in the 2007 Plan), which must be administered by our full board of directors). To administer the 2007 Plan, our Compensation Committee must consist of at least two members of our Board of Directors, each of whom is a “non-employee director” for purposes ofRule 16b-3 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and, with respect to awards that are intended to constitute performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended, an “outside director” for purposes of Section 162(m). Subject to the terms and conditions of the 2007 Plan, our Compensation Committee has the authority to select the persons to whom awards are to be made, to determine the type or types of awards to be granted to each person, the number of awards to grant, the number of shares to be subject to such awards, and the terms and conditions of such awards, and to make all other determinations and decisions and to take all other actions necessary or advisable for the administration of the 2007 Plan. Our Compensation Committee is also authorized to establish, adopt, amend or revise rules relating to administration of the 2007 Plan. Our Board of Directors may at any time revest in itself the authority to administer the 2007 Plan. The full Board of Directors will administer the 2007 Plan with respect to awards to non-employee directors.
Eligibility
Options, stock appreciation rights, or SARs, restricted stock and other awards under the 2007 Plan may be granted to individuals who are then our officers or employees or are the officers or employees of any of our subsidiaries. Such awards may also be granted to our non-employee directors and consultants but only employees may be granted incentive stock options, or ISOs. The maximum number of shares that may be subject to awards granted under the 2007 Plan to any individual in any calendar year cannot exceed 392,156.
Awards
The 2007 Plan provides that our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors) may grant or issue stock options, SARs, restricted stock, restricted stock units, dividend equivalents, performance share awards, performance stock units, stock payments, deferred stock, performance bonus awards, performance-based awards, and other stock-based awards, or any combination thereof. The
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Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors) will consider each award grant subjectively, considering factors such as the individual performance of the recipient and the anticipated contribution of the recipient to the attainment of our long-term goals. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type, terms and conditions of the award.
| | |
| • | Nonqualified stock options, or NQSOs, will provide for the right to purchase shares of our common stock at a specified price which may not be less than the greater of the par value of a share of common stock on the date of grant or 85% of fair market value, and usually will become exercisable (at the discretion of our Compensation Committee or the Board of Directors, in the case of awards to non-employee directors) in one or more installments after the grant date, subject to the participant’s continued employment or service with usand/or subject to the satisfaction of performance targets established by our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors). NQSOs may be granted for any term specified by our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors), but the term may not exceed ten years. |
| | |
| • | Incentive stock options, or ISOs, will be designed to comply with the provisions of the Internal Revenue Code and will be subject to specified restrictions contained in the Internal Revenue Code. Among such restrictions, ISOs must have an exercise price of not less than the fair market value of a share of common stock on the date of grant, may only be granted to employees, must expire within a specified period of time following the optionee’s termination of employment, and must be exercised within the ten years after the date of grant. In the case of an ISO granted to an individual who owns (or is deemed to own) more than 10% of the total combined voting power of all classes of our capital stock, the 2007 Plan provides that the exercise price must be more than 110% of the fair market value of a share of common stock on the date of grant and the ISO must expire upon the fifth anniversary of the date of its grant. |
| | |
| • | Restricted stock may be granted to participants and made subject to such restrictions as may be determined by our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors). Typically, restricted stock may be forfeited for no consideration if the conditions or restrictions are not met, and may not be sold or otherwise transferred to third parties until restrictions are removed or expire. Recipients of restricted stock, unlike recipients of options, may have voting rights and may receive dividends, if any, prior to the time when the restrictions lapse. |
| | |
| • | Restricted stock units may be awarded to participants, typically without payment of consideration or for a nominal purchase price, but subject to vesting conditions including continued employment or on performance criteria established by our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors). Like restricted stock, restricted stock units may not be sold or otherwise transferred or hypothecated until vesting conditions are removed or expire. Unlike restricted stock, stock underlying restricted stock units will not be issued until the restricted stock units have vested, and recipients of restricted stock units generally will have no voting or dividend rights prior to the time when vesting conditions are satisfied. |
| | |
| • | SARs may be granted in connection with stock options or other awards, or separately. SARs granted under the 2007 Plan in connection with stock options or other awards typically will provide for payments to the holder based upon increases in the price of our common stock over the exercise price of the related option or other awards. Except as required by Section 162(m) of the Internal Revenue Code with respect to SARs intended to qualify as performance-based compensation, there are no restrictions specified in the 2007 Plan on the exercise of SARs or the amount of gain realizable therefrom. Our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors) may elect to pay SARs in cash or in common stock or in a combination of both. |
| | |
| • | Dividend equivalents represent the value of the dividends, if any, per share paid by us, calculated with reference to the number of shares covered by the stock options, SARs or other awards held by the participant. |
| | |
| • | Performance awards (i.e., performance share awards, performance stock units, performance bonus awards, performance-based awards and deferred stock) may be granted by our Compensation Committee (or the |
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| | |
| | Board of Directors, in the case of awards to non-employee directors) on an individual or group basis. Generally, these awards will be based upon specific performance targets and may be paid in cash or in common stock or in a combination of both. Performance awards may include “phantom” stock awards that provide for payments based upon increases in the price of our common stock over a predetermined period. Performance awards may also include bonuses that may be granted by our Compensation Committee (or the Board of Directors, in the case of awards to non- employee directors) on an individual or group basis, which may be paid on a current or deferred basis and may be payable in cash or in common stock or in a combination of both. The maximum amount of any such bonuses to a “covered employee” within the meaning of Section 162(m) of the Internal Revenue Code must not exceed $1,000,000 for any fiscal year during the term of the 2007 Plan. |
| | |
| • | Stock payments may be authorized by our Compensation Committee (or the Board of Directors, in the case of awards to non-employee directors) in the form of common stock or an option or other right to purchase common stock as part of a deferred compensation arrangement, made in lieu of all or any part of compensation, including bonuses, that would otherwise be payable to employees, consultants or members of our Board of Directors. |
Corporate Transactions
In the event of a change of control where the acquiror does not assume awards granted under the 2007 Plan, awards issued under the 2007 Plan will be subject to accelerated vesting such that 100% of the awards will become vested and exercisable or payable, as applicable. Under the 2007 Plan, a change of control is generally defined as:
| | |
| • | a transaction or series of related transactions (other than an offering of our stock to the general public through a registration statement filed with the United States Securities and Exchange Commission, or SEC) whereby any person or entity or related group of persons or entities (other than us, our subsidiaries, an employee benefit plan maintained by us or any of our subsidiaries or a person or entity that, prior to such transaction, directly or indirectly controls, is controlled by, or is under common control with, us) directly or indirectly acquires beneficial ownership (within the meaning ofRule 13d-3 under the Exchange Act) of more than 50% of the total combined voting power of our securities outstanding immediately after such acquisition; |
| | |
| • | during any two-year period, individuals who, at the beginning of such period, constitute our Board of Directors together with any new director(s) whose election by our Board of Directors or nomination for election by our shareholders was approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of the two-year period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority of our Board of Directors; |
| | |
| • | our consummation (whether we are directly or indirectly involved through one or more intermediaries) of (x) a merger, consolidation, reorganization, or business combination that results in our outstanding voting securities immediately before the transaction continuing to represent a majority of the voting power of the acquiring company’s outstanding voting securities or a merger, consolidation, reorganization, or business combination after which no person or entity owns 50% of the successor company’s voting power, (y) the sale, exchange or transfer of all or substantially all of our assets in any single transaction or series of transactions or (z) the acquisition of assets or stock of another entity. |
Amendment and Termination of the 2007 Plan
Our Board of Directors or our Compensation Committee may terminate, amend or modify the 2007 Plan. However, shareholder approval of any amendment to the 2007 Plan will be obtained to the extent necessary and desirable to comply with any applicable law, regulation or stock exchange rule, or for any amendment to the 2007 Plan that increases the number of shares available under the 2007 Plan. If not terminated earlier by the Compensation Committee or the Board of Directors, the 2007 Plan will terminate on the tenth anniversary of the date of its initial approval by our Board of Directors.
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2007 Employee Stock Purchase Plan
Our Board of Directors has adopted the 2007 Employee Stock Purchase Plan, or the Purchase Plan, which will be submitted to our shareholders for their approval within twelve months from the date our Board of Directors approved the Purchase Plan. The Purchase Plan is designed to allow our eligible employees and the eligible employees of our participating subsidiaries to purchase shares of common stock with accumulated payroll deductions. However, the Board of Directors will not establish the first offering period (as further described below) earlier than the first anniversary and no later than the fourth anniversary of the date immediately preceding the date of our initial public offering, and the Purchase Plan will terminate on such fourth anniversary if our Board of Directors does not take action to commence the first offering period under the Purchase Plan prior to such date.
We have initially reserved a total of 588,235 shares of our common stock for issuance under the Purchase Plan. The Purchase Plan will contain an “evergreen provision” that allows for an annual increase in the number of shares available for issuance under the Purchase Plan on July 1 of each year during the ten-year term of the Purchase Plan, beginning on July 1 following the fiscal year in which the first offering period commences. The annual increase shall be equal to the least of:
| | |
| • | 2% of our outstanding common stock on the applicable July 1; |
| | |
| • | a lesser amount determined by our Board of Directors. |
Therefore, the Purchase Plan provides for an aggregate limit of 588,235 shares of common stock plus the share increases as a result of the “evergreen provision” which may be issued under the Purchase Plan over the course of its ten-year term. The material terms of the Purchase Plan are summarized below. The Purchase Plan is filed as an exhibit to the registration statement of which this prospectus is a part.
The Purchase Plan will have consecutivethree-month offering periods. Under the Purchase Plan, purchases will be made on the last day of each offering period. The first offering period will commence no earlier than the first anniversary and no later than the fourth anniversary of the date immediately preceding the date of our initial public offering. A new three-month offering period will commence on each applicable January 1, April 1, July 1 and October 1 thereafter during the term of the Purchase Plan. Our Compensation Committee may change the frequency and duration of offering periods under the Purchase Plan.
Individuals scheduled to work more than 20 hours per week for more than five calendar months per year may join an offering period on the first day of the offering period to the extent such individual does not, immediately after any rights under the Purchase Plan are granted, own (directly or through attribution) stock possessing 5% or more of the total combined voting power or value of all classes of our common or other stock or of our parent or a subsidiary. As of June 30, 2007, 439 of our employees would have been eligible to participate in the Purchase Plan if it were in effect.
Participants may contribute up to 20% of their cash earnings through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on each purchase date. The purchase price per share will be between 85% and 95% of the fair market value per share on the first day of the offering period or on the purchase date, as determined by our Board of Directors. In each calendar year, no employee is permitted to purchase more than $25,000 worth of shares at the fair market value determined as of the first day of the offering period.
In the event of a proposed sale of all or substantially all of our assets, or our merger with or into another company, the outstanding rights under the Purchase Plan will be assumed or an equivalent right substituted by the successor company or its parent. If the successor company or its parent refuses to assume the outstanding rights or substitute an equivalent right, then all outstanding purchase rights will automatically be exercised prior to the effective date of the transaction. The purchase price will be equal to between 85% and 95% of the market value per share on the first day of the offering period in which the acquisition occurs or the date the purchase rights are exercised, as determined by our Board of Directors.
The Purchase Plan will terminate no later than the tenth anniversary of the Purchase Plan’s initial adoption by our Board of Directors.
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CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS
The following is a summary of transactions since July 1, 2004 to which we have been a party in which the amount involved exceeded $120,000 and in which any of our executive officers, directors or beneficial holders of more than 5% of our capital stock had or will have a direct or indirect material interest, other than compensation arrangements that are described under the section of this prospectus entitled “Compensation Discussion and Analysis.”
Policies and Procedures for Related-Party Transactions
We recognize that related party transactions present a heightened risk of conflicts of interest and in connection with this offering, have adopted a policy to which all related party transactions shall be subject. Pursuant to the policy, the audit committee of our board of directors, or in the case of a transaction in which the aggregate amount is, or is expected to be, in excess of $250,000, the board of directors will review the relevant facts and circumstances of all related party transactions, including, but not limited to, (i) whether the transaction is on terms comparable to those that could be obtained in arm’s length dealings with an unrelated third party and (ii) the extent of the related party’s interest in the transaction. Pursuant to the policy, no director, including the chairman of the audit committee may participate in any approval of a related party transaction to which he or she is a related party.
The audit committee will then, in its sole discretion, either approve or disapprove the transaction.
Certain types of transactions, which would otherwise require individual review, have been pre-approved by the audit committee. These types of transactions include, for example, (i) compensation to an officer or director where such compensation is required to be disclosed in our proxy statement, (ii) transactions where the interest of the related party arises only by way of a directorship or minority stake in another organization that is a party to the transaction and (iii) transactions involving competitive bids or fixed rates. Additionally, pursuant to the terms of our related party transaction policy, all related party transactions are required to be disclosed in the Company’s applicable filings as required by the Securities Act and the Exchange Act and related rules. Furthermore, any material related party transactions are required to be disclosed to the full Board of Directors. In connection with becoming a public company, we will establish new internal policies relating to disclosure controls and procedures, which we expect will include policies relating to the reporting of related party transactions that are pre-approved under our related party transactions policy.
All of the transactions set forth below were approved by a majority of the board of directors, including a majority of the independent and disinterested members of the board of directors prior to the adoption of our related party transaction policy. We believe that we have executed all of the transactions set forth below on terms no less favorable to us than we could have obtained from unaffiliated third parties.
Loan From Director Stockholders
On June 28, 2005, the Company entered into a loan commitment with certain of its director stockholders and their affiliates. The loan, which was made to supplement our working capital, entitled us to borrow up to $8.050 million in two installments. In June 2005, we borrowed $4.025 million. The loan was secured by our accounts receivable and certain other assets and was to mature on December 31, 2006. However, we paid the loan in full, including $1.0 million in interest, on December 21, 2006 and all obligations relating to the loan have since been released.
Stockholders Agreement
We entered into a Second Amended and Restated Stockholders Agreement, dated December 19, 2003, with the holders of our common stock and the holders of our Series B and Series C preferred stock. We refer to this agreement below as the stockholders agreement. The stockholders agreement contains certain transfer restrictions, preemptive rights and drag-along rights, each of which will terminate upon completion of this offering.
Pursuant to the stockholders agreement, holders of shares of our common stock and preferred stock have the registration rights described below. These registration rights are subject to certain conditions and limitations, including the right of the underwriters of an offering to limit the number of shares included in such registration and
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our right to postpone a requested registration for a period of no more than 120 days if our board determines such registration would be detrimental to us.
The holders of at least one-third of the shares of our common stock issued or issuable to our preferred stockholders upon conversion of their preferred stock, subject to certain exceptions, may require us to file a registration statement under the Securities Act at our expense with respect to such shares of common stock. We are not obligated to take any action to effect any registration demanded pursuant to the stockholders agreement during the period starting 60 days prior to and ending six months following the effective date of any registration statement pertaining to any of our securities. The stockholders agreement grants three such demand registration rights.
Beginning six months after this offering, if we propose to register any shares of our common stock, persons owning or having the right to acquire shares of our common stock are entitled to notice of such registration and are entitled to include shares of their common stock therein.
We are obligated to pay all registration expenses, other than underwriting commissions, brokerage fees or transfer taxes related to any demand or piggyback registration. Each holder agrees not to undertake any public sale or distribution of shares of our common stock during the180-day period following the closing of an initial public offering of our common stock. The stockholders agreement contains customary indemnification provisions.
Individual Stockholder Agreements
We entered into a Stockholder Agreement with our Chief Executive Officer, Ronald J. Packard, and Knowledge Universe Learning, Inc. (KULI) dated April 26, 2000. Pursuant to that agreement, Mr. Packard granted to KULI an irrevocable proxy to voteand/or give written consents with respect to any and all shares of the Company owned by Mr. Packardand/or standing in the name of Mr. Packard on the books and records of the Company or with respect to which Mr. Packard otherwise may be entitled to vote at any and all annual or special meetings of the stockholders of the Company or by written consent. Upon the completion of this offering, this agreement shall automatically terminate.
We entered into a Stockholder Agreement with William J. Bennett and KULI on February 20, 2000. Dr. Bennett resigned as a director and our Chairman in October 2005, at which time certain terms of this agreement were amended in connection with his resignation. Upon the closing of the offering, any antidilution rights that remain in the agreement will terminate. The agreement initially prohibited sales by Dr. Bennett of the 1,500,000 shares he was issued in 2000, and now limits him to sales of no more than 20% of such shares per year.
Employment Agreements
We have entered into employment with certain of our executive officers. For more information regarding these agreements. See “Compensation Discussion and Analysis — Employment Agreements.”
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table provides certain information regarding the beneficial ownership of our outstanding capital stock as of JuneSeptember 30, 2007, after giving effect to athe 1 for 5.10 stock split that was affected on November 2, 2007, for:
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| • | each person or group who beneficially owns more than 5% of our capital stock on a fully diluted basis; |
|
| • | each of the executive officers named in the Summary Compensation Table; |
|
| • | each of our directors; |
|
| • | each of the selling stockholders; and |
|
| • | all of our directors and executive officers as a group. |
The selling stockholders will only offer shares in this offering if, and to the extent, that the underwriters exercise their overallotment option.
Unless otherwise noted, the address for each director and executive officer is c/o K12 Inc., 2300 Corporate Park Drive, Herndon, VA 20171.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | Maximum
| | | | | | |
| | | | | | | | Number of
| | Shares Beneficially
| | |
| | | | | | Percentage of
| | Shares to be
| | Owned After
| | |
| | | | | | Ownership After
| | Sold in This
| | This Offering if
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Shares Beneficially
| | This Offering if
| | Offering if the
| | the Underwriters
| | | Shares Beneficially
| | | | | | | | | | | | | |
| | Owned Prior
| | the Underwriters
| | Underwriters
| | Exercise Their
| | | Owned Prior
| | | | Shares Beneficially
| | | | Shares Beneficially Owned
| |
| | to This
| | Do Not Exercise
| | Exercise Their
| | Overallotment
| | | to This
| | Shares to
| | Owned After This
| | Shares to be
| | After this Offering with
| |
| | Offering(1) | | Their Overallotment
| | Overallotment
| | Option in Full(1) | | | Offering(1) | | be Sold in
| | Offering | | Sold in the
| | the Over-Allotment | |
Name of Beneficial Owner | | Number | | Percent | | Option | | Option in Full | | Number | | Percent | | | Number | | Percent | | This Offering | | Number | | Percent | | Over-Allotment | | Number | | Percent | |
|
Executive Officers | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ronald J. Packard(2) | | | 4,681,369 | | | | 4.07 | % | | | | | | | | | | | | | | | | | | | 917,908 | | | | 4.07 | % | | | | | | | | | | | | | | | | | | | | | | | | |
John F. Baule(3) | | | 550,000 | | | | * | | | | | | | | | | | | | | | | | | | | 122,547 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Bror V. H. Saxberg(4) | | | 444,375 | | | | * | | | | | | | | | | | | | | | | | | | | 91,910 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Howard D. Polsky(5) | | | 101,000 | | | | * | | | | | | | | | | | | | | | | | | | | 22,254 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Nancy Hauge(6) | | | 68,125 | | | | * | | | | | | | | | | | | | | | | | | | | 15,808 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Celia M. Stokes(7) | | | 62,500 | | | | * | | | | | | | | | | | | | | | | | | | | 14,705 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Bruce J. Davis | | | — | | | | — | | | | | | | | | | | | | | | | | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | |
George B. Hughes, Jr. | | | — | | | | — | | | | | | | | | | | | | | | | | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | |
Directors | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Andrew H. Tisch(8) | | | 5,532,243 | | | | 4.94 | % | | | | | | | | | | | | | | | | | | | 1,087,195 | | | | 4.95 | % | | | | | | | | | | | | | | | | | | | | | | | | |
Thomas J. Wilford(9) | | | 4,206,345 | | | | 3.76 | % | | | | | | | | | | | | | | | | | | | 825,993 | | | | 3.76 | % | | | | | | | | | | | | | | | | | | | | | | | | |
Guillermo Bron(10) | | | 432,738 | | | | * | | | | | | | | | | | | | | | | | | | | 84,850 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Steven B. Fink(11) | | | 105,269 | | | | * | | | | | | | | | | | | | | | | | | | | 23,157 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Liza A. Boyd(12) | | | — | | | | — | | | | | | | | | | | | | | | | | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | |
Dr. Mary H. Futrell | | | — | | | | — | | | | | | | | | | | | | | | | | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | |
All Directors and Executive Officers as a Group (14 persons) | | | 16,183,964 | | | | 13.92 | % | | | | | | | | | | | | | | | | | | | 3,206,327 | | | | 14.04 | % | | | | | | | | | | | | | | | | | | | | | | | | |
Beneficial Owners of 5% or More of Our Outstanding Common Stock | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Learning Group LLC(13) | | | 27,521,420 | | | | 24.48 | % | | | | | | | | | | | | | | | | | | | 5,396,355 | | | | 24.48 | % | | | | | | | | | | | | | | | | | | | | | | | | |
CV II Entities(14) | | | 17,573,842 | | | | 15.70 | % | | | | | | | | | | | | | | | | | | | 3,445,849 | | | | 15.70 | % | | | | | | | | | | | | | | | | | | | | | | | | |
Mollusk Holdings, LLC(15) | | | 13,002,086 | | | | 11.51 | % | | | | | | | | | | | | | | | | | | | 2,549,427 | | | | 11.51 | % | | | | | | | | | | | | | | | | | | | | | | | | |
First Dallas International Ltd.(16) | | | | 1,566,472 | | | | 7.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
Locke Limited(16) | | | | 1,566,472 | | | | 7.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
Stargate, Ltd.(16) | | | | 1,566,472 | | | | 7.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
Tallulah, Ltd.(16) | | | | 1,566,472 | | | | 7.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
102
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Shares Beneficially
| | | | | | | | | | | | | | | | | | | |
| | Owned Prior
| | | | | | Shares Beneficially
| | | | | | Shares Beneficially Owned
| |
| | to This
| | | Shares to
| | | Owned After This
| | | Shares to be
| | | After this Offering with
| |
| | Offering(1) | | | be Sold in
| | | Offering | | | Sold in the
| | | the Over-Allotment | |
Name of Beneficial Owner | | Number | | | Percent | | | This Offering | | | Number | | | Percent | | | Over-Allotment | | | Number | | | Percent | |
|
Other Selling Stockholders | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Alscott Investments, LLC(17) | | | 825,997 | | | | 3.77 | | | | | | | | | | | | | | | | | | | | | | | | | |
Continental Casualty Company(18) | | | 731,636 | | | | 3.34 | | | | | | | | | | | | | | | | | | | | | | | | | |
Bennett Family Investment Limited Partnership II(19) | | | 588,234 | | | | 2.65 | | | | | | | | | | | | | | | | | | | | | | | | | |
Madison West Associates Corp.(20) | | | 341,430 | | | | 1.56 | | | | | | | | | | | | | | | | | | | | | | | | | |
Irani Family Limited Partnership II(21) | | | 304,503 | | | | 1.39 | | | | | | | | | | | | | | | | | | | | | | | | | |
MBNA Community Development Corporation(22) | | | 292,654 | | | | 1.33 | | | | | | | | | | | | | | | | | | | | | | | | | |
Adase Partners, L.P.(23) | | | 249,834 | | | | 1.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
AT Investors, LLC(24) | | | 249,834 | | | | 1.14 | | | | | | | | | | | | | | | | | | | | | | | | | |
RS Associates(25) | | | 178,765 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
LexMap, LLC(26) | | | 166,378 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Jerry & Joy Monkarsh, H.W.C.P.(27) | | | 166,378 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Westbury Capital, L.P.(28) | | | 152,456 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
David F. Nathanson, Trustee(29) | | | 83,189 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Douglas I. Lovison IRA Bear Sterns Sec. Co.(30) | | | 73,163 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
David William Hanna, Trustee(31) | | | 73,162 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Violet Hanna & David W. Hanna, Trustees(32) | | | 73,162 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Hanna Ventures, LLC(33) | | | 73,162 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Peter W. May(34) | | | 48,775 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Nelson Peltz(35) | | | 48,775 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
BuenaVentura Communications(36) | | | 47,556 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Rodgers Business Interests(37) | | | 23,491 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
Theodore J. Eischeid(38) | | | 8,823 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
David S. Kyman(39) | | | 478 | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | |
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* | | Less than 1% beneficial ownership. |
95
| | |
(1) | | Beneficial ownership of shares is determined in accordance with the rules of the Securities and Exchange Commission and generally includes any shares over which a person exercises sole or shared voting or investment power. Except as indicated by footnote, and subject to applicable community property laws, to our knowledge, each stockholder identified in the table possesses sole voting and investment power with respect to all shares of common stock shown as beneficially owned by the stockholder. The number of shares beneficially owned by a person includes shares of common stock subject to options and warrants held by that person that are currently exercisable or exercisable within 60 days of JuneSeptember 30, 2007 and not subject to repurchase as of that date. Shares issuable pursuant to options and warrants are deemed outstanding for calculating the percentage ownership of the person holding the options and warrants but are not deemed outstanding for the purposes of calculating the percentage ownership of any other person. For purposes of this table, the number of shares of common stock outstanding as of JuneSeptember 30, 2007 is deemed to be 111,798,779,21,924,892 after giving effect to the conversion of our outstanding |
103
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| | preferred stock into 101,386,53619,879,675 shares of common stock immediately prior to the closing of this offering. For purposes of calculating the percentage beneficially owned by any person, shares of common stock issuable to such person upon the exercise of any options or warrants exercisable within 60 days of JuneSeptember 30, 2007 are also assumed to be outstanding. |
