As filed
with the Securities and Exchange Commission on December 10,
2007
Registration
No. 333-144894
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.
20549
Amendment No. 6
to
Form S-1
REGISTRATION
STATEMENT
UNDER
THE SECURITIES ACT OF
1933
K12 INC.
(Exact name of registrant as
specified in its charter)
Delaware
8211
95-4774688
(State or Other Jurisdiction
of
Incorporation or Organization)
(Primary Standard Industrial
Classification Number)
(IRS Employer
Identification No.)
K12
Inc.
2300 Corporate Park Drive
Herndon, VA 20171
(703) 483-7000
(Address, including zip code,
and telephone number, including area code, of Registrants
principal executive offices)
Ronald J.
Packard
Chief Executive Officer
K12 Inc.
2300 Corporate Park Drive
Herndon, VA 20171
(703) 483-7000
(Name, address, including zip
code, and telephone number, including area code, of agent for
service)
Copies to:
William P. ONeill, Esq.
Howard D. Polsky, Esq.
Richard D. Truesdell, Jr., Esq.
Blaise F. Brennan, Esq.
Senior Vice President, General Counsel and Secretary
Davis Polk & Wardwell
Latham & Watkins LLP
K12 Inc.
450 Lexington Avenue
555 Eleventh Street, N.W
2300 Corporate Park Drive
New York, NY 10017
Washington, D.C. 20004
Herndon, VA 20171
(212) 450-4674
(202) 637-2200
(703) 483-7000
Approximate date of commencement of proposed sale to the
public: As soon as practicable after the
effective date of this registration statement.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to
Rule 415 under the Securities Act of 1933, check the
following
box. o
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act,
check the following box and list the Securities Act registration
statement number of the earlier effective registration statement
for the same
offering. o
If this Form is a post-effective amendment filed pursuant to
Rule 462(c) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
If this Form is a post-effective amendment filed pursuant to
Rule 462(d) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
CALCULATION
OF REGISTRATION FEE
Proposed Maximum
Proposed Maximum
Title of Each Class of
Amount to be
Offering Price Per
Aggregate Offering
Amount of
Securities to be Registered
Registered(a)
Share(b)
Price(b)
Registration Fee(c)
Common Stock, $0.0001 par value
6,900,000
$18.00
$124,200,000
$3,812.94
(a)
Including shares of common stock
which may be purchased by the underwriters to cover
overallotments, if any.
(b)
Estimated solely for the purpose of
calculating the registration fee in accordance with
Rule 457(a) promulgated under the Securities Act of 1933.
(c)
Previously paid.
The Registrant hereby amends this Registration Statement on
such date or dates as may be necessary to delay its effective
date until the Registrant shall file a further amendment which
specifically states that this Registration Statement shall
thereafter become effective in accordance with Section 8(a)
of the Securities Act of 1933, or until the Registration
Statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
The
information in this prospectus is not complete and may be
changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these
securities, and we are not soliciting offers to buy these
securities in any state or jurisdiction where the offer or sale
is not permitted.
PROSPECTUS
(Subject to Completion)
Issued
December 10, 2007
6,000,000 Shares
K12 Inc.
Common Stock
K12 Inc. is offering 4,450,000 shares of its common stock
and the selling stockholders are offering 1,550,000 shares.
This is our initial public offering and no public market exists
for our shares. We anticipate that the initial public offering
price will be between $16.00 and $18.00 per share.
Investing in our common stock involves risks. See
Risk Factors beginning on page 8 to read about
factors you should consider before buying shares of our common
stock.
We intend to list our common stock on NYSE Arca under the
symbol LRN.
Underwriting
Proceeds to
Discounts and
Proceeds to
Selling
Price to Public
Commissions
K12 Inc.
Stockholders
Per Share
$
$
$
$
Total
$
$
$
$
The underwriters may also purchase up to an additional
900,000 shares of common stock from the selling
stockholders at the public offering price, less the underwriting
discount within 30 days from the date of this prospectus to
cover over allotments, if any. We will not receive any proceeds
from the sale of shares by the selling stockholders in this
offering or any shares sold by the selling stockholders if the
underwriters exercise their overallotment option.
Neither the Securities and Exchange Commission nor any other
regulatory body has approved or disapproved of these securities
or passed upon the accuracy or adequacy of this prospectus. Any
representation to the contrary is a criminal offense.
The underwriters expect to deliver the shares of common stock to
purchasers on or
about ,
2007.
Managements Discussion and Analysis of Financial Condition
and Results of Operations
29
Business
51
Regulation
71
Management
76
Compensation Discussion and Analysis
84
Certain Relationships and Related-Party Transactions
100
Principal and Selling Stockholders
103
Description of Capital Stock
107
Certain United States Federal Income Tax Considerations to
Non-U.S.
Holders
110
Shares Eligible for Future Sale
113
Underwriting
115
Notice to Canadian Residents
119
Sales Outside the United States Other Than Canada
120
Legal Matters
123
Experts
123
Where You Can Find More Information
123
Index to Consolidated Financial Statements
F-1
You should rely only on the information contained in this
prospectus. We and the underwriters have not authorized anyone
to provide you with different or additional information. This
prospectus is not an offer to sell or a solicitation of an offer
to buy our common stock in any jurisdiction where it is unlawful
to do so. The information contained in this prospectus is
accurate only as of its date, regardless of the date of delivery
of this prospectus or of any sale of our common stock.
Until and
including ,
2007, 25 days after the commencement of this offering, all
dealers that affect transactions in these securities, whether or
not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers obligation
to deliver a prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
i
PROSPECTUS
SUMMARY
This summary highlights selected information contained
elsewhere in this prospectus and does not contain all of the
information you should consider in making your investment
decision. You should read the following summary together with
the more detailed information regarding us and our common stock
being sold in the offering, including the risks of investing in
our common stock discussed under Risk Factors
beginning on page 8 and our consolidated financial
statements and the related notes appearing elsewhere in this
prospectus, before making an investment decision. For
convenience in this prospectus, the Company,
K12,
K12,
we, us, and our refer to K12
Inc. and its subsidiaries, taken as a whole. References to
fiscal years refer to the fiscal year ended June 30 of the
year indicated.
K12
Inc.
Our
Company
We are a technology-based education company. We offer
proprietary curriculum and educational services created for
online delivery to students in kindergarten through
12th grade, or K-12. Our mission is to maximize a
childs 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 $100 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual schools
and other educational applications. From fiscal year 2004 to
fiscal year 2007, we increased average enrollments in the
virtual public schools we serve from approximately 11,000
students to 27,000 students, representing a compound annual
growth rate of approximately 35%. For the three months ended
September 30, 2007, we increased average enrollments 50% to
approximately 39,500, as compared to the same period in the
prior year. From fiscal year 2004 to fiscal year 2007, we
increased revenues from $71.4 million to
$140.6 million, representing a compound annual growth rate
of approximately 25%, and improved from a net loss of
$7.4 million to net income of $3.9 million. For the
three months ended September 30, 2007, we increased
revenues to $59.4 million, representing a growth rate of
57%, as compared to the same period in the prior year. Over the
same period, we increased net income to $5.7 million
(excluding an income tax benefit of $7.1 million) from
$4.7 million.
We believe we are unique in the education industry because of
our direct involvement in every component of the educational
development and delivery process. Most educational content,
software and service providers typically concentrate on only a
portion of that process, such as publishing textbooks, managing
schools or providing testing and assessment services. This
traditional segmented approach has resulted in an uncoordinated
and unsatisfactory education for many students. Unburdened by
legacy, we have taken a holistic approach to the design of our
learning system. We have developed an engaging curriculum which
includes online lessons delivered over our proprietary school
platform. We combine this with a rigorous system to test and
assess students and processes to manage school performance and
compliance. In addition, our professional development programs
enable teachers to better utilize technology for instruction.
Our end-to-end learning system is designed to optimize the
performance of the schools we serve and enhance student academic
achievement.
As evidence of the benefit of our holistic approach, the virtual
public schools we serve generally test near, and in some cases
above, state averages on standardized achievement tests. These
results have been achieved despite the enrollment of a
significant number of new students each school year who have had
limited exposure to our learning system prior to taking these
required state tests. Students using our learning system for at
least three years usually perform better on standardized tests
relative to state averages than students using it for one year
or less. The efficacy of our learning system has also helped us
achieve high levels of customer satisfaction. According to a
2006 internal survey of parents of students enrolled in virtual
public schools we serve (with an approximately 33% response
rate), approximately 97% of respondents stated that they were
either satisfied or very satisfied with our curriculum and 95%
of respondents stated that they would recommend our curriculum
to other families.
We deliver our learning system to students primarily through
virtual public schools. As with any public school, these schools
must meet state educational standards, administer proctored
exams and are subject to fiscal oversight. The fundamental
difference is that students attend virtual public schools
primarily over the Internet instead of
1
traveling to a physical classroom. In their online learning
environment, students receive assignments, complete lessons, and
obtain instruction from certified teachers with whom they
interact online, telephonically, and face-to-face. Virtual
public schools provide families with a publicly funded
alternative to a traditional classroom-based education when
relocating or private schooling is not an option, making them
the most public of schools.
We offer virtual schools our proprietary curriculum, online
learning platform and varying levels of academic and management
services, which can range from targeted programs to complete
turnkey solutions, under long-term contracts. These contracts
provide the basis for a recurring revenue stream as students
progress through successive grades. Additionally, without the
requirement of a physical classroom, virtual schools can be
scaled quickly to accommodate a large dispersed student
population, and allow more capital resources to be allocated
towards teaching, curriculum and technology rather than towards
a physical infrastructure.
Substantially all of our enrollments are served through
25 virtual public schools to which we provide full turnkey
solutions and seven virtual public schools to which we provide
limited management services, located in 17 states and the
District of Columbia. Parents can also purchase our curriculum
and online learning platform directly to facilitate or
supplement their childrens education. Additionally, we
have piloted our curriculum in brick and mortar classrooms with
promising academic results. We also believe there is additional
widespread applicability for our learning system internationally.
Our
Market
The U.S. market for K-12 education is large and growing.
For example:
According to the National Center for Education Statistics
(NCES), a division of the U.S. Department of Education,
there were more than 49 million students in K-12 public
schools during the
2005-06
school year. In addition, according to National Home Education
Research, approximately two million students are home schooled
and, according to a March 2006 NCES report, approximately five
million students are enrolled in private schools.
According to the NCES, the public school system alone
encompassed more than 98,000 schools and 17,000 school
districts during the
2005-06
school year.
The NCES estimates that total spending in the public K-12 market
was $558 billion for the
2005-06
school year.
Parents and lawmakers are demanding increased standards and
accountability in an effort to improve academic performance in
U.S. public schools. As a result, each state is now
required to establish performance standards and to regularly
assess student progress relative to these standards. We expect
continued focus on academic standards, assessments and
accountability in the near future.
Many parents and educators are also seeking alternatives to
traditional classroom-based education that can help improve
academic achievement. Demand for these alternatives is evident
in the growing number of choices available to parents and
students. For example, charter schools emerged in 1988 to
provide an alternative to traditional public schools. Similarly,
acceptance of online learning initiatives, including not only
virtual schools but also online testing and Internet-based
professional development, has become widespread. As of September
2006, 38 states had some form of online learning initiative.
Virtual public schools represent one approach to online learning
that is gaining acceptance. According to the Center for
Education Reform, as of January 2007 there were 173 virtual
schools with total enrollment exceeding 92,000 students,
operating in 18 states compared to just 86 virtual
schools in 13 states with total enrollment of approximately
31,000 students in the 2004-05 school year. Virtual schools
can offer a comprehensive curriculum and flexible delivery
model; therefore, we believe that a growing number of families
will pursue virtual public schools as an attractive public
school alternative. Given these statistics and the nascence of
this market, we believe there is a significant opportunity for a
high-quality, trusted, national education provider to serve
virtual public schools.
2
Our
Competitive Strengths
We believe the following to be our key competitive strengths:
Proprietary Curriculum Specifically Designed for a
Technology-Enabled Environment. We specifically
designed our curriculum for online learning, in contrast to
other online curriculum providers who often just digitize
classroom textbooks for transmission over the Internet. Our
cognitive research-based curriculum contains more than 11,000
discrete lessons that utilize a combination of innovative
technologies, including flash animations, online interactivity
and real-time individualized feedback, which we combine with
textbooks and other offline course materials to create an
engaging and highly effective curriculum and drive greater, more
consistent academic achievement.
Flexible, Integrated Online Learning
Platform. Our online learning platform provides a
highly flexible and effective means for delivering educational
content to students and allows us to update the content on a
real-time basis. Our platform offers assessment capabilities to
identify the current and targeted academic level of achievement
for each student, measures mastery of each learning objective,
updates each students lesson plan for completed lessons
and enables us to track the effectiveness of each lesson with
each student on a real-time basis.
Expertise in Opening Channels for Virtual
Schooling. Our education policy experts and
established relationships with key educational authorities have
allowed us to help individual educational policymakers
understand the benefits of virtual schools and establish highly
effective, publicly funded education alternatives for parents
and their children.
Track Record of Student Achievement and Customer
Satisfaction. The virtual public schools we serve
generally test near, and in some cases above, state averages on
standardized achievement tests. The efficacy of our learning
system has also helped us achieve high levels of customer
satisfaction, which has been a strong contributor to our growth,
helps drive new student referrals and leads to re-enrollments.
Highly Scalable Model. We have built our
educational model, systems and management team to successfully
and efficiently serve the academic needs of a large, dispersed
student population. Our ability to leverage the historical
investment we made in developing our learning system and our
ability to deliver our offering over the Internet enables us to
successfully serve a greater number of students at a reduced
level of capital investment.
Our
Growth Strategy
We intend to pursue the following strategies to drive our future
growth:
Generate Enrollment Growth at Existing Virtual Public
Schools. In the
2007-08
school year, we are serving virtual public schools in
17 states and the District of Columbia. We intend to
continue to drive increased enrollments at the virtual public
schools we serve through targeted marketing and recruiting
efforts as well as through referrals.
Enhance Curriculum to Include a Complete High School
Offering. We believe that serving virtual public
high schools represents a significant growth opportunity for
online education delivery given the increased independence of
high school students and the wide variance in academic
achievement levels and objectives of students who are entering
high school. In the
2005-06 and
2006-07
school years, we began enrolling 9th and 10th grade
students, respectively, and with the launch of our 11th and
12th grades in the
2007-08
school year, we are able to provide a complete high school
offering to satisfy the broad range of high school student
interests.
Expand Virtual Public School Presence into Additional
States. The flexibility and comprehensiveness of
our learning system allows us to efficiently adapt our
curriculum to meet the individual educational standards of any
state with minimal capital investment. We intend to continue to
seek opportunities to assist states in establishing virtual
public schools and to contract with them to provide our
curriculum, online learning platform and related services.
Strengthen Awareness and Recognition of the
K12
Brand. The
K12
brand already enjoys strong recognition within the virtual
public school community. We have developed a comprehensive brand
strategy and intend to invest in further developing awareness of
both the
K12
brand and the core philosophy behind our learning system outside
the virtual public school community.
Pursue International Opportunities to Offer Our Learning
System. We believe there is strong worldwide
demand for high-quality, flexible education alternatives. Given
the highly flexible design and technology-based
3
nature of our platform, it can be adapted to other languages and
cultures efficiently and with modest capital investment.
Additionally, our ability to operate virtually is not
constrained by the need for a physical classroom or local
teachers, which makes our learning system ideal for use
internationally.
Develop Additional Channels Through Which to Deliver our
Learning System. We intend to regularly evaluate
additional delivery channels and to pursue opportunities where
we believe there is likely to be significant demand for our
offering, such as direct classroom instruction, hybrid classroom
models, supplemental educational offerings, and individual
products packaged and sold directly to parents and students.
Certain
Risk Factors
Investing in our common stock involves substantial risk. You
should carefully consider all the information in this prospectus
prior to investing in our common stock and review the section
entitled Risk Factors immediately following this
prospectus summary. These risks and uncertainties include, but
are not limited to, the following:
Most of our revenues depend on per pupil funding amounts
remaining near the levels existing at the time we execute
service agreements with the virtual public schools we serve. If
those funding levels are materially reduced, new restrictions
adopted or payments delayed, our business, financial condition,
results of operations and cash flows could be adversely affected.
The poor performance or misconduct of other virtual public
school operators could tarnish the reputation of all virtual
public school operators, which could have a negative influence
on our business.
Opponents of virtual public schools have sought to challenge the
establishment and expansion of such schools through the judicial
process. If their interests prevail, it could damage our ability
to sustain or grow our current business in certain jurisdictions.
We have a limited operating history, and sustained cumulative
net losses of approximately $90 million before only
recently achieving profitability. If we fail to remain
profitable or achieve further marketplace acceptance for our
products and services, our business, financial condition and
results of operations will be adversely affected.
Highly qualified teachers are critical to the success of our
learning system. If we are not able to continue to recruit,
train and retain quality certified teachers, our lessons might
not be effectively delivered to students, compromising their
academic performance and our reputation with the virtual public
schools we serve. As a result, our brand, business and operating
results may be adversely affected.
The
Regulation S Transaction
On November 6, 2007, we entered into a stock subscription
agreement pursuant to which we agreed to sell KB Education
Investments Limited, a company organized under the laws of the
British Virgin Islands and a
non-U.S. person,
in a transaction outside the United States in reliance upon
Regulation S under the Securities Act, concurrently with
and contingent upon the closing of this offering and at the
initial public offering price, that number of shares of common
stock that can be purchased for an aggregate purchase price of
$15,000,000. We refer to this transaction herein as the
Regulation S Transaction. Assuming an initial
public offering price of $17.00 per share, the midpoint of
the range set forth on the cover page of this prospectus, we
will sell 882,352 shares of common stock in such
transaction. The shares to be sold in the Regulation S
Transaction are not registered by the registration statement of
which this prospectus is a part and have not been registered
under the Securities Act, and may be offered or sold only
pursuant to an effective registration statement, pursuant to an
available exemption from the registration requirements of the
Securities Act or pursuant to the terms of Regulation S.
Additionally, the shares to be sold in the Regulation S
Transaction are subject to a
lock-up
pursuant to which the investor has agreed not to offer, sell or
agree to sell, directly or indirectly, any shares of common
stock without the permission of the underwriters for a period of
180 days from the date of this prospectus.
Our
Corporate Information
We were incorporated in Delaware in December 1999. Our principal
executive offices are located at 2300 Corporate Park Drive,
Herndon, VA 20171. Our telephone number is
(703) 483-7000.
Our website address is www.K12.com. These are textual
references only. We do not incorporate the information on, or
accessible through, any of our websites into this prospectus,
and you should not consider any information on, or that can be
accessed through, our websites as part of this prospectus.
4
The
Offering
Common Stock offered by us
4,450,000
shares
Common Stock offered by the selling stockholders
1,550,000
shares
Total
6,000,000
shares
Common Stock outstanding after the offering
27,257,244
shares
Overallotment option
900,000 shares from the selling stockholders
Proposed NYSE Arca symbol
LRN
Use of proceeds from this offering
We estimate that our net proceeds from this offering will be
approximately $67.4 million, based on an assumed initial
public offering price of $17.00 per share (which is the
midpoint of the range on the cover page of this prospectus). In
addition, we anticipate that we will receive net proceeds of
$14.9 million from the sale of additional shares in the
Regulation S Transaction. We intend to use the net proceeds
from this offering and from the Regulation S Transaction
for general corporate purposes, including working capital,
capital expenditures and the development of new courses and
product offerings, to repay approximately $15.0 million of
borrowings under our revolving credit facility and to pay a cash
dividend of approximately $6.4 million to the holders of
our Series C Preferred Stock, which will become payable
upon the closing of this offering. The net proceeds will also
provide us with the financial flexibility to make acquisitions
and strategic investments. We will receive no proceeds from the
sale of common stock to be sold by the selling stockholders in
this offering or any shares to be sold by the selling
stockholders if the underwriters exercise their overallotment
option. See Use of Proceeds.
The number of shares of common stock outstanding after this
offering:
is based on 2,045,217 shares of common stock outstanding as
of September 30, 2007;
gives effect to the automatic conversion of all 101,386,536 of
the outstanding shares of our preferred stock into
19,879,675 shares of our common stock immediately prior to
the completion of this offering;
gives effect to the sale of 882,352 shares of common stock
pursuant to the Regulation S Transaction concurrently with
the consummation of the offering (assuming an initial offering
price of $17.00 per share, the midpoint of the range set
forth on the cover of this prospectus);
excludes 4,860,973 shares of common stock issuable upon the
exercise of options outstanding as of September 30, 2007 at
a weighted average exercise price of $10.37 per share,
2,328,358 shares of preferred stock that may be issued upon
the exercise of warrants outstanding as of September 30,
2007 (or upon the consummation of the offering,
456,540 shares of common stock that may be issued upon the
exercise of such warrants at a purchase price of $6.83 per
share), all of which are currently exercisable at a purchase
price of $1.34 per share, and 21,299 shares of common
stock that may be issued upon the exercise of warrants
outstanding as of September 30, 2007, all of which are
exercisable at a purchase price of $8.16 per share;
excludes an additional 784,313 shares of common stock
reserved for issuance under the K12 Inc. 2007 Equity Incentive
Award Plan; and
excludes an additional 588,235 shares of common stock
reserved for issuance under the K12 Inc. 2007 Employee Stock
Purchase Plan.
Except as otherwise indicated, all information contained in this
prospectus assumes:
a 1 for 5.10 reverse stock split of our common stock that was
effected on November 2, 2007, as a result of which each
5.10 shares of preferred stock are now convertible into one
share of common stock;
an initial offering price of $17.00 per share (which is the
midpoint of the range on the cover page of this
prospectus); and
the underwriters option to purchase up to
900,000 additional shares of common stock is not exercised.
5
SUMMARY
CONSOLIDATED FINANCIAL DATA
We derived the summary consolidated financial data presented
below as of June 30, 2006 and 2007 and for each of the
three years ended June 30, 2005, 2006 and 2007, from our
audited consolidated financial statements included elsewhere in
this prospectus. We derived the summary consolidated financial
data presented below as of June 30, 2005 from our audited
consolidated financial statements that are not included in this
prospectus. We have derived our consolidated statement of
operations data for the three months ended September 30,
2006 and 2007 and consolidated balance sheet data as of
September 30, 2007 from our unaudited consolidated
financial statements that are included elsewhere in this
prospectus. 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 Companys financial position and results
of operations and cash flows for the three months ended
September 30, 2007 and 2006. Our historical results are not
necessarily indicative of future operating results. You should
read the information set forth below in conjunction with
Selected Consolidated Financial and Operating Data,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and our consolidated
financial statements and their related notes included elsewhere
in this prospectus.
Three Months Ended
September 30,
Year Ended June 30,
2007
2006
2007
2006
2005
(dollars in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues
$
59,353
$
37,743
$
140,556
$
116,902
$
85,310
Cost and expenses:
Instructional costs and services
34,778
19,177
76,064
64,828
49,130
Selling, administrative, and other operating expenses
16,039
11,385
51,159
41,660
30,031
Product development expenses
2,527
2,206
8,611
8,568
9,410
Total costs and expenses
53,344
32,768
135,834
115,056
88,571
Income (loss) from operations
6,009
4,975
4,722
1,846
(3,261
)
Interest expense, net
(304
)
(94
)
(639
)
(488
)
(279
)
Net income (loss) before income taxes
5,705
4,881
4,083
1,358
(3,540
)
Income tax benefit (expense)
7,117
(146
)
(218
)
Net income (loss)
12,822
4,735
3,865
1,358
(3,540
)
Dividends on preferred stock
(1,671
)
(1,519
)
(6,378
)
(5,851
)
(5,261
)
Preferred stock accretion
(6,560
)
(5,367
)
(22,353
)
(18,697
)
(15,947
)
Net income (loss) attributable to common stockholders
$
4,591
$
(2,151
)
$
(24,866
)
$
(23,190
)
$
(24,748
)
Net income (loss) attributable to common stockholders per share:
Basic
$
2.25
$
(1.08
)
$
(12.42
)
$
(11.73
)
$
(12.54
)
Diluted
$
0.20
$
(1.08
)
$
(12.42
)
$
(11.73
)
$
(12.54
)
Basic (pro
forma)(1)
$
0.58
n/a
$
0.18
n/a
n/a
Diluted (pro forma)
$
0.56
n/a
$
0.18
n/a
n/a
Weighted average shares used in computing per share amounts:
Basic
2,043,589
1,998,853
2,001,661
1,977,195
1,973,053
Diluted
22,744,525
1,998,853
2,001,661
1,977,195
1,973,053
Basic (pro
forma)(1)
21,923,244
n/a
21,881,316
n/a
n/a
Diluted (pro
forma)(1)
22,744,525
n/a
21,890,720
n/a
n/a
Other Data:
Net cash provided by (used in) operating activities
$
(2,740
)
$
3,398
$
5,563
$
3,625
$
9,697
Depreciation and amortization
$
2,252
$
1,224
$
7,404
$
4,986
$
5,509
Capital
expenditures(2)
$
8,494
$
4,784
$
13,418
$
10,842
$
5,133
EBITDA(3)
$
8,261
$
6,199
$
12,126
$
6,832
$
2,248
Average
enrollments(4)
39,493
26,405
27,005
20,220
15,097
6
As of
September 30,
As of June 30,
2007
2007
2006
2005
(dollars in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents
$
2,903
$
1,660
$
9,475
$
19,953
Total assets
106,202
61,212
48,485
41,968
Total short-term debt
12,500
1,500
Total long-term obligations
13,406
7,135
4,025
4,466
Convertible redeemable preferred stock
237,787
229,556
200,825
176,277
Total stockholders deficit
(192,891
)
(197,807
)
(173,451
)
(150,299
)
Working capital
9,939
8,548
15,421
22,953
(1)
Pro forma net income per common
share gives effect to the automatic conversion of all of our
outstanding shares of preferred stock into common stock
immediately prior to the completion to this offering. Assuming
the completion of this offering on September 30, 2007, all
of our outstanding shares of preferred stock would convert into
19,879,675 shares of common stock.
(2)
Capital expenditures consist of the
purchase of property and equipment, capitalized software and new
capital lease obligations.
(3)
EBITDA consists of net income
(loss) minus interest income, plus interest expense, plus income
tax expense and plus depreciation and amortization. Interest
income consists primarily of interest earned on short-term
investments or cash deposits. Interest expense primarily
consists of interest expense for capital leases, long-term and
short-term borrowings. We use EBITDA as a measure of operating
performance. However, EBITDA is not a recognized measurement
under U.S. generally accepted accounting principles, or GAAP,
and when analyzing our operating performance, investors should
use EBITDA in addition to, and not as an alternative for, net
income (loss) as determined in accordance with GAAP. Because not
all companies use identical calculations, our presentation of
EBITDA may not be comparable to similarly titled measures of
other companies. Furthermore, EBITDA is not intended to be a
measure of free cash flow for our managements
discretionary use, as it does not consider certain cash
requirements such as tax payments.
We believe EBITDA is useful to an
investor in evaluating our operating performance because it is
widely used to measure a companys operating performance
without regard to items such as depreciation and amortization,
which can vary depending upon accounting methods and the book
value of assets, and to present a meaningful measure of
corporate performance exclusive of our capital structure and the
method by which assets were acquired.
Our management uses EBITDA:
as a measurement of operating performance, because it assists us
in comparing our performance on a consistent basis, as it
removes depreciation, amortization, interest and taxes; and
in presentations to the members of our board of directors to
enable our board to have the same measurement basis of operating
performance as is used by management to compare our current
operating results with corresponding prior periods and with the
results of other companies in our industry.
The following table provides a reconciliation of net income
(loss) to EBITDA:
Three Months
Ended
September 30,
Year Ended June 30,
2007
2006
2007
2006
2005
(dollars in thousands)
Net income (loss)
$
12,822
$
4,735
$
3,865
$
1,358
$
(3,540
)
Interest expense, net
304
94
639
488
279
Income tax (benefit) expense
(7,117
)
146
218
Depreciation and amortization
2,252
1,224
7,404
4,986
5,509
EBITDA
$
8,261
$
6,199
$
12,126
$
6,832
$
2,248
(4)
To ensure that all schools are
reflected in our measure of enrollments, we consider our
enrollments as of the end of September to be our opening
enrollment level, and the number of students enrolled at the end
of May to be our ending enrollment level. To provide
comparability, we do not consider enrollment levels for June,
July and August as all schools are not open during these months.
For each period, average enrollments represent the average of
the month end enrollment levels for each month that has
transpired between September and the end of the period, up to
and including the month of May.
7
RISK
FACTORS
Investing in our common stock involves a high degree of risk.
You should carefully consider the following risk factors and all
other information contained in this prospectus, including our
consolidated financial statements and the related notes, before
investing in our common stock. The risks and uncertainties
described below are not the only ones we face. Additional risks
and uncertainties that we are unaware of, or that we currently
believe are not material, also may become important factors that
affect us. If any of the following risks materialize, our
business, financial condition or results of operations could be
materially harmed. In that case, the trading price of our common
stock could decline, and you may lose some or all of your
investment.
Risks
Related to Government Funding and Regulation of Public
Education
Most of our revenues depend on per pupil funding amounts
remaining near the levels existing at the time we execute
service agreements with the virtual public schools we serve. If
those funding levels are materially reduced, new restrictions
adopted or payments delayed, our business, financial condition,
results of operations and cash flows could be adversely
affected.
The public schools we contract with are financed with government
funding from federal, state and local taxpayers. Our business is
primarily dependent upon those funds. Budget appropriations for
education at all levels of government are determined through the
political process and, as a result, funding for the virtual
public schools we serve may fluctuate. This political process
creates a number of risks that could have an adverse affect on
our business including the following:
legislative proposals could result in budget cuts for the
virtual public schools we serve, and therefore reduce or
eliminate the products and services those schools purchase from
us, causing our revenues to decline. From time to time,
proposals are introduced in state legislatures that single out
virtual public schools for disparate treatment. For example, in
its fiscal year
2007-09
education budget appropriation, the Indiana legislature decided
not to fund any virtual public school that provided for the
online delivery of more than 50 percent of its instruction
to students. As a result, we decided not to open a virtual
public school in Indiana that was already approved by a
chartering authority and therefore the anticipated associated
revenues were not realized. Other examples include laws that
decrease per pupil funding for virtual public schools or alter
eligibility and attendance criteria or other funding conditions
that could decrease our revenues and limit our ability to grow;
as a public company, we will be required to file periodic
financial and other disclosure reports with the Securities and
Exchange Commission, or the SEC. This information may be
referenced in the legislative process, including budgetary
considerations, related to the funding of alternative public
school options, including virtual public schools. The disclosure
of this information by a for-profit education company,
regardless of parent satisfaction and student academic
achievement, may nonetheless be used by opponents of virtual
public schools to propose funding reductions; and
from time to time, government funding to schools is not provided
when due, which sometimes causes the affected schools to delay
or cease payments to us for our products and services. These
payment delays have occurred in the past and can deprive us of
significant working capital until the matter is resolved, which
could hinder our ability to implement our growth strategies and
conduct our business. For example, in 2003 the Pennsylvania
state legislature withheld monthly payments for every school
because it was unable to approve an education budget for six
months, which necessitated our borrowing of funds to continue
operations.
The poor performance or misconduct of other virtual public
school operators could tarnish the reputation of all virtual
public school operators, which could have a negative impact on
our business.
As a relatively new form of public education, virtual school
operators will be subject to scrutiny, perhaps even greater than
that applied to traditional public schools or charter schools.
Not all virtual public school operators will have successful
academic programs or operate efficiently, and new entrants may
not perform well either. Such underperforming operators could
create the impression that virtual schooling is not an effective
way to educate students, whether or not our learning system
achieves solid performance. Moreover, some virtual school
operators
8
have been subject to governmental investigations alleging the
misuse of public funds or financial irregularities. These
allegations have attracted significant adverse media coverage
and have prompted legislative hearings and regulatory responses.
Although these investigations have focused on specific companies
and individuals, they may negatively impact public perceptions
of virtual public school providers generally, including us. The
precise impact of these negative public perceptions on our
business is difficult to discern, in part because of the number
of states in which we operate and the range of particular
malfeasance or performance issues involved. We have incurred
significant lobbying costs in several states advocating against
harmful legislation which, in our opinion, was aggravated by
negative media coverage of particular virtual school operators.
If these few situations, or any additional misconduct, cause all
virtual public school providers to be viewed by the public
and/or policymakers unfavorably, we may find it difficult to
enter into or renew contracts to operate virtual schools. In
addition, this perception could serve as the impetus for more
restrictive legislation, which could limit our future business
opportunities.
Opponents of virtual public schools have sought to
challenge the establishment and expansion of such schools
through the judicial process. If these interests prevail, it
could damage our ability to sustain or grow our current business
or expand in certain jurisdictions.
We have been, and will likely continue to be, subject to
lawsuits filed against virtual public schools by those who do
not share our belief in the value of this form of public
education. Legal claims have involved challenges to the
constitutionality of authorizing statutes, methods of
instructional delivery, funding provisions and the respective
roles of parents and teachers. We currently face two such
lawsuits pertaining to the Wisconsin Virtual Academy and the
Chicago Virtual Charter School. See Business
Legal Proceedings. An adverse judgment in these cases
could serve as a negative precedent in other jurisdictions where
we do business, and new lawsuits could result in unexpected
liabilities and limit our ability to sustain or grow our current
business or expand in certain jurisdictions.
The failure of the virtual public schools we serve to
comply with applicable government regulations could result in a
loss of funding and an obligation to repay funds previously
received, which could adversely affect our business, financial
condition and results of operations.
Once authorized by law, virtual public schools are generally
subject to extensive regulation. These regulations cover
specific program standards and financial requirements including,
but not limited to: (i) student eligibility standards;
(ii) numeric and geographic limitations on enrollments;
(iii) prescribed teacher funding allocations from per pupil
revenue; (iv) state-specific curriculum requirements; and
(v) restrictions on open-enrollment policies by and among
districts. State and federal funding authorities conduct regular
program and financial audits of virtual public schools,
including the virtual public schools we serve, to ensure
compliance with applicable regulations. Two virtual public
schools we serve are currently undergoing such audits. See
Business Distribution Channels. If a
virtual public school we serve is found to be noncompliant, it
can be barred from receiving additional funds and could be
required to repay funds received during the period of
non-compliance, which could impair that schools ability to
pay us for services in a timely manner, if at all. Additionally,
the indemnity provisions in our standard service agreements with
virtual public schools may require us to return any contested
funds on behalf of the school. For a more detailed discussion of
the regulations affecting our business, see
Regulation.
