Stride, Inc. - Quarter Report: 2014 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2014

 

OR

 

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

 

For the transition period from          to          

 

Commission File Number: 001-33883

 

K12 Inc.

(Exact name of registrant as specified in its charter)

 

 

(703) 483-7000

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company)

Accelerated filer x Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of April 24, 2014, the Registrant had 39,553,049 shares of common stock, $0.0001 par value per share outstanding.

 

 

Table of Contents

 

K12 Inc.

Form 10-Q

For the Quarterly Period Ended March 31, 2014

Index

 

		Page
		Number
PART I.	Financial Information
Item 1.	Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	Other Information
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Mine Safety Disclosures
Item 5.	Other Information
Item 6.	Exhibits
Signatures

 

2

Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1.      Financial Statements (Unaudited).

 

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31,			June 30,
		2014			2013
		(In thousands, except share and per share data)
ASSETS
Current assets
Cash and cash equivalents		$	185,332		$	181,480
Accounts receivable, net of allowance of $3,310 and $2,560 at March 31, 2014 and June 30, 2013, respectively		236,445			186,459
Inventories, net		21,294			44,395
Current portion of deferred tax asset		6,165			11,368
Prepaid expenses		10,396			10,331
Other current assets		27,823			23,916
Total current assets		487,455			457,949
Property and equipment, net		50,010			56,142
Capitalized software, net		46,660			43,504
Capitalized curriculum development costs, net		61,219			64,599
Intangible assets, net		24,783			32,139
Goodwill		61,581			61,413
Deposits and other assets		5,547			3,150
Total assets		$	737,255		$	718,896
LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND EQUITY
Current liabilities
Current portion of capital lease obligations		$	20,954		$	19,395
Current portion of note payable		—			390
Accounts payable		24,614			21,838
Accrued liabilities		14,910			17,027
Accrued compensation and benefits		19,436			21,970
Deferred revenue		52,468			28,567
Total current liabilities		132,382			109,187
Capital lease obligations, net of current portion		16,651			16,107
Deferred rent, net of current portion		8,595			8,833
Deferred tax liability		28,690			33,299
Other long-term liabilities		2,297			2,512
Total liabilities		188,615			169,938
Commitments and contingencies		—			—
Redeemable noncontrolling interest		15,200			15,200
Equity:
K12 Inc. stockholders’ equity
Common stock, par value $0.0001; 100,000,000 shares authorized; 41,138,238 and 37,440,662 shares issued and 39,895,938 and 37,440,662 outstanding at March 31, 2014 and June 30, 2013, respectively		4			4
Additional paid-in capital		630,533			548,390
Series A Special Stock, par value $0.0001; 2,750,000 shares authorized, zero and 2,750,000 issued and outstanding at March 31, 2014 and June 30, 2013, respectively		—			63,112
Accumulated other comprehensive loss		(54		)	(294		)
Accumulated deficit		(73,806		)	(81,050		)
Treasury stock of 1,242,300 and zero shares at cost at March 31, 2014 and June 30, 2013, respectively		(26,624		)	—
Total K12 Inc. stockholders’ equity		530,053			530,162
Noncontrolling interest		3,387			3,596
Total equity		533,440			533,758
Total liabilities, redeemable noncontrolling interest and equity		$	737,255		$	718,896

 

See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.

 

3

Table of Contents

 

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Three Months Ended						Nine Months Ended
		March 31,						March 31,
		2014			2013			2014			2013
		(In thousands, except share and per share data)
Revenues		$	235,222		$	218,009		$	687,507		$	645,133
Cost and expenses
Instructional costs and services		140,592			127,759			427,165			369,205
Selling, administrative, and other operating expenses		64,414			65,828			238,411			216,826
Product development expenses		2,831			5,070			11,916			14,817
Total costs and expenses		207,837			198,657			677,492			600,848
Income from operations		27,385			19,352			10,015			44,285
Interest expense, net		(12		)	(306		)	(125		)	(807		)
Income before income tax expense and noncontrolling interest		27,373			19,046			9,890			43,478
Income tax expense		(11,861		)	(7,626		)	(3,726		)	(18,195		)
Net income		15,512			11,420			6,164			25,283
Adjust net loss attributable to noncontrolling interest		437			555			1,080			559
Net income attributable to common stockholders, including Series A stockholders		$	15,949		$	11,975		$	7,244		$	25,842
Net income attributable to common stockholders per share, excluding Series A stockholders, through the conversion date September 3, 2013:
Basic and Diluted		$	0.40		$	0.31		$	0.19		$	0.66
Weighted average shares used in computing per share amounts:
Basic and Diluted		39,596,798			36,283,353			39,136,667			36,142,689

 

See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.

 

4

Table of Contents

 

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2014			2013			2014			2013
		(In thousands)
Net income		$	15,512		$	11,420		$	6,164		$	25,283
Other comprehensive income (loss), net of tax
Foreign currency translation adjustment		47			(276		)	240			(426		)
Total other comprehensive income, net of tax		15,559			11,144			6,404			24,857
Comprehensive loss attributable to noncontrolling interest		437			555			1,080			559
Comprehensive income attributable to common stockholders, including Series A stockholders		$	15,996		$	11,699		$	7,484		$	25,416

 

See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.

