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LRN > SEC Filings for LRN > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for K12 INC

Form 10-Q for K12 INC


9-Nov-2012

Quarterly Report


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, 2012, which we refer to as our Annual Report. We undertake no obligation to publicly update or revise any forward-looking statements, including any changes that might result from any facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.

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

Executive Summary - a general description of our business and key highlights of the three months ended September 30, 2012.

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

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

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

Executive Summary

We are a technology-based education company. We offer proprietary curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade, or K-12. Our mission is to maximize a child's potential by providing access to an engaging and effective education, regardless of geographic location or socio-economic background. Since our inception, we have invested more than $320 million to develop and, to a lesser extent, acquire curriculum and online learning platforms that promote mastery of core concepts and skills for students of all abilities. K12 provides a continuum of technology-based educational products and solutions to districts, public schools, private schools, charter schools and families as we strive to transform the educational experience into one that delivers individualized education on a highly scalable basis.

Virtual and blended public schools generally under turn-key management contracts (Managed Public Schools) accounted for approximately 84% of our revenue in the three months ended September 30, 2012. We currently manage public schools in 32 states and the District of Columbia.


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We serve an increasing number of schools and school districts enabling them to offer our course catalog to students either full-time or on an individual course basis. We have a growing sales team to focus on this sector and, through our acquisitions of KC Distance Learning, or KCDL, and The American Education Corporation, or AEC, in 2010, we increased the size and expertise of our sales team, added a reseller network and expanded our course portfolio. The services we provide to these schools and school districts are designed to assist them in launching their own online learning programs which vary according to the needs of the individual school and school district and may include teacher training programs, administrator support and our PEAK12 management system. With our services, schools and districts can offer programs that allow students to participate full-time, as their primary school, or part-time, supplementing their education with core courses, electives, credit recovery options, remediation and supplemental content options. We continued to provide these services to school districts or individual schools in all 50 states and the District of Columbia.

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

For the three months ended September 30, 2012, we increased revenues to $221.1 million from $193.3 million in the same period in the prior year, a growth rate of 14.4%. Over the same period, operating income increased to $8.7 million from $8.3 million, a change of 4.8%, and net income to common stockholders decreased to $4.4 million from $4.6 million, a change of 4.3%. The increase in operating income was primarily due to increases in revenue from period to period, while the change in net income to common stockholders was due to an increase in the net income attributable to noncontrolling interests.

Recent Acquisitions, Strategic Investments and Equity Private Placement

During the last three years, we completed several strategic transactions to accelerate our growth, expand our course catalog and service offerings and extend our distribution capabilities. While these initiatives have expanded our markets and growth opportunities, we have incurred additional costs associated with acquiring, integrating and operating these acquired businesses.

Formation of Middlebury Interactive Languages LLC

In April 2010, we formed a joint venture with Middlebury College, known as MIL, to develop online foreign language courses. We contributed substantially all of the assets in our Power-Glide Language Courses Inc. subsidiary, along with certain intellectual property licenses and cash for a 60% interest in the joint venture. Middlebury College contributed a license to use its school name, its Middlebury-Monterey Language Academy business and cash for a 40% interest in the joint venture. As the majority and controlling owner, we consolidate the results and operations of MIL into our financial statements. We offer the MIL courses in our virtual and blended public schools and to school districts and believe they have wide applicability in online learning. MIL creates innovative, online language programs for pre-college students and leverages Middlebury College's recognized experience in foreign language instruction and our expertise in online education. Language faculty from Middlebury collaborates with MIL to develop and manage the academic content of the Web-based language courses. MMLA offers foreign language camps through four-week residential and day camps at selected college campuses.

Acquisition of KC Distance Learning, Inc.

