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LRN > SEC Filings for LRN > Form 10-Q on 3-May-2013All Recent SEC Filings

Show all filings for K12 INC

Form 10-Q for K12 INC


3-May-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 this filing and in 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 nine months ended March 31, 2013.

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 nine months ended March 31, 2013. We currently provide management services to public schools in 33 states and the District of Columbia.


Table of Contents

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 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 national catalog of advanced and specialized online courses is offered to school districts with certified teachers, and we are in the process of improving our internal controls to ensure appropriate state-specific certifications are met at the time school districts provide individual course offerings to their students. The services we provide to 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 nine months ended March 31, 2013, revenues grew to $645.1 million from $538.0 million in the same period in the prior year, a growth rate of 19.9%. Over the same period, operating income increased to $44.3 million from $26.9 million, a change of 64.7% and net income to common stockholders increased to $25.8 million from $15.7 million, a change of 64.3%. These increases were primarily due to revenue growth and expense improvement 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.

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.


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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          Institutional Sales           International and Private Pay
Schools                                               Schools
 Full-time virtual      K12 curriculum               Managed private schools
schools                                           
 Blended schools       Aventa curriculum            The Keystone School
 Flex schools           A+ curriculum                George Washington University
                                                     Online High School
 Passport schools      Middlebury joint venture     K12 International Academy
 Discovery schools     Pre-kindergarten             International School of Berne
 Other blended          Post-secondary               Web International Education
schools                                             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 March 31,              Nine Months Ended March 31,
                  2013      2012     Change   Change %     2013      2012     Change   Change %

Managed Public
Schools
Average
Student
Enrollments *    118,717   105,828   12,889       12.2 %  119,354   105,522   13,832       13.1 %
International
and Private
Pay Schools
Total Student
Enrollments        5,060     5,652     (592 )    (10.5 )%  22,459    22,038      421        1.9 %
Total Semester
Course
Enrollments       20,445    18,879    1,566        8.3 %   68,614    65,530    3,084        4.7 %


*The Managed Public Schools average student enrollments include enrollments for which we receive no public funding.

Revenue by Business Line

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 nine months ended March 31, 2013 and 2012.

                     Three Months Ended          Change           Nine Months Ended           Change
                         March 31,             2013 / 2012            March 31,            2013 / 2012
($ in thousands)      2013        2012         $         %        2013        2012          $         %
Managed Public
Schools            $  191,305   $ 151,885   $ 39,420     26.0   $ 556,607   $ 451,980   $ 104,627     23.1
Institutional
Sales                  15,888      16,412       (524 )   (3.2 )    55,949      56,555        (606 )   (1.1 )
International
and Private Pay
Schools                10,816       9,878        938      9.5      32,577      29,470       3,107     10.5
Total              $  218,009   $ 178,175   $ 39,834     22.4 % $ 645,133   $ 538,005   $ 107,128     19.9 %


Table of Contents

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

                                      Three Months Ended              Nine Months Ended
                                           March 31,                      March 31,
                                      2013           2012            2013           2012
                                                       ($ in thousands)
Revenues                          $    218,009    $   178,175    $    645,133        538,005

Cost and expenses
Instructional costs and
services                               127,759        105,955         369,205        305,981
Selling, administrative, and
other operating expenses                65,828         53,619         216,826        184,265
Product development expenses             5,070          7,012          14,817         20,810

Total costs and expenses               198,657        166,586         600,848        511,056

Income from operations                  19,352         11,589          44,285         26,949
Interest expense, net                     (306 )         (265 )          (807 )         (722 )

Income before income taxes
and noncontrolling interest             19,046         11,324          43,478         26,227
Income tax expense                      (7,626 )       (4,638 )       (18,195 )      (11,311 )

Net income                              11,420          6,686          25,283         14,916
Add net loss attributable to
noncontrolling interest                    555            291             559            827

Net Income attributable to
common stockholders,
including Series A
stockholders                      $     11,975    $     6,977    $     25,842    $    15,743

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

                                   Three Months Ended          Nine Months Ended
                                       March 31,                   March 31,
                                   2013          2012          2013          2012

Revenues                             100.0 %       100.0 %       100.0 %       100.0 %

Cost and expenses
Instructional costs and
services                              58.6          59.5          57.2          56.9
Selling, administrative,
and other operating
expenses                              30.2          30.1          33.6          34.2
Product development
expenses                               2.3           3.9           2.3           3.9