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(2) | | Includes options for 3,175,000 shares of common stock, warrants to purchase 6,369622,543 shares of common stock and 1,500,000warrants to purchase 1,248 shares of common stock. These totals include both shares and options held individually and in the 2006 Packard Investment Partnership, L.P. |
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(3) | | Includes options for 550,000122,547 shares of common stock. |
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(4) | | Includes 300,000 shares of common stock and options for 144,37533,087 shares of common stock. |
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(5) | | Includes options for 101,00022,254 shares of common stock. |
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(6) | | Includes options for 68,12515,808 shares of common stock. |
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(7) | | Includes options for 62,50014,705 shares of common stock. |
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(8) | | Includes options for 175,00036,758 shares of common stock and warrants to purchase 12,7392,497 shares of common stock. Also includes 1,248,900244,882 shares of common stock issuable upon conversion of preferred stock held by Andrew H. Tisch 1991 Trust #2, 182,13035,711 shares of common stock issuable upon conversion of preferred stock held by KAL Family Partnership and 182,12935,711 shares of common stock issuable upon conversion of preferred stock held by KSC Family Partnership. Mr. Tisch has voting and investment control with respect to the shares held by these entities. The address of these stockholders isc/o Loews Corporation, 667 Madison Avenue, 7th Floor, New York, New York 10021. Also includes 3,731,345731,636 shares of common stock issuable upon conversion of preferred stock held by Continental Casualty Company. Mr. Tisch is on the board of directors of CNA Financial Corporation, which is affiliated with Continental Casualty Company. Mr. Tisch disclaims beneficial ownership of the shares held by Continental Casualty Company. The address for Continental Casualty Company is c/o CNA Financial Corporation, CNA Center, Chicago, Illinois 60685. |
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(9) | | Includes options for 75,00015,926 shares of common stock. Also includes 4,131,345810,067 shares of common stock held by Alscott Investments, LLC. Mr. Wilford has voting and investment power with respect to shares held by this stockholder. The address of Alscott Investments, LLC is 501 Baybrook Court, Boise, Idaho 83706. Mr. Wilford disclaims beneficial ownership of the shares held by Alscott Investment, LLC except to the extent of his pecuniary interest therein. |
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(10) | | Includes 432,73884,850 shares of common stock issuable upon conversion of preferred stock held by The Bron Trust, dated July 27, 1998. Mr. Bron is not the trustee of The Bron Trust, however, he is the beneficiary of The Bron Trust and, therefore, is deemed to beneficially own such shares. Mr. Bron disclaims beneficial ownership of the shares held by The Bron Trust except to the extent of his pecuniary interest, if any, therein. |
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(11) | | Includes options for 105,26923,157 shares of common stock. Does not include the shares of common stock or preferred stock held by Mollusk Holdings, LLC. Mr. Fink is the Chief Executive Officer of Lawrence Investments, LLC. Lawrence Investments, LLC is a managing member of Mollusk Holdings, LLC. Mr. Fink does not have voting power nor investment power with respect to the common stock directly or beneficially owned by Mollusk Holdings, LLC. |
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(12) | | Does not include the shares of preferred stock or options to acquire common stock held by Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund IV, L.P. and CVC II Partners, LLC (See note (14)). Ms. Boyd is a Managing Director of Constellation Ventures. Ms. Boyd does not have voting power nor investment power with respect to the common stock beneficially owned by such funds. |
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(13) | | Includes 23,791,9314,665,084 shares of common stock issuable upon conversion of preferred stock, 3,106,774609,171 shares of common stock, warrants to purchase 40,6257,965 shares of common stock and warrants to purchase 582,090 shares of preferred stock convertible into an equivalent amount of114,135 shares of common stock upon consummation of this offering. Learning Group LLC may be deemed to be controlled by Michael R. Milken and/or Lowell J. Milken and as such, Michael R. Milken and/or Lowell J. Milken may be deemed to have the power to exercise investment and voting control over, and to share in the beneficial ownership of, the shares beneficially owned by Learning Group LLC. The address for Messrs. M. Milken and L. Milken and Learning Group LLC is 1250 Fourth Street, Santa Monica, CA 90401. |
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(14) | | The CV II Entities consist of (i) Constellation Venture Capital II, L.P. (CVC II), (ii) Constellation Venture Capital Offshore II, L.P. (Offshore), (iii) The BSC Employee Fund IV, L.P. (BSC) and (iv) CVC II Partners, LLC (CVC II Partners, and together with CVC II, Offshore and BSC, the Constellation Funds). Constellation Ventures Management II LLC is the sole general partner of CVC II, the sole general partner of Offshore and the sole managing general partner of BSC. Bear Stearns Asset Management Inc. is the managing member of CVC II Partners and the investment adviser to each Constellation Fund. Clifford Friedman is a member of Constellation Ventures Management II, LLC and a senior managing director of Bear Stearns Asset Management Inc. The Bear Stearns Companies Inc., a registered broker-dealer, is the sole managing member of Constellation Ventures Management II, LLC and the parent corporation of Bear Stearns Asset Management Inc. Constellation Ventures Management II, LLC, Bear Stearns Asset Management Inc. and Mr. Friedman share investment and voting control of shares beneficially owned by CVC II, Offshore and BSC. Bear Stearns Asset Management Inc. exercises sole investment and voting control of the shares beneficially owned by CVC II Partners. The address for each such entity and person is 237 Park Avenue, New York, New York 10017. |
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| | The holdings of the CV II Entities include: (i) 9,220,0611,807,855 shares of common stock issuable upon conversion of preferred stock held by CVC II and options for 72,71014,256 shares of common stock assigned to CVC II by Ms. Boyd or a former director appointed by the Constellation Funds; (ii) 4,358,964854,698 shares of common stock issuable upon conversion of preferred stock held by Offshore and options for 34,3756,740 shares of common stock assigned to Offshore by Ms. Boyd or a former director appointed by the Constellation Funds; (iii) 3,652,763716,228 shares of common stock issuable upon conversion of preferred stock held by BSC and options for 28,8065,648 shares of common stock assigned to BSC by |
96
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| | Ms. Boyd or a former director appointed by the Constellation Funds; and (iv) 204,55440,108 shares of common stock issuable upon conversion of preferred stock held by CVC II Partners and options for 1,609316 shares of common stock assigned to CVC II Partners by Ms. Boyd or a former director appointed by the Constellation Funds. Ms. Boyd is affiliated with the Constellation Funds but disclaims beneficial ownership of the shares held by them. The CV II Entities has informed us that it purchased the shares being registered on their behalf in the ordinary course of business and, at the time of their purchase, had no agreement or understanding, directly or indirectly, with any person to distribute those shares. |
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(15) | | Includes 7,962,3951,561,253 shares of common stock issuable upon conversion of preferred stock held, 3,875,512 shares of common stock and warrants to purchase 1,164,179 shares of preferred stock convertible into an equivalent amount of228,270 shares of common stock upon consummation of this offering. The address of this stockholder is 101 Ygnacio Valley Road, Suite 310, Walnut Creek, California 94596. Cephalopod Corporation and Lawrence Investments, LLC are the members of Mollusk Holdings, LLC. Cephalopod Corporation is the managing member of Mollusk Holdings, LLC. Mr. Lawrence J. Ellison is the Chief Executive Officer of Cephalopod Corporation. The Lawrence J. Ellison Revocable Trust U/D/D 12/8/95 (“Ellison Trust”), Philip B. |
104
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| | Simon and Steven B. Fink are the members of Lawrence Investments, LLC. Mr. Fink is the Chief Executive Officer of Lawrence Investments, LLC and Mr. Simon is the President of Lawrence Investments, LLC. Mr. Ellison is the sole beneficiary and co-trustee of the Ellison Trust. Mr. Simon is the other co-trustee. Mr. Ellison may be deemed to exercise investment and voting control over the shares beneficially owned by Mollusk Holdings, LLC. The address for Mr. Ellison is 500 Oracle Parkway, Redwood Shores, California 94065. |
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(16) | | The general partner of Tallulah, Ltd. (Tallulah) is Mr. Sam Wyly. Mr. Sam Wyly’s children are contingent beneficiaries of a trust that is the owner of all of the shares of stock of Locke Limited (Locke). The general partner of Stargate, Ltd. (Stargate) is The Charles J. Wyly, Jr. and Caroline D. Wyly Revocable Trust of which Mr. Charles J. Wyly, Jr. is a trustee. Mr. Charles J. Wyly, Jr.’s children or Mr. Charles J. Wyly, Jr., his spouse and his issue are present or contingent beneficiaries of certain trusts that own subsidiaries that are the owners of all of the shares of stock of First Dallas International Ltd. (First Dallas). First Dallas is under voluntary liquidation under the direction of Kinetic Partners Cayman LLP. Mr. Sam Wyly and Mr. Charles J. Wyly, Jr. are brothers. Collectively, Sam Wyly, Charles J. Wyly, Jr., Tallulah, Stargate, Locke and First Dallas may be deemed to beneficially own, for purposes of Section 13(d) of the Exchange Act, 1,566,472 shares of common stock issuable upon conversion of preferred stock. The address for each of Tallulah, and Stargate isc/o Highland Stargate, Ltd., 300 Crescent Court, Suite 1000, Dallas, Texas 75201. The address for Locke is International House, Castle Hill, Victoria Road, Douglas, Isle of Man IM2 4RB. The address for First Dallas isc/o Kinetic Partners, P.O. Box 10387, Grand Cayman Islands KY1-1004. |
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| | Includes 435,218 shares of common stock issuable upon conversion of preferred stock held by First Dallas, 870,176 shares of common stock issuable upon conversion of preferred stock held by Locke, 86,939 shares of common stock issuable upon conversion of preferred stock held by Stargate and 174,139 common stock issuable upon conversion of preferred stock held by Tallulah. Locke disclaims beneficial ownership of the shares held by First Dallas, Stargate and Tallulah. |
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(17) | | Includes 810,067 shares of common stock issuable upon conversion of preferred stock and options for 15,930 shares of common stock. |
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(18) | | Includes 731,636 shares of common stock issuable upon conversion of preferred stock. |
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(19) | | Includes options for 294,117 shares of common stock. |
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(20) | | Includes 341,430 shares of common stock issuable upon conversion of preferred stock. |
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(21) | | Includes 101,501 shares of common stock issuable upon conversion of preferred stock. Also includes 203,002 shares of common stock issuable upon conversion of preferred stock held by Ray R. Irani, Trustee of the Ray R. Irani Declaration of Trust dtd 11/13/90. |
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(22) | | Includes 292,654 shares of common stock issuable upon conversion of preferred stock. |
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(23) | | Includes 166,729 shares of common stock issuable upon conversion of preferred stock. Also includes 17,075 shares of common stock issuable upon conversion of preferred stock held by AT Investors, LLC, 45,202 shares of common stock issuable upon conversion of preferred stock held by Bahram Nour-Omid and options for 20,828 shares of common stock held by Arthur Bilger. |
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(24) | | Includes 17,075 shares of common stock issuable upon conversion of preferred stock. Also includes 166,729 shares of common stock issuable upon conversion of preferred stock held by Adase Partners, L.P., 45,202 shares of common stock issuable upon conversion of preferred stock held by Bahram Nour-Omid and options for 20,828 shares of common stock held by Arthur Bilger. |
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(25) | | Includes 178,765 shares of common stock issuable upon conversion of preferred stock. |
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(26) | | Includes 166,378 shares of common stock issuable upon conversion of preferred stock. |
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(27) | | Includes 166,378 shares of common stock issuable upon conversion of preferred stock. |
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(28) | | Includes 152,456 shares of common stock issuable upon conversion of preferred stock. |
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(29) | | Includes 83,189 shares of common stock issuable upon conversion of preferred stock. Mr. Nathanson is the trustee for the David F. Nathanson Revocable Trust dtd 7/22/06. |
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(30) | | Includes 73,163 shares of common stock issuable upon conversion of preferred stock. |
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(31) | | Includes 29,265 shares of common stock issuable upon conversion of preferred stock. Also includes 29,265 shares of common stock issuable upon conversion of preferred stock held by Violet Hanna & David W. Hanna, Trustees for the Hanna Living Trust dtd7/7/83 and 14,632 shares of common stock issuable upon conversion of preferred stock held by Hanna Ventures, LLC. Mr. Hanna is the trustee for the David William Hanna Trust dtd 10/30/89. |
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(32) | | Includes 29,265 shares of common stock issuable upon conversion of preferred stock. Also includes 29,265 shares of common stock issuable upon conversion of preferred stock held by David William Hanna, Trustee for the David William Hanna Trust dtd10/30/89 and 14,632 shares of common stock issuable upon conversion of preferred stock held by Hanna Ventures, LLC. Ms. Hanna and Mr. Hanna are the trustees for the Hanna Living Trust dtd 7/7/83. |
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(33) | | Includes 14,632 shares of common stock issuable upon conversion of preferred stock. Also includes 29,265 shares of common stock issuable upon conversion of preferred stock held by David William Hanna, Trustee for the David William Hanna Trust dtd10/30/89 and 29,265 shares of common stock issuable upon conversion of preferred stock held by Violet Hanna & David W. Hanna, Trustees for the Hanna Living Trust dtd7/7/83. |
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(34) | | Includes 48,775 shares of common stock issuable upon conversion of preferred stock. |
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(35) | | Includes 48,775 shares of common stock issuable upon conversion of preferred stock. |
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(36) | | Includes 47,556 shares of common stock issuable upon conversion of preferred stock. |
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(37) | | Includes 23,491 shares of common stock issuable upon conversion of preferred stock. |
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(38) | | Includes 8,823 shares of common stock issuable upon conversion of preferred stock. |
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(39) | | Includes 365 shares of common stock issuable upon conversion of preferred stock. |
97105
DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock is only a summary, and is qualified in its entirety by reference to the actual terms and provisions of the capital stock contained in our Amended and Restated Certificate of Incorporation, as amended, Bylaws, as amended, and other agreements to which we and our stockholders are parties.
As of JuneSeptember 30, 2007, there were 10,412,2432,041,604 shares of common stock outstanding, held of record by 35 stockholders, and there were 51,524,974 shares of Series B preferred stock and 49,861,562 shares of Series C preferred stock outstanding, held of record by 62 and 39 stockholders, respectively.
Immediately prior to the completion of this offering, all outstanding shares of our preferred stock will be converted into shares of our common stock pursuant to the terms thereof without any further action required by us or the holders of the preferred stock. Upon completion of this offering, our authorized capital stock will consist of shares of common stock, par value $0.0001 per share, and shares of preferred stock, par value $0.0001 per share, all of which shares of preferred stock will be undesignated.
Common Stock
The holders of our common stock are entitled to the following rights:
Voting Rights
Each share of our common stock entitles its holder to one vote per share on all matters to be voted upon by the stockholders. There is no cumulative voting, which means that a holder or group of holders of more than 50% of the shares of our common stock can elect all of our directors.
Dividend Rights
The holders of our common stock are entitled to receive dividends when and as declared by our board of directors from legally available sources, subject to any restrictions in our Amended and Restated Certificate of Incorporation, as amended, or prior rights of the holders of our preferred stock. See “Dividend Policy.”
Liquidation Rights
In the event of our liquidation or dissolution, the holders of our common stock are entitled to share ratably in the assets available for distribution after the payment of all of our debts and other liabilities, subject to the prior rights of the holders of our preferred stock.
Other Matters
The holders of our common stock have no subscription, redemption or conversion privileges. Our common stock does not entitle its holders to preemptive rights. All of the outstanding shares of our common stock are fully paid and nonassessable. The rights, preferences and privileges of the holders of our common stock are subject to the rights of the holders of shares of any series of preferred stock which we may issue in the future.
Preferred Stock
Our board of directors has the authority to issue preferred stock in one or more classes or series and to fix the designations, powers, preferences, and rights, and the qualifications, limitations or restrictions thereof including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any class or series, without further vote or action by the stockholders. The issuance of preferred stock may have the effect of delaying, deferring, or preventing a change in control of our company without further action by the stockholders and may adversely affect the voting and other rights of the holders of our common stock. As of JuneSeptember 30, 2007, there was 51,524,974 shares of Series B preferred stock and 49,861,562 of Series C preferred stock issued and outstanding.
98106
Governing Documents and Delaware Law that May Have an Antitakeover Effect
The provisions of (1) Delaware law, (2) our amended and restated certificate of incorporation to be effective upon completion of this offering, and (3) our amended and restated bylaws to be effective upon completion of this offering, which are discussed below, could discourage or make it more difficult to accomplish a proxy contest or other change in our management or the acquisition of control by a holder of a substantial amount of our voting stock.
Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws
Upon consummation of the offering, we expect that our amended and restated certificate of incorporation and amended and restated bylaws will contain provisions that could have the effect of discouraging potential acquisition proposals or tender offers or delaying or preventing a change of control of the Company. In particular, we expect that our amended and restated certificate of incorporation and amended and restated bylaws, as applicable, among other things, will:
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| • | provide that special meetings of the stockholders may be called only by our Chairman of the Board, Chief Executive Officer, by the request in writing of a majority of the members of the board of directors or by the request in writing of stockholders holding in aggregate at least 40 % of the number of shares outstanding; |
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| • | establish procedures with respect to stockholder proposals and stockholder nominations, including requiring advance written notice of a stockholder proposal or director nomination; |
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| • | not permit action by stockholders by written consent in lieu of a meeting of stockholders; |
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| • | not include a provision for cumulative voting in the election of directors. Under cumulative voting, a minority stockholder holding a sufficient number of shares may be able to ensure the election of one or more directors. The absence of cumulative voting may have the effect of limiting the ability of minority stockholders to effect changes in the board of directors and, as a result, may have the effect of deterring a hostile takeover or delaying or preventing changes in control or management of our company; |
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| • | provide that vacancies on our board of directors may be filled by a majority of directors in office, although less than a quorum, and not by the stockholders; |
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| • | require that the vote of holders of 662/3% of the voting power of the outstanding shares entitled to vote generally in the election of directors is required to amend our amended and restated certificate of incorporation and amended and restated bylaws; and |
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| • | provide that the board of directors has the power to alter, amend or repeal the bylaws without stockholder approval. |
Following the completion of this offering, our amended and restated certificate of incorporation will authorize our board of directors, without further vote or action by the stockholders, to issue up to shares of preferred stock, par value $0.0001 per share, in one or more classes or series, and to fix or alter:
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| • | the number of shares constituting any class or series; |
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| • | the designations, powers and preferences of each class or series; |
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| • | the relative, participating, optional and other special rights of each class or series; and |
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| • | any qualifications, limitations or restrictions on each class or series. |
The above provisions are intended to promote continuity and stability in the composition of our board of directors and in the policies formulated by the board, and to discourage certain types of transactions that may involve an actual or threatened change of control. These provisions are expected to reduce our vulnerability to unsolicited acquisition attempts as well as discourage certain tactics that may be used in proxy fights. Such provisions, however, could discourage others from making tender offers for our shares and, as a consequence, may also inhibit fluctuations in the market price of our common stock that could result from actual or rumored takeover attempts. These provisions could also operate to prevent changes in our management.
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Delaware Takeover Statute
We are subject to the provisions of Section 203 of the Delaware General Corporation Law, or the DGCL. Subject to certain exceptions, Section 203 prohibits a Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the time that the stockholder became an interested stockholder, unless:
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| • | prior to the date of the business combination, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; |
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| • | on consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock of the interested stockholder) those shares owned: |
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| • | by persons who are directors and also officers, and |
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| • | by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or |
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| • | at or subsequent to such time, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 662/3% of the outstanding voting stock that is not owned by the interested stockholder. |
A “business combination” includes:
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| • | any merger or consolidation involving the corporation and the interested stockholder; |
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| • | any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder; |
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| • | subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; |
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| • | any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or |
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| • | the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. |
Subject to various exceptions, an “interested stockholder” is an entity or person who, together with affiliates and associates, owns (or within three years from the date of determination, did own) 15% or more of the corporation’s outstanding voting stock. This statute could delay, defer or prohibit a merger or other takeover or a change of control of the Company.
New York Stock Exchange
We will apply to list our common stock on the New York Stock Exchange under the symbol LRN.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock will be Registrar and Transfer Company.
100108
CERTAIN UNITED STATES FEDERAL INCOME TAX
CONSIDERATIONS TONON-U.S. HOLDERS
The following is a summary of the material U.S. federal income tax consequences tonon-U.S. holders of the ownership and disposition of our common stock, but does not purport to be a complete analysis of all the potential tax considerations relating thereto. This summary is based upon the provisions of the Internal Revenue Code of 1986, as amended, or the Code, U.S. Department of the Treasury regulations promulgated thereunder, administrative rulings and judicial decisions, all as of the date hereof. These authorities may be changed, possibly retroactively, so as to result in U.S. federal income tax consequences different from those set forth below. This summary is applicable only tonon-U.S. holders who hold our common stock as a capital asset (generally, an asset held for investment purposes). We have not sought any ruling from the Internal Revenue Service, or the IRS, with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions.
This summary also does not address the tax considerations arising under the laws of any foreign, state or local jurisdiction. In addition, this discussion does not address tax considerations applicable to an investor’s particular circumstances or to investors that may be subject to special tax rules, including, without limitation:
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| • | banks, insurance companies, or other financial institutions; |
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| • | persons subject to the alternative minimum tax; |
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| • | tax-exempt organizations; |
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| • | dealers in securities or currencies; |
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| • | traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; |
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| • | entities treated as partnerships for U.S. federal income tax purposes or investors in such entities; |
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| • | “controlled foreign corporations,” “passive foreign investment companies” and corporations that accumulate earnings to avoid U.S. federal income tax; |
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| • | U.S. expatriates or former long-term residents of the United States; |
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| • | persons who hold our common stock as a position in a hedging transaction, “straddle,” “conversion transaction” or other risk reduction transaction; or |
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| • | persons deemed to sell our common stock under the constructive sale provisions of the Code. |
In addition, if a partnership or other entity treated as a partnership for U.S. federal income tax purposes holds our common stock, the tax treatment of a partner generally will depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships which hold our common stock and partners in such partnerships should consult their tax advisors.
This discussion is for general information only and is not tax advice. You are urged to consult your tax advisor with respect to the application of the U.S. federal income tax laws to your particular situation, as well as any tax consequences of the purchase, ownership and disposition of our common stock arising under the U.S. federal estate or gift tax rules or under the laws of any state, local, foreign or other taxing jurisdiction or under any applicable tax treaty.
Non-U.S. Holder Defined
For purposes of this discussion, you are anon-U.S. holder if you are a holder that, for U.S. federal income tax purposes, is not a U.S. person. For purposes of this discussion, you are a U.S. person if you are:
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| • | an individual who is a citizen or resident of the United States, including an alien individual who is a lawful permanent resident of the United States or who meets the “substantial presence” test under Section 7701(b) of the Code; |
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| • | a corporation, or other entity taxable as a corporation for U.S. tax purposes, created or organized in the United States or under the laws of the United States or of any state therein or the District of Columbia; |
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| • | an estate whose income is subject to U.S. federal income tax regardless of its source; or |
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| • | a trust (1) whose administration is subject to the primary supervision of a U.S. court and which has one or more U.S. persons who have the authority to control all substantial decisions of the trust or (2) which has made an election to be treated as a U.S. person. |
Distributions
As discussed under “Dividend Policy” above, we do not currently expect to pay dividends or other distributions on our common stock.
If distributions are made on shares of our common stock, those payments will constitute dividends for U.S. tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. To the extent those distributions exceed both our current and our accumulated earnings and profits, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock.
Any dividend paid to you generally will be subject to U.S. withholding tax either at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by an applicable tax treaty. In order to receive a reduced treaty rate, you must provide the appropriate withholding agent with an IRSForm W-8BEN or other appropriate version of IRSForm W-8 certifying qualification for the reduced rate.
Dividends received by you that are effectively connected with your conduct of a U.S. trade or business (and, where a tax treaty applies, are attributable to a U.S. permanent establishment maintained by you) are exempt from such withholding tax. In order to obtain this exemption, you must provide the appropriate withholding agent with an IRSForm W-8ECI properly certifying such exemption. Such effectively connected dividends, although not subject to withholding tax, are taxed at the same graduated rates applicable to U.S. persons, net of any allowable deductions and credits. In addition, if you are a corporatenon-U.S. holder, dividends you receive that are effectively connected with your conduct of a U.S. trade or business may also be subject to a branch profits tax at a rate of 30% or such lower rate as may be specified by an applicable tax treaty.
If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the IRS in a timely manner.