In July 2010, we acquired KCDL, a provider of online curriculum and public and private virtual education. KCDL included three distribution channels: Aventa Learning (online curriculum and instruction), The Keystone School (an online and correspondence private school) and the contracts to serve iQ Academies (statewide virtual public charter schools). Aventa Learning offers schools and school districts over 140


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core, elective and Advanced Placement, or AP, courses in grades 6-12, including credit recovery courses, full-scale virtual school programs and instructional services.

Acquisition of The American Education Corporation

In December 2010, we acquired the stock of AEC. AEC is a leading provider of research-based core curriculum instructional software for kindergarten through adult learners. The acquisition increases our portfolio of innovative, high quality instructional courseware and curriculum used by school districts all over the country.

Investment in Web International Education Group, Ltd.

In January 2011, we invested $10.0 million to obtain a 20% minority interest in Web International Education Group, Ltd or Web. Web is a provider of English language training for learners of all ages throughout China, including university students, government workers and employees of international companies and it maintains an extensive network of learning centers throughout China.

Acquisition of International School of Berne

In April, 2011, we acquired the operations of IS Berne, a traditional private school located in Berne, Switzerland serving students in grades Pre-K through
12. IS Berne is an IB school in its 50th year of operation. Our purchase provided us with the right to operate IS Berne and substantially all of its assets excluding real estate.

Investment by Technology Crossover Ventures in K12 Inc.

In April 2011, we completed a private placement sale of 4 million shares of restricted common stock at a price of $31.46 per share to Technology Crossover Ventures, or TCV. The gross proceeds of $125.8 million were unrestricted and available for acquisitions, strategic investments and general corporate purposes. Under the terms of the transaction, our Board of Directors, or Board, appointed a director nominated by TCV to the Board to hold office until our next annual meeting. Additionally, we granted TCV the right to participate on a pro-rata basis in any of our subsequent private offerings of common stock, subject to certain exclusions such as issuances in connection with acquisitions or employee equity plans. As provided by the terms of the transaction, we filed a resale registration statement with respect to these shares with the SEC and the registration statement was declared effective.

Acquisition of Assets from Kaplan Virtual Education

In July 2011, we completed the purchase of certain K-12 assets and Insight School management contracts of KVE, a subsidiary of Kaplan, Inc. KVE assets included contracts to serve online public schools in eight states serving students in grades 6-12. The acquisition allows us to serve more students with multiple curriculum platforms and leverage the Insight School brand and our existing virtual academy operations.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our consolidated financial statements. Critical accounting policies are disclosed in our fiscal year 2012 Annual Report. There have been no significant updates to our critical accounting policies disclosed in our Annual Report.


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Results of Operations

As described in the Annual Report, the Company reclassified its three lines of business: Managed Public Schools (turn-key management services provided to public schools), Institutional Business (educational products and services provided to school districts, public schools and other educational institutions that it does not manage), and International and Private Pay Business (private schools for which it charges student tuition and makes direct consumer sales).

Managed Public Schools         Institutional Business        International and Private Pay Business
 Full-time virtual schools    K12 curriculum              Managed private schools
 Blended schools              Aventa curriculum           - The Keystone School
-Flex schools Online HS        A+ curriculum               -George Washington University
-Passport schools              Middlebury joint venture    -K12 International Academy
-Discovery schools             Pre-kindergarten            -International School of Berne
-Other blended schools          Post-secondary                   Web International Education
                                                           Group, Ltd. (via investment)
                                                                  Independent course sales
                                                             (Consumer)

Enrollment



The following table sets forth the average quarterly student enrollment data for
students in Managed Public Schools.  These figures exclude enrollments from
classroom pilot programs.



                                                                         Growth
                               Three Months Ended September 30,        2012 / 2011
                                   2012                2011         Change   Change %

Managed Public Schools
Average Student Enrollments           121,665             106,665   15,000       14.1 %

The following table sets forth the quarterly cumulative total enrollment data for students in the International and Private Pay Business (excluding enrollments for individual courses to individual consumers).