Total costs and expenses              91.1          93.5          93.1          95.0

Income from operations                 8.9           6.5           6.9           5.0
Interest expense, net                 (0.1 )        (0.2 )        (0.1 )        (0.1 )

Income before income taxes
and noncontrolling interest            8.8           6.3           6.8           4.9
Income tax expense                    (3.6 )        (2.6 )        (2.8 )        (2.1 )

Net income                             5.2           3.7           4.0           2.8
Add net loss attributable
to noncontrolling interest             0.3           0.2             -           0.1

Net income attributable to
common stockholders,
including Series A
stockholders                           5.5 %         3.9 %         4.0 %         2.9 %


Table of Contents

Comparison of the Three Months Ended March 31, 2013 and Three Months Ended March 31, 2012

Revenues. Revenues for the three months ended March 31, 2013 were $218.0 million, representing an increase of $39.8 million, or 22.3%, as compared to revenues of $178.2 million for the same period in the prior year. Managed Public Schools revenue increased $39.4 million, or 26.0% year over year, primarily as a result of organic growth in existing states and funding increases in certain states. The growth in Managed Public Schools revenue was driven by a 12.2% growth in average student enrollments, improved funding rates and capture in certain states and a decrease in the number of unfunded enrollments. Institutional Sales revenue decreased $0.5 million, or 3.2%, primarily as a result of a weaker sales and a change in product mix. International and Private Pay Schools revenue increased $0.9 million or 9.5%, primarily due to an 8.3% increase in total semester course enrollments during the three months ended March 31, 2013 as compared to the prior year period, and the contribution derived from a shift in the mix of enrollments to higher priced programs, including an increase in full-time enrollments.

Instructional costs and services expenses. Instructional costs and services expenses for the three months ended March 31, 2013 were $127.8 million, representing an increase of $21.8 million, or 20.6%, from $106.0 million for the three months ended March 31, 2012. Instructional costs grew as a result of an increase in the number of enrollments. Instructional costs and services expenses were 58.6% of revenue during the three months ended March 31, 2013, representing a slight decrease from 59.5% for the three months ended March 31, 2012.

Selling, administrative and other operating expenses. Selling, administrative and other operating expenses for the three months ended March 31, 2013 were $65.8 million, representing an increase of $12.2 million, or 22.8%, as compared to $53.6 million for the prior year period. The current fiscal year increase was primarily associated with increased personnel and associated benefit costs, including stock compensation and marketing costs. As a percentage of revenues, selling, administrative and other operating expenses were essentially flat at 30.2% for the three months ended March 31, 2013 as compared to 30.1% for the three months ended March 31, 2012.

Product development expenses. Product development expenses include costs related to new products and information technology systems. Product development expenses for the three months ended March 31, 2013 were $5.1 million, representing a decrease of $1.9 million, or 27.1%, as compared to $7.0 million for the prior year period. As a percentage of revenues, product development expenses decreased to 2.3% for the three months ended March 31, 2013 as compared to 3.9% for the same period in the prior year, primarily related to the capitalization of curriculum development activities, the timing of placing projects into service and transfers to selling, administrative and other operating expenses as a result of internal reorganization of our business systems group.

Interest expense, net. Net interest expense for the three months ended March 31, 2013 was $0.3 million, consistent with 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 March 31, 2013 was $7.6 million, or 40.0% of income before taxes, as compared to $4.6 million, or 41.0% of income before taxes for the three months ended March 31, 2012. Our effective tax rate decreased slightly between periods primarily because of the impact of international operations, a change in nondeductible expenses, the change in loss from non-controlling interest in a joint venture, and the benefit of research and development credits reinstated in January 2013 by the American Taxpayer Relief Act of 2012.

Net Income Net income was $11.4 million for the three months ended March 31, 2013 compared to net income of $6.7 million for the three months ended March 31, 2012, an increase of $4.7 million. Net income as a percentage of revenues increased to 5.2% for the three months ended March 31, 2013 as compared to 3.7% for the prior year period, as a result of the factors discussed above.

Noncontrolling interest. Net loss attributable to noncontrolling interest for the three months ended March 31, 2013 and 2012 was $0.6 million and $0.3 million, respectively. Noncontrolling interest reflects the after-tax income attributable to minority interest owners in our joint venture investments.