Virtual public schools are relatively new, and enabling
legislation therefore is often ambiguous and subject to
discrepancies in interpretation by regulatory authorities, which
may lead to disputes over our ability to invoice and receive
payments for services rendered.
Statutory language providing for virtual public schools is
sometimes interpreted by regulatory authorities in ways that may
vary from year to year, making compliance subject to
uncertainty. For example, in Colorado, the regulators
approach to determining the eligibility of virtual school
students for funding purposes, which is based on a
students substantial completion of a semester in a public
school, has undergone varying interpretations. These regulatory
uncertainties may lead to disputes over our ability to invoice
and receive payments for services rendered, which could
adversely affect our business, financial condition and results
of operations.
9
The operation of virtual public schools depends on the
maintenance of the authorizing charter and compliance with
applicable laws. If these charters are not renewed, our
contracts with these schools would be terminated.
In many cases, virtual public schools operate under a charter
that is granted by a state or local authority to the charter
holder, such as a community group or an established
not-for-profit corporation, which typically is required by state
law to qualify for student funding. In fiscal year 2007,
approximately 90% of our revenues were derived from virtual
public schools operating under a charter. The service agreement
for these schools is with the charter holder or the charter
board. Non-profit charter schools qualifying for exemption from
federal taxation under Internal Revenue Code
Section 501(c)(3) as charitable organizations must also
operate in accordance with Internal Revenue Service rules and
policies to maintain that status and their funding eligibility.
In addition, all state charter school statutes require periodic
reauthorization. While none of the virtual public schools we
serve have failed to maintain their authorizing charter, if a
virtual public school we serve fails to maintain its tax-exempt
status and funding eligibility, or if its charter is revoked for
non-performance or other reasons that may be due to actions of
the independent charter board completely outside of our control,
our contract with that school would be terminated.
Actual or alleged misconduct by our senior management and
directors would make it more difficult for us to enter into new
contracts or renew existing contracts.
If any of our directors, officers or key employees are accused
or found to be guilty of serious crimes, including the
mismanagement of public funds, the schools we serve could be
barred from entering into or renewing service agreements with us
or otherwise discouraged from contracting with us and, as a
result, our business and revenues would be adversely affected.
Risks
Related to Our Business and Our Industry
We have a limited operating history, and sustained
cumulative net losses of approximately $90 million before
only recently achieving profitability. If we fail to remain
profitable or achieve further marketplace acceptance for our
products and services, our business, financial condition and
results of operations will be adversely affected.
The virtual public schools we serve began enrolling students in
the 2002-03 school year. As a result, we have only a limited
operating history upon which you can evaluate our business and
prospects. Since our inception, we have recorded cumulative net
losses totaling approximately $90 million until we recently
achieved profitability. We recorded our first profit in the
fiscal year ended June 30, 2006. There can be no assurance
that we will remain profitable, or that our products and
services will achieve further marketplace acceptance. Our
marketing efforts may not generate a sufficient number of
student enrollments to sustain our business plan; our capital
and operating costs may exceed planned levels; and we may be
unable to develop and enhance our service offerings to meet the
demands of virtual public schools and students to the extent
that such demands and preferences change. If we are not
successful in managing our business and operations, our
financial condition and results of operations will be adversely
affected.
Highly qualified teachers are critical to the success of
our learning system. If we are not able to continue to recruit,
train and retain quality certified teachers, our curriculum
might not be effectively delivered to students, compromising
their academic performance and our reputation with the virtual
public schools we serve. As a result, our brand, business and
operating results may be adversely affected.
Effective teachers are critical to maintaining the quality of
our learning system and assisting students with their daily
lessons. Teachers in virtual public schools must be state
certified and have strong interpersonal communications skills to
be able to effectively instruct students in a virtual school
setting. They must also possess the technical skills to use our
technology-based learning system. There is a limited pool of
teachers with these specialized attributes and the virtual
public schools we serve must provide competitive compensation
packages to attract and retain such qualified teachers.
The teachers in most virtual public schools we serve are not our
employees and the ultimate authority relating to those teachers
resides with the governing body overseeing the schools. However,
under many of our service agreements with virtual public
schools, we have responsibility to recruit, train and manage
these teachers. We must also provide continuous training to
virtual public school teachers so that they can stay abreast of
changes in student demands, academic standards and other key
trends necessary to teach online effectively. We may not be able
to
10
recruit, train and retain enough qualified teachers to keep pace
with our growth while maintaining consistent teaching quality in
the various virtual public schools we serve. Shortages of
qualified teachers or decreases in the quality of our
instruction, whether actual or perceived, would have an adverse
effect on our business.
The schools we contract with and serve are governed by
independent governing bodies who may shift their priorities or
change objectives in ways adverse to us.
We contract with and provide a majority of our products and
services to virtual public schools governed by independent
boards or similar governing bodies. While we typically share a
common objective at the outset of our business relationship,
over time our interests could diverge. If these independent
boards of the schools we serve subsequently shift their
priorities or change objectives, and as a result reduce the
scope or terminate their relationship with us, our ability to
generate revenues would be adversely affected.
Our contracts with the virtual public schools we serve are
subject to periodic renewal, and each year several of these
agreements are set to expire. If we are unable to renew several
such contracts or if a single significant contract expires
during a given year, our business, financial condition, results
of operations and cash flow could be adversely affected.
For the 2007-08 school year, we have contracts to provide our
full range of products and services to virtual public schools in
17 states and the District of Columbia. Several of these
contracts are scheduled to expire in any given year. For
example, five such contracts are scheduled to expire in 2008,
and we usually begin to engage in renewal negotiations during
the final year of these contracts. In order to renew these
contracts, we have to enter into negotiations with the
independent boards of these virtual public schools. Historically
we have been successful in renewing these contracts, but such
renewals typically contain revised terms, which may be more or
less favorable then the terms of the original contract. For
example, a school in Pennsylvania reduced the term of its
contract from five years to three years when renewing
its contract in 2006, whereas a school in Ohio increased the
term of its contract from five years to 10 years upon
renewal in 2007. While we have no reason to believe that schools
will not continue to renew their contracts upon expiration, we
recognize that each renegotiation is unique and, if we are
unable to renew several such contracts or one significant
contract expiring during a given year, or if such renewals have
significantly less favorable terms than existing contracts, our
business, financial condition, results of operations and cash
flow could be adversely affected.
We generate significant revenues from four virtual public
schools, and the termination, revocation, expiration or
modification of our contracts with these virtual public schools
could adversely affect our business, financial condition and
results of operation.
In fiscal year 2007, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy, the Arizona Virtual
Academy, the Pennsylvania Virtual Charter School and the
Colorado Virtual Academy. In aggregate, these schools accounted
for 49% of our total revenues. If our contracts with any of
these virtual public schools are terminated, the charters to
operate any of these schools are not renewed or are revoked,
enrollments decline substantially, funding is reduced, or more
restrictive legislation is enacted, our business, financial
condition and results of operations could be adversely affected.
We may not be able to effectively address the execution
risks associated with our expansion into the virtual high school
market. Our failure to do so could substantially harm our growth
strategy.
The virtual high school market presents us with a number of
challenges, including the launch of 11th and
12th grade offerings. We are currently using third-party
platforms and some third-party curriculum in our high school
offering. If the quality of the third-party curriculum or
platforms is unsatisfactory, student enrollments could decline.
Furthermore, the subject matter expertise and skills necessary
to teach in high school are fundamentally different than those
necessary to teach kindergarten through 8th grade. If the
high school instructional experience does not meet the
expectations of students previously enrolled in our kindergarten
through 8th grade programs, or new enrollees experience
performance issues with our high school program delivery, the
virtual public schools we serve may decline to offer our high
school program and our business, financial condition and results
of operations may be adversely affected.
11
Our growth strategy anticipates that we will create new
products and distribution channels and expand existing
distribution channels. If we are unable to effectively manage
these initiatives, our business, financial condition, results of
operations and cash flows would be adversely affected.
As we create new products and distribution channels and expand
our existing distribution channels, we expect to face challenges
distinct from those we currently encounter, including:
our development of public hybrid schools, which will produce
different operational challenges than those we currently
encounter. In addition to the online component, hybrid schools
require us to lease facilities for classrooms, staff classrooms
with teachers, provide meals, adhere to local safety and fire
codes, purchase additional insurance and fulfill many other
responsibilities;
our expansion into international markets may require us to
conduct our business differently than we do in the United
States. For example, we may attempt to open a tuition-based
private school or establish a traditional brick and mortar
school. Additionally, we may have difficulty training and
retaining qualified teachers or generating sufficient demand for
our products and services in international markets.
International opportunities will also produce different
operational challenges than those we currently
encounter; and
our use of our curriculum in classrooms will produce challenges
with respect to adapting our curriculum for effective use in a
traditional classroom setting.
Our failure to manage these new distribution channels, or any
new distribution channels we pursue, may have an adverse effect
on our business, financial condition, results of operations and
cash flows.
Increasing competition in the market segments that we
serve could lead to pricing pressures, reduced operating
margins, loss of market share and increased capital
expenditures.
We face varying degrees of competition from several discrete
education providers because our learning system integrates all
the elements of the education development and delivery process,
including curriculum development, textbook publishing, teacher
training and support, lesson planning, testing and assessment,
and school performance and compliance management. We compete
most directly with companies that provide online curriculum and
support services to
K-12 virtual
public schools. Additionally, we expect increased competition
from for-profit post-secondary and supplementary education
providers that have begun to offer virtual high school
curriculum and services. In certain jurisdictions and states
where we currently serve virtual public schools, we expect
intense competition from existing providers and new entrants.
Our competitors may adopt similar curriculum delivery, school
support and marketing approaches, with different pricing and
service packages that may have greater appeal in the market. If
we are unable to successfully compete for new business, win and
renew contracts or maintain current levels of academic
achievement, our revenue growth and operating margins may
decline. Price competition from our current and future
competitors could also result in reduced revenues, reduced
margins or the failure of our product and service offerings to
achieve or maintain more widespread market acceptance.
We may also face direct competition from publishers of
traditional educational materials that are substantially larger
than we are and have significantly greater financial, technical
and marketing resources. As a result, they may be able to devote
more resources to develop products and services that are
superior to our platform and technologies. We may not have the
resources necessary to acquire or compete with technologies
being developed by our competitors, which may render our online
delivery format less competitive or obsolete.
Our future success will depend in large part on our ability to
maintain a competitive position with our curriculum and our
technology, as well as our ability to increase capital
expenditures to sustain the competitive position of our product.
We cannot assure you that we will have the financial resources,
technical expertise, marketing, distribution or support
capabilities to compete effectively.
If demand for increased options in public schooling does
not continue or if additional jurisdictions do not authorize or
adequately fund virtual public schools, our business, financial
condition and results of operations could be adversely
affected.
According to the Center for Education Reform, as of January 2007
there were 173 virtual schools with total enrollments exceeding
92,000 students, operating in 18 states. However, if the demand
for virtual public schools
12
does not increase, if additional jurisdictions do not authorize
new virtual schools or if the funding of such schools is
inadequate, our business, financial condition and results of
operations could be adversely affected.
Our business is subject to seasonal fluctuations, which
may cause our operating results to fluctuate from
quarter-to-quarter and adversely impact the market price of our
common stock.
Our revenues and operating results normally fluctuate as a
result of seasonal variations in our business, principally due
to the number of months in a fiscal quarter that our virtual
public schools are fully operational and serving students. In
the typical academic year, our first and fourth fiscal quarters
may have fewer than three full months of operations, whereas our
second and third fiscal quarters will have three complete months
of operations. We ship offline learning kits to students in the
beginning of the school year, our first fiscal quarter,
generally resulting in higher offline learning kit revenues and
margins in the first fiscal quarter relative to the other
quarters. In aggregate, the seasonality of our revenues has
generally produced higher revenues in the first fiscal quarter
and lower revenues in the fourth fiscal quarter.
Our operating expenses are also seasonal. Instructional costs
and services increase in the first fiscal quarter primarily due
to the costs incurred to ship offline learning kits at the
beginning of the school year. These instructional costs may
increase significantly quarter-to-quarter as school operating
expenses increase. The majority of our selling and marketing
expenses are incurred in the first and fourth fiscal quarters,
as our primary enrollment season is July through September.
We expect quarterly fluctuations in our revenues and operating
results to continue. These fluctuations could result in
volatility and adversely affect our cash flow. As our business
grows, these seasonal fluctuations may become more pronounced.
As a result, we believe that quarterly comparisons of our
financial results may not be reliable as an indication of future
performance.
Our revenues for a fiscal year are based in part on our
estimate of the total funds each school will receive in a
particular school year and our estimate of the full year
deficits to be incurred by each school. As a result, differences
between our estimates and the actual funds received and deficits
incurred could have an adverse impact on our results of
operations and cash flows.
We recognize revenues from certain of our fees ratably over the
course of our fiscal year. To determine the amount of revenues
to recognize, we estimate the total funds each school will
receive in a particular school year. Additionally, we take
responsibility for any operating deficits at most of the virtual
schools we serve. Because these operating deficits may impair
our ability to collect the full amount invoiced in a period and
collection cannot reasonably be assured, we reduce revenues by
the estimated amount of these deficits. We review our estimates
of total funds and operating deficits periodically, and we
revise as necessary, amortizing any adjustments over the
remaining portion of the fiscal year. Actual funding received
and operating deficits incurred may vary from our estimates or
revisions and could adversely impact our results of operation
and cash flows.
The continued development of our brand identity is
important to our business. If we are not able to maintain and
enhance our brand, our business and operating results may
suffer.
Expanding brand awareness is critical to attracting and
retaining students, and for serving additional virtual public
schools. In order to expand brand awareness, we intend to spend
significant resources on a brand-enhancement strategy, which
includes sales and marketing efforts directed to targeted
locations as well as the national marketplace, the educational
community at large, key political groups, image-makers and the
media. We believe that the quality of our curriculum and
management services has contributed significantly to the success
of our brand. As we continue to increase enrollments and extend
our geographic reach, maintaining quality and consistency across
all of our services and products may become more difficult to
achieve, and any significant and well-publicized failure to
maintain this quality and consistency will have a detrimental
effect on our brand. We cannot provide assurances that our new
sales and marketing efforts will be successful in further
promoting our brand in a competitive and cost effective manner.
If we are unable to further enhance our brand recognition and
increase awareness of our products and services, or if we incur
excessive sales and marketing expenses, our business and results
of operations could be adversely affected.
13
Our intellectual property rights are valuable, and any
inability to protect them could reduce the value of our
products, services and brand.
Our patent, trademarks, trade secrets, copyrights and other
intellectual property rights are important assets for us. For
example, we have been granted a patent relating to the hardware
and network infrastructure of our online school, including the
system components for creating and administering assessment
tests and our lesson progress tracker. Additionally, we are the
copyright owner of over 11,000 lessons in the courses comprising
our proprietary curriculum and we have registered copyrights or
filed copyright applications that cover nearly all of these
lessons. Various events outside of our control pose a threat to
our intellectual property rights. For example, effective
intellectual property protection may not be available in every
country in which our products and services are distributed or
made available through the Internet. Also, the efforts we have
taken to protect our proprietary rights may not be sufficient or
effective. Any significant impairment of our intellectual
property rights could harm our business or our ability to
compete. Also, protecting our intellectual property rights is
costly and time consuming. Any unauthorized use of our
intellectual property could make it more expensive to do
business and harm our operating results.
Although we seek to obtain patent protection for our
innovations, it is possible that we may not be able to protect
some of these innovations. In addition, given the costs of
obtaining patent protection, we may choose not to protect
certain innovations that later turn out to be important.
Furthermore, there is always the possibility, despite our
efforts, that the scope of the protection gained will be
insufficient or that an issued patent may be deemed invalid or
unenforceable.
We also seek to maintain certain intellectual property as trade
secrets. This secrecy could be compromised by outside parties,
or by our employees intentionally or accidentally, which would
cause us to lose the competitive advantage resulting from these
trade secrets.
We must monitor and protect our Internet domain names to
preserve their value.
We own the domain names K12 (.com and .org) and K-12 (.com,
.net, and .org) as well as the service mark
K12.
Third parties may acquire substantially similar domain names
that decrease the value of our domain names and trademarks and
other proprietary rights which may hurt our business. The
regulation of domain names in the United States and foreign
countries is subject to change. Governing bodies could appoint
additional domain name registrars or modify the requirements for
holding domain names. Governing bodies could also establish
additional top-level domains, which are the portion
of the Web address that appears to the right of the
dot, such as com, gov, or
org. As a result, we may not maintain exclusive
rights to all potentially relevant domain names in the United
States or in other countries in which we conduct business.
We may be sued for infringing the intellectual property
rights of others and such actions would be costly to defend,
could require us to pay damages and could limit our ability or
increase our costs to use certain technologies in the
future.
Companies in the Internet, technology, education, curriculum and
media industries own large numbers of patents, copyrights,
trademarks and trade secrets and frequently enter into
litigation based on allegations of infringement or other
violations of intellectual property rights. As we grow, the
likelihood that we may be subject to such claims also increases.
Regardless of the merits, intellectual property claims are often
time-consuming and expensive to litigate or settle. In addition,
to the extent claims against us are successful, we may have to
pay substantial monetary damages or discontinue any of our
products, services or practices that are found to be in
violation of another partys rights. We also may have to
seek a license and make royalty payments to continue offering
our products and services or following such practices, which may
significantly increase our operating expenses.
We may be subject to legal liability resulting from the
actions of third parties, including independent contractors and
teachers, which could cause us to incur substantial costs and
damage our reputation.
We may be subject, directly or indirectly, to legal claims
associated with the actions of our independent contractors and
teachers. In the event of accidents or injuries or other harm to
students, we could face claims alleging that we were negligent,
provided inadequate supervision or were otherwise liable for
their injuries. Additionally, we could face claims alleging that
our independent curriculum contractors or teachers infringed the
14
intellectual property rights of third parties. A liability claim
against us or any of our independent contractors or teachers
could adversely affect our reputation, enrollment and revenues.
Even if unsuccessful, such a claim could create unfavorable
publicity, cause us to incur substantial expenses and divert the
time and attention of management.
Unauthorized disclosure or manipulation of student,
teacher and other sensitive data, whether through breach of our
network security or otherwise, could expose us to costly
litigation or could jeopardize our contracts with virtual public
schools.
Maintaining our network security is of critical importance
because our Student Administration Management System (SAMS)
stores proprietary and confidential student and teacher
information, such as names, addresses, and other personal
information. Individuals and groups may develop and deploy
viruses, worms and other malicious software programs that attack
or attempt to infiltrate SAMS. If our security measures are
breached as a result of third-party action, employee error,
malfeasance or otherwise, third parties may be able to access
student records and we could be subject to liability or our
business could be interrupted. Penetration of our network
security could have a negative impact on our reputation and
could lead virtual public schools and parents to choose
competitive offerings. As a result, we may be required to expend
significant resources to provide additional protection from the
threat of these security breaches or to alleviate problems
caused by these breaches.
We rely on the Internet to enroll students and to deliver
our products and services to children, which exposes us to a
growing number of legal risks and increasing regulation.
We collect information regarding students during the online
enrollment process, and a significant amount of our curriculum
content is delivered over the Internet. As a result, specific
federal and state laws that could have an impact on our business
include the following:
the Childrens Online Privacy Protection Act, which
restricts the distribution of certain materials deemed harmful
to children and imposes additional restrictions on the ability
of online companies to collect personal information from
children under the age of 13; and
the Family Educational Rights and Privacy Act, which imposes
parental or student consent requirements for specified
disclosures of student information, including online information.
In addition, the laws applicable to the Internet are still
developing. These laws impact pricing, advertising, taxation,
consumer protection, quality of products and services, and are
in a state of change. New laws may also be enacted, which could
increase the costs of regulatory compliance for us or force us
to change our business practices. As a result, we may be exposed
to substantial liability, including significant expenses
necessary to comply with such laws and regulations.
System disruptions and vulnerability from security risks
to our online computer networks could impact our ability to
generate revenues and damage our reputation, limiting our
ability to attract and retain students.
The performance and reliability of our technology infrastructure
is critical to our reputation and ability to attract and retain
virtual public schools, parents and students. Any sustained
system error or failure, or a sudden and significant increase in
bandwidth usage, could limit access to our learning system, and
therefore, damage our ability to generate revenues. Our
technology infrastructure could be vulnerable to interruption or
malfunction due to events beyond our control, including natural
disasters, terrorist activities and telecommunications failures.
Substantially all of the inventory for our offline
learning kits is located in one warehouse facility. Any damage
or disruption at this facility would have an adverse effect on
our business, financial condition and results of
operations.
Substantially all of the inventory for our offline learning kits
is located in one warehouse facility operated by a third-party.
A natural disaster, fire, power interruption, work stoppage or
other unanticipated catastrophic event, especially during the
period from May through September when we have received most of
the curriculum materials for the school year and have not yet
shipped such materials to students, could significantly disrupt
our ability to deliver our products and operate our business. If
any of our material inventory were to experience any significant
damage, we would be unable to meet our contractual obligations
and our business would suffer.
15
Any significant interruption in the operations of our data
center could cause a loss of data and disrupt our ability to
manage our network hardware and software and technological
infrastructure.
We host our products and serve all of our students from a
third-party data center facility. While we are developing a risk
mitigation plan, such a plan may not be able to prevent a
significant interruption in the operation of this facility or
the loss of school and operational data due to a natural
disaster, fire, power interruption, act of terrorism or other
unanticipated catastrophic event. Any significant interruption
in the operation of this facility, including an interruption
caused by our failure to successfully expand or upgrade our
systems or manage our transition to utilizing the expansions or
upgrades, could reduce our ability to manage our network and
technological infrastructure, which could result in lost sales,
enrollment terminations and impact our brand reputation.
Additionally, we do not control the operation of this facility
and must rely on a third-party to provide the physical security,
facilities management and communications infrastructure services
related to our data center. Although we believe we would be able
to enter into a similar relationship with another third-party
should this relationship fail or terminate for any reason, our
reliance on a third-party vendor exposes us to risks outside of
our control. If this third-party vendor encounters financial
difficulty such as bankruptcy or other events beyond our control
that causes it to fail to secure adequately and maintain its
hosting facilities or provide the required data communications
capacity, students of the virtual public schools we serve may
experience interruptions in our service or the loss or theft of
important customer data.
Any significant interruption in the operations of our call
center could disrupt our ability to respond to service requests
and process orders and to deliver our products in a timely
manner.
Our call center is housed in a single facility. We do not
currently have a fully functional
back-up
system in place for this facility. While we are developing a
risk mitigation plan, such a plan may not be able to prevent a
significant interruption in the operation of this facility due
to natural disasters, accidents, failures of the inventory
locator or automated packing and shipping systems we use or
other events. Any significant interruption in the operation of
this facility, including an interruption caused by our failure
to successfully expand or upgrade our systems or to manage these
expansions or upgrades, could reduce our ability to respond to
service requests, receive and process orders and provide
products and services, which could result in lost and cancelled
sales, and damage to our brand reputation.
Capacity limits on some of our technology, transaction
processing systems and network hardware and software may be
difficult to project and we may not be able to expand and
upgrade our systems in a timely manner to meet significant
unexpected increased demand.
As the number of virtual public schools we serve increases and
our student base grows, the traffic on our transaction
processing systems and network hardware and software will rise.
We may be unable to accurately project the rate of increase in
the use of our transaction processing systems and network
hardware and software. In addition, we may not be able to expand
and upgrade our systems and network hardware and software
capabilities to accommodate significant unexpected increased
use. If we are unable to appropriately upgrade our systems and
network hardware and software in a timely manner, our operations
and processes may be temporarily disrupted.
We may be unable to manage and adapt to changes in
technology.
We will need to respond to technological advances and emerging
industry standards in a cost-effective and timely manner in
order to remain competitive. The need to respond to
technological changes may require us to make substantial,
unanticipated expenditures. There can be no assurance that we
will be able to respond successfully to technological change.
We may be unable to attract and retain skilled
employees.
Our success depends in large part on continued employment of
senior management and key personnel who can effectively operate
our business. If any of these employees leave us and we fail to
effectively manage a transition to new personnel, or if we fail
to attract and retain qualified and experienced professionals on
acceptable terms, our business, financial conditions and results
of operations could be adversely affected.
16
Our success also depends on our having highly trained financial,
technical, recruiting, sales and marketing personnel. We will
need to continue to hire additional personnel as our business
grows. A shortage in the number of people with these skills or
our failure to attract them to our Company could impede our
ability to increase revenues from our existing products and
services and to launch new product offerings, and would have an
adverse effect on our business and financial results.
We may not be able to effectively manage our growth, which
could impair our ability to operate profitably.
We have experienced significant expansion since our inception,
which has sometimes strained our managerial, operational,
financial and other resources. A substantial increase in our
enrollment or the addition of new schools in a short period of
time could strain our current resources and increase capital
expenditures, without an immediate increase in revenues. Our
failure to successfully manage our growth in a cost efficient
manner and add and retain personnel to adequately support our
growth could disrupt our business and decrease profitability.
We may need additional capital in the future, but there is
no assurance that funds will be available on acceptable
terms.
We may need to raise additional funds in order to achieve growth
or fund other business initiatives. This financing may not be
available in sufficient amounts or on terms acceptable to us and
may be dilutive to existing stockholders. Additionally, any
securities issued to raise funds may have rights, preferences or
privileges senior to those of existing stockholders. If adequate
funds are not available or are not available on acceptable
terms, our ability to expand, develop or enhance services or
products, or respond to competitive pressures will be limited.
Our curriculum and approach to instruction may not achieve
widespread acceptance, which would limit our growth and
profitability.
Our curriculum and approach to instruction are based on the
structured delivery, clarification, verification and practice of
lesson subject matter. The goal of this approach is to make
students proficient at the fundamentals and to instill
confidence in a subject prior to confronting new and complex
concepts. This approach, however, is not accepted by all
academics and educators, who may favor less formalistic methods.
Accordingly, some academics and educators are opposed to the
principles and methodologies associated with our approach to
learning, and have the ability to negatively influence the
market for our products and services.
If student performance falls or parent and student
satisfaction declines, a significant number of students may not
remain enrolled in a virtual public school that we serve, and
our business, financial condition and results of operations will
be adversely affected.
The success of our business depends on a familys decision
to have their child continue his or her education in a virtual
public school that we serve. This decision is based on many
factors, including student achievement and parent and student
satisfaction. Students may perform significantly below state
averages or the virtual school may fail to meet the standards of
the No Child Left Behind Act. For instance, in the
2005-06
school year, an increase in certain enrollments in two of the
virtual schools we served created the need to monitor two
subgroups that did not meet Adequate Yearly Progress
requirements of NCLB, causing those schools not to meet the
Adequate Yearly Progress requirements for that year. We expect
that, as our enrollments increase and the portion of students
that have not used our learning system for multiple years
increases, the average performance of all students using our
learning system may decrease, even if the individual performance
of other students improves over time. Additionally, parent and
student satisfaction may decline as not all parents and students
are able to devote the substantial time and energy necessary to
complete our curriculum. A students satisfaction may also
suffer if his or her relationship with the virtual school
teacher does not meet expectations. If a students
performance or satisfaction declines, students may decide not to
remain enrolled in a virtual public school that we serve and our
business, financial condition and results of operations will be
adversely affected.
Although we do not currently transact a material amount of
business in a foreign country, we intend to expand into
international markets, which will subject us to additional
economic, operational and political risks that could increase
our costs and make it difficult for us to continue to operate
profitably.
One of our growth strategies is to pursue international
opportunities that leverage our current product and service
offerings. The addition of international operations may require
significant expenditure of financial and
17
management resources and result in increased administrative and
compliance costs. As a result of such expansion, we will be
increasingly subject to the risks inherent in conducting
business internationally, including:
foreign currency fluctuations, which could result in reduced
revenues and increased operating expenses;
potentially longer payment and sales cycles;
difficulty in collecting accounts receivable;
the effect of applicable foreign tax structures, including tax
rates that may be higher than tax rates in the United States or
taxes that may be duplicative of those imposed in the United
States;
tariffs and trade barriers;
general economic and political conditions in each country;
inadequate intellectual property protection in foreign countries;
uncertainty regarding liability for information retrieved and
replicated in foreign countries;
the difficulties and increased expenses in complying with a
variety of U.S. and foreign laws, regulations and trade
standards, including the Foreign Corrupt Practices Act; and
unexpected changes in regulatory requirements.
Risks
Related to this Offering
The price of our common stock may be subject to wide
fluctuations and may trade below the initial public offering
price.
Before this offering, there has not been a public market for our
common stock. The initial public offering price of our common
stock will be determined by negotiations between us and
representatives of the underwriters based on numerous factors,
including those that we discuss under Underwriting.
This price may not be indicative of the market price of our
common stock after this offering. We cannot assure you that an
active public market for our common stock will develop or be
sustained after this offering. The market price of our common
stock also could be subject to significant fluctuations. As a
result, you may not be able to sell your shares of our common
stock quickly or at prices equal to or greater than the price
you paid in this offering.
Among the factors that could affect our common stock price are
the risks described in this section and other factors, including:
quarterly variations in our operating results compared to market
expectations;
changes in expectations as to our future financial performance,
including financial estimates or reports by securities analysts;
changes in market valuations of similar companies;
liquidity and activity in the market for our common stock;
sales of our common stock by our stockholders;
strategic moves by us or our competitors, such as acquisitions
or restructurings;
general market conditions; and
domestic and international economic, legal and regulatory
factors unrelated to our performance.
Stock markets in general have experienced extreme volatility
that has often been unrelated to the operating performance of a
particular company. These broad market fluctuations could
adversely affect the trading price of our common stock,
regardless of our operating performance.
Sales of substantial amounts of our common stock in the
public markets, or the perception that they might occur, could
reduce the price of our common stock and may dilute your voting
power and your ownership interest in us.
After the completion of this offering, we will have
27,257,244 shares of common stock outstanding. This number
is comprised of all the shares of our common stock that we and
the selling stockholders are selling in this
18
offering and any shares sold by the selling stockholders if the
underwriters exercise their overallotment option, which may be
resold immediately in the public market, the 882,352 shares
we will sell pursuant to the Regulation S Transaction
concurrently with this offering (assuming an initial offering
price of $17.00 per share, the midpoint of the range set
forth on the cover of this prospectus) and 20,374,892 shares
held by our existing stockholders that are not being sold in
this offering or pursuant to the underwriters
over-allotment option. Subject to certain exceptions described
under the caption Underwriting, we and all of our
directors and executive officers and certain of our stockholders
and optionholders have agreed not to offer, sell or agree to
sell, directly or indirectly, any shares of common stock without
the permission of the underwriters for a period of 180 days
from the date of this prospectus. When this period expires we
and our
locked-up
stockholders will be able to sell our shares in the public
market. As of November 14, 2007, approximately 21.6 million
of our outstanding shares were subject to the lock-up
restrictions. Sales of a substantial number of such shares upon
expiration, or early release, of the
lock-up (or
the perception that such sales may occur) could cause our share
price to fall.
We cannot predict what effect, if any, future sales of our
common stock, or the availability of common stock for future
sale, will have on the market price of our common stock. Sales
of substantial amounts of our common stock in the public market
following our initial public offering, including a secondary
offering by the Company, or the perception that such sales could
occur, could adversely affect the market price of our common
stock and may make it more difficult for you to sell your common
stock at a time and price that you deem appropriate.
We also may issue our shares of common stock from time to time
as consideration for future acquisitions and investments. If any
such acquisition or investment is significant, the number of
shares that we may issue may in turn be significant. In
addition, we may also grant registration rights covering those
shares in connection with any such acquisitions and investments.
Upon completion of this offering, 21,257,244 of our shares of
common stock will be restricted or control securities within the
meaning of Rule 144 under the Securities Act of 1933, as
amended, (20,357,244 shares of common stock if the
underwriters overallotment option is exercised in full).
The rules affecting the sale of these securities are summarized
under Shares Eligible for Future Sale.
Our principal stockholders hold (and following completion of
this offering will continue to hold) shares of our common stock
in which they have a large unrealized gain, and these
stockholders may wish, to the extent they may permissibly do so,
to realize some or all of that gain relatively quickly by
selling some or all of their shares.
Investors purchasing common stock in this offering will
experience immediate and substantial dilution after giving
effect to the net proceeds from this offering and the
Regulation S Transaction.
The assumed initial public offering price of our common stock is
substantially higher than the net tangible book value per
outstanding share of our common stock immediately after this
offering and the Regulation S Transaction. As a result, you
will pay a price per share that substantially exceeds the book
value of our assets after subtracting our liabilities.
Purchasers of our common stock in this offering will incur
immediate and substantial dilution of $12.33 per share in the
net tangible book value of our common stock from the assumed
initial public offering price of $17.00 per share, which is the
mid-point of the estimated range set forth on the cover of this
prospectus. If the underwriters exercise their over-allotment
option in full, there will be an additional dilution of $0.15
per share in the net tangible book value of our common stock,
assuming the same public offering price. See
Dilution. In addition, if outstanding options to
purchase shares of common stock are exercised, there could be
substantial additional dilution.
Antitakeover provisions in our charter documents and under
Delaware law could make an acquisition of us, which may be
beneficial to our stockholders, more difficult and may prevent
attempts by our stockholders to replace or remove our current
management.
Provisions in our amended and restated certificate of
incorporation and amended and restated bylaws to be effective
upon the consummation of this offering may delay or prevent an
acquisition of us or a change in our management. These
provisions will include prohibition on actions by written
consent of our stockholders and the ability of our board of
directors to issue preferred stock without stockholder approval.
In addition, because we are incorporated in Delaware, we are
governed by the provisions of Section 203 of the Delaware
General Corporation Law, which prohibits stockholders owning in
excess of 15% of our outstanding voting stock from merging or
19
combining with us. Although we believe these provisions
collectively provide for an opportunity to receive higher bids
by requiring potential acquirers to negotiate with our board of
directors, they would apply even if the offer may be considered
beneficial by some stockholders. In addition, these provisions
may frustrate or prevent attempts by our stockholders to replace
or remove our current management by making it more difficult for
stockholders to replace members of our board of directors, which
is responsible for appointing the members of our management.
