Stride, Inc. - Quarter Report: 2019 September (Form 10-Q)

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒

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

For the quarterly period ended September 30, 2019

☐

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

For the transition period from to

Commission File Number: 001-33883

K12 Inc.

(Exact name of registrant as specified in its charter)


Delaware		95-4774688
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

2300 Corporate Park Drive
Herndon, VA		20171
(Address of Principal Executive Offices)		(Zip Code)

(703) 483-7000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, $0.0001 par value	LRN	New York Stock Exchange (NYSE)

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 ⌧ No ◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 ⌧ No ◻

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

Large accelerated filer ⌧

Accelerated filer ◻

Non-accelerated filer ◻

Smaller reporting company ☐

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

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

As of October 18, 2019, the Registrant had 40,955,110 shares of common stock, $0.0001 par value per share outstanding.

Table of Contents

K12 Inc.

Form 10-Q

For the Quarterly Period Ended September 30, 2019

Index

		Page
		Number

PART I.	Financial Information
Item 1.	Financial Statements (Unaudited)	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34

PART II.	Other Information
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Issuer Purchases of Equity Securities	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	Mine Safety Disclosures	35
Item 5.	Other Information	35
Item 6.	Exhibits	36

Signatures		37

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited).

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS


	September 30,		June 30,
	2019		2019
				(audited)
	(In thousands except share and per share data)
ASSETS
Current assets
Cash and cash equivalents	$	165,944	$	283,121
Accounts receivable, net of allowance of $9,561 and $11,766 at September 30, 2019 and June 30, 2019, respectively		267,690		191,639
Inventories, net		20,516		29,946
Prepaid expenses		29,871		12,643
Other current assets		14,289		12,307
Total current assets		498,310		529,656
Property and equipment, net (1)		37,253		31,980
Capitalized software, net		50,232		51,165
Capitalized curriculum development costs, net		53,495		53,297
Intangible assets, net		14,238		14,981
Goodwill		90,197		90,197
Deposits and other assets (1)		69,772		48,330
Total assets	$	813,497	$	819,606
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable	$	46,204	$	50,488
Accrued liabilities		18,590		20,685
Accrued compensation and benefits		18,961		41,998
Deferred revenue		25,557		22,828
Current portion of finance lease liability		22,019		19,588
Current portion of operating lease liability (1)		8,371		—
Total current liabilities		139,702		155,587
Long-term finance lease liability		3,495		5,060
Long-term operating lease liability (1)		17,048		—
Deferred tax liability		20,357		16,670
Other long-term liabilities		8,183		8,924
Total liabilities		188,785		186,241
Commitments and contingencies		—		—
Stockholders’ equity
Common stock, par value $0.0001; 100,000,000 shares authorized; 46,290,570 and 45,575,236 shares issued; and 40,955,827 and 40,240,493 shares outstanding at September 30, 2019 and June 30, 2019, respectively		4		4
Additional paid-in capital		714,374		713,436
Accumulated other comprehensive income (loss)		99		(40)
Retained earnings		12,717		22,447
Treasury stock of 5,334,743 shares at cost at September 30, 2019 and June 30, 2019		(102,482)		(102,482)
Total stockholders’ equity		624,712		633,365
Total liabilities and stockholders' equity	$	813,497	$	819,606

(1) Reflects the adoption of Accounting Standards Update No. 2016-02, Leases (Topic 842), which the Company adopted on July 1, 2019.

See accompanying notes to unaudited condensed consolidated financial statements.

Table of Contents

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


	Three Months Ended September 30,
	2019		2018
		(In thousands except share and per share data)
Revenues	$	257,121	$	251,314
Instructional costs and services		169,358		158,985
Gross margin		87,763		92,329
Selling, general, and administrative expenses		107,151		106,081
Loss from operations		(19,388)		(13,752)
Interest income, net		910		316
Other income (expense), net		(8)		193
Loss before income taxes and loss from equity method investments		(18,486)		(13,243)
Income tax benefit		8,818		5,058
Loss from equity method investments		(62)		(97)
Net loss attributable to common stockholders	$	(9,730)	$	(8,282)
Net loss attributable to common stockholders per share:
Basic and diluted	$	(0.25)	$	(0.22)
Weighted average shares used in computing per share amounts:
Basic and diluted		39,288,557		38,434,049

See accompanying notes to unaudited condensed consolidated financial statements.

Table of Contents

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS


	Three Months Ended September 30,
	2019		2018

Net loss	$	(9,730)	$	(8,282)
Other comprehensive income, net of tax:
Foreign currency translation adjustment		139		72

Comprehensive loss attributable to common stockholders	$	(9,591)	$	(8,210)

See accompanying notes to unaudited condensed consolidated financial statements.

Table of Contents

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY


	K12 Inc. Stockholders' Equity
(In thousands except share data)	Common Stock			Additional Paid-in		Accumulated Other Comprehensive		Retained		Treasury Stock
	Shares	Amount		Capital		Income (Loss)		Earnings		Shares	Amount		Total
Balance, June 30, 2019	45,575,236	$	4	$	713,436	$	(40)	$	22,447	(5,334,743)	$	(102,482)	$	633,365
Net loss	—		—		—		—		(9,730)	—		—		(9,730)
Foreign currency translation adjustment	—		—		—		139		—	—		—		139
Stock-based compensation expense	—		—		5,594		—		—	—		—		5,594
Exercise of stock options	2,500		—		42		—		—	—		—		42
Issuance of restricted stock awards	918,702		—		—		—		—	—		—		—
Forfeiture of restricted stock awards	(34,090)		—		—		—		—	—		—		—
Repurchase of restricted stock for tax withholding	(171,778)		—		(4,698)		—		—	—		—		(4,698)
Balance, September 30, 2019	46,290,570	$	4	$	714,374	$	99	$	12,717	(5,334,743)	$	(102,482)	$	624,712


	K12 Inc. Stockholders' Equity
(In thousands except share data)	Common Stock			Additional Paid-in		Accumulated Other Comprehensive		Accumulated		Treasury Stock
	Shares	Amount		Capital		Loss		Deficit		Shares	Amount		Total

Balance, June 30, 2018	44,902,567	$	4	$	703,351	$	(252)	$	(13,432)	(5,334,743)	$	(102,482)	$	587,189
Adjustment related to new revenue recognition guidance	—		—		—		—		(1,330)	—		—		(1,330)
Net loss	—		—		—		—		(8,282)	—		—		(8,282)
Foreign currency translation adjustment	—		—		—		72		—	—		—		72
Stock-based compensation expense	—		—		4,109		—		—	—		—		4,109
Exercise of stock options	687		—		10		—		—	—		—		10
Vesting of performance share units, net of tax withholding	258,263		—		—		—		—	—		—		—
Issuance of restricted stock awards	722,809		—		—		—		—	—		—		—
Forfeiture of restricted stock awards	(122,242)		—		—		—		—	—		—		—
Repurchase of restricted stock for tax withholding	(188,804)		—		(6,072)		—		—	—		—		(6,072)
Balance, September 30, 2018	45,573,280	$	4	$	701,398	$	(180)	$	(23,044)	(5,334,743)	$	(102,482)	$	575,696

See accompanying notes to unaudited condensed consolidated financial statements.

Table of Contents

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


	Three Months Ended September 30,
	2019		2018
	(In thousands)
Cash flows from operating activities
Net loss	$	(9,730)	$	(8,282)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization expense		17,146		18,511
Stock-based compensation expense		5,522		4,024
Deferred income taxes		3,776		5,865
(Recovery of) provision for doubtful accounts		(280)		446
Other		4,141		2,932
Changes in assets and liabilities:
Accounts receivable		(75,765)		(92,584)
Inventories, prepaid expenses, deposits and other current and long-term assets		(8,942)		(5,774)
Accounts payable		(2,396)		15,998
Accrued liabilities		(266)		(398)
Accrued compensation and benefits		(23,038)		(17,321)
Operating lease liability		(2,073)		—
Deferred revenue and other liabilities		5,091		27,491
Net cash used in operating activities		(86,814)		(49,092)
Cash flows from investing activities
Purchase of property and equipment		(1,246)		(1,738)
Capitalized software development costs		(7,196)		(9,317)
Capitalized curriculum development costs		(8,528)		(6,685)
Acquisitions and investments		(1,277)		(11,652)
Net cash used in investing activities		(18,247)		(29,392)
Cash flows from financing activities
Repayments on finance lease obligations (1)		(7,460)		(3,518)
Proceeds from exercise of stock options		42		10
Repurchase of restricted stock for income tax withholding		(4,698)		(6,072)
Net cash used in financing activities		(12,116)		(9,580)
Net change in cash, cash equivalents and restricted cash		(117,177)		(88,064)
Cash, cash equivalents and restricted cash, beginning of period		284,621		233,113
Cash, cash equivalents and restricted cash, end of period	$	167,444	$	145,049

Reconciliation of cash, cash equivalents and restricted cash to balance sheet as of September 30th:
Cash and cash equivalents	$	165,944	$	143,049
Other current assets (restricted cash)		500		—
Deposits and other assets (restricted cash)		1,000		2,000
Total cash, cash equivalents and restricted cash	$	167,444	$	145,049

(1) Previously referred to as repayments on capital lease obligations.