Gain on Disposition of Common Stock
You generally will not be required to pay U.S. federal income tax on any gain realized upon the sale or other disposition of our common stock unless:
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| • | the gain is effectively connected with your conduct of a U.S. trade or business (and, where a tax treaty applies, is attributable to a U.S. permanent establishment maintained by you); |
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| • | you are an individual who is present in the United States for a period or periods aggregating 183 days or more during the calendar year in which the sale or disposition occurs and certain other conditions are met; or |
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| • | our common stock constitutes a U.S. real property interest by reason of our status as a “United States real property holding corporation” (a USRPHC) for U.S. federal income tax purposes at any time within the shorter of the five-year period preceding the disposition or your holding period for our common stock. |
We believe that we are not currently and will not become a USRPHC. However, because the determination of whether we are a USRPHC depends on the fair market value of our U.S. real property relative to the fair market value of our other business assets, there can be no assurance that we will not become a USRPHC in the future. Even if we become USRPHC, however, as long as our common stock is regularly traded on an established securities market, such common stock will be treated as U.S. real property interests only if you actually or constructively hold more than 5% of our common stock.
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If you are anon-U.S. holder described in the first bullet above, you will be required to pay tax on the net gain derived from the sale under regular graduated U.S. federal income tax rates, and corporatenon-U.S. holders described in the first bullet above may be subject to the branch profits tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. If you are an individualnon-U.S. holder described in the second bullet above you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by U.S. source capital losses. You should consult any applicable income tax treaties that may provide for different rules.
Backup Withholding and Information Reporting
Generally, we must report annually to the IRS the amount of dividends paid to you, your name and address, and the amount of tax withheld, if any. A similar report will be sent to you. These information reporting requirements apply even if withholding is not required. Pursuant to tax treaties or other agreements, the IRS may make its reports available to tax authorities in your country of residence.
Payments of dividends made to you will not be subject to backup withholding if you establish an exemption, for example, by properly certifying yournon-U.S. status on aForm W-8BEN or another appropriate version ofForm W-8. Notwithstanding the foregoing, backup withholding at a current rate of 28%, may apply if either we or our paying agent has actual knowledge, or reason to know, that you are a U.S. person.
Payments of the proceeds from a disposition of our common stock effected outside the United States by anon-U.S. holder made by or through a foreign office of a broker generally will not be subject to information reporting or backup withholding. However, information reporting (but not backup withholding) will apply to such a payment if the broker is a U.S. person, a controlled foreign corporation for U.S. federal income tax purposes, a foreign person 50% or more of whose gross income is effectively connected with a U.S. trade or business for a specified three-year period, or a foreign partnership with certain connections with the United States, unless the broker has documentary evidence in its records that the beneficial owner is anon-U.S. holder and specified conditions are met or an exemption is otherwise established.
Payments of the proceeds from a disposition of our common stock by anon-U.S. holder made by or through the U.S. office of a broker is generally subject to information reporting and backup withholding unless thenon-U.S. holder certifies as to itsnon-U.S. holder status under penalties of perjury or otherwise establishes an exemption from information reporting and backup withholding.
Backup withholding is not an additional tax. Rather, the U.S. income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may be obtained, provided that the required information is furnished to the IRS in a timely manner.
103111
SHARES ELIGIBLE FOR FUTURE SALE
If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options or warrants, in the public market following the offering, the market price of our common stock could decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
Upon completion of the offering, we will have outstanding an aggregate of shares of our common stock, assuming no exercise of the underwriters’ overallotment option and no exercise of outstanding options.options and assuming the sale of shares of common stock in the Regulation S Transaction (based on an assumed initial public offering price of $ per share, the midpoint of the range set forth on the cover page of this prospectus). Of these shares, all of the shares sold in the offering will be freely tradable without restriction or further registration under the Securities Act, unless the shares are purchased by “affiliates” as that term is defined in Rule 144 under the Securities Act. This leaves shares eligible for sale in the public market as follows:
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Number of
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Shares | | Date |
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| | After days from the date of this prospectus (subject, in some cases, to volume limitations). |
| | At various times after 180 days from the date of this prospectus as described below under “Lock-up” Agreements. |
Rule 144
In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of:
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| • | 1% of the number of shares of our common stock then outstanding, which will equal approximately shares immediately after the offering; or |
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| • | the average weekly trading volume of our common stock on the New York Stock Exchange during the four calendar weeks preceding the filing of a notice on Form 144 with respect to that sale. |
Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. The Securities and Exchange Commission has a proposal pending to shorten theone-year holding period to six months.
Rule 144(k)
Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, including the holding period of any prior owner other than an affiliate, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. The Securities and Exchange Commission has a proposal pending to shorten the two-year holding period to six months.
Lock-Up Agreements
All of our officers and directors and certain of our stockholders have entered intolock-up agreements under which they agreed not to transfer or dispose of, directly or indirectly, any shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock, except for shares sold in this offering by the selling stockholders, for a period of 180 days after the date of this prospectus without the prior written consent of Morgan Stanley & Co. Incorporated and Credit Suisse Securities (USA) LLC on behalf of the underwriters.
In addition, at our request, Morgan Stanley & Co. Incorporated has reserved for sale, at the initial public offering price, up to 10% of the shares of common stock offered for sale pursuant to this prospectus for sale to our
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directors, officers, employees, business associates and related persons in a directed share program. Any of these directed shares purchased by our directors, executive officers, employees and business associates, such as
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clients or suppliers, will be subject to a180-daylock-up restriction. Accordingly, the number of shares freely transferable upon completion of this offering will be reduced by the number of directed shares purchased by our directors, executive officers, employees and business associates, and there will be a corresponding increase in the number of shares that become eligible for sale after 180 days from the date of this prospectus.
Rule 701
In general, under Rule 701 of the Securities Act as currently in effect, any of our employees, consultants or advisors who purchase shares of our common stock from us in connection with a compensatory stock or option plan or other written agreement is eligible to resell those shares 90 days after the effective date of the offering in reliance on Rule 144, but without compliance with some of the restrictions, including the holding period, contained in Rule 144.
The Securities and Exchange Commission has indicated that Rule 701 will apply to typical stock options granted by an issuer before it becomes subject to the reporting requirements of the Securities Exchange Act of 1934, along with the shares acquired upon exercise of such options, including exercises after the date of this prospectus. Securities issued in reliance on Rule 701 are restricted securities and, subject to the contractual restrictions described above, beginning 90 days after the date of this prospectus, may be sold by persons other than “affiliates,” as defined in Rule 144, subject only to the manner of sale provisions of Rule 144 and by “affiliates” under Rule 144 without compliance with its one-year minimum holding period requirement.
Following the offering, we intend to file a registration statement onForm S-8 under the Securities Act covering approximately shares of common stock issued or issuable upon the exercise of stock options, subject to outstanding options or reserved for issuance under our employee and director stock benefit plans. Accordingly, shares registered under the registration statement will, subject to Rule 144 provisions applicable to affiliates, be available for sale in the open market, except to the extent that the shares are subject to vesting restrictions or the contractual restrictions described above. See “Compensation Discussion and Analysis — Elements of Compensation — Stock Options.”
105113
Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the underwriters named below, for whom Morgan Stanley & Co. Incorporated and Credit Suisse Securities (USA) LLC are acting as representatives, have severally agreed to purchase, and we and the selling stockholders have agreed to sell to them, severally, the number of shares indicated below:
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| | Number of
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Underwriters | | Shares | |
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Morgan Stanley & Co. Incorporated | | | | |
Credit Suisse Securities (USA) LLC | | | | |
Merrill Lynch, Pierce, Fenner & Smith Incorporated | | | | |
Robert W. Baird & Co. Incorporated | | | | |
BMO Capital Markets Corp. | | | | |
ThinkEquity Partners LLC | | | | |
Subtotal | | | | |
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Total | | | | |
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The underwriters are offering the shares of common stock subject to their acceptance of the shares from us and the selling stockholders and subject to prior sale. The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered by this prospectus are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are obligated to take and pay for all of the shares of common stock offered by this prospectus if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters’ overallotment option described below.
The underwriters initially propose to offer part of the shares of common stock directly to the public at the public offering price listed on the cover page of this prospectus and part to certain dealers at a price that represents a concession not in excess of $ a share under the public offering price. Any underwriter may allow, and such dealers may reallow, a concession not in excess of $ a share to other underwriters or to certain dealers. After the initial offering of the shares of common stock, the offering price and other selling terms may from time to time be varied by the representatives.
The selling stockholders have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of additional shares of common stock at the public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering overallotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. They may exercise this option during the30-day period from the date of this prospectus. To the extent the option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of the additional shares of common stock as the number listed next to the underwriter’s name in the preceding table bears to the total number of shares of common stock listed next to the names of all underwriters in the preceding table. If the underwriters’ option is exercised in full, the total price to the public would be $ , the total underwriters’ discounts and commissions would be $ , total proceeds to us would be $ and total proceeds to the selling stockholders would be $ .
The underwriters have informed us that they do not intend sales to discretionary accounts to exceed 5% of the total number of shares of common stock offered by them.
We intend to apply to have the common stock approved for listing on the New York Stock Exchange under the symbol “LRN”.
106114
The following table shows the per share and total underwriting discounts and commissions that we and the selling stockholders willare to pay to the underwriters:underwriters in connection with this offering. These amounts are shown assuming both no exercise and full exercise of the underwriters’ option to purchase additional shares of our common stock from the selling stockholders.
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| | Paid by Us | | | Paid by Selling Stockholders | | Total |
| | | | | SellingFull
| |
| | | | | StockholdersFull
| |
| | | | | WithFull
| |
| | Paid by UsNo Exercise | | Exercise | | No Exercise | | Exercise | | No Exercise | | Exercise |
Per Share | | $ | | | Overallotment | $ | |
|
Per Share | $ | | | | $ | | | | $ | | | | $ | | |
Total | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | |
We will pay all of the expenses of the offering, including those of the selling stockholders from this offering or if the underwriters exercise their overallotment option (other than underwriting discounts and commissions relating to the shares sold by the selling stockholders). We estimate that the expenses of this offering other than underwriting discounts and commissions payable by us will be $ .
We, our directors, our executive officers, the selling stockholders and certain of our stockholders have agreed that subject to certain exceptions, without the prior written consent of Morgan Stanley & Co. Incorporated and Credit Suisse Securities (USA) LLC on behalf of the underwriters, we and they will not, during the period ending 180 days after the date of this prospectus:
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| • | offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend, or otherwise transfer or dispose of directly or indirectly, any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock; |
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| • | file any registration statement with the Securities and Exchange Commission relating to the offering of any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock; or |
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| • | enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock; |
whether any such transaction described above is to be settled by delivery of common stock or such other securities, in cash or otherwise. The restrictions described in this paragraph do not apply to:
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| • | the sale of shares to the underwriters; |
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| • | the issuance by us of shares of common stock upon the exercise of an option or a warrant or the conversion of a security outstanding on the date of this prospectus of which the underwriters have been advised in writing; |
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| • | any shares of common stock issued upon the exercise of options granted under existing employee option plans, grants of employee stock options or restricted stock in accordance with the terms in effect on the date hereof and the filing by the Company of any registration statement with the SEC onForm S-8 relating to the offering of securities pursuant to the terms of a plan in effect on the date hereof; |
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| • | the issuance by us of shares of common stock or any security convertible into shares of common stock in connection with a bona fide merger or acquisition transaction; provided, however, that the aggregate number of shares issued in these transactions shall not exceed 5% of the total shares offered in this offering and that any recipient of these shares executes a copy of thelock-up agreement; |
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| • | transactions relating to shares of common stock or other securities acquired in open market transactions after completion of this offering, provided, however, that no filing under the Securities Exchange Act of 1934, as amended (Exchange Act), shall be required or shall be voluntarily made in connection with such transaction (other than a filing on Form 4 after the expiration of the lock-up period or on a Form 5 made when required); or |
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| • | the transfer of shares of common stock (i) pursuant to a will, other testamentary document or applicable laws of descent, (ii) as a bona fide gift or (iii) to a family member or trust, provided that, in each case, the transferee |
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| | |
| | agrees to be bound in writing by the terms of thelock-up agreement prior to such transfer and no filing by any party (donor, donee, transferor or transferee) under the Exchange Act shall be required or shall be voluntarily made in connection with such transfer (other than a filing on a Form 5 made when required) and such transfer does not involve a disposition for value. |
The180-day restricted period described above is subject to extension such that, in the event that either (1) during the last 17 days of the restricted period, we issue an earnings release or material news or a material event relating to us occurs or (2) prior to the expiration of the restricted period, we announce that we will release earnings results during the16-day period beginning on the last day of the applicable restricted period, the“lock-up” restrictions described above will, subject to limited exceptions, continue to apply until the expiration of the18-day period beginning on the earnings release or the occurrence of the material news or material event.
As of , 2007, of our outstanding shares were subject to the abovementioned restrictions.
In order to facilitate the offering of the common stock, the underwriters may engage in stabilizing transactions, overallotment transactions, syndicate covering transactions, penalty bids.
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| • | Stabilizing transactions permit bids to purchase the underlying security so long as the stabilizing bids do not exceed a specified maximum. |
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| • | Overallotment involves sales by the underwriters of shares in excess of the number of shares the underwriters are obligated to purchase, which creates a syndicate short position. The short position may be either a covered short position or a naked short position. In a covered short position, the number of shares over-allotted by the underwriters is not greater than the number of shares that they may purchase in the overallotment option. In a naked short position, the number of shares involved is greater than the number of shares in the overallotment option. The underwriters may close out any covered short position by either exercising their overallotment optionand/or purchasing shares in the open market. |
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| • | Syndicate covering transactions involve purchases of the common stock in the open market after the distribution has been completed in order to cover syndicate short positions. In determining the source of shares to close out the short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the overallotment option. If the underwriters sell more shares than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. |
|
| • | Penalty bids permit the representatives to reclaim a selling concession from a syndicate member when the common stock originally sold by the syndicate member is purchased in a stabilizing or syndicate covering transaction to cover syndicate short positions. |
These stabilizing transactions, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of our common stock or preventing or retarding a decline in the market price of the common stock. As a result, the price of our common stock may be higher than the price that might otherwise exist in the open market. The underwriters are not required to engage in these activities, and may end any of these activities at any time.
We, the selling stockholders and the underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act.
116
Directed Share Program
At our request, Morgan Stanley & Co. Incorporated has reserved for sale, at the initial public offering price, up to 10% of the shares offered in this prospectus for our directors, officers, employees, business associates and related persons. The number of shares of common stock available for sale to the general public will be reduced to the extent such persons purchase such reserved shares. Any reserved shares which are not so purchased will be offered by
108
Morgan Stanley & Co. Incorporated to the general public on the same basis as the other shares offered in this prospectus.
Pricing of the Offering
Prior to this offering, there has been no public market for the shares of common stock. The initial public offering price will be determined by negotiations among us and the representatives. Among the factors to be considered in determining the initial public offering price will be the future prospects of us and our industry in general and our sales, earnings and certain other financial operating information in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and certain financial and operating information of companies engaged in activities similar to us. The estimated initial public offering price range set forth on the cover page of this preliminary prospectus is subject to change as a result of market conditions and other factors.
109117
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the shares in Canada is being made only on a private placement basis exempt from the requirement that we prepare and file a prospectus with the securities regulatory authorities in each province where trades of the shares are made. Any resale of the shares in Canada must be made under applicable securities laws which will vary depending on the relevant jurisdiction, and which may require resales to be made under available statutory exemptions or under a discretionary exemption granted by the applicable Canadian securities regulatory authority. Purchasers are advised to seek legal advice prior to any resale of the shares.
Representations of Purchasers
By purchasing shares in Canada and accepting a purchase confirmation, a purchaser is representing to us and the dealer from whom the purchase confirmation is received that:
| | |
| • | the purchaser is entitled under applicable provincial securities laws to purchase the shares without the benefit of a prospectus qualified under those securities laws, |
|
| • | where required by law, that the purchaser is purchasing as principal and not as agent, |
|
| • | the purchaser has reviewed the text above under Resale Restrictions, and |
|
| • | the purchaser acknowledges and consents to the provision of specified information concerning its purchase of the shares to the regulatory authority that by law is entitled to collect the information. |
Further details concerning the legal authority for this information is available on request.
Rights of Action — Ontario Purchasers Only
Under Ontario securities legislation, certain purchasers who purchase a security offered by this prospectus during the period of distribution will have a statutory right of action for damages, or while still the owner of the shares, for rescission against us in the event that this prospectus contains a misrepresentation without regard to whether the purchaser relied on the misrepresentation. The right of action for damages is exercisable not later than the earlier of 180 days from the date the purchaser first had knowledge of the facts giving rise to the cause of action and three years from the date on which payment is made for the shares. The right of action for rescission is exercisable not later than 180 days from the date on which payment is made for the shares. If a purchaser elects to exercise the right of action for rescission, the purchaser will have no right of action for damages against us. In no case will the amount recoverable in any action exceed the price at which the shares were offered to the purchaser and if the purchaser is shown to have purchased the securities with knowledge of the misrepresentation, we will have no liability. In the case of an action for damages, we will not be liable for all or any portion of the damages that are proven to not represent the depreciation in value of the shares as a result of the misrepresentation relied upon. These rights are in addition to, and without derogation from, any other rights or remedies available at law to an Ontario purchaser. The foregoing is a summary of the rights available to an Ontario purchaser. Ontario purchasers should refer to the complete text of the relevant statutory provisions.
Enforcement of Legal Rights
All of our directors and officers as well as the experts named herein may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon us or those persons. All or a substantial portion of our assets and the assets of those persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against us or those persons in Canada or to enforce a judgment obtained in Canadian courts against us or those persons outside of Canada.
Taxation and Eligibility for Investment
Canadian purchasers of the shares should consult their own legal and tax advisors with respect to the tax consequences of an investment in the shares in their particular circumstances and about the eligibility of the shares for investment by the purchaser under relevant Canadian legislation.
110118
SALES OUTSIDE THE UNITED STATES OTHER THAN CANADA
No common stock has been offered to the public or will be offered to the public in the United Kingdom prior to the publication of a prospectus in relation to the common stock and the approval of the offer by the Financial Services Authority (FSA) or, where appropriate, approval in another Member State and notification to the FSA, all in accordance with the Prospectus Directive, except that an offer of the stock may be made to persons who fall within the definition of “qualified investor” as that term is defined in Section 86(1) of the Financial Services and Markets Act 2000 (FSMA) or otherwise in circumstances which do not result in an offer of transferable securities to the public in the United Kingdom within the meaning of the FSMA;
Each underwriter has only communicated or caused to be communicated and will only communicate or cause to be communicated any invitation or inducement to engage in investment activity (within the meaning of Section 21 of the FSMA) received by it in connection with the issue or sale of any stock in circumstances in which Section 21(1) of the FSMA does not apply to us or to persons who have professional experience in matters relating to investments falling within Article 19(5) of the FSMA; and
Each underwriter has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to the stock in, from or otherwise involving the United Kingdom.
No prospectus (including any amendment, supplement or replacement thereto) has been prepared in connection with the offering of the shares of our common stock that has been approved by France’s Autorité des marchés financiers or by the competent authority of another state that is a contracting party to the Agreement on the European Economic Area and notified to the Autorité des marchés financiers; no shares of our common stock have been offered or sold and will be offered or sold, directly or indirectly, to the public in France except to permitted investors (Permitted Investors) consisting of persons licensed to provide the investment service of portfolio management for the account of third parties, qualified investors (investisseurs qualifiés) acting for their own accountand/or investors belonging to a limited circle of investors (cercle restraint d’investisseurs) acting for their own account, with “qualified investors” and “limited circle of investors” having the meaning ascribed to them inArticles L. 411-2,D. 411-1,D. 411-2,D. 411-4,D. 734-1,D. 744-1,D. 754-1 andD. 764-1 of the French Code Monétaire et Financier and applicable regulations thereunder; none of this prospectus or any other materials related to the offering or information contained therein relating to the shares of our common stock has been released, issued or distributed to the public in France except to Permitted Investors; and the direct or indirect resale to the public in France of any Securities acquired by any Permitted Investors may be made only as provided byArticles L. 411-1,L. 411-2,L. 412-l andL. 621-8 toL. 621-8-3 of the French Code Monétaire et Financier and applicable regulations thereunder.
The offering of shares of our common stock has not been cleared by the Italian Securities Exchange Commission (Commissione Nazionale per le Società e la Borsa, the CONSOB) pursuant to Italian securities legislation and, accordingly, each underwriter acknowledges and agrees that the shares of our common stock may not and will not be offered, sold or delivered, nor may or will copies of this prospectus or any other documents relating to the shares of our common stock be distributed in Italy, except (i) to professional investors (operatori qualificati), as defined in Article 31, second paragraph, of CONSOB Regulation No. 11522 of July 1, 1998, as amended (the Regulation No. 11522), or (ii) in other circumstances which are exempted from the rules on solicitation of investments pursuant to Article 100 of Legislative Degree No. 58 of February 24, 1998 (the Financial Service Act) and Article 33, first paragraph, of CONSOB Regulation No. 11971 of May 14, 1999, as amended.
Any offer, sale or delivery of shares of our common stock or distribution of copies of this prospectus or any other document relating to the shares of our common stock in Italy may and will be effected in accordance with all Italian securities, tax, exchange control and other applicable laws and regulations, and, in particular, will be: (1) made by an investment firm, bank or financial intermediary permitted to conduct such activities in Italy in accordance with the Financial Services Act, Legislative Decree No. 385 of September 1, 1993, as amended (the Italian Banking Law), Regulation No. 11522 and any other applicable laws and regulations; (2) in compliance with Article 129 of the Italian Banking Law and the implementing guidelines of the Bank of Italy; and (3) in compliance with any other applicable notification requirement or limitation which may be imposed by CONSOB or the Bank of Italy.
111119
In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a Relevant Member State), and effective as of the date on which the Prospectus Directive is implemented in that Relevant Member State (the Relevant Implementation Date), no common stock have been offered to the public in that Relevant Member State prior to the publication of a prospectus in relation to the common stock which has been approved by the competent authority in that Relevant Member State or, where appropriate, approved in another Relevant Member State and brought to the attention of the competent authority in that Relevant Member State, all in accordance with the Prospectus Directive. Notwithstanding the foregoing, an offer of common stock may be made effective as of the Relevant Implementation Date to the public in that Relevant Member State at any time:
(1) to legal entities which are authorized or regulated to operate in the financial markets or, if not so authorized or regulated, whose corporate purpose is solely to invest in securities;
(2) to any legal entity which has two or more of (a) an average of at least 250 employees during the last financial year; (b) a total balance sheet of more than €43,000,000 and (c) an annual net turnover of more than €50,000,000, as shown in its last annual or consolidated accounts; or
(3) in any other circumstances which do not require the publication by the issuer of a prospectus pursuant to Article 3 of the Prospectus Directive. For the purposes of this paragraph, the expression an “offer of common stock to the public” in relation to any common stock in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and the common stock to be offered so as to enable an investor to decide to purchase or subscribe for the common stock, as the same may be varied in that Member State by any measure implementing the Prospectus Directive in that Member State and the expression Prospectus Directive means Directive 2003/71/EC and includes any relevant implementing measure in each Relevant Member State.
This prospectus does not constitute a public offer to sell any common stock to any member of the public in the Cayman Islands.
The common stock may not be offered or sold in Hong Kong, by means of any document, other than to persons whose ordinary business is to buy or sell stock or debentures, whether as principal or agent, or in circumstances which do not constitute an offer to the public within the meaning of the Companies Ordinance (Cap. 32) of Hong Kong. No advertisement, invitation or document relating to the common stock, whether in Hong Kong or elsewhere, may be issued, which is directed at, or the contents of which are likely to be accessed or read by, the public of Hong Kong (except if permitted to do so under the securities laws of Hong Kong) other than with respect to common stock which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” within the meaning of the Securities and Futures Ordinance (Cap. 571) of Hong Kong and any rules made thereunder.
The common stock have not been and will not be registered under the Securities and Exchange Law of Japan (Law No. 235 of 1948 as amended) (the Securities Exchange Law) and disclosure under the Securities Exchange Law has not been and will not be made with respect to the common stock. Accordingly, the common stock may not be, directly or indirectly, offered or sold in Japan or to, or for the benefit of, any resident of Japan or to others for re-offering or re-sale, directly or indirectly in Japan or to, or for the benefit of, any resident of Japan except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the Securities Exchange Law and other relevant laws, regulations and ministerial guidelines of Japan. As used in this paragraph, “resident of Japan” means any person residing in Japan, including any corporation or other entity organized under the laws of Japan.
This prospectus has not been and will not be registered as a prospectus with the Monetary Authority of Singapore under the Securities and Futures Act (Cap. 289) of Singapore, or the Securities and Futures Act. Accordingly, the common stock may not be offered or sold or made the subject of an invitation for subscription or purchase nor may this prospectus or any other document or material in connection with the offer or sale, or invitation for subscription or purchase of such common stock be circulated or distributed, whether directly or indirectly, to the public or any members of the public in Singapore other than: (1) to an institutional investor or other person falling within Section 274 of the Securities and Futures Act, (2) to a sophisticated investor, and in accordance
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with the conditions specified in Section 275 of the Securities and Futures Act or (3) pursuant to, and in accordance with the conditions of any other applicable provision of the Securities and Futures Act.