As a result of becoming a public company, we will be
obligated to develop and maintain proper and effective internal
control over financial reporting and will be subject to other
requirements that will be burdensome and costly. We may not
timely complete our analysis of our internal control over
financial reporting, or these internal controls may not be
determined to be effective, which could adversely affect
investor confidence in our company and, as a result, the value
of our common stock.
We will be required, pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002 (Section 404), to furnish a
report by management on, among other things, the effectiveness
of our internal control over financial reporting for the first
fiscal year beginning after the effective date of this offering.
This assessment will need to include disclosure of any material
weaknesses identified by our management in our internal control
over financial reporting. In addition, our auditors will issue
an attestation report on our internal control over financial
reporting.
We are just beginning the costly and challenging process of
compiling the system and processing documentation before we
perform the evaluation needed to comply with Section 404.
We may not be able to complete our evaluation, testing and any
required remediation in a timely fashion. During the evaluation
and testing process, if we identify one or more material
weaknesses in our internal control over financial reporting, we
will be unable to assert that our internal control is effective.
If we are unable to assert that our internal control over
financial reporting is effective, or if our auditors are unable
to issue an unqualified opinion that we maintained, in all
material respects, effective internal control over financial
reporting, we could lose investor confidence in the accuracy and
completeness of our financial reports, which would have a
material adverse effect on the price of our common stock.
Failure to comply with the new rules might make it more
difficult for us to obtain certain types of insurance, including
director and officer liability insurance, and we might be forced
to accept reduced policy limits and coverage
and/or incur
substantially higher costs to obtain the same or similar
coverage. The impact of these events could also make it more
difficult for us to attract and retain qualified persons to
serve on our board of directors, on committees of our board of
directors, or as executive officers.
In addition, as a public company, we will incur significant
legal, accounting and other expenses that we did not incur as a
private company, and our administrative staff will be required
to perform additional tasks. For example, in anticipation of
becoming a public company, we will need to create or revise the
roles and duties of our board committees, adopt disclosure
controls and procedures, retain a transfer agent, adopt an
insider trading policy and bear all of the internal and external
costs of preparing and distributing periodic public reports in
compliance with our obligations under federal securities laws.
In addition, changing laws, regulations and standards relating
to corporate governance and public disclosure, and related
regulations implemented by the SEC and NYSE Arca, are creating
uncertainty for public companies, increasing legal and financial
compliance costs and making some activities more time consuming.
These laws, regulations and standards are subject to varying
interpretations, in many cases due to their lack of specificity,
and, as a result, their application in practice may evolve over
time as new guidance is provided by regulatory and governing
bodies. We intend to invest resources to comply with evolving
laws, regulations and standards, and this investment may result
in increased general and administrative expenses and a diversion
of managements time and attention from revenue-generating
activities to compliance activities. If our efforts to comply
with new laws, regulations and standards differ from the
activities intended by regulatory or governing bodies due to
ambiguities related to practice, regulatory authorities may
initiate legal proceedings against us and our business may be
harmed.
Our largest stockholders will continue to have significant
control over us after this offering, and they may make decisions
with which you disagree.
Following the offering, assuming no exercise of the
underwriters overallotment option, our current
stockholders will beneficially own approximately 74.8% of the
outstanding shares of common stock (or approximately 62.5% of
the shares of common stock on a fully diluted basis, after
giving effect to the exercise of all outstanding options and
other rights to acquire common stock). As a result, such current
stockholders may have the ability to
20
control the election of our directors and the outcome of
corporate actions requiring stockholder approval. This
concentration of ownership could have the effect of discouraging
potential take-over attempts and may make attempts by
stockholders to change our management more difficult.
We have not paid and do not expect to pay dividends, and
any return on your investment will likely be limited to the
appreciation of our common stock.
We have never paid dividends on our common stock and do not
anticipate paying dividends on our common stock in the
foreseeable future. If, however, we decide to pay dividends on
our common stock in the future, the payment of dividends will
depend on our earnings, financial condition and other business
and economic factors affecting us at such time as our board of
directors may consider relevant. In addition, our credit
facility with PNC Bank, N.A. (PNC Bank) contains covenants
prohibiting the payment of cash dividends without their consent.
Accordingly, for the foreseeable future, any return on your
investment will be related to the appreciation of our stock
price.
We have broad discretion in the use of the net proceeds
from this offering and the Regulation S Transaction and may
not use them effectively.
We cannot specify with certainty the particular uses of the net
proceeds we will receive from this offering and the
Regulation S Transaction. Our management will have broad
discretion in the application of the net proceeds, including for
any of the purposes described in Use of Proceeds.
The failure by our management to apply these funds effectively
could harm our business. Pending their use, we may invest the
net proceeds from this offering and the Regulation S
Transaction in a manner that does not produce income or that
loses value.
If equity research analysts do not publish research or
reports about our business or if they issue unfavorable
commentary or downgrade our common stock, the price of our
common stock could decline.
The trading market for our common stock will rely in part on the
research and reports that equity research analysts publish about
us and our business. The price of our stock could decline if one
or more securities analysts downgrade our stock or if those
analysts issue other unfavorable commentary or cease publishing
reports about us or our business.
The Securities and Exchange Commission, or SEC, encourages
companies to disclose forward-looking information so that
investors can better understand a companys future
prospects and make informed investment decisions. This
prospectus contains such forward-looking statements.
All statements other than statements of historical facts
contained in this prospectus, including our disclosure and
analysis concerning our operations, cash flows and financial
position, business strategy and plans and objectives, including,
in particular, the likelihood of our success developing and
expanding our business, are forward-looking statements. In some
cases, you can identify forward-looking statements by terms such
as may, will, should,
expects, plans, anticipates,
could, intends, target,
projects, contemplates,
believes, estimates,
predicts, potential or
continue or the negative of these terms or other
similar words. These statements are only predictions. All
forward-looking statements are managements present
expectations of future events and are subject to a number of
risks and uncertainties that could cause actual results to
differ materially from those described in the forward-looking
statements. These risks include, but are not limited to, the
risks and uncertainties set forth in Risk Factors,
beginning on page 8 of this prospectus.
In light of these assumptions, risks and uncertainties, the
results and events discussed in the forward-looking statements
contained in this prospectus might not occur. You are cautioned
not to place undue reliance on the forward-looking statements,
which speak only as of the date of this prospectus. We are not
under any obligation, and we expressly disclaim any obligation,
to update or alter any forward-looking statements, whether as a
result of new information, future events, or otherwise. All
subsequent forward-looking statements attributable to us or to
any person acting on our behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to
in this section.
This prospectus also contains estimates and other statistical
data made by independent parties and by us relating to market
size and growth and other industry data. These data involves a
number of assumptions and limitations, and you are cautioned not
to give undue weight to such estimates. We have not
independently verified the statistical and other industry data
generated by independent parties and contained in this
prospectus and, accordingly, we cannot guarantee their accuracy
or completeness. In addition, projections, assumptions and
estimates of our future performance and the future performance
of the industries in which we operate are necessarily subject to
a high degree of uncertainty and risk due to a variety of
factors, including those described in Risk Factors,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this
prospectus. These and other factors could cause results to
differ materially from those expressed in the estimates made by
the independent parties and by us.
22
USE
OF PROCEEDS
Assuming an initial public offering price of $17.00 per share,
we estimate that we will receive net proceeds from this offering
of approximately $67.4 million, after deducting
underwriting discounts and commissions and other estimated
expenses of $3.0 million payable by us. We will not receive
any of the proceeds from the sale of shares to be sold by the
selling stockholders in this offering or any shares to be sold
by the selling stockholders if the underwriters exercise their
overallotment option. See Principal and Selling
Stockholders for more information. A $1.00 increase
(decrease) in the assumed initial public offering price of
$17.00 per share would increase (decrease) the net proceeds to
us from this offering by approximately
$4.1 (4.1) million, assuming the number of shares
offered, as set forth on the cover page of this prospectus,
remains the same and after deducting the estimated underwriting
discounts and commissions and estimated offering expenses
payable by us. In addition, we anticipate that we will receive
net proceeds of $14.9 million from the sale of additional
shares in the Regulation S Transaction.
We intend to use the net proceeds from this offering and from
the Regulation S Transaction for general corporate
purposes, including working capital, capital expenditures and
the development of new courses and product offerings. In
addition, we intend to repay approximately $15.0 million of
borrowings under our revolving credit facility, which bears
interest at rates of approximately 6.0% to 7.0%, with various
maturity dates on or before December 14, 2007 that may be
renewed at the then current interest rate, and to pay a cash
dividend of approximately $6.4 million to the holders of
our Series C Preferred Stock, which will become payable
upon the closing of this offering. The net proceeds will also
provide us with the financial flexibility to make acquisitions
and strategic investments. Management will have broad discretion
in the allocation of the net proceeds from this offering and
from the Regulation S Transaction. Depending upon future
events, we may determine at a later time to use the net proceeds
for different purposes. Pending their use, we plan to invest the
net proceeds in short-term, investment grade, interest-bearing
securities.
DIVIDEND
POLICY
We have never paid or declared a dividend on our common stock,
and we intend to retain all future earnings, if any, for use in
the operation of our business and to fund future growth. We do
not anticipate paying any dividends on our common stock for the
indefinite future, and our credit facility with PNC Bank, N.A.
limits our ability to pay dividends or other distributions on
our common stock. The decision whether to pay dividends will be
made by our board of directors in light of conditions then
existing, including factors such as our results of operations,
financial condition and requirements, business conditions, and
covenants under any applicable contractual arrangements.
23
CAPITALIZATION
The following table sets forth our capitalization as of
September 30, 2007:
on an actual basis;
on a pro forma basis, giving effect to the automatic conversion
of all of the outstanding shares of our preferred stock into
19,879,675 shares of our common stock immediately prior to
the completion of this offering; and
on a pro forma basis as discussed in the prior bullet point, as
adjusted to give effect to (i) our receipt of the estimated
net proceeds from the sale of 4,450,000 shares of common
stock offered by us in this offering, assuming an initial public
offering price of $17.00, the midpoint of the estimated price
range shown on the cover page of this prospectus, after
deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us and (ii) our
receipt of the estimated net proceeds from the sale of shares of
common stock in the Regulation S Transaction, assuming the
sale of 882,352 shares of common stock (based on the same
assumed initial public offering price of $17.00 per share,
which is the midpoint of the range shown on the cover page of
this prospectus), after deducting estimated expenses payable by
us, and our use of proceeds from this offering and the
Regulation S Transaction to repay approximately
$15.0 million of outstanding indebtedness under our
revolving credit facility and to pay a cash dividend of
approximately $6.4 million to the holders of our
Series C Preferred Stock, which will become payable upon
the closing of this offering.
You should read this table in conjunction with the consolidated
financial statements and the related notes,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and Use of
Proceeds included elsewhere in this prospectus.
As of September 30, 2007
Pro forma
Actual
Pro forma
as
adjusted(1)
(dollars in thousands)
Cash and cash
equivalents(2)
$
2,903
$
2,903
$
63,757
Total
debt(2)
25,906
25,906
13,406
Redeemable Convertible Preferred Stock
Redeemable Convertible Series C Preferred Stock, par value
$0.0001 per share; 55,000,000 shares authorized,
49,861,562 issued and outstanding, actual; no shares issued
and outstanding pro forma and pro forma as adjusted
95,571
Redeemable Convertible Series B Preferred Stock, par value
$0.0001 per share; 76,000,000 shares authorized;
51,524,974 issued and outstanding, actual; no shares issued
and outstanding pro forma and pro forma as adjusted
142,216
Stockholders deficit:
Common stock, par value $0.0001 per share;
33,362,500 shares authorized, 2,045,217 issued and
outstanding, actual; 21,924,892 issued and outstanding, pro
forma; 100,000,000 shares authorized, 27,257,244 issued and
outstanding pro forma as
adjusted(3)
1
2
3
Additional paid-in capital
237,786
320,040
Accumulated deficit
(192,892
)
(192,892
)
(192,892
)
Total stockholders (deficit) equity
(192,891
)
44,896
127,151
Total capitalization
$
70,802
$
70,802
$
140,557
(1)
A $1.00 increase (decrease) in the
assumed initial public offering price of $17.00 per share, which
is the midpoint of the range on the cover page of this
prospectus, would increase (decrease) each of cash and cash
equivalents, additional paid-in capital, total
stockholders equity and total capitalization by
approximately $4.1 (4.1) million, assuming the number of
shares offered by us, as set forth on the cover page of this
prospectus, remains the same and after deducting the
underwriting discounts and commissions and estimated offering
expenses payable by us.
(2)
Total debt on a pro forma as
adjusted basis reflects the repayment of the $12.5 million
principal amount outstanding on our revolving credit facility as
of September 30, 2007. Cash and cash equivalents on a pro
forma as adjusted basis give effect to the repayment of the
$12.5 million outstanding as of September 30, 2007
plus the repayment of $2.5 million of additional net
borrowings under the revolving credit facility since
September 30, 2007.
(3)
A $1.00 increase (decrease) in the
assumed initial public offering price of $17.00 per share, which
is the midpoint of the range shown on the cover page of this
prospectus, would decrease (increase) the number of shares
issued and outstanding by approximately 49,019
(55,148) shares.
24
DILUTION
Dilution is the amount by which the offering price paid by the
purchasers of the common stock to be sold in the offering
exceeds the net tangible book value per share of common stock
after the offering. Net tangible book value per share is
determined at any date by subtracting our total liabilities from
the total book value of our tangible assets and dividing the
difference by the number of shares of common stock deemed to be
outstanding at that date.
Our net tangible book value as of September 30, 2007 was
($192.9) million, or ($94.31) per share. Our pro forma
net tangible book value as of September 30, 2007 was
$44.9 million, or $2.05 per share after giving effect to
the automatic conversion of all of our preferred stock into
shares of common stock in accordance with their terms
immediately prior to the consummation of the offering. This
represents an increase of $237.8 million or $96.36 per
share. After giving effect to (i) our receipt of the
estimated net proceeds from the sale of shares of common stock
offered by us in this offering, assuming an initial public
offering price of $17.00, the midpoint of the estimated price
range shown on the cover page of this prospectus, after
deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us and (ii) our
receipt of the estimated net proceeds from the sale of shares of
common stock in the Regulation S Transaction, assuming the
sale of 882,352 shares of common stock (based on an initial
offering price of $17.00 per share, which is the midpoint
of the range on the cover of this prospectus), after deducting
estimated expenses payable by us, our pro forma as adjusted net
tangible book value as of September 30, 2007 would have
been approximately $127.2 million, or $4.67 per share. This
represents an immediate increase in pro forma net tangible book
value of $2.62 per share to existing stockholders and an
immediate dilution of $12.33 per share to new investors
purchasing shares of common stock in the offering. The following
table illustrates this substantial and immediate per share
dilution to new investors:
Per Share
Assumed initial public offering price per share
$
17.00
Pro forma net tangible book value before this offering
$
2.05
Increase per share attributable to our investors in this offering
2.21
Increase per share attributable to the investor in the
Regulation S Transaction
0.41
Pro forma net tangible book value per share after this offering
and the Regulation S Transaction
4.67
Dilution per share to new investors in this offering
$
12.33
A $1.00 increase (decrease) in the assumed initial public
offering price of $17.00 per share would increase (decrease),
the as adjusted pro forma net tangible book value per share
after this offering by $0.19 and the dilution per share to new
investors in this offering by $0.19, assuming the number of
shares offered by us, as set forth on the cover page of this
prospectus, remains the same but adjusting the number of shares
sold by us in the Regulation S Transaction in accordance
with the terms thereof, and after deducting the estimated
underwriting discounts and commissions and estimated offering
expenses and expenses of the Regulation S Transaction
payable by us.
The following table summarizes on a pro forma as adjusted basis
as of September 30, 2007, giving effect to the automatic
conversion of all of our shares of preferred stock into shares
of common stock in connection with the offering:
the total number of shares of common stock purchased from us by
our existing stockholders, by the investor in the
Regulation S Transaction and by new investors purchasing
shares in this offering;
the total consideration paid to us by our existing stockholders,
by the investor in the Regulation S Transaction and by new
investors purchasing shares in this offering, assuming an
initial public offering price of $17.00 per share and the sale
of 882,352 shares in the Regulation S Transaction
(before deducting the estimated underwriting discount and
commissions and offering expenses payable by us in connection
with this offering and expenses of the Regulation S
Transaction); and
25
the average price per share paid by existing stockholders, by
the investor in the Regulation S Transaction and by new
investors purchasing shares in this offering:
Shares Purchased
Total Consideration
Average Price
Number
Percent
Amount
Percent
Per Share
Existing stockholders
21,924,892
80.5
%
$
118,568,262
56.7
%
$
5.41
Investor in the Regulation S Transaction
882,352
3.2
%
15,000,000
7.2
%
17.00
Investors in the offering
4,450,000
16.3
%
75,650,000
36.1
%
17.00
Total
27,257,244
100
%
$
209,218,262
100
%
$
7.68
The tables and calculations above assume no exercise of:
stock options outstanding as of September 30, 2007 to
purchase 4,860,973 shares of common stock at a weighted
average exercise price of $10.37 per share;
2,328,358 shares of preferred stock that may be issued upon
the exercise of warrants outstanding as of September 30,
2007, all of which are currently exercisable at a purchase price
of $1.34 per share (or upon the consummation of the
offering, 456,540 shares of common stock that may be issued
upon the exercise of such warrants at a purchase price of $6.83
per share), and 21,299 shares of common stock that may be
issued upon the exercise of warrants outstanding as of
September 30, 2007, all of which are exercisable at a
purchase price of $8.16 per share; or
the underwriters overallotment option.
To the extent any of these options are exercised, there will be
further dilution to new investors. For example, if, immediately
after the offering, we were to issue (i) all
4,860,973 shares of common stock issuable upon exercise of
outstanding options and (ii) all 477,839 shares of
common stock issuable upon exercise of outstanding warrants and,
in each case, we receive the aggregate exercise price therefrom,
our net tangible book value would be approximately
$180.8 million, or $5.55 per share. This would represent
immediate further dilution of $0.88 per share to new investors
purchasing shares at the initial public offering price.
26
SELECTED
CONSOLIDATED FINANCIAL DATA
The following table sets forth our selected consolidated
statement of operations, balance sheet and other data for the
periods indicated. We have derived our selected consolidated
statement of operations data for the years ended June 30,
2005, 2006 and 2007 and our balance sheet data as of
June 30, 2006 and 2007, from our audited consolidated
financial statements that are included elsewhere in this
prospectus. We have derived our selected consolidated statement
of operations data for the years ended June 30, 2003 and
2004, and our balance sheet data as of June 30, 2003, 2004
and 2005, from our audited consolidated financial statements
that are not included in this prospectus. We have derived our
consolidated statement of operations data for the three months
ended September 30, 2006 and 2007 and consolidated balance
sheet data as of September 30, 2007 from our unaudited
consolidated financial statements that are included elsewhere in
this prospectus. 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 Companys financial
position and results of operations and cash flows for the three
months ended September 30, 2007 and 2006. Our historical results
are not necessarily indicative of future operating results. You
should read the information set forth below in conjunction with
Selected Consolidated Financial and Operating Data,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and our consolidated
financial statements and their related notes included elsewhere
in this prospectus.
Three Months Ended
September 30,
Year Ended June 30,
2007
2006
2007
2006
2005
2004
2003
(dollars in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues
$
59,353
$
37,743
$
140,556
$
116,902
$
85,310
$
71,434
$
30,930
Cost and expenses
Instructional costs and services
34,778
19,177
76,064
64,828
49,130
39,943
25,580
Selling, administrative, and other operating expenses
16,039
11,385
51,159
41,660
30,031
25,656
20,903
Product development expenses
2,527
2,206
8,611
8,568
9,410
12,750
12,416
Total costs and expenses
53,344
32,768
135,834
115,056
88,571
78,349
58,899
Income (loss) from operations
6,009
4,975
4,722
1,846
(3,261
)
(6,915
)
(27,969
)
Interest expense, net
(304
)
(94
)
(639
)
(488
)
(279
)
(516
)
(388
)
Net income (loss) before taxes
5,705
4,881
4,083
1,358
(3,540
)
(7,431
)
(28,357
)
Income tax benefit (expense)
7,117
(146
)
(218
)
Net income (loss)
12,822
4,735
3,865
1,358
(3,540
)
(7,431
)
(28,357
)
Dividends on preferred stock
(1,671
)
(1,519
)
(6,378
)
(5,851
)
(5,261
)
(2,667
)
Preferred stock accretion
(6,560
)
(5,367
)
(22,353
)
(18,697
)
(15,947
)
(15,768
)
(11,912
)
Net income (loss) attributable to common stockholders
$
4,591
$
(2,151
)
$
(24,866
)
$
(23,190
)
$
(24,748
)
$
(25,866
)
$
(40,269
)
Net income (loss) attributable to common stockholders per share:
Basic
$
2.25
$
(1.08
)
$
(12.42
)
$
(11.73
)
$
(12.54
)
$
(13.17
)
$
(20.52
)
Diluted
$
0.20
$
(1.08
)
$
(12.42
)
$
(11.73
)
$
(12.54
)
$
(13.17
)
$
(20.52
)
Basic (pro
forma)(1)
$
0.58
n/a
$
0.18
$
n/a
n/a
n/a
n/a
Diluted (pro
forma)(1)
$
0.56
n/a
$
0.18
n/a
n/a
n/a
n/a
Weighted average shares used in computing per share amounts:
Basic
2,043,589
1,998,853
2,001,661
1,977,195
1,973,053
1,964,147
1,962,726
Diluted
22,744,525
1,998,853
2,001,661
1,977,195
1,973,053
1,964,147
1,962,726
Basic (pro
forma)(1)
21,923,244
n/a
21,881,316
n/a
n/a
n/a
n/a
Diluted (pro
forma)(1)
22,744,525
n/a
21,890,720
n/a
n/a
n/a
n/a
Other Data:
Net cash provided by (used in) operating activities
$
(2,740
)
$
3,398
$
5,563
$
3,625
$
9,697
$
(8,020
)
$
(15,990
)
Depreciation and amortization
$
2,252
$
1,224
$
7,404
$
4,986
$
5,509
$
4,922
$
4,005
Capital
expenditures(2)
$
8,494
$
4,784
$
13,418
$
10,842
$
5,133
$
4,643
$
4,677
EBITDA(3)
$
8,261
$
6,199
$
12,126
$
6,832
$
2,248
$
(1,993
)
$
(23,964
)
Average
enrollments(4)
39,493
26,405
27,005
20,220
15,097
11,158
5,872
27
As of
September 30,
As of June 30,
2007
2007
2006
2005
2004
2003
(dollars in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents
$
2,903
$
1,660
$
9,475
$
19,953
$
15,881
$
7,727
Total assets
106,202
61,212
48,485
41,968
42,714
21,331
Total short-term debt
12,500
1,500
Total long-term obligations
13,406
7,135
4,025
4,466
3,432
1,697
Convertible redeemable preferred stock
237,787
229,556
200,825
176,277
155,069
111,634
Total stockholders deficit
(192,891
)
(197,807
)
(173,451
)
(150,299
)
(125,621
)
(99,762
)
Working capital
9,939
8,548
15,421
22,953
24,130
6,823
(1)
Pro forma net income per common
share gives effect to the automatic conversion of all of our
outstanding shares of preferred stock into common stock
immediately prior to the completion to this offering. Assuming
the completion of this offering on September 30, 2007, all
of our outstanding shares of preferred stock would convert into
19,879,675 shares of common stock.
(2)
Capital expenditures consist of the
purchase of property and equipment, capitalized software and new
capital lease obligations.
(3)
EBITDA consists of net income
(loss) minus interest income, plus interest expense, plus income
tax expense and plus depreciation and amortization. Interest
income consists primarily of interest earned on short-term
investments or cash deposits. Interest expense primarily
consists of interest expense for capital leases, long-term and
short-term borrowings. We use EBITDA as a measure of operating
performance. However, EBITDA is not a recognized measurement
under U.S. generally accepted accounting principles, or GAAP,
and when analyzing our operating performance, investors should
use EBITDA in addition to, and not as an alternative for, net
income (loss) as determined in accordance with GAAP. Because not
all companies use identical calculations, our presentation of
EBITDA may not be comparable to similarly titled measures of
other companies. Furthermore, EBITDA is not intended to be a
measure of free cash flow for our managements
discretionary use, as it does not consider certain cash
requirements such as tax payments.
We
believe EBITDA is useful to an investor in evaluating our
operating performance because it is widely used to measure a
companys operating performance without regard to items
such as depreciation and amortization, which can vary depending
upon accounting methods and the book value of assets, and to
present a meaningful measure of corporate performance exclusive
of our capital structure and the method by which assets were
acquired. Our management uses EBITDA:
as a measurement of operating performance, because it assists us
in comparing our performance on a consistent basis, as it
removes depreciation, amortization, interest and taxes; and
in presentations to the members of our board of directors to
enable our board to have the same measurement basis of operating
performance as is used by management to compare our current
operating results with corresponding prior periods and with the
results of other companies in our industry.
The following table provides a reconciliation of net income
(loss) to EBITDA:
Three Months Ended September 30,
Year Ended June 30,
2007
2006
2007
2006
2005
2004
2003
(dollars in thousands)
Net income (loss)
$
12,822
$
4,735
$
3,865
$
1,358
$
(3,540
)
$
(7,431
)
$
(28,357
)
Interest expense, net
304
94
639
488
279
516
388
Income tax (benefit) expense
(7,117
)
146
218
Depreciation and amortization
2,252
1,224
7,404
4,986
5,509
4,922
4,005
EBITDA
$
8,261
$
6,199
$
12,126
$
6,832
$
2,248
$
(1,993
)
$
(23,964
)
(4)
To ensure that all schools are
reflected in our measure of enrollments, we consider our
enrollments as of the end of September to be our opening
enrollment level, and the number of students enrolled at the end
of May to be our ending enrollment level. To provide
comparability, we do not consider enrollment levels for June,
July and August as all schools are not open during these months.
For each period, average enrollments represent the average of
the month end enrollment levels for each month that has
transpired between September and the end of the period, up to
and including the month of May.
28
MANAGEMENTS
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our
consolidated financial statements and the related notes included
elsewhere in this prospectus. This discussion contains
forward-looking statements about our business and operations.
Our actual results may differ materially from those we currently
anticipate as a result of the factors we describe under
Risk Factors and elsewhere in this prospectus.
Our
Company
We are a technology-based education company. We offer
proprietary curriculum and educational services created for
online delivery to students in kindergarten through
12th grade, or K-12. Our mission is to maximize a
childs 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 $100 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual schools
and other educational applications. From fiscal year 2004 to
fiscal year 2007, we increased average enrollments in the
virtual public schools we serve from approximately 11,000
students to 27,000 students, representing a compound annual
growth rate of approximately 35%. For the three months ended
September 30, 2007, we increased average enrollments 50% to
approximately 39,500, as compared to the same period in the
prior year. From fiscal year 2004 to fiscal year 2007, we
increased revenues from $71.4 million to
$140.6 million, representing a compound annual growth rate
of approximately 25%, and improved from a net loss of
$7.4 million to net income of $3.9 million. For the
three months ended September 30, 2007, we increased
revenues to $59.4 million, representing a growth rate of
57%, as compared to the same period in the prior year. Over the
same period, we increased net income to $5.7 million
(excluding an income tax benefit of $7.1 million) from
$4.7 million.
We deliver our learning system to students primarily through
virtual public schools. Many states have embraced virtual public
schools as a means to provide families with a publicly funded
alternative to a traditional classroom-based education. We offer
virtual schools our proprietary curriculum, online learning
platform and varying levels of academic and management services,
which can range from targeted programs to complete turnkey
solutions, under long-term contracts. These contracts provide
the basis for a recurring revenue stream as students progress
through successive grades. Additionally, without the requirement
of a physical classroom, virtual schools can be scaled quickly
to accommodate a large dispersed student population, and allow
more capital resources to be allocated towards teaching,
curriculum and technology rather than towards a physical
infrastructure.
Our proprietary curriculum is currently used primarily by public
school students in 17 states and the District of Columbia.
Parents can also purchase our curriculum and online learning
platform directly to facilitate or supplement their
childrens education. Additionally, we have piloted our
curriculum in brick and mortar classrooms with promising
academic results. We also believe there is additional widespread
applicability for our learning system internationally.
Our
History
We were founded in 2000 to utilize the advances in technology to
provide children access to a high-quality public school
education regardless of their geographic location or
socio-economic background. Given the geographic flexibility of
technology-based education, we believed that the pursuit of this
mission could help address the growing concerns regarding the
regionalized disparity in the quality of public school
education, both in the United States and abroad. These concerns
were reflected in the passage of the No Child Left Behind (NCLB)
Act in 2000, which implemented new standards and accountability
requirements for public K-12 education. The convergence of these
concerns and rapid advances in Internet technology created the
opportunity to make a significant impact by deploying a high
quality learning system on a flexible, online platform.
In September 2001, after 18 months of research and
development on our curriculum, we launched our kindergarten
through 2nd grade offering. We initially launched our
learning system in virtual public schools in Pennsylvania and
Colorado, serving approximately 900 students in the two states
combined. During the
2002-03
school year, we added our 3rd through 5th grade
offering and entered into contracts to operate virtual public
schools
29
in California, Idaho, Ohio, Minnesota and Arkansas, increasing
our average enrollment to approximately 5,900 students during
the 2002-03 school year. For the
2003-04
school year, we added our 6th and 7th grade offerings. During
the 2004-05
school year, we added our 8th grade offering and entered
into contracts to operate virtual public schools in Wisconsin,
Arizona and Florida. By the end of the
2004-05
school year, we had increased enrollment to approximately 15,100
students. In the 2005-06 school year, we added contracts to
operate virtual public schools in Washington, Illinois and
Texas. Additionally during the
2006-07
school year, we implemented a hybrid school offering in Chicago
that combines face-to-face time in the classroom with online
instruction. We recently entered the virtual high school market,
enrolling 9th and 10th grade students at the start of
the 2005-06
and 2006-07
school years, respectively, and enrolling 11th and
12th grade students at the start of the
2007-08
school year. Finally, we added contracts to operate virtual
public schools in Georgia and Nevada for the 2007-08 school year.
We believe we have significant growth potential. Therefore over
the last three years, we have put a great deal of effort into
developing the infrastructure necessary to scale our business.
We further developed our logistics and technological
infrastructure and implemented sophisticated financial systems
to allow us to more effectively operate a large and growing
company.
Key
Aspects and Trends of Our Operations
Revenues
We generate a significant portion of our revenues from
enrollments in virtual public schools. In each of the past four
years, more than 90% of our revenues have been derived through
contracts with these schools. We anticipate that these revenues
will continue to represent the bulk of our total revenues over
the next
12-24 months,
although the percentage may decline over the longer term as we
identify new channels through which to market our curriculum and
educational services. These contracts provide the channels
through which we can enroll students into the school, and we
execute marketing and recruiting programs designed to create
awareness and generate enrollments for these schools. We
generate our revenues by providing each student with access to
our online lessons and offline learning kits, including use of a
personal computer. In addition, we provide a variety of
management and academic support services to virtual public
schools, ranging from turnkey end-to-end management solutions to
a single service to meet a schools specific needs. We also
generate revenues from sales of our curriculum and offline
learning kits through other channels, including directly to
consumers and pilots in a traditional classroom environment.
Factors affecting our revenues include: (i) the number of
enrollments; (ii) the nature and extent of the management
services provided to the schools and school districts;
(iii) state or district per student funding levels; and
(iv) prices for our products and services.
We define an enrollment as a full-time student using our
provided courses as their primary curriculum. We consider
full-time students to be those utilizing our curriculum
regardless of the nature and extent of the management services
we provide to the virtual public school. Generally, a full-time
student will take five or six courses, except for kindergarten
students who participate in
half-day
programs. We count each
half-day
kindergarten student as an enrollment.
School sessions generally begin in August or September and end
in May or June. We consider the duration of a school year to be
10 months. To ensure that all schools are reflected in our
measure of enrollments, we consider the number of students on
the last day of September to be our opening enrollment level,
and the number of students enrolled on the last day of May to be
our ending enrollment level. To provide comparability, we do not
consider enrollment levels for June, July and August as most
schools are not open during these months. For each period,
average enrollments represent the average of the month-end
enrollment levels for each month that has transpired between
September and the end of the period, up to and including the
month of May. We continually evaluate our enrollment levels by
state, by school and by grade. We track new student enrollments
and withdrawals throughout the year.
We believe that the number of enrollments depends upon the
following:
the number of states and school districts in which we operate;
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the appeal of our curriculum to students and families;
the effectiveness of our program in delivering favorable
academic outcomes;
the quality of the teachers working in the virtual public
schools we serve; and
the effectiveness of our marketing and recruiting programs.
We continually evaluate our trends in revenues by monitoring the
number of enrollments in total, by state, by school and by
grade, assessing the impact of changes in funding levels and the
pricing of our curriculum and educational services. We track
enrollments throughout the year, as students enroll and
withdraw. We also provide our courses for use in a traditional
classroom setting and we sell our courses directly to consumers.
Our classroom course revenues are generally for single courses.
Consumers typically purchase from one to six courses in a year,
however, we do not monitor the progress of these students.
Therefore, we do not include classroom or consumer students in
our enrollment totals.
We closely monitor the financial performance of the virtual
public schools to which we provide turnkey management services.
Under the contracts with these schools, we take responsibility
for any operating deficits that they may incur in a given school
year. These operating deficits represent the excess of costs
over revenues incurred by the virtual public schools as
reflected on their financial statements. The costs include our
charges to the schools. These operating deficits may result from
a combination of cost increases or funding reductions
attributable to the following: 1) costs associated with new
schools including the initial hiring of teachers and the
establishment of school infrastructure; 2) school
requirements to establish contingency reserves; 3) one-time
costs such as a legal claim; 4) funding reductions due to
the inability to qualify specific students for funding; and
5) regulatory or academic performance thresholds which may
initially restrict the ability of a school to fund all expenses.
In these cases, because a deficit may impair our ability to
collect our invoices in full, we reduce revenues by the sum of
these deficits. Over the past three years, these deficits and
the related reduction to revenues have grown substantially
faster than overall revenue growth reflecting a significant
number of new school
start-ups,
the time required to meet performance thresholds in certain
states and funding adjustments in two states related to the
disqualification of certain past enrollments. We expect these
deficits to continue to grow faster than overall revenue growth
as we expand into new states, continue investment in educational
programs, and incur the higher costs associated with our high
school offering.