 

5

Table of Contents

 

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF EQUITY (DEFICIT)

 

		Common Stock					Common Stock - Series A					Additional Paid-in			Accumulated Other Comprehensive			Accumulated			Treasury Stock					Noncontrolling
		Shares		Amount			Shares		Amount			Capital			Income (Loss)			Deficit			Shares		Amount			Interest			Total
(In thousands, except share and per share data)
Balance, June 30, 2013		37,440,662		$	4		2,750,000		$	63,112		$	548,390		$	(294	)	$	(81,050	)	—		$	—		$	3,596		$	533,758
Net income (1)		—		—			—		—			—			—			7,244			—		—			(209		)	7,035
Foreign currency translation adjustment		—		—			—		—			—			240			—			—		—			—			240
Conversion of Series A Special Stock to common stock		2,750,000		—			(2,750,000	)	(63,112		)	63,112			—			—			—		—			—			—
Purchase of treasury stock		—		—			—		—			—			—			—			(1,242,300	)	(26,624		)	—			(26,624		)
Stock-based compensation expense		—		—			—		—			16,199			—			—			—		—			—			16,199
Exercise of stock options		481,497		—			—		—			8,444			—			—			—		—			—			8,444
Excess tax benefit from stock-based compensation		—		—			—		—			(472		)	—			—			—		—			—			(472		)
Issuance of restricted stock awards		693,354		—			—		—			—			—			—			—		—			—			—
Forfeiture of restricted stock awards		(51,820	)	—			—		—			—			—			—			—		—			—			—
Accretion of redeemable noncontrolling interests to estimated redemption value		—		—			—		—			(870		)	—			—			—		—			—			(870		)
Retirement of restricted stock for tax withholding		(175,455	)	—			—		—			(4,270		)	—			—			—		—			—			(4,270		)
Balance, March 31, 2014		41,138,238		$	4		—		$	—		630,533			$	(54	)	$	(73,806	)	(1,242,300	)	$	(26,624	)	$	3,387		$	533,440

 

(1)       Net income (loss) attributable to noncontrolling interests excludes $0.9 million due to the redeemable noncontrolling interest related to Middlebury Interactive Languages (“MIL”), which is reported outside of permanent equity in the accompanying unaudited condensed consolidated balance sheets.

 

See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.

 

6

Table of Contents

 

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Nine Months Ended March 31,
		2014			2013
		(In thousands)
Cash flows from operating activities
Net income		$	6,164		$	25,283
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense		69,491			48,176
Stock-based compensation expense		16,199			9,833
Excess tax benefit from stock-based compensation		472			(4,413		)
Deferred income taxes		122			16,348
Provision for doubtful accounts		1,206			1,814
Provision for excess and obsolete inventory		4,161			272
Provision (benefit) for student computer shrinkage and obsolescence		(555		)	439
Changes in assets and liabilities:
Accounts receivable		(51,547		)	(75,549		)
Inventories		18,941			8,237
Prepaid expenses		(39		)	(9,919		)
Other current assets		(3,906		)	992
Deposits and other assets		(351		)	(142		)
Accounts payable		2,759			(3,976		)
Accrued liabilities		(2,165		)	12,229
Accrued compensation and benefits		(2,535		)	2,333
Deferred revenue		23,543			24,092
Release of restricted cash		—			1,501
Deferred rent and other liabilities		(454		)	1,666
Net cash provided by operating activities		81,506			59,216
Cash flows from investing activities
Purchase of property and equipment		(6,323		)	(5,265		)
Capitalized software development costs		(18,486		)	(17,867		)
Capitalized curriculum development costs		(11,324		)	(13,597		)
Mortgage note to managed school partner		(2,100		)	—
Net cash used in investing activities		(38,233		)	(36,729		)
Cash flows from financing activities
Repayments on capital lease obligations		(16,988		)	(14,674		)
Repayments on note payable		(390		)	(1,177		)
Proceeds from exercise of stock options		8,444			3,027
Excess tax benefit from stock-based compensation		(472		)	4,413
Purchase of treasury stock		(26,624		)	—
Retirement of restricted stock for tax withholding		(4,270		)	(1,817		)
Net cash used in financing activities		(40,300		)	(10,228		)
Effect of foreign exchange rate changes on cash and cash equivalents		879			57
Net change in cash and cash equivalents		3,852			12,316
Cash and cash equivalents, beginning of period		181,480			144,652
Cash and cash equivalents, end of period		$	185,332		$	156,968

 

See accompanying summary of accounting policies and notes to unaudited condensed consolidated financial statements.

 

7

Table of Contents

 

K12 Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

1.  Description of the Business

 

K12 Inc. and its subsidiaries (“K12” or the “Company”) is a technology-based education company. The Company offers proprietary curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade, (“K-12”). The Company’s 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 its inception, the Company has made significant investments to develop and, to a lesser extent, acquire curriculum and online learning platforms that promote mastery of core concepts and skills for students of all abilities. This learning system combines the Company’s curriculum and offerings with an individualized learning approach well-suited for virtual and blended public schools, school district online programs, public charter schools and private schools that utilize varying degrees of online and traditional classroom instruction, and other educational applications. In contracting with a virtual and blended public school, the Company typically provides students with access to the K12 online curriculum, offline learning kits and the use of a personal computer in certain cases, in addition to providing management services. The Company manages virtual public schools in 33 states and the District of Columbia.

 

In addition, the Company works closely as partners with a growing number of public schools, school districts, private schools and charter schools enabling them to offer their students an array of solutions, including full-time virtual programs, semester course and supplemental solutions. In addition to curriculum, systems and programs, the Company provides teacher training, teaching services and other support services.

 

2.  Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of March 31, 2014, the condensed consolidated statements of operations for the three and nine months ended March 31, 2014 and March 31, 2013, the condensed consolidated statements of comprehensive income for the three and nine months ended March 31, 2014 and March 31, 2013, the condensed consolidated statement of equity (deficit) for nine months ended March 31, 2014 and the condensed consolidated statements of cash flows for the nine months ended March 31, 2014 and March 31, 2013 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 for the periods presented. The results of the three and nine month periods ended March 31, 2014 are not necessarily indicative of the results to be expected for the year ending June 30, 2014 or for any other interim period or for any other future fiscal year. The condensed consolidated balance sheet as of June 30, 2013 has been derived from the audited consolidated financial statements at that date.

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, the Company does not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of the Company’s condensed consolidated results of operations, financial position and cash flows. Preparation of the Company’s financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This quarterly report on Form 10-Q should be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on August 29, 2013, which contains the Company’s audited financial statements for the fiscal year ended June 30, 2013.