See accompanying notes to unaudited condensed consolidated financial statements.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of the Business

K12 Inc., together with its subsidiaries (“K12” or the “Company”), is a technology-based education company. The Company offers proprietary and third party curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12. The Company’s learning systems combine curriculum, instruction and related support services to create an individualized learning approach. The Company’s learning systems are well-suited for virtual and blended public schools, school districts, charter schools, and private schools that utilize varying degrees of online and traditional classroom instruction, and other educational applications. These products and services are provided through three lines of business:

●

Managed Public School Programs – programs which offer an integrated package of systems, services, products, and professional expertise that K12 administers to support an online or blended public school, including: administrative support (e.g., budget proposals, financial reporting, student data reporting, and staff recruitment), information technology and provisioning, academic support services, curriculum, learning systems, and instructional services;

●

Institutional – Non-managed Public School Programs – programs which provide instruction, curriculum, supplemental courses, marketing, enrollment and other educational services where K12 does not provide primary administrative support services, and Institutional Software and Services – educational software and services provided to school districts, public schools and other educational institutions; and

●

Private Pay Schools and Other – private schools for which the Company charges student tuition and makes direct consumer sales.

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

2. Basis of Presentation

The accompanying condensed consolidated balance sheet as of September 30, 2019, the condensed consolidated statements of operations and comprehensive loss for the three months ended September 30, 2019 and 2018, the condensed consolidated statements of cash flows for the three months ended September 30, 2019 and 2018, and the condensed consolidated statements of stockholders’ equity for the three months ended September 30, 2019 and 2018 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 for the three months ended September 30, 2019 are not necessarily indicative of the results to be expected for the year ending June 30, 2020, for any other interim period or for any other future fiscal year. The condensed consolidated balance sheet as of June 30, 2019 has been derived from the audited consolidated financial statements at that date.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended (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 7, 2019, which contains the Company’s audited financial statements for the fiscal year ended June 30, 2019.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The Company operates in one operating and reportable business segment as a technology-based education company providing proprietary and third party 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 on consolidated results.

3. Summary of Significant Accounting Policies

Recent Accounting Pronouncements

Accounting Standards Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) (“ASU 2016-02”), also known as Accounting Standards Codification Topic 842 (“ASC 842”), which supersedes most existing lease guidance under ASC Topic 840 (“ASC 840”). The core principal of ASC 842 establishes a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations.

The most significant impact to the Company was its accounting for operating leases, which under ASC 840, were not recorded on the balance sheet. The Company reviewed its rent expense to ensure all leases were captured. The Company concluded that these leases were operating leases under ASC 842. Additionally, the Company’s capital leases under ASC 840 were reviewed and determined to be finance leases under ASC 842.

The Company adopted this standard during the first quarter of fiscal year 2020 using the modified retrospective approach. Under this method, the Company applied ASC 842 to existing leases that had commenced as of July 1, 2019. The comparative information for prior periods has not been restated and continues to be reported under ASC 840. The Company has provided the required disclosures under ASC 840 for the comparative periods. The Company elected to apply the package of practical expedients that was available upon adoption of ASC 842 to not reassess (1) whether any expired or existing contracts contain a lease, (2) the lease classification of any expired or existing lease, and (3) the initial direct costs for existing leases. The adoption of ASC 842 resulted in the recognition of a new lease liability for its operating leases of $22.7 million and a right-of-use asset of $17.7 million (net of existing deferred rent and lease impairment liabilities) on July 1, 2019.

In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40) (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). It requires an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. ASU 2018-15 is effective for the Company’s fiscal year beginning July 1, 2020; however, the Company early adopted this standard in the first quarter of fiscal year 2020. As a result of the adoption, during the three months ended September 30, 2019, the Company capitalized $1.4 million of implementation costs that would have been expensed previously. These costs are included in deposits and other assets in the condensed consolidated balance sheets.

Accounting Standards Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) (“ASU 2016-13”) related to the methodology for recognizing credit losses. The new standard revises the accounting requirements related to the measurement of credit losses and will require organizations to measure all expected credit losses for financial assets based on historical experience, current conditions and reasonable and supportable forecasts about collectability. Assets must be presented in the financial statements at the net amount expected to be collected. This ASU will be effective for the Company in the first quarter of fiscal year 2021, and early adoption is permitted. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Contracts with Customers

Revenues are principally earned from contractual agreements to provide online curriculum, books, materials, computers and management services to virtual and blended schools, traditional public schools, school districts, and private schools through its three lines of business; Managed Public School Programs, Institutional, and Private Pay Schools and Other.

Under ASC 606, revenue is recognized when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration it expects to be entitled to in exchange for those goods or services using the following steps:

●

identify the contract, or contracts, with a customer;

●

identify the performance obligations in the contract;

●

determine the transaction price;

●

allocate the transaction price to the performance obligations in the contract; and

●

recognize revenue when, or as, the Company satisfies a performance obligation.

Revenue Recognition

Managed Public School Programs

The Company provides an integrated package of systems, services, products, and professional expertise that we administer to support an online or blended public school. Contractual agreements generally span multiple years with performance obligations being isolated to annual periods. Customers for these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning systems platforms and instructional services under the terms of a negotiated service agreement. 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 revenue.

The Company generates revenues under contracts with virtual and blended public schools and include the following components, where required:

●

providing each of a school’s students with access to the Company’s online school and lessons;

●

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;

●

instruction by a state-certified teacher; and

●

management and technology services necessary to support a virtual public or blended school. In certain contracts, revenues are determined directly by per enrollment funding.

To determine the pro rata amount of revenue to recognize in a fiscal quarter, the Company estimates the total funds each school will receive in a particular school year. Total funds for a school are primarily a function of the number of students enrolled in the school and established per enrollment funding levels, which are generally published on an annual basis by the state or school district. The Company reviews its estimates of funding periodically, and revises as necessary, amortizing any adjustments to earned revenues over the remaining portion of the fiscal year. Actual school funding may vary from these estimates and the impact of these differences could impact the Company’s 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 funding and actual costs incurred (including costs for the Company’s services to the schools plus other costs the schools may incur) in the calculation of school operating losses. The Company’s schools’ reported results are subject to annual school district financial audits, which incorporate enrollment counts, funding and other routine financial audit considerations. The results of these audits are incorporated into the Company’s monthly funding estimates for the three months ended September 30, 2019 and 2018.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Each state and/or school district has variations in the school funding formulas and methodologies that it uses to estimate funding for revenue recognition at its respective schools. As the Company estimates funding for each school, it takes into account the state definition for count dates on which reported enrollment numbers will be used for per pupil funding. The parameters the Company considers in estimating funding for revenue recognition purposes include school district count definitions, withdrawal rates, average daily attendance, special needs enrollment, student demographics, academic progress and historical completion, student location, funding caps and other state specified categorical program funding.

Under the contracts where the Company provides services to schools, the Company has generally agreed to absorb any operating losses of the schools in a given school year. These school operating losses represent the excess of costs incurred over revenues earned by the virtual or blended public school as reflected on its respective financial statements, including Company charges to the schools. To the extent a school does not receive funding for each student enrolled in the school, the school would still incur costs associated with serving the unfunded enrollment. If losses due to unfunded enrollments result in a net operating loss for the year that loss is reflected as a reduction in the revenues and net receivables that the Company collects from the school. A school net 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 over the remainder of 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. For the three months ended September 30, 2019 and 2018, the Company’s revenues included a reduction for these school operating losses of $16.3 million and $17.3 million, respectively.

The Company has certain contracts where it is responsible for substantially all of the expenses incurred by the school. For these contracts, the Company records both revenue and expenses incurred by the schools. Amounts recorded as revenues for the three months ended September 30, 2019 and 2018 were $85.5 million and $88.3 million, respectively.

Institutional

The products and services delivered to the Company’s Institutional customers include curriculum and technology for full-time virtual and blended programs, as well as instruction, curriculum and associated materials, supplemental courses, marketing, enrollment and other educational services. Each of these contracts are considered to be one performance obligation under ASC 606.

The Company provides certain online curriculum and services to schools and school districts under subscription agreements. Revenues from the licensing of curriculum under subscription arrangements are recognized on a ratable basis over the subscription period. Revenues from professional consulting, training and support services are deferred and recognized ratably over the service period.

Private Pay Schools and Other

Private Pay Schools and Other revenues are generated from individual customers who prepay and have access for one to two years to company-provided online curriculum. Each of these contracts are considered to be one performance obligation under ASC 606. The Company recognizes these revenues pro rata over the maximum term of the customer contract.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Disaggregated Revenues

The following table presents the Company’s revenues disaggregated based on its three lines of business for the three months ended September 30, 2019 and 2018:


	Three Months Ended		Three Months Ended
	September 30, 2019		September 30, 2018
	(In thousands)		(In thousands)

Managed Public School Programs	$	227,534	$	220,543

Institutional
Non-managed Public School Programs		9,574		11,405
Institutional Software & Services		11,354		11,094
Total Institutional		20,928		22,499
Private Pay Schools and Other		8,659		8,272
Total Revenues	$	257,121	$	251,314

Concentration of Customers

During the three months ended September 30, 2019 and 2018, the Company had one contract that represented greater than 10% of total revenues.