The common stock have not been registered under the South Korean Securities and Exchange Law. The common stock has not been offered, sold or delivered and will not be offered, sold or delivered, directly or indirectly, in South Korea or to, or for the account or benefit of, any resident of South Korea, except as otherwise permitted by applicable South Korean laws and regulations; and any securities dealer to whom any Underwriter sells common stock will agree that it will not offer any common stock, directly or indirectly, in South Korea or to any resident of South Korea, except as permitted by applicable South Korean laws and regulations, or to any other dealer who does not so represent and agree.
The underwriters will not circulate or distribute this prospectus in the People’s Republic of China (PRC) and have not offered or sold, and will not offer or sell to any person for re-offering or resale directly or indirectly, any securities to any resident of the PRC except pursuant to applicable laws and regulations of the PRC.
The offer of the shares has not been approved or licensed by the UAE Central Bank or any other relevant licensing authorities or governmental agencies in the United Arab Emirates. This document is strictly private and confidential and has not been reviewed, deposited or registered with any licensing authority or governmental agency in the United Arab Emirates, and is being issued to a limited number of institutional and/or private investors and must not be provided to any person other than the original recipient and may not be reproduced or used for any other purpose. The shares may not be offered or sold directly or indirectly to the public in the United Arab Emirates.
This statement relates to an Exempt Offer in accordance with the Offered Securities Rules of the Dubai Financial Services Authority.
This statement is intended for distribution only to Persons of a type specified in those rules. It must not be delivered to, or relied on by, any other Person.
The Dubai Financial Services Authority has no responsibility for reviewing or verifying any documents in connection with Exempt Offers. The Dubai Financial Services Authority has not approved this document nor taken steps to verify the information set out in it, and has no responsibility for it.
The Securities to which this document relates may be illiquidand/or subject to restrictions on their resale. Prospective purchasers of the Securities offered should conduct their own due diligence on the Securities.
If you do not understand the contents of this document you should consult an authorised financial adviser.
No action may be taken in any jurisdiction other than the United States that would permit a public offering of the common stock or the possession, circulation or distribution of this prospectus in any jurisdiction where action for that purpose is required. Accordingly, the common stock may not be offered or sold, directly or indirectly, and neither the prospectus nor any other offering material or advertisements in connection with the common stock may be distributed or published in or from any country or jurisdiction except under circumstances that will result in compliance with any applicable rules and regulations of any such country or jurisdiction.
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The validity of the shares of common stock offered hereby will be passed upon for us by our counsel, Latham & Watkins LLP, Washington, DC. Various legal matters relating to this offering will be passed upon for the underwriters by Davis Polk &Wardwell, New York, New York.
The consolidated financial statements and schedules included in this Prospectus and in the Registration Statement have been audited by BDO Seidman, LLP, an independent registered public accounting firm, to the extent and for the periods set forth in their report appearing elsewhere herein and in the Registration Statement, and are included in reliance upon such report given upon the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933, as amended with respect to the shares of our common stock offered by this prospectus. This prospectus, filed as a part of the registration statement, does not contain all of the information set forth in the registration statement or the exhibits and schedules thereto as permitted by the rules and regulations of the SEC. For further information about us and our common stock, you should refer to the registration statement. This prospectus summarizes provisions that we consider material of certain contracts and other documents to which we refer you. Because the summaries may not contain all of the information that you may find important, you should review the full text of those documents. We have included copies of those documents as exhibits to the registration statement.
The registration statement and the exhibits thereto filed with the SEC may be inspected, without charge, and copies may be obtained at prescribed rates, at the public reference facility maintained by the SEC at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The registration statement and other information filed by us with the SEC are also available at the SECs website atwww.sec.gov.
As a result of the offering, we and our stockholders will become subject to the proxy solicitation rules, annual and periodic reporting requirements, restrictions of stock purchases and sales by affiliates and other requirements of the Securities Exchange Act of 1934. We will furnish our stockholders with annual reports containing audited consolidated financial statements by an independent registered accounting firm and quarterly reports containing unaudited financial statements for the first three quarters of each fiscal year.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| | | | |
Audited Financial Statements: | | | | |
| | | F-2 | |
| | | F-3 | |
| | | F-4 | |
| | | F-5 | |
| | | F-6 | |
| | | F-7 | |
| | | | |
Unaudited Interim Financial Statements | | | F-7 | |
Condensed Consolidated Balance Sheet as of September 30, 2007 | | | F-24 | |
Condensed Consolidated Statement of Operations for the three months ended September 30, 2007 and 2006 | | | F-25 | |
Condensed Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Deficit for the three months ended September 30, 2007 | | | F-26 | |
Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2007 and 2006 | | | F-27 | |
Notes to Condensed Consolidated Financial Statements | | | F-28 | |
Schedule II — Valuation and Qualifying Accounts | | | F-23F-37 | |
F-1
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
K12 Inc.
Herndon, Virginia
We have audited the accompanying consolidated balance sheets of K12 Inc. and subsidiaries (the Company) as of June 30, 2007 and 2006 and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders’ deficit, and cash flows for each of the three years in the period ended June 30, 2007. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K12 Inc. and subsidiaries at June 30, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2007, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, effective July 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment.”
Also, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.
/s/ BDO Seidman, LLP
Bethesda, Maryland
September 25, 2007, except for Note 15,
as to which date is November 2, 2007
F-2
CONSOLIDATED BALANCE SHEETS
| | | | | | | | |
| | June 30, | |
| | 2007 | | | 2006 | |
| | (in thousands,
| |
| | except share and
| |
| | per share data) | |
ASSETS |
Current assets | | | | | | | | |
Cash and cash equivalents | | $ | 1,660 | | | $ | 9,475 | |
Restricted cash | | | — | | | | 2,332 | |
Accounts receivable, net of allowance of $589 and $1,440 at June 30, 2007 and June 30, 2006, respectively | | | 15,455 | | | | 11,449 | |
Inventories, net | | | 13,804 | | | | 11,110 | |
Prepaid expenses and other current assets | | | 1,245 | | | | 568 | |
| | | | | | | | |
Total current assets | | | 32,164 | | | | 34,934 | |
Property and equipment, net | | | 17,234 | | | | 10,388 | |
Capitalized curriculum development costs, net | | | 9,671 | | | | 1,470 | |
Other assets, net | | | 1,182 | | | | 1,054 | |
Deposits and other assets | | | 961 | | | | 639 | |
| | | | | | | | |
Total assets | | $ | 61,212 | | | $ | 48,485 | |
| | | | | | | | |
|
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ DEFICIT |
Current liabilities | | | | | | | | |
Bank overdraft | | $ | 1,577 | | | $ | — | |
Line of credit | | | 1,500 | | | | — | |
Accounts payable | | | 6,928 | | | | 6,349 | |
Accrued liabilities | | | 1,819 | | | | 2,643 | |
Accrued compensation and benefits | | | 6,200 | | | | 5,100 | |
Deferred revenue | | | 2,620 | | | | 1,396 | |
Current portion of capital lease obligations | | | 2,780 | | | | — | |
Current portion of notes payable | | | 192 | | | | — | |
Notes payable — related party | | | — | | | | 4,025 | |
| | | | | | | | |
Total current liabilities | | | 23,616 | | | | 19,513 | |
Deferred rent, net of current portion | | | 1,684 | | | | 1,598 | |
Capital lease obligations, net of current portion | | | 3,974 | | | | — | |
Notes payable, net of current portion | | | 189 | | | | — | |
| | | | | | | | |
Total liabilities | | | 29,463 | | | | 21,111 | |
| | | | | | | | |
Commitments and contingencies | | | | | | | | |
| | | | | | | | |
Redeemable convertible preferred stock | | | | | | | | |
Redeemable Convertible Series C Preferred stock, par value $0.0001; 55,000,000 shares authorized; 49,861,562 and 45,328,693 shares issued and outstanding at 2007 and 2006, respectively; liquidation value of $133,629 and $121,481 at 2007 and 2006, respectively | | | 91,122 | | | | 76,211 | |
| | | | | | | | |
Redeemable Convertible Series B Preferred stock, par value $0.0001; 76,000,000 shares authorized; 51,524,974 shares issued and outstanding at 2007 and 2006, respectively; liquidation value of $138,087 at 2007 and 2006 | | | 138,434 | | | | 124,614 | |
| | | | | | | | |
Stockholders’ deficit | | | | | | | | |
Common stock, par value $0.0001; 170,000,000 shares authorized; 10,412,243 and 10,194,414 shares issued and outstanding at 2007 and 2006, respectively | | | 1 | | | | 1 | |
Accumulated deficit | | | (197,808 | ) | | | (173,452 | ) |
| | | | | | | | |
Total stockholders’ deficit | | | (197,807 | ) | | | (173,451 | ) |
| | | | | | | | |
Total liabilities, redeemable convertible preferred stock and stockholders’ deficit | | $ | 61,212 | | | $ | 48,485 | |
| | | | | | | | |
| | | | | | | | |
| | June 30, | |
| | 2007 | | | 2006 | |
| | (in thousands,
| |
| | except share and
| |
| | per share data) | |
ASSETS |
Current assets | | | | | | | | |
Cash and cash equivalents | | $ | 1,660 | | | $ | 9,475 | |
Restricted cash | | | — | | | | 2,332 | |
Accounts receivable, net of allowance of $589 and $1,440 at June 30, 2007 and June 30, 2006, respectively | | | 15,455 | | | | 11,449 | |
Inventories, net | | | 13,804 | | | | 11,110 | |
Prepaid expenses and other current assets | | | 1,245 | | | | 568 | |
| | | | | | | | |
Total current assets | | | 32,164 | | | | 34,934 | |
Property and equipment, net | | | 17,234 | | | | 10,388 | |
Capitalized curriculum development costs, net | | | 9,671 | | | | 1,470 | |
Other assets, net | | | 1,182 | | | | 1,054 | |
Deposits and other assets | | | 961 | | | | 639 | |
| | | | | | | | |
Total assets | | $ | 61,212 | | | $ | 48,485 | |
| | | | | | | | |
|
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ DEFICIT |
Current liabilities | | | | | | | | |
Bank overdraft | | $ | 1,577 | | | $ | — | |
Line of credit | | | 1,500 | | | | — | |
Accounts payable | | | 6,928 | | | | 6,349 | |
Accrued liabilities | | | 1,819 | | | | 2,643 | |
Accrued compensation and benefits | | | 6,200 | | | | 5,100 | |
Deferred revenue | | | 2,620 | | | | 1,396 | |
Current portion of capital lease obligations | | | 2,780 | | | | — | |
Current portion of notes payable | | | 192 | | | | — | |
Notes payable — related party | | | — | | | | 4,025 | |
| | | | | | | | |
Total current liabilities | | | 23,616 | | | | 19,513 | |
Deferred rent, net of current portion | | | 1,684 | | | | 1,598 | |
Capital lease obligations, net of current portion | | | 3,974 | | | | — | |
Notes payable, net of current portion | | | 189 | | | | — | |
| | | | | | | | |
Total liabilities | | | 29,463 | | | | 21,111 | |
| | | | | | | | |
Commitments and contingencies | | | | | | | | |
| | | | | | | | |
Redeemable convertible preferred stock | | | | | | | | |
Redeemable Convertible Series C Preferred stock, par value $0.0001; 55,000,000 shares authorized; 49,861,562 and 45,328,693 shares issued and outstanding at 2007 and 2006, respectively; liquidation value of $133,629 and $121,481 at 2007 and 2006, respectively | | | 91,122 | | | | 76,211 | |
| | | | | | | | |
Redeemable Convertible Series B Preferred stock, par value $0.0001; 76,000,000 shares authorized; 51,524,974 shares issued and outstanding at 2007 and 2006, respectively; liquidation value of $138,087 at 2007 and 2006 | | | 138,434 | | | | 124,614 | |
| | | | | | | | |
Stockholders’ deficit | | | | | | | | |
Common stock, par value $0.0001; 33,362,500 shares authorized; 2,041,604 and 1,998,896 shares issued and outstanding at 2007 and 2006, respectively | | | 1 | | | | 1 | |
Accumulated deficit | | | (197,808 | ) | | | (173,452 | ) |
| | | | | | | | |
Total stockholders’ deficit | | | (197,807 | ) | | | (173,451 | ) |
| | | | | | | | |
Total liabilities, redeemable convertible preferred stock and stockholders’ deficit | | $ | 61,212 | | | $ | 48,485 | |
| | | | | | | | |
See accompanying summary of accounting policies and notes to consolidated financial statements.
F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | | | | | | | | | | |
| | Year Ended June 30, | |
| | 2007 | | | 2006 | | | 2005 | |
| | (in thousands, except per share data) | |
|
Revenues | | $ | 140,556 | | | $ | 116,902 | | | $ | 85,310 | |
| | | | | | | | | | | | |
Cost and expenses | | | | | | | | | | | | |
Instructional costs and services | | | 76,064 | | | | 64,828 | | | | 49,130 | |
Selling, administrative, and other operating expenses | | | 51,159 | | | | 41,660 | | | | 30,031 | |
Product development expenses | | | 8,611 | | | | 8,568 | | | | 9,410 | |
| | | | | | | | | | | | |
Total costs and expenses | | | 135,834 | | | | 115,056 | | | | 88,571 | |
| | | | | | | | | | | | |
Income (loss) from operations | | | 4,722 | | | | 1,846 | | | | (3,261 | ) |
Interest expense, net | | | (639 | ) | | | (488 | ) | | | (279 | ) |
| | | | | | | | | | | | |
Income (loss) before income taxes | | | 4,083 | | | | 1,358 | | | | (3,540 | ) |
Income tax expense | | | (218 | ) | | | — | | | | — | |
| | | | | | | | | | | | |
Net income (loss) | | | 3,865 | | | | 1,358 | | | | (3,540 | ) |
Dividends on preferred stock | | | (6,378 | ) | | | (5,851 | ) | | | (5,261 | ) |
Preferred stock accretion | | | (22,353 | ) | | | (18,697 | ) | | | (15,947 | ) |
| | | | | | | | | | | | |
Net loss attributable to common stockholders | | $ | (24,866 | ) | | $ | (23,190 | ) | | $ | (24,748 | ) |
| | | | | | | | | | | | |
Net loss attributable to common stockholders per share: | | | | | | | | | | | | |
Basic and diluted | | $ | (2.44 | ) | | $ | (2.30 | ) | | $ | (2.46 | ) |
| | | | | | | | | | | | |
Weighted average shares used in computing per share amounts: | | | | | | | | | | | | |
Basic and diluted | | | 10,208,507 | | | | 10,083,721 | | | | 10,062,587 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | Year Ended June 30, | |
| | 2007 | | | 2006 | | | 2005 | |
| | (in thousands, except per share data) | |
|
Revenues | | $ | 140,556 | | | $ | 116,902 | | | $ | 85,310 | |
| | | | | | | | | | | | |
Cost and expenses | | | | | | | | | | | | |
Instructional costs and services | | | 76,064 | | | | 64,828 | | | | 49,130 | |
Selling, administrative, and other operating expenses | | | 51,159 | | | | 41,660 | | | | 30,031 | |
Product development expenses | | | 8,611 | | | | 8,568 | | | | 9,410 | |
| | | | | | | | | | | | |
Total costs and expenses | | | 135,834 | | | | 115,056 | | | | 88,571 | |
| | | | | | | | | | | | |
Income (loss) from operations | | | 4,722 | | | | 1,846 | | | | (3,261 | ) |
Interest expense, net | | | (639 | ) | | | (488 | ) | | | (279 | ) |
| | | | | | | | | | | | |
Income (loss) before income taxes | | | 4,083 | | | | 1,358 | | | | (3,540 | ) |
Income tax expense | | | (218 | ) | | | — | | | | — | |
| | | | | | | | | | | | |
Net income (loss) | | | 3,865 | | | | 1,358 | | | | (3,540 | ) |
Dividends on preferred stock | | | (6,378 | ) | | | (5,851 | ) | | | (5,261 | ) |
Preferred stock accretion | | | (22,353 | ) | | | (18,697 | ) | | | (15,947 | ) |
| | | | | | | | | | | | |
Net loss attributable to common stockholders | | $ | (24,866 | ) | | $ | (23,190 | ) | | $ | (24,748 | ) |
| | | | | | | | | | | | |
Net loss attributable to common stockholders per share: | | | | | | | | | | | | |
Basic and diluted | | $ | (12.42 | ) | | $ | (11.73 | ) | | $ | (12.54 | ) |
| | | | | | | | | | | | |
Weighted average shares used in computing per share amounts: | | | | | | | | | | | | |
Basic and diluted | | | 2,001,661 | | | | 1,977,195 | | | | 1,973,053 | |
| | | | | | | | | | | | |
See accompanying summary of accounting policies and notes to consolidated financial statements.
F-4
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS’ DEFICIT
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Redeemable
| | | Redeemable
| | | Stockholders’ Deficit | |
| | Convertible Series C
| | | Convertible Series B
| | | | | | | | | Additional
| | | | | | | |
| | Preferred Stock | | | Preferred Stock | | | Common Stock | | | Paid-in
| | | Accumulated
| | | | |
| | Shares | | | Amount | | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Deficit | | | Total | |
| | (dollars in thousands) | |
|
Balance, June 30, 2004 | | | 37,461,730 | | | $ | 54,629 | | | | 51,524,974 | | | $ | 100,440 | | | | 10,019,232 | | | $ | 1 | | | $ | — | | | $ | (125,622 | ) | | $ | (125,621 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 59,994 | | | | — | | | | 70 | | | | — | | | | 70 | |
Accretion of Preferred Stock | | | — | | | | 4,403 | | | | — | | | | 11,544 | | | | — | | | | — | | | | (70 | ) | | | (15,877 | ) | | | (15,947 | ) |
Series C 10% Stock Dividend | | | 3,746,173 | | | | 5,261 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,261 | ) | | | (5,261 | ) |
Net loss | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (3,540 | ) | | | (3,540 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2005 | | | 41,207,903 | | | | 64,293 | | | | 51,524,974 | | | | 111,984 | | | | 10,079,226 | | | | 1 | | | | — | | | | (150,300 | ) | | | (150,299 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 115,188 | | | | — | | | | 38 | | | | — | | | | 38 | |
Accretion of Preferred Stock | | | — | | | | 6,067 | | | | — | | | | 12,630 | | | | — | | | | — | | | | (38 | ) | | | (18,659 | ) | | | (18,697 | ) |
Series C 10% Stock Dividend | | | 4,120,790 | | | | 5,851 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,851 | ) | | | (5,851 | ) |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 1,358 | | | | 1,358 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2006 | | | 45,328,693 | | | | 76,211 | | | | 51,524,974 | | | | 124,614 | | | | 10,194,414 | | | | 1 | | | | — | | | | (173,452 | ) | | | (173,451 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 217,829 | | | | — | | | | 292 | | | | — | | | | 292 | |
Record stock compensation expense | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 218 | | | | — | | | | 218 | |
Accretion of Preferred Stock | | | — | | | | 8,533 | | | | — | | | | 13,820 | | | | — | | | | — | | | | (510 | ) | | | (21,843 | ) | | | (22,353 | ) |
Series C 10% Stock Dividend | | | 4,532,869 | | | | 6,378 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (6,378 | ) | | | (6,378 | ) |
Net Income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 3,865 | | | | 3,865 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2007 | | | 49,861,562 | | | $ | 91,122 | | | | 51,524,974 | | | $ | 138,434 | | | | 10,412,243 | | | $ | 1 | | | $ | — | | | $ | (197,808 | ) | | $ | (197,807 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Redeemable
| | | Redeemable
| | | Stockholders’ Deficit | |
| | Convertible Series C
| | | Convertible Series B
| | | | | | | | | Additional
| | | | | | | |
| | Preferred Stock | | | Preferred Stock | | | Common Stock | | | Paid-in
| | | Accumulated
| | | | |
| | Shares | | | Amount | | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Deficit | | | Total | |
| | (dollars in thousands) | |
|
Balance, June 30, 2004 | | | 37,461,730 | | | $ | 54,629 | | | | 51,524,974 | | | $ | 100,440 | | | | 1,964,552 | | | $ | 1 | | | $ | — | | | $ | (125,622 | ) | | $ | (125,621 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 11,760 | | | | — | | | | 70 | | | | — | | | | 70 | |
Accretion of Preferred Stock | | | — | | | | 4,403 | | | | — | | | | 11,544 | | | | — | | | | — | | | | (70 | ) | | | (15,877 | ) | | | (15,947 | ) |
Series C 10% Stock Dividend | | | 3,746,173 | | | | 5,261 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,261 | ) | | | (5,261 | ) |
Net loss | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (3,540 | ) | | | (3,540 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2005 | | | 41,207,903 | | | | 64,293 | | | | 51,524,974 | | | | 111,984 | | | | 1,976,312 | | | | 1 | | | | — | | | | (150,300 | ) | | | (150,299 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 22,584 | | | | — | | | | 38 | | | | — | | | | 38 | |
Accretion of Preferred Stock | | | — | | | | 6,067 | | | | — | | | | 12,630 | | | | — | | | | — | | | | (38 | ) | | | (18,659 | ) | | | (18,697 | ) |
Series C 10% Stock Dividend | | | 4,120,790 | | | | 5,851 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,851 | ) | | | (5,851 | ) |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 1,358 | | | | 1,358 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2006 | | | 45,328,693 | | | | 76,211 | | | | 51,524,974 | | | | 124,614 | | | | 1,998,896 | | | | 1 | | | | — | | | | (173,452 | ) | | | (173,451 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 42,708 | | | | — | | | | 292 | | | | — | | | | 292 | |
Record stock compensation expense | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 218 | | | | — | | | | 218 | |
Accretion of Preferred Stock | | | — | | | | 8,533 | | | | — | | | | 13,820 | | | | — | | | | — | | | | (510 | ) | | | (21,843 | ) | | | (22,353 | ) |
Series C 10% Stock Dividend | | | 4,532,869 | | | | 6,378 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (6,378 | ) | | | (6,378 | ) |
Net Income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 3,865 | | | | 3,865 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, June 30, 2007 | | | 49,861,562 | | | $ | 91,122 | | | | 51,524,974 | | | $ | 138,434 | | | | 2,041,604 | | | $ | 1 | | | $ | — | | | $ | (197,808 | ) | | $ | (197,807 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
See accompanying summary of accounting policies and notes to consolidated financial statements.
F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | | | | | | | |
| | Year Ended June 30, | |
| | 2007 | | | 2006 | | | 2005 | |
| | (in thousands) | |
|
Cash Flows from Operating Activities | | | | | | | | | | | | |
Net income (loss) | | $ | 3,865 | | | $ | 1,358 | | | $ | (3,540 | ) |
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | | | | |
Depreciation and amortization expense | | | 7,404 | | | | 4,986 | | | | 5,509 | |
Stock based compensation expense | | | 218 | | | | — | | | | — | |
Provision for (reduction of) doubtful accounts | | | (852 | ) | | | (275 | ) | | | 1,113 | |
Provision for (reduction of) inventory obsolescence | | | 95 | | | | (39 | ) | | | (50 | ) |
Provision for (reduction of) student computer shrinkage and obsolescence | | | (48 | ) | | | 174 | | | | (256 | ) |
Impairment of curriculum development costs | | | — | | | | 362 | | | | 2,118 | |
Impairment of software development costs | | | — | | | | — | | | | 1,188 | |
Changes in assets and liabilities: | | | | | | | | | | | | |
Accounts receivable | | | (3,154 | ) | | | (2,718 | ) | | | 3,434 | |
Inventories | | | (2,790 | ) | | | (5,359 | ) | | | (555 | ) |
Prepaid and other current assets | | | (763 | ) | | | 100 | | | | (431 | ) |
Other assets | | | (255 | ) | | | (258 | ) | | | (468 | ) |
Deposits | | | (322 | ) | | | (268 | ) | | | (56 | ) |
Accounts payable | | | 579 | | | | 1,559 | | | | (163 | ) |
Accrued liabilities | | | (824 | ) | | | 122 | | | | 1,208 | |
Accrued compensation and benefits | | | 1,100 | | | | 1,782 | | | | 994 | |
Deferred revenue | | | 1,224 | | | | 501 | | | | (348 | ) |
Deferred rent | | | 86 | | | | 1,598 | | | | — | |
| | | | | | | | | | | | |
Net cash provided by operating activities | | | 5,563 | | | | 3,625 | | | | 9,697 | |
| | | | | | | | | | | | |
Cash flows from investing activities | | | | | | | | | | | | |
Purchase of property and equipment | | | (5,366 | ) | | | (10,842 | ) | | | (4,692 | ) |
Capitalized curriculum development costs | | | (8,683 | ) | | | (655 | ) | | | (3,787 | ) |
| | | | | | | | | | | | |
Net cash used in investing activities | | | (14,049 | ) | | | (11,497 | ) | | | (8,479 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities | | | | | | | | | | | | |
Proceeds (payments on) from notes payable — related party | | | (4,025 | ) | | | — | | | | 4,025 | |
Proceeds from notes payable | | | 441 | | | | — | | | | — | |
Payments on notes payable | | | (62 | ) | | | — | | | | — | |
Net borrowings from revolving credit facility | | | 1,500 | | | | — | | | | — | |
Repayments for capital lease obligations | | | (1,384 | ) | | | (441 | ) | | | (3,432 | ) |
Proceeds from exercise of stock options | | | 292 | | | | 38 | | | | 70 | |
Bank overdraft | | | 1,577 | | | | — | | | | — | |
Cash invested in restricted escrow account | | | 2,332 | | | | (2,203 | ) | | | 2,191 | |
| | | | | | | | | | | | |
Net cash provided by (used in) financing activities | | | 671 | | | | (2,606 | ) | | | 2,854 | |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | (7,815 | ) | | | (10,478 | ) | | | 4,072 | |
| | | | | | | | | | | | |
Cash and cash equivalents, beginning of year | | | 9,475 | | | | 19,953 | | | | 15,881 | |
| | | | | | | | | | | | |
Cash and cash equivalents, end of year | | $ | 1,660 | | | $ | 9,475 | | | $ | 19,953 | |
| | | | | | | | | | | | |
See accompanying summary of accounting policies and notes to consolidated financial statements.
