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LRN > SEC Filings for LRN > Form 10-Q on 5-Feb-2013All Recent SEC Filings

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Form 10-Q for K12 INC


5-Feb-2013

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 and six months ended December 31, 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 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, public charter schools and families as we strive to transform the educational experience into one that delivers individualized education on a highly scalable basis.

Virtual and blended public schools generally under turn-key management contracts (Managed Public Schools) accounted for approximately 86% of our revenue in the six months ended December 31, 2012. We currently provide management services to public schools in 33 states and the District of Columbia.

In addition to our Managed Public Schools, 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


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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 continue to provide these services to school districts or individual schools in all 50 states and the District of Columbia.

We also own and 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 a college preparatory focus 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 six months ended December 31, 2012, revenues grew to $427.1 million from $359.8 million in the same period in the prior year, a growth rate of 18.7%. Over the same period, operating income increased to $24.9 million from $15.4 million, a change of 62.3%, and net income to common stockholders increased to $13.9 million from $8.8 million, a change of 58.0%. These increases were primarily due to revenue growth between periods. We have reclassified certain prior year enrollment related costs from instructional costs and services to selling, administrative and other operating expenses to conform to the current year presentation. There was no effect on total costs and expenses, income from operations or net income from such reclassification.

Recent Acquisitions

During the periods presented, we completed the purchase of certain K-12 assets and Insight School management contracts of Kaplan Virtual Education, or KVE, a subsidiary of Kaplan, Inc. We refer to these assets as the Kaplan/Insight Assets, which included contracts to serve nine virtual public charter schools in eight states serving students in grades 6-12. The acquisition allows us to serve more students with multiple curriculum platforms 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 the accompanying condensed consolidated financial statements and 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 condensed consolidated financial statements. Critical accounting policies are disclosed in our Annual Report. There have been no significant updates to the critical accounting policies disclosed in our Annual Report.

Appointment of Executive Chairman

On January 7, 2013, our Board of Directors appointed our Chairman of the Board, Nathaniel A. Davis, as our Executive Chairman. Following his appointment, Mr. Davis became a full-time employee who directly supervises our operations and financial performance. Our Chief Executive Officer, Ronald J. Packard, continues to supervise corporate development, business development, academic achievement, and nascent business ventures. In addition, the Board appointed Jon Q. Reynolds as its Lead Independent Director. We believe these arrangements enhance our executive leadership team and organizational structure. Both Mr. Davis and Mr. Packard actively participate in our internal control and quarterly disclosure activities.


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Results of Operations

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

Managed Public Schools         Institutional Sales     International and Private Pay Schools
 Full-time virtual schools    K12 curriculum        Managed private schools
 Blended schools              Aventa curriculum     -The Keystone School
-Flex schools                   A+ curriculum         -George Washington University Online
                                                      High School
-Passport schools               Middlebury joint      -K12 International Academy
                              venture
-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 Data

The following table sets forth average enrollment data for students in Managed Public Schools and total enrollment data for students in the International and Private Pay Schools for the periods indicated. These figures exclude enrollments from classroom pilot programs and consumer programs.

                              Three Months Ended December 31,            Six Months Ended December 31,
                            2012       2011     Change   Change %     2012      2011     Change   Change %

Managed Public Schools
Average Student
Enrollments                119,132    104,836   14,296     13.6%     119,831   105,293   14,538     13.8%
International and
Private Pay Schools
Total Student
Enrollments                  4,403      3,971      432     10.9%      17,399    16,386    1,013      6.2%
Total Semester Course
Enrollments                 12,138     11,959      179      1.5%      48,170    46,651    1,519      3.3%

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 Sales customer) may decide to implement a full-time virtual school program managed by K12 (Managed Public Schools 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 and six months ended December 31, 2012 and 2011.

                      Three Months Ended          Change          Six Months Ended           Change
                         December 31,          2012 / 2011          December 31,          2012 / 2011
($ in thousands)       2012        2011         $         %       2012        2011         $         %
Managed Public
Schools             $  177,541   $ 140,645   $ 36,896    26.2   $ 365,302   $ 300,095   $ 65,207    21.7
Institutional
Sales                   18,089      16,662      1,427     8.6      40,061      40,143        (82 )  (0.2 )
International and
Private Pay
Schools                 10,398       9,193      1,205    13.1      21,761      19,592      2,169    11.1
Total               $  206,028   $ 166,500   $ 39,528    23.7 % $ 427,124   $ 359,830   $ 67,294    18.7 %


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

                                       Three Months Ended            Six Months Ended
                                          December 31,                 December 31,
                                       2012           2011          2012          2011
                                                      ($ in thousands)
Revenues                            $   206,028    $  166,500    $  427,124    $  359,830
Cost and expenses