Contract Balances

The timing of revenue recognition, invoicing, and cash collection results in accounts receivable, unbilled receivables (a contract asset) and deferred revenue (a contract liability) in the condensed consolidated balance sheets. Accounts receivable is recorded when there is an executed customer contract and the customer is billed. The collectability of outstanding receivables is evaluated regularly by the Company and an allowance is recorded to reflect probable losses. Unbilled receivables are created when revenue is earned prior to the customer being billed. Deferred revenue is recorded when customers are billed in advance of services being provided.

The opening and closing balances of the Company’s accounts receivable, unbilled receivables and deferred revenue are as follows:


	September 30,		June 30,
	2019		2019
	(In thousands)

Accounts receivable	$	267,690	$	191,639
Unbilled receivables (included in accounts receivable)		15,272		16,189
Deferred revenue		25,557		22,828
Deferred revenue, long-term (included in other long-term liabilities)		1,956		—

The difference between the opening and closing balance of the accounts receivable and unbilled receivables relates to the timing of the Company’s billing in relation to month end and contractual agreements. The difference between the opening and closing balance of the deferred revenue relates to the timing difference between billings to customers and the service periods under the contract. Typically, each of these balances are at their highest during the first quarter of the fiscal year and lowest at the end of the fiscal year. The amount of revenue recognized during the three months ended September 30, 2019 that was included in the opening July 1, 2019 deferred revenue balance was $11.2 million. The amount of revenue recognized during the three months ended September 30, 2018 that was included in the opening July 1, 2018 deferred revenue balance was $11.8 million.

During the three months ended September 30, 2019 and 2018, the Company recorded revenues of $0.4 million and a reduction in revenues of $0.6 million, respectively, related to performance obligations satisfied in prior periods.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. For the majority of its contracts, the Company’s performance obligations are satisfied over time, as the Company delivers, and the customer receives the services, over the service period of the contract. The Company’s payment terms are generally net 30 or net 45, but can vary depending on when the school receives its funding from the state.

The Company has elected, as a practical expedient, not to report the value of unsatisfied performance obligations for contracts with customers that have an expected duration of one year or less. The amount of unsatisfied performance obligations for contracts with customers which extend beyond one year as of September 30, 2019 was $2.0 million.

Significant Judgments

The Company determined that the majority of its contracts with customers contain one performance obligation. The Company markets the products and services as an integrated package building off its curriculum offerings. It does not market distinct products or services to be sold independently from the curriculum offering.

The Company has determined that the time elapsed method as described under ASC 606 is the most appropriate measure of progress towards the satisfaction of the performance obligation. The Company delivers the integrated products and services package related to its Managed Public School Programs largely over the course of the Company’s fiscal year. This package includes enrollment, marketing, teacher training, etc. in addition to the core curriculum and instruction. All of these activities are necessary and contribute to the overall education of its students, which occurs evenly throughout the year. Accordingly, the Company will recognize revenue on a straight-line basis.

As discussed above, the Company estimates the total funds each school will receive in a particular school year and the amount of full-year school revenues and operating expenses to determine the amount of revenue the Company will receive. Enrollment is a key input to this estimate. To the extent the estimates change during the year, the cumulative impact of the change is recognized over the remaining service period.

Sales Taxes

Sales tax collected from customers is excluded from revenues. Collected but unremitted sales tax is included as part of accrued liabilities in the accompanying consolidated balance sheets. Revenues do not include sales tax as the Company considers itself a pass-through conduit for collecting and remitting sales tax.

Consolidation

The condensed consolidated financial statements include the accounts of the Company, the wholly-owned and affiliated companies that the Company owns, 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 virtual 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 net realizable value. The Company classifies its inventory as current or long-term based on the holding period. As of September 30, 2019 and June 30, 2019, $4.0 million and $4.1 million, respectively, of inventory was deemed long-term and included in deposits and other assets on the condensed consolidated balance sheets. The provision for excess and obsolete inventory is established based upon the evaluation of the quantity on hand relative to demand. The excess and obsolete inventory reserve was $4.0 million and $4.1 million at September 30, 2019 and June 30, 2019, respectively.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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 and amortization 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 842.

Property and equipment are depreciated over the following useful lives:


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

The Company makes an estimate of unreturned student computers based on an analysis of recent trends of returns. The Company recorded accelerated depreciation of $0.6 million and $0.5 million for the three months ended September 30, 2019 and 2018, respectively, related to unreturned student computers. Depreciation expense for property and equipment, including accelerated depreciation, for the three months ended September 30, 2019 and 2018 was $5.1 million and $5.6 million, respectively.

The Company fully expenses computer peripheral equipment (e.g. keyboards, mouses) upon purchase as recovery has been determined to be uneconomical. These expenses totaled $2.5 million and $2.7 million for the three months ended September 30, 2019 and 2018, respectively, and are recorded as instructional costs and services.

Capitalized Software Costs

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 (“ASC 350”). 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 additions totaled $7.2 million and $9.3 million for the three months ended September 30, 2019 and 2018, respectively. Amortization expense for the three months ended September 30, 2019 and 2018 was $6.9 million and $7.7 million, respectively.

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

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

phases of the project. 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 are amortized is generally five years.

Total capitalized curriculum development additions were $8.5 million and $6.7 million for the three months ended September 30, 2019 and 2018, respectively. These amounts are recorded on the accompanying condensed consolidated balance sheets net of amortization charges. Amortization is recorded in instructional costs and services on the accompanying condensed consolidated statements of operations. Amortization expense for the three months ended September 30, 2019 and 2018 was $4.4 million and $4.5 million, respectively.

Leases

The Company’s principal leasing activities include student computers and peripherals, classified as finance leases, and facilities, classified as operating leases.

Under ASC 842, for a lessee, leases are classified as operating leases unless they meet any of the criteria below to be classified as a finance lease:

●

the lease transfers ownership of the asset at the end of the lease;

●

the lease grants an option to purchase the asset which the lessee is expected to exercise;

●

the lease term reflects a major part of the asset’s economic life;

●

the present value of the lease payments equals or exceeds the fair value of the asset; or

●

the asset is specialized with no alternative use to the lessor at the end of the term.

Finance Leases

The Company enters into agreements to finance the purchase of student computers and peripherals provided to students of its schools. Individual leases typically include 1 to 3-year payment terms, at varying rates, with a $1 purchase option at the end of each lease term. The Company pledges the assets financed to secure the outstanding leases.

Operating Leases

The Company enters into agreements for facilities that serve as offices for its headquarters, sales and enrollment teams, and school operations. Initial lease terms vary between 1 and 10 years. Certain leases include renewal options, usually based upon current market rates, as well as termination rights. The Company performs an evaluation of each lease to determine if the lease payments included in the renewal option should be included in the initial measurement of the lease liability. As of the adoption date, the remaining lease terms varied between 1 and 5 years and the Company concluded that renewal options on the existing leases would be excluded from the determination of the initial lease liability.

Discount Rate

Under ASC 842, the present value of the lease payments is calculated using either the rate implicit in the lease, or the lessee’s incremental borrowing rate, over the lease term. For the Company’s finance leases, the stated rate is defined within the lease terms; while for the Company’s operating leases, the rate is not implicit. For operating leases, the Company uses its incremental borrowing rate as the discount rate; determined as the Company’s borrowing rate on a collateralized basis for a similar term and amount to the term and amount of the lease.

The Company utilizes its agreements used for its finance leases as the basis for calculating its incremental borrowing rate. The rate is collateralized and its term reflects a similar term of the remaining lease payments of the Company’s largest

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

operating lease. As of the adoption date, the incremental borrowing rate was 3.86%. The incremental borrowing rate is subsequently reassessed upon modification of its leasing arrangements or with the execution of a new lease agreement.

Policy Elections

Short-term Leases

The Company has elected as an on-going accounting policy election not to apply ASC 842 to short-term facility leases of 12 months or less. By making this election, the Company will not record a right-of-use asset or lease liability at the commencement of the lease, and will continue to expense its lease payments on a straight-line basis over the lease term. The accounting policy election is made by class of underlying asset to which the right of use relates. The Company has elected to apply the accounting policy election only to operating leases.

Income Taxes

The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740”). 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.

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, acquired customers and distributors, developed technology and non-compete agreements. Such intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortization expense for the three months ended September 30, 2019 and 2018 was $0.7 million and $0.7 million, respectively. Future amortization of intangible assets is expected to be $2.1 million , $2.4 million, $2.2 million, $2.0 million, and $1.4 million in the fiscal years ending June 30, 2020 through June 30, 2024, respectively and $3.8 million thereafter. At September 30, 2019 and June 30, 2019, the goodwill balance was $90.2 million.

The Company reviews its 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. There were no such events during the three months ended September 30, 2019 and 2018.