F-6
Notes to Consolidated Financial Statements
| |
1. | Description of the Business |
K12 Inc. and its subsidiaries (K12 or the Company) sell on-line curriculum and educational books and materials designed for students in grades K-12 and provide management and technology services to virtual public schools. The K12 proprietary curriculum is research based and combines content with innovative technology to allow students to receive an outstanding education regardless of geographic location. The Company provides complete management and technology services to virtual public schools. Through these schools, the Company typically provides students with access to the K12 on-line curriculum, offline learning kits, and use of a personal computer. In addition, the company sells access to its on-line curriculum and offline learning kits directly to individual consumers. For the year ended June 30, 2007, the Company served schools in 15 states and the District of Columbia, providing curriculum for grades kindergarten through tenth.
Basis of Presentation
The consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
| |
2. | Summary of Significant Accounting Policies |
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions affecting the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition and Concentration of Revenues
Revenues are principally earned from long-term contractual agreements to provide on-line curriculum, books, materials, computers and management services to public charter schools and school districts. In addition to providing the curriculum, books and materials, under most contracts, the Company is responsible to the virtual public schools for all aspects of the 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 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 they are the primary obligor for substantially all expenses under these contracts, the 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 Emerging Issues Task Force (EITF)99-19,Reporting Revenue Gross as a Principal Versus Net as an Agent.As a result, amounts recorded as revenues and instructional costs and services for the years ended June 30, 2007, 2006 and 2005 were $38.5 million, $35.6 million and $29.6 million, respectively. 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 public virtual schools which include multiple elements. These elements include providing each of a school’s students with access to the Company’s on-line school and the on-line component of lessons; offline learning kits which include books and materials designed to complement and supplement the on-line lessons; the use of a personal computer and associated reclamation services; internet access and technology support services; the services of a state-certified teacher and; all management and technology services required to operate a public virtual school.
We have determined that the elements of our contracts are valuable to schools in combination, but do not have standalone value. In addition, we have determined that we do not have objective and reliable evidence of fair value for each element of our contracts. As a result, the elements within our multiple-element contracts do not qualify for
F-7
K12 Inc.
Notes to Consolidated Financial Statements
treatment as separate units of accounting. Accordingly, we account for revenues received under multiple element arrangements as a single unit of accounting and recognize the entire arrangement based upon the approximate rate at which we incur the costs associated with each element.
Under the contracts with the schools where the Company provides turnkey management services, the Company has generally agreed to absorb any operating deficits of the schools in a given school year. These operating deficits represent the excess of costs over revenues incurred by the virtual public schools as reflected on their financial statements. The costs include Company charges to the schools. These operating deficits may impair the Company’s ability to collect invoices in full. Accordingly, the Company’s amount of recognized revenue reflects this impairment. For the years ended June 30, 2007, 2006 and 2005, the Company’s revenue reflected impairment from these operating deficits of $13.7 million, $7.0 million and $5.5 million, respectively. Included in these deficits is the impact of certain disallowed enrollments stemming from regulatory audits in Colorado totaling $0.9 million in 2006 and $1.0 million in 2007, and $1.0 million in California in 2007.
Other revenues are generated from individual customers who prepay and have access for 12 or 24 months to curriculum via the Company’s 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 years ended June 30, 2007, 2006 and 2005, approximately 97%, 94% and 96%, respectively, of the Company’s revenues were recognized from virtual public schools. In fiscal year 2007, we had contracts with four schools that individually represented 16%, 11%, 11% and 11% of revenues. In fiscal year 2006, we had contracts with three schools that individually represented 28%, 16% and 10% of revenues. In fiscal year 2005, we had contracts with four schools that individually represented 32%, 17%, 11% and 10% of revenues.
Research and Development Costs
All research and development costs are expensed as incurred in accordance with Statement of Financial Accounting Standards (SFAS) No. 2,Accounting for Research and Development Costs.
Cash and Cash Equivalents
Cash and cash equivalents generally consist of cash on hand and cash held in money market and demand deposit accounts. For purposes of the statements of cash flows, the Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company maintains funds in accounts in excess of FDIC insurance limits; however, management believes it minimizes risk by maintaining deposits in well-capitalized financial institutions.
Restricted Cash
Restricted cash consists primarily of cash held in escrow related to the lease on our primary office facility. There was no balance in restricted cash as of June 30, 2007, as the result of the release of certain letters of credit related to operating leases. The letters of credit were incorporated into our revolving credit facility (see Note 6).
Fair Value of Financial Instruments
The carrying values reflected in our consolidated balance sheets for cash and cash equivalents, receivables, inventory and short and long term debt approximate their fair values.
Allowance for Doubtful Accounts
The Company maintains an allowance for uncollectible accounts primarily for estimated losses resulting from the inability, failure or refusal of individual customers to make required payments. These losses have been within
F-8
K12 Inc.
Notes to Consolidated Financial Statements
management’s expectations. The Company analyzes accounts receivable, historical percentages of uncollectible accounts and changes in payment history when evaluating the adequacy of the allowance for uncollectible accounts. Management believes that an allowance for doubtful accounts of $0.6 million and $1.4 million as of June 30, 2007 and 2006, respectively, is adequate. However, actual write-offs might exceed the recorded allowance.
Inventory
Inventory consists primarily of schoolbooks and curriculum materials, a majority of which are leased to virtual schools and utilized directly by students. Inventory represents items that are purchased and held for sale and are recorded at the lower of cost(first-in, first-out method) or market value.
Other Assets
Other assets consist primarily of schoolbooks and curriculum materials which have been returned to the Company upon the completion of the school year. These assets are amortized over a period of two years which is included in instructional costs and services on the accompanying consolidated statement operations. Materials not returned are expensed as part of instructional costs and services.
Property and Equipment
Property and equipment, which includes capitalized software development, are stated at cost less accumulated depreciation and amortization. Depreciation expense is calculated using the straight-line method over the estimated useful life of the asset (or the lesser of the term of the lease and the estimated useful life of the asset for fixed assets under capital leases). Amortization of assets capitalized under capital lease arrangements is included in depreciation expense. Property and equipment are depreciated over the following lives:
| | | | |
| | Useful Life | |
|
Computer hardware | | | 3 years | |
Computer software and capitalized software development costs | | | 3 years | |
Office equipment | | | 5-6 years | |
Furniture and fixtures | | | 5-6 years | |
Leasehold Improvements | | | 3-12 years | |
Leasehold improvements are amortized over the lesser of the lease term or the estimated useful life of the asset. The Company determines the lease term in accordance with Statement of Financial Accounting Standards No. 13 (FAS 13),Accounting for Leases, as the fixed non-cancelable term of the lease plus all periods for which failure to renew the lease imposes a penalty on the lessee in an amount such that renewal appears, at the inception of the lease, to be reasonably assured. Accordingly, the Company has determined the lease term as defined herein to be twelve years.
Software Developed or Obtained for Internal Use
The Company develops software for internal use. Software development costs incurred during the application development stage are capitalized in accordance with Statement of Position (SOP)98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The Company amortizes these costs over the estimated useful life of the software which is generally three years.
Software development costs incurred totaled $3.1 million, $1.4 million and $0.5 million for the years ended June 30, 2007 and 2006 and 2005, respectively. These amounts are recorded on the balance sheet as part of property and equipment, net of amortization and impairment charges. The estimated aggregate amortization expense for each of the three succeeding years ending June 30, 2008, 2009 and 2010 is $1.2 million, $1.0 million and $0.6 million, respectively.
F-9
K12 Inc.
Notes to Consolidated Financial Statements
Capitalized Curriculum Development Costs
The Company internally develops its curriculum, which is provided as web content and accessed via the Internet.
We capitalize curriculum development costs incurred during the application development stage in accordance with Statement of Position (SOP)98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.SOP 98-1 provides guidance for the treatment of costs associated with computer software development and defines those costs to be capitalized and those to be expensed. Costs that qualify for capitalization are external direct costs, payroll, payroll-related costs, and interest costs. Costs related to general and administrative functions are not capitalizable and are expensed as incurred. We capitalize curriculum development costs when the projects under development reach technological feasibility. Many of our new courses leverage off of proven delivery platforms and are primarily content, which has no technological hurdles. As a result, a significant portion of our courseware development costs qualify for capitalization due to the concentration of our development efforts on the content of the courseware. Technological feasibility is established when we have completed all planning, designing, coding, and testing activities necessary to establish that a course can be produced to meet its design specifications. Capitalization ends when a course is available for general release to our customers, at which time amortization of the capitalized costs begins. The period of time over which these development costs will be amortized is generally five years. This is consistent with the capitalization period used by others in our industry and corresponds with our product development lifecycle.
Total capitalized curriculum development costs incurred were $8.7 million, $0.7 million and $3.8 million for the years ended June 30, 2007, 2006 and 2005, respectively. These amounts are recorded on the accompanying consolidated balance sheet, net of amortization and impairment charges. Amortization and impairment charges are recorded in product development expenses on the accompanying consolidated statement of operations. The estimated aggregate amortization expense for each of the five succeeding years ending June 30, 2008, 2009, 2010, 2011 and 2012 is $1.6 million, $1.6 million, $1.5 million, $1.4 million and $1.2 million, respectively.
Web Site Development Costs
The Company accounts for web site development costs in accordance with Emerging Issues Task Force IssueNo. 00-2, Accounting for Web Site Development Costs(EITF 00-2). Total capitalized web site development costs incurred for the year ended June 30, 2007 were $0.4 million. For the years ended June 30, 2006 and 2005 all web site development costs occurred in the operating stage and were expensed as incurred.
Impairment of Long-Lived Assets
Long-lived assets include property, equipment, capitalized curriculum and software developed or obtained for internal use. In accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, 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. Impairment charges recorded were $0.4 million and $3.3 million for the years ended June 30, 2006 and 2005, respectively. There was no impairment for the year ended June 30, 2007.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes.Under SFAS No. 109, 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. SFAS No. 109 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.
F-10
K12 Inc.
Notes to Consolidated Financial Statements
Stock-Based Compensation
The Company adopted SFAS No. 123(R),Share-Based Payment (Revised 2004), as of July 1, 2006, which replaces SFAS No. 123,Accounting for Stock-Based Compensation,and supersedes Accounting Principles Board Opinion No. 25 (APB No. 25),Accounting for Stock Issued to Employees. The Company adopted SFAS 123(R) using the prospective application method. SFAS No. 123(R) eliminates the intrinsic value method that was previously used by the Company as an alternative method of accounting for stock-based compensation. SFAS No. 123(R) requires an entity to recognize the grant date fair value of stock options and other equity-based compensation issued to employees in the consolidated statement of operations. The Company applied SFAS 123(R) to all new awards granted after July 1, 2006.
Advertising and Marketing Expenses
Advertising and marketing costs consist primarily of print media and brochures and are expensed when incurred. The advertising and marketing expenses recorded were $5.2 million, $2.9 million and $2.1 million during the years ended June 30, 2007, 2006 and 2005, respectively.
Net Loss Per Common Share
The Company calculates net income (loss) per share in accordance with SFAS No. 128,Earnings Per Share. Under SFAS No. 128, basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted net income (loss) per common share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The potentially dilutive securities consist of convertible preferred stock, stock options and warrants.
As of June 30, 2007, 2006 and 2005, the shares of common stock issuable in connection with convertible preferred stock, stock options, and warrants of 118,626,692, 107,638,157 and 100,579,529, respectively, were not included in the diluted loss per common share calculation since their effect was anti-dilutive.
Recent Accounting Pronouncements
In February 2006, FASB issued SFAS No. 155,Accounting for Certain Hybrid Financial Instruments — An Amendment of FASB Statements No. 133 and 140. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. At adoption, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative effect adjustment to beginning retained earnings. The Company does not believe that the adoption of SFAS No. 155 will have a material impact on its consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation (FIN) 48,Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,Accounting for Income Taxes. This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 on July 1, 2007. The Company’s adoption of this guidance will not have a material effect on its financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157 (SFAS No. 157),Fair Value Measurements,which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of this statement on the consolidated financial statements.
F-11
K12 Inc.
Notes to Consolidated Financial Statements
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159 (SFAS No. 159),The Fair Value Option for Financial Assets and Financial Liabilities.This Statement permits companies and not-for-profit organizations to make a one-time election to carry eligible types of financial assets and liabilities at fair value, even if fair value measurement is not required under GAAP. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted if the decision to adopt the standard is made after the issuance of the Statement but within 120 days after the first day of the fiscal year of adoption, provided no financial statements have yet been issued for any interim period and provided the requirements of SFAS No. 157, Fair Value Measurements, are adopted concurrently with SFAS No. 159. The Company does not believe that it will adopt the provisions of this Statement.
| |
3. | Property and Equipment |
Property and equipment consists of the following at:
| | | | | | | | |
| | June 30, | |
| | 2007 | | | 2006 | |
|
Student computers | | $ | 20,208 | | | $ | 12,617 | |
Computer hardware | | | 5,811 | | | | 6,615 | |
Computer software | | | 3,390 | | | | 4,127 | |
Capitalized software and web site development costs | | | 4,905 | | | | 1,717 | |
Leasehold improvements | | | 2,270 | | | | 2,130 | |
Furniture and fixtures | | | 809 | | | | 752 | |
Office equipment | | | 784 | | | | 1,083 | |
| | | | | | | | |
| | | 38,177 | | | | 29,041 | |
Less accumulated depreciation and amortization | | | (20,943 | ) | | | (18,653 | ) |
| | | | | | | | |
| | $ | 17,234 | | | $ | 10,388 | |
| | | | | | | | |
The Company recorded depreciation expense related to property and equipment reflected in selling, administrative and other operating expenses of $1.9 million, $1.1 million and $0.8 million during the years ended June 30, 2007, 2006 and 2005, respectively. Depreciation expense of $5.1 million, $3.5 million and $3.9 million related primarily to computers leased to students reflected in instructional costs and services was recorded during the years ended June 30, 2007, 2006 and 2005, respectively. Included in depreciation expense reflected in instructional costs and services for the year ended June 30, 2007 was $0.5 million of depreciation related to the reduction in useful life of a portion of our software related to our on-line school. Amortization expense of $0.4 million, $0.1 million and $0.2 million related to capitalized software development reflected in product development expenses was recorded during the years ended June 30, 2007, 2006 and 2005, respectively.
In the course of its normal operations, the Company incurs maintenance and repair expenses. Those are expensed as incurred and amounted to $0.4 million, $0.2 million and $0.1 million for the years ended June 30, 2007, 2006 and 2005, respectively.
F-12
K12 Inc.
Notes to Consolidated Financial Statements
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s net deferred income taxes consists of the following:
| | | | | | | | |
| | June 30, | |
| | 2007 | | | 2006 | |
|
Deferred tax assets: | | | | | | | | |
Net operating loss carryforwards | | $ | 25,376 | | | $ | 25,445 | |
Intangible assets | | | 4,202 | | | | 5,247 | |
Reserves | | | 613 | | | | 935 | |
Property and equipment | | | 491 | | | | 857 | |
Accrued expenses | | | 486 | | | | 671 | |
Deferred rent | | | 180 | | | | — | |
Charitable contributions carryforward | | | 131 | | | | 130 | |
Stock compensation expense | | | 87 | | | | — | |
| | | | | | | | |
Total deferred tax assets | | | 31,566 | | | | 33,285 | |
| | | | | | | | |
Deferred tax liabilities: | | | | | | | | |
Capitalized development costs | | | (1,378 | ) | | | (522 | ) |
Other assets | | | (262 | ) | | | (236 | ) |
| | | | | | | | |
Total deferred tax liabilities | | | (1,640 | ) | | | (758 | ) |
| | | | | | | | |
Deferred tax asset | | | 29,926 | | | | 32,527 | |
Valuation allowance | | | (29,926 | ) | | | (32,527 | ) |
| | | | | | | | |
Net deferred tax asset | | $ | — | | | $ | — | |
| | | | | | | | |
The Company requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The utilization of recorded net operating loss carryforwards and other deferred tax assets is subject to the Company’s ability to generate future taxable income. As the Company has historically generated tax losses and therefore has no tax earnings history, the net deferred tax assets have been fully reserved. At June 30, 2007, the Company has available net operating loss carryforwards of $63.4 million that expire between 2020 and 2027 if unused. When the Company begins to generate taxable income, a change in the Company’s ownership of outstanding classes of stock as defined in Internal Revenue Code Section 382 could prohibit or limit the Company’s ability to utilize its net operating losses.
The provision for income taxes can be reconciled to the income tax that would result from applying the statutory rate to the net income (loss) before income taxes as follows:
| | | | | | | | | | | | |
| | Year Ended June 30, | |
| | 2007 | | | 2006 | | | 2005 | |
|
U.S. federal tax at statutory rates | | | 35.00 | % | | | 35.00 | % | | | 35.00 | % |
Permanent items | | | 20.22 | | | | 55.77 | | | | (20.19 | ) |
State taxes, net of federal benefit | | | 13.65 | | | | 12.98 | | | | 2.12 | |
Change in valuation allowance | | | (63.56 | ) | | | (103.75 | ) | | | (16.93 | ) |
| | | | | | | | | | | | |
Provision for income taxes | | | 5.31 | % | | | — | % | | | — | % |
| | | | | | | | | | | | |
F-13
K12 Inc.
Notes to Consolidated Financial Statements
As of June 30, 2007, computer equipment and software under capital leases are recorded at a cost of $8.1 million and accumulated depreciation of $1.7 million. The Company has an equipment lease line of credit with Hewlett-Packard Financial Services Company that expires on March 31, 2008 for new purchases on the line of credit. The interest rate on new advances under the equipment lease line is set quarterly. Prior borrowings under the equipment lease line had interest rates ranging from 8.5% to 8.8%. The prior borrowings include a 36-month payment term with a $1 purchase option at the end of the term. The Company has pledged the assets financed with the equipment lease line to secure the amounts outstanding. The Company entered into a guaranty agreement with Hewlett-Packard Financial Services Company to guarantee the obligations under this equipment lease and financing agreement.
The following is a summary as of June 30, 2007 of the present value of the net minimum lease payments on capital leases under the Company’s commitments:
| | | | |
| | Year ending June 30, | |
|
2008 | | $ | 3,238 | |
2009 | | | 2,888 | |
2010 | | | 1,399 | |
2011 | | | 6 | |
| | | | |
Total minimum lease payments | | | 7,531 | |
Less amount representing interest (imputed interest rate of 8.6%) | | | (777 | ) |
| | | | |
Net minimum lease payments | | | 6,754 | |
Less current portion | | | (2,780 | ) |
| | | | |
Present value of net minimum payments, less current portion | | $ | 3,974 | |
| | | | |
The Company has fixed non-cancelable operating leases expiring in 2013. Office leases generally contain renewal options and certain leases provide for scheduled rate increases over the lease terms.
In December 2005, the Company entered into an operating lease for non-owned facilities commencing in May 2006. The term of the lease is seven years with the option to extend the lease for two five year periods. In accordance with the lease terms, the Company delivered to the landlord an unconditional and irrevocable letter of credit in the amount of $2.1 million for a term ending 90 days after the expiration of the lease. The letter of credit can be reduced up to 25% on the first day of each of the fourth, fifth and sixth years if certain covenants are met. Additionally, in December 2005, the Company entered into an operating sublease for non-owned facilities commencing in January 2006. The term of the sublease is through September 2009. In accordance with the lease terms, the Company delivered to the sublandlord an unconditional and irrevocable letter of credit in the amount of $0.2 million for a term ending 60 days after the expiration of the lease. In November 2006, the Company entered into an operating lease for non-owned facilities commencing in January 2007. The term of the lease is through April 2013. Rent expense was $2.1 million, $1.8 million and $1.4 million for the years ended June 30, 2007, 2006 and 2005, respectively.
F-14
K12 Inc.
Notes to Consolidated Financial Statements
Future minimum lease payments under noncancelable operating leases with initial terms of one year or more as follows:
| | | | |
| | Year Ending
| |
| | June 30, | |
|
2008 | | $ | 2,138 | |
2009 | | | 2,127 | |
2010 | | | 1,576 | |
2011 | | | 1,386 | |
2012 | | | 1,367 | |
Thereafter | | | 8,627 | |
| | | | |
Total future minimum lease payments | | $ | 17,221 | |
| | | | |
In December 2006, the Company entered into a $15 million revolving credit agreement with PNC Bank (the “Credit Agreement”). Pursuant to the terms of the Credit Agreement, the proceeds of the term loan facility were to be used primarily for working capital requirements and other general business or corporate purposes. Because of the seasonality of our business and timing of funds received from the state, expenditures are higher in relation to funds received in certain periods during the year. The Credit Agreement provides the ability to fund these periods until cash is received from the schools; therefore, borrowings against the Credit Agreement are primarily going to be short term.
Borrowings under the Credit Agreement bear interest based upon the term of the borrowings. Interest is charged, at either: (i) the higher of (a) the rate of interest announced by PNC Bank from time to time as its “prime rate” and (b) the federal funds rate plus 0.5% or (ii) the applicable London interbank offered rate divided by a number equal to 1.00 minus the maximum aggregate reserve requirement which is imposed on member banks of the Federal Reserve System against “eurocurrency liabilities” as defined in Regulation D as promulgated by the Board of Governors of the Federal Reserve System, plus the applicable margin for such loans, which ranges between 1.250% and 1.750%, based on the leverage ratio (as defined in the Credit Agreement).
The Company pays a commitment fee on the unused portion of the Credit Agreement, quarterly in arrears, during the term of the credit agreement which varies between 0.150% and 0.250% depending on the leverage ratio. The commitment fees incurred for the year ended June 30, 2007 were minimal. We are also required to pay certain letter of credit and audit fees.
The working capital line includes a $5.0 million letter of credit facility. Issuances of letters of credit reduce the availability of permitted borrowings under the Credit Agreement.
Borrowings under the Credit Agreement are secured by substantially all of our assets of the Company. The Credit Agreement contains a number of financial and other covenants that, among other things, restrict our and our subsidiaries’ abilities to incur additional indebtedness, grant liens or other security interests, make certain investments, become liable for contingent liabilities, make specified restricted payments including dividends, dispose of assets or stock, including the stock of its subsidiaries, or make capital expenditures above specified limits and engage in other matters customarily restricted in senior secured credit facilities. We must also maintain a minimum net worth (as defined in the Credit Agreement) and maximum debt leverage ratios. These covenants are subject to certain qualifications and exceptions.
In March 2007, certain letters of credit in the amount of $2.3 million in connection with an operating lease commenced in May 2006 and an operating sublease that commenced in January 2006 were cancelled and reissued under our Credit Agreement.
F-15
K12 Inc.
Notes to Consolidated Financial Statements
As of June 30, 2007, $1.5 million was outstanding on the working capital line of credit at an interest rate of 8.25% and approximately $2.3 million under the letter of credit facility with an interest rate of 1.25%.
From July 1, 2007 to September 15, 2007, the Company borrowed additional funds of $11.0 million under the Credit Agreement at interest rates of 6.6% to 7.1%. As of September 15, 2007, $12.5 million was outstanding on the working capital line of credit and $2.3 million was outstanding related to letters of credit.
All of the warrants for Series B Preferred Stock and common stock are still outstanding at June 30, 2007. These consisted of (i) 2,328,358 warrants to purchase an equivalent number of Series B Preferred Stock at a price of $1.34 per share that expire in April 2008 and (ii) 108,64921,299 warrants to purchase an equivalent number of common stock at a price of $1.60$8.16 per share that expire in March 2010. For the years ended June 30, 2007, 2006 and 2005 there were no warrants issued or exercised.