Instructional costs and services        122,799        98,909       241,446       200,016
Selling, administrative, and
other operating expenses                 61,379        52,925       150,998       130,656
Product development expenses              5,578         7,574         9,746        13,798

Total costs and expenses                189,756       159,408       402,190       344,470

Income from operations                   16,272         7,092        24,934        15,360
Interest expense, net                      (272 )        (236 )        (501 )        (457 )

Income before income taxes and
noncontrolling interest                  16,000         6,856        24,433        14,903
Income tax expense                       (6,680 )      (2,976 )     (10,569 )      (6,673 )

Net income                                9,320         3,880        13,864         8,230
Adjust net loss attributable to
noncontrolling interest                     191           285             4           536

Net Income - K12 Inc.               $     9,511    $    4,165    $   13,868    $    8,766


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

                                      Three Months Ended         Six Months Ended
                                         December 31,              December 31,
                                      2012         2011         2012         2011
Revenues                                100.0 %      100.0 %      100.0 %      100.0 %

Cost and expenses
Instructional costs and services         59.6         59.4         56.5         55.6
Selling, administrative, and
other operating expenses                 29.8         31.8         35.4         36.3
Product development expenses              2.7          4.5          2.3          3.8

Total costs and expenses                 92.1         95.7         94.2         95.7

Income from operations                    7.9          4.3          5.8          4.3
Interest expense, net                    (0.1 )       (0.2 )       (0.1 )       (0.1 )

Income before income taxes and
noncontrolling interest                   7.8          4.1          5.7          4.2
Income tax expense                       (3.3 )       (1.8 )       (2.5 )       (1.9 )

Net income                                4.5          2.3          3.2          2.3
Adjust net loss attributable to
noncontrolling interest                   0.1          0.2            -          0.1

Net income - K12 Inc.                     4.6 %        2.5 %        3.2 %        2.4 %

Comparison of the Three Months Ended December 31, 2012 and Three Months Ended December 31, 2011

Revenues. Our revenues for the three months ended December 31, 2012 were $206.0 million, representing an increase of $39.5 million, or 23.7%, as compared to revenues of $166.5 million for the same period in the prior year. Without the impact of negative revenue adjustments made in the prior year period for state funding reductions, our revenue growth would have been 18.1%. Managed Public Schools revenue increased $36.9 million year over year, primarily as a result of organic growth in existing states. The growth in Managed Public Schools revenue was driven by a 13.6% growth in average student enrollments, an increase in average revenue per student due to improved revenue capture and a decrease in the number of unfunded enrollments. Our International and Private Pay Schools revenue increased $1.2 million, or 13.1%, due to a 10.9% increase in total student enrollments and a 1.5% increase in total semester course enrollments during the three months ended December 31, 2012 as compared to the three months ended December 31, 2011, and the contribution derived from a shift in the mix of enrollments to higher priced programs, including an increase in full-time enrollments. Revenue in our Institutional Sales grew by $1.4 million from continued expansion into additional school districts.

Instructional costs and services expenses. Instructional costs and services expenses for the three months ended December 31, 2012 were $122.8 million, representing an increase of $23.9 million, or 24.2%, from $98.9 million for the three months ended December 31, 2011. Instructional costs increased as a result of an increase in the number of enrollments. Instructional costs and services expenses were 59.6% of revenue during the three months ended December 31, 2012, consistent with 59.4% for the three months ended December 31, 2011.

Selling, administrative, and other operating expenses. Selling, administrative, and other operating expenses for the three months ended December 31, 2012 were $61.4 million, representing an increase of $8.5 million, or 16.1%, as compared to $52.9 million for the three months ended December 31, 2011. The current year increase was primarily associated with increased sales and administrative personnel and associated benefit costs as compared to the prior year period. As a percentage of revenues, selling, administrative, and other operating expenses decreased to 29.8% from 31.8% for the three months ended December 31, 2012.

Product development expenses. Product development expenses include costs related to new products and to information technology systems. Product development expenses for the three months ended December 31, 2012 were $5.6 million, representing a decrease of $2.0 million, or 26.3%, as compared to $7.6 million for the three months ended December 31, 2011. As a percentage of revenues, product development expenses decreased to 2.7%


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for the three months ended December 31, 2012 as compared to 4.5% for the same period in the prior year. The decrease was primarily due to an increase in the number of development projects that qualified for cost capitalization than in the prior year period and a decrease in the amount of systems development expense in connection with the implementation phase of our enterprise resource planning, or ERP, system.

Interest expense, net. Net interest expense for the three months ended December 31, 2012 was $0.3 million, relatively 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 December 31, 2012 was $6.7 million, or 41.8% of income before taxes, as compared to $3.0 million, or 43.4% of income before taxes for the three months ended December 31, 2011. Our effective tax rate decreased between periods primarily because of the positive impact of international operations and a change in nondeductible expenses.