                                                                                         Growth
                                           Three Months Ended September 30,           2012 / 2011
                                               2012                2011           Change      Change %

International and Private Pay Business
Cumulative Student Enrollments                     12,996              12,415          581          4.7 %
Cumulative Semester Course Enrollments             36,032              34,692        1,340          3.9 %


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Revenue by Business Lines

Revenue is captured by business line based on the underlying customer contractual agreement. Periodically, a customer may change business line classification. For example, a district who purchases a single course (Institutional Business customer) may decide to implement 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 following represents our revenue for our three lines of business for the three months ended September 30, 2012 and 2011.

                                                                                      Change
                                       Three Months Ended September 30,             2012 / 2011
($ in thousands)                          2012                 2011               $             %
Managed Public Schools              $         187,761    $         159,449    $   28,312         17.8 %
Institutional Business                         21,972               23,482        (1,510 )       (6.4 )
International and Private Pay
Business                                       11,363               10,399           964          9.3
Total                               $         221,096    $         193,330    $   27,766         14.4 %


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The following table sets forth statements of operations data for each of the periods indicated:

                                                               Three Months ended September 30,
                                                                  2012                 2011
                                                                       ($ in thousands)
Revenues                                                    $         221,096    $         193,330

Cost and expenses
Instructional costs and services                                      118,648              101,079
Selling, administrative, and other operating expenses                  89,619               77,760
Product development expenses                                            4,168                6,224

Total costs and expenses                                              212,435              185,063

Income from operations                                                  8,661                8,267
Interest expense, net                                                    (228 )               (221 )

Income before income taxes and noncontrolling interest                  8,433                8,046
Income tax expense                                                     (3,889 )             (3,697 )

Net income                                                              4,544                4,349
Adjust net (income) loss attributable to noncontrolling
interest                                                                 (187 )                251

Net Income - K12 Inc.                                       $           4,357    $           4,600

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

                                                                   2012    2011
Revenues                                                           100.0 % 100.0 %

Cost and expenses
Instructional costs and services                                    53.7    52.3
Selling, administrative, and other operating expenses               40.5    40.2
Product development expenses                                         1.9     3.2

Total costs and expenses                                            96.1    95.7

Income from operations                                               3.9     4.3
Interest expense, net                                               (0.1 )  (0.1 )

Income before income taxes and noncontrolling interest               3.8     4.2
Income tax expense                                                  (1.7 )  (1.9 )

Net income                                                           2.1     2.3
Adjust net (income) loss attributable to noncontrolling interest    (0.1 )   0.1

Net income - K12 Inc.                                                2.0 %   2.4 %

Comparison of the Three Months Ended September 30, 2012 and September 30, 2011

Revenues. Our revenues for the three months ended September 30, 2012 were $221.1 million, representing an increase of $27.8 million, or 14.4%, as compared to revenues of $193.3 million for the same period in the prior year. Managed Public Schools revenue increased 17.8% year over year, primarily as a result of organic growth in existing states. The growth in Managed Public Schools revenue was driven by a 14.1% growth in average student enrollments and an increase in average revenue per student due to improved capture and a decrease in the number of unfunded enrollments. At the same time, International and Private Pay Business cumulative semester course enrollments grew 3.9% year over year. Revenue growth year over year was partially offset by a decline in Institutional Business revenue, primarily as a result of perpetual license revenue in the prior year period.

Instructional costs and services expenses. Instructional costs and services expenses for the three months ended September 30, 2012 were $118.6 million, representing an increase of $17.5 million, or 17.3%, from


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$101.1 million for the three months ended September 30, 2011. The three months ended September 30, 2011 gives effect to a reclassification of certain costs to selling, administrative and other operating expenses to conform with the presentation for the period ended September 30, 2012 and to reflect changes in our enrollment operations. Instructional costs and services expenses were 53.7% of revenue during the three months ended September 30, 2012, an increase from the 52.3% for the three months ended September 30, 2011. The increase as a percentage of revenue was associated primarily with advance hiring during the first quarter of fiscal 2013.