In June 2005, the Company closed on an $8.1 million loan from certain shareholders, $4.0 million of which was funded at closing and the remainder to be funded, at the Company’s option, within 120 days of the closing date. The outstanding loan amount has a term of thirteen months and an interest rate of 15%. During the 120 day period during which funds are committed but not yet provided, the commitment carries an interest rate of 2% on an annual basis. The Company has chosen not to call upon the remaining portion of the loan. The loan is secured by assets of the Company and there are no penalties for prepayment.
In July 2006, the term for repayment of the outstanding loan amount was extended to December 31, 2006. In December 2006, the Company repaid the loan and all accrued interest.
In January and April 2007, the Company entered into a two financing arrangements totaling $0.4 million for software purchases and hardware maintenance support, respectively. The payment terms range from 24 to 36 months at interest rates ranging up to 11.4%. The balance outstanding on these financing arrangements at June 30, 2007 is $0.4 million.
Common Stock
On July 27, 2001, all holders of Class A Common stock (1,500,000(294,117 shares outstanding) and Class B Common stock (8,500,000(1,666,667 shares outstanding) converted these shares into 10,000,0001,960,784 shares of common stock. The Company has reserved sufficient shares of common stock for potential issuance from exercise of stock options and warrants and conversion of Redeemable Convertible Series B and Series C Preferred stock.
Redeemable Convertible Series B Preferred Stock
During the years ended June 30, 2003 and 2002, K12 issued approximately 21.6 million and 40.1 million shares of Redeemable Convertible Series B Preferred stock (Series B Preferred), respectively.
The Series B Preferred shares are convertible into common stock at a conversion rate equal to the original amount invested divided by $1.34. The Series B Preferred shares convert automatically upon certain events, including a qualified initial public offering by the Company. These shares have a liquidation preference over common stock shares equal to the greater of (i) two times the invested amount per share and (ii) the amount the Series B shareholders would have received had they converted their Series B shares into common stock immediately prior to the Liquidation. The Series B Preferred shares have voting rights equal to the number of common stock shares into which the Series B Preferred shares are convertible. The Series B Preferred shares are entitled to dividends when and if declared by the board of directors and are not cumulative. In the event the Board declares a dividend on the common stock, the Series B Preferred shareholders will receive dividends equal to the amount of such dividend had the shares been converted into common stock.
F-16
K12 Inc.
Notes to Consolidated Financial Statements
The Series B Preferred shares are redeemable at the option of the holder on December 31, 2006 at a price of two times the amount invested to the extent the Series B Preferred shares have not been previously converted into common shares. It is classified as temporary equity on the balance sheet based upon guidance in EITF Topic D-98,Classification and Measurement of Redeemable Securities. The Company accounts for the difference between the invested amount and the redemption value by increasing the book value under the effective interest method, charging the accretion to accumulated deficit each period. As discussed below, the redemption date for the Series B Preferred shares was extended to December 2008.
Redeemable Convertible Series C Preferred Stock
The Series C Preferred shares are convertible into common stock at a conversion rate equal to the original amount invested divided by $1.34. The Series C Preferred shares convert automatically upon certain events, including a qualified initial public offering by the Company. These shares have a liquidation preference over common stock shares equal to the greater of (i) two times the invested amount per share and (ii) the amount the Series C shareholders would have received had they converted their Series C shares into common stock immediately prior to the Liquidation. The Series C shares have voting rights equal to the number of common stock shares into which the Series C shares are convertible.
The Series C shares are entitled to dividends, which accrue at the rate of 10% per annum, compounded annually and shall be paid on January 2 of each year in additional Series C shares or, at the option of the Company, in cash. No dividends are paid to any other classes of capital stock unless any and all accrued but unpaid dividends on the Series C shares have been declared and paid in full. For any other dividends or similar distributions, the Series C shares participate with Common Stock on an as-if-converted basis.
The Series C shares are redeemable at the option of the holder on December 31, 2008 at a price of two times the amount invested, to the extent the Series C shares had not previously been converted into common stock. It is classified as temporary equity on the balance sheet based upon guidance in EITF Topic D-98,Classification and Measurement of Redeemable Securities. The Company accounts for the difference between the invested amount and the redemption value by increasing the book value using the effective interest method, charging the accretion to accumulated deficit each period.
In accordance with the Series C placement, the redemption date for the Series B shares was extended to December 31, 2008.
In July 2006, the Company amended its Certificate of Incorporation, to effect an increase in the authorized number of shares of Series C Convertible Preferred Stock to 55,000,000 as well as a corresponding increase in the authorized number of shares of Preferred Stock and Common Stock into which such shares are convertible.
The Company adopted a Stock Option Plan (the Plan) in May 2000. Under the Plan, employees, outside directors and independent contractors are able to participate in the Company’s future performance through the awards of nonqualified stock options to purchase common stock. In December 2003, the Board increased the total number of common stock shares reserved and available for grant and issuance pursuant to the Plan to 13,000,0002,549,019 shares. Each stock option is exercisable pursuant to the vesting schedule set forth in the stock option agreement granting such stock option, generally over four years. Unless a shorter period is provided by the Board or a stock option agreement, each stock option may be exercisable until December 31, 2009, the term of the Plan. No stock option shall be exercisable after the expiration of its option term. The Company also grants stock options to executive officers under stand-alone agreements outside the Plan. These options totaled 7,350,0001,441,168 as of June 30, 2007.
Effective July 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the prospective transition method which requires the
F-17
K12 Inc.
Notes to Consolidated Financial Statements
Company to apply the provisions of SFAS 123R only to awards granted, modified, repurchased or cancelled after the effective date. Equity-based compensation expense for all equity-based compensation awards granted after July 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs on a straight-line basis over the requisite service period, which is generally the vesting period of the award.
The Company uses the Black-Scholes-Merton method to calculate the fair value of stock options. The use of option valuation models requires the input of highly subjective assumptions, including the expected stock price volatility and the expected term of the option. In March 2005, the Securities and Exchange Commission (SEC) issued SAB No. 107 (SAB 107) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. For options issued subsequent to July 1, 2006, the Company has applied the provisions of SAB 107 in its adoption of SFAS 123R. Under SAB 107, the Company has estimated the expected term of granted options to be the weighted average mid-point between the vesting date and the end of the contractual term. The Company estimates the volatility rate based on historical closing stock prices.
The following weighted-average assumptions were used for options granted in the year ended June 30, 2007 and a discussion of the Company’s methodology for developing each of the assumptions used in the valuation model follows:
| | |
| | Year Ended
|
| | June 30, 2007 |
|
Dividend yield | | 0.0% |
Expected volatility | | 51% |
Risk-free interest rate | | 4.53% to 5.01% |
Expected life of the option term (in years) | | 3.25 — 6.40 |
Forfeiture rate | | 20% to 30% |
Dividend yield — The Company has never declared or paid dividends on its common stock and has no plans to do so in the foreseeable future.
Expected volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. Since the Company ’s common shares are not publicly traded, the basis for the standard option volatility calculation is derived from known publicly traded comparable companies. The annual volatility for these companies is derived from their historical stock price data.
Risk-free interest rate — The assumed risk free rate used is a zero coupon U.S. Treasury security with a maturity that approximates the expected term of the option.
Expected life of the option term — This is the period of time that the options granted are expected to remain unexercised. Options granted during the quarter have a maximum term of eight years. The Company estimates the expected life of the option term based on an average life between the dates that options become fully vested and the maximum life of options granted in the year ended June 30, 2007.
Forfeiture rate — This is the estimated percentage of options granted that are expected to be forfeited or canceled before becoming fully vested. The Company uses a forfeiture rate that is based on historical forfeitures at various classification levels with the Company.
On a contemporaneous basis, the Company estimated the value of its common stock as of December 31, 2006, March 31, 2007 and June 27, 2007. The fair value applied to the option grants in July 2006 was based on the December 31, 2006 valuation applied retrospectively. The fair value applied to option grants in February 2007 and May 2007 was based on the contemporaneous valuations.
F-18
K12 Inc.
Notes to Consolidated Financial Statements
SFAS 123(R) requires management to make assumptions regarding the expected life of the options, the expected liability of the options and other items in determining estimated fair value. Changes to the underlying assumptions may have significant impact on the underlying value of the stock options, which could have a material impact on our financial statements.
The Company also grants stock options to executive officers under stand-alone agreements outside the plan. These options totaled 7,350,0001,141,168 and 2,000,000392,155 as of June 30, 2007 and 2006, respectively.
A summary of the Company’s stock option activity including stand-alone agreements is as follows:
| | | | | | | | |
| | | | | Weighted-
| |
| | | | | Average
| |
| | | | | Exercise
| |
| | Shares | | | Price | |
|
Outstanding, June 30, 2005 | | | 10,457,617 | | | $ | 1.34 | |
Granted | | | 3,121,000 | | | | 1.47 | |
Exercised | | | (115,188 | ) | | | 0.32 | |
Canceled | | | (647,140 | ) | | | 1.38 | |
| | | | | | | | |
Outstanding, June 30, 2006 | | | 12,816,289 | | | | 1.38 | |
Granted | | | 6,372,185 | | | | 2.62 | |
Exercised | | | (217,829 | ) | | | 1.34 | |
Canceled | | | (492,842 | ) | | | 1.39 | |
| | | | | | | | |
Outstanding, June 30, 2007 | | | 18,477,803 | | | $ | 1.81 | |
| | | | | | | | |
| | | | | | | | |
| | | | | Weighted-
| |
| | | | | Average
| |
| | | | | Exercise
| |
| | Shares | | | Price | |
|
Outstanding, June 30, 2005 | | | 2,050,299 | | | $ | 6.83 | |
Granted | | | 611,903 | | | | 7.50 | |
Exercised | | | (22,584 | ) | | | 1.65 | |
Canceled | | | (126,812 | ) | | | 7.01 | |
| | | | | | | | |
Outstanding, June 30, 2006 | | | 2,512,806 | | | | 7.03 | |
Granted | | | 1,249,409 | | | | 13.35 | |
Exercised | | | (42,708 | ) | | | 6.84 | |
Canceled | | | (96,657 | ) | | | 7.06 | |
| | | | | | | | |
Outstanding, June 30, 2007 | | | 3,622,850 | | | $ | 9.21 | |
| | | | | | | | |
The total intrinsic value of options exercised during the years ended June 30, 2007 and 2006 was $0.1 million and $0, respectively.
The following table summarizes the option grant activity for the year ended June 30, 2007:
| | | | | | | | | | | | | | | | |
| | | | | | | | Weighted-Average
| | | | |
| | Options
| | | Weighted-Average
| | | Grant-Date
| | | | |
Grant date | | Granted | | | Exercise Price | | | Fair Value | | | Intrinsic Value | |
|
July 2006 | | | 5,136,385 | | | $ | 2.81 | | | $ | 0.58 | | | $ | 0.00 | |
February 2007 | | | 960,800 | | | $ | 1.80 | | | $ | 0.95 | | | $ | 0.00 | |
May 2007 | | | 275,000 | | | $ | 1.80 | | | $ | 1.58 | | | $ | 0.00 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | Weighted-Average
| | | | |
| | Options
| | | Weighted-Average
| | | Grant-Date
| | | | |
Grant date | | Granted | | | Exercise Price | | | Fair Value | | | Intrinsic Value | |
|
July 2006 | | | 1,007,113 | | | $ | 14.35 | | | $ | 2.96 | | | $ | 0.00 | |
February 2007 | | | 188,381 | | | $ | 9.18 | | | $ | 4.84 | | | $ | 0.00 | |
May 2007 | | | 53,915 | | | $ | 9.18 | | | $ | 8.06 | | | $ | 0.00 | |
A summary of the Company’s unvested stock options, including those related to stand-alone agreements, as of June 30, 2006 and changes during the year ended June 30, 2007 are presented below:
| | | | | | | | |
| | | | | Weighted-Average
| |
| | | | | Grant-Date
| |
| | Shares | | | Fair Value | |
|
Unvested options outstanding, June 30, 2006 | | | 4,936,899 | | | $ | 1.42 | |
Granted | | | 6,372,185 | | | | 0.68 | |
Vested | | | (2,860,026 | ) | | | 0.96 | |
Exercised | | | (217,829 | ) | | | 1.34 | |
Canceled | | | (492,842 | ) | | | 1.37 | |
| | | | | | | | |
Unvested options outstanding, June 30, 2007 | | | 7,738,387 | | | $ | 0.99 | |
| | | | | | | | |
| | | | | | | | |
| | | | | Weighted-Average
| |
| | | | | Grant-Date
| |
| | Shares | | | Fair Value | |
|
Unvested options outstanding, June 30, 2006 | | | 968,004 | | | $ | 7.25 | |
Granted | | | 1,249,409 | | | | 3.46 | |
Vested | | | (560,673 | ) | | | 4.92 | |
Exercised | | | (42,708 | ) | | | 6.84 | |
Canceled | | | (96,657 | ) | | | 6.99 | |
| | | | | | | | |
Unvested options outstanding, June 30, 2007 | | | 1,517,375 | | | $ | 5.02 | |
| | | | | | | | |
F-19
K12 Inc.
Notes to Consolidated Financial Statements
As of June 30, 2007, there was $0.7 million of total unrecognized compensation expense related to unvested stock options granted under the Plan. The cost is expected to be recognized over weighted average period of 3.1 years. The total fair value of shares vested during the year ended June 30, 2007 was $4.2 million. During the year ended June 30, 2007, the Company recognized $0.2 million of stock based compensation.
The stock option agreements generally provide for accelerated and full vesting of unvested stock options upon certain corporate events. Those events include a sale of all or substantially all of the Company’s assets, a merger or consolidation which results in the Company’s stockholders immediately prior to the transaction owning less than 50% of the Company’s voting stock immediately after the transaction, and a sale of the Company’s outstanding securities (other than in connection with an initial public offering) which results in the Company’s stockholders immediately prior to the transaction owning less than 50% of the Company’s voting stock immediately after the transaction.
The following table summarizes information about stock options outstanding, including those related to stand-alone agreements, as of June 30, 2007:
| | | | | | | | | | | | | | | | | | | | |
| | | | | Weighted-
| | | | | | | | | | |
| | | | | Average
| | | Weighted-
| | | | | | Weighted-
| |
Range of
| | | | | Remaining
| | | Average
| | | | | | Average
| |
Exercise
| | Number
| | | Contractual
| | | Exercise
| | | Number
| | | Exercise
| |
Prices | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
|
$.20 - $1.80 | | | 16,977,803 | | | | 5.3 years | | | $ | 1.44 | | | | 10,739,416 | | | $ | 1.38 | |
| | | | | | | | | | | | | | | | | | | | |
$6.00 | | | 1,500,000 | | | | 5.5 years | | | $ | 6.00 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | Weighted-
| | | | | | | | | | |
| | | | | Average
| | | Weighted-
| | | | | | Weighted-
| |
Range of
| | | | | Remaining
| | | Average
| | | | | | Average
| |
Exercise
| | Number
| | | Contractual
| | | Exercise
| | | Number
| | | Exercise
| |
Prices | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
|
$1.02 - $9.18 | | | 3,328,733 | | | | 5.3 years | | | $ | 7.32 | | | | 2,105,475 | | | $ | 7.05 | |
| | | | | | | | | | | | | | | | | | | | |
$30.60 | | | 294,117 | | | | 5.5 years | | | $ | 30.60 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
The total intrinsic value of options outstanding and exercisable at June 30, 2007 was $6.5 million and $4.7 million, respectively.
| |
10. | Commitments and Contingencies |
Litigation
In the ordinary conduct of the Company’s business, we are subject to lawsuits and other legal proceedings from time to time. There are currently two pending lawsuits in which the Company is involved,Johnson v. Burmaster andIllinois v. Chicago Virtual Charter School that, in each case, have been brought by teachers’ unions seeking the closure of the virtual public schools the Company serves in Wisconsin and Illinois, respectively.
While the Company prevailed on summary judgment at the circuit court level inJohnson v. Burmaster, and recently won a preliminary motion inIllinois v. Chicago Virtual Charter School, it is not possible to predict the final outcome of these matters with any degree of certainty. Even so, the Company does not believe at this time that a loss in either case would have a material adverse impact on our future results of operations, financial position or cash flows. Depending on the legal theory advanced by the plaintiffs, however, there is a risk that a loss in these cases could have a negative precedential effect if like claims were to be advanced and succeed under similar laws in other states where the Company operates. The cumulative effect under those circumstances could be material.
Johnson v. Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the State of Wisconsin established a virtual public school, the Wisconsin Virtual Academy (WIVA), and entered into a service agreement with us for online curriculum and school management services. On January 6, 2004, Stan Johnson, et al., and the Wisconsin Education Association Council (WEAC) filed suit in the Circuit Court of Ozaukee County against the Superintendent of the Department of Public Instruction (DPI), Elizabeth Burmaster, the NOSD and K12 Inc. The plaintiffs alleged that the NOSD violated the state charter school, open enrollment and teacher-licensure statutes when it authorized WIVA.
F-20
K12 Inc.
Notes to Consolidated Financial Statements
On March 16, 2006, the Circuit Court issued a Decision and Order upholding on Summary Judgment that WIVA complies with applicable law(No. 04-CV-12 ). WEAC and DPI filed an appeal in the Wisconsin Court of Appeals, District II(No. 2006-AP/01380). Should the plaintiff prevail, and state funding of open enrollment payments to the NOSD are enjoined, a claim could be made that the Company must indemnify the NOSD for expenses approximating $2.5 million.
Illinois v. Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed a citizen taxpayers lawsuit in the Circuit Court of Cook County challenging the decision of the Illinois State Board of Education to certify the Chicago Virtual Charter School (CVCS) and to enjoin the disbursement of state funds to the Chicago Board of Education under its contract with the CVCS. Specifically, the CTU alleges that the Illinois charter school law prohibits any “home-based” charter schools and that CVCS does not provide sufficient “direct instruction” by certified teachers of at least five clock hours per day to qualify for funding. K12 Inc. and K12 Illinois LLC were also named as defendants. On May 16, 2007, the Court dismissed K12 Inc. and K12 Illinois LLC from the case and on June 15, 2007, the plaintiffs filed a second amended complaint. The Company continues to participate in the defense of CVCS under an indemnity obligation in the Company’s service agreement with that school, which requires the Company to indemnify CVCS against certain liabilities arising out of the performance of the service agreement and certain other claims and liabilities, including liabilities arising out of challenges to the validity of the virtual school charter. The Company is not able to estimate the range of potential loss if the plaintiff were to prevail and a claim was made against the Company for indemnification.
The Company expenses legal costs as incurred in connection with a loss contingency.
Employment Agreements
The Company has entered into employment agreements with certain executive officers that provide for severance payments and, in some cases other benefits, upon certain terminations of employment. Except for one agreement that has a three year term, all other agreements provide for employment on an “at-will” basis. If the employee is terminated for “good reason” or without cause, the employee is entitled to salary continuation, and in some cases benefit continuation, for varying periods depending on the agreement.
On July 12, 2007, the Company’s board of directors approved an amended and restated employment agreement for an executive officer. The amended and restated agreement extends the term of employment until January 1, 2011 and amended certain elements of compensation including salary, stock options and severance. Additionally, on July 12, 2007, the Company’s board of directors also approved the terms of a new option agreement for an executive officer which provides that all outstanding options will become fully vested upon a change in control of Company.
The Company maintains an annual cash performance bonus program that is intended to reward executive officers based on our performance and the individual named executive officer’s contribution to that performance. In determining the performance-based compensation awarded to each named executive officer, the Company may generally evaluate the Company’s and the executive’s performance in a number of areas, which could include revenues, operating earnings, student retention, efficiency in product and systems development, marketing investment efficacy, new enrollment and developing company leaders.
Vendor Payment Commitments
In April 2007, the Company entered into a master services and license agreement with a third party that provides for the Company to license their proprietary computer system. The agreement is effective through July 2010. In exchange for the license of the computer system, the Company agrees to pay a service fee per enrollment. In the event the fees paid over the term of the contract do not exceed $1 million (the minimum commitment fee), the Company agrees to pay the difference between the actual fees paid and the minimum commitment fee.
F-21
K12 Inc.
Notes to Consolidated Financial Statements
| |
11. | Related Party Transactions |
Affiliates of the Company, controlled by a major investor, rendered $0.3 million, $0.1 million and $0.1 million of professional services to the Company during the years ended June 30, 2007, 2006 and 2005, respectively. These costs include administrative operations, consulting and curriculum development services, and other operating charges.
In June 2005, the Company closed on an $8.1 million loan from certain shareholders, $4.0 million of which was funded at closing and the remainder to be funded, at the Company’s option, within 120 days of the closing date. The Company has chosen not to call upon the remaining portion of the loan. In July 2006, the term for repayment of the outstanding loan amount was extended to December 31, 2006. In December 2006, the Company repaid the loan and all accrued interest.
The Company is party to a Section 401(k) Salary Deferral Plan (the 401(k) Plan). Under the 401(k) Plan, employees at least 18 years of age having been employed for at least 30 days may voluntarily contribute up to 15% of their compensation. The 401(k) Plan provides for a matching Company contribution of 25% of the first 4% of each participant’s compensation, which begins following six months of service and vests after three years of service. Under the 401(k) Plan, the Company expensed $0.1 million during each of the years ended June 30, 2007, 2006 and 2005.
| |
13. | Supplemental Disclosure of Cash Flow Information |
| | | | | | | | | | | | |
| | Year Ended June 30, | |
| | 2007 | | | 2006 | | | 2005 | |
|
Cash paid for interest | | $ | 1,317 | | | $ | 33 | | | $ | 446 | |
| | | | | | | | | | | | |
Supplemental disclosure of non cash investing and financing activities: | | | | | | | | | | | | |
New capital lease obligations | | $ | 8,052 | | | $ | — | | | $ | 441 | |
| | | | | | | | | | | | |
Letters of Intent
On July 3, 2007, the Company entered into a non-binding letter of intent (LOI) with Socratic Network L.P., Socratic Learning, Inc. and Tutors Worldwide (India) Private Ltd. (individually and collectively referred to as Socratic) to acquire all, substantially all or a selected set of assets (as determined in the Company’s sole discretion) of Socratic, or all the equity interest in Socratic or any of its affiliates or subsidiaries, for the aggregate purchase price of $2.2 million plus 300,00058,823 shares of the common stock of the Company. Socratic is an eduction company whose primary asset is its India based tutoring and development center.
On August 2, 2007, the Company entered into a non-binding letter of intent (LOI) with a curriculum content developer to acquire substantially all of its assets or all of the equity interest in the developer (as determined in the Company’s sole discretion) for the aggregate purchase price of up to 1,000,000196,078 shares of the Company’s common stock and the assumption of up to $1.2 million in liabilities.
F-22
K12 Inc.
Notes to Consolidated Financial Statements
Initial Public Offering
On July 12, 2007, the Company’s Board of Directors authorized management to file aForm S-1 “Registration Statement Under the Securities Act of 1933” in order to pursue a public offering of the Company’s common stock. Immediately prior to the completion of this offering, all outstanding shares of Redeemable Convertible Series B and
F-22
K12 Inc.
Notes to Consolidated Financial Statements
Series C preferred stock will be converted into shares of our common stock without any further action required by us or the holders of the preferred stock.
Stock Options
On July 3, 2007, the Board approved the grant of 3,287,965640,304 stock options with an exercise price of $2.68$13.67 per share subject to amendment of the Stock Option Plan. On July 12, 2007, the Board authorized the Company to seek shareholder approval to amend the Stock Option Plan by increasing the number of shares reserved for issuance from 132.5 million to 203.9 million.
| |
15. | Subsequent Event — Reverse Stock Split |
Reverse Stock Split— On October 30, 2007, the Board approved a1-for-5.1 reverse split of the Company’s common stock. On October 31, 2007, the reverse split was further approved by a majority of the shareholders. The stock split was effective on November 2, 2007. In conjunction with this, the number of authorized shares of common stock was amended to 33,362,500. All share and per share amounts related to common stock, options and common stock warrants included in the consolidated financial statements have been retroactively adjusted for all periods presented to give effect to the stock split.