Our annual growth in revenues may be materially affected by
changes in the level of management services we provide to
certain schools. Currently a significant portion of our
enrollments are associated with virtual public schools to which
we provide turnkey management services. We are responsible for
the complete management of these schools and therefore, we
recognize as revenues the funds received by the schools, up to
the level of costs incurred. These costs are substantial, as
they include the cost of teacher compensation and other
ancillary school expenses. Accordingly, enrollments in these
schools generate substantially more revenues than enrollments in
other schools where we provide limited or no management
services. In these situations, our revenues are limited to
direct invoices and are independent of the total funds received
by the school from a state or district. As a result, changes in
the number of enrollments associated with schools operating
under turnkey arrangements relative to total enrollments may
have a disproportionate impact on average revenues per
enrollment and growth in revenues relative to the growth in
enrollments.
The percentage of enrollments associated with turnkey management
service schools was 81% for the three months ended
September 30, 2007 as compared to 76% for the three months
ended September 30, 2006. This increase was primarily
attributable to the enrollments at new schools in Georgia and
Nevada. The percentage of enrollments associated with turnkey
management service schools was 77% in fiscal year 2007 as
compared to 92% in fiscal year 2006. This decline was
attributable to a reduction in management services in one large
school. Changes in the mix of enrollments associated with
turnkey management services compared with limited management
services may change the average revenues per enrollment and
accordingly impact total revenues. As we renew our existing
management contracts, the extent of the management services we
provide may change. Where it is beneficial to do so, management
intends to renew these contracts as they expire. Our turnkey
management contracts have terms from three to ten years and none
expire prior to the end of fiscal year 2008. Consequently, we
anticipate that the percentage of enrollments associated with
turnkey management services will remain relatively
31
constant through fiscal year 2008. As a result, we expect this
factor to increase average per enrollment revenue in fiscal year
2008 as compared to fiscal year 2007.
In fiscal year 2007, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy, the Arizona Virtual
Academy, the Pennsylvania Virtual Charter School and the
Colorado Virtual Academy. In aggregate, these schools accounted
for 49% of our total revenues. We provide our full turnkey
management solution pursuant to our contract with the Ohio
Virtual Academy, which terminates June 30, 2017 and
provides for the parties to renew the agreement in 2012. This
agreement is renewable automatically for an additional two years
unless the school notifies us one year prior to the expiration
that it elects to terminate the contract. We provide our full
turnkey solution to the Arizona Virtual Academy, pursuant to a
contract with Portable Practical Education Inc., an Arizona
not-for-profit organization holding the charter under which the
school operates, that expires June 30, 2010. We provide our
curriculum and online learning platform to the Pennsylvania
Virtual Charter School pursuant to a contract that terminates
June 30, 2009, and which automatically renews for an
additional three-years unless the school notifies us one year
prior to expiration that it elects to terminate the contract. We
provide our full turnkey solution pursuant to our contract with
the Colorado Virtual Academy, which terminates June 30,
2008. We are currently engaged in negotiations with the Colorado
Virtual Academy for a new contract. Each of the contracts with
these schools provides for termination of the agreement if the
school ceases to hold a valid and effective charter from the
charter-issuing authority in their respective states or if there
is a material reduction in the per enrollment funding level. The
annual revenues generated under each of these contracts
represent a material portion of our total revenues in fiscal
year 2007 and we expect this to continue in fiscal year 2008.
Our annual growth in revenues will also be impacted by changes
in state or district per enrollment funding levels. These
funding levels are typically established on an annual basis, are
usually consistent from grade to grade, and generally increase
at modest levels from year to year. Over our operating history,
per enrollment funding levels have increased annually in almost
every school we operate. These increases are essential to enable
schools to provide for an annual increase in teachers
wages and to offset the impact of inflation on other school
operating costs. For these reasons, we anticipate that per
enrollment funding levels will continue to increase at modest
levels over time. Finally, we may generate modest growth in
revenues from increases in the prices of our curriculum and
educational services. We evaluate our pricing annually against
market benchmarks and conditions and raise them as we deem
appropriate. We do not expect our price increases to have a
significant incremental impact as they are encompassed within
increases in per enrollment funding levels.
Instructional
Costs and Services Expenses
Instructional costs and services expenses include expenses
directly attributable to the educational products and services
we provide. The virtual public schools we manage are the primary
drivers of these costs, including teacher and administrator
salaries and benefits and expenses of related support services.
Instructional costs also include fulfillment costs of student
textbooks and materials, depreciation and reclamation costs of
computers provided for student use, and the cost of any
third-party online courses. In addition, we include in
instructional costs the amortization of capitalized curriculum
and related systems. We measure, track and manage instructional
costs and services as a percentage of revenues and on a per
enrollment basis as these are key indicators of performance and
operating efficiency. As a percentage of revenues, instructional
costs and services expenses decreased slightly for the year
ended June 30, 2007, as compared to the year ended
June 30, 2006 primarily due to lower costs associated with
a renewed virtual school contract that no longer includes
turnkey management services. This was partially offset by higher
school operating costs and the
start-up
costs of new schools. We expect instructional costs and services
expenses as a percentage of revenues to increase as we expand
our high school enrollments, develop new delivery models, and
incur
start-up
costs for new schools. Reflecting the impact of these items,
instructional costs and services expenses increased to 58.6% of
revenue for the three-months ended September 30, 2007
compared with 50.8% for the three-months ended
September 30, 2006.
Over time, we expect high school enrollments to grow as a
percentage of total enrollments. Our high school offering
requires increased instructional costs as a percentage of
revenues compared to our kindergarten to 8th grade
offering. This is due to the following: (i) demand for
numerous electives which requires licensing of third-party
courses to augment our proprietary curriculum;
(ii) generally lower student-to-teacher ratios;
(iii) higher
32
compensation costs for teachers due to the need for
subject-matter expertise; and (iv) ancillary costs for
required student support services including college placement,
SAT preparation and guidance counseling.
We are developing new delivery models, such as the hybrid model,
where students receive both face-to-face and online instruction.
Development costs may include instructional research and
curriculum development. These models necessitate additional
costs including facilities related costs and additional
administrative support, which are generally not required to
operate typical virtual public schools. As a result,
instructional costs as a percentage of revenues may be higher
than our typical offering. In addition, we are pursuing
expansion into new states. If we are successful, we will incur
start-up
costs and other expenses associated with the initial launch of a
virtual public school, which may result in increased
instructional costs as a percentage of revenues.
Selling,
Administrative and Other Operating Expenses
Selling, administrative and other operating expenses include the
salaries, benefits and related costs of employees engaged in
business development, sales and marketing, and administrative
functions. We measure and track selling, administrative and
other operating expenses as a percentage of revenues to track
performance and efficiency of these areas. In addition, we track
measures of sales and marketing efficiency including the number
of new enrollment prospects for virtual public schools and our
ability to convert these prospects into enrollments. We also
track various operating, call center and information technology
statistics as indicators of operating efficiency and customer
service. Over the past three years, our selling, administrative
and other operating expenses as a percentage of revenues have
remained relatively stable. Over this period, we have
significantly increased our marketing and selling expenses and
expanded our management team and administrative staff. We expect
the trend in marketing and selling expenses to continue as we
increase our marketing and student recruitment programs, pursue
schools in new states and explore new business opportunities.
However, we believe our current management and administrative
infrastructure, which includes executive management, and
personnel in the areas of finance, legal, information
technology, facilities, human resources and logistics
management, can support significant growth in revenue and
enrollments without a corresponding increase in expense growth.
As a result of these factors, we expect our selling,
administrative and other operating expenses to decline over time
as a percentage of revenues.
Product
Development Expenses
Product development expenses include research and development
costs and overhead costs associated with the management of
projects to develop curriculum and internal systems. In
addition, product development expenses include the amortization
and internal systems and any impairment charges. We measure and
track our product development expenditures on a per course or
project basis to measure and assess our development efficiency.
In addition, we monitor employee utilization to evaluate our
workforce efficiency. We plan to invest in additional curriculum
development and related software in the future, primarily to
produce additional high school courses, new releases of existing
courses and to upgrade our content management system and our
Online School (OLS). We capitalize most of the costs incurred to
develop our curriculum and software, beginning with application
development, through production and testing.
We account for impairment of capitalized curriculum development
costs in accordance with Statement of Financial Accounting
Standard No. 144 (SFAS No. 144,) Accounting
for the Impairment or Disposal of Long-Lived Assets. See
Critical Accounting Policies and Estimates.
Impairment charges for the three months ended September 30,
2007 and for the year ended June 30, 2007 were $0.0.
Impairment charges recorded for the years ended June 30,
2006 and 2005 were $0.4 million and $3.3 million,
respectively. In fiscal year 2006, we recognized impairment of
capitalized curriculum as the potential to earn revenues from
the use of our curriculum in a traditional classroom was
uncertain. In 2005, we recognized impairment as we generated a
net loss in that year and development costs exceeded future cash
flows.
Other
Factors That May Affect Comparability
Public Company Expenses. Upon consummation of
our initial public offering, we will become a public company,
and our shares of common stock will be publicly traded on NYSE
Arca. As a result, we will need to comply with new laws,
regulations and requirements that we did not need to comply with
as a private company, including certain provisions of the
Sarbanes-Oxley Act of 2002, other applicable SEC regulations and
the requirements of the New York
33
Stock Exchange. Compliance with the requirements of being a
public company will require us to increase our general and
administrative expenses in order to pay our employees, legal
counsel and independent registered public accountants to assist
us in, among other things, instituting and monitoring a more
comprehensive compliance and board governance function,
establishing and maintaining internal control over financial
reporting in accordance with Section 404 of the
Sarbanes-Oxley Act of 2002 and preparing and distributing
periodic public reports in compliance with our obligations under
the federal securities laws. In addition, as a public company,
it will make it more expensive for us to obtain directors and
officers liability insurance.
Stock Option Expense. The adoption of
Statement of Financial Accounting Standard No. 123R,
Share Based Payments
(SFAS No. 123R), requires that we recognize an
expense for stock options granted beginning July 1, 2006.
We incurred approximately $0.3 million in stock
compensation expense for the three months ended
September 30, 2007. We expect stock option expense to
increase in the future as we grant additional stock options.
Income Tax Benefits Resulting from Decrease of Valuation
Allowance. In the period from our inception
through fiscal year 2005, we incurred significant operating
losses that resulted in a net operating loss carryforward for
tax purposes and net deferred tax assets. For the three months
ended September 30, 2007, we recognized a $9.7 million
tax benefit as we expect to be able to utilize a portion of our
net deferred tax assets. For the three months ended
September 30, 2007, we recorded income tax expense of
$2.6 million. Continued positive earnings in future years
will require management to re-evaluate the realizability of the
remaining deferred tax asset and determine if a further release
of the valuation allowance is warranted.
Public Funding and Regulation. Our public
school customers are financed with federal, state and local
government funding. Budget appropriations for education at all
levels of government are determined through a political process
and, as a result, our revenues may be affected by changes in
appropriations. Decreases in funding could result in an adverse
affect on our financial condition, results of operations and
cash flows.
Competition. The market for providing online
education for grades K-12 is becoming increasingly competitive
and attracting significant new entrants. If we are unable to
successfully compete for new business and contract renewals, our
growth in revenues and operating margins may decline. With the
introduction of new technologies and market entrants, we expect
this competition to intensify.
Critical
Accounting Policies and Estimates
The discussion of our financial condition and results of
operations is based upon our consolidated financial statements,
which have been prepared in accordance with U.S. generally
accepted accounting principles. In the preparation of our
consolidated financial statements, we are required to make
estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as the
related disclosures of contingent assets and liabilities. We
base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the
circumstances. The results of our analysis form the basis for
making assumptions about the carrying values of assets and
liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different
assumptions or conditions, and the impact of such differences
may be material to our consolidated financial statements. Our
critical accounting policies have been discussed with the audit
committee of our board of directors.
We believe that the following critical accounting policies
affect the more significant judgments and estimates used in the
preparation of our consolidated financial statements:
Revenue
Recognition
In accordance with SEC Staff Accounting
Bulletin No. 104 (SAB No. 104), we
recognize revenues when each of the following conditions is met:
(1) persuasive evidence of an arrangement exists;
(2) delivery of physical goods or rendering of services is
complete; (3) the sellers price to the buyer is fixed
or determinable; and (4) collection is reasonably assured.
Once these conditions are satisfied, the amount of revenues we
record is determined in accordance with Emerging Issues Task
Force
(EITF 99-19),
Reporting Revenue Gross as a Principal versus Net as an
Agent.
34
We generate almost all of our revenues through long-term
contracts with virtual public schools. These schools are
generally funded by state or local governments on a per student
basis. Under these contracts, we are responsible for providing
each enrolled student with access to our OLS, our online
lessons, offline learning kits and student support services
required for their complete education. In most cases, we are
also responsible for providing complete management and
technology services required for the operation of the school.
The revenues derived from these long-term agreements are
primarily dependent upon the number of students enrolled, the
extent of the management services contracted for by the school,
and the level of funding provided to the school for each student.
We have determined that the elements of our contracts are
valuable to schools in combination, but do not have standalone
value. In addition, we have determined that we do not have
objective and reliable evidence of fair value for each element
of our contracts. As a result, the elements within our
multiple-element contracts do not qualify for treatment as
separate units of accounting. Accordingly, we account for
revenues received under multiple element arrangements as a
single unit of accounting and recognize the entire arrangement
based upon the approximate rate at which we incur the costs
associated with each element.
We invoice virtual public schools in accordance with the
established contractual terms. Generally, this means that for
each enrolled student, we invoice their school on a per student
basis for the following items: (1) access to our online
school and online lessons; (2) offline learning kits; and
(3) student personal computers. We also invoice for
management and technology services. We apply
SAB No. 104 to each of these items as follows:
Access to the
K12
Online School and Online Lessons. Our OLS
revenues come primarily from contracts with charter schools and
school districts. Students are provided access to the OLS and
online lessons at the start of the school year for which they
have enrolled. On a per student basis, we invoice schools an
upfront fee at the beginning of the school year or at the time a
student enrolls and a monthly fee for each month during the
school year in which the student is enrolled. A school year
generally consists of 10 months. The upfront fee is
initially recorded as deferred revenue and is recognized as
revenues ratably over the remaining months of the current school
year. If a student withdraws prior to the end of a school year,
any remaining deferred revenue related to the upfront fee is
recognized ratably over the remaining months of the school year.
The monthly fees are recognized in the month in which they are
earned.
The majority of our enrollments occur at the beginning of the
school year in August or September, depending upon the state.
Because upfront fees are generally charged at the beginning of
the school year, the balance in our deferred revenue account
tends to be at its highest point at the end of the first
quarter. Generally, the balance will decline over the course of
the year and all deferred revenue related to virtual public
schools will be fully recognized by the end of our fiscal year
on June 30.
Offline Learning Kits. Our offline learning
kit revenues come primarily from contracts with virtual public
schools and our curriculum blends which online and offline
content. The lessons in our online school are meant to be used
in conjunction with selected printed materials, workbooks,
laboratory materials and other manipulative items which we
provide to students. We generally ship all offline learning kits
to a student when their enrollment is approved and invoice the
schools in full for the materials at that time. Once materials
have been shipped, our efforts are substantially complete.
Therefore, we recognize revenues upon shipment. Because offline
learning kits revenues are recognized near the time of
enrollment in its entirety, we generate a majority of these
revenues in our first fiscal quarter which coincides with the
start of the school year.
Student Personal Computers. In most of our
contracts with virtual public schools, we are responsible for
ensuring that each enrolled student has the ability to access
our online school. To accomplish this, we generally provide each
enrolled student with the use of a personal computer, complete
technical support through our call center, and reclamation
services when a student withdraws or a computer needs to be
exchanged. Schools are invoiced on a per student basis for each
enrolled student to whom we have provided a personal computer.
This may include an upfront fee at the beginning of the school
year or at the time a student enrolls and a monthly fee for each
month during the school year in which the student is enrolled. A
school year generally consists of 10 months. The upfront
fee is initially recorded as deferred revenue and is recognized
as revenues ratably over the remaining months of the current
school year. If a student withdraws prior to the end of a school
year, any remaining deferred revenue related to the upfront fee
is recognized ratably over the remaining months of the school
year. All deferred revenue will be recognized by the end of our
fiscal year, June 30. The monthly fees are recognized in
the month in which they are earned.
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Management and Technology Services. Under most
of our school contracts, we provide the boards of the virtual
public schools we serve with turnkey management and technology
services. We take responsibility for all academic and fiscal
outcomes. This includes responsibility for all aspects of the
management of the schools, including monitoring academic
achievement, teacher recruitment and training, compensation of
school personnel, financial management, enrollment processing
and procurement of curriculum, equipment and required services.
Management and technology fees are generally determined based
upon a percentage of the funding received by the virtual public
school. We generally invoice schools for management and
technology services in the month in which they receive such
funding.
We recognize the revenues from turnkey management and technology
fees ratably over the course of our fiscal year. We use
12 months as a basis for recognition because administrative
offices of the school remain open for the entire year. To
determine the amount of revenues to recognize in our fiscal
year, we estimate the total funds that each school will receive
in a particular school year, and our related fees associated
with the estimated funding. Our management and technology
service fees are generally a contracted percentage of yearly
school revenues. We review our estimates of funding
periodically, and revise as necessary, amortizing any
adjustments over the remaining portion of the fiscal year.
Actual school funding may vary from these estimates or
revisions, and the impact of these differences could have a
material impact on our results of operations. Since the end of
the school year coincides with the end of our fiscal year, we
are generally able to base our annual revenues on actual school
revenues. As a result, on an annual basis, we have not had to
make any material adjustments to our estimates of revenue over
the last three years.
Under most contracts, we provide the virtual schools we manage
with turnkey management services and agree to operate the school
within per enrollment funding levels. This includes assuming
responsibility for any operating deficits that the schools may
incur in a given school year. These operating deficits represent
the excess of costs over revenues incurred by the virtual public
schools as reflected on their financial statements. The costs
include our charges to the schools. Such deficits may arise from
school
start-up
costs, from funding shortfalls, from temporary or long-term
incremental cost requirements for a particular school, or due to
specific one-time expenses that a school may incur. Up to the
level of school revenues, our collections are reasonably
assured. We consider the operating deficits to estimate any
impairment of collection, and our recognized revenue reflects
this impairment. The fact that a school has an operating deficit
does not mean we anticipate losing money on the contract. We
recognize the impact of these operating deficits by estimating
the full year revenues and full year deficits of schools at the
beginning of the fiscal year. We amortize the estimated deficits
against recognized revenues based upon the percentage of actual
revenues in the period to total estimated revenues for the
fiscal year. We periodically review our estimates of full year
school revenues and full year operating deficits and amortize
the impact of any changes to these estimates over the remainder
of our fiscal year. Actual school operating deficits may vary
from these estimates or revisions, and the impact of these
differences could have a material impact on our results of
operations. Since the end of the school year coincides with the
end of our fiscal year, we are generally able to base our annual
revenues on actual school revenues and use actual costs incurred
in our calculation of school operating deficits. As a result, on
an annual basis, we have not had to make any material
adjustments to our estimates of realizable revenue over the last
three years.
The amount of revenues we record is determined in accordance
with Emerging Issues Task Force Reporting Revenue Gross as a
Principal versus Net as an Agent,
EITF 99-19.
For these schools, we have determined that we are the primary
obligor for substantially all expenses of the school.
Accordingly, we report revenues on a gross basis by recording
the associated per student revenues received by the school from
its funding state or school district up to the expenses incurred
by the school. Revenues are recognized when the underlying
expenses are incurred by the school. For the small percentage of
contracts where we provide individually selected services for
the school, we invoice on a per student or per service basis and
recognize revenues in accordance with SAB No. 104.
Under these contracts, where we do not assume responsibility for
operating deficits, we record revenues on a net basis.
We also generate a small percentage of our revenues through the
sale of our online courses and offline learning kits directly to
consumers. Online course sales are generally subscriptions for
periods of 12 to 24 months and customers have the option of
paying a discounted amount in full upfront or paying in monthly
installments.
36
Payments are generally made with charge cards. For those
customers electing to pay these subscription fees in their
entirety upfront, we record the payment as deferred revenue and
amortize the revenues over the life of the subscription. For
customers paying monthly, we recognize these payments as
revenues in the month earned. Revenues for offline learning kits
are recognized when shipped. Within 30 days of enrollment,
customers can receive a full refund, however customers
terminating after 30 days will receive a pro rata refund
for the unused portion of their subscription less a termination
fee. Historically, the impact of refunds has been immaterial.
Capitalized
Curriculum Development Costs
Our curriculum is primarily developed by our employees and to a
lesser extent, by independent contractors. Generally, our
courses cover traditional subjects and utilize examples and
references designed to remain relevant for long periods of time.
The online nature of our curriculum allows us to incorporate
user feedback rapidly and make ongoing corrections and
improvements. For these reasons, we believe that our courses,
once developed, have an extended useful life, similar to
computer software. Our curriculum is integral to our learning
system. Our customers do not acquire our curriculum or future
rights to it.
We capitalize curriculum development costs incurred during the
application development stage in accordance with Statement of
Position (SOP)
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use.
SOP 98-1
provides guidance for the treatment of costs associated with
computer software development and defines those costs to be
capitalized and those to be expensed. Costs that qualify for
capitalization are external direct costs, payroll,
payroll-related costs, and interest costs. Costs related to
general and administrative functions are not capitalizable and
are expensed as incurred. We capitalize curriculum development
costs when the projects under development reach technological
feasibility. Many of our new courses leverage off of proven
delivery platforms and are primarily content, which has no
technological hurdles. As a result, a significant portion of our
courseware development costs qualify for capitalization due to
the concentration of our development efforts on the content of
the courseware. Technological feasibility is established when we
have completed all planning, designing, coding, and testing
activities necessary to establish that a course can be produced
to meet its design specifications. Capitalization ends when a
course is available for general release to our customers, at
which time amortization of the capitalized costs begins. The
period of time over which these development costs will be
amortized is generally five years. This is consistent with the
capitalization period used by others in our industry and
corresponds with our product development lifecycle.
Software
Developed or Obtained for Internal Use
We develop our own proprietary computer software programs to
provide specific functionality to support both our unique
education offering and the student and school management
services. These programs enable us to develop courses, process
student enrollments, meet state documentation requirements,
track student academic progress, deliver online courses to
students, coordinate and track the delivery of course-specific
materials to students and provide teacher support and training.
These applications are integral to our learning system and we
continue to enhance existing applications and create new
applications. Our customers do not acquire our software or
future rights to it.
We capitalize software development costs incurred during the
development stage of these applications in accordance with
SOP 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. These development costs are
generally amortized over three years.
Impairment
of Long-lived Assets
Long-lived assets include property, equipment, capitalized
curriculum and software developed or obtained for internal use.
In accordance with Statement of Financial Accounting Standards
No. 144 (SFAS No. 144), Accounting for the
Impairment or Disposal of Long-Lived Assets, we review our
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. We determine
the extent to which an asset may be impaired based upon our
expectation of the assets 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
37
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.
Accounting
for Stock-based Compensation
Prior to July 1, 2006, we accounted for stock-based
compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, or APB No. 25 and
related interpretations. Accordingly, compensation cost for
stock options generally was measured as the excess, if any, of
the estimated fair value of our common stock over the amount an
employee must pay to acquire the common stock on the date that
both the exercise price and the number of shares to be acquired
pursuant to the option are fixed. We had adopted the
disclosure-only provisions of SFAS No. 123 which was
released in May 1995, and used the minimum value method of
valuing stock options as allowed for non-public companies.
In December 2004, SFAS No. 123R revised
SFAS No. 123 and superseded APB No. 25.
SFAS No. 123R requires the measurement of the cost of
employee services received in exchange for an award of equity
instruments based on the fair value of the award on the
measurement date of grant, with the cost being recognized over
the applicable requisite service period. In addition,
SFAS No. 123R requires an entity to provide certain
disclosures in order to assist in understanding the nature of
share-based payment transactions and the effects of those
transactions on the financial statements. The provisions of
SFAS No. 123R are required to be applied as of the
beginning of the first interim or annual reporting period of the
entitys first fiscal year that begins after
December 15, 2005.
Effective July 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123R using the
prospective transition method, which requires the Company to
apply the provisions of SFAS No. 123R only to awards
granted, modified, repurchased or cancelled after the effective
date. Under this transition method, stock- based compensation
expense recognized beginning July 1, 2006 is based on the
fair value of stock awards as of the grant date. As the Company
had used the minimum value method for valuing its stock options
under the disclosure requirements of SFAS No. 123, all
options granted prior to July 1, 2006 continue to be
accounted for under APB No. 25.
The computation of non-cash compensation charges requires a
determination of the fair value of our common stock at various
dates. Such determinations require complex and subjective
judgments. We considered several methodologies to estimate our
enterprise value, including guideline public company analysis,
an analysis of comparable company transactions, and a discounted
cash flow analysis. The results of the public company and
comparable company transactions components of the analyses vary
not only with factors such as our revenue, EBITDA, and income
levels, but also with the performance and public market
valuation of the companies and transactions used in the
analyses. Although the market-based analyses did not include
companies directly comparable to us, the analysis provided
useful benchmarks.
We also considered several equity allocation methodologies to
allocate the estimate of enterprise value to our two classes of
stock including the current value method, the option pricing
method, and the probability weighted expected return method
(PWERM). The final valuation conclusion was based upon the PWERM
equity allocation because it considers the value that would be
attributable to each equity interest under different scenarios.
The PWERM assessed the value of common stock based upon possible
scenarios including completion of an initial public offering, an
advantageous strategic sale of the Company, and remaining a
private company. The significant factors included preliminary
estimates of the public offering price range from underwriters,
the value of comparable company transactions, and discounted
cash flow analysis. Key assumptions included the relative
probability of the three scenarios. The relative probabilities
were based upon where the Company was in the initial public
offering registration process, empirical analysis of companies
that go public after the registration process, and qualitative
characteristics of the Company. The value of common stock was
estimated by applying the relative probability to the value of
common stock under each scenario. Based upon the foregoing, we
believe the analysis provides a reasonable basis for valuing the
common stock.
For the three months ended September 30, 2007, all option grants
took place in the month of July. For the year ended
June 30, 2007, we granted stock options in July 2006,
February 2007 and May 2007. The significant factor contributing
to the difference between the fair value as of the date of each
grant and our public offering price is the probability of
completing a public offering used in the PWERM. The probability
of completing an initial public
38
offering at each grant date was determined based on the
progression of the Company in the initial public offering
process. As the probability increased the relative fair value of
the option increased. Specifically, for the options granted on
February 1, February 27, May 17, July 3 and
July 12, 2007, we discounted the value of our common stock
by 70.8%, 62.6%, 47.1%, 39.1% and 39.1%, respectively, to
account for the probability that a public offering would not
occur. The amount of these discounts reflect, in February, a
very low but increasing likelihood of completing such an
offering as the Board had not yet affirmatively determined to
pursue a public offering, in May, a higher likelihood of
completing a public offering following the Boards
determination to pursue the offering and the Companys
progress in preparing its registration statement, and in July, a
much higher likelihood of completing a public offering as a
majority of the work in preparing for the initial filing of a
registration statement had been completed. Since the date of the
most recent grant, we have made progress on our business
strategy, including the launch of the 11th and 12th grade
offerings and enrolling new students for the
2007-08
school year. In addition, we expect the completion of our public
offering to add value to our shares for a variety of reasons,
such as strengthening our balance sheet, increased liquidity and
marketability of our common stock, and increased capacity to
consummate acquisitions. However, the amount of such additional
value, if any, cannot be measured with either precision or
certainty, and it is possible that the value of our common stock
will decrease.
The Company accounts for equity instruments issued to
nonemployees in accordance with the provisions of
SFAS No. 123 and
EITF 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.
Deferred
Tax Asset Valuation Allowance
We account for income taxes as prescribed by Statement of
Financial Accounting Standards No. 109
(SFAS No. 109), Accounting for Income Taxes.
SFAS No. 109 prescribes the use of the asset and
liability method to compute the differences between the tax
bases of assets and liabilities and the related financial
amounts, using currently enacted tax laws. If necessary, a
valuation allowance is established, based on the weight of
available evidence, to reduce deferred tax assets to the amount
that is more likely than not to be realized. Realization of the
deferred tax assets, net of deferred tax liabilities, is
principally dependent upon achievement of sufficient future
taxable income offset by deferred tax liabilities. We exercise
significant judgment in determining our provisions for income
taxes, our deferred tax assets and liabilities and our future
taxable income for purposes of assessing our ability to utilize
any future tax benefit from our deferred tax assets. However,
our ability to forecast sufficient future taxable income is
subject to certain market factors that we may not be able to
control such as a material reduction in per pupil funding
levels, legislative budget cuts reducing or eliminating the
products and services we provide and government regulation.
Since inception, the Company has generated significant losses.
However, in the past two years, the Company has generated small
amounts of operating profit; 1.2% of revenue in fiscal year 2006
and 2.9% of revenue in fiscal year 2007. In addition, the
Companys revenue is dependent upon the number of student
enrollments, the majority of which are generated in the first
quarter of the fiscal year in conjunction with the start of the
school year. For the three months ended September 30, 2007,
the Company generated a significant increase in enrollments with
average enrollments climbing to 39,493, an increase of
approximately 50% with a corresponding revenue increase of
approximately 57%. When considering this positive evidence of
future profitability, we also noted operating profits as a
percentage of revenues for the three months ended
September 30, 2007 decreased to 9.6% compared with 12.9%
for the three months ended September 30, 2006. Nonetheless,
the Companys significant enrollment growth for the first
quarter of fiscal year 2007 leads us to believe that it is more
likely than not that we will be able to utilize some portion of
our net deferred tax asset. Therefore, for the three months
ended September 30, 2007, we have reversed approximately
$9.7 million of the valuation allowance on our net deferred
tax asset, or approximately 32.4% of the total allowance. We
determined this amount based upon our estimated profitability
for the remainder of fiscal year 2008 and for fiscal year 2009,
beyond which we have significantly diminished visibility. We
reflected this reversal entirely in the first quarter because
average enrollments in the first quarter have historically
tended to be highly correlated with average enrollments for the
remainder of the year. Therefore, first quarter enrollment
performance provided us with what we believe to be sufficient
evidence to reduce the valuation allowance. In the future, we
intend to evaluate our net deferred tax asset valuation
allowance each quarter in light of events, including enrollment
trends, in order to determine when further adjustments to the
allowance are appropriate.
39
Although we believe that our tax estimates are reasonable, the
ultimate tax determination involves significant judgments that
could become subject to examination by tax authorities in the
ordinary course of business. We periodically assess the
likelihood of adverse outcomes resulting from these examinations
to determine the impact on our deferred taxes and income tax
liabilities and the adequacy of our provision for income taxes.
Changes in income tax legislation, statutory income tax rates,
or future taxable income levels, among other things, could
materially impact our valuation of income tax assets and
liabilities and could cause our income tax provision to vary
significantly among financial reporting periods.
As of September 30, 2007, we had net operating loss
carry-forwards of $59.2 million that expire between 2020
and 2028 if unused. We recorded a partial valuation allowance
against net deferred tax assets, including deferred tax assets
generated by net operating loss carry-forwards. The valuation
allowance on net deferred tax assets was $18.9 million as
of September 30, 2007.
Results
of Operations
The following table presents our selected consolidated statement
of operations data expressed as a percentage of our total
revenues for the periods indicated:
Three Months
Ended
Year Ended
September 30,
June 30,
2007
2006
2007
2006
2005
Consolidated Statement of Operations Data:
Revenues
100
%
100
%
100
%
100
%
100
%
Cost and expenses
Instructional costs and services
59
51
54
55
58
Selling, administrative, and other operating expenses
27
30
36
36
35
Product development expenses
4
6
6
7
11
Total costs and expenses
90
87
96
98
104
Income (loss) from operations
10
13
4
2
(4
)
Interest expense, net
(1
)
(1
)
Income (loss) from operations before income taxes
10
13
3
1
(4
)
Income tax benefit (expense)
12
Net income (loss)
22
%
13
%
3
%
1
%
(4
)%
Comparison
of the Three Months Ended September 30, 2007 and Three
Months ended September 30, 2006
Revenues. Our revenues for the three months
ended September 30, 2007 were $59.4 million,
representing an increase of $21.7 million, or 57.6%, as
compared to revenues of $37.7 million for the three months
ended September 30, 2006. Average enrollments increased
49.6% to 39,493 for the three months ended September 30,
2007 from 26,405 for the three months ended September 30,
2006. The increase in average enrollments was primarily
attributable to enrollment growth in existing states. New school
openings in Georgia and Nevada contributed approximately 9% to
enrollment growth. For both new and existing states, high school
enrollments contributed approximately 12% to overall enrollment
growth. Also contributing to the growth in revenues was a 5%
increase in average revenue per enrollment. This increase was
partially attributable to an increase in the percentage of
enrollments associated with managed schools which increased to
81% for the three months ended September 30, 2007 from 76%
for the three months ended September 30, 2006.
Instructional Costs and Services
Expenses. Instructional costs and services
expenses for the three months ended September 30, 2007 were
$34.8 million, representing an increase of
$15.6 million, or 81.3% as compared to instructional costs
and services of $19.2 million for the three months ended
September 30, 2006. This increase was primarily
attributable to an $8.1 million increase in expenses to
operate and manage the schools and a $7.1 million increase
in costs to supply books, educational materials and computers to
students, including depreciation and amortization. As a
percentage of revenues, instructional costs increased to 58.6%
for the three months ended
40
September 30, 2007, as compared to 50.8% for the three
months ended September 30, 2006. The increase in
instructional costs and service expenses as a percentage of
revenues is primarily due to increased teacher and course costs
for our high school offering, higher costs to procure and supply
materials due to greater than anticipated enrollments, and an
increase in enrollments associated with managed schools.
Selling, Administrative, and Other Operating
Expenses. Selling, administrative, and other
operating expenses for three months ended September 30,
2007 were $16.0 million, representing an increase of
$4.6 million, or 40.4%, as compared to selling,
administrative and other operating expenses of
$11.4 million for the three months ended September 30,
2006. This increase is primarily attributable to a
$2.2 million increase in personnel costs primarily due to
increased headcount and higher average salaries due to annual
salary increases in fiscal year 2008 and a $1.4 million
increase in professional services. In addition, there was a
$0.7 million increase in marketing, advertising and selling
expenses. As a percentage of revenues, selling, administrative,
and other operating expenses decreased to 27.0% for the three
months ended September 30, 2007 compared to 30.2% for the
three months ended September 30, 2006.