 

The Company operates in one operating and reportable business segment as a technology—based education company providing proprietary curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade. The Chief Operating Decision Maker evaluates profitability based only on consolidated results.

 

8

Table of Contents

 

3.  Summary of Significant Accounting Policies

 

Revenue Recognition

 

Revenues are principally earned from long-term contractual agreements to provide online curriculum, books, materials, computers and management services to virtual and blended public schools, traditional schools, school districts, public charter schools, and private schools. In addition to providing the curriculum, books and materials, under most contracts, the Company manages virtual and blended public 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. Shipments of materials for schools that occur in the fourth fiscal quarter and for the upcoming school year are recorded in deferred revenues.

 

Where the Company provides turn-key management service and it has determined that it is 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 Accounting Standards Codification (“ASC”) 605, Revenue Recognition. For contracts where the Company is not the primary obligor, the Company records revenue based on its net fees earned under the contractual agreement. As a result of being the primary obligor, amounts recorded as revenues and school operating expenses for the three months ended March 31, 2014 and March 31, 2013 were $71.3 million and $66.8 million, respectively, and for the nine months ended March 31, 2014 and March 31, 2013 were $190.8 million and $178.3 million, respectively.

 

The Company generates revenues under contracts with virtual and blended public schools which include multiple elements. These elements include providing each of a school’s students with access to the Company’s online curriculum; offline learning kits, which include books and materials to supplement the online 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 management and technology services required to operate a virtual public or blended school. In certain managed school contracts, revenue is determined directly by per enrollment funding.

 

The Company has determined that the elements of its contracts are valuable to schools in combination, but do not have standalone value. As a result, the elements within the Company’s multiple-element contracts do not qualify for separate units of accounting. Accordingly, the Company accounts for revenues under multiple element arrangements as a single unit of accounting and recognizes the entire arrangement based upon the approximate rate at which it incurs the costs associated with each element. Revenue from certain managed schools is recognized ratably over the period services are performed.

 

Under the contracts where the Company provides turn-key management services to schools, the Company has generally agreed to absorb any cumulative operating losses of the schools over the respective contract period. These school operating losses represent the excess of costs incurred over revenues earned by the virtual or blended public school as reflected on its respective financial statements, including Company charges to the schools. A school operating loss in one year does not necessarily mean the Company anticipates losing money on the entire contract with the school. However, a school operating loss may reduce the Company’s ability to collect its management fees in full and recognized revenues are reduced accordingly to reflect the expected cash collections from such schools. The Company amortizes the estimated school operating loss against revenues based upon the percentage of actual revenues in the period to total estimated revenues for the fiscal year. Management periodically reviews its estimates of full year school revenues and operating expenses and amortizes the net impact of any changes to these estimates proportionately over the fiscal year. Actual school operating losses may vary from these estimates or revisions, and the impact of these differences could have a material impact on results of operations. Since the end of the school year coincides with the end of the Company’s fiscal year, annual revenues are generally based on actual school revenues and actual costs incurred in the calculation of school operating losses.

 

The Company provides certain online curriculum and services to schools and school districts under subscription and perpetual license agreements. Revenue under these agreements is recognized in accordance with ASC 605 when all of the following conditions are met: there is persuasive evidence of an arrangement; delivery has occurred or services have been rendered; the amount of fees to be paid by the customer is fixed and determinable; and the collectability of the fee is probable. Revenue from the licensing of curriculum under subscription arrangements is recognized on a ratable basis over the subscription period. Revenue from the licensing of

 

9

Table of Contents

 

curriculum under non-cancelable perpetual arrangements is recognized when all revenue recognition criteria have been met. Revenue from professional consulting, training and support services are deferred and recognized ratably over the service period.

 

Other revenues are generated from individual customers who prepay and have access for 12 to 24 months to Company-provided online curriculum. The Company recognizes these revenues pro rata over the maximum term of the customer contract. Revenues from associated offline learning kits are recognized upon shipment.

 

During the three months ended March 31, 2014 and March 31, 2013, the Company had contracts with two schools that represented approximately 14% and 10% of revenues. The percentage of revenues for these two schools is not indicative of the percentage of revenues for the full year. Approximately 7% of accounts receivable was attributable to a contract with one school as of March 31, 2014 and June 30, 2013. During the nine months ended March 31, 2014, the Company had contracts with two managed public schools that represented approximately 13% and 10% of revenues. During the nine months ended March 31, 2013, the Company had contracts with two managed public schools that represented approximately 14% and 10% of revenues.

 

Consolidation

 

The condensed consolidated financial statements include the accounts of the Company, its wholly-owned and affiliated companies owned, directly or indirectly, and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

 

Inventories

 

Inventories consist primarily of textbooks and curriculum materials, a majority of which are supplied to managed public schools and blended public schools and utilized directly by students. Inventories represent items that are purchased and held for sale and are recorded at the lower of cost (first-in, first-out method) or market value. The Company records a provision for excess and obsolete inventory when impairment has been identified. The Company writes down its inventory for estimated excess or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During the nine months ended March 31, 2014, the Company increased the provision for excess and obsolete inventory by $6.1 million primarily related to the decision to discontinue certain products and excess inventory relative to anticipated demand. The excess and obsolete inventory reserve was $9.0 million and $4.9 million at March 31, 2014 and June 30, 2013, respectively.

 

Other Current Assets

 

Other current assets consist primarily of textbooks, curriculum materials and other supplies which are expected to be returned upon the completion of the school year. Materials not returned are expensed as part of instructional costs and services.

 

Property and Equipment

 

Property and equipment 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 under capital lease). Amortization of assets capitalized under capital lease arrangements is included in depreciation expense. 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 ASC 840, 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. Depreciation expense for the three months ended March 31, 2014 and March 31, 2013 was $9.2 million and $8.0 million, respectively. Depreciation expense for the nine months ended March 31, 2014 and March 31, 2013 was $32.1 million and $23.8 million, respectively, which, for the nine months ended March 31, 2014, includes accelerated expenses described below.