F-23
CONDENSED CONSOLIDATED BALANCE SHEETS
| | | | | | | | |
| | September 30,
| | | June 30,
| |
| | 2007 | | | 2007 | |
| | (unaudited) | | | | |
| | (in thousands,
| |
| | except share and
| |
| | per share data) | |
|
ASSETS |
Current assets | | | | | | | | |
Cash and cash equivalents | | $ | 2,903 | | | $ | 1,660 | |
Accounts receivable, net of allowance of $610 and $589 at September 30, 2007 and June 30, 2007, respectively | | | 49,682 | | | | 15,455 | |
Inventories, net | | | 6,768 | | | | 13,804 | |
Current portion of deferred tax asset | | | 1,141 | | | | — | |
Prepaid expenses and other current assets | | | 983 | | | | 1,245 | |
| | | | | | | | |
Total current assets | | | 61,477 | | | | 32,164 | |
Property and equipment, net | | | 23,427 | | | | 17,234 | |
Capitalized curriculum development costs, net | | | 10,881 | | | | 9,671 | |
Deferred tax asset, net of current portion | | | 5,976 | | | | — | |
Other assets, net | | | 2,416 | | | | 1,182 | |
Deposits and other assets | | | 2,025 | | | | 961 | |
| | | | | | | | |
Total assets | | $ | 106,202 | | | $ | 61,212 | |
| | | | | | | | |
|
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ DEFICIT |
Current liabilities | | | | | | | | |
Bank overdraft | | $ | — | | | $ | 1,577 | |
Line of credit | | | 12,500 | | | | 1,500 | |
Accounts payable | | | 11,028 | | | | 6,928 | |
Accrued liabilities | | | 4,193 | | | | 1,819 | |
Accrued compensation and benefits | | | 3,321 | | | | 6,200 | |
Deferred revenue | | | 15,191 | | | | 2,620 | |
Current portion of capital lease obligations | | | 5,111 | | | | 2,780 | |
Current portion of notes payable | | | 194 | | | | 192 | |
| | | | | | | | |
Total current liabilities | | | 51,538 | | | | 23,616 | |
Deferred rent, net of current portion | | | 1,667 | | | | 1,684 | |
Capital lease obligations, net of current portion | | | 7,959 | | | | 3,974 | |
Notes payable, net of current portion | | | 142 | | | | 189 | |
| | | | | | | | |
Total liabilities | | | 61,306 | | | | 29,463 | |
| | | | | | | | |
Commitments and contingencies | | | | | | | | |
| | | | | | | | |
Redeemable convertible preferred stock | | | | | | | | |
Redeemable Convertible Series C Preferred stock, par value $0.0001; 55,000,000 shares authorized; 49,861,562 shares issued and outstanding at September 30, 2007 and June 30, 2007, respectively; liquidation value of $133,629 at September 30, 2007 and June 30, 2007, respectively | | | 95,571 | | | | 91,122 | |
| | | | | | | | |
Redeemable Convertible Series B Preferred stock, par value $0.0001; 76,000,000 shares authorized; 51,524,974 shares issued and outstanding at September 30, 2007 and June 30, 2007, respectively; liquidation value of $138,087 at September 30, 2007 and June 30, 2007, respectively | | | 142,216 | | | | 138,434 | |
| | | | | | | | |
Stockholders’ deficit | | | | | | | | |
Common stock, par value $0.0001; 33,362,500 shares authorized; 2,045,217 and 2,041,604 shares issued and outstanding at September 30, 2007 and June 30, 2007, respectively | | | 1 | | | | 1 | |
Accumulated deficit | | | (192,892 | ) | | | (197,808 | ) |
| | | | | | | | |
Total stockholders’ deficit | | | (192,891 | ) | | | (197,807 | ) |
| | | | | | | | |
Total liabilities, redeemable convertible preferred stock and stockholders’ deficit | | $ | 106,202 | | | $ | 61,212 | |
| | | | | | | | |
See notes to unaudited condensed consolidated financial statements.
F-24
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
| | | | | | | | |
| | Three Months Ended September 30, | |
| | 2007 | | | 2006 | |
| | (in thousands, except per share data) | |
|
Revenues | | $ | 59,353 | | | $ | 37,743 | |
| | | | | | | | |
Cost and expenses | | | | | | | | |
Instructional costs and services | | | 34,778 | | | | 19,177 | |
Selling, administrative, and other operating expenses | | | 16,039 | | | | 11,385 | |
Product development expenses | | | 2,527 | | | | 2,206 | |
| | | | | | | | |
Total costs and expenses | | | 53,344 | | | | 32,768 | |
| | | | | | | | |
Income from operations | | | 6,009 | | | | 4,975 | |
Interest expense, net | | | (304 | ) | | | (94 | ) |
| | | | | | | | |
Net income before income tax expense | | | 5,705 | | | | 4,881 | |
Income tax benefit (expense) | | | 7,117 | | | | (146 | ) |
| | | | | | | | |
Net income | | | 12,822 | | | | 4,735 | |
Dividends on preferred stock | | | (1,671 | ) | | | (1,519 | ) |
Preferred stock accretion | | | (6,560 | ) | | | (5,367 | ) |
| | | | | | | | |
Net income (loss) attributable to common stockholders | | $ | 4,591 | | | $ | (2,151 | ) |
| | | | | | | | |
Net income (loss) attributable to common stockholders per share: | | | | | | | | |
Basic | | $ | 2.25 | | | $ | (1.08 | ) |
| | | | | | | | |
Diluted | | $ | 0.20 | | | $ | (1.08 | ) |
| | | | | | | | |
Weighted average shares used in computing per share amounts: | | | | | | | | |
Basic | | | 2,043,589 | | | | 1,998,853 | |
| | | | | | | | |
Diluted | | | 22,744,525 | | | | 1,998,853 | |
| | | | | | | | |
See notes to unaudited condensed consolidated financial statements.
F-25
CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS’ DEFICIT
(UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Stockholders’ Deficit | |
| | Redeemable Convertible
| | | Redeemable Convertible
| | | | | | | | | Additional
| | | | | | | |
| | Series C Preferred Stock | | | Series B Preferred Stock | | | Common Stock | | | Paid-in
| | | Accumulated
| | | | |
| | Shares | | | Amount | | | Shares | | | Amount | | | Shares | | | Amount | | | Capital | | | Deficit | | | Total | |
| | (dollars in thousands, except share amounts) | | | | |
|
Balance, June 30, 2007 | | | 49,861,562 | | | $ | 91,122 | | | | 51,524,974 | | | $ | 138,434 | | | | 2,041,604 | | | $ | 1 | | | $ | — | | | $ | (197,808 | ) | | $ | (197,807 | ) |
Employee exercised options | | | — | | | | — | | | | — | | | | — | | | | 3,613 | | | | — | | | | 25 | | | | — | | | | 25 | |
Accretion of Preferred Stock | | | — | | | | 2,778 | | | | — | | | | 3,782 | | | | — | | | | — | | | | (325 | ) | | | (6,235 | ) | | | (6,560 | ) |
Accrued Series C 10% Stock Dividend | | | — | | | | 1,671 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (1,671 | ) | | | (1,671 | ) |
Record stock compensation expense | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 300 | | | | — | | | | 300 | |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 12,822 | | | | 12,822 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, September 30, 2007 | | | 49,861,562 | | | $ | 95,571 | | | | 51,524,974 | | | $ | 142,216 | | | | 2,045,217 | | | $ | 1 | | | $ | — | | | $ | (192,892 | ) | | $ | (192,891 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
See notes to unaudited condensed consolidated financial statements.
F-26
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| | | | | | | | |
| | Three Months Ended September 30, | |
| | 2007 | | | 2006 | |
| | (in thousands) | |
|
Cash Flows from Operating Activities | | | | | | | | |
Net income | | $ | 12,822 | | | $ | 4,735 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | | | | | | |
Depreciation and amortization expense | | | 2,252 | | | | 1,224 | |
Stock based compensation expense | | | 300 | | | | 41 | |
Deferred tax benefit | | | (7,117 | ) | | | — | |
Provision for (reduction of) doubtful accounts | | | 21 | | | | (958 | ) |
Provision for (reduction of) inventory obsolescence | | | 7 | | | | (31 | ) |
Provision for (reduction of) student computer shrinkage and obsolescence | | | 161 | | | | (153 | ) |
Changes in assets and liabilities: | | | | | | | | |
Accounts receivable | | | (34,248 | ) | | | (20,397 | ) |
Inventories | | | 7,029 | | | | 3,680 | |
Prepaid expenses and other current assets | | | 261 | | | | (75 | ) |
Other assets | | | (933 | ) | | | (1,112 | ) |
Deposits and other assets | | | 557 | | | | 34 | |
Accounts payable | | | 4,100 | | | | 3,187 | |
Accrued liabilities | | | 2,374 | | | | 3,321 | |
Accrued compensation and benefits | | | (2,880 | ) | | | (2,074 | ) |
Deferred revenue | | | 12,571 | | | | 11,963 | |
Deferred rent | | | (17 | ) | | | 13 | |
| | | | | | | | |
Net cash (used in) provided by operating activities | | | (2,740 | ) | | | 3,398 | |
| | | | | | | | |
Cash flows from investing activities | | | | | | | | |
Purchase of property and equipment | | | (1,530 | ) | | | (4,784 | ) |
Purchase of domain name | | | (250 | ) | | | — | |
Capitalized curriculum development costs | | | (1,622 | ) | | | (2,066 | ) |
| | | | | | | | |
Net cash used in investing activities | | | (3,402 | ) | | | (6,850 | ) |
| | | | | | | | |
Cash flows from financing activities | | | | | | | | |
Deferred initial public offering costs | | | (1,371 | ) | | | — | |
Payments on notes payable | | | (44 | ) | | | — | |
Net borrowings from revolving credit facility | | | 11,000 | | | | — | |
Repayments for capital lease obligations | | | (648 | ) | | | — | |
Proceeds from exercise of stock options | | | 25 | | | | — | |
Repayment of bank overdraft | | | (1,577 | ) | | | — | |
| | | | | | | | |
Net cash provided by financing activities | | | 7,385 | | | | — | |
| | | | | | | | |
Net change in cash and cash equivalents | | | 1,243 | | | | (3,452 | ) |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 1,660 | | | | 9,475 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 2,903 | | | $ | 6,023 | |
| | | | | | | | |
See notes to unaudited condensed consolidated financial statements.
F-27
Notes to Condensed Consolidated Financial Statements
(unaudited)
The accompanying condensed consolidated balance sheet as of September 30, 2007, the condensed consolidated statements of operations and cash flows for the three months ended September 30, 2007 and 2006 and the condensed consolidated statement of shareholders’ equity for the three months ended September 30, 2007 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 and results of operations and cash flows for the three months ended September 30, 2007 and 2006. The financial data and other information disclosed in these notes to the financial statements related to the three month periods are unaudited. The results of the three months ended September 30, 2007 are not necessarily indicative of the results to be expected for the year ending June 30, 2008 or for any other interim period or for any other future year.
The consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
| |
2. | Summary of Significant Accounting Policies |
Stock-Based Compensation
The Company adopted SFAS No. 123(R),Share-Based Payment (Revised 2004), as of July 1, 2006, which replaces SFAS No. 123,Accounting for Stock-Based Compensation,and supersedes Accounting Principles Board Opinion No. 25 (APB No. 25),Accounting for Stock Issued to Employees. The Company adopted SFAS 123(R) using the prospective application method. SFAS No. 123(R) eliminates the intrinsic value method that was previously used by the Company as an alternative method of accounting for stock-based compensation. SFAS No. 123(R) requires an entity to recognize the grant date fair value of stock options and other equity-based compensation issued to employees in the consolidated statement of operations. The Company applied SFAS 123(R) to all new awards granted after July 1, 2006.
Net Income (Loss) Per Common Share
The Company calculates net income (loss) per share in accordance with SFAS No. 128,Earnings Per Share. Under SFAS No. 128, basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted net income (loss) per common share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The potentially dilutive securities consist of convertible preferred stock, stock options and warrants.
Recent Accounting Pronouncements
In June 2006, the FASB issued FASB Interpretation (FIN) 48,Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,Accounting for Income Taxes. This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, the Company has implemented FIN 48 in the first quarter of the fiscal year which will end on June 30, 2008. The Company did not have any unrecognized tax benefits and there was no effect on our financial condition or results of operations as a result of implementing FIN 48.
F-28
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company does not believe there will be any material changes in its unrecognized tax positions over the next twelve months.
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements,which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of this statement on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.This statement permits companies and not-for-profit organizations to make a one-time election to carry eligible types of financial assets and liabilities at fair value, even if fair value measurement is not required under GAAP. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted if the decision to adopt the standard is made after the issuance of the statement but within 120 days after the first day of the fiscal year of adoption, provided no financial statements have yet been issued for any interim period and provided the requirements of statement 157, Fair Value Measurements, are adopted concurrently with SFAS 159. The Company does not believe that it will adopt the provisions of this statement.
In December 2006, the Company entered into a $15 million revolving credit agreement with PNC Bank (Credit Agreement). Pursuant to the terms of the Credit Agreement, the proceeds of the term loan facility were to be used primarily for working capital requirements and other general business or corporate purposes. Because of the seasonality of our business and timing of funds received from the state, expenditures are higher in relation to funds received in certain periods during the year. The Credit Agreement provides the ability to fund these periods until cash is received from the schools; therefore, borrowings against the Credit Agreement are primarily going to be short term.
Borrowings under the Credit Agreement bear interest based upon the term of the borrowings. Interest is charged, at either: (i) the higher of (a) the rate of interest announced by PNC Bank from time to time as its “prime rate” and (b) the federal funds rate plus 0.5% or (ii) the applicable London interbank offered rate divided by a number equal to 1.00 minus the maximum aggregate reserve requirement which is imposed on member banks of the Federal Reserve System against “eurocurrency liabilities” as defined in Regulation D as promulgated by the Board of Governors of the Federal Reserve System, plus the applicable margin for such loans, which ranges between 1.250% and 1.750%, based on the leverage ratio (as defined in the credit agreement).
The Company pays a commitment fee on the unused portion of the credit agreement, quarterly in arrears, during the term of the credit agreement which varies between 0.150% and 0.250% depending on the leverage ratio. The commitment fees incurred for the three months ended September 30, 2007 were minimal. We are also required to pay certain letter of credit and audit fees.
The working capital line includes a $5.0 million letter of credit facility. Issuances of letters of credit reduce the availability of permitted borrowings under the credit agreement.
The credit agreement contains a number of financial and other covenants that, among other things, restrict our and our subsidiaries’ abilities to incur additional indebtedness, grant liens or other security interests, make certain investments, become liable for contingent liabilities, make specified restricted payments including dividends, dispose of assets or stock, including the stock of its subsidiaries, or make capital expenditures above specified limits and engage in other matters customarily restricted in senior secured credit facilities. We must also maintain a minimum net worth (as defined in the credit agreement) and maximum debt leverage ratios. These covenants are subject to certain qualifications and exceptions.
F-29
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
In March 2007, certain letters of credit in the amount of $2.3 million in connection with an operating lease commenced in May 2006 and an operating sublease that commenced in January 2006 were released and incorporated into our revolving credit facility.
As of September 30, 2007, $12.5 million was outstanding on the working capital line of credit at interest rates of 6.4% to 7.0% and approximately $2.3 million under the letter of credit facility with an interest rate of 1.25%.
On October 5, 2007, the Company amended the Credit Agreement increasing the commitment level to $20 million. This agreement expires on December 20, 2009. From October 1, 2007 to October 31, 2007, the Company borrowed additional funds of $4.0 million under the Credit Agreement at an interest rate of 6.4%. On November 2, 2007, the Company repaid $1.5 million of the outstanding balance on the working capital line of credit.
Through the year ended June 30, 2007, the Company had recorded a valuation allowance against deferred tax assets. A valuation allowance is recorded when it is more likely than not that some or all of the deferred tax assets will not be realized. Negative evidence, such as a history of pre-tax losses through fiscal year 2005, recent marginal pre-tax income for fiscal years 2006 and 2007 and difficulty in projecting operating results until enrollments are determined at the end of the first quarter, suggested that a valuation allowance was needed. However, positive evidence in the three months ended September 30, 2007, such as strong enrollment growth and positive taxable income as well as the Company’s projections for the years ended June 30, 2008 and June 30, 2009 indicate that the Company will be able to utilize a portion of its net operating loss. As a result, in the three months ended September 30, 2007, the Company determined that only a partial valuation allowance was necessary and reversed $9.7 million of its valuation allowance based upon projected taxable income over the next two years. This was offset by the income tax expense onpre-tax earnings for the three months ended September 30, 2007 of $2.6 million resulting in a deferred tax asset of $7.1 million. As of September 30, 2007, the Company had net operating loss carry-forwards of $59.2 million that expire between 2020 and 2028 if unused.
Effective July 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), using the prospective transition method which requires the Company to apply the provisions of SFAS No. 123R only to awards granted, modified, repurchased or cancelled after the effective date. Equity-based compensation expense for all equity-based compensation awards granted after July 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs on a straight-line basis over the requisite service period, which is generally the vesting period of the award.
The Company uses the Black-Scholes-Merton method to calculate the fair value of stock options. Depending on certain substantive characteristics of the stock option, the Company, where appropriate, utilizes a binomial model. The use of option valuation models requires the input of highly subjective assumptions, including the expected stock price volatility and the expected term of the option. In March 2005, the Securities and Exchange Commission (SEC) issued SAB No. 107 (SAB 107) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. For options issued subsequent to July 1, 2006, the Company has applied the provisions of SAB 107 in its adoption of SFAS 123R. Under SAB 107, the Company has estimated the expected term of granted options to be the weighted average mid-point between the vesting date and the end of the contractual term. The Company estimates the volatility rate based on historical closing stock prices.
F-30
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
The following weighted-average assumptions were used for calculating the fair value of each option at the date of grant for the three months ended September 30, 2007 and a discussion of the Company’s methodology for developing each of the assumptions used in the valuation model follows:
| | |
| | Three Months Ended
|
| | September 30, 2007 |
|
Dividend yield | | 0.0% |
Expected volatility | | 41% — 47% |
Risk-free interest rate | | 4.93% — 4.97% |
Expected term, in years | | 4.05 — 5.76 |
Dividend yield — The Company has never declared or paid dividends on its common stock and has no plans to do so in the foreseeable future.
Expected volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. Since the Company ’s common shares are not publicly traded, the basis for the standard option volatility calculation is derived from known publicly traded comparable companies. The annual volatility for these companies is derived from their historical stock price data.
Risk-free interest rate — The assumed risk free rate used is a zero coupon U.S. Treasury security with a maturity that approximates the expected term of the option.
Expected term of the option — This is the period of time that the options granted are expected to remain unexercised. Options granted during the quarter have a maximum term of eight years. The Company estimates the expected life of the option term based on the weighted average life between the dates that options become fully vested and the maximum life of options granted in the three months ended September 30, 2007.
In order to compute stock compensation expense after determining the fair value of an individual option, the Company applies a forfeiture rate to the total number of options granted representing those options that are expected to be forfeited or canceled before becoming fully vested. The forfeiture rate is based on historical trends at various classification levels with the Company.
SFAS 123(R) requires management to make assumptions regarding the expected life of the options, the expected liability of the options and other items in determining estimated fair value. Changes to the underlying assumptions may have significant impact on the underlying value of the stock options, which could have a material impact on our financial statements.
The Company also grants stock options to executive officers under stand-alone agreements outside the plan. These options totaled 1,441,168 as of September 30, 2007.
F-31
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Stock option activity including stand-alone agreements during the three months ended September 30, 2007 was as follows:
| | | | | | | | |
| | | | | Weighted-
| |
| | | | | Average
| |
| | | | | Exercise
| |
| | Shares | | | Price | |
|
Outstanding, June 30, 2007 | | | 3,622,850 | | | $ | 9.21 | |
Granted | | | 1,257,948 | | | | 13.66 | |
Exercised | | | (3,613 | ) | | | 6.85 | |
Canceled | | | (16,212 | ) | | | 8.12 | |
| | | | | | | | |
Outstanding, September 30, 2007 | | | 4,860,973 | | | $ | 10.37 | |
| | | | | | | | |
The total intrinsic value of options exercised during the three months ended September 30, 2007 was $0.1 million.
The following table summarizes the option grant activity for the three months ended September 30, 2007.
| | | | | | | | | | | | | | | | |
| | | | | | | | Weighted Average
| | | | |
| | Options
| | | Weighted-Average
| | | Grant-Date
| | | Intrinsic
| |
Grant date | | Granted | | | Exercise Price | | | Fair Value | | | Value | |
|
July 2007 | | | 1,257,948 | | | $ | 13.66 | | | $ | 9.28 | | | $ | 0.00 | |
A summary of the Company’s unvested stock options, including those related to stand-alone agreements, as of June 30, 2007 and changes during the three months ended September 30, 2007 are presented below:
| | | | | | | | |
| | | | | Weighted
| |
| | | | | Average
| |
| | Unvested
| | | Grant Date
| |
| | Options | | | Fair Value | |
|
Unvested options outstanding, June 30, 2007 | | | 1,517,375 | | | $ | 5.02 | |
Granted | | | 1,257,948 | | | | 9.28 | |
Vested | | | (102,326 | ) | | | 6.16 | |
Exercised | | | (3,613 | ) | | | 6.85 | |
Canceled | | | (16,212 | ) | | | 3.52 | |
| | | | | | | | |
Unvested options outstanding, September 30, 2007 | | | 2,653,172 | | | $ | 7.00 | |
| | | | | | | | |
As of September 30, 2007, there was $3.9 million of total unrecognized compensation expense related to unvested stock options granted under the Stock Option Plan (“Plan”) adopted in May 2000. The cost is expected to be recognized over a weighted average period of 3.0 years. The total fair value of shares vested during the three months ended September 30, 2007 was $0.8 million. During the three months ended September 30, 2007, the Company recognized $0.3 million of stock based compensation.
On July 3, 2007, the Board approved the grant of 640,304 stock options with an exercise price of $13.67 per share, subject to the amendment of the Stock Option Plan. On July 12, 2007, the Board authorized the Company to seek shareholder approval to amend the Stock Option Plan by increasing the number of shares reserved for issuance from approximately 2.549 million to 3.922 million. The Board also approved the grant of 617,644 options to certain officers of the Company with an exercise price of $13.66 per share subject to amendment of the Plan. On November 5, 2007, the shareholders approved the amendment to the Stock Option Plan to increase the number of shares reserved for issuance.
F-32
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
The stock option agreements for outstanding stock options generally provide for accelerated and full vesting of unvested stock options upon certain corporate events. Those events include a sale of all or substantially all of the Company’s assets, a merger or consolidation which results in the Company’s stockholders immediately prior to the transaction owning less than 50% of the Company’s voting stock immediately after the transaction, and a sale of the Company’s outstanding securities (other than in connection with an initial public offering) which results in the Company’s stockholders immediately prior to the transaction owning less than 50% of the Company’s voting stock immediately after the transaction.
The following table summarizes information about stock options outstanding, including those related to stand-alone agreements, as of September 30, 2007:
| | | | | | | | | | | | | | | | | | | | |
| | | | | Weighted-
| | | | | | | | | | |
| | | | | Average
| | | Weighted-
| | | | | | Weighted-
| |
Range of
| | | | | Remaining
| | | Average
| | | | | | Average
| |
Exercise
| | Number
| | | Contractual
| | | Exercise
| | | Number
| | | Exercise
| |
Prices | | Outstanding | | | Life | | | Price | | | Exercisable | | | Price | |
|
$1.02 - $9.18 | | | 3,310,201 | | | | 5.1 years | | | $ | 7.32 | | | | 2,206,821 | | | $ | 7.07 | |
| | | | | | | | | | | | | | | | | | | | |
$13.66 | | | 1,256,655 | | | | 7.8 years | | | $ | 13.66 | | | | 980 | | | $ | 13.66 | |
| | | | | | | | | | | | | | | | | | | | |
$30.60 | | | 294,117 | | | | 5.3 years | | | $ | 30.60 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
As of September 30, 2007, computer equipment and software under capital leases are recorded at a cost of $13.9 million and accumulated depreciation of $2.5 million. The Company has an equipment lease line of credit with Hewlett-Packard Financial Services Company that expires on March 31, 2008 for new purchases on the line of credit. We expect to renew this facility. The interest rate on new advances under the equipment lease line is set quarterly. Prior borrowings under the equipment lease line had interest rates ranging from 8.5% to 8.8%. The prior borrowings include a 36-month payment term with a $1 purchase option at the end of the term. The Company has pledged the assets financed with the equipment lease line to secure the amounts outstanding. The Company entered into a guaranty agreement with Hewlett-Packard Financial Services Company to guarantee the obligations under this equipment lease and financing agreement.
The following is a summary as of September 30, 2007 of the present value of the net minimum lease payments on capital leases under the Company’s commitments:
| | | | |
| | Capital
| |
September 30, | | Leases | |
|
2008 | | $ | 6,105 | |
2009 | | | 5,520 | |
2010 | | | 3,061 | |
| | | | |
Total minimum lease payments | | | 14,686 | |
Less amount representing interest (imputed interest rate of 8.7%) | | | (1,616 | ) |
| | | | |
Net minimum lease payments | | | 13,070 | |
Less current portion | | | (5,111 | ) |
| | | | |
Present value of net minimum payments, less current portion | | $ | 7,959 | |
| | | | |
F-33
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
| |
7. | Commitments and Contingencies |
In the ordinary conduct of our business, we are subject to lawsuits and other legal proceedings from time to time. There are currently two significant pending lawsuits in which we are involved;Johnson v. Burmaster andIllinois v. Chicago Virtual Charter School that, in each case, have been brought by teachers’ unions seeking the closure of the virtual public schools we serve in Wisconsin and Illinois, respectively.
While we prevailed on summary judgment at the circuit court level inJohnson v. Burmaster, and recently won a preliminary motion inIllinois v. Chicago Virtual Charter School, it is not possible to predict the final outcome of these matters with any degree of certainty. Even so, we do not believe at this time that a loss in either case would have a material adverse financial impact on our business. Depending on the legal theory advanced by the plaintiffs, however, there is a risk that a loss in these cases could have a negative precedential effect if like claims were to be advanced and succeed under similar laws in other states where we operate. The cumulative effect under those circumstances could be material.