ASC 350 prescribes a two-step 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 based on one reporting unit. ASC 350 also allows preparers to qualitatively assess goodwill impairment through a screening process which would permit companies to forgo Step 1 of their annual goodwill impairment process. This qualitative screening process will hereinafter be referred to as “Step 0”. The Company performs its annual assessment on May 31st. During the year ended June 30, 2019, the Company performed “Step 0” of the impairment test and determined that there were no facts and circumstances that indicated that the fair value of the reporting unit may be less than its carrying amount, and as a result, the Company determined that no impairment was required. During the three months ended September 30, 2019 and 2018, there were no events or changes in circumstances that would indicate that the carrying amount of the goodwill was impaired.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table represents the balance of the Company’s intangible assets as of September 30, 2019 and June 30, 2019:


	September 30, 2019						June 30, 2019
($ in millions)	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value		Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
Trade names	$	17.6	$	(9.6)	$	8.0	$	17.6	$	(9.4)	$	8.2
Customer and distributor relationships		20.5		(15.1)		5.4		20.5		(14.7)		5.8
Developed technology		3.2		(2.9)		0.3		3.2		(2.8)		0.4
Other		1.4		(0.9)		0.5		1.4		(0.8)		0.6
Total	$	42.7	$	(28.5)	$	14.2	$	42.7	$	(27.7)	$	15.0

Impairment of Long-Lived Assets

Long-lived assets include property, equipment, right-of-use assets, capitalized curriculum and software developed or obtained for internal use. In accordance with ASC 360, Property, Plant and Equipment (“ASC 360”), management reviews the Company’s recorded long-lived assets for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The Company determines the extent to which an asset may be impaired based upon its expectation of the asset’s future usability as well as on a reasonable assurance that the future cash flows associated with the asset will be in excess of its carrying amount. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between fair value and the carrying value of the asset. There was no such impairment charge during the three months ended September 30, 2019 and 2018.

Fair Value Measurements

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

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

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

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

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

The carrying values reflected in the accompanying condensed consolidated balance sheets for cash and cash equivalents, receivables, and short and long term debt approximate their fair values. The lease exit liability is discussed in more detail in Note 9, “Restructuring.” The Tallo, Inc. convertible note is discussed in more detail in Note 10, “Acquisitions and Investments.”

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

There were no assets or liabilities measured at fair value on a nonrecurring basis at September 30, 2019 – see Note 9, “Restructuring.”

The following table summarizes certain fair value information at June 30, 2019 for assets or liabilities measured at fair value on a nonrecurring 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)

Lease exit liability

1,779

—

1,779

The following table summarizes certain fair value information at September 30, 2019 for assets or 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)

Convertible note received in acquisition

5,006

—

5,006

The following table summarizes certain fair value information at June 30, 2019 for assets or 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)

Convertible note received in acquisition

5,006

—

5,006

The following table presents activity related to the Company’s fair value measurements categorized as Level 3 of the valuation hierarchy, valued on a recurring basis, for the three months ended September 30, 2019 and 2018:

Three Months Ended September 30, 2019

Purchases,

Fair Value

Issuances,

Unrealized

Fair Value

Description

June 30, 2019

and Settlements

Gains/(Losses)

September 30, 2019

(In thousands)

Convertible note received in acquisition

5,006

—

5,006

Three Months Ended September 30, 2018

Purchases,

Fair Value

Issuances,

Unrealized

Fair Value

Description

June 30, 2018

and Settlements

Gains/(Losses)

September 30, 2018

(In thousands)

Contingent consideration associated with acquisitions

1,345

(200)

1,147

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Net Income (Loss) Per Common Share

The Company calculates net income (loss) per share in accordance with ASC 260, Earnings Per Share (“ASC 260”). Under ASC 260, 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. The weighted average number of shares of common stock outstanding includes vested restricted stock awards. Diluted net income (loss) per share (“EPS”) reflects 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 as income tax expense 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 net income (loss) per share when they are antidilutive. Common stock outstanding reflected in the Company’s condensed consolidated balance sheets includes restricted stock awards outstanding.

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


	Three Months Ended September 30,
	2019		2018
		(In thousands except share and per share data)
Basic and diluted net loss per share computation:

Net loss attributable to common stockholders	$	(9,730)	$	(8,282)
Weighted average common shares — basic		39,288,557		38,434,049
Weighted average common shares — diluted		39,288,557		38,434,049
Basic and diluted net loss per share	$	(0.25)	$	(0.22)

For the three months ended September 30, 2019 and 2018, 122,400 and 2,028,846 shares issuable in connection with stock options and restricted stock were excluded from the diluted income per share calculation because the effect would have been antidilutive. As of September 30, 2019, the Company had 46,290,570 shares issued and 40,955,827 shares outstanding.

Revision to Previously Issued Financial Statements

The Company has corrected the unaudited condensed consolidated statements of cash flows for the three, six, and nine month periods previously disclosed in the 2019 Form 10-Q’s to correct cash flows resulting from changes in accounts receivable and deferred revenue and other liabilities. The revisions are a result of an adjustment to the unaudited condensed consolidated balance sheets as of September 30, 2018, December 31, 2018, and March 31, 2019 to correct the overstatement of accounts receivable and deferred revenue as of each respective date. The adjustments had no impact on the consolidated balance sheet as of June 30, 2019, the consolidated statement of cash flows for the year ended June 30, 2019 or any consolidated statements of operations (audited or unaudited) reported in fiscal year 2019.


	Three Months Ended September 30, 2018						Six Months Ended December 31, 2018						Nine Months Ended March 31, 2019						Year Ended June 30, 2019
	As Previously				As Currently		As Previously				As Currently		As Previously				As Currently
	Reported		Adjustment		Reported		Reported		Adjustment		Reported		Reported		Adjustment		Reported		Adjustment
	(In thousands)

Changes in assets and liabilities:
Accounts receivable	$	(107,930)	$	15,346	$	(92,584)	$	(64,116)	$	11,942	$	(52,174)	$	(65,147)	$	6,421	$	(58,726)	$	—
Deferred revenue and other liabilities		42,837		(15,346)		27,491		24,795		(11,942)		12,853		24,510		(6,421)		18,089		—

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Additionally, certain previous year amounts have been reclassified to conform with current year presentations, as related to the impact of the adoption of ASC 842 and the Company’s presentation of deferred rent as a separate line item on the condensed consolidated balance sheet as of June 30, 2019. Deferred rent is now included in other long-term liabilities.

4. Income Taxes

The provision for income taxes is based on earnings reported in the condensed consolidated financial statements. A deferred income tax asset or liability is determined by applying currently enacted tax laws and rates to the expected reversal of the cumulative temporary differences between the carrying value of assets and liabilities for financial statement and income tax purposes. Deferred income tax expense or benefit is measured by the change in the deferred income tax asset or liability during the period. For the three months ended September 30, 2019 and 2018, the Company’s effective income tax rate was 47.5% and 37.9%, respectively.

5. Finance and Operating Leases

Finance Leases

The Company is a lessee under finance leases for student computers and peripherals under agreements with PNC Equipment Finance, LLC (“PNC”) and Banc of America Leasing & Capital, LLC (“BALC”). As of September 30, 2019 and June 30, 2019, the finance lease liability (“capital leases” as of June 30, 2019) was $25.5 million and $24.6 million, respectively, with interest rates ranging from 1.97% to 4.05%. As of September 30, 2019 and June 30, 2019, the balance of the associated right-of-use assets (“student computers” as of June 30, 2019) was $22.5 million and $19.8 million, respectively. The right-of-use asset is recorded within property and equipment, net on the condensed consolidated balance sheets. Lease amortization expense associated with the Company’s finance leases is recorded within selling, general, and administrative expenses on the condensed consolidated statements of operations.

Individual leases under the agreement with PNC include 36-month payment terms, at varying rates, with a $1 purchase option at the end of each lease term. The Company has pledged the assets financed to secure the outstanding leases.

The Company executed an agreement with BALC in February 2019 for $25.0 million to provide financing for its leases through December 2019 at a fluctuating rate of LIBOR plus 1.25%. Individual leases with BALC include 12-month payment terms, fixed rates ranging from 3.28% to 4.05%, and a $1 purchase option at the end of each lease term. The Company has pledged the assets financed to secure the outstanding leases.

The following is a summary as of September 30, 2019 (under ASC 842) and June 30, 2019 (under ASC 840), respectively, of the present value of the minimum lease payments on finance leases under the Company’s commitments:


	September 30, 2019		June 30, 2019
	(in thousands)

2020	$	18,749	$	20,070
2021		6,937		4,819
2022		340		340
Total minimum payments		26,026		25,229
Less: imputed interest		(512)		(581)
Finance lease liability		25,514		24,648
Less: current portion of finance lease liability		(22,019)		(19,588)
Long-term finance lease liability	$	3,495	$	5,060

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Operating Leases

The Company is a lessee under operating leases for various facilities to support the Company’s operations. As of September 30, 2019 and June 30, 2019, the operating lease liability was $25.4 million and zero, respectively. As of September 30, 2019 and June 30, 2019, the balance of the associated right-of-use assets was $20.9 million and zero, respectively. The right-of-use asset is recorded within deposits and other assets on the condensed consolidated balance sheets. Lease expense associated with the Company’s operating leases are recorded within selling, general, and administrative expenses on the condensed consolidated statements of operations.

Individual operating leases range in terms of 1 to 7 years that expire through fiscal year 2026 and the minimum lease payments are discounted using the Company’s incremental borrowing rate of 3.86%.