 

10

Table of Contents

 

Property and equipment are depreciated over the following useful lives:

 

		Useful Life
Student computers		3 years
Computer hardware		3 years
Computer software		3-5 years
Web site development costs		3 years
Office equipment		5 years
Furniture and fixtures		7 years
Leasehold improvements		3-12 years

 

During the nine months ended March 31, 2014, the Company updated the estimate of unreturned computers based on an analysis of recent trends of returns and utilization rates, as well as information obtained from the student computer processing systems. As a result, the Company recorded accelerated depreciation of $6.3 million for computers that we estimate will not be returned by our students.

 

Capitalized Software

 

The Company develops software for internal use. Software development costs incurred during the application development stage are capitalized in accordance with ASC 350, Intangibles — Goodwill and Other. The Company amortizes these costs over the estimated useful life of the software, which is generally three years. Capitalized software development costs are stated at cost less accumulated amortization.

 

Capitalized software development additions totaled $18.5 million and $17.9 million for the nine months ended March 31, 2014 and March 31, 2013, respectively. Amortization expense for the three months ended March 31, 2014 and March 31, 2013 was $3.9 million and $3.6 million, respectively. During the nine months ended March 31, 2014, the Company wrote down approximately $3.8 million of capitalized software projects after determining the assets either have no future use or are being sunset. Amortization expense for the nine months ended March 31, 2014 and March 31, 2013 was $15.3 million and $10.3 million, respectively. The amortization expense for the nine months ended March 31, 2014 included the write down.

 

Capitalized Curriculum Development Costs

 

The Company internally develops curriculum, which is primarily provided as online content and accessed via the Internet. The Company also creates textbooks and other materials that are complementary to online content.

 

The Company capitalizes curriculum development costs incurred during the application development stage in accordance with ASC 350. The Company capitalizes curriculum development costs during the design and deployment phases of the project. Many of the Company’s new courses leverage off of proven delivery platforms and are primarily content, which has no technological hurdles. As a result, a significant portion of the Company’s courseware development costs qualify for capitalization due to the concentration of its development efforts on the content of the courseware. Capitalization ends when a course is available for general release to its 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.

 

Capitalized curriculum development additions were $11.3 million and $13.6 million for the nine months ended March 31, 2014 and March 31, 2013, respectively. These amounts are recorded on the accompanying condensed consolidated balance sheets net of amortization charges. In addition, the Company wrote down approximately $2.2 million of capitalized curriculum development costs due to its decision to discontinue certain curriculum during the nine months ended March 31, 2014. Amortization is recorded in product development expenses on the accompanying condensed consolidated statements of operations. Amortization expense for the three months ended March 31, 2014 and March 31, 2013 was $4.3 million and $3.6 million, respectively. Amortization expense for the nine months ended March 31, 2014 and March 31, 2013 was $14.7 million and $10.7 million, respectively. The amortization expense for the nine months ended March 31, 2014 included the write down.

 

11

Table of Contents

 

Income Taxes

 

The Company accounts for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred tax assets and liabilities are computed based on the difference between the financial reporting and income tax bases of assets and liabilities using the enacted marginal tax rate. ASC 740 requires that the net deferred tax asset be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the net deferred tax asset will not be realized.

 

Series A Special Stock

 

The Company issued 2,750,000 shares of Series A Special stock in July 2010 in connection with an acquisition. The holders of the Series A Special stock had the right to convert those shares into common stock on a one-for-one basis and the right to vote on all matters presented to K12 stockholders, other than for the election and removal of directors, for which holders of the Series A Special stock had no voting rights. These shares were converted into common stock on September 3, 2013 and no Series A Special stock remains outstanding as of March 31, 2014.

 

Noncontrolling Interest

 

Earnings or losses attributable to other stockholders of a consolidated affiliated company are classified separately as “noncontrolling interest” in the Company’s condensed consolidated statements of operations. Net (income) loss attributable to noncontrolling interest reflects only the Company’s share of the after-tax earnings or losses of an affiliated company. Income taxes attributable to noncontrolling interest are determined using the applicable statutory tax rates in the jurisdictions where such operations are conducted. These rates vary from country to country. The Company’s condensed consolidated balance sheets reflect the noncontrolling interest within the equity section of the condensed consolidated balance sheets rather than in the mezzanine section of the condensed consolidated balance sheets, except for redeemable noncontrolling interest. Noncontrolling interest is classified separately in the Company’s condensed consolidated statements of equity (deficit).

 

Redeemable Noncontrolling Interests

 

Noncontrolling interests in subsidiaries that are redeemable outside of the Company’s control for cash or other assets are classified outside of permanent equity at redeemable value which approximates fair value. The redeemable noncontrolling interests are adjusted to their fair value at each balance sheet date. The resulting increases or decreases in the estimated redemption amount are affected by corresponding charges against retained earnings, or in the absence of retained earnings, additional paid-in-capital.

 

Goodwill and Intangible Assets

 

The Company records as goodwill the excess of the purchase price over the fair value of the identifiable net assets acquired. Finite-lived intangible assets acquired in business combinations subject to amortization are recorded at their fair value. Finite-lived intangible assets include trade names, customer and distributor relationships and developed technology. Such intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortization expense for the three months ended March 31, 2014 and March 31, 2013 was $0.7 million and $1.1 million, respectively. Amortization expense for the nine months ended March 31, 2014 and March 31, 2013 was $7.4 million and $3.4 million, respectively. Future amortization of intangible assets is $0.7 million, $2.6 million, $2.5 million, $2.0 million and $2.0 million in the fiscal years ending June 30, 2014 through June 30, 2018, respectively, and $15.0 million thereafter.

 

The Company reviews its recorded finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between fair value and the carrying value of the asset.