Johnson v. Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the State of Wisconsin established a virtual public school, the Wisconsin Virtual Academy (WIVA), and entered into a service agreement with us for online curriculum and school management services. On January 6, 2004, Stan Johnson, et al., and the Wisconsin Education Association Council (WEAC) filed suit in the Circuit Court of Ozaukee County against the Superintendent of the Department of Public Instruction (DPI), Elizabeth Burmaster, the NOSD and K12 Inc. The plaintiffs alleged that the NOSD violated the state charter school, open enrollment and teacher-licensure statutes when it authorized WIVA.
On March 16, 2006, the Circuit Court issued a Decision and Order upholding on Summary Judgment that WIVA complies with applicable law(No. 04-CV-12 ). WEAC and DPI filed an appeal in the Wisconsin Court of Appeals, District II(No. 2006-AP/01380). On July 3, 2007, the Court of Appeals certified the case to the Wisconsin Supreme Court for its review because the questions involved in the case are of first impression and will have a significant statewide impact on education finance and policy. Should the plaintiff prevail and state funding of open enrollment payments to the NOSD are enjoined, a claim could be made that the Company must indemnify the NOSD for expenses approximating $2.5 million.
Illinois v. Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed a citizen taxpayers lawsuit in the Circuit Court of Cook County challenging the decision of the Illinois State Board of Education to certify the Chicago Virtual Charter School (CVCS) and to enjoin the disbursement of state funds to the Chicago Board of Education under its contract with the CVCS. Specifically, the CTU alleges that the Illinois charter school law prohibits any “home-based” charter schools and that CVCS does not provide sufficient “direct instruction” by certified teachers of at least five clock hours per day to qualify for funding. K12 Inc. and K12 Illinois LLC were also named as defendants. On May 16, 2007, the Court dismissed K12 Inc. and K12 Illinois LLC from the case and on June 15, 2007, the plaintiffs filed a second amended complaint which the court dismissed on October 30, 2007 with leave to re-plead. The Company continues to participate in the defense of CVCS under an indemnity obligation in its service agreement with that school, which requires the Company to indemnify CVCS against certain liabilities arising out of the performance of the service agreement and certain other claims and liabilities, including liabilities arising out of challenges to the validity of the virtual school charter.
Employment Agreements
The Company has entered into employment agreements with certain executive officers that provide for severance payments and, in some cases other benefits, upon certain terminations of employment. Except for one agreement that has a three year term, all other agreements provide for employment on an “at-will” basis. If the
F-34
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
employee is terminated for “good reason” or without cause, the employee is entitled to salary continuation, and in some cases benefit continuation, for varying periods depending on the agreement.
On July 12, 2007, the Company’s board of directors approved an amended and restated employment agreement for an executive officer. The amended and restated agreement extends the term of employment until January 1, 2011 and amended certain elements of compensation including salary, stock options and severance. Additionally, on July 12, 2007, the Company’s board of directors also approved the terms of a new agreement for an executive officer which provides that all outstanding options will become fully vested upon a change in control of the Company.
The Company maintains an annual cash performance bonus program that is intended to reward executive officers based on the Company’s performance and the individual named executive officer’s contribution to that performance. In determining the performance-based compensation awarded to each named executive officer, the Company may generally evaluate the Company’s and the executive’s performance in a number of areas, which could include revenues, operating earnings, student retention, efficiency in product and systems development, marketing investment efficacy, new enrollment and developing company leaders.
Vendor Payment Commitments
In April 2007, the Company entered into a master services and license agreement with a third party that provides for the Company to license its proprietary computer system. The agreement is effective through July 2010. In exchange for the license of the computer system, the Company agrees to pay a service fee per enrollment. In the event the fees paid over the term of the contract do not exceed $1 million (the minimum commitment fee), the Company agrees to pay the difference between the actual fees paid and the minimum commitment fee.
Letter of Intent
On September 28, 2007, the Company discontinued discussions with Socratic Network L.P., Socratic Learning, Inc. and Tutors Worldwide (India) Private Ltd. (individually and collectively referred to as Socratic) related to a non-binding letter of intent.
| |
8. | Supplemental Disclosure of Cash Flow Information |
| | | | | | | | |
| | Three Months Period Ended September 30, | |
| | 2007 | | | 2006 | |
|
Cash paid for interest | | $ | 281 | | | $ | — | |
| | | | | | | | |
Supplemental disclosure of non cash investing and financing activities: | | | | | | | | |
New capital lease obligations | | $ | 6,964 | | | $ | — | |
| | | | | | | | |
Acquisition
On October 1, 2007, and related to the August 2, 2007 non-binding letter of intent, the Company acquired all of the equity interest in Power-Glide Language Courses, Inc., a curriculum content developer, for the aggregate purchase price of 196,078 shares of the Company’s common stock and the assumption of up to $1.2 million in liabilities.
F-35
K12 Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Private Placement of Shares
On November 6, 2007, the Company entered into an agreement to sell to anon-U.S. person in a transaction outside the United States in reliance upon Regulation S under the Securities Act, concurrently with and contingent upon the closing of the initial public offering and at the initial public offering price, $15,000,000 worth of shares of the Company’s common stock.
Series C Dividend
On November 5, 2007, the Company’s Board unanimously declared a cash dividend to the holders of Redeemable, Convertible Series C Preferred stock effective immediately prior to and contingent upon the closing of an initial public offering and payable from the proceeds of the offering. The amount of the declared dividend is equal to the pro rata amount of the annual cumulative dividend that would have normally accrued on January 2, 2008.
| |
10. | Subsequent Event — Reverse Stock Split |
Reverse Stock Split — On October 30, 2007, the Board approved a1-for-5.1 reverse split of the Company’s common stock. On October 31, 2007, the reverse split was further approved by a majority of the shareholders. The stock split was effective on November 2, 2007. In conjunction with this, the number of authorized shares of common stock was amended to 33,362,500. All share and per share amounts related to common stock, options and common stock warrants included in the consolidated financial statements have been retroactively adjusted for all periods presented to give effect to the stock split.
F-36
K12 INC
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 2006, 2005 AND 2004
1. ALLOWANCE FOR DOUBTFUL ACCOUNTS
| | | | | | | | | | | | | | | | |
| | | | | Additions
| | | | | | | |
| | Balance at
| | | Charged to
| | | Deductions
| | | | |
| | Beginning of
| | | Cost and
| | | from
| | | Balance at End
| |
| | Period | | | Expenses | | | Allowance | | | of Period | |
|
June 30, 2007 | | $ | 1,440,499 | | | | 106,038 | | | | 957,566 | | | $ | 588,972 | |
June 30, 2006 | | $ | 1,715,781 | | | | 174,895 | | | | 450,177 | | | $ | 1,440,499 | |
June 30, 2005 | | $ | 602,919 | | | | 1,407,143 | | | | 294,281 | | | $ | 1,715,781 | |
| | | | | | | | | | | | | | | | |
| | | | | Additions
| | | | | | | |
| | Balance at
| | | Charged to
| | | Deductions
| | | | |
| | Beginning of
| | | Cost and
| | | from
| | | Balance at End
| |
| | Period | | | Expenses | | | Allowance | | | of Period | |
|
June 30, 2007 | | $ | 1,440,499 | | | | 106,038 | | | | 957,566 | | | $ | 588,971 | |
June 30, 2006 | | $ | 1,715,781 | | | | 174,895 | | | | 450,177 | | | $ | 1,440,499 | |
June 30, 2005 | | $ | 602,919 | | | | 1,407,143 | | | | 294,281 | | | $ | 1,715,781 | |
2. INVENTORY RESERVE
| | | | | | | | | | | | | | | | |
| | | | | Additions
| | | | | | | |
| | Balance at
| | | Charged to
| | | Deductions
| | | | |
| | Beginning of
| | | Cost and
| | | Shrinkage and
| | | Balance at End
| |
| | Period | | | Expenses | | | Obsolescence | | | of Period | |
|
June 30, 2007 | | $ | 232,055 | | | | 320,960 | | | | 225,407 | | | $ | 327,608 | |
June 30, 2006 | | $ | 270,611 | | | | — | | | | 38,556 | | | $ | 232,055 | |
June 30, 2005 | | $ | 320,809 | | | | 19,572 | | | | 69,770 | | | $ | 270,611 | |
3. COMPUTER RESERVE (1)
| | | | | | | | | | | | | | | | |
| | | | | Additions
| | | | | | | |
| | | | | (Deductions)
| | | | | | | |
| | Balance at
| | | Charged to
| | | Deductions
| | | | |
| | Beginning of
| | | Cost and
| | | Shrinkage and
| | | Balance at End
| |
| | Period | | | Expenses | | | Obsolescence | | | of Period | |
|
June 30, 2007 | | $ | 664,186 | | | | (47,825 | ) | | | — | | | $ | 616,361 | |
June 30, 2006 | | $ | 490,533 | | | | 173,653 | | | | — | | | $ | 664,186 | |
June 30, 2005 | | $ | 746,294 | | | | (255,761 | ) | | | — | | | $ | 490,533 | |
| | |
(1) | | A reserve account is maintained against potential shrinkage and obsolescence for those computers provided to our students. The reserve is calculated based upon several factors including historical percentages, the net book value and remaining useful life. |
4. INCOME TAX VALUATION ALLOWANCE
| | | | | | | | | | | | | | | | |
| | Balance at
| | | Changes in Net
| | | | | | | |
| | Beginning of
| | | Deferred
| | | Income Tax
| | | Balance at End
| |
| | Period | | | Tax Assets | | | Benefit Realized | | | of Period | |
|
June 30, 2007 | | $ | 32,527,019 | | | | (2,601,121 | ) | | | — | | | $ | 29,925,898 | |
June 30, 2006 | | $ | 33,866,482 | | | | (1,339,463 | ) | | | — | | | $ | 32,527,019 | |
June 30, 2005 | | $ | 33,267,514 | | | | 598,968 | | | | — | | | $ | 33,866,482 | |
F-24F-37
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
| |
Item 13. | Other Expenses of Issuance and Distribution |
Set forth below is a table of the registration fee for the Securities and Exchange Commission, the filing fee for the National Association of Securities Dealers, Inc., the listing fee for the New York Stock Exchange and estimates of all other expenses to be incurred in connection with the issuance and distribution of the securities described in the registration statement, other than underwriting discounts and commissions:
| | | | |
SEC registration fee | | $ | 5,296 | |
NYSE listing fee | | | * | |
NASD fee | | | 17,750 | |
Printing and engraving expenses | | | * | |
Legal fees and expenses | | | * | |
Accounting fees and expenses | | | * | |
Transfer agent and registrar fees | | | * | |
Miscellaneous | | | * | |
| | | | |
Total | | $ | * | |
| | | | |
| | |
* | | To be completed by amendment. |
| |
Item 14. | Indemnification of Directors and Officers |
K12 Inc. is incorporated under the laws of the State of Delaware. Reference is made to Section 102(b)(7) of the Delaware General Corporation Law, or DGCL, which enables a corporation in its original certificate of incorporation or an amendment thereto to eliminate or limit the personal liability of a director for violations of the director’s fiduciary duty, except (1) for any breach of the director’s duty of loyalty to the corporation or its stockholders, (2) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (3) pursuant to Section 174 of the DGCL, which provides for liability of directors for unlawful payments of dividends of unlawful stock purchase or redemptions or (4) for any transaction from which a director derived an improper personal benefit.
Reference is also made to Section 145 of the DGCL, which provides that a corporation may indemnify any person, including an officer or director, who is, or is threatened to be made, party to any threatened, pending or completed legal action, suit or proceeding, whether civil, criminal, administrative or investigative, other than an action by or in the right of such corporation, by reason of the fact that such person was an officer, director, employee or agent of such corporation or is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such officer, director, employee or agent acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the corporation’s best interest and, for criminal proceedings, had no reasonable cause to believe that his conduct was unlawful. A Delaware corporation may indemnify any officer or director in an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial approval if the officer or director is adjudged to be liable to the corporation. Where an officer or director is successful on the merits or otherwise in the defense of any action referred to above, the corporation must indemnify him against the expenses that such officer or director actually and reasonably incurred.
Our Amended and Restated Certificate of Incorporation provides for, and upon consummation of this offering, our amended and restated bylaws will provide for indemnification of the officers and directors to the full extent permitted by applicable law.
The Underwriting Agreement provides for indemnification by the underwriters of the registrant and its officers and directors for certain liabilities arising under the Securities Act of 1933, as amended, or otherwise.
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| |
Item 15. | Recent Sales of Unregistered Securities |
Set forth in chronological order is information regarding all securities sold and employee stock options granted from June 2004 to date by the Company. Also included is the consideration, if any, received for such securities, and information relating to the section of the Securities Act and the rules of the Securities and Exchange Commission pursuant to which the following issuances were exempt from registration. None of these securities were registered under the Securities Act. No award of options involved any sale under the Securities Act. No sale of securities involved the use of an underwriter and no commissions were paid in connection with the sales of any securities.
1. At various times during the period from July 2004 through July 2007, we granted options to purchase an aggregate of 12,405,7652,432,206 shares of common stock to current and prior employees and directors at a weighted average exercise price of exercise prices of $2.09$10.66 per share, of which 6,415,9651,257,948 are subject to shareholder approval.
2. In addition to the foregoing option grants, at various times during the period from July 2004 through July 2007, we granted options to purchase 7,350,0001,441,168 shares of our common stock to current and prior employees related to stand-alone agreements at a weighted average exercise price of $2.42$12.35 per share.
3. In December 2003, we issued and sold an aggregate of 18,656,89618,656,716 shares of Series C Preferred Stock. Pursuant to the payment in kind dividend feature of Series C Preferred Stock, we have issued an aggregate of 12,399,833 additional shares of Series C Preferred Stock through a series of stock dividends to existing Series C Preferred stockholders from January 2005 through January 2007.
4. In October 2007, we issued an aggregate of 900,000196,078 shares of common stock in connection with our acquisition of Power-Glide Language Courses, Inc. to the stockholders thereof.
5. On November 6, 2007, the Company entered into an agreement to sell to anon-U.S. person in a transaction outside the United States in reliance upon Regulation S under the Securities Act, concurrently with and contingent upon the closing of the initial public offering and at the initial public offering price, $15,000,000 worth of shares of the Company’s common stock.
The issuances of the securities described in paragraph 1 were exempt from registration under the Securities Act under Rule 701, as transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701. The recipients of such options and common stock were related to compensation. Appropriate legends were affixed to any share certificates issued in such transactions. All recipients either received adequate information from us or had adequate access, through their employment with us or otherwise, to information about us.
The issuances of the securities described in paragraphs 2, 3 and 4 were exempt from registration under the Securities Act in reliance on Section 4(2) because the issuance of securities to recipients did not involve a public offering. The recipient of securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to resale or distribution thereof, and appropriate legends were affixed to share certificates and warrants issued in such transactions. Each of the recipients of securities in the transactions described in paragraphs 2, 3 and 4 were accredited or sophisticated investors and had adequate access, through employment, business or other relationships, to information about us.
Upon issuance and sale, the securities described in paragraph 5 will be exempt from registration under the Securities Act pursuant to the terms of Regulation S promulgated thereunder.
All of the shares of Series C Preferred Stock described in paragraph 3 will automatically convert into shares of common stock prior to completion of this offering.
| |
Item 16. | Exhibits and Financial Statement Schedule |
(a) Exhibits
| | | | |
Exhibit No.
| | Description of Exhibit
|
|
| 1 | .1* | | Form of Underwriting Agreement |
| 3 | .1** | | Amended and Restated Certificate of Incorporation |
| 3 | .2** | | Bylaws (as amended) |
| 3 | .3* | | Form of Amended and Restated Certificate of Incorporation to be effective upon completion of this offering |
| 3 | .4* | | Form of Amended and Restated Bylaws to be effective upon completion of this offering |
| 4 | .1* | | Form of stock certificate of common stock |
| 4 | .2** | | Amended and Restated Stock Option Plan and Amendment thereto |
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| | | | |
Exhibit No. | | Description of Exhibit |
|
| 4 | .3** | | Form of Stock Option Contract — Employee |
| 4 | .4** | | Form of Stock Option Contract — Director |
| 4 | .5** | | Form of Second Amended and Restated Stockholders Agreement |
| 4 | .6** | | Form of Common Stock Warrant Agreement |
| 4 | .7** | | Form of Series B Convertible Preferred Stock Warrant Agreement |
| 5 | .1* | | Opinion of Latham & Watkins LLP |
| 10 | .1** | | Revolving Credit Agreement and Certain Other Loan Documents by and among K12 Inc., School Leasing Corporation, American School Supply Corporation and PNC Bank, N.A. |
| 10 | .2** | | Stockholders Agreement dated as of April 26, 2000 (as amended) by and among Premierschool.com, Inc., Knowledge Universe Learning, Inc. and Ronald J. Packard |
| 10 | .3** | | Stockholders Agreement dated as of February 20, 2000 (as amended) by and among Premierschool.com, Inc., Knowledge Universe Learning, Inc. and William J. Bennett |
| 10 | .4** | | Series B Convertible Preferred Stock Warrant Agreement of Mollusk Holdings LLC |
| 10 | .5* | | Amended and Restated Stock Option Agreement of Ronald J. Packard dated as of July 12, 2007 |
| 10 | .6** | | Stock Option Agreement of Bruce J. Davis |
| 10 | .7** | | Stock Option Agreement of John Baule |
| 10 | .8** | | Stock Option Agreement of Bror Saxberg |
| 10 | .9* | | Employment Agreement of Ronald J. Packard |
| 10 | .10 | | Employment Agreement of John F. Baule and Amendment thereto |
| 10 | .11** | | Employment Agreement of Bruce J. Davis |
| 10 | .12** | | Employment Agreement of Bror V. H. Saxberg |
| 10 | .13** | | Deed of Lease by and between ACP/2300 Corporate Park Drive, LLC and K12 Inc. |
| 10 | .14** | | Sublease between France Telecom Long Distance USA, LLC and K12 Inc. |
| 10 | .15** | | Employment Agreement of Celia M. Stokes |
| 10 | .16** | | Employment Agreement of Howard D. Polsky |
| 10 | .17* | | Stock Option Agreement of Ronald J. Packard dated as of July 12, 2007 |
| 21 | .1** | | Subsidiaries of K12 Inc. |
| 23 | .1 | | Consent of BDO Seidman, LLP |
| 23 | .2* | | Consent of Latham & Watkins LLP (included in Exhibit 5.1) |
| 24 | .1** | | Power of Attorney (excluding Dr. Mary H. Futrell) |
| 24 | .2** | | Power of Attorney of Dr. Mary H. Futrell |
| | | | |
Exhibit No. | | Description of Exhibit |
|
| 1 | .1 | | Form of Underwriting Agreement |
| 3 | .1* | | Amended and Restated Certificate of Incorporation |
| 3 | .2* | | Bylaws (as amended) |
| 3 | .3 | | Certificate of Amendment, dated December 15, 2006, to Second Amended and Restated Certificate of Incorporation |
| 3 | .4 | | Certificate of Amendment to Second Amended and Restated Certificate of Incorporation dated November 2, 2007, and Certificate of Correction related thereto |
| 3 | .5 | | Form of Third Amended and Restated Certificate of Incorporation to be effective upon completion of this offering |
| 3 | .6 | | Form of Amended and Restated Bylaws to be effective upon completion of this offering |
| 4 | .1 | | Form of stock certificate of common stock |
| 4 | .2* | | Amended and Restated Stock Option Plan and Amendment thereto |
| 4 | .3* | | Form of Stock Option Contract — Employee |
| 4 | .4* | | Form of Stock Option Contract — Director |
| 4 | .5* | | Form of Second Amended and Restated Stockholders Agreement |
| 4 | .6* | | Form of Common Stock Warrant Agreement |
| 4 | .7* | | Form of Series B Convertible Preferred Stock Warrant Agreement |
| 4 | .8 | | 2007 Equity Incentive Award Plan |
| 4 | .9 | | 2007 Employee Stock Purchase Plan |
| 5 | .1 | | Opinion of Latham & Watkins LLP |
| 10 | .1* | | Revolving Credit Agreement and Certain Other Loan Documents by and among K12 Inc., School Leasing Corporation, American School Supply Corporation and PNC Bank, N.A. |
| 10 | .2* | | Stockholders Agreement dated as of April 26, 2000 (as amended) by and among Premierschool.com, Inc., Knowledge Universe Learning, Inc. and Ronald J. Packard |
| 10 | .3* | | Stockholders Agreement dated as of February 20, 2000 (as amended) by and among Premierschool.com, Inc., Knowledge Universe Learning, Inc. and William J. Bennett |
| 10 | .4* | | Series B Convertible Preferred Stock Warrant Agreement of Mollusk Holdings LLC |
| 10 | .5*† | | Amended and Restated Stock Option Agreement of Ronald J. Packard dated as of July 12, 2007 |
| 10 | .6* | | Stock Option Agreement of Bruce J. Davis |
| 10 | .7* | | Stock Option Agreement of John Baule |
| 10 | .8* | | Stock Option Agreement of Bror Saxberg |
| 10 | .9*† | | Amended and Restated Employment Agreement of Ronald J. Packard |
| 10 | .10* | | Employment Agreement of John F. Baule and Amendment thereto |
| 10 | .11* | | Employment Agreement of Bruce J. Davis |
| 10 | .12* | | Employment Agreement of Bror V. H. Saxberg |
| 10 | .13* | | Deed of Lease by and between ACP/2300 Corporate Park Drive, LLC and K12 Inc. |
| 10 | .14* | | Sublease between France Telecom Long Distance USA, LLC and K12 Inc. |
| 10 | .15* | | Employment Agreement of Celia M. Stokes |
| 10 | .16* | | Employment Agreement of Howard D. Polsky |
| 10 | .17*† | | Stock Option Agreement of Ronald J. Packard dated as of July 12, 2007 |
| 10 | .18 | | First Amendment to Employment Agreement of Howard D. Polsky |
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| | | | |
Exhibit No. | | Description of Exhibit |
|
| 10 | .19 | | Amendment No.1 to Revolving Credit Agreement by and among K12 Inc., School Leasing Corporation, American School Supply Corporation and PNC Bank N.A. |
| 10 | .20 | | Stock Subscription Agreement dated as of November 1, 2007 by and among K12 Inc. and KB Education Investments Limited |
| 10 | .21 | | Second Amended and Restated Educational Products, and Administrative, and Technology Services Agreement between the Ohio Virtual Academy and K12 Ohio L.L.C. |
| 21 | .1* | | Subsidiaries of K12 Inc. |
| 23 | .1 | | Consent of BDO Seidman, LLP |
| 23 | .2 | | Consent of Latham & Watkins LLP (included in Exhibit 5.1) |
| 24 | .1* | | Power of Attorney (excluding Dr. Mary H. Futrell) |
| 24 | .2* | | Power of Attorney of Dr. Mary H. Futrell |
| | |
* | | To be filed by amendment. |
** | | Previously filed. |
| | |
† | | Portions omitted pursuant to a request for confidential treatment. The omitted information has been filed separately with the Securities and Exchange Commission. |
(b) Financial Statement Schedules:
See Schedule II — “Valuation and Qualifying Accounts” contained onpage F-33. All other schedules are omitted as the information is not required or is included in the Registrant’s financial statements and related notes.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public
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policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issues.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the Underwriting Agreement, certificates in such denomination and registered in such names as required by the underwriters to permit prompt delivery to each purchaser.
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Signatures
Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Herndon, Commonwealth of Virginia on October 9,November 7, 2007.
K12 INC.
| | |
| By: | /s/ Ronald J. Packard |
| | |
| Name: | Ronald J. Packard |
| Title: | Chief Executive Officer |
Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
| | | | | | |
Signature | | Title | | Date |
|
| | | | |
/s/ Ronald J. Packard Ronald J. Packard | | Chief Executive Officer (Principal Executive Officer) | | October 9,November 7, 2007 |
| | | | |
/s/ John F. Baule John F. Baule | | Chief Operating Officer and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | | October 9,November 7, 2007 |
| | | | |
/s/ Andrew H. Tisch* Andrew H. Tisch | | Chairman of the Board and Director | | October 9,November 7, 2007 |
| | | | |
/s/ Guillermo Bron* Guillermo Bron | | Director | | October 9,November 7, 2007 |
| | | | |
/s/ Liza A. Boyd* Liza A. Boyd | | Director | | October 9,November 7, 2007 |
| | | | |
/s/ Steven B. Fink* Steven B. Fink | | Director | | October 9,November 7, 2007 |
| | | | |
/s/ Dr. Mary H. Futrell* Dr. Mary H. Futrell | | Director | | October 9,November 7, 2007 |
| | | | |
/s/ Thomas J. Wilford* Thomas J. Wilford | | Director | | October 9,November 7, 2007 |
| | | | | | |
*By: | | /s/ Howard D. Polsky Howard D. Polsky | | Attorney-in-Fact | | |
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