Noncontrolling interest. Net loss attributable to noncontrolling interest for the three months ended December 31, 2012 was $0.2 million as compared to net loss attributable to noncontrolling interest of $0.3 million for the same period in the prior year. Noncontrolling interest reflects the after-tax income attributable to minority interest owners in our joint venture investments.

Comparison of the Six Months Ended December 31, 2012 and Six Months Ended December 31, 2011

Revenues. Our revenues for the six months ended December 31, 2012 were $427.1 million, representing an increase of $67.3 million, or 18.7%, as compared to revenues of $359.8 million for the same period in the prior year. Without the impact of negative revenue adjustments made in the prior year period for state funding reductions, our revenue growth would have been 16.1%. Managed Public Schools revenue increased 21.7% year over year, primarily as a result of organic growth in existing states. The growth in Managed Public Schools revenue was driven by a 13.8% increase in average student enrollments and an increase in average revenue per student due to improved revenue capture and a decrease in the number of unfunded enrollments. International and Private Pay Schools revenue increased $2.2 million, or 11.1%, due to a 6.2% increase in total student enrollments and a 3.3% increase in total semester course enrollments at December 31, 2012 compared to December 31, 2011, and the contribution derived from a shift in the mix of enrollments to higher priced programs, including an increase in full-time enrollments. Revenue growth year over year in our Institutional Sales was partially offset by a decrease in perpetual license sales compared to the prior year period.

Instructional costs and services expenses. Instructional costs and services expenses for the six months ended December 31, 2012 were $241.4 million, representing an increase of $41.4 million, or 20.7%, from $200.0 million for the six months ended December 31, 2011. Instructional costs increased as a result of revenue growth during the period. Instructional costs and services expenses were 56.5% of revenue during the six months ended December 31, 2012, an increase from 55.6% for the six months ended December 31, 2011. The increase as a percentage of revenue was associated primarily with advance hiring of teachers in early fiscal 2013.

Selling, administrative, and other operating expenses. Selling, administrative, and other operating expenses for the six months ended December 31, 2012 were $151.0 million, representing an increase of $20.3 million, or 15.5%, as compared to $130.7 million for the six months ended December 31, 2011. While selling, administrative and other operating expenses increased from period to period associated with increased marketing to support our growth, sales and administrative personnel and related benefit costs, including stock compensation, our selling, administrative, and other operating expenses as a percentage of revenues decreased to 35.4% from 36.3% for the six months ended December 31, 2012. This decrease as a percentage of revenue was attributable in part to higher professional fees incurred in the prior year period associated with our ERP and CRM implementations, integration of the acquired Kaplan/Insight Assets, and accounting and audit fees related to the delayed filing of our Form 10-K and a registration statement.

Product development expenses. Product development expenses include costs related to new products and to information technology systems. Product development expenses for the six months ended December 31, 2012 were $9.7 million, representing a decrease of $4.1 million, or 29.7%, as compared to $13.8 million for the six months ended December 31, 2011. As a percentage of revenues, product development expenses decreased to 2.3%


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for the six months ended December 31, 2012 as compared to 3.8% for the same period in the prior year. The decrease was primarily due to an increase in the number of development projects that qualified for cost capitalization than in the prior year period, and a decrease in the amount of systems development expense in connection with the implementation phase of our ERP system.

Interest expense, net. Net interest expense for the six months ended December 31, 2012 was $0.5 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 six months ended December 31, 2012 was $10.6 million, or 43.3% of income before taxes, as compared to $6.7 million, or 44.8% of income before taxes for the six months ended December 31, 2011. Our tax rate decreased slightly between periods because of the impact of foreign operations in the prior year period and a change in nondeductible expenses incurred during the current year period. We expect our tax rate to decrease during the remainder of our 2013 fiscal year to reflect the retroactive renewal of Research and Development Credits with the January 2013 passage of the American Taxpayer Relief Act of 2012 by the United States Congress and the full year impact of our international operations.

Noncontrolling interest. Net income attributable to noncontrolling interest for the six months ended December 31, 2012 was negligible as compared to net loss attributable to noncontrolling interest of $0.5 million for the same period in the prior year. Noncontrolling interest reflects the after-tax loss attributable to minority interest owners in our joint venture investments and may fluctuate from period to period.

Liquidity and Capital Resources

As of December 31, 2012, we had net working capital, or current assets minus current liabilities, of $308.3 million. Our working capital includes cash and cash equivalents of $143.2 million, including $5.1 million associated with our two joint ventures, and accounts receivable of $223.3 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 December 31, 2012.

We have a $35.0 million unsecured line of credit that expires December 31, 2013 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. In December 2012, the Credit Agreement was amended and the maturity date was extended to December 2013 and to release liens that had previously secured the facility. Interest is charged, at our option, either at: (i) the higher of . . .

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