 

ASC 350 prescribes a process for impairment testing of goodwill and intangible assets with indefinite lives, which is performed annually, as well as when an event triggering impairment may have occurred. Goodwill and intangible assets deemed to have an indefinite life are tested for impairment on an annual basis, or earlier when

 

12

Table of Contents

 

events or changes in circumstances suggest the carrying amount may not be fully recoverable. The Company has elected to perform its annual assessment on May 31 of each year.

 

The following table represents goodwill activity for the nine months ended March 31, 2014:

 

		Amount
Rollforward of Goodwill		$(in thousands)
Balance as of June 30, 2013		$	61,413
Adjustments due to other foreign exchange translations		168
Balance as of March 31, 2014		$	61,581

 

The following table represents the balance of intangible assets as of March 31, 2014 and June 30, 2013:

 

		March 31, 2014									June 30, 2013
($ in millions)		Gross Carrying Amount			Accumulated Amortization			Net Carrying Value			Gross Carrying Amount			Accumulated Amortization			Net Carrying Value
Trade names		$	17.4		$	(4.2	)	$	13.2		$	24.0		$	(5.1	)	$	18.9
Customer and distributor relationships		18.9			(7.7		)	11.2			18.9			(6.5		)	12.4
Developed technology		1.5			(1.4		)	0.1			1.5			(1.0		)	0.5
Other		0.5			(0.2		)	0.3			0.5			(0.2		)	0.3
		$	38.3		$	(13.5	)	$	24.8		$	44.9		$	(12.8	)	$	32.1

 

During the second quarter of fiscal year 2014, the Company determined that based on rebranding of the Institutional business, the Company fully amortized certain trade names that are no longer going to be used and recorded a $5.2 million impairment charge for the nine months ended March 31, 2014. There was no impairment charge for the three months ended March 31, 2014 or the three and nine months ended March 31, 2013.

 

Impairment of Long-Lived Assets

 

Long-lived assets include property, equipment, capitalized curriculum and software developed or obtained for internal use. In accordance with ASC 360, the Company reviews its recorded long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between fair value and the carrying value of the asset.

 

Fair Value Measurements

 

ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

ASC 820 describes three levels of inputs that may be used to measure fair value:

 

Level 1:  Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

 

Level 2:  Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

13

Table of Contents

 

Level 3:  Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

 

The carrying values reflected in the accompanying condensed consolidated balance sheets for cash and cash equivalents, receivable and debt approximate their fair values.

 

The redeemable noncontrolling interest is a result of the Company’s joint venture with Middlebury College to form Middlebury Interactive Languages. Under the agreement, Middlebury College has an irrevocable election to sell all (but not less than all) of its membership interest to the Company (put right). The fair value of the redeemable noncontrolling interest reflects management’s best estimate of the redemption of the put right.

 

The following table summarizes certain information at March 31, 2014 and June 30, 2013 for assets and liabilities measured at fair value on a recurring basis:

 

		Fair Value Measurements Using:
					Quoted Prices
					in Active			Significant
					Markets for			Other			Significant
					Identical			Observable			Unobservable
					Assets			Input			Inputs
Description		Fair Value			(Level 1)			(Level 2)			(Level 3)
		(In thousands)
Redeemable Noncontrolling Interest in Middlebury Joint Venture		$	15,200		$	—		$	—		$	15,200
Total		$	15,200		$	—		$	—		$	15,200

 

The fair value of the redeemable noncontrolling interest in Middlebury Joint Venture was measured in accordance with ASC 480, Distinguishing Liabilities from Equity, and was based upon a valuation from a third-party valuation firm as of June 30, 2013. As of March 31, 2014, the Company performed an internal analysis and determined there was no underlying change in the estimated fair market value. This analysis incorporated a number of assumptions and estimates including the financial results of the joint venture to date.

 

Earnings Per Common Share

 

The Company calculates net income per share in accordance with ASC 260, Earnings Per Share. Under ASC 260, basic net income per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. The weighted average number of shares of common stock outstanding includes vested restricted stock awards. Diluted earnings per share (“EPS”) reflect the potential dilution that could occur assuming conversion or exercise of all dilutive unexercised stock options. The dilutive effect of stock options and restricted stock awards was determined using the treasury stock method. Under the treasury stock method, the proceeds received from the exercise of stock options and restricted stock awards, the amount of compensation cost for future service not yet recognized by the Company and the amount of tax benefits that would be recorded in additional paid-in capital when the stock options become deductible for income tax purposes are all assumed to be used to repurchase shares of the Company’s common stock. Stock options and restricted stock awards are not included in the computation of diluted earnings per share when they are antidilutive. Common stock outstanding reflected in the Company’s consolidated balance sheets include restricted stock awards outstanding. Securities that may participate in undistributed earnings with common stock are considered participating securities. The Series A Special stock was considered participating until all shares were converted into common stock on September 3, 2013. Participating securities are included in the computation of both basic and diluted EPS (as a reduction of the numerator) using the two-class method. Under the two-class method, all undistributed earnings in a period are allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. EPS is presented using the two-class method in the three and nine months ended March 31, 2013 only, since the Series A Special stock was outstanding.

 

14

Table of Contents

 

The following schedule presents the calculation of basic and diluted net income per share:

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2014			2013			2014			2013
		(In thousands except shares and per share data)
Basic and dilutive earnings (loss) per share computation:
Net income — K12		$	15,949		$	11,975		$	7,244		$	25,842
Amount allocated to participating Series A stockholders		—			(844		)	—			(1,827		)
Income available to common stockholders — basic and diluted		$	15,949		$	11,131		$	7,244		$	24,015
Weighted average common shares — basic and diluted		39,596,798			36,283,353			39,136,667			36,142,689
Basic and diluted net income per share		$	0.40		$	0.31		$	0.19		$	0.66

 

The basic and diluted weighted average common shares were the same for the three and nine months ended March 31, 2014 and March 31, 2013, as the inclusion of dilutive securities were out of the money based on a lower average stock price during the period and Series A special stock prior to the conversion date would have been anti-dilutive. At March 31, 2014, we had 41,138,238 shares issued and 39,895,938 shares outstanding, which included the 2,750,000 common shares associated with the Series A special stock conversion which occurred on September 3, 2013.