Product Development Expenses. Product
development expenses for the three months ended
September 30, 2007 were $2.5 million, relatively
stable compared to product development expenses of
$2.2 million for the three months ended September 30,
2006. As a percentage of revenues, product development expenses
declined to 4.2% for the three months ended September 30,
2007 from 5.8% for the three months ended September 30,
2006. Capitalized curriculum development costs for the three
months ended September 30, 2007 were $1.6 million,
representing a decrease of $0.5 million, as compared to
capitalized curriculum development costs of $2.1 million
for the three months ended September 30, 2006. These
investments were primarily attributable to the development of
courses for our high school offering.
Net Interest Expense. Net interest expense for
the three months ended September 30, 2007 was
$0.3 million, an increase of $0.2 million, from
$0.1 million for the three months ended September 30,
2006. The increase in net interest expense is primarily due to
interest charges on increased capital lease obligations and
borrowings on our line of credit.
Income Taxes. Our provision for income taxes
for the three months ended September 30, 2007 was
$2.6 million. This was offset by a $9.7 million tax
benefit we recognized as we were able to utilize a portion of
our net deferred tax assets that were fully reserved for in
prior periods. Our provision for income taxes was
$0.1 million for the three months ended September 30,
2006, primarily attributable to state tax liabilities and the
use of net operating loss carry-forwards that were fully
reserved for in prior periods.
Net Income. Net income for the three months
ended September 30, 2007 was $12.8 million,
representing an increase of $8.1 million, or 172.3%, as
compared to net income of $4.7 million for the three months
ended September 30, 2006. Net income as a percentage of
revenues increased to 21.6% for the three months ended
September 30, 2007, as compared to 12.5% for the three
months ended September 30, 2006, as a result of the factors
discussed above.
Comparison
of Years Ended June 30, 2007 and 2006
Revenues. Our revenues for the year ended
June 30, 2007 were $140.6 million, representing an
increase of $23.7 million, or 20.3%, as compared to
revenues of $116.9 million for the year ended June 30,
2006. Average enrollments increased 33.6% to 27,005 for the year
ended June 30, 2007 from 20,220 for the year ended
June 30, 2006. Primarily offsetting the increased revenues
related to enrollment growth, was a decline in average revenues
per enrollment resulting from the impact of a substantial
reduction in the percentage of enrollments associated with
schools to which we provide turnkey management services, as a
school to which we formerly provided turnkey management services
switched to limited service contracts. For the year ended
June 30, 2007, 76.9% of our enrollments were associated
with turnkey management service schools, down from 91.7% for the
corresponding period in 2006. The increase in average
enrollments was primarily attributable to enrollment growth in
existing states. New school openings in Washington and in
Chicago, where we opened our first hybrid school, contributed
approximately 7% to enrollment growth. In addition, we launched
10th grade in August 2006 attracting new students as well
as prior year 9th grade students. High school enrollments
contributed approximately 8% to overall enrollment growth.
Average price increases of approximately 2% for per student fees
were implemented in July
41
2006. Finally, increased operating deficits at certain schools
partially offset the growth in revenues. These deficits were
attributable to greater school operating expenses required to
support increased enrollment and high school services as well as
school funding adjustments of approximately $1.0 million each in
schools we operate in California and Colorado resulting from
enrollment audits. See Business Distribution
Channels.
Instructional Costs and Services
Expenses. Instructional costs and services
expenses for the year ended June 30, 2007 were
$76.1 million, representing an increase of
$11.3 million, or 17.4% as compared to instructional costs
and services of $64.8 million for the year ended
June 30, 2006. This increase was primarily attributable to
a $6.6 million increase in expenses to operate and manage
the schools and a $4.7 million increase in costs to supply
books, educational materials and computers to students,
including depreciation and amortization. As a percentage of
revenues, instructional costs decreased by 1.3% to 54.1% for the
year ended June 30, 2007, as compared to 55.4% for the year
ended June 30, 2006. The decrease in instructional cost and
service expenses as a percentage of revenues is primarily due to
lower costs associated with a renegotiated management and
services agreement, partially offset by a shift in the mix of
enrollments to schools with higher operating costs and the
start-up
costs of new schools.
Selling, Administrative, and Other Operating
Expenses. Selling, administrative, and other
operating expenses for year ended June 30, 2007 were
$51.2 million, representing an increase of
$9.5 million, or 22.8%, as compared to selling,
administrative and other operating expenses of
$41.7 million for the year ended June 30, 2006. This
increase is primarily attributable to a $2.9 million
increase in marketing, advertising and selling expenses and a
$3.1 million increase in professional services. In
addition, there was a $2.7 million increase in personnel
costs primarily due to increased headcount and higher average
salaries due to annual salary increases in fiscal year 2007. As
a percentage of revenues, selling, administrative, and other
operating expenses increased slightly to 36.4% for the year
ended June 30, 2007 compared to 35.7% for the year ended
June 30, 2006.
Product Development Expenses. Product
development expenses for the year ended June 30, 2007 were
$8.6 million, relatively stable compared to product
development expenses of $8.6 million for the year ended
June 30, 2006. Employee headcount and contract labor
increased, but was offset by greater utilization of these
resources for capitalized curriculum. As a percentage of
revenues, product development expenses declined to 6.1% for the
year ended June 30, 2007 from 7.4% for the year ended
June 30, 2006. Capitalized curriculum development costs for
the year ended June 30, 2007 were $8.7 million,
representing an increase of $8.0 million, as compared to
capitalized curriculum development costs of $0.7 million
for the year ended June 30, 2006. This increase was
primarily attributable to the development of courses for our
high school offering.
Net Interest Expense. Net interest expense for
the year ended June 30, 2007 was $0.6 million, an
increase of $0.1 million, or 20%, from $0.5 million
for the year ended June 30, 2006. The increase in net
interest expense is primarily due to interest charges on
increased capital lease obligations.
Income Taxes. Our provision for income taxes
for the year ended June 30, 2007 was $0.2 million,
compared with no provision for the year ended June 30,
2006. Our tax expense for the year ended June 30, 2007 is
primarily attributable to state tax liabilities. Effectively, no
tax expense was recorded for the year ended June 30, 2006,
as we were able to utilize net operating loss carry-forwards
that were fully reserved for in prior periods.
Net Income. Net income for the year ended
June 30, 2007 was $3.9 million, representing an
increase of $2.5 million, or 179%, as compared to net
income of $1.4 million for the year ended June 30,
2006. Net income as a percentage of revenues increased to 2.8%
for the year ended June 30, 2007, as compared to 1.2% for
the year ended June 30, 2006, as a result of the factors
discussed above.
Comparison
of Years Ended June 30, 2006 and 2005
Revenues. Our revenues for the year ended
June 30, 2006 were $116.9 million, representing an
increase of $31.6 million, or 37.0%, as compared to
revenues of $85.3 million for the year ended June 30,
2005. Average enrollments increased 33.9% to 20,220 for the year
ended June 30, 2006 from 15,097 average enrollments for the
year ended June 30, 2005. Our enrollment growth was
primarily attributable to enrollment growth in existing states.
In addition, enrollment growth was driven by the addition of the
9th grade which attracted new students in addition to
students enrolled in 8th grade in the prior year.
Enrollments in 9th grade contributed approximately 7% to
overall enrollment growth. Also, average price increases of
approximately 4% for per student fees were implemented in
42
July 2005. Partially offsetting growth in revenues as compared
to enrollment growth was growth in the percentage of enrollments
attributable to schools where we earn limited or no services
revenues. Enrollments associated with schools to which we
provide turnkey management services declined from 91.7% for the
year ended June 30, 2006 from 94.7% for the corresponding period
in 2005. Finally, increased operating deficits at certain
schools partially offset the growth in revenues. These deficits
were primarily attributable to greater school operating expenses
to support increased enrollment and high school services.
Included in these deficits is the impact of disallowed
enrollments resulting from a regulatory audit in Colorado
totaling $1.0 million. See Business
Distribution Channels.
Instructional Costs and Services
Expenses. Instructional costs and services
expenses for the year ended June 30, 2006 were
$64.8 million, representing an increase of
$15.7 million, or 31.9%, as compared to instructional costs
and services of $49.1 million for the year ended
June 30, 2005. This increase was primarily attributable to
a $9.0 million increase in expenses to operate and manage
the schools, and a $6.6 million increase in costs to supply
books, educational materials and computers to students. As a
percentage of revenues, instructional costs and services
decreased to 55.5% for the year ended June 30, 2006, as
compared to 57.6% for the year ended June 30, 2005. The
decrease in instructional costs and services as a percentage of
revenues is primarily due to economies in scale in the operation
of the virtual public schools partially offset by higher costs
for books and materials.
Selling, Administrative, and Other Operating
Expenses. Selling, administrative, and other
operating expenses for the year ended June 30, 2006 were
$41.7 million, representing an increase of
$11.7 million, or 38.7%, as compared to selling,
administrative and other operating expenses of
$30.0 million for the year ended June 30, 2005. This
increase is primarily attributable, to a $4.1 million
increase in personnel costs primarily due to increased headcount
and higher average salaries due to annual salary increases in
fiscal year 2006. In addition, professional services expenses
increased by $3.4 million and marketing, advertising and
selling expenses by $1.5 million. As a percentage of
revenues, selling, administrative, and other operating expenses
remained relatively stable at 35.7% for the year ended
June 30, 2006 compared to 35.2% for the year ended
June 30, 2005.
Product Development Expenses. Product
development expenses for the year ended June 30, 2006 were
$8.6 million, representing a decrease of $0.8 million,
or 8.5%, as compared to product development expenses of
$9.4 million for the year ended June 30, 2005. This
decrease is primarily attributable to a year over year decrease
of $2.9 million in impairment charges. Offsetting this
decrease is an increase in personnel and contract labor. As a
percentage of revenues, product development expenses decreased
to 7.4% for the year ended June 30, 2006 compared to 11.0%
for the year ended June 30, 2005. This decrease is
primarily attributable to the factors described above and our
ability to leverage these costs over an increasing number of
enrollments. Capitalized curriculum development costs for the
year ended June 30, 2006 were $0.7 million,
representing a decrease of $3.1 million, as compared to
capitalized curriculum development costs of $3.8 million
for the year ended June 30, 2005. This decrease was
primarily due to reduced curriculum development efforts as we
launched our 9th grade offering with third-party curriculum.
Net Interest Expense. Net interest expense for
the year ended June 30, 2006 was $0.5 million, an
increase of $0.2 million, or 66.7%, from $0.3 million
for the year ended June 30, 2005. The increase in interest
expense is primarily due to debt of $4.0 million borrowed
in June 2005.
Income Taxes. Our provision for income taxes
for the year ended June 30, 2006 was zero as we were able
to utilize net operating loss carry-forwards that were fully
reserved for in prior periods. We also recorded no income tax
expense for the year ended June 30, 2005 as the Company had
a net loss.
Net Income (Loss). Net income for the year
ended June 30, 2006 was $1.4 million, representing an
increase of $4.9 million as compared to a net loss of
$3.5 million for the year ended June 30, 2005. Net
income as a percentage of revenues was 1.2% for the year ended
June 30, 2006, as compared to a net loss of 4.1% for the
year ended June 30, 2005, as a result of the factors
discussed above.
43
Quarterly
Results of Operations
The following tables set forth selected unaudited quarterly
consolidated statement of operations data for the eight most
recent quarters, as well as each line item expressed as a
percentage of total revenues. The information for each of these
quarters has been prepared on the same basis as the audited
consolidated financial statements included in this prospectus
and, in the opinion of management, includes all adjustments
necessary for the fair presentation of the results of operations
for such periods. This data should be read in conjunction with
the audited consolidated financial statements and the related
notes included in this prospectus. These quarterly operating
results are not necessarily indicative of our operating results
for any future period
Three Months Ended
Sep 30, 2005
Dec 31, 2005
Mar 31, 2006
Jun 30, 2006
Sep 30, 2006
Dec 31, 2006
Mar 31, 2007
Jun 30, 2007
Sep 30, 2007
Revenues
$
31,176
$
28,245
$
30,667
$
26,814
$
37,743
$
32,356
$
34,831
$
35,626
$
59,353
Cost and expenses
Instructional costs and services
17,416
15,696
15,361
16,355
19,177
18,022
17,904
20,961
34,778
Selling, administrative, and other
8,742
8,402
11,259
13,257
11,385
11,030
12,644
16,100
16,039
Product development expenses
1,864
1,862
1,861
2,981
2,206
1,566
2,083
2,756
2,527
Total costs and expenses
28,022
25,960
28,481
32,593
32,768
30,618
32,631
39,817
53,344
Income (loss) from operations
3,154
2,285
2,186
(5,779
)
4,975
1,738
2,200
(4,191
)
6,009
Interest expense, net
(135
)
(127
)
(132
)
(94
)
(94
)
(263
)
(117
)
(165
)
(304
)
Income (loss) before income taxes
3,019
2,158
2,054
(5,873
)
4,881
1,475
2,083
(4,356
)
5,705
Income tax benefit (expense)
(146
)
(30
)
(51
)
9
7,117
Net income (loss)
$
3,019
$
2,158
$
2,054
$
(5,873
)
$
4,735
$
1,445
$
2,032
$
(4,347
)
$
12,822
The following table sets forth statements of operations data as
a percentage of revenues for each of the periods indicated:
Three Months Ended
Sep 30, 2005
Dec 31, 2005
Mar 31, 2006
Jun 30, 2006
Sep 30, 2006
Dec 31, 2006
Mar 31, 2007
Jun 30, 2007
Sep 30, 2007
Revenues
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
Cost and expenses
Instructional costs and services
56
56
50
61
51
56
52
59
59
Selling, administrative, and other
28
30
37
50
30
34
36
45
27
Product development expenses
6
6
6
11
6
5
6
8
4
Total costs and expenses
90
92
93
122
87
95
94
112
90
Income (loss) from operations
10
8
7
(22
)
13
5
6
(12
)
10
Interest expense, net
(1
)
Income (loss) before income taxes
10
8
7
(22
)
13
4
6
(12
)
10
Income tax benefit (expense), net
12
Net income (loss)
10
%
8
%
7
%
(22
)%
13
%
4
%
6
%
(12
)%
22
%
44
Discussion
of Quarterly Results of Operations
Our revenues and operating results normally fluctuate as a
result of seasonal variations in our business, principally due
to the number of months that our virtual public school are fully
operational and serving students in a fiscal quarter. While
school administrative offices are generally open year round, a
school typically serves students during a 10 month academic
year. A schools academic year will typically start in
August or September, our first fiscal quarter, and finish in May
or June, our fourth fiscal quarter. Consequently, our first and
fourth fiscal quarters may have fewer than three months of full
operations when compared to the second and third fiscal quarters.
In the first and fourth fiscal quarters, online curriculum and
computer revenues are generally lower as these revenues are
primarily earned during the school academic year which may
provide for only one or two months of these revenues in these
quarters versus the second and third fiscal quarters. In
addition, we ship materials to students in the beginning of the
school year, our first fiscal quarter, generally resulting in
higher materials revenues and margin in the first fiscal quarter
versus other quarters. The overall impact of these factors is
partially offset by students enrolling after the start of the
academic year. The seasonality of our business produces higher
revenues in the first fiscal quarter.
Operating expenses are also seasonal. Instruction costs and
services expenses will increase in the first fiscal quarter
primarily due to the costs incurred to ship student materials at
the beginning of the school year. Instructional costs may
increase significantly quarter-to-quarter as school operating
expenses increase. For example, enrollment growth will require
additional teaching staff, thereby increasing salary and
benefits expense. School events may be seasonal, (e.g.
professional development and community events,) impacting the
quarterly change in instructional costs. The majority of our
marketing and selling expenses are incurred in the first and
fourth fiscal quarters, as our primary enrollment season is July
through September.
Financial
Condition
Certain accounts in our balance sheet are subject to seasonal
fluctuations. The bulk of our materials are shipped to students
prior to the beginning of the school year, usually in July or
August. In order to prepare for the upcoming school year, we
generally build up inventories during the fourth quarter of our
fiscal year. Therefore, inventories tend to be at the highest
levels at the end of our fiscal year. In the first quarter of
our fiscal year, inventories tend to decline significantly as
materials are shipped to students. Accounts receivable balances
tend to be at the highest levels in the first quarter of our
fiscal year as we begin billing for all enrolled students and
our billing arrangements include upfront fees for many of the
elements of our offering. These upfront fees along with direct
sales of subscriptions to private customers result in seasonal
fluctuations to our deferred revenue balances. In general, this
deferred revenue has not been a significant source of funds to
the Company since the offsetting entry is usually to accounts
receivable. In a few cases, virtual public schools may have
funds to pay these invoices in a timely manner and this provides
the Company with liquidity. However, in most cases, schools
receive funding over the course of the year and pay invoices in
a corresponding manner. Thus, liquidity associated with
increases in deferred revenue is usually offset by increased
accounts receivable balances. Since the upfront fees are charged
to the schools at the time of enrollment, deferred revenue
balances related to the schools tend to be highest in the first
quarter, when the majority of students enroll. Since the
deferred revenue is amortized over the course of the school
year, which ends in June, the balance would be at its lowest at
the end of our fiscal year. The deferred revenue related to our
direct-to-consumer business results from advance payments for
twelve and twenty-four month subscriptions to our on-line
school. These advance payments are amortized over the life of
the subscription and tend to be highest at the end of the fourth
quarter and first quarter, when the majority of subscriptions
are sold. Year end balances in deferred revenue are primarily
related to the direct-to-consumer sales. Billings related to the
direct-to-consumer sales are small relative to those of public
virtual schools; however, they do represent a source of
liquidity.
Liquidity
and Capital Resources
As of September 30, 2007 and June 30, 2007, we had
cash and cash equivalents of $2.9 million and
$1.7 million, respectively. Net cash used in operating
activities during the three months ended September 30,
2007, was $2.7 million.
We financed our operating activities and capital expenditures
during the three months ended September 30, 2007 through
cash provided by operating activities, capital lease financing
and short-term debt. During the years
45
ended June 30, 2007, 2006 and 2005, we financed our
operating activities and capital expenditures through a
combination of cash provided by operating activities, long-term
debt and capital lease financing. Prior to 2005, we financed our
operating activities and capital expenditures primarily with
sales of equity to private investors. From the Companys
founding in 2000 through December 2003, we raised over
$115 million from the sale of equity.
In December 2006, we entered into a $15 million revolving
credit agreement with PNC Bank (the Credit Agreement). Pursuant
to the terms of the Credit Agreement, we agreed that the
proceeds of the term loan facility were to be used primarily for
working capital requirements and other general business or
corporate purposes. Because of the seasonality of our business
and timing of funds received, the school expenditures are higher
in relation to funds received in certain periods during the
year. The Credit Agreement provides the ability to fund these
periods until cash is received from the schools; therefore,
borrowings against the Credit Agreement are primarily going to
be short-term.
Borrowings under the Credit Agreement bear interest based upon
the term of the borrowings. Interest is charged, at our option,
either at: (i) the higher of (a) the rate of interest
announced by PNC Bank 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 1.250% and 1.750%, based on the leverage
ratio (as defined in the Credit Agreement). We pay a quarterly
commitment fee which varies between 0.150% and 0.250% on the
unused portion of the credit agreement (depending on the
leverage ratio). The working capital line includes a
$5.0 million letter of credit facility. Issuances of
letters of credit reduce 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 its subsidiaries, or make capital expenditures above
specified limits and engage in other matters customarily
restricted in senior secured credit facilities. We must also
maintain a minimum net worth (as defined in the credit
agreement) and maximum debt leverage ratios. These covenants are
subject to certain qualifications and exceptions. Through
September 30, 2007, we were in compliance with these
covenants.
As of September 30, 2007, $12.5 million of borrowings
were outstanding on the working capital line of credit and
approximately $2.3 million outstanding for letters of
credit. On October 5, 2007, we amended the Credit Agreement
to increase the borrowing limit from $15 million to
$20 million under substantially the same terms. This
agreement expires on December 20, 2009. From
October 1, 2007 to October 31, 2007, the Company
borrowed additional funds of $4.0 million under the Credit
Agreement at an interest rate of 6.4%. On November 2, 2007,
the Company repaid $1.5 million of the outstanding balance
on the working capital line of credit.
One of our subsidiaries has an equipment lease line of credit
for new purchases with Hewlett-Packard Financial Services
Company that expires on March 31, 2008 for new purchases on
the line of credit. The interest rate on new borrowings under
the equipment lease line is set quarterly. For the three months
ended September 30, 2007, we borrowed $7.0 million to
finance the purchase of student computers and related equipment
at an interest rate of 8.8%. These leases include a 36-month
payment term with a bargain purchase option at the end of the
term. Accordingly, we include this equipment in property and
equipment and the related liability in capital lease
obligations. In addition, we have pledged the assets financed
with the equipment lease line to secure the amounts outstanding.
A substantial portion of our revenues are generated through our
contractual arrangements with virtual public schools. The
virtual public schools are generally funded on a per student
basis by their state and local governments and the timing of
funding varies by state. Funding receipts by an individual
school may vary over the year and may be in arrears. Because our
receivables represent obligations indirectly due from
governments, we have not historically had an issue with
non-payment and believe the risk of non-payment is minimal
although we cannot guarantee this will continue.
Our operating requirements consist primarily of day-to-day
operating expenses, capital expenditures and contractual
obligations with respect to facility leases, capital equipment
leases and other operating leases. Capital
46
expenditures are expected to increase in the next several years
as we invest in additional courses, new releases of existing
courses and purchase computers to support increases in virtual
school enrollments. We expect our capital expenditures in the
next 12 months will be approximately $22 million to
$30 million for curriculum development and related systems
as well as computers for students. We expect to be able to fund
these capital expenditures with cash generated from operations,
short-term debt and capital lease financing. We lease all of our
office facilities. We expect to make future payments on existing
leases from cash generated from operations. In addition, our
Board of Directors has approved a cash dividend on our
Series C Preferred Stock, contingent upon the closing of
this offering, of approximately $6.4 million. We believe
that our existing cash balances and continued cash generated
from operations, our revolving credit facility, and in-part, the
net proceeds from this offering and from the Regulation S
Transaction, will provide sufficient resources to fund the cash
dividend on the Series C Preferred Stock and to meet our
projected operating requirements,
start-up
costs to open new schools, and planned capital expenditures for
at least the next 12 months. In addition, we expect that
the net proceeds from this offering and from the
Regulation S Transaction will allow us to meet our
long-term liquidity needs and provide us with the financial
flexibility to execute our strategic objectives, including the
ability to make acquisitions and strategic investments. Our
ability to generate cash, however, is subject to our
performance, general economic conditions, industry trends and
other factors. To the extent that funds from this offering and
from the Regulation S Transaction, combined with existing
cash and operating cash flow are insufficient to fund our future
activities and requirements, we may need to raise additional
funds through public or private equity or debt financing.
Operating
Activities
Net cash used in operating activities during the three months
ended September 30, 2007, was $2.7 million. Net cash
provided by operating activities in fiscal year 2007, 2006 and
2005 was $5.6 million, $3.6 million and
$9.7 million, respectively.
The cash used in operations during the three months ended
September 30, 2007 was primarily due to an increase in
accounts receivable of $34.2 million, an increase in
deferred tax assets of $7.1 million and a decrease in
accrued compensation and benefits of $2.9 million. This was
primarily offset by net income of $12.8 million, an
increase in deferred revenue of $12.6 million, a decrease
in inventory of $7.0 million, an increase in accounts
payable and accrued liabilities totaling $6.5 million and
depreciation and amortization of $2.3 million.
The cash provided by operations in fiscal year 2007 was
primarily due to net income of $3.9 million, depreciation
and amortization of $7.4 million and increases in deferred
revenue of $1.2 million and accrued compensation and
benefits of $1.1 million. This was primarily offset by an
increase in accounts receivable of $3.2 million, an
increase in inventory of $2.8 million, a change in accounts
receivable allowance of $0.9 million, and a decrease in
accrued liabilities of $0.8 million. The change in accounts
receivable allowance of $0.9 million was related to the
write-off of accounts receivable that were fully reserved in
prior years and attempts to collect were unsuccessful. Because
these accounts were fully reserved in prior years, there was no
impact on our results of operations for the year ended
June 30, 2007.
The cash provided by operations in fiscal year 2006 was
primarily due to net income of $1.4 million, depreciation
and amortization of $5.0 million, an increase in accounts
payable of $1.6 million, an increase of accrued
compensation and benefits of $1.8 million, and an increase
in deferred rent of $1.6 million. This was primarily offset
by an increase in inventory of $5.4 million and an increase
of accounts receivable of $2.7 million.
The cash provided by operations in fiscal year 2005 was
primarily due to depreciation and amortization of
$5.5 million, a decrease in accounts receivable of
$3.4 million, impairment charges of $3.3 million, an
increase in accrued liabilities of $1.2 million, and an
increase in accrued compensation and benefits of
$1.0 million. This was primarily offset by a net loss of
$3.5 million and an increase in inventories, prepaid and
other assets of $1.5 million.
Investing
Activities
Net cash used in investing activities for the three months ended
September 30, 2007 was $3.4 million. Net cash used in
investing activities for the fiscal year 2007, 2006 and 2005 was
$14.0 million, $11.5 million and $8.5 million,
respectively.
47
Net cash used in investing activities for the three months ended
September 30, 2007 was primarily due to capitalized
curriculum of $1.6 million and purchases of property and
equipment of $1.5 million. This does not include
$7.0 million of student computers financed with capital
leases. Purchases of property and equipment for the fiscal year
ended 2007, 2006 and 2005 were $5.4 million,
$10.8 million and $4.7 million, respectively. In
fiscal year 2007, we also financed, with capital leases,
purchases of property and equipment and student computers of
$8.1 million. In fiscal year 2005, we also financed with
capital leases, purchases of student computers in the amount of
$0.4 million. Capitalized curriculum for the fiscal year
ended 2007, 2006 and 2005 were $8.7 million,
$0.7 million and $3.8 million, respectively.
Financing
Activities
Net cash provided by financing activities for the three months
ended September 30, 2007 was $7.4 million. This was
primarily due to $11.0 million in borrowings against our
revolving credit facility.
Net cash provided by financing activities for the year ended
June 30, 2007 was $0.7 million. This was primarily due
to the release of cash from a restricted escrow account of
$2.3 million, a bank overdraft of $1.6 million, and
net borrowings from our revolving credit facility of
$1.5 million. This was offset by a payment on a related
party note payable of $4.0 million and repayments of
capital lease obligations of $1.4 million. Net cash used in
financing activities for fiscal year 2006 was $2.6 million
primarily attributable to cash invested in a restricted escrow
account of $2.2 million and repayments for capital lease
obligations of $0.4 million.
Net cash provided by financing activities for the fiscal year
2005 was $2.9 million primarily due to proceeds from a
related party note payable of $4.0 million and the release
of cash from a restricted escrow account of $2.2 million.
This was partially offset by repayments of capital lease
obligations of $3.4 million.
Contractual
Obligations
Our contractual obligations consist primarily of leases for
office space, capital leases for equipment and other operating
leases. The following summarizes our long-term contractual
obligations as of September 30, 2007:
For the Twelve Months Ending September 30,
Total
2008
2009
2010
2011
2012
Thereafter
(dollars in thousands)
Contractual Obligations at September 30, 2007
Capital
leases(1)
$
14,653
$
6,072
$
5,520
$
3,061
$
$
$
Operating leases
16,712
2,126
2,130
1,396
1,404
1,376
8,280
Line of
credit(2)
12,500
12,500
Long-term
obligations(1)
335
193
101
41
Total
$
44,200
$
20,891
$
7,751
$
4,498
$
1,404
$
1,376
$
8,280
(1)
Includes interest expense.
(2)
Pertains to revolving line of
credit and excludes interest expense due to short-term repayment
period.
Under most contracts, we provide the virtual schools we manage
with turnkey management services and take responsibility for any
operating deficits that the school may incur. These deficits are
recorded as a reduction in revenues, and therefore are not
included as a commitment or obligation in the above table.
In connection with our service agreement with the Northern
Ozaukee School District (and the Wisconsin Virtual Academy),
there is an indemnification provision which arguably could be
asserted by the school district for certain expenses in the
event the plaintiff prevails and the Court enjoins open
enrollment payments to the district that otherwise would cover
those expenses. As of September 30, 2007, we have assessed
the likelihood of a claim as not probable, and therefore it has
not been included as a commitment or obligation in the table
above. See Business Legal
Proceedings Johnson v. Burmaster.
48
Off-Balance
Sheet Arrangements
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 that are material to investors.
Impact of
Inflation
We believe that inflation has not had a material impact on our
results of operations for any of the years in the three year
period ended June 30, 2007. We cannot assure you that
future inflation will not have an adverse impact on our
operating results and financial condition.
Quantitative
and Qualitative Disclosures About Market Risk
Interest
Rate Risk
We had unrestricted cash and cash equivalents totaling
$2.9 million, $1.7 million and $9.5 million as of
September 30, 2007, June 30, 2007 and June 30,
2006, respectively. Unrestricted cash and cash equivalents are
maintained primarily in non-interest bearing accounts and are
used for working capital purposes. Because we currently do not
have balances in interest bearing accounts, fluctuations in
interest rates would not have a material impact on our
investment income.
Our interest rate exposure is related to short-term debt
obligations under our revolving credit facility. A significant
portion of our interest expense is based upon changes in the
LIBOR benchmark interest rate. Due to the short-term nature of
our outstanding debt subject to variable interest rates as of
September 30, 2007 of $12.5 million, fluctuations in
the LIBOR rate would not have a material impact on our interest
expense.
Foreign
Currency Exchange Risk
We currently do not operate in a foreign country or transact a
material amount of business in a foreign currency and therefore
we are not subject to fluctuations due to changes in foreign
currency exchange rates. However, we intend to pursue
opportunities in international markets in the future. 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 operation 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.
Recent
Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, which
revised SFAS No. 123, and supersedes APB Opinion
No. 25. The revised statement addresses the accounting for
share-based payment transactions with employees and other third
parties, eliminates the ability to account for share-based
compensation transactions using APB Opinion No. 25 and
requires that the compensation costs relating to such
transactions be recognized in the statements of operations. We
adopted SFAS No. 123R for the fiscal year ended
June 30, 2007.
In February 2006, FASB issued Statement of Financial Accounting
Standard No. 155 (SFAS No. 155), Accounting
for Certain Hybrid Financial Instruments An
Amendment of FASB Statements No. 133 and 140. This
Statement is effective for all financial instruments acquired or
issued after the beginning of an entitys first fiscal year
that begins after September 15, 2006. At adoption, any
difference between the total carrying amount of the individual
components of the existing bifurcated hybrid financial
instrument and the fair value of the combined hybrid financial
instrument should be recognized as a cumulative effect
adjustment to beginning retained earnings. We do not believe
that the adoption of SFAS No. 155 will have a material
impact on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation (FIN) 48,
Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes
49
recognized in an enterprises financial statements in
accordance with SFAS No. 109, Accounting for Income
Taxes. This interpretation defines the minimum recognition
threshold a tax position is required to meet before being
recognized in the financial statements. FIN 48 is effective
for fiscal years beginning after December 15, 2006. We
adopted FIN 48 on July 1, 2007. We determined the impact of
FIN 48 will not have a material effect on our financial
position and results of operations.
In September 2006, the FASB issued Statement of Financial
Accounting Standard No. 157 (SFAS No. 157),
Fair Value Measurements, which defines fair value,
establishes a framework for measuring fair value, and expands
disclosures about fair value measurements.
SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007. We are in the process of
evaluating the impact of this statement on our consolidated
financial statements.
In February 2007, the FASB issued Statement of Financial
Accounting Standard No. 159 (SFAS No. 159),
The Fair Value Option for Financial Assets and Financial
Liabilities. This statement permits companies and
not-for-profit organizations to make a one-time election to
carry eligible types of financial assets and liabilities at fair
value, even if fair value measurement is not required under
GAAP. SFAS No. 159 is effective for fiscal years beginning
after November 15, 2007. Early adoption is permitted if the
decision to adopt the standard is made after the issuance of
this statement but within 120 days after the first day of
the fiscal year of adoption, provided no financial statements
have yet been issued for any interim period and provided the
requirements of SFAS No. 157, Fair Value Measurements, are
adopted concurrently with SFAS No. 159. The Company does
not believe that it will adopt the provisions of this statement.
50
BUSINESS
Our
Company
We are a technology-based education company. We offer
proprietary curriculum and educational services created for
online delivery to students in kindergarten through
12th grade, or K-12. Our mission is to maximize a
childs 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 $100 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual schools
and other educational applications. From fiscal year 2004 to
fiscal year 2007, we increased average enrollments in the
virtual public schools we serve from approximately 11,000
students to 27,000 students, representing a compound annual
growth rate of approximately 35%. For the three months ended
September 30, 2007, we increased average enrollments 50% to
approximately 39,500, as compared to the same period in the
prior year. From fiscal year 2004 to fiscal year 2007, we
increased revenues from $71.4 million to
$140.6 million, representing a compound annual growth rate
of approximately 25%, and improved from a net loss of
$7.4 million to net income of $3.9 million. For the
three months ended September 30, 2007, we increased
revenues to $59.4 million, representing a growth rate of
57%, as compared to the same period in the prior year. Over the
same period, we increased net income to $5.7 million
(excluding an income tax benefit of $7.1 million) from
$4.7 million.
We believe we are unique in the education industry because of
our direct involvement in every component of the educational
development and delivery process. Most educational content,
software and service providers typically concentrate on only a
portion of that process, such as publishing textbooks, managing
schools or providing testing and assessment services. This
traditional segmented approach has resulted in an uncoordinated
and unsatisfactory education for many students. Unburdened by
legacy, we have taken a holistic approach to the design of our
learning system. We have developed an engaging curriculum which
includes online lessons delivered over our proprietary school
platform. We combine this with a rigorous system to test and
assess students and processes to manage school performance and
compliance. In addition, our professional development programs
enable teachers to better utilize technology for instruction.
Our end-to-end learning system is designed to maximize the
performance of the schools we serve and enhance student academic
achievement.