The following is a summary as of September 30, 2019 (under ASC 842) and June 30, 2019 (under ASC 840), respectively of the present value of the minimum lease payments on operating leases under the Company’s commitments:


	September 30, 2019		June 30, 2019
	(in thousands)

2020	$	6,853	$	8,441
2021		9,232		8,229
2022		7,771		6,735
2023		1,570		550
2024		1,039		137
Thereafter		615		—
Total minimum payments		27,080	$	24,092
Less: imputed interest		(1,661)
Operating lease liability		25,419
Less: current portion of operating lease liability		(8,371)
Long-term operating lease liability	$	17,048

The Company is subleasing two of its facilities through June 2021 and May 2022. The following is a summary as of September 30, 2019 and June 30, 2019, respectively, of the sublease income:


	September 30, 2019		June 30, 2019
	(in thousands)

2020	$	716	$	930
2021		955		961
2022		509		528
Total sublease income	$	2,180	$	2,419

The following is a summary of the Company’s lease cost, weighted-average remaining lease term, weighted-average discount rate and certain other cash flows as it relates to its operating leases for the three months ended September 30, 2019:

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued


		Three months ended
		September 30, 2019

Lease cost

Finance lease cost:
Amortization of right-of-use assets	$	3,945
Interest on lease liabilities		203
Operating lease cost		1,607
Short-term lease cost		389
Sublease income		(188)
Total lease cost	$	5,956

Other information

Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	(2,073)
Financing cash flows from finance leases		(7,460)
Right-of-use assets obtained in exchange for new finance lease liabilities		6,446
Right-of-use assets obtained in exchange for new operating lease liabilities		4,847
Weighted-average remaining lease term - finance leases		1.10	yrs.
Weighted-average remaining lease term - operating leases		3.21	yrs.
Weighted-average discount rate - finance leases		3.54	%
Weighted-average discount rate - operating leases		3.86	%

6. Equity Incentive Plan

On December 15, 2016 (the “Effective Date”), the Company’s stockholders approved the 2016 Incentive Award Plan (the “Plan”). The Plan is designed to attract, retain and motivate employees who make important contributions to the Company by providing such individuals with equity ownership opportunities. Awards granted under the Plan may include stock options, stock appreciation rights, restricted stock, restricted stock units, and other stock-based awards. Under the Plan, the following types of shares go back into the pool of shares available for issuance:

●

unissued shares related to forfeited or cancelled restricted stock and stock options from Plan awards and Prior Plan awards (that were outstanding as of the Effective Date); and

●

shares tendered to satisfy the tax withholding obligation related to the vesting of restricted stock (but not stock options).

Unlike the Company’s 2007 Equity Incentive Award Plan (the “Prior Plan”), the Plan has no evergreen provision to increase the shares available for issuance; any new shares would require stockholder approval. The Prior Plan was set to expire in October 2017; however, with the approval of the Plan, the Company will no longer award equity from the Prior Plan. As of September 30, 2019, the remaining aggregate number of shares of the Company’s common stock authorized for future issuance under the Plan was 1,381,835. As of September 30, 2019, there were 5,211,706 shares of the Company’s common stock that remain outstanding or nonvested under the Plan and Prior Plan.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Stock Options

Stock option activity including stand-alone agreements during the three months ended September 30, 2019 was as follows:


				Weighted
		Weighted		Average
		Average		Remaining	Aggregate
		Exercise		Contractual	Intrinsic
	Shares	Price		Life (Years)	Value
Outstanding, June 30, 2019	1,036,017	$	19.82
Granted	—		—
Exercised	(2,500)		16.90
Forfeited or canceled	—		—
Outstanding and exercisable, September 30, 2019	1,033,517	$	19.83	2.38	$	7,568,280

The total intrinsic value of options exercised during each of the three months ended September 30, 2019 and 2018 was $0.0 million. During the three months ended September 30, 2019 and 2018, the Company recognized $0.1 million and $0.2 million, respectively, of stock-based compensation expense related to stock options.

Restricted Stock Awards

Restricted stock award activity during the three months ended September 30, 2019 was as follows:


		Weighted
		Average
		Grant-Date
	Shares	Fair Value
Nonvested, June 30, 2019	1,322,552	$	17.08
Granted	918,702		28.12
Vested	(433,673)		15.09
Canceled	(34,090)		20.96
Nonvested, September 30, 2019	1,773,491	$	23.21

Performance Based Restricted Stock Awards (included above)

During the three months ended September 30, 2019, 499,818 new performance based restricted stock awards were granted and 567,433 remain nonvested at September 30, 2019. During the three months ended September 30, 2019, 203,538 performance based restricted stock awards vested. Vesting of the performance based restricted stock awards is contingent on the achievement of certain financial performance goals and service vesting conditions.

Included above are 358,294 performance based restricted stock awards that were granted to the Company’s CEO with a weighted average grant-date fair value of $27.91 per share. These awards were granted pursuant to the Plan and are subject to the achievement of target free cash flow metrics in each of the fiscal years 2020 through 2022. The metrics are measured at the end of each fiscal year; however the first two-thirds of the award will not vest until fiscal year 2021. The remaining one-third will vest in fiscal year 2022, if achieved. Additionally, if either of the first two tranches are not achieved, the awards may still vest if the free cash flow metric in aggregate, is met over the three-year life of the award. The Company is currently amortizing these awards over their vesting periods because it believes that it is probable that the free cash flow targets will be met each year.

Included above are 141,524 performance based restricted stock awards that were granted to the Company’s named executive officers (“NEOs”) with a weighted average grant-date fair value of $27.91 per share. These awards were granted pursuant to the Plan and are subject to the achievement of Adjusted EBITDA metrics in fiscal year 2020. If achieved, one-third of the award will vest immediately, and the remaining two-thirds will vest annually over two years. The Company is

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

currently amortizing these awards over their vesting periods because it believes that it is probable that the Adjusted EBITDA metric will be achieved at target for fiscal year 2020.

Equity Incentive Market Based Restricted Stock Awards (included above)

During fiscal year 2017, the Company granted equity incentive market based restricted stock awards which were subject to the attainment of an average stock price of $14.35 for 30 consecutive days after the date of the Company’s earnings release for the fourth quarter and fiscal year ended June 30, 2017. During the three months ended September 30, 2019, the remaining 6,800 equity incentive market based restricted stock awards vested.

Service Based Restricted Stock Awards (included above)

During the three months ended September 30, 2019, 418,884 new service based restricted stock awards were granted and 1,206,058 remain nonvested at September 30, 2019. During the three months ended September 30, 2019, 223,335 service based restricted stock awards vested.

Summary of All Restricted Stock Awards

As of September 30, 2019, there was $35.7 million of total unrecognized compensation expense related to nonvested restricted stock awards. The cost is expected to be recognized over a weighted average period of 2.1 years. The fair value of restricted stock awards granted for the three months ended September 30, 2019 and 2018 was $25.8 million and $12.5 million, respectively. The total fair value of shares vested for the three months ended September 30, 2019 and 2018 was $11.9 million and $8.7 million, respectively. During the three months ended September 30, 2019 and 2018, the Company recognized $4.0 million and $3.9 million, respectively, of stock-based compensation expense related to restricted stock awards.

Performance Share Units (“PSU”)

Certain PSUs vest upon achievement of performance criteria associated with a Board-approved Long Term Incentive Plan (“LTIP”) and continuation of employee service over a defined period. The level of performance will determine the number of PSUs earned as measured against threshold, target and outperform achievement levels of the LTIP. Each PSU represents the right to receive one share of the Company’s common stock, or at the option of the Company, an equivalent amount of cash, and is classified as an equity award in accordance with ASC 718.

In addition to the LTIP performance conditions, there is a service vesting condition which is dependent upon continuing service by the grantee as an employee of the Company, unless the grantee is eligible for earlier vesting upon a change in control and qualifying termination, as defined by the PSU agreement. For equity performance awards, including the PSUs, subject to graduated vesting schedules for which vesting is based on achievement of a performance metric in addition to grantee service, stock-based compensation expense is recognized on an accelerated basis by treating each vesting tranche as if it was a separate grant.

Fiscal Year 2019 LTIP

During fiscal year 2019 and first quarter of fiscal year 2020, the Company granted 278,135 PSUs at target under a LTIP that was driven by certain revenue targets and enrollment levels, as well as students’ academic progress. These PSUs had a grant date fair value of $8.3 million, or a weighted average grant-date fair value of $29.95 per share. Forty-five percent of the earned award is based on students’ academic progress (“Tranche #1”) and twenty-five percent of the earned award is based on certain enrollment levels (“Tranche 2”), both of which will vest on October 15, 2021. The remaining thirty percent of the earned award is based on certain revenue targets (“Tranche #3”) and will vest on August 15, 2022. In all cases, vesting is dependent upon continuing service by the grantee as an employee of the Company. The Company determined the achievement of the performance conditions associated with all three tranches were not probable and therefore no expense was recorded during the three months ended September 30, 2019.

Fiscal Year 2019 SPP

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

During fiscal year 2019, the Company adopted a new long-term shareholder performance plan (“2019 SPP”) that provides for incentive award opportunities to its key senior executives. The awards were granted in the form of PSUs and will be earned based on the Company’s market capitalization growth over a completed three-year performance period. The 2019 SPP was designed to provide the executives with a percentage of shareholder value growth. No amounts will be earned if total stock price growth over the three-year period is below 25% (7.6% annualized). An amount of 6% of total value growth will be earned based on achieving total stock price growth of 33% (10% annualized) and a maximum of 7.5% of total value growth will be earned if total stock price growth equals or exceeds 95% (25% annualized).

During fiscal year 2019, the Company granted 2,108,305 PSUs at a weighted average grant-date fair value of $8.18 per share, based on the highest level of performance. The final amount of PSUs will be determined (and vesting will occur) based on the 30-day average price of the Company’s stock subsequent to seven days after the release of fiscal year 2021 results. The fair value was determined using a Monte Carlo simulation model and will be amortized on a straight-line basis over the vesting period.