Table of Contents

Comparison of the Nine Months Ended March 31, 2013 and Nine Months Ended March 31, 2012

Revenues. Revenues for the nine months ended March 31, 2013 were $645.1 million, representing an increase of $107.1 million, or 19.9%, as compared to revenues of $538.0 million for the same period in the prior year. Managed Public Schools revenue increased $104.6 million, or 23.1%, year over year, primarily as a result of organic growth in existing states. The growth in Managed Public Schools revenue was driven by a 13.1% increase in average student enrollments, improved funding rates and capture in certain states and a decrease in the number of unfunded enrollments. Institutional Sales revenue decreased by $0.6 million compared to the prior year period due to a decrease in perpetual license sales and overall weaker sales and a change in product mix. International and Private Pay Schools revenue increased $3.1 million, or 10.5%, due to a 4.7% increase in total semester course enrollments at March 31, 2013 compared to March 31, 2012, and the contribution derived from a shift in the mix of enrollments to higher priced programs, including an increase in full-time enrollments.

Instructional costs and services expenses. Instructional costs and services expenses for the nine months ended March 31, 2013 were $369.2 million, representing an increase of $63.2 million, or 20.7%, from $306.0 million for the nine months ended March 31, 2012. Instructional costs increased as a result of an increase in the number of enrollments and an increase in pass through expenses during the period. Instructional costs and services expenses were 57.2% of revenue during the nine months ended March 31, 2013, a slight increase from 56.9% for the nine months ended March 31, 2012. The increase as a percentage of revenue was primarily associated with advance hiring of teachers in early fiscal 2013, which in some cased unfavorably impacted utilization rates, and increased depreciation and amortization.

Selling, administrative and other operating expenses. Selling, administrative and other operating expenses for the nine months ended March 31, 2013 were $216.8 million, representing an increase of $32.5 million, or 17.6%, as compared to $184.3 million for the nine months ended March 31, 2012. Selling, administrative and other operating expenses increased from period to period as a result of increased marketing costs to support enrollment growth and increased personnel and associated benefit costs, including stock compensation. As a percentage of revenue, selling, administrative and other operating expenses decreased to 33.6% from 34.2% for the nine months ended March 31, 2013.

Product development expenses. Product development expenses include costs related to new products and to information technology systems. Product development expenses for the nine months ended March 31, 2013 were $14.8 million, representing a decrease of $6.0 million, or 28.8%, as compared to $20.8 million for the nine months ended March 31, 2012. As a percentage of revenues, product development expenses decreased to 2.3% for the nine months ended March 31, 2013 as compared to 3.9% 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.

Interest expense, net. Net interest expense for the nine months ended March 31, 2013 was $0.8 million compared to $0.7 million in 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 nine months ended March 31, 2013 was $18.2 million, or 41.9% of income before taxes, as compared to $11.3 million, or 43.1% of income before taxes for the nine months ended March 31, 2012. Our tax rate decreased between periods because of the impact of foreign operations in the prior year period, a change in nondeductible expenses between periods and the benefit of research, the change in loss from non-controlling interest in a joint venture and the benefit of research and development credits reinstated in January 2013 by the American Taxpayer Relief Act of 2012.

Net Income Net income was $25.3 million for the nine months ended March 31, 2013 compared to net income of $14.9 million for the nine months ended March 31, 2012, an increase of $10.4 million or 69.8%. Net income as a percentage of revenues increased to 4.0% for the nine months ended March 31, 2013 as compared to 2.8% for the prior year period, as a result of the factors discussed above.

Noncontrolling interest. Net loss attributable to noncontrolling interest for the nine months ended March 31, 2013 was $0.6 million as compared to net loss attributable to noncontrolling interest of $0.8 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.


Table of Contents

Liquidity and Capital Resources

As of March 31, 2013, we had net working capital, or current assets minus current liabilities, of $328.8 million. Our working capital includes cash and cash equivalents of $157.0 million, including $5.7 million associated with our two joint ventures, and accounts receivable of $234.6 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 March 31, 2013.

We have a $35.0 million unsecured line of credit that expires December 31, 2013 with PNC Bank, N.A., 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 (a) the rate of interest announced by PNC from time to time as its "prime rate", (b) the federal funds open rate plus 0.5% and (c) the Daily London Interbank Offered Rate
(LIBOR) plus 1.0%; 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 . . .

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