As evidence of the benefit of our holistic approach, the virtual
public schools we serve generally test near, and in some cases
above, state averages on standardized achievement tests. These
results have been achieved despite the enrollment of a
significant number of new students each school year who have had
limited exposure to our learning system prior to taking these
required state tests. Students using our learning system for at
least three years usually perform better on standardized tests
relative to state averages than students using it for one year
or less. The efficacy of our learning system has also helped us
achieve high levels of customer satisfaction. According to a
2006 internal survey of parents of students enrolled in virtual
public schools we serve, approximately 97% of respondents stated
that they were either satisfied or very satisfied with our
curriculum and 95% of respondents stated that they would
recommend our curriculum to other families.
We deliver our learning system to students primarily through
virtual public schools. As with any public school, these schools
must meet state educational standards, administer proctored
exams and are subject to fiscal oversight. The fundamental
difference is that students attend virtual public schools
primarily over the Internet instead of traveling to a physical
classroom. In their online learning environment, students
receive assignments, complete lessons, and obtain instruction
from certified teachers with whom they interact online,
telephonically, and face-to-face. Many states have embraced
virtual public schools as a means to provide families with a
publicly funded alternative to a traditional classroom-based
education. For parents who believe their child is not thriving
and for whom relocating or private school is not an option,
virtual public schools can provide a compelling choice. This
widespread availability makes them the most public
of schools. From an education policy standpoint, virtual public
schools often represent a savings to the taxpayers when compared
with traditional public schools because they are generally
funded at a lower per pupil level than the per pupil state
average reported by the U.S. Department of Education. Finally,
because parents are not required to pay tuition, virtual public
schools make our learning system available to the broadest range
of students.
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We offer virtual schools our proprietary curriculum, online
learning platform and varying levels of academic and management
services, which can range from targeted programs to complete
turnkey solutions, under long-term contracts. These contracts
provide the basis for a recurring revenue stream as students
progress through successive grades. Additionally, without the
requirement of a physical classroom, virtual schools can be
scaled quickly to accommodate a large dispersed student
population, and allow more capital resources to be allocated
towards teaching, curriculum and technology rather than towards
a physical infrastructure.
Substantially all of our enrollments are served through
25 virtual public schools to which we provide full turnkey
solutions and seven virtual public schools to which we provide
limited management services. With the exception of a school we
manage in Chicago, these schools are able to enroll students on
a statewide basis in 17 states and the District of
Columbia. In contrast, a small number of enrollments are served
by an additional 27 schools that only enroll students in a
single school district in these and other states. The services
we provide to these districts are designed to assist them in
launching their own distance learning programs and vary
according to the needs of the individual school districts. These
services generally consist of our student account management
systems, administrator and teacher training programs, and
student placement support. Parents can also purchase our
curriculum and online learning platform directly to facilitate
or supplement their childrens education. Additionally, we
have piloted our curriculum in brick and mortar classrooms with
promising academic results. We also believe there is additional
widespread applicability for our learning system internationally.
Families that choose our learning system for their children come
from a broad range of social, economic and academic backgrounds.
They share, however, the desire for an individualized learning
program to maximize their childrens potential. Examples
include, but are not limited to, families with: (i) students
seeking to learn faster or slower than they could in a one
size fits all traditional classroom; (ii) safety concerns
about their local school; (iii) students with disabilities for
which traditional classrooms are problematic; (iv) students with
geographic or travel constraints; and (v) student athletes and
performers who are not able to attend regularly scheduled
classes. Our individualized learning approach allows students to
optimize their individual academic performance and, therefore,
their chances of achieving their goals.
Our
History
We were founded in 2000 to utilize the advances in technology to
provide children access to a high-quality public school
education regardless of their geographic location or
socio-economic background. Given the geographic flexibility of
technology-based education, we believed that the pursuit of this
mission could help address the growing concerns regarding the
regionalized disparity in the quality of public school
education, both in the United States and abroad. These concerns
were reflected in the passage of the No Child Left Behind (NCLB)
Act in 2000, which implemented new standards and accountability
requirements for public K-12 education. The convergence of these
concerns and rapid advances in Internet technology created the
opportunity to make a significant impact by deploying a high
quality learning system on a flexible, online platform.
In September 2001, after 18 months of research and
development on our curriculum, we launched our kindergarten
through 2nd grade offering. We initially launched our
learning system in virtual public schools in Pennsylvania and
Colorado, serving approximately 900 students in the two states
combined. During the
2002-03
school year, we added our 3rd through 5th grade
offering and entered into contracts to operate virtual public
schools in California, Idaho, Ohio, Minnesota and Arkansas,
increasing our average enrollment to approximately 5,900
students during the 2002-03 school year. For the
2003-04
school year, we added our 6th and 7th grade offerings. During
the 2004-05
school year, we added our 8th grade offering and entered
into contracts to operate virtual public schools in Wisconsin,
Arizona and Florida. By the end of the
2004-05
school year, we had increased enrollment to approximately 15,100
students. In the 2005-06 school year, we added contracts to
operate virtual public schools in Washington, Illinois and
Texas. Additionally during the
2006-07
school year, we implemented a hybrid school offering in Chicago
that combines face-to-face time in the classroom with online
instruction. We recently entered the virtual high school market,
enrolling 9th and 10th grade students at the start of
the 2005-06
and 2006-07
school years, respectively, and enrolling 11th and
12th grade students at the start of the
2007-08
school year. Finally, we added contracts to operate virtual
public schools in Georgia and Nevada for the 2007-08 school year.
We believe we have significant growth potential. Therefore over
the last three years, we have put a great deal of effort into
developing the infrastructure necessary to scale our business.
We further developed our logistics and
52
technological infrastructure and implemented sophisticated
financial systems to allow us to more effectively operate a
large and growing company.
Our
Market
The U.S. market for K-12 education is large and growing.
For example:
According to the National Center for Education Statistics
(NCES), a division of the U.S. Department of Education,
there were more than 49 million students in K-12 public
schools during the 2005-06 school year. In addition, according
to National Home Education Research, approximately two million
students are home schooled and, according to a March 2006 NCES
report, approximately five million students are enrolled in
private schools.
According to the NCES, the public school system alone
encompassed more than 98,000 schools and 17,000 districts during
the 2005-06 school year.
The NCES estimates that total spending in the public K-12 market
was $558 billion for the 2005-06 school year.
Parents and lawmakers are demanding increased standards and
accountability in an effort to improve academic performance in
U.S. public schools. As a result, each state is now required to
establish performance standards and to regularly assess student
progress relative to these standards. We expect continued focus
on academic standards, assessments and accountability in the
near future.
Many parents and educators are also seeking alternatives to
traditional classroom-based education that can help improve
academic achievement. Demand for these alternatives is evident
in the growing number of choices available to parents and
students. For example, charter schools emerged in 1988 to
provide an alternative to traditional public schools. Currently,
40 states and the District of Columbia have passed charter
school legislation and there are approximately 4,000 charter
schools in the U.S. with an estimated enrollment of over
1.1 million students according to the Center for Education
Reform. Similarly, acceptance of online learning initiatives,
including not only virtual schools but also online testing and
Internet-based professional development, has become widespread.
As of September 2006, 38 states had established some form
of online learning initiative, and Michigan recently became the
first state to pass legislation mandating that high school
students take part in an online learning experience
in order to graduate.
Virtual public schools represent one approach to online learning
that is gaining acceptance. According to the Center for
Education Reform, as of January 2007 there were 173 virtual
schools with total enrollment exceeding 92,000 students,
operating in 18 states compared to just 86 virtual schools
in 13 states with total enrollment of 31,000 students in the
2004-05 school year. Virtual schools can offer a comprehensive
curriculum and flexible delivery model; therefore, we believe
that a growing number of families will pursue virtual public
schools as an attractive public school alternative. Given these
statistics and the nascence of this market, we believe there is
a significant opportunity for a high-quality, trusted, national
education provider to serve virtual public schools.
Our
Competitive Strengths
We believe the following to be our key competitive strengths:
Proprietary Curriculum Specifically Designed for a
Technology-Enabled Environment. We specifically
designed our curriculum for online learning, in contrast to
other online curriculum providers who often just digitize
classroom textbooks for transmission over the Internet. Our
lessons utilize a combination of innovative technologies,
including flash animations, online interactivity and real-time
individualized feedback, which we combine with textbooks and
other offline course materials to create an engaging and highly
effective curriculum. Our curriculum contains more than 11,000
discrete lessons, each of which addresses specific learning
objectives and can be utilized in the manner most appropriate
for each student. We continuously measure student performance
and use this information to improve our curriculum and drive
greater, more consistent academic achievement, a valuable
competitive advantage we enjoy by virtue of our integration into
all aspects of the educational development and
53
delivery process. We believe our curriculum is the most advanced
cognitive research-based curriculum in
K-12
education.
Flexible, Integrated Online Learning
Platform. Our online learning platform provides a
highly flexible and effective means for delivering educational
content to students. Our platform offers assessment capabilities
to identify the current and targeted academic level of
achievement for each individual student, and then incorporates
this information into a detailed lesson plan. As students
progress through their studies, our learning platform measures
mastery of each learning objective to ensure that students grasp
each concept prior to proceeding to the next lesson.
Additionally, our learning platform updates each students
lesson plan for completed lessons and enables us to track the
effectiveness of each lesson with each student on a real-time
basis. Finally, the fact that our learning system is
Internet-based allows us to update our proprietary content and
incorporate user feedback on a real-time basis. For example, our
content for the 2006-07 school year reflected the fact that
Pluto is no longer considered a planet, which was announced in
August 2006.
Expertise in Opening Channels for Virtual
Schooling. Our education policy experts and
established relationships with key educational authorities have
allowed us to participate effectively in advocating for virtual
public schools. Specifically, we have demonstrated our expertise
in helping individual educational policymakers understand the
benefits of virtual schools and in managing the regulatory
requirements once new virtual schools are opened. Since our
inception, we have partnered with individual state governing
bodies to establish highly effective, publicly funded education
alternatives for parents and their children. Our experience in
opening up these new channels gives us a valuable first-mover
advantage over potential competitors.
Track Record of Student Achievement and Customer
Satisfaction. The virtual public schools we serve
generally test near, and in some cases above, state averages on
standardized achievement tests. These results have been achieved
despite the enrollment of a significant number of new students
each school year who have had limited exposure to our learning
system prior to taking these required state tests. Students
using our learning system for at least three years usually
perform better on standardized tests relative to state averages
than students using it for one year or less. Additionally, in
California, the virtual public schools we serve performed in the
50th to 70th percentile of all public schools in the
state during the
2005-06
school year. Among statewide virtual public schools, those using
the
K12
learning system outperform other providers in terms of academic
performance. The efficacy of our learning system has also helped
us achieve high levels of customer satisfaction. According to a
2006 internal survey of parents of students enrolled in virtual
public schools we serve, approximately 97% of respondents stated
that they were either satisfied or very satisfied with our
curriculum and 95% of respondents stated that they would
recommend our curriculum to other families. This high degree of
customer satisfaction has been a strong contributor to our
growth, helps drive new student referrals and leads to
re-enrollments.
Highly Scalable Model. We have built our
educational model systems and management team to successfully
and efficiently serve the academic needs of a large dispersed
student population. We generate high levels of recurring revenue
as a result of our long-term contracts with schools (typically
five years in length), the extended duration over which an
individual student can utilize our learning system (kindergarten
through 12th grade) and our high level of customer
satisfaction. Since our inception, we have invested over
$100 million to develop our learning system, incurring
significant losses. Our ability to leverage this historical
investment in our learning system and our ability to deliver our
offering over the Internet enables us to successfully serve a
greater number of students at a reduced level of capital
investment.
Our
Growth Strategy
We intend to pursue the following strategies to drive our future
growth:
Generate Enrollment Growth at Existing Virtual Public
Schools. From fiscal year 2004 to fiscal year
2007, we increased average enrollments in the virtual public
schools we serve from more than 11,000 students to more than
27,000 students. In the
2007-08
school year, substantially all of our enrollments are served
through virtual public schools in 17 states and the
District of Columbia. We intend to continue to drive increased
enrollments at the virtual public schools we serve through
targeted marketing and recruiting efforts as well as through
referrals. Our marketing and recruiting efforts utilize both
traditional and online media as well as community events to
communicate the effectiveness of our solution to parents who are
evaluating educational alternatives for their children.
Historically, we
54
have also enrolled a significant number of new students each
year through referrals from families who have had a positive
experience with our learning system and recommended
K12
to their friends and family members.
Enhance Curriculum to Include a Complete High School
Offering. We believe that serving virtual public
high schools represents a significant growth opportunity for
online education delivery given the increased independence of
high school students and the wide variance in academic
achievement levels and objectives of students who are entering
high school. Americas Digital Schools 2006, a
survey sponsored by Discovery Education and Pearson Education,
projects that the percentage of U.S. high school students
enrolled in online courses will increase from 3.8% in 2006 to
15.6% in 2011. We believe that our early offering of our
integrated
K-8 learning
system and our experience serving K-8 virtual public schools
positions us well for growth in serving virtual public high
schools. In the 2005-06 and 2006-07 school years, we began
enrolling 9th and 10th grade students, respectively, and with
the launch of our 11th and 12th grades in the
2007-08
school year, we are able to provide a complete high school
offering. We are developing our high school curriculum to
satisfy the broad range of high school student interests with a
broad variety of required and elective courses, supplemented by
selected courses from other content providers.
Expand Virtual Public School Presence into Additional
States. We work closely with state policymakers
and school districts to assist them in considering virtual
public schools as an effective educational choice for parents
and students. A virtual public school program can help state
administrations or school districts quickly establish and offer
an alternative to traditional classroom-based education,
expanding the range of choices available to parents and
students. The flexibility and comprehensiveness of our learning
system allows us to efficiently adapt our curriculum to meet the
individual educational standards of any state with minimal
capital investment. We intend to continue to seek opportunities
to assist states in establishing virtual public schools and to
contract with them to provide our curriculum, online learning
platform and related services.
Strengthen Awareness and Recognition of the
K12Brand. Within the virtual public school
community, we enjoy strong brand recognition among parents and
students as a leading provider of virtual education. Outside of
this community, however, the
K12
brand is not as well recognized. We have developed a
comprehensive brand strategy and intend to invest in further
developing awareness of both the
K12
brand and the core philosophy behind our learning system. The
recent launch of our Unleash the xPotential
campaign is a strong first step towards this goal of creating
broader brand awareness. We believe that a strong and recognized
brand will result in an increased presence among virtual public
schools, attract more student applications and facilitate our
entry into adjacent markets.
Pursue International Opportunities to Offer Our Learning
System. We believe there is strong worldwide
demand for high-quality, flexible education alternatives. In
many countries, students seek a U.S. accredited education
to gain access to higher education and improved employment
opportunities. Given the highly flexible design and
technology-based nature of our platform, it can be adapted to
other languages and cultures efficiently and with modest capital
investment. Additionally, our ability to operate virtually is
not constrained by the need for a physical classroom or local
teachers, which makes our learning system ideal for use
internationally.
Develop Additional Channels Through Which to Deliver our
Learning System. We believe there are many
additional channels through which the
K12
learning system can be offered. These include direct classroom
instruction, hybrid models, and as a supplemental educational
offering. For example, in an urban public school in
Philadelphia, we piloted our
K-5
curriculum in traditional classrooms and were able to generate
meaningful improvements in academic performance. Additionally,
we have recently implemented a hybrid classroom offering in
Chicago that combines face-to-face time in the classroom with
online instruction. Outside the public school channels, the
flexibility of our learning system enables us to package lessons
to be sold as individual products directly to parents and
students. We intend to regularly evaluate additional delivery
channels and to pursue opportunities where we believe there is
likely to be significant demand for our offering.
55
Educational
Philosophy
The design, development and delivery of our learning system is
based on the following set of guiding principles:
Apply Tried and True Educational Approaches for
Instruction. Our learning system is designed to utilize both
tried and true methods to drive academic
success. True methodologies are based on cognitive
research regarding the way in which individuals learn. We also
supplement our learning system with teaching tools and
methodologies that have been tested, or tried, and
proven to be effective. This tried and true
philosophy allows us to benefit from both decades of research
about learning, and effective methods of teaching.
Employ Technology Appropriately for Learning. While all
of our courses are delivered primarily through an online
platform and generally include a significant amount of online
content, we employ technology only where we feel it is
appropriate and can enhance the learning process. In addition to
online content, our curriculum includes a rich mix of offline
course materials, including engaging textbooks and hands-on
materials such as phonics kits and musical instruments. We
believe our balanced use of technology and offline materials
helps to maximize the effectiveness of our learning system.
Base Learning Objectives on Rich Content and Big
Ideas. We refer to big ideas as the key,
subconscious frameworks that serve as the foundation to a
students future understanding of a subject matter. For
example, an understanding of waves is fundamental to a
physicists understanding of quantum mechanics; therefore,
we teach 1st graders the fundamentals of waves. We use
these big ideas to organize and provide the master
objectives of every course we develop. We then utilize rich,
engaging content to best communicate these concepts to students
to promote mastery of the topics.
Assess Every Objective to Ensure Mastery. Ongoing
assessments are the most effective way to evaluate a
students mastery of a lesson or concept. To facilitate
effective assessment, our curriculum establishes clear
objectives for each lesson. Throughout a course, each
students progress is assessed and evaluated by a teacher
at a point when each objective is expected to be mastered,
providing direction for appropriate pacing. These periodic and
well-timed assessments reinforce learning and promote mastery of
a topic before a student moves to the next lesson or course.
Facilitate Flexibility as the Level, Pace and Hours Spent on
Each Objective Vary by Child. We believe that each student
should be challenged appropriately. Generally, adequate progress
for most students is to complete one academic years
curriculum within a nine-month school year. Each individual
student may take greater or fewer instructional hours and more
or less effort than the average student to achieve this
progress. Our learning system is designed to facilitate this
flexibility in order to ensure that the appropriate amount of
time and effort is allocated to each lesson.
Prioritize Important, Complex Objectives. We have
developed a clear understanding of those subjects and concepts
that are difficult for students. Greater instructional effort is
focused on the most important and difficult concepts and skills.
We use existing research, feedback from parents and students and
experienced teacher judgments to determine these priorities, and
to modify our learning system to guide the allocation of each
students time and effort.
Products
and Services
Our
Products
K12
Curriculum
Our curriculum consists of the
K12
online lessons, offline learning kits and teachers guides.
We have developed an extensive catalogue of proprietary courses,
consisting of more than 11,000 lessons, designed to teach
concepts to students from kindergarten through 10th grade.
Each lesson is designed to last approximately 45 to
60 minutes, although students are able to work at their own
pace. A single course generally consists of 120 to
180 individual lessons.
56
Online Lessons. Our online lessons are
accessed through our Online School (OLS) platform. Each online
lesson provides the roadmap for the entire lesson including
direction to specific online and offline materials, online
lesson content and a summary of the major objectives for the
lesson. Lessons utilize a combination of innovative technologies
including flash animations and online interactivity, coordinated
textbooks and hands-on materials and individualized feedback to
create an engaging, responsive and highly effective curriculum.
Each lesson also contains an online assessment to ensure that
students have mastered the material and are ready to proceed to
the next lesson, allowing them to work at their own pace.
Pronunciation guides for key words and references to suggested
additional resources, specific to each lesson and each
students assessment, are also included.
Offline Learning Kits. All of our courses
utilize a series of offline learning kits in conjunction with
the online lessons to help maximize the effectiveness of our
learning system. In addition to receiving access to our online
lessons through the Internet, each student receives a shipment
of offline materials, including textbooks, art supplies,
laboratory supplies (e.g. microscopes and scales) and other
reference materials which are incorporated throughout our
curriculum. This approach is consistent with our guiding
principle to utilize technology where appropriate in our
learning system. Most of the textbooks we use are proprietary
textbooks that are written in a way that is designed to be
engaging to students and to compliment the online experience. We
believe that our ability to combine online lessons and offline
materials so effectively is a competitive advantage.
Teachers Guides. All of our courses are
paired with a teachers guide. Each guide outlines the
course objectives, refers back to all of the course content that
is contained in the online and offline course materials,
includes answers and explanations to the exercises that the
students complete and contains suggestions for explaining
difficult concepts to students.
57
Courses
Offered
The following table provides a list of our proprietary courses
(including 11 foreign language courses the licences of which we
have acquired by virtue of our recent acquisition of Power-Glide
Language Courses, Inc., a third-party content provider) and
selected third-party courses (shown in italics) that we are
offering during the 2007-08 school year. We also offer an
additional 20 third-party courses at the high school level.
English and Language
Arts
Mathematics
Science
Elementary School
Middle School
High School
Elementary School
Middle School
High School
Kindergarten Language Arts
Kindergarten Phonics
1st Grade Language Arts
1st Grade Phonics
2nd Grade Language Arts
3rd Grade Language Skills
3rd Grade Spelling
3rd Grade Literature
4th Grade Language Skills
4th Grade Spelling
4th Grade Literature
5th Grade Language Skills
5th Grade Spelling
5th Grade Literature
Intermediate Language Skills A
Intermediate Language Skills B
Intermediate Literature A
Intermediate Literature B
Literary Analysis and Composition
Literary Analysis and Composition I Foundations
Literary Analysis and Composition I
Literary Analysis and Composition II American Literature
AP English Literature and Composition
World Literature and Language
History Kindergarten History
1st Grade History
2nd Grade History
3rd Grade History
4th Grade History
American History Before 1865
American History Since 1865
Intermediate World History A
Intermediate World History B
Modern World Studies World History
U.S. History
AP U.S. History
American Government and Economics
Macroeconomics
Kindergarten Math
1st Grade Math
2nd Grade Math
3rd Grade Math
4th Grade Math
5th Grade Math
Pre-Algebra A
Pre-Algebra B
Algebra I
Pre-Algebra
Pre-Algebra Foundations
Algebra Foundations
Algebra I
Geometry Algebra II
Art Kindergarten Art
1st Grade Art
2nd Grade Art
3rd Grade Art
4th Grade Art
Intermediate Art: American A
Intermediate Art: American B
Intermediate Art: World A
Intermediate Art: World B
Music/Other Preparatory Music
Beginning 1 Music
Beginning 2 Music
Introduction to Music
Intermediate 1 Music
Intermediate 2 Music
Intermediate 3 Music
Exploring Music
Music Concepts A
Music Concepts B
Music Appreciation
Learning Online
Physical Education
Spanish I, II, III
French I, II, III
German I, II
Latin I, II
Chinese I
58
K-8 Courses. From kindergarten through 8th grade,
our courses are categorized into six major subject areas:
English and Language Arts, Mathematics, Science, History, Art
and Music. Our proprietary curriculum includes all of the
courses that students need to complete their core kindergarten
through 8th grade education. These courses focus on
developing fundamental skills and teaching the key knowledge
building blocks or schemas that each student will need to master
the major subject areas, meet state standards and complete more
advanced coursework. Unlike a traditional classroom education,
our learning system offers the flexibility for each student to
take courses at different grade levels in a single academic
year, providing flexibility for students to progress at their
own level and pace within each subject area. In addition, the
flexibility of our learning system allows us to tailor our
curriculum to state specific requirements. For example, we have
developed eight courses specifically for use in Texas public
schools.
High School Courses. The curriculum sought by students in
each of the high school grades is much broader and varies from
student to student, largely as a result of the increased
flexibility in course selection required for high school
students. In order to offer a full suite of courses, including
the many elective courses required to meet the needs of high
school students, we offer a combination of proprietary courses
and selected rigorously tested courses licensed from
third-parties. We have 27 proprietary high school courses for
the 2007-08 school year (including eight courses that have one
or more lessons that remain under development for delivery prior
to their first scheduled use later in the school year). The high
school students we serve using our proprietary courses account
for approximately 60% of the total course enrollment of our high
school students in the
2007-08
school year.
Online
School Platform
Our Online School (OLS) platform is an intuitive, web-based
software platform that provides access to our online lessons as
well as our lesson planning and scheduling tools and our
progress tracking tool, both of which serve a key role in
assisting parents and teachers in managing each students
progress. Because the OLS is a web-based platform, students,
parents and teachers can access our online tools and lessons
through the OLS from anywhere with an Internet connection at any
time of the day or night.
Lesson Planning and Scheduling Tools. In a school year, a
typical student will complete between 800 and 1,200 lessons
across six or more subject areas. Our lesson planning and
scheduling tools enable teachers and parents to establish a
master plan for completing these lessons. These tools are
designed to dynamically update the lesson plan as a student
progresses through each lesson and course, allowing flexibility
to increase or decrease the pace at which the student moves
through the curriculum while ensuring that the student
progresses towards completion in the desired time frame. For
example, the schedule can easily be adapted to accommodate a
student who desires to attend school six days a week, a student
who is interested in studying during the winter holidays to take
time off during the spring, or a student who chooses to take two
math classes a day for the first month of the school year and
delay art classes until the second month of the school year.
Moreover, changes can be made to the schedule at any point
during the school year and the remainder of the students
schedule will automatically adjust in the OLS.
Progress Tracking Tools. Once a master schedule has been
established, the OLS delivers lessons based upon the specified
parameters. Each day, a student is initially directed to a
screen listing the syllabus for that particular day and begins
the school day by selecting one of the listed lessons. As each
lesson is completed, the student returns to the days
syllabus to proceed to the next subject. If a student does not
complete a lesson during the session, the lesson will be
rescheduled to the next day and will resume at the point where
the student left off. Our progress tracking tool allows
students, parents and teachers to monitor student progress. In
addition, information collected by our progress tracking tool
regarding student performance, attendance and other data is
transferred to our proprietary management system for use in
providing administrative support services.
Student
Administration Management System
Our Student Administration Management System (SAMS) organizes,
updates and reports information that is automatically collected
through interfaces with our OLS and related management systems.
SAMS collects and provides us with all of the information
required to manage student enrollment and monitor student
performance.
59
SAMS is also central to collecting and managing all
administrative data required to operate a virtual public school.
In addition, the information provided by SAMS feeds our
proprietary Order Management System (OMS) that generates orders
for offline learning kits and computers to be delivered to
students.
Student
Community Tools
We place a strong emphasis on the importance of building a sense
of community in the schools we manage. Accordingly, we offer a
combination of tools that foster communication and interaction
among virtual public school students and parents. Our
K12
Community Chest website for virtual public school students
includes discussion boards, blogs, games, competitions and other
functions. Additionally, our
K12
Family Directory web-based tool enables parents of virtual
public school students to organize online and offline social
activities for their children. Parents can run searches based on
criteria such as their childs location, age or interests
(such as hobbies or sports) to locate and contact other parents
of children with similar interests to facilitate student
interaction.
Our
Services
We provide a wide array of services to students and their
families as well as directly to virtual public schools. Our
services can be categorized broadly into academic support
services and management and technology services.
Academic
Support Services
Teachers and Related Services. Teachers are
critical to the educational success of students in virtual
public schools. Teachers in the virtual public schools that we
serve are generally employed by the school, with the ultimate
authority over these teachers residing with the schools
governing body. Under our service agreements, we recruit, train
and provide management support for these teachers. Historically,
we have seen significant demand for teaching positions in the
virtual public schools that we serve. For example, for the
virtual public schools we serve in California, we recently
received approximately six applications for each teaching
position filled for the
2006-07
school year.
We use a rigorous evaluation program for making hiring
recommendations to the virtual public schools we serve. We hire
teachers who, at a minimum, are state certified and meet the
federal requirements for designation as a Highly Qualified
Teacher, and generally have at least three years of
teaching experience. We also seek to recruit teachers who have
the skill set necessary to be successful in a virtual public
school environment. Teaching in a virtual public school is
characterized by heightened
one-on-one
student-teacher and parent-teacher interaction, so virtual
public school teachers must have strong interpersonal
communications skills. Additionally, a virtual public school
teacher must be creative in finding ways to effectively connect
with their students and integrate themselves into the daily
lives of the students families.
New virtual public school teachers attend our comprehensive
training program during which, among other things, they are
introduced to our educational philosophy, our curriculum and our
OLS and other technology applications, and are provided
strategies for communicating and connecting with students and
their families in a virtual public school environment. We also
provide ongoing training opportunities for teachers so that they
may stay abreast of changing educational standards and key
learning trends, which we believe enhances their teaching
abilities and effectiveness.
Gifted and Special Education Services. We
believe that our individualized learning system is able to
effectively address the educational needs of gifted and special
education students because it is self-paced and employs flexible
teaching methods. For students requiring special attention, we
employ a national director who is an expert on the delivery of
special education services in a virtual public school
environment and who oversees and directs the special education
programs at the virtual public schools we serve. We direct and
facilitate the development and implementation of
individualized education plans for students with
special needs. Our special education program is compliant with
the federal Individuals with Disabilities Education Act and all
state special education requirements. Each special needs student
is assigned a certified special education teacher who arranges
for any required ancillary services, including speech and
occupational therapy, and any required assistive technologies,
such as special computer displays or speech recognition software.
60
Student Support Services. We provide students
attending virtual public schools that we serve and their
families with a variety of support services to ensure that we
effectively meet their educational needs and goals. Each student
is assigned a guidance counselor to assist them with academic
achievement planning. Additionally, we provide tutors as
necessary to help students with courses that they find
difficult. We also plan and coordinate social events to offer
students opportunities to meet and socialize with their virtual
public school peers. Finally, we offer our
K12
HUG (Help, Understanding and Guidance) program to address
any other questions or concerns that students and their parents
have during the course of their matriculation.
Management
Services
Under many of our contracts, we provide virtual public schools
with turnkey management services. In these circumstances, we
take responsibility for all aspects of the management of the
schools, including monitoring academic achievement, teacher
hiring and training, compensation of school personnel, financial
management, enrollment processing and procurement of curriculum,
equipment and required services. In 2007, the Commission on
International and Trans-regional Accreditation (CITA), a leading
worldwide education accreditation agency, thoroughly evaluated
our school management services and we ultimately received the
prestigious CITA accreditation.
Compliance and Tracking Services. Operating a
virtual public school entails most of the compliance and
regulatory requirements of a traditional public school. We have
developed management systems and processes designed to ensure
that schools we serve are in compliance with all applicable
requirements, including tracking appropriate student information
and meeting various state reporting requirements. For example,
we collect enrollment related information, monitor attendance
and administer proctored state tests. As we have expanded into
new states, our processes have grown increasingly robust, and we
believe our compliance and tracking processes provide us with a
distinct competitive advantage.
Financial Support Services. We provide each
school we serve with a dedicated business manager who oversees
the preparation of the annual budget and coordinates with the
schools directors to determine their annual objectives. In
addition, we implement an internal control framework, develop
policies and procedures, provide accounting services and payroll
administration, oversee all federal entitlement programs and
arrange for external audits.
Facility, Operations and Technology Support
Services. We operate administrative offices and
all other facilities on behalf of the virtual public schools we
serve. We provide these schools with a complete technology
infrastructure. In addition, we provide a comprehensive student
help desk solution.
Human Resources Support Services. We are
actively involved in hiring virtual public school
administrators, teachers and staff, through a thorough interview
and orientation process. To better facilitate the hiring
process, we review and analyze the profiles of teachers that
have been highly effective in our learning system to identify
the attributes desired in future new hires. We also negotiate
and secure employment benefits for teachers on behalf of virtual
public schools and administer employee benefit plans for virtual
public school employees. Additionally, we assist the virtual
schools we serve in drafting and implementing administrative
policies and procedures.
Product
Development
We develop our products and related service offerings through a
highly collaborative process that blends cognitive research with
an innovative development approach by utilizing best practices
from the education industry and other industries. Our approach
provides for effective content and rapid time to market. Unlike
many traditional content companies that may take several years
to develop a new course, our course development process usually
takes between six and 12 months, depending upon grade and
subject. Our development team includes professionals from the
following disciplines:
Cognitive Scientists, Evaluation and Research
Specialists conduct and review cognitive
research to determine how students master the key ideas in a
subject area, the common misconceptions that present obstacles
to mastery and available techniques that can effectively address
common misconceptions.
61
Curriculum and Teaching
Specialists bring deep subject matter
knowledge and experience with a variety of pedagogical
approaches to our course design process.
Writers and Editors script out the text
of the lessons, ensuring that the information is accurate,
meaningful and suitable for the age group we are trying to reach.
Instructional Designers weave together
all elements of a lesson and determine the extent to which
online, multi-media components, textbooks and other offline
materials, and activities can be integrated to achieve the
desired learning outcomes.
Graphic Artists/Media Specialists/Flash
Designers ensure overall visual integrity
of each lesson and build creative and interactive content.
Print Designers design and publish our
proprietary textbooks and printed learning materials.
User Experience Specialists work closely
with our design teams to ensure that lessons are easy for
students to navigate and understand.
Training Specialists concurrent with the
development of the courses, develop training materials and
programs to support the effective delivery of our curriculum by
teachers.
Project Managers coordinate all of the
activities, including the work of the above-listed resources to
develop the product as designed, on time, and on budget.
Using these highly skilled resources, we follow a six-stage
product development process beginning with idea-generation and
carrying through to post-production evaluation. Our ability to
continually modify our products based upon student, parent and
teacher feedback and assessment data is one of the significant
advantages of our online curriculum. All of our lessons contain
a user feedback button that allows us to identify learning
issues on a real-time basis. In a given week, we receive
hundreds of feedback items from students, parents and teachers.
The related descriptions below illustrate each stage in our
product development process.
Blueprint Stage. During this stage of
development, we gather the key requirements for a new product,
which may be a new course or a group of related courses. We
conduct a thorough review to identify all of the cognitive
research related to learning of the subject and gain an
understanding of the stages a student will go through in
mastering the subject material. We also look at how experts
perform in the subject. Expert-novice research has shown that an
experts knowledge of a domain is contained in a
subconscious framework, the components of which can help guide
the development of a course. During this stage, we also analyze
state standards to confirm that we are encompassing the elements
of the nations highest state standards and that we are
building courses which meet or surpass all state standards.
Design Stage. We begin the design stage by developing the
learning environment in which the product will be used. This
includes understanding the types of students that will be using
the product, how the course will be taught, the learning
objectives within the course and what online and offline
materials can be utilized. We then produce a design document and
our creative teams develop a work plan for every aspect of the
product, including the look and feel of the product, level of
functionality and length of the course. We produce, test and
refine prototypes with focus groups of students, teachers and
parents.
Pre-production Stage. With the work plan complete, a
pre-production team is assembled to develop the scope and
sequence of the course. The scope and sequence is an ordered
collection of learning objectives based on cognitive research
and state standards. These learning objectives, once organized,
guide the production team in the creation of the individual
course lessons. The pre-production team also creates the list of
materials that will be required and provides this list to our
logistics group for sourcing.