Summary of All Performance Share Units

As of September 30, 2019, there was $11.8 million of total unrecognized compensation expense related to nonvested PSUs. The cost is expected to be recognized over a weighted average period of 2.0 years. During the three months ended September 30, 2019 and 2018, the Company recognized $1.6 million and $0.1 million, respectively, of stock-based compensation expense related to PSUs.

Performance share unit activity during the three months ended September 30, 2019 was as follows:


		Weighted
		Average
		Grant-Date
	Shares	Fair Value
Nonvested, June 30, 2019	2,372,241	$	10.61
Granted	14,199		28.17
Vested	—		—
Canceled	—		—
Nonvested, September 30, 2019	2,386,440	$	10.71

Deferred Stock Units (“DSU”)

During fiscal year 2019, the Company granted 18,258 DSUs at a weighted average grant-date fair value of $25.41 per share. The DSUs vest on the grant-date anniversary and are settled in the form of shares of common stock issued to the holder upon separation from the Company. The DSUs are excluded from the tables above. As of September 30, 2019, 18,258 DSUs remain nonvested.

7. Related Party Transactions

During fiscal years 2020 and 2019, the Company contributed to The Foundation for Blended and Online Learning (“Foundation”). The Foundation is a related party as an executive officer of the Company serves on the Board of the Foundation. For the three months ended September 30, 2019 and 2018, contributions made by the Company to the Foundation were $0.4 million and $0.6 million, respectively. The amounts shown for fiscal year 2020 were accrued in fiscal year 2019, and as of September 30, 2019, $2.0 million remains outstanding.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

8. Commitments and Contingencies

Litigation

In the ordinary conduct of the Company’s business, the Company is subject to lawsuits, arbitrations and administrative proceedings from time to time. The Company vigorously defends these claims; however, no assurances can be given as to the outcome of any pending legal proceedings. The Company believes, based on currently available information, that the outcome of any existing or known threatened proceedings, even if determined adversely, should not have a material adverse effect on its business, financial condition, liquidity or results of operations.

On July 20 and September 15, 2016, two securities class action lawsuits—captioned Babulal Tarapara v. K12 Inc., et al., Case No. 3:16-cv-04069, and Gil Tuinenburg v. K12 Inc., et al., Case No. 3:16-cv-05305, respectively—were filed against the Company, two of its officers and one of its former officers in the United States District Court for the Northern District of California. On October 6, 2016, the Court consolidated the cases and recaptioned the matter as In Re K12 Inc. Securities Litigation, Master File No. 4:16-cv-04069-PJH. On August 30, 2017, the Court dismissed the plaintiffs’ claims alleging false or misleading statements and omissions related to Scantron results and the quality and effectiveness of K12’s academic services and offerings. On September 5, 2018, and as a result of a Court ordered mediation, the parties reached an agreement in principle to settle the remaining claim concerning disclosure of a notice of non-automatic renewal of a managed school contract. Although the Company believes that the remaining claim in this matter lacked merit, it agreed to settle the case to avoid continued distraction and management time, and the Company’s insurance carriers agreed to pay $3.5 million into a settlement fund for the alleged class and attorneys’ fees and costs. The Court preliminarily approved the proposed settlement on February 14, 2019, and granted the plaintiffs’ motion for final settlement approval on July 10, 2019.

On May 10, 2019, K12 Virtual Schools LLC filed a demand for arbitration with the American Arbitration Association (“AAA”), Case No. 01-19-001-4778, naming Georgia Cyber Academy, Inc. (“GCA”) and Georgia Cyber Academy Board as the respondents. The demand asserts claims for GCA’s breach and anticipatory breach of the Educational Products and Services Agreement between GCA and K12 Virtual Schools LLC, as amended on January 4, 2019, based on GCA’s engagement of other educational products and service providers for the school year 2019-2020. On May 29, 2019, GCA filed counterclaims against K12 Virtual Schools, LLC for breach of contract, fraud, breach of the duty of good faith and fair dealing, and negligent misrepresentation. On June 12, 2019, the AAA appointed an arbitrator. The arbitration proceedings are continuing, and discovery is ongoing.

The Company is presently unable to predict the outcome of this arbitration, though it does not expect that the outcome will have a material adverse effect on our financial condition or results of operations. K12 intends to pursue vigorously its claims against GCA, and defend vigorously against each and every counterclaim set forth by GCA.

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 the agreement with the Company’s Chairman and Chief Executive Officer with an amended extended term to September 30, 2022, all other agreements provide for employment on an “at-will” basis. If the employee resigns for “good reason” or is terminated without cause, the employee is entitled to salary continuation, and in some cases benefit continuation, for varying periods depending on the agreement.

Off-Balance Sheet Arrangements

As of September 30, 2019, the Company provided guarantees of approximately $1.4 million related to lease commitments on the buildings for certain of the Company’s schools.

In addition, the Company contractually guarantees that certain schools under the Company’s management will not have annual operating deficits and the Company’s management fees from these schools may be reduced accordingly to cover any school operating deficits.

Table of Contents

K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Other than these lease and operating deficit guarantees, the Company did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

9. Restructuring

In the third quarter of fiscal year 2017, the Company exited three facilities that were no longer being utilized, which were subject to operating leases. In aggregate, during fiscal year 2017, the Company recorded an impairment of $5.4 million for the three leases. As part of the adoption of ASC 842, the lease impairment liability of $1.8 million as of June 30, 2019 was offset against the right-of-use asset.

10. Acquisition and Investments

Investments in Limited Partnerships

During the fiscal year 2019, the Company invested in two early stage funds focused on career education with a total commitment of $13.0 million. As of September 30, 2019, the Company has contributed an aggregate $2.7 million to these funds: $1.5 million is recorded at cost and will be adjusted, as necessary, for impairment; and $1.2 million is recorded under the equity method of accounting. The Company’s investments in these funds are included in deposits and other assets on the condensed consolidated balance sheet.

Investment in Tallo, Inc.

In August 2018, the Company invested $6.7 million for a 39.5% minority interest in Tallo, Inc. (“Tallo”). This investment in preferred stock that contains additional rights over common stock and has no readily determinable fair value, was recorded at cost and will be adjusted, as necessary, for impairment. In the event Tallo issues equity at a materially different price than what the Company paid, the Company would also assess changing the carrying value. Tallo also issued a convertible note to the Company for $5.0 million that will be accounted for as an available-for-sale debt security and adjusted to fair value quarterly. The note bears interest at the mid-term Applicable Federal Rate plus 25 bps per annum with a maturity of 48 months. The note is convertible at the Company’s option into 3.67 million Series D Preferred Shares that would give the Company an effective ownership of 56% if exercised. The Company’s investment in Tallo is included in deposits and other assets on the condensed consolidated balance sheets.

11. Supplemental Disclosure of Cash Flow Information


	Three Months Ended September 30,
	2019		2018
	(In thousands)
Cash paid for interest	$	203	$	263

Cash paid for taxes	$	2,168	$	541

Right-of-use assets obtained as a result of the adoption of ASC 842	$	17,652	$	—

Supplemental disclosure of non-cash financing activities:
Right-of-use assets obtained in exchange for new finance lease liabilities (1)	$	6,446	$	15,192

Supplemental disclosure of non-cash investing activities:
Stock-based compensation expense capitalized on software development	$	27	$	31
Stock-based compensation expense capitalized on curriculum development	$	45	$	54

(1) Previously referred to as property and equipment financed by capital lease obligations, including student peripherals.

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, 2019, 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 elsewhere 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 ended September 30, 2019.

●

Critical Accounting Policies and Estimates — a discussion of critical accounting policies requiring 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 and quantitative and qualitative disclosures about market risk.

Executive Summary

We are a technology-based education company and offer proprietary and third party curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12. Our learning systems combine curriculum, instruction and related support services to create an individualized learning approach. Our learning systems are well-suited for virtual and blended public schools, school districts, charter schools, and private schools that utilize varying degrees of online and traditional classroom instruction, and other educational applications. These products and services are provided through three lines of business: (1) Managed Public School Programs; (2) Institutional; and (3) Private Pay Schools and Other.

K12’s career readiness education (“CRE”) initiative offers online curriculum and career services to middle and high school students, under the Destinations Career Academy (“DCA”) brand name, which can provide services to all of our lines of business. The initiative is designed to give students a head start on their career goals by providing them with content pathways toward an industry certification, college credits, and work experiences.

Table of Contents


Managed Public School Programs	Institutional	Private Pay Schools and Other
● Virtual public schools	● Non-managed public school programs	● Private schools —K12 International Academy
● Blended public schools	● Institutional software and services	—George Washington University Online High School
● Destinations Career Academies / Career readiness education	● Destinations Career Academies / Career readiness course offerings	—The Keystone School
		● Private Destinations Career Academy (Private)

Managed Public School Programs accounted for approximately 88% of our revenues during the three months ended September 30, 2019. Our Managed Public School Programs offer an integrated package of systems, services, products, and professional expertise that we administer to support an online or blended public school. Customers for these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning system platforms and instructional services under the terms of a negotiated service agreement. We provide our Managed Public School Programs and DCA programs to virtual and blended public charter schools and school districts. These contracts are negotiated with and approved by the governing authorities of the customer. The duration of the Managed Public School Program service and product agreements are typically 2-5 years, and most provide for automatic renewals absent a customer notification within a negotiated time frame. During any fiscal year, the Company may enter into new Managed Public School agreements, receive non-automatic renewal notices, and negotiate replacement agreements, terminate the contract or receive notice of termination, or transition a school between a Managed Public School Program and a Non-managed Public School Program. The governing boards may also establish school policies and other terms and conditions over the course of a contract, such as enrollment parameters. The authorizers who issue the charters to our Managed Public School customers can renew, revoke, or modify those charters as well. We provided our Managed Public School Programs to 76 schools in 30 states and the District of Columbia.