 

Recent Accounting Pronouncements

 

Accounting Standards Updates issued but not yet effective are not expected to have a material effect on the Company’s future financial statements.

 

4.  Income Taxes

 

The benefit (expense) for income taxes is based on income (loss) reported in the condensed consolidated financial statements. A deferred income tax asset or liability is determined by applying currently enacted tax laws and rates to the expected reversal of the cumulative temporary differences between the carrying value of assets and liabilities for financial statement and income tax purposes. Deferred income tax expense or benefit is measured by the change in the deferred income tax asset or liability during the period. For the three months ended March 31, 2014 and March 31, 2013, the Company’s effective income tax rate was 43.3% and 40.0%, respectively. For the nine months ended March 31, 2014 and March 31, 2013, the Company’s effective tax rate was 37.7% and 41.9%, respectively. The effective income tax rate differs from the statutory federal income tax rate of 35% primarily due to the impact of foreign operations, state taxes, noncontrolling interests and permanent differences between book and tax deductions.

 

5.  Long-term Obligations

 

Capital Leases

 

The Company incurs capital lease obligations for student computers under a lease line of credit with PNC Equipment Finance, LLC with annual lease availability limits. The current annual availability of $35.0 million expires in June 2014. As of March 31, 2014 and June 30, 2013, the aggregate outstanding balance under the lease line of credit, including balances from prior years, was $37.6 million and $35.5 million, respectively, with lease interest rates ranging from 2.52% to 3.08%. Individual leases under the lease line of credit include 36-month payment terms with a $1 purchase option at the end of each lease term. The interest rates on the new borrowings are based upon an initial rate of 2.40% modified by changes in the three year interest rate swaps rate as published in the Federal Reserve Statistical Release H.15, “Selected Interest Rates,” between May 29, 2013 and the Lease Commencement Date (as defined in the lease line of credit). The Company has pledged the assets financed to secure the outstanding leases. The net carrying value of leased student computers as of March 31, 2014 and June 30, 2013 was $27.3 million and $31.2 million, respectively.

 

15

Table of Contents

 

The following is a summary as of March 31, 2014 of the present value of the net minimum payments due on outstanding capital leases and the note payable under the Company’s commitments:

 

		Capital
June 30,		Leases
		($ in thousands)
2014		6,296
2015		19,352
2016		10,266
2017		2,760
Total minimum payments		38,674
Less amount representing interest (imputed weighted average capital lease interest rate of 2.8%)		(1,069		)
Net minimum payments		37,605
Less current portion		(20,954		)
Present value of minimum payments, less current portion		$	16,651

 

Note Payable

 

The Company purchased computer software licenses and maintenance services through an unsecured note payable arrangement with a vendor at 3.4% interest rate and a payment term of three years. There are no covenants associated with this note payable arrangement. The balance of the note payable at March 31, 2014 and June 30, 2013 was zero and $0.4 million, respectively.

 

6.  Line of Credit

 

On January 31, 2014, we executed a $100 million unsecured line of credit with the Bank of America, N.A. (“Bank”) to be used for general corporate operating purposes. The line has a five year term, bears interest at the higher of the Bank’s prime rate plus 0.25% or the Federal Funds Rates plus 0.75%, or the LIBOR rate plus 1.25% and incorporates customary financial and other covenants, including but not limited to a maximum debt leverage and a minimum fixed charge coverage ratio. As of March 31, 2014, the Company was in compliance with these covenants and there were no borrowings outstanding on the line of credit during the period ended March 31, 2014.

 

7.  Stock Option Plan

 

Stock Options

 

Stock option activity during nine months ended March 31, 2014 was as follows:

 

				Weighted-			Average
				Average			Remaining		Aggregate
				Exercise			Contractual		Intrinsic
		Shares		Price			Life (Years)		Value
Outstanding, June 30, 2013		2,893,188		$	20.17		4.98		$	50,038
Granted		269,220		27.47
Exercised		(481,497	)	17.54
Forfeited or canceled		(51,993	)	23.34
Outstanding, March 31, 2014		2,628,918		$	21.37		4.74		$	7,244
Stock options exercisable at March 31, 2014		1,815,535		$	20.12		2.88		$	12,609

 

The aggregate intrinsic value of options exercised during nine months ended March 31, 2014 was $6.1 million. The weighted-average grant date fair value of options granted was $12.69 during the nine months ended March 31, 2014.

 

16

Table of Contents

 

As March 31, 2014, there was $7.3 million of total unrecognized compensation expense related to unvested stock options granted. The cost is expected to be recognized over a weighted average period of 2.3 years. During the nine months ended March 31, 2014, the Company recorded additional stock-based compensation of $1.5 million associated with accelerated vesting of option awards to our former Chief Executive Officer and other employees upon termination of employment. During the three months ended March 31, 2014 and March 31, 2013, the Company recognized $0.9 million and $1.1 million, respectively, of stock-based compensation expense related to stock options. During nine months ended March 31, 2014 and March 31, 2013, the Company recognized $4.6 million and $3.2 million, respectively, of stock-based compensation expense related to stock options.

 

Restricted Stock Awards

 

Restricted stock award activity during nine months ended March 31, 2014 was as follows:

 

				Weighted-
				Average
		Shares		Fair Value
Outstanding, June 30, 2013		928,137		$	22.97
Granted		693,354		31.53
Vested		(457,390	)	25.13
Forfeited or canceled		(51,820	)	27.36
Outstanding, March 31, 2014		1,112,281		$	27.40

 

As of March 31, 2014, there was $21.5 million of total unrecognized compensation expense related to unvested restricted stock awards granted. The cost is expected to be recognized over a weighted average period of 2.3 years. The total fair value of shares vested during nine months ended March 31, 2014 was $11.5 million. During the nine months ended March 31, 2014, the Company recorded additional stock-based compensation of $2.5 million associated with accelerated vesting of equity awards to our former Chief Executive Officer and other employees upon termination of employment. During the three months ended March 31, 2014 and March 31, 2013, the Company recognized $3.1 million and $2.9 million, respectively, of stock-based compensation expense related to restricted stock awards. During nine months ended March 31, 2014 and March 31, 2013, the Company recognized $11.6 million and $6.6 million, respectively, of stock-based compensation expense related to restricted stock awards.