Production Stage. During this stage, the product is built
in accordance with the work plan. First, manuscripts,
storyboards and lesson design specifications are created. Online
screens, offline materials such as textbooks, simulations,
photographs, and other reference materials are then created,
reviewed and refined. Rights for licensed materials are cleared
at this point, if needed. Each lesson then goes through a
rigorous quality review before being released.
62
Support Stage. The goal during this stage is to support
the initial launch and ongoing utilization of our lessons and to
enhance the products during the course of their useful life. We
break this stage down into three components: (i) content
development, where we design and develop teacher and student
training packages; (ii) alignment and standards analysis,
where we examine performance on state tests to determine the
extent to which we should refine or adjust the standard
alignments initially developed during the blueprint stage; and
(iii) long-term maintenance, where we maintain and update
the online and offline materials on an ongoing basis based upon
feedback from teachers, parents and students.
Evaluation Stage. The final stage of the product
development cycle is the evaluation stage. During this phase, we
evaluate the overall performance of our product against the
original design specifications. We obtain measurement feedback
from a number of sources, including:
User Feedback we receive a substantial
amount of feedback from teachers, parents and students. Some
feedback is directly incorporated into course modifications. In
addition, we observe students in our usability labs and visit
students and parents to better understand how our products are
being used;
Progress Reports through our OLS, we are
able to monitor each students progress through a course.
This data helps us identify portions of a course that may be
especially difficult for students, and may require revision or
enhancements; and
State Test Scores students in the
virtual public schools we serve participate in proctored state
exams. These tests provide an impartial assessment of how these
students are performing against established benchmarks and
within their state.
Using these sources of feedback, we can revise our courses as
necessary to achieve the desired learning objectives. We believe
that this ability to proactively respond to feedback and other
data in an efficient manner is a key competitive advantage
within the educational industry.
Education Advisory Committee. To ensure the
effectiveness of our learning systems, we have established an
external Education Advisory Committee comprised of experienced
leaders in the education industry. The members of this Committee
have the responsibility to review our curriculum and
instructional model, identify the needs of the growing online
education market and propose solutions for consideration by our
management, and discuss ways that we can better implement our
guiding principles. The current members of the Committee include:
Thomas C. Boysen, Ed.D., Senior Vice President of Classroom
Solutions, K12 Inc. and formerly Kentucky Commissioner of
Education, Chief Operating Officer of the Los Angeles Unified
School District, Senior Vice President of the Milken Family
Foundation and a school district superintendent in California,
Washington and New York. Mr. Boysen is also the Chair of
the Education Advisory Committee.
Barbara Byrd-Bennett, Ed.D., Executive-In-Residence, College of
Education and Human Services, Cleveland State University and
formerly Chief Executive Officer of the Cleveland Municipal
School District and a school district superintendent for two
school districts in New York City.
Benjamin Canada, Ph.D., Associate Executive Director,
District Services, Texas Association of School Boards and
formerly President of the American Association of School
Administrators and a school district superintendent in Georgia,
Mississippi and Oregon.
Ramon Cortines, Ed.D., Deputy Mayor for Education, Youth and
Families, City of Los Angeles and formerly a school district
superintendent in California and New York.
Jo Lynne DeMary, Ed.D., Educational Leadership Director, Center
for School Improvement, Virginia Commonwealth University and
formerly Virginia Superintendent of Public Instruction.
David Driscoll, Ed.D., Education Consultant and formerly
President, Council of Chief State School Officers, Commissioner
of Education, Commonwealth of Massachusetts and a school
district superintendent in Massachusetts. Dr. Driscoll
currently serves on the board of the National Assessment
Governing Board.
Chester Finn, Ed.D., President, Thomas B. Fordham Foundation and
formerly Assistant Secretary for Research and
Improvement & Counselor to the Secretary,
U.S. Department of Education.
63
Charles Fowler Ed.D., President of School Leadership, LLC,
Executive Secretary of the Suburban School Superintendents, an
Adjunct Professor of School Organization and Leadership,
Teachers College, Columbia University and formerly Chairperson
of State and National Relations for the American Association of
School Administrators and a school district superintendent in
Connecticut, Florida, Illinois and New York.
Mary Futrell, Ed.D., Dean, Graduate School of Education and
Human Development, George Washington University, Director,
George Washington Institute for Curriculum Standards and
Technology and founding President, World Confederation of the
Teaching Procession and formerly President, National Education
Association, President, Virginia Education Association,
President, Education International and President, ERAmerica.
Michael Kirst, Ph.D., Professor Emeritus of Education and
Business, Stanford University and formerly President of the
California State Board of Education.
Dale Mann, Ph.D., Managing Director, Interactive Inc. and
Professor Emeritus of Educational Administration, Teachers
College, Columbia University and formerly Senior Research
Associate, Institute on Education and the Economy, Teachers
College, Columbia University.
Thomas Payzant, Ed.D., Professor of Practice, Harvard Graduate
School of Education and formerly Assistant Secretary for
Elementary and Secondary Education, U.S. Department of
Education and a school district superintendent in California,
Pennsylvania, Massachusetts, Oklahoma and Oregon.
Betty Rosa, Ed.D., Education Consultant and formerly a school
district superintendent in New York City. Ms. Rosa also
serves on the board of the Alumni Council of the Harvard
Graduate School of Education.
Bernice Stafford, M.A., Principal Consultant, Center for
Interactive Learning and Collaboration and formerly Vice
President of School Strategies and Evaluation, PLATO Learning,
Inc. and a co-founder of Lightspan, Inc.
Channel
Development
K12
receives numerous inquiries from school districts, legislators,
community leaders, educators and parents who express the desire
to offer a virtual public school alternative. Our school
development and public affairs groups work together with these
interested parties to identify and pursue opportunities to
expand the use of our products and services through new channels
and in new jurisdictions. Where interested parties seek to offer
a virtual public school alternative in their state, our public
affairs group works with them to establish the legal framework,
advocate for appropriate legislation and explain the educational
and fiscal benefits of our learning system. Our public affairs
group also seeks to increase public awareness and ensure
transparency in virtual schooling by supporting accountability
standards for virtual public schools.
Once there is legal and regulatory authorization for, as well as
sufficient interest in, a virtual public school, our school
development group engages state and school district officials,
legislators, community leaders, educators and parent groups
seeking to open a virtual public school, and initiates a dialog
with these interested parties to explain the steps necessary to
pursue this public school alternative in their jurisdiction. Our
school development group works with these officials and parent
groups in planning, developing and launching the virtual school.
We also offer assistance to independent school boards with
charter application and authorization processes.
After virtual public schools are approved and established, our
school development group engages school administrators and
maintains relationships with school officials in order to ensure
that they are aware of our product and services offerings and
that we understand their specific needs and goals.
Distribution
Channels
We distribute our products and services primarily to virtual
public schools and directly to consumers. We derive revenues
from virtual public schools by providing access to our OLS,
offline learning kits, student computers and a variety of
management and academic support services, ranging from turnkey
end-to-end management solutions to a single service to meet a
schools specific needs.
64
In fiscal year 2007, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy, the Arizona Virtual
Academy, the Pennsylvania Virtual Charter School and the
Colorado Virtual Academy. In aggregate, these schools accounted
for 49% of our total revenues. As with all of the virtual public
schools we serve, each of these schools is subject to periodic
audits. Two such audits of the Colorado Virtual Academy have
initially resulted in the disallowance of funding with respect
to approximately 63 students alleged not to have satisfied
enrollment requirements and approximately 290 students alleged
not to have satisfied certain other documentation requirements
in the
2004-05
school year and approximately 90 students alleged not to have
satisfied enrollment requirements in the
2005-06
school year (out of total enrollments of approximately 2,000
students in 2004-05 and approximately 2,500 students in
2005-06). Certain of these determinations are being appealed,
but to the extent determined adversely to these schools, we
would be obligated to reimburse these schools pursuant to our
agreements with them to forgive expenses that they incur in
excess of their revenues. We have not received written notice of
any other claims or litigation involving these schools. We
provide our full turnkey solution pursuant to our contract with
the Ohio Virtual Academy, which terminates June 30, 2017
and provides for the parties to review the agreement in 2012.
The agreement is renewable automatically for an additional two
years unless the school notifies us one year prior to expiration
that it elects to terminate the contract. We provide our full
turnkey solution to the Arizona Virtual Academy, pursuant to a
contract with Portable Practical Education, Inc., an Arizona
not-for-profit organization holding the charter under which the
school operates, that expires June 30, 2010. We provide our
curriculum and online learning platform to the Pennsylvania
Virtual Charter School pursuant to a contract that terminates
June 30, 2009, and which automatically renews for an
additional three-years unless the school notifies us one year
prior to expiration that it elects to terminate the contract. We
provide turnkey solution pursuant to our contract with the
Colorado Virtual Academy, which terminates June 30, 2008.
We are currently engaged in negotiations with the Colorado
Virtual Academy for a new contract. Each of the contracts with
these schools provides for termination of the agreement if the
school ceases to hold a valid and effective charter from the
charter-issuing authority in their respective states.
Our direct-to-consumer product is purchased through our customer
call center or online by parents, who are looking either to
educate their children outside the public school system or as a
supplement to their childs existing public school
curriculum. The flexibility of our curriculum combined with the
assessment capabilities of our online delivery platform enables
us to modularize and repackage lesson modules that can be sold
as individual products. For example, if a child has particular
difficulties with fractions, the parent could purchase our
fractions module. The ability to rebundle individual lessons is
highly scalable and we believe this opportunity is significant.
In addition to these primary distribution channels, we are
continuously pursuing additional channels through which to offer
our learning system, including direct classroom instruction and
hybrid models. For example, we have piloted select grades and
subjects of our curriculum in classrooms in 11 states.
Although our in-class offering business is at a nascent stage,
we believe that this distribution channel offers significant
potential. Additionally, we have recently implemented a hybrid
offering in Chicago that combines some face-to-face time for
students and teachers in a traditional classroom setting along
with online instruction. In addition to expanding our offering
to additional jurisdictions within the United States, we intend
to pursue international opportunities where we believe there is
significant demand for a quality online education. On
November 14, 2007, the Company entered into a non-binding
letter of intent (LOI) with SARA For Trade Holding (SARA) to
establish a joint venture in the Middle East. Pursuant to the
LOI, K12 International Holdings B.V., a subsidiary of the
Company, would own a majority of the shares in the joint venture
and would contribute its proprietary curriculum and $1,000,000
of initial capital to fund the joint ventures operations.
SARA would own a minority of the shares in the joint venture and
would contribute $5,000,000 of initial capital to fund the joint
ventures operations.
Student
Recruitment and Marketing
Our student recruitment and marketing team consisted of
49 employees as of September 30, 2007, and is
responsible for promoting our corporate brand, generating new
student enrollments and enhancing the experience of students and
families enrolled in the virtual public schools we serve. This
team employs a variety of strategies designed to better
understand and address the requirements of our target markets.
First, this team is responsible for defining our brand image and
associating our brand with the many positive attributes of our
learning system. We believe that a strong brand provides the
basis for our expansion into new states and other markets.
65
Second, our student recruitment and marketing team generates new
enrollments in the virtual public schools we serve through
targeted recruiting programs, which utilize coordinated direct
mailings, email marketing, print and radio advertising and
search engine marketing. In addition, our marketing team
conducts information sessions and workshops that provide
teachers and parents with the opportunity to learn about
K12
and the products and services that we offer. We conducted more
than 2,500 such events during fiscal year 2007. We have found
that effectively communicating the details and benefits of our
learning system is an important first step towards building a
core group of interested parties. Additionally, we believe that
our consistently high customer satisfaction rates serve as the
foundation for word-of-mouth referrals which supplement our
other recruiting efforts.
Finally, this team is responsible for enhancing our relationship
with students enrolled in the virtual public schools that we
serve to complement the relationship that these students have
with their teachers and school. In order to maintain a sense of
community, we host the
K12
Community Chest website for students to interact online with our
Chief Learning Officer and with each other. We also send welcome
packages, conduct art contests, survey parents and provide
support to students through assigned support counselors under
our
K12
HUG program.
Technology
As of September 30, 2007, we employed 70 employees in
our technology department. Our learning system, along with our
back office systems supporting order management, logistics and
e-commerce,
are built on our proprietary Service Oriented Architecture, or
SOA, to ensure high availability and redundancy and allow
flexibility and security to be core principles of our
systems foundation.
Service Oriented Architecture. All of our
systems leverage our SOA built on top of Enterprise Java that
separates an implemented capability from a request flow that
utilizes those capabilities. This leverage provides us with the
ability to deliver different presentations against a single
request workflow. Additionally, this flexibility allows
iterative solutions to be developed expeditiously to meet both
present and future market needs. Our high availability and
scalability are also facilitated by this architecture. The SOA
also enables seamless integration with third-party solutions in
our platform with ease and efficiency.
Availability and Redundancy. Our SOA allows
for a hardware topology where primary and secondary equipment
can be utilized at all network and application tiers. Each
application layer is load balanced across multiple servers,
which, along with our sophisticated state management
capabilities, allows for additional hardware to be inserted into
our network providing us with impressive scalability and
availability as evidenced by our greater than 99.9999% uptime
with our ever growing user base. We regularly backup critical
data and store this backup data at an offsite location.
Security. Our security measures and policies
include dividing application layers into multiple zones
controlled by firewall technology. Sensitive communications are
encrypted between client and server and our server-to-server
accessibility is strictly controlled and monitored.
Physical Infrastructure. We utilize the best
of breed hardware from industry leading vendors including Cisco,
F5, Oracle, Sun, Microsoft, Dell, Intel, and NetApp to provide a
foundation for our SOA. Our systems are housed offsite in a
state of the art data center that provides robust, redundant
network backbone and power. We vigilantly monitor our physical
infrastructure for security, availability, and performance.
Competition
We face varying degrees of competition from a variety of
education companies because our learning system encompasses many
components of the educational development and delivery process.
We compete primarily with companies that provide online
curriculum and school support services to
K-12 virtual
public schools. These companies include Connections Academy,
LLC, White Hat Management, LLC and National Network of Digital
Schools. We also face competition from curriculum developers,
including traditional textbook publishers such as the
McGraw-Hill Companies, Harcourt, Inc., Pearson plc and Houghton
Mifflin Riverdeep Group plc. Additionally, we expect increased
competition from post-secondary and supplementary education
providers that have begun to establish a presence in the
K-12 virtual
school sector, including Apollo Group, Pearson plc and Kaplan,
Inc.
66
We believe that the primary factors on which we compete are:
track record of academic results and customer satisfaction;
quality of curriculum and online delivery platform;
qualifications and experience of teachers;
comprehensiveness of school management and student support
services; and
cost of the solution.
We are unable to provide meaningful data with respect to our
market share. At a minimum, we believe that we serve the market
for public education, and in any jurisdiction in which we
operate, we serve far less than 1% of the public school students
in the geographic area in which virtual school enrollments are
drawn. Defining a more precise relevant market upon which to
base a share estimate would not be meaningful due to significant
limitations on the comparability of data among jurisdictions.
For example, some providers to K-12 virtual schools serve only
the high school segment, others serve the elementary and middle
school segment, and a few serve both. Furthermore, some school
districts offer their own virtual programs. Parents in search of
an alternative to their local public school also have a number
of substitutable choices beyond virtual schools including
private schools, charter schools, home schooling, and blended
public schools. In addition, our integrated learning system
consists of components that face competition from many different
education industry segments, such as traditional textbook
publishers, test and assessment firms and private education
management companies. Finally, our learning system is designed
to operate domestically and internationally over the Internet,
and thus the geographic addressable market is global and
indeterminate in size.
Intellectual
Property
Since our inception, we have invested more than
$100 million to develop our proprietary curriculum and OLS.
We continue to invest in our intellectual property as we develop
more courses for new grades and expand into adjacent education
markets, both in the U.S. and overseas. These intellectual
property assets are critical to our success and we avail
ourselves of the full protections provided under the patent,
copyright, trademark and trade secrets laws. We also routinely
utilize confidentiality and licensing agreements with our
employees, students, the virtual public schools that we serve,
direct-to-consumer customers, independent contractors and other
businesses and persons with which we have commercial
relationships.
On May 1, 2007, the United States Patent and Trademark
Office (USPTO) granted us the patent for our System and
Method of Virtual Schooling (Patent No. 7,210,938),
which provides us with a period of exclusive use until
January 26, 2024. In general terms, this patent covers the
hardware and network infrastructure of our online school,
including the system components for creating and administering
assessment tests, the planner, lesson progress tracker and
instructional sequencer. We also have four additional
international and five additional U.S. patents pending, and
several pending provisional U.S. patent applications.
We own the copyright in over 11,000 lessons contained in 87
courses that make up our proprietary curriculum, including our
online lessons and offline learning kits, and we register this
growing lesson portfolio with the U.S. Copyright Office as
each new course is completed or updated. We own and use the
domain names K12 (.com, .org) and
K-12 (.com,
.net, .org) as well as the trademark and service mark,
K12.
In addition, we have applied to the USPTO to register the
trademark Unleash the xPotential.
Students who enroll in the virtual public schools we serve are
granted a license to use our software in order to access our
learning system. Similarly, virtual public schools are granted a
license to use our learning system in order to access SAMS and
our other systems. These licenses are intended to protect our
ownership and the confidentiality of the embedded information
and technology contained in our software and systems. We also
own the trademarks and service marks that we use as part of the
student recruitment and branding services we provide to virtual
public schools. Those marks are licensed to the schools for use
during the term of the products and services agreements.
Our employees, contractors and other parties with access to our
confidential information sign agreements that prohibit the
unauthorized use or disclosure of our proprietary rights,
information and technology.
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Operations
An essential component of the
K12
courses are the offline learning kits that accompany our online
lessons. A student enrolling in one of our courses receives
multiple textbooks, art supplies, laboratory supplies
(e.g. microscopes and scales) and other reference materials
designed to enhance the learning experience. We package these
books and materials into course-specific learning kits. Because
each students curriculum is customized, the combination of
kits for each student must also be customized. In fiscal year
2007, we assembled approximately 2.5 million items into
more than 200,000 kits.
Over our six years of operation, we believe that we have gained
significant experience in the fulfillment of offline materials
and that this experience provides us with an advantage over many
of our current and potential future competitors. We have
developed strong relationships with partners allowing us to
source goods at favorable price, quality and service levels.
Through our fulfillment partner located in Harrisonburg,
Virginia, we store our inventory, build our learning kits and
ship the kits to students throughout the United States. We have
invested in systems including our Order Management System (OMS),
to automatically translate the curriculum selected by each
enrolled student into an order to build the corresponding
learning kit. In 2008, we plan to establish a second logistics
and fulfillment center in the western portion of the United
States to support our growth and to mitigate single-location
fulfillment risk.
For many of our virtual public school customers, we attempt to
reclaim any materials that are not consumed during the course of
the school year. These items, once returned to our fulfillment
center, are refurbished and included in future learning kits.
This reclamation process allows us to maintain lower materials
costs.
In order to ensure that students in virtual public schools have
access to our OLS, we often provide students with a computer and
all necessary support. We source computers and ship them to
students when they enroll and reclaim the computers at the end
of a school year or upon termination of their enrollment or
withdrawal from the virtual public school in which they are
enrolled. As of June 30, 2007, we had approximately
20,370 personal computers deployed for use by students.
Our fulfillment activities are highly seasonal, and are centered
around the start of school in August or September. Accordingly,
approximately 70% of our annual materials receiving occurs
between March and May, approximately 75% of our annual offline
learning kit assembly is accomplished between May and July, and
approximately 75% of customer item fulfillment and shipping
occurs between July and October.
Properties
The Companys headquarters are located in approximately
70,000 square feet of office space in Herndon, Virginia
under a lease that expires in April 2013 and a sublease that
expires in September 2009.
Employees
As of September 30, 2007, we had 636 employees. In
addition, there are more than 650 teachers who are employed
by virtual schools we serve, but who we manage under turnkey
solution contracts with those schools. No
K12
employees are union employees; however, certain virtual public
schools we serve employ unionized teachers. We believe that our
employee relations are good.
We have an agreement with a professional employer organization
(PEO), to manage all payroll processing, workers
compensation, health insurance, and other employment-related
benefits for our employees. The PEO is a co-employer of our
employees along with us. Although the PEO processes our payroll
and pays our workers compensation, health insurance and
other employment-related benefits, we are ultimately responsible
for such payments and are responsible for complying with state
and federal employment regulations. We pay the PEO a fee based
on the number of employees we have.
Legal
Proceedings
In the ordinary conduct of our business, we are subject to
lawsuits and other legal proceedings from time to time. There
are currently two significant pending lawsuits in which we are
involved; Johnson v. Burmaster and
68
Illinois v. Chicago Virtual Charter School that, in each
case, have been brought by teachers unions seeking the
closure of the virtual public schools we serve in Wisconsin and
Illinois, respectively.
As described more fully below, we intend to appeal a recent
ruling against us by the Court of Appeals in Johnson v.
Burmaster, and we recently won a preliminary motion in
Illinois v. Chicago Virtual Charter School.
Nevertheless, it is not possible to predict the final outcome of
these matters with any degree of certainty. Even so, we do not
believe at this time that a loss in either case would have a
material adverse impact on our future results of operations,
financial position or cash flows. Depending on the legal theory
advanced by the plaintiffs, however, there is a risk that a loss
in these cases could have a negative precedential effect if like
claims were to be advanced and succeed under similar laws in
other states where we operate. The cumulative effect under those
circumstances could be material.
Johnson v.
Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the
State of Wisconsin established a virtual public school, the
Wisconsin Virtual Academy (WIVA), and entered into a service
agreement with us for online curriculum and school management
services. On January 6, 2004, Stan Johnson, et al., and the
Wisconsin Education Association Council (WEAC) filed suit in the
Circuit Court of Ozaukee County against the Superintendent of
the Department of Public Instruction (DPI), Elizabeth Burmaster,
the NOSD and K12 Inc. The plaintiffs alleged that the NOSD
violated the state charter school, open enrollment and
teacher-licensure statutes when it authorized WIVA.
On March 16, 2006, the Circuit Court issued a decision and
order finding that nothing in these three statutes prohibits
virtual schools like WIVA. Specifically, the Court concluded
that: (i) WIVA was located in NOSD because its offices,
where WIVAs administration operates the school and
establishes policies, are in the district and thus comply with
the charter school law; (ii) that lessons and instruction
delivered over the Internet to non-resident students constitute
attendance because the open-enrollment law does not mandate a
students physical presence; and (iii) that
WIVAs certified teachers satisfy the requirement for
licensed teachers in public schools, whereas the parents
role does not constitute teaching as defined in the Wisconsin
Administrative Code. The Court thus granted the defendants
motion for summary judgment (Case
No. 04-CV-12).
On June 5, 2006, WEAC and DPI filed an appeal in the
Wisconsin Court of Appeals, District II
(No. 2006-AP/01380).
On December 5, 2007, the Court of Appeals reversed the
Circuit Court decision and held that WIVA is not in compliance
with these statutes; granted summary judgment to WEAC and DPI;
and ordered the Circuit Court to enter a declaratory ruling that
NOSD and K12 are in violation of the applicable statutes and to
enjoin the DPI from making pupil transfer payments based on
students enrolled in WIVA. Specifically, the court found that
(i) at least part of WIVA was not within the physical
boundaries of its chartering school district because a majority
of the students and teachers are not located there, and that
such a separation violates the charter school law,
(ii) WIVAs non-resident pupils attend school outside
the district (based on its prior conclusion that WIVA is
partially located outside the district), and therefore that WIVA
does not qualify for open-enrollment funding, and
(iii) although WIVA utilizes certified teachers, the
activities of WIVA parents (including working
one-on-one
with a pupil, presenting the lesson, answering questions and
assessing progress) also fall within the applicable definition
of teaching under the Wisconsin Administrative Code,
and therefore that WIVA violated Wisconsins teacher
licensure requirements.
Under Wisconsin law, the order of the Court of Appeals will be
automatically stayed for 30 days to provide us an
opportunity to appeal the decision to the Wisconsin Supreme
Court. We intend to appeal the decision to the Wisconsin Supreme
Court, which in its discretion may decide whether or not to hear
our appeal. Upon the filing of our petition with the Wisconsin
Supreme Court, the order of the Court of Appeals will remain
without effect until the Wisconsin Supreme Court either
determines not to hear our appeal or issues a ruling in the case.
While our appeal remains pending before the Wisconsin Supreme
Court, WIVA will continue to operate and we will continue to
provide our curriculum and school management services to WIVA.
We estimate that revenue from WIVA for fiscal year 2008 will be
approximately $5.0 million, of which $1.6 million was
recognized in the fiscal quarter ended September 30, 2007.
We believe we will be entitled to full payment from WIVA for the
curriculum and school management services we provide in fiscal
2008. However, if we determine that it is probable
69
that DPI will cease making open enrollment payments to WIVA for
students enrolled in WIVA, we will be required to establish a
reserve in fiscal year 2008 of up to $5.0 million, though
we would still seek to collect payment in full for curriculum
and services provided to WIVA in fiscal 2008. If we ultimately
do not prevail in this case, we will not be able to continue to
manage WIVA or any other statewide virtual public school in
Wisconsin unless the state legislature adopts legislation to
allow us to do so. In fiscal year 2007 and the fiscal quarter
ended September 30, 2007, average enrollments in WIVA were
677 and 840, respectively, and we derived 3.0% and 2.7%,
respectively, of our revenues from WIVA.
Illinois v.
Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed
a citizen taxpayers lawsuit in the Circuit Court of Cook County
challenging the decision of the Illinois State Board of
Education to certify the Chicago Virtual Charter School (CVCS)
and to enjoin the disbursement of state funds to the Chicago
Board of Education under its contract with the CVCS.
Specifically, the CTU alleges that the Illinois charter school
law prohibits any home-based charter schools and
that CVCS does not provide sufficient direct
instruction by certified teachers of at least five clock
hours per day to qualify for funding. K12 Inc. and K12 Illinois
LLC were also named as defendants. On May 16, 2007, the
Court dismissed K12 Inc. and K12 Illinois LLC from the case and
on June 15, 2007, the plaintiffs filed a second amended
complaint which the court dismissed on October 30, 2007
with leave to re-plead. We continue to participate in the
defense of CVCS under an indemnity obligation in our service
agreement with that school, which requires us to indemnify CVCS
against certain liabilities arising out of the performance of
the service agreement, and certain other claims and liabilities,
including liabilities arising out of challenges to the validity
of the virtual school charter. In fiscal year 2007 and the
fiscal quarter ended September 30, 2007, average
enrollments in CVCS were 225 and 407, respectively, and we
derived 1.1% and 1.3%, respectively of our revenues from CVCS.
70
REGULATION
We and the virtual public schools that purchase our curriculum
and management services are subject to regulation by each of the
states in which we operate, including Colorado, Arizona, Idaho,
Florida, Wisconsin, Arkansas, Texas, Illinois, Minnesota,
Kansas, Utah, Nevada, California, Georgia, Ohio, Pennsylvania,
Washington and the District of Columbia. The state laws and
regulations that directly impact our business are those that
authorize or restrict our ability to operate virtual public
schools, and those that restrict virtual public school growth
and funding. In addition, there are state laws and regulations
that are applicable to virtual public schools that indirectly
affect our business insofar as they affect these virtual public
schools ability to operate and receive funding. Finally,
to the extent a virtual school obtains federal funds, such as
through a grant program or financial support dedicated for the
education of low-income families, these schools then become
subject to additional federal regulation. These federal
regulations have not had a material impact on our business.
State Laws Authorizing or Restricting Virtual Public
Schools. The authority to operate a virtual
public school is dependent on the laws and regulations of each
state. Laws and regulations vary significantly from one state to
the next and are constantly evolving. In states that have
implemented specific legislation to support virtual public
schools, the schools are able to operate under these statutes.
Other states provide for virtual public schools under existing
charter school legislation or provide that school districts
and/or state
education agencies may authorize them. Some states do not
currently have legislation that provides for virtual public
schools or have requirements that effectively prohibit virtual
public schools and, as a result, may require new legislation
before virtual public schools can open in the state. According
to a September 2006 review of state online learning policies by
the North American Council for Online Learning
(NACOL), there are 38 states that have either
adopted legislation or formal rules or have created programs for
the purpose of providing statewide online learning
opportunities. We currently serve virtual schools or school
district-led programs in 22 of these 38 states. NACOL also
identified 12 states that do not currently have either a
state-led program or significant state-level policies for online
education; however, the absence of such conditions has not
precluded us from applying to serve, and in certain cases
serving, schools in some of those states.
Obtaining new legislation in these remaining states can be a
protracted and uncertain process despite their limited number.
When determining whether to pursue expansion into new states in
which the laws are ambiguous, we research the relevant
legislation and political climate and then make an assessment of
the perceived likelihood of success before deciding to commit
resources. Specifically, we take into account numerous factors
including, but not limited to, the regulations of the state
educational authorities, whether the overall political
environment is amenable to school choice, whether current
funding levels for virtual school enrollments are adequate and
accessible, and the presence of non-profit and for-profit
competitors in the state.
State Laws and Regulations Applicable to Virtual Public
Schools. Virtual public schools that purchase our
curriculum and management services are often governed and
overseen by a non-profit or local or state education agency,
such as an independent charter school board, local school
district or state education authority. We generally receive
funds for products and services rendered to operate virtual
schools under detailed service agreements with that governing
authority. Virtual public schools are typically funded by state
or local governments on a per student basis. A virtual school
that fails to comply with the state laws and regulations
applicable to it may be required to repay these funds and could
become ineligible for receipt of future state funds. Subject to
the outcome of the legal proceedings described in the section
entitled Business Legal Proceedings, we
are not aware of any material
non-compliance
with these state regulations by the virtual public schools we
serve.
To be eligible for state funding, some states require that
virtual schools be organized under not-for-profit charters
exempt from taxation under Section 501(c)(3) of the
Internal Revenue Code. The schools must then be operated
exclusively for charitable educational purposes, and not for the
benefit of private, for-profit management companies. The board
or governing authority of the not-for-profit virtual school must
retain ultimate accountability for the schools operations
to retain its tax-exempt status. It may not delegate its
responsibility and accountability for the schools
operations. Our service agreements with these virtual schools
are therefore structured to ensure the full independence of the
not-for-profit board and preserve its ability to exercise its
fiduciary obligations to operate a virtual public school.
71
Laws and regulations affect many aspects of operating a virtual
public school. They can dictate the content and sequence of the
curriculum, the requirements to earn a diploma, use of approved
textbooks, the length of the school year and the school day, the
assessment of student performance, and any accountability
requirements. In addition, a virtual public school may be
obligated to comply with state requirements to offer programs
for specific populations, such as students at risk of dropping
out of school, gifted and talented students, non-English
speaking students, pre-kindergarten students, and students with
disabilities. Tutoring services and the use of technology may
also be regulated. Other state laws and regulations may affect
the schools compulsory attendance requirements, treatment
of absences and
make-up
work, and access by parents to student records and teaching and
testing materials. Additionally, states have various
requirements concerning the reporting of extensive student data
that may apply to the school. A virtual public school may have
to comply with state requirements that school campuses report
various types of data as performance indicators of the success
of the program.
States have laws and regulations concerning certification,
training, experience and continued professional development of
teachers and staff with which a virtual public school may be
required to comply. There are also numerous laws pertaining to
employee salaries and benefits, statewide teacher retirement
systems, workers compensation, unemployment benefits, and
matters related to employment agreements and procedures for
termination of school employees. A virtual public school must
also comply with requirements for performing criminal background
checks on school staff, reporting criminal activity by school
staff and reporting suspected child abuse.
As with any public school, virtual public schools must comply
with state laws and regulations applicable to governmental
entities, such as open meetings laws, which may require the
board of trustees of a virtual public school to hold its
meetings open to the public unless an exception in the law
allows an executive session. Failure to comply with these
requirements may lead to personal civil
and/or
criminal penalties for board members or officers. Virtual public
schools must also comply with public information or open records
laws, which require them to make school records available for
public inspection, review and copying unless a specific
exemption in the law applies. Additionally laws pertaining to
records privacy and retention and to standards for maintenance
of records apply to virtual public schools.
Other types of regulation applicable to virtual public schools
include restrictions on the use of public funds, the types of
investments made with public funds, the collection of and use of
student fees, and controlling accounting and financial
management practices.
There remains uncertainty about the extent to which we may be
required to comply with state laws and regulations applicable to
traditional public schools because the concept of virtual public
schools is relatively new. Although we receive state funds
indirectly, according to the terms of each service agreement
with the local public school entity, our receipt of state funds
subjects us to extensive state regulation and scrutiny. Several
states have commenced audits, some of which are still pending,
to verify enrollment, attendance, fiscal accountability, special
education services, and other regulatory issues. While we may
believe that a virtual public school we serve is compliant with
state law, an agencys different interpretation of law in a
particular state could result in non-compliance, potentially
affecting funding.
Regulations Restricting Virtual Public School Growth and
Funding. As a new public schooling alternative,
some state and regulatory authorities have elected to proceed
cautiously with virtual public schools while providing
opportunities for taxpayer families seeking this alternative.
Regulations that control the growth of virtual public schools
range from prescribing the number of schools in a state to
limiting the percentage of time students may receive instruction
online. Funding regulations can also have this effect.
Regulations that hinder our ability to serve certain
jurisdictions include: restrictions on student eligibility, such
as mandating attendance at a traditional public school prior to
enrolling in a virtual public school or course completion
(Arizona and Colorado); caps on the total number of students in
a virtual school (Arkansas, Idaho, Wisconsin, Texas, Illinois,
Florida and the District of Columbia); restrictions on grade
levels served (Nevada and Arkansas); geographic limitations on
enrollments (California); fixing the percentage of per pupil
funding that must be paid to teachers; state-specific curriculum
requirements; and limits on the number of charters that can be
granted in a state.
72
Funding regulations for virtual schools can take a variety of
forms. These regulations include:
(i) attendance some state daily attendance
rules were designed for traditional classroom procedures and
applying them to track daily attendance and truancy in an online
setting can cause disputes to arise over interpretation and
funding; (ii) enrollment eligibility some states
place restrictions on the students seeking to enroll in virtual
schools, resulting in lower aggregate funding levels; and
(iii) teacher contact time some states have
regulations that specify minimum levels of teacher-student
face-to-face time, which can create logistical challenges for
statewide virtual schools, reduce funding and eliminate some of
the economic, academic and technological advantages of virtual
learning.