Our Institutional business includes Non-managed public school programs and Institutional software and services where K12 offers curriculum, including career technical education (“CTE”) electives, and technology for full-time virtual and blended programs. In addition, we offer options whereby the school contracts with us for instruction, curriculum, supplemental courses, marketing, enrollment and other educational services and products. Unlike Managed Public School Programs, the Institutional business does not offer primary administrative support services, which remain the responsibility of the school district or the school customer. In addition to curriculum, platforms and programs, the services we offer to Institutional clients also can assist them in launching their own online and blended learning programs tailored to their own requirements and may include instructional support, reporting tools and content libraries. We work closely as a partner with school districts, public schools, charter schools, private companies, and private schools to provide them with educational solutions. For the 2018-19 school year, we served school districts or schools in all 50 states and the District of Columbia.

Our Private Pay Schools and Other includes three accredited, tuition-based private schools that meet a range of student needs from individual course credit recovery to college preparatory programs. These schools are: (1) K12 International Academy and its DCA program, 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, (2) The Keystone School, a private school that offers online and correspondence courses, and (3) the George Washington University Online High School, a school that offers a college preparatory program and is designed for middle and high school students who are seeking a challenging academic experience.

For the three months ended September 30, 2019, revenues increased to $257.1 million from $251.3 million in the prior year, an increase of 2.3%. Over the same period, operating loss increased to $19.4 million, from $13.8 million in the prior year, an increase of 40.6%. Net loss to common stockholders was $9.7 million, as compared to $8.3 million in the prior year, an increase of 16.9%.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) 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

Table of Contents

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. Other than leases (discussed below), there have been no significant updates to our critical accounting policies disclosed in our Annual Report.

Leases

The Company’s principal leasing activities include student computers and peripherals, classified as finance leases, and facilities, classified as operating leases.

Finance Leases

Operating Leases

Discount Rate

For the Company’s finance leases, the stated rate is defined within the lease terms; while for the Company’s operating leases, the rate is not implicit. For operating leases, the Company uses its incremental borrowing rate as the discount rate; determined as the Company’s borrowing rate on a collateralized basis for a similar term and amount to the term and amount of the lease. Based on its current population of operating lease liabilities, a 1% change in the incremental borrowing rate would result in a $0.5 million change in the initial present value of the operating lease liability.

Results of Operations

We have three lines of business: (1) Managed Public School Programs; (2) Institutional; and (3) Private Pay Schools and Other.

Enrollment Data

The following table sets forth total enrollment data for students in our Managed Public School Programs and Non-managed Public School Programs. Our Managed Public School Programs offer an integrated package of systems, services, products, and professional expertise that we administer to support an online or blended public school. Customers for these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning system platforms and instructional services under the terms of a negotiated service agreement. Unlike Managed Public School Programs, Non-managed Public School Programs do not offer comprehensive administrative support services, which remain the responsibility of the school district or the school customer. Rather, Non-Managed Public School Programs offer options whereby the school can contract for instruction, curriculum, supplemental courses, marketing, enrollment and other educational services. Enrollments in Managed Public School Programs on average generate more revenues than enrollments served through our Institutional business where we provide limited or no management services. We do not award or permit incentive compensation to be paid to our public school program enrollment staff or contractors based on the number of students enrolled. If the mix of enrollments changes, our revenues will be impacted to the extent the average revenues per enrollments are significantly different. For example, the independent board of the Georgia Cyber Academy (“GCA”) has acted to engage other service providers with respect to curriculum and other managed school services for the 2019-2020 school year even though our exclusive contract with GCA provides that we are to be the sole provider of those services during the school year. The student enrollment data and revenues from GCA for the 2018-2019 school year are classified under the Managed Public School Programs in the tables below. The average quarterly enrollment of students at GCA during its most recent school year was almost 10,000. As set forth in Part I, Item 3 of the

Table of Contents

Form 10-K filed on August 7, 2019, on May 10, 2019 we filed a confidential arbitration demand against GCA and its Board to seek enforcement of our exclusive contract. We continue to provide limited products and services to GCA and we are receiving a minimal amount of revenue for those products and services. The types and extent of services we may end up providing to GCA for the current school year are unclear at this time.


	Three Months Ended
	September 30,				2019 / 2018
	2019		2018		Change		Change %
	(In thousands, except percentages)

Managed Public School Programs (1)(2)		122.3		118.8		3.5	2.9%
Non-managed Public School Programs (1)		15.6		23.8		(8.2)	(34.5%)

(1)

If a school changes from a Managed to a Non-managed Public School Program, the corresponding enrollment classification would change in the period in which the contract arrangement changed. Enrollments reported for the first quarter are equal to the official count date number, which is the first Wednesday of October in a year, or October 2, 2019 for the first quarter of fiscal year 2020 and October 3, 2018 for the first quarter of fiscal year 2019.

(2)	Managed Public School Programs include enrollments for which K12 receives no public funding or revenue.

Revenues by Business Lines

Revenues are captured by business line based on the underlying customer contractual agreements. Periodically, a customer may change business line classification. Alternatively, a Managed Public School may become a Non-managed Public School and seek to renegotiate an existing contract or the scope of services we provide to the school. A re-classification of a public school from one business line to another would be reflected in our disclosure of revenues and total student enrollment between the two business lines. For example, a district that purchases a single course (Institutional business customer) may decide to convert to a full-time virtual school program (Managed Public School customer). Changes in business line classification occur at the time the contractual agreement is modified. The mix of our revenue between our Managed Public School Programs and our Institutional business could change as one or more of our managed schools transitions to a self-managed model such that we would provide only selected services to the school. This transition could occur due to a change in focus sought by the independent school board, or by state legislative or regulatory developments, and thus reducing revenue we generate from the school. The following represents our revenues for each of the periods indicated:




	Three Months Ended
	September 30,				Change 2019 / 2018
	2019		2018		$		%
	(In thousands, except percentages)

Managed Public School Programs	$	227,534	$	220,543	$	6,991	3.2%
Institutional
Non-managed Public School Programs		9,574		11,405		(1,831)	(16.1%)
Institutional Software & Services		11,354		11,094		260	2.3%
Total Institutional		20,928		22,499		(1,571)	(7.0%)
Private Pay Schools and Other		8,659		8,272		387	4.7%
Total Revenues	$	257,121	$	251,314	$	5,807	2.3%

Table of Contents

Financial Information

The following table sets forth statements of operations data and the amounts as a percentage of revenues for each of the periods indicated:


	Three Months Ended September 30,
	2019				2018

Revenues	$	257,121	100.0	%	$	251,314	100.0	%
Instructional costs and services		169,358	65.9			158,985	63.3
Gross margin		87,763	34.1			92,329	36.7
Selling, general, and administrative expenses		107,151	41.7			106,081	42.2
Loss from operations		(19,388)	(7.5)			(13,752)	(5.5)
Interest income, net		910	0.4			316	0.1
Other income (expense), net		(8)	(0.0)			193	0.1
Loss before income taxes and loss from equity method investments		(18,486)	(7.2)			(13,243)	(5.3)
Income tax benefit		8,818	3.4			5,058	2.0
Loss from equity method investments		(62)	(0.0)			(97)	(0.0)
Net loss attributable to common stockholders	$	(9,730)	(3.8)	%	$	(8,282)	(3.3)	%

Comparison of the Three Months Ended September 30, 2019 and 2018

Revenues. Our revenues for the three months ended September 30, 2019 were $257.1 million, representing an increase of $5.8 million, or 2.3%, from $251.3 million for the same period in the prior year. Managed Public School Program revenues increased $7.0 million, or 3.2%, year over year. The increase in Managed Public School Program revenues was primarily due to the 2.9% increase in enrollments and increases in the per-pupil achieved funding, school mix (distribution of enrollments by school), and other factors.

Total Institutional revenues decreased $1.6 million, or 7.0%, primarily due to a 34.5% decline in enrollments in our Non-managed Public School Programs. Private Pay Schools and Other revenues increased $0.4 million, or 4.7%, over the prior year period.

Instructional costs and services expenses. Instructional costs and services expenses for the three months ended September 30, 2019 were $169.4 million, representing an increase of $10.4 million, or 6.5%, from $159.0 million for the same period in the prior year. This increase in expense was primarily due to the incremental personnel and related benefit costs associated with supporting higher enrollments. Instructional costs and services expenses were 65.9% of revenues during the three months ended September 30, 2019, an increase from 63.3% for the three months ended September 30, 2018.

Selling, general, and administrative expenses. Selling, general, and administrative expenses for the three months ended September 30, 2019 were $107.2 million, representing an increase of $1.1 million, or 1.0% from $106.1 million for the same period in the prior year. The increase was primarily due to an increase in personnel and related benefit costs. Selling, general, and administrative expenses were 41.7% of revenues during the three months ended September 30, 2019, a decrease from 42.2% for the three months ended September 30, 2018.