 

8.  Related Party Transactions

 

For the three months ended March 31, 2014 and March 31, 2013, the Company purchased services in the amount of zero and $0.1 million, respectively from Knowledge Universe Technologies (“KUT”) pursuant to a Transition Services Agreement related to the Company’s acquisition of KCDL, as well as other administrative services. KUT is an affiliate of Learning Group, LLC, which was a related party until September 2013. For the nine months ended March 31, 2014 and March 31, 2013, the Company purchased services in the amount of zero and $0.3 million, respectively.

 

During the nine months ended March 31, 2014, in accordance with the original terms of the joint venture agreement, the Company loaned $1.0 million to its 60% owned joint venture, MIL. At March 31, 2014 and June 30, 2013, the loan totaled $4.0 million and $3.0 million, respectively, and was repayable under terms and conditions specified in the loan agreement. The loan balance and related interest are eliminated since MIL is consolidated in the Company’s financial statements; however, repayment of the loan is dependent on the continued liquidity of MIL.

 

9.  Commitments and Contingencies

 

Litigation

 

In the ordinary conduct of business, the Company is subject to lawsuits, arbitrations and administrative proceedings from time to time. The Company expenses legal costs as incurred.

 

17

Table of Contents

 

IpLearn

 

On October 26, 2011, IpLearn, LLC (“IpLearn”) filed a complaint for patent infringement against the Company in the United States District Court for the District of Delaware, IpLearn, LLC v. K12 Inc., Case No. 1:11-1026-LPS, which it subsequently amended on November 18, 2011. IpLearn is a privately-held technology development and licensing company for web and computer-based learning technologies. In its complaint, IpLearn alleges that the Company has infringed three of its patents for various computer-aided learning methods and systems and it is primarily seeking an injunction enjoining K12 from any continued infringement as well as an award of unspecified monetary damages. On July 2, 2012, the court granted the Company’s motion to dismiss IpLearn’s allegations of indirect patent infringement and allowed IpLearn’s allegations of direct patent infringement to proceed. On January 15, 2013, the court approved a stay of IpLearn’s claims alleging infringement of one of the three patents in the case involving technology licensed to K12 by a third party. The discovery process is currently in progress and the claims construction hearings were held on September 30, 2013. At March 31, 2014 and June 30, 2013, the Company had not recorded a liability as a loss was neither probable nor estimable.

 

Oklahoma Firefighters Complaint

 

On January 30, 2014, a securities class-action lawsuit captioned Oklahoma Firefighters Pension & Retirement System v. K12 Inc., et al., was filed against the Company, four of its officers and directors, and a former officer, in the United States District Court for the Eastern District of Virginia, Oklahoma Firefighters Pension & Retirement System v. K12, Inc., Case No. 1:14-CV-108-AJT-JFA (the “Oklahoma Firefighters Complaint”). The plaintiff purports to represent a class of persons who purchased or otherwise acquired K12 common stock between March 11, 2013 and October 9, 2013, inclusive, and alleges violations by the defendants of Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder. The Oklahoma Firefighters Complaint alleges, among other things, that the defendants made false or misleading statements of material fact, or failed to disclose material facts, about (i) the Company’s enrollment and revenue growth prospects for fiscal 2014, and (ii) the Company’s compliance with state regulations governing enrollment. The plaintiff seeks unspecified monetary damages and other relief. The Company intends to defend vigorously against the claims asserted in the Oklahoma Firefighters Complaint.

 

10.  Investments

 

Investment in Web International Education Group Ltd. (Web)

 

In January 2011, the Company invested $10.0 million to obtain a 20% minority interest in Web International Group, Ltd. (“Web”), a provider of English language learning centers in cities throughout China. From January 2011 through May 2013, the Company recorded its investment in Web as an available for sale debt security because of the ability to put the investment to other Web shareholders in return for the original $10.0 million investment plus interest. The Company’s option to purchase no less than 51% of Web expired on March 31, 2013 and on May 6, 2013, the Company exercised its right to put its investment back to Web for return of its original $10.0 million investment plus interest of 8%, which Web is contractually required to pay by May 6, 2014. The Company reclassified this $10.0 million investment plus accrued interest of $2.4 million to a receivable, which is included in other current assets. During the three months ended March 31, 2014 and March 31, 2013, the Company recorded interest income of $0.2 million and zero, respectively, associated with Web. During the nine months ended March 31, 2014 and March 31, 2013, the Company recorded interest income of $0.6 million and zero, respectively, associated with Web.

 

Investment in School Mortgage

 

On September 11, 2013, the Company issued a mortgage note (“Mortgage”) lending $2.1 million to a managed school partner. The note bears interest at a fixed rate of 5.25% per year and has a term of five years. Monthly principal and interest payments will be made beginning October 2013 with a final balloon payment of $1.8 million at the term of the loan. The Mortgage is primarily secured by the underlying property.

 

18

Table of Contents

 

The Mortgage and ancillary documents include customary affirmative and financial covenants for secured transactions of this type. The Company has recorded this as a held to maturity investment and the current amounts are included in other current assets while the non-current amounts are included in deposits and other assets on the balance sheet.