Selling, administrative, and other operating expenses. Selling, administrative, and other operating expenses for the three months ended September 30, 2012 were $89.6 million, representing an increase of $11.8 million, or 15.2%, as compared to $77.8 million for the three months ended September 30, 2011. The three months ended September 30, 2011 gives effect to a reclassification of certain costs from instructional costs and services expenses to conform with the presentation for the period ended September 30, 2012 and to reflect changes in our enrollment operations. As a percentage of revenues, selling, administrative, and other operating expenses increased to 40.5% from 40.2% for the three months ended September 30, 2012. This increase was primarily attributable to increases in personnel costs related to growth in headcount, related benefits and recruiting costs. This was partially offset by a decrease in ERP implementation costs.

Product development expenses. Product development expenses for the three months ended September 30, 2012 were $4.2 million, representing a decrease of $2.0 million, or 32.3%, as compared to $6.2 million for the three months ended September 30, 2011. As a percentage of revenues, product development expenses decreased to 1.9% for the three months ended September 30, 2012 as compared to 3.2% for the same period in the prior year. The decrease was primarily due to more development projects that qualify for cost capitalization than in the prior year and a decrease in ERP implementation costs. Our cash expenditures for product development, including capitalized costs, however, increased year over year by 4%.

Interest expense, net. Net interest expense for the three months ended September 30, 2012 was $0.2 million, unchanged from the same period in the prior year. Net interest expense is primarily associated with interest on our student computer leases.

Income taxes. Income tax expense for the three months ended September 30, 2012 was $3.9 million, or 46.1% of income before taxes, compared to $3.7 million, or 46.0% of income before taxes for the three months ended September 30, 2011. The tax rate remained relatively consistent between periods.

Noncontrolling interest. Net income attributable to noncontrolling interest for the three months ended September 30, 2012 was $0.2 million compared to a net loss from noncontrolling interest of $0.3 million for the same period in the prior year. Noncontrolling interest reflects the after-tax income/losses attributable to minority interest owners in our joint venture investments.

Liquidity and Capital Resources

As of September 30, 2012, we had net working capital, or current assets minus current liabilities, of $292.2 million. Our working capital includes cash and cash equivalents of $107.9 million, including $4.6 million associated with our two joint ventures, and accounts receivable of $258.8 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, 2012.

We have a $35.0 million line of credit with PNC Bank, N.A., or PNC, for general corporate operating purposes, which we refer to as the Credit Agreement. The Credit Agreement provides the ability, if required, to fund operations until cash is received from the schools. The Credit Agreement matures in December 2012 and although we currently expect to enter into a new line of credit agreement prior to termination of the existing line of credit, there can be no guarantee that we will do so on acceptable terms,


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if at all. Interest is charged, at our option, either at: (i) the higher of
(a) the rate of interest announced by PNC from time to time as its "prime rate" and (b) the federal funds rate plus 0.5%; or (ii) the applicable London Interbank Offered Rate (LIBOR) divided by a number equal to 1.00, minus the maximum aggregate reserve requirement which is imposed on member banks of the Federal Reserve System against "Eurocurrency liabilities," plus the applicable margin for such loans, which ranges between 1.50% and 2.00%, based on the leverage ratios (as defined in the Credit Agreement). We pay a quarterly commitment fee on the unused portion available under the Credit Agreement. The Credit Agreement includes a $5.0 million letter of credit facility. Issuance of letters of credit reduces the availability of permitted borrowings under the Credit Agreement.

Borrowings under the Credit Agreement are secured by substantially all of our assets. The Credit Agreement contains a number of financial and other covenants that, among other things, restrict our and our subsidiaries abilities to incur additional indebtedness, grant liens, or other security interests, make certain investments, become liable for contingent liabilities, make specified restricted payments, including dividends, dispose of assets or stock, including the stock of our subsidiaries, or make capital expenditures above specified limits and . . .

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