Income tax benefit. We had an income tax benefit of $8.8 million for the three months ended September 30, 2019, or 47.5% of loss before income taxes, as compared to $5.1 million, or 37.9% of loss before income taxes for the same period in the prior year. The increase in the effective tax rate for the three months ended September 30, 2019 was primarily due to an increase in the amount of non-deductible compensation.

Net loss. Net loss was $9.7 million for the three months ended September 30, 2019, compared to $8.3 million for the same period in the prior year, representing an increase of $1.4 million.

Table of Contents

Liquidity and Capital Resources

As of September 30, 2019, we had net working capital, or current assets minus current liabilities, of $358.6 million. Our working capital includes cash and cash equivalents of $165.9 million and accounts receivable of $267.7 million. Our working capital provides a significant source of liquidity for our normal operating needs. Our accounts receivable balance fluctuates throughout the fiscal year based on the timing of customer billings and collections and tends to be highest in our first fiscal quarter as we begin billing for students. In addition, our cash and accounts receivable were significantly in excess of our accounts payable and short-term accrued liabilities at September 30, 2019.

We incur capital lease obligations for student computers and peripherals under agreements with PNC Equipment Finance, LLC (“PNC”) and Banc of America Leasing & Capital, LLC (“BALC”). As of September 30, 2019 and June 30, 2019, the outstanding balance of capital leases was $25.5 million and $24.6 million, respectively, with lease interest rates ranging from 1.97% to 4.05%.

Individual leases with PNC include 36-month payment terms, at varying rates, with a $1 purchase option at the end of each lease term. We have pledged the assets financed to secure the outstanding leases.

We executed an agreement with BALC in February 2019 for $25.0 million to provide financing for our leases through December 2019 at a fluctuating rate of LIBOR plus 1.25%. Individual leases with BALC include 12-month payment terms, fixed rates ranging from 3.28% to 4.05%, and a $1 purchase option at the end of each lease term. We pledged the assets financed to secure the outstanding leases.

Our cash requirements consist primarily of day-to-day operating expenses, capital expenditures and contractual obligations with respect to office facility leases, capital equipment leases and other operating leases. We expect to make future payments on existing leases from cash generated from operations. We believe that the combination of funds to be generated from operations and net working capital on hand will be adequate to finance our ongoing operations for the foreseeable future. In addition, to a lesser degree, we continue to explore acquisitions, strategic investments and joint ventures related to our business that we may acquire using cash, stock, debt, contribution of assets or a combination thereof.

Operating Activities

Net cash used in operating activities for the three months ended September 30, 2019 was $86.8 million compared to $49.1 million for the three months ended September 30, 2018. The increase of $37.7 million in cash used in operations between periods was primarily due to changes in accounts receivable and accounts payable.

Investing Activities

Net cash used in investing activities for the three months ended September 30, 2019 was $18.2 million compared to $29.4 million for the three months ended September 30, 2018, a decrease of $11.2 million. The decrease is primarily due to the investment in Tallo, Inc. (FKA Stem Premier, Inc.) in August 2018.

Financing Activities

Net cash used in financing activities for the three months ended September 30, 2019 was $12.1 million compared to $9.6 million during the three months ended September 30, 2018, an increase of $2.5 million. The increase is primarily due to an increase in the repayment of finance lease obligations incurred for the acquisition of student computers of $4.0 million, partially offset by a decrease in the repurchase of restricted stock for income tax withholding of $1.4 million.

Off Balance Sheet Arrangements, Contractual Obligations and Commitments

As of September 30, 2019, we provided guarantees of approximately $1.4 million related to lease commitments on the buildings for certain of the Company’s schools.

In addition, we contractually guarantee that certain schools under our management will not have annual operating deficits and our management fees from these schools may be reduced accordingly to cover any school operating deficits.

Table of Contents

Other than these lease and operating deficit guarantees, 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

As of September 30, 2019 and June 30, 2019, we had cash and cash equivalents totaling $165.9 million and $283.1 million, respectively. Our excess cash has been invested primarily in U.S. Treasury money market funds although we may also invest in money market accounts, government securities, corporate debt securities and similar investments. Future interest and investment income is subject to the impact of interest rate changes and we may be subject to changes in the fair value of our investment portfolio as a result of changes in interest rates. At September 30, 2019, a 1% gross increase in interest rates earned on cash would result in a $1.7 million annualized increase in interest income.

Our short-term debt obligations under our revolving credit facility are subject to interest rate exposure; however, as we had no outstanding balance on this facility as of September 30, 2019, fluctuations in interest rates had no impact on our interest expense.

Foreign Currency Exchange Risk

We currently operate in several foreign countries, but we do not transact a material amount of business in a foreign currency. 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 operations in a foreign currency, we will be exposed to currency transaction risk and/or currency translation risk. Exchange rates between U.S. dollars and many foreign currencies have fluctuated significantly over the last few years and may continue to do so in the future. Accordingly, we may decide in the future to undertake hedging strategies to minimize the effect of currency fluctuations on our financial condition and results of operations.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(f) of the Exchange Act) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

We carried out an evaluation, required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Exchange Act, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this review, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2019.

Changes to Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Table of Contents

Part II. Other Information

Item 1. Legal Proceedings.

In the ordinary conduct of our business, we are subject to lawsuits, arbitrations and administrative proceedings from time to time. We vigorously defend these claims; however, no assurances can be given as to the outcome of any pending legal proceedings. We believe, based on currently available information, that the outcome of any existing or known threatened proceedings, even if determined adversely, should not have a material adverse effect on our business, financial condition, liquidity or results of operations.

On July 20 and September 15, 2016, two securities class action lawsuits—captioned Babulal Tarapara v. K12 Inc., et al., Case No. 3:16-cv-04069, and Gil Tuinenburg v. K12 Inc., et al., Case No. 3:16-cv-05305, respectively—were filed against the Company, two of its officers and one of its former officers in the United States District Court for the Northern District of California. On October 6, 2016, the Court consolidated the cases and recaptioned the matter as In Re K12 Inc. Securities Litigation, Master File No. 4:16-cv-04069-PJH. On August 30, 2017, the Court dismissed the plaintiffs’ claims alleging false or misleading statements and omissions related to Scantron results and the quality and effectiveness of K12’s academic services and offerings. On September 5, 2018, and as a result of a Court ordered mediation, the parties reached an agreement in principle to settle the remaining claim concerning disclosure of a notice of non-automatic renewal of a managed school contract. Although we believe that the remaining claim in this matter lacked merit, we agreed to settle the case to avoid continued distraction and management time, and our insurance carriers agreed to pay $3.5 million into a settlement fund for the alleged class and attorneys’ fees and costs. The Court preliminarily approved the proposed settlement on February 14, 2019, and granted the plaintiffs’ motion for final settlement approval on July 10, 2019.

On May 10, 2019, K12 Virtual Schools LLC filed a demand for arbitration with the American Arbitration Association (“AAA”), Case No. 01-19-001-4778, naming Georgia Cyber Academy, Inc. (“GCA”) and Georgia Cyber Academy Board as the respondents. The demand asserts claims for GCA’s breach and anticipatory breach of the Educational Products and Services Agreement between GCA and K12 Virtual Schools LLC, as amended on January 4, 2019, based on GCA’s engagement of other educational products and service providers for the school year 2019-2020. On May 29, 2019, GCA filed counterclaims against K12 Virtual Schools LLC for breach of contract, fraud, breach of the duty of good faith and fair dealing, and negligent misrepresentation. On June 12, 2019, the AAA appointed an arbitrator. The arbitration proceedings are continuing, and discovery is ongoing.

We are presently unable to predict the outcome of this arbitration, though we do not expect that the outcome will have a material adverse effect on our financial condition or results of operations. K12 intends to pursue vigorously its claims against GCA, and defend vigorously against each and every counterclaim set forth by GCA.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in “Risk Factors” in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 as filed with the SEC on August 7, 2019.

Item 2. Issuer Purchases of Equity Securities.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information.

None.

Table of Contents

Item 6. Exhibits

(a) Exhibits.

Number		Description

10.1		Second Amendment to Second Amended and Restated Employment Agreement of Nathaniel A. Davis, dated August 29, 2019 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the SEC on September 3, 2019, File No. 001-33883.
31.1		Certification of Principal Executive Officer Required Under Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2		Certification of Principal Financial Officer Required Under Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1		Certification of Principal Executive Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.
32.2		Certification of Principal Financial Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.
101		The following financial statements and footnotes from the K12 Inc. Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2019, formatted in Inline XBRL (Inline eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets (unaudited), (ii) Condensed Consolidated Statements of Operations (unaudited), (iii) Condensed Consolidated Statements of Comprehensive Income, (iv) Condensed Consolidated Statement of Equity (unaudited), (v) Condensed Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Condensed Consolidated Financial Statements (unaudited).
104		The cover page from this Quarterly Report on Form 10-Q, formatted in Inline XBRL (contained in Exhibit 101).

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		K12 Inc.

		/s/ JAMES J. RHYU
	Name:	James J. Rhyu
	Title:	Chief Financial Officer, Principal Accounting Officer and Authorized Signatory

Date: October 23, 2019