 

11.  Supplemental Disclosure of Cash Flow Information

 

		Nine Months Ended
		March 31,
		2014			2013
		(In thousands)
Cash paid for interest		$	879		$	895
Cash paid for taxes, net of refunds		$	4,865		$	510
Supplemental disclosure of non-cash investing and financing activities:
New capital lease obligations		$	19,090		$	24,671

 

12.  Common Stock Repurchases

 

On November 4, 2013, the Board of Directors authorized the repurchase of up to $75.0 million of the Company’s outstanding common stock over a two year period. Any purchases under the buyback are dependent upon business and market conditions and other factors. The stock purchases are made from time to time and may be made through a variety of methods including open market purchases and in accordance with the SEC’s Rule 10b5-1. For the three months ended March 31, 2014, the Company paid approximately $20.7 million for the repurchase of 958,100 shares. For the nine months ended March 31, 3014, the Company paid approximately $26.6 million under the plan for the repurchase of 1,242,300 shares. As of March 31, 2014, the approximate dollar amount of shares yet to be repurchased under the plan was $48.4 million.

 

19

Table of Contents

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Certain statements in Management’s Discussion and Analysis or MD&A, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Historical results may not indicate future performance. Our forward-looking statements reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those contemplated by these statements. Factors that may cause differences between actual results and those contemplated by forward-looking statements include, but are not limited to, those discussed in “Risk Factors” in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, which we refer to as our Annual Report. We undertake no obligation to publicly update or revise any forward-looking statements, including any changes that might result from any facts, events or circumstances after the date hereof that may bear upon forward-looking statements. Furthermore, we cannot guarantee future results, events, levels of activity, performance or achievements.

 

This MD&A is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition. As used in this MD&A, the words, “we,” “our” and “us” refer to K12 Inc. and its consolidated subsidiaries. This MD&A should be read in conjunction with our condensed consolidated financial statements and related notes included in this report, as well as the consolidated financial statements and MD&A of our Annual Report. The following overview provides a summary of the sections included in our MD&A:

 

·                  Executive Summary — a general description of our business and key highlights of the three months and nine months ended March 31, 2014.

 

·                  Critical Accounting Policies and Estimates — a discussion of critical accounting policies requiring critical judgments and estimates.

 

·                  Results of Operations — an analysis of our results of operations in our condensed consolidated financial statements.

 

·                  Liquidity and Capital Resources — an analysis of cash flows, sources and uses of cash, commitments and contingencies, seasonality in the results of our operations and quantitative and qualitative disclosures about market risk.

 

Executive Summary

 

We are a technology—based education company. We offer proprietary curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12. Our mission is to maximize a child’s potential by providing access to an engaging and effective education, regardless of geographic location or socio economic background. Since our inception, we have invested to develop and acquire curriculum and online learning platforms that promote mastery of core concepts and skills for students of all abilities. K12 provides a continuum of technology based educational products and solutions to school districts, public schools, private schools, public charter schools and families as we strive to transform the educational experience into one that delivers individualized education on a highly scalable basis.

 

Virtual and blended public schools generally under turn-key management contracts (Managed Public Schools) accounted for approximately 87% of our revenue in the nine months ended March 31, 2014. We currently provide management services to public schools in 33 states and the District of Columbia.

 

20

Table of Contents

 

We serve an increasing number of schools and school districts enabling them to offer our course catalog to students either full-time or on an individual course basis. We have increased, over time, the size and expertise of our sales team, added a reseller network and expanded our course portfolio. The services we provide to these schools and school districts are designed to assist them in launching their own online learning programs which vary according to the needs of the individual school and school district and may include teacher training programs, administrator support and our PEAK12 management system. With our services, schools and districts can offer programs that allow students to participate full-time, as their primary school, or part-time, supplementing their education with core courses, electives, credit recovery options, remediation and supplemental content options. We continue to provide these services to school districts or individual schools in all 50 states and the District of Columbia.

 

We operate three online private schools where parents can enroll students on a tuition basis for a full-time online education or individual courses to supplement their children’s traditional instruction. These include our K12 International Academy, an online private school that enables us to offer students worldwide the same full-time education programs and curriculum that we provide to the virtual and blended public schools, The Keystone School, a private school that offers online and correspondence courses, and the George Washington University Online High School, a program that offers college preparatory curriculum and is designed for high school students who are seeking a challenging academic experience. In addition, we currently own and operate the International School of Berne, or IS Berne, a traditional private school located in Berne, Switzerland and a recognized IB school serving students in grades Pre-K through 12.

 

For the nine months ended March 31, 2014, revenues grew to $687.5 million from $645.1 million in the prior year period, a growth rate of 6.6%. We had operating income of $10.0 million for nine months ended March 31, 2014 compared to operating income of $44.3 million in the prior year period, and net income to common stockholders of $7.2 million compared to net income to common stockholders of $25.8 million in the prior year period. The operating income for the nine months ended March 31, 2014 included $31.2 million of severance and related stock-based compensation, accelerated depreciation and amortization for certain curriculum, learning systems, trade names, and other fixed assets that will no longer be used or developed and additional provisions for inventory that we previously anticipated using.

 

During the third quarter we decided not to pursue our previously announced intent to create a new company with Safanad Limited due to the complexities of the transaction.  We continue to evaluate strategic options with respect to the possible sale of one or more of these assets, including discussions with Safanad Limited.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with Generally Accepted Accounting Principles requires us to make estimates and assumptions about future events that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our consolidated financial statements. Critical accounting policies are disclosed in our Annual Report. There have been no significant updates to our critical accounting policies disclosed in our Annual Report.

 

Results of Operations

 

As described in the Annual Report, we reclassified our three lines of business: Managed Public Schools (turn-key management services provided to public schools), Institutional Sales (educational products and services provided to school districts, public schools and other educational institutions that we do not manage), and International and Private Pay Schools (private schools for which we charge student tuition and make direct consumer sales).

 

Managed Public Schools		Institutional Sales		International and Private Pay Schools
· Full-time virtual public schools		· K12 curriculum		· Managed private schools
· Blended schools		· Middlebury joint venture		· The Keystone School
· Flex schools		· Pre-kindergarten		· George Washington University Online High School
· Passport schools		· Post-secondary		· K12 International Academy
· Discovery schools				· International School of Berne
· Other blended schools				· Independent course sales (Consumer)

 

21