Federal and State Grants. We have worked with
certain entities to secure public and grant funding that flows
to virtual public schools that we serve. These grants are
awarded to the not-for-profit entity that holds the charter of
the virtual public school on a competitive basis in some
instances and on an entitlement basis in other instances. Grants
awarded to public schools and programs whether by a
federal or state agency or nongovernmental
organization often include reporting requirements,
procedures, and obligations.
Federal Laws and Regulations Applicable to Education
Programs. Some of the virtual public schools we
serve may receive federal funds under Title I (funding for
education of children from low-income families), Title II
(funding for the professional development of teachers),
Title III (funding for technology programs), Title VII
(funding for bilingual education programs) and Title X
(start-up
funding for charter schools) of the Elementary and Secondary
Education Act. The schools must comply with applicable federal
laws and regulations to remain eligible for receipt of federal
funds. The schools we manage could lose all or part of these
funds if they fail to comply with the applicable statutes or
regulations, if the federal authorities reduce the funding for
the programs or if the schools are determined to be ineligible
to receive funds under such programs. Under the terms of our
service agreements, we assist virtual public schools in
fulfilling these reporting requirements.
Four primary federal laws are directly applicable to the
day-to-day provision of educational services we provide to
virtual public schools:
No Child Left Behind (NCLB) Act. Through the
funding of the Title I programs for disadvantaged students
under NCLB, the federal government requires public schools to
develop a state accountability system based on academic
standards and assessments developed by the state, which are
applicable to all public school students. Each state must
determine a proficiency level of academic achievement based on
the state assessments, and must determine what constitutes
adequate yearly progress (AYP) toward that goal. NCLB has a
timeline to ensure that no later than the
2013-14
school year, all students, including those in all identified
subgroups (such as economically disadvantaged, limited English
proficient and minority students,), will meet or exceed the
state proficient level of academic achievement on state
assessments. The progress of each school is reviewed annually to
determine whether the school is making adequate yearly progress.
If a Title I school does not make adequate yearly progress
as defined in the states plan, the local education agency
(LEA) is required to identify the school as needing school
improvement, and to provide all students enrolled in the
school with the option to transfer to another public school
served by the LEA, which may include a virtual public school.
The LEA must develop a school improvement plan for each school
identified as needing improvement in consultation with parents,
staff and outside experts and this plan must be implemented not
later than the beginning of the next full school year. If the
school does not make adequate yearly progress in subsequent
years, the school transfer option remains open to students and
other corrective action must be taken ranging from providing
supplemental education services to the students who remain in
the school to taking corrective action including, but not
limited to, replacing school staff, implementing a new
curriculum, appointing outside experts to advise the school,
extending the school year or the school day, reopening the
school as a public charter school with a private management
company or turning over the operation of the school to the state
educational agency.
Another provision of NCLB requires public school programs to
ensure that all teachers are highly qualified. A highly
qualified teacher means one who has: (1) obtained full
state certification or licensure as a teacher and who has not
had certification or licensure requirements waived on an
emergency, temporary or provisional basis; (2) obtained a
bachelors degree; and (3) demonstrated competence in
the academic subject the teacher teaches. All teacher aides
working in a school supported with Title I funds must be
highly
73
qualified which means the person must have a high school diploma
or its equivalent and one of the following: completed at least
two years of study in an institution of higher education,
obtained an associates or higher degree, or met a rigorous
standard of quality demonstrated through a formal state or local
assessment. Virtual public schools using our products and
services may be required to meet these requirements for any
persons who perform instructional services.
Virtual schools that receive Title I funding and use our
products and services may be required to provide parents of
Title I students with a variety of notices regarding the
teachers and teachers aides that teach their children. In
addition, if these schools serve limited English proficient
(LEP) children, they may be required to provide a variety of
notices to the parents regarding the identification of the
student as LEP and certain information about the instruction to
be provided to the student, as well as the right to remove or
refuse to enroll the student in the LEP program. Finally, these
schools may also be required annually to develop, with input
from parents of Title I students, and implement a written
policy on parental involvement in the education of their
children, to hold annual meetings with these parents and to
provide these parents with assistance in various areas to help
the parents to work with their children to improve student
achievement.
Under NCLB, even schools that do not receive Title I
funding must provide certain notices to parents. For example,
schools may be required to provide a school report card and
identify whether any school has been identified as needing
improvement and for how long. Parents also must be provided data
that will be used to determine adequate yearly progress. Virtual
public schools may be contacted by military recruiters who have
the right to access the names, addresses and telephone numbers
of secondary school students for military recruiting purposes.
Additionally, virtual public schools may be required to notify
parents that they have the option to request that this
information not be released to military recruiters or to
institutions of higher education.
Individuals with Disabilities Education Act
(IDEA). The IDEA is implemented through
regulations governing every aspect of the special education of a
child with one or more of the specific disabilities listed in
the act. The IDEA created a responsibility on the part of a
school to identify students who may qualify under the IDEA and
to perform periodic assessments to determine the students
needs for services. A student who qualifies for services under
the IDEA must have in place an individual education plan, which
must be updated at least annually, created by a team consisting
of school personnel, the student, and the parent. This plan must
be implemented in a setting where the child with a disability is
educated with non-disabled peers to the maximum extent
appropriate. The act provides the student and parents with
numerous procedural rights relating to the students
program and education, including the right to seek mediation of
disputes and make complaints to the state education agency. The
schools we manage are responsible for ensuring the requirements
of this act are met. The virtual schools could be required to
comply with requirements in the act concerning teacher
certification and training. We or the virtual public school
could be required to provide additional staff, related services
and supplemental aids and services at our own cost to comply
with the requirement to provide a free appropriate public
education to each child covered under the IDEA. If we fail
to meet this requirement, we or the virtual public school could
lose federal funding and could be liable for compensatory
educational services, reimbursement to the parent for
educational service the parent provided, and payment of the
parents attorneys fees.
Section 504 of the Rehabilitation Act of
1973. A virtual public school receiving federal
funds is subject to Section 504 of the Rehabilitation Act
of 1973 (Section 504) insofar as the regulations
implementing the act govern the education of students with
disabilities as well as personnel and parents. Section 504
prohibits discrimination against a person on the basis of
disability in any program receiving federal financial assistance
if the person is otherwise qualified to participate in or
receive benefit from the program. Students with disabilities not
specifically listed in the IDEA may be entitled to specialized
instruction or related services pursuant to Section 504 if
their disability substantially limits a major life activity.
There are many similarities between the regulatory requirements
of Section 504 and the IDEA; however this is a separate law
which may require a virtual public school to provide a qualified
student with a plan to accommodate his or her disability in the
educational setting. If a school fails to comply with the
requirements and the procedural safeguards of Section 504,
it may lose federal funds even though these funds flow
indirectly to the school
74
through a local board. In the case of bad faith or intentional
wrongdoing, some courts have awarded monetary damages to
prevailing parties in Section 504 lawsuits.
Family Educational Rights and Privacy
Act. Virtual public schools are subject to the
Family Educational Rights and Privacy Act which protects the
privacy of a students educational records and generally
prohibits a school from disclosing a students records to a
third-party without the parents prior consent. The law
also gives parents certain procedural rights with respect to
their minor childrens education records. A schools
failure to comply with this law may result in termination of its
eligibility to receive federal education funds.
If we fail to comply with other federal laws, including federal
civil rights laws not specific to education programs, we could
be determined ineligible to receive funds from federal programs
or face criminal or civil penalties.
75
MANAGEMENT
Directors,
Executive Officers and Other Key Employees
The following table sets forth information concerning our
directors, executive officers and other key members of our
management team as of October 31, 2007:
Name
Age
Position
Executive Officers
Ronald J. Packard
44
Chief Executive Officer, Founder and Director
John F. Baule
43
Chief Operating Officer and Chief Financial Officer
Bruce J. Davis
44
Executive Vice President, Worldwide Business Development
Nancy H. Hauge
53
Senior Vice President, Human Resources
George B. Hughes, Jr.
49
Executive Vice President, School Services
Howard D. Polsky
56
Senior Vice President, General Counsel and Secretary
Bror V. H. Saxberg
48
Chief Learning Officer
Celia M. Stokes
43
Chief Marketing Officer
Key Employees
Mary C. Desrosiers
43
Senior Vice President, Strategic Relationships
Bryan W. Flood
41
Senior Vice President, Public Affairs
Keith T. Haas
43
Vice President, Financial Planning and Analysis &
Investor Relations
John P. Olsen
40
Senior Vice President, High School Programs
and Classroom Solutions
Peter G. Stewart
39
Senior Vice President, School Development
Maria A. Szalay
41
Senior Vice President, Product Development
E. Ray Williams
45
Senior Vice President, Systems and Technology
Nonemployee Directors
Andrew H. Tisch
57
Chairman
Liza A. Boyd
32
Director
Guillermo Bron
55
Director
Steven B. Fink
55
Director
Dr. Mary H. Futrell
67
Director
Thomas J. Wilford
64
Director
Executive
Officers
Ronald
J. Packard, Chief Executive Officer, Founder and
Director
Ronald J. Packard started
K12
in 2000 and has served as Chief Executive Officer since May 2007
after having served as Chairman of the Board of Directors.
Previously, Mr. Packard served as Vice President of
Knowledge Universe from 1997 to 2000, and he served as Chief
Executive Officer of Knowledge Schools, a provider of early
childhood education and after school companies, from 1998 to
2002. Mr. Packard has also held positions at
McKinsey & Company from 1989 to 1993 and Goldman Sachs
in mergers and acquisitions from 1986 to 1988. Additionally,
Mr. Packard has served on the Advisory Board of the
Department of Defense Schools since 2002, and from 2004 to 2006
served as a director of Academy 123. Mr. Packard holds B.A.
degrees in Economics and Mechanical Engineering from the
University of California at Berkeley, an M.B.A. from the
University of Chicago, and he was a Chartered Financial Analyst.
76
John
F. Baule, Chief Operating Officer and Chief Financial
Officer
John F. Baule joined us in March 2005, and serves as Chief
Operating Officer and Chief Financial Officer. Previously,
Mr. Baule spent five years at Headstrong, a global
consultancy services firm, first serving as Senior Vice
President of Finance from 1999 until 2001 and later as Chief
Financial Officer from 2001 to 2004. Prior to Headstrong,
Mr. Baule worked for Bristol-Myers Squibb (BMS) from 1990
to 1999, initially joining their corporate internal audit
division. He then spent six years with BMS based in the Asia
Pacific region, first as the Director of Finance for BMS
Philippines, and then as the Regional Finance Director for BMS
Asia-Pacific. He later served as Director of International
Finance for the BMS Nutritional Division. Mr. Baule began
his career working in the audit services practice at KPMG from
1986 to 1990. Mr. Baule holds a B.B.A. in Accounting from
the College of William and Mary and he is a Certified Public
Accountant.
Bruce
J. Davis, Executive Vice President, Worldwide Business
Development
Bruce J. Davis joined us January 2007, and serves as Executive
Vice President, Worldwide Business Development. From 2002 until
joining us, Mr. Davis ran his own strategy consultancy
where his clients included Laureate Education, Discovery
Communications, Pearson Publishing, Sylvan Learning Systems,
Educate Inc., AICPA, and USAID. Mr. Davis previously held
the position of Chief Executive Officer at Medasorb
Technologies, a biotechnology company, from 2001 to 2002 and at
Mindsurf Networks, a wireless educational system provider, from
1999 to 2000. He also served as Chief Operating Officer of
Prometric, a computer test administration company, from 1994 to
1999. Prior to Prometric, he was a senior consultant with
Deloitte and Touche from 1985 to 1991 in the Information Systems
Strategy group where he managed their IT practice in Egypt.
Mr. Davis holds a B.S. in Computer Science from Loyola
College and an M.B.A. from Columbia University.
Nancy
H. Hauge, Senior Vice President, Human Resources
Nancy H. Hauge joined us in February 2006, and serves as Senior
Vice President, Human Resources. From 2004 to 2006,
Ms. Hauge served as Chief Customer Advocate and Senior Vice
President of Human Resources for Ruckus Network, a digital media
company. Prior to Ruckus, she founded and operated
54th Street Partners, an international management
consulting company, from 1999 to 2004. Ms. Hauge has also
held the position of Vice President of Human Resources at Ridge
Technologies, Crag Technologies, Noahs New York Bagels,
and Gymboree Corporation. Previously, Ms. Hauge held
multiple senior management positions in human resources,
strategic planning and quality at Sun Microsystems from 1984 to
1994.
George
B. (Chip) Hughes, Jr., Executive Vice President,
School Services
George B. (Chip) Hughes, Jr. joined us in July 2007,
and serves as Executive Vice President, School Services. From
1997 until joining us, Mr. Hughes was a co-founder and
Managing Director of Blue Capital Management, L.L.C., a
middle-market private equity firm. Mr. Hughes previously
served as a Partner of McKinsey & Company, Inc., a
global management consulting firm, in McKinseys Los
Angeles and New Jersey offices, where he was a member of the
firms Strategy and Health Care practices. Mr. Hughes
serves on the National Board of Recording for the
Blind & Dyslexic, and on the Board of Councilors of
the College of Letters, Arts & Sciences at the
University of Southern California. Previously he was a member of
the Board of Trustees at Big Brothers of Greater Los Angeles and
of Big Brothers Big Sisters of Morris, Bergen, and Passaic
Counties (New Jersey). Mr. Hughes holds a B.A. in Economics
from the University of Southern California and an M.B.A. from
Harvard University.
Howard
D. Polsky, Senior Vice President, General Counsel and
Secretary
Howard D. Polsky joined us in June 2004, and serves as Senior
Vice President, General Counsel and Secretary. Mr. Polsky
previously held the position of Vice President and General
Counsel of Lockheed Martin Global Telecommunications from 2000
to 2002. Prior to Lockheed Martin, Mr. Polsky worked at
COMSAT Corporation from 1992 to 2000, initially serving as Vice
President and General Counsel of COMSATs largest operating
division, and subsequently serving on the executive management
team as Vice President of Federal Policy and Regulation. From
1983 to 1992, Mr. Polsky was a partner at Wiley,
Rein & Fielding after having worked at
77
Kirkland & Ellis. Mr. Polsky began his legal
career at the Federal Communications Commission. Mr. Polsky
received a B.A. in Government from Lehigh University, and a J.D.
from Indiana University.
Bror
V. H. Saxberg, Chief Learning Officer
Bror V.H. Saxberg joined us in February 2000, and serves as
Chief Learning Officer. From 1998 to 2000, Dr. Saxberg
served as Vice President of Operations at Knowledge Testing
Enterprises, a developer of web-based assessments for IT skills
owned by Knowledge Universe; he was a Vice President at
Knowledge Universe from 1997 through 2000 as well. Prior to
Knowledge Universe, Dr. Saxberg held the position of
Publisher and General Manager at DK Multimedia, the North
American subsidiary of educational and reference publisher
Dorling Kindersley, from 1995 to 1997. Previously,
Dr. Saxberg also worked as a consultant at
McKinsey & Company from 1990 to 1995. Dr. Saxberg
holds B.S. degrees in Electrical Engineering and Mathematics
from the University of Washington, an M.A. in Mathematics from
Oxford University, an M.A. and Ph.D. in Electrical Engineering
and Computer Science from Massachusetts Institute of Technology,
and an M.D. from Harvard University.
Celia
M. Stokes, Chief Marketing Officer
Celia M. Stokes joined us in March 2006, and serves as Chief
Marketing Officer. Before joining
K12,
Ms. Stokes served as Vice President of Marketing at
Independence Air from 2003 to 2006. Previously, Ms. Stokes
ran her own marketing firm providing consulting services to
organizations such as Fox TV, PBS, the National Gallery of Art,
JWalter Thompson, and ADP. From 1993 to 1998, Ms. Stokes
served in successive roles leading to Vice President of
Marketing at Bell Atlantic and at a joint venture of Bell
Atlantic and two other Regional Bell Operating Companies. From
1990 to 1993, Ms. Stokes was Manager of Marketing at
Software AG, and from 1988 to 1990, was Client Group Manager at
Targeted Communications, an Ogilvy & Mather Direct
company. Ms. Stokes holds a B.A. in Economics from the
University of Virginia.
Key
Employees
Mary
C. Desrosiers, Senior Vice President, Strategic
Relationships
Mary C. Desrosiers joined us in May 2000, and currently serves
as Senior Vice President, Strategic Relationships. From May 2000
to March 2007 she headed our Product Development department. She
also managed our Systems group from May 2000 to October 2003 and
our Operations group from May 2000 to March 2004. From May 1999
until joining us, Ms. Desrosier was managing director at
Origin Technology, a national
e-business
practice. At Origin Technology, Ms. Desrosiers designed and
produced applications for the educational, training, and
commercial markets. Previously, she was a senior director for
Philips Electronics NV, where she established Fountain Works, an
internal Internet technology organization, and helped develop
and implement global
e-business
strategies. Ms. Desrosiers also established and managed
Studio Interactive, a division of Philips Media, which produced
award-winning educational software. Ms. Desrosiers started
her career at Booz, Allen. Ms. Desrosier holds a B.S. from
St. Marys College and an M.B.A. from Marymount
University.
Bryan
W. Flood, Senior Vice President, Public Affairs
Bryan W. Flood joined us in June 2002, and serves as Senior Vice
President, Public Affairs. From 1996 to 2001, Mr. Flood
served as Vice President of the MPGH Agency, a public affairs
consulting firm. Mr. Flood previously served as National
Spokesman for the Lamar Alexander for President campaign from
1995 to 1996. Prior to that, Mr. Flood served as spokesman
for the reelection campaign for Gov. John Engler (MI) in
1994. Additionally, Mr. Flood held the positions of
Director of Communications for the Michigan Republicans State
Committee from 1991 to 1993 and as Spokesman for Rinfret for
Governor (NY). Mr. Flood started his career as a
Legislative Aide for the Town of Brookhaven, New York.
Mr. Flood holds a B.A. in Public Policy from New College of
Florida.
Keith
T. Haas, Vice President, Financial Planning and
Analysis & Investor Relations
Keith T. Haas joined us in July 2003, and serves as Vice
President, Financial Planning and Analysis & Investor
Relations. From 1999 to July 2003, Mr. Haas served in
finance and consulting roles for several
start-up
technology companies. Prior to that, Mr. Haas held the
position of Principal at SCA Consulting from 1998 to 1999. Prior
to that,
78
Mr. Haas worked for KPMG first as Manager and later, as
Senior Manager from 1996 to 1998. Prior to KPMG, Mr. Haas
was a management consultant with Stern Steward & Co.
Mr. Haas holds a B.S. in Electrical Engineering from
University of Virginia, an M.B.A. from University of North
Carolina at Chapel Hill and is a Certified Public Accountant.
John
P. Olsen, Senior Vice President, High School Programs and
Classroom Solutions
John Olsen joined us in March 2004 and currently serves as
Senior Vice President, High School Programs and Classroom
Solutions. From March 2004 to October 2006 Mr. Olsen served as
Senior Vice President, Operations and from October 2004 to March
2006 was also head of our Marketing department. Prior to joining
us, he was Vice President of Performance Improvement for America
Onlines Broadband, Premium, and Advanced Technology
Services. Mr. Olsen previously served as a management
consultant at Diamond Technology Partners where he practiced in
the telecommunications, financial services and consumer products
industries. From May 1989 to August 1997 Mr. Olsen served
in the U.S. Navy as a Supply Officer in activities ranging
from aviation logistics to major weapons systems acquisition to
duty as a White House Social Aide. Mr. Olsen holds a B.S.
from the United States Naval Academy and an MBA from the
University of Michigan.
Peter
G. Stewart, Senior Vice President, School
Development
Peter G. Stewart joined us in September 2000, and serves as
Senior Vice President, School Development. From 1990 to 2000,
Mr. Stewart worked at urban, rural, and international
schools in various roles including teacher, school principal,
head of school and curriculum director. Mr. Stewart holds a
B.A. in English from Williams College and a M.A. from Columbia
University Teachers College.
Maria
A. Szalay, Senior Vice President, Product
Development
Maria A. Szalay joined us in March 2001, and serves as Vice
President, Product Development. From 1999 to 2001,
Ms. Szalay served as Practice Director at Operon Partners,
an
e-business
consulting firm. Prior to that, Ms. Szalay worked at
Telecom New Zealand from 1994 to 1999 and served as a management
consultant at KPMG from 1990 to 1994. Previously,
Ms. Szalay served as a Client Portfolio Analyst at Shearson
Lehman from 1988 to 1990. Ms. Szalay holds a B.S. in
Finance and a B.A. in German Literature from Virginia
Polytechnic Institute & State University and an M.B.A.
from American University.
E. Ray
Williams, Senior Vice President, Systems and
Technology
Elton R. Williams joined us in August 2006, and serves as Senior
Vice President, Systems and Technology. From 2005 to 2006,
Mr. Williams served as Senior Vice President of Product
Development and Operations for Ruckus Network, a digital media
company. From 1993 to 2004, Mr. Williams held multiple
technology positions at America Online leading up to Senior
Technical Director. Mr. Williams previously served as a
software developer at Software A.G., a software infrastructure
solutions company from 1988 to 1993. Mr. Williams holds a
B.S. in Computer Science from Rochester Institute of Technology.
Nonemployee
Directors
Andrew
H. Tisch, Chairman
Andrew H. Tisch joined us as director in August 2001, and has
served as Chairman of the Board of Directors since May 2007.
Since 1985, Mr. Tisch has been a director of Loews
Corporation, and is Co-Chairman of its Board, Chairman of its
Executive Committee and, since 1999, has been a member of its
Office of the President. In addition, Mr. Tisch has served
as past Chairman of the board of directors of Bulova Corporation
and a director since 1979. Mr. Tisch has also served as
director on the board of directors of CNA Financial Corporation
since 2006, at Texas Gas Transmission, LLC and Boardwalk
Pipelines, LLC since 2005 and Lord & Taylor, Inc.
since 2006. Mr. Tisch holds a B.S. in Hotel Administration
from Cornell University and an M.B.A. from Harvard University.
79
Liza
A. Boyd, Director
Liza A. Boyd joined us as director in April 2006. Ms. Boyd
has been employed with Constellation Ventures, a venture capital
fund affiliated with The Bear Stearns Companies, Inc. investing
in early to mid-stage companies, since 2000, and has been a
Managing Director since 2006. At Constellation Ventures,
Ms. Boyd focuses on investments in software and services
and online media technologies. Ms. Boyd has served as a
director on the board of directors of Widevine Technologies
since 2004, Fathom Online since August 2005, Siperian since
2006, Avolent since 2006 and Orchestria since 2006. Ms Boyd
holds a B.A. in Mathematical Economics from Colgate University.
Guillermo
Bron, Director
Guillermo Bron joined us as a director in July 2007.
Mr. Bron has served as Chairman of the Board and a director
of United Pan Am Financial Corp. (UPFC) since April 1994, and as
a director of Pan American Bank, FSB (Pan American), a federally
chartered savings association and former wholly owned subsidiary
of UPFC, from 1994 until its dissolution in February 2005.
Mr. Bron is a Managing Director of Acon Funds Management
LLC, a private equity firm, and the Managing Member of PAFGP,
LLC, the sole general partner of Pan American Financial, L.P.
From 2000 to 2002, Mr. Bron was a director of Telemundo
Group, Inc. Mr. Bron founded UPFC and organized a Hispanic
investor group that acquired certain assets and assumed certain
liabilities of Pan Americans predecessor from the
Resolution Trust Corporation in April 1994. From 1994 to
2003, Mr. Bron was an officer, director and principal
stockholder of a general partner of Bastion Capital Fund, L.P.,
a private equity investment fund primarily focused on the
Hispanic Market. Previously, Mr. Bron was a Managing
Director of Corporate Finance and Mergers and Acquisitions at
Drexel Burnham Lambert. Mr. Bron holds a B.S. in Electrical
Engineering and Management from Massachusetts Institute of
Technology and an M.B.A. from Harvard University.
Steven
B. Fink, Director
Steven B. Fink joined us as director in October 2003. Since
2000, Mr. Fink has been the Chief Executive Officer of
Lawrence Investments, LLC, a technology and biotechnology
private equity investment firm, and since 1996, Mr. Fink
has served as a Vice Chairman of Knowledge Universe (now Mounte
LLC), a private company focused on building leading companies in
areas relating to education, technology and career management.
Since 1995, Mr. Fink has also served as Chairman and Vice
Chairman of Heron International, a European real estate
development company. Mr. Fink has served as non-executive
Chairman of Spring Group PLC, an information technology services
company in the United Kingdom affiliated with Knowledge
Universe, from 1997 to 2000 and again from 2002 to the present,
and has served as a director of Leapfrog, Inc. since 1999 and as
Chairman of the board since 2004. Mr. Fink has also served
as a director of Nextera Enterprises, Inc. since 1997.
Mr. Fink holds a B.S. in Psychology from the University of
California, Los Angeles and a J.D. and an L.L.M. from New York
University.
Dr. Mary
H. Futrell, Director
Dr. Mary H. Futrell joined us as a director in August 2007.
Dr. Futrell is currently the director of the George
Washington Institute for Curriculum Standards and Technology and
the founding president of the World Confederation of the
Teaching Profession. Previously, she served as president of the
Virginia Education Association, Education International, and
ERAmerica. After teaching and holding various administrative
positions in different secondary schools, Dr. Futrell
joined the faculty at the George Washington University, while
earning her Ph.D. and in 1995 was promoted to dean of the
Graduate School of Education and Human Development.
Dr. Futrell is best known for serving six years as
president of the National Education Association from 1983 to
1989. Dr. Futrell has also served on the boards of the
Kettering Foundation and the Carnegie Foundation for the
Advancement of Teaching Leadership, and on the editorial board
of Phi Delta Kappa. She has published articles in a number of
scholarly journals, such as Education Record, Foreign Language
Annals, and Education Administration Quarterly. Dr. Futrell
holds a B.A. in Business Education from Virginia State
University, a M.A. from and a Ph.D. in Education Policy Studies
from George Washington University. She is also the recipient of
numerous honors and awards, including more than twenty honorary
degrees.
80
Thomas
J. Wilford, Director
Thomas J. Wilford joined us as director in November 2002. Since
1993, Mr. Wilford has served as director of Alscott, Inc.,
privately held a real estate investment company, and since 1997
has served as President. Since 2003, Mr. Wilford has served
as Chief Executive Officer of the J.A. and Kathryn Albertson
Foundation, a foundation focused on education within Idaho.
Mr. Wilford has served as director on the board of
directors of Idacorp, Inc. since 2004, and has served on its
Audit Committee since 2005. Previously, Mr. Wilford served
as an Office Managing Partner of Ernst & Young LLP
from 1979 to 1993. Mr. Wilford holds a B.S., and a M.S. in
Business from the University of Minnesota and he is a Certified
Public Accountant.
Board of
Directors and Director Independence
Our board of directors is authorized to have nine members and is
currently composed of six nonemployee members and our Chief
Executive Officer, Ronald J. Packard. Our executive
officers and key employees serve at the discretion of our board
of directors.
All directors are elected for a period of one year at our annual
meeting of stockholders and serve until their successors are
duly elected and qualified. Additionally, our stockholders will
have the ability to remove directors with cause by the
affirmative vote of a majority of the common stock.
Director
Independence
Our board has determined that each of our directors, with the
exception of Mr. Packard, is independent as
defined in the currently applicable listing standards of NYSE
Arca. Mr. Packard is not independent because he is one of
our executive officers.
Board
Committees
Our board directs the management of our business and affairs as
provided by Delaware law and conducts its business through
meetings of the board of directors, an audit committee, a
nominating and corporate governance committee and a compensation
committee. Further, from time to time, other committees may be
established under the direction of the board when necessary to
address specific issues. The composition of the board committees
will comply, when required, with the applicable rules of NYSE
Arca and applicable law.
Audit Committee. Our audit committee is
responsible for, among other things, making recommendations
concerning the engagement of our independent public accountants,
reviewing with the independent public accountants the plans and
results of the audit engagement, approving professional services
provided by the independent public accountants, reviewing the
independence of the independent public accountants, considering
the range of audit and non-audit fees, and reviewing the
adequacy of our internal accounting controls. Our audit
committee comprises Steven B. Fink, Liza A. Boyd and
Thomas J. Wilford. Mr. Fink is the chairman of the
audit committee. Each of Mr. Fink and Mr. Wilford has been
designated as an audit committee financial expert as
such term is defined in Item 401(h) of
Regulation S-K.
Both Mr. Fink and Mr. Wilford are independent as such
term is defined in
Rule 10A-3(b)(1)
under the Securities Exchange Act of 1934, as amended, or the
Exchange Act, and under the currently applicable listing
standards of NYSE Arca. Ms. Boyd is not independent within
the meaning of
Rule 10A-3(b)(1)
under the Exchange Act.
In accordance with
Rule 10A-3(b)(1)
under the Exchange Act and the listing standards of NYSE Arca,
we plan to modify the composition of the audit committee within
12 months after the effectiveness of our registration
statement relating to this offering so that all of our audit
committee members will be independent as such term is defined in
Rule 10A-3(b)(1)
under the Exchange Act and under the listing standards of NYSE
Arca rules.
Our board of directors has adopted a written charter for the
audit committee, which will be effective immediately prior to
the effectiveness of our registration statement relating to this
offering.
Nominating and Corporate Governance
Committee. Our nominating and corporate
governance committee provides assistance to the board of
directors by identifying qualified candidates to become board
members, selecting nominees for election as directors at
stockholders meetings and to fill vacancies, developing
and
81
recommending to the board a set of applicable corporate
governance guidelines and principles as well as oversight of the
evaluation of the board and management. Our nominating and
corporate governance committee comprises Mr. Steven B. Fink, Mr.
Guillermo Bron and Mr. Andrew H. Tisch. Mr. Bron is the chairman
of the nominating and corporate governance committee. Mr. Fink,
Mr. Bron and Mr. Tisch are independent as defined in
the currently applicable listing standards of NYSE Arca.
Our board of directors has adopted a written charter for the
nominating and corporate governance committee, which will be
effective immediately prior to the pricing of our common stock
to be sold in this offering and will be available on our website
upon consummation of this offering.
Compensation Committee. The compensation
committee is responsible for determining compensation for our
executive officers and administering our amended and restated
stock option plans and other compensation programs. The
compensation committee is also charged with establishing,
periodically re-evaluating and, where appropriate, adjusting and
administering policies concerning compensation of management
personnel, including the Chief Executive Officer and all of our
other executive officers. Our compensation committee comprises
Andrew H. Tisch, Dr. Mary H. Futrell and Liza A. Boyd.
Mr. Tisch is the chairman of the compensation committee. Mr.
Tisch, Dr. Futrell and Ms. Boyd are independent as
defined in the currently applicable listing standards of NYSE
Arca.
Our board of directors has adopted a written charter for the
compensation committee, which will be effective immediately
prior to the effectiveness of our registration statement
relating to this offering.
Compensation
Committee Interlocks and Insider Participation
None of the members of our compensation committee at any time
has been one of our executive officers or employees. None of our
executive officers currently serves, or in the past year has
served, as a member of the board of directors or compensation
committee of any entity that has one or more executive officers
serving on our board of directors or compensation committee. Our
entire board of directors made all compensation decisions prior
to the creation of our compensation committee.
Limitation
of Liability and Indemnification of Officers and
Directors
As permitted by Section 102 of the Delaware General
Corporation Law, upon consummation of this offering, we expect
that our amended and restated certificate of incorporation and
amended and restated bylaws will limit or eliminate the personal
liability of our directors for a breach of their fiduciary duty
of care as directors. The duty of care generally requires that
when acting on behalf of the corporation, directors exercise an
informed business judgment based on all material information
reasonably available to them. Consequently, a director will not
be personally liable to us or our stockholders for monetary
damages or breach of fiduciary duty as a director, except for
liability for:
any breach of the directors duty of loyalty to us or our
stockholders;
any act or omission not in good faith or that involves
intentional misconduct or a knowing violation of law;
any act related to unlawful stock repurchases, redemptions or
other distributions or payment of dividends; or
any transaction from which the director derived an improper
personal benefit.
These limitations of liability do not alter liability under the
federal securities laws and do not affect the availability of
equitable remedies such as injunction or rescission. As
permitted by Section 145 of the Delaware General
Corporation Law, upon consummation of this offering, we expect
that our amended and restated certificate of incorporation and
amended and restated bylaws will authorize us to indemnify or
officers, directors and other agents to the fullest extent
permitted under Delaware law and provide that:
we may indemnify our directors, officers and employees to the
fullest extent permitted by the Delaware General Corporation
Law, subject to limited exceptions;
82
we may advance expenses to our directors, officers and employees
in connection with a legal proceeding to the fullest extent
permitted by the Delaware General Corporation Law, subject to
limited exceptions; and
the rights provided in our amended and restated bylaws are not
exclusive.
Contemporaneously with the completion of this offering, we
intend to enter into indemnification agreements with each of our
executive officers and directors which will be in addition to
and may be broader than the indemnification provided for in our
charter documents. These agreements will provide that we will
indemnify each of our directors to the fullest extent permitted
by law and advance expenses to each indemnitee in connection
with any proceeding in which indemnification is available.
We also maintain general liability insurance that covers certain
liabilities of our directors and officers arising out of claims
based on acts or omissions in their capacities as directors or
officers and intend to obtain a policy of directors and officers
liability insurance that will be effective upon completion of
this offering which will also cover certain liabilities arising
under the Securities Act of 1933, as amended. Insofar as
indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers, or persons controlling
the registrant pursuant to the foregoing provisions, we have
been informed that in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
These provisions may discourage stockholders from bringing a
lawsuit against our directors for breach of their fiduciary
duty. These provisions may also have the effect of reducing the
likelihood of derivative litigation against directors and
officers, even though such an action, if successful, might
otherwise benefit us and our stockholders. Furthermore, a
stockholders investment may be adversely affected to the
extent we pay the costs of settlement and damage awards against
directors and officers pursuant to these indemnification
provisions. We believe that these provisions, the
indemnification agreements and the insurance are necessary to
attract and retain talented and experienced directors and
officers.
At present, there is no pending litigation or proceeding
involving any of our directors, officers, employees or agents in
which any of them is seeking indemnification from us, nor are we
aware of any threatened litigation or proceeding that may result
in a claim for indemnification.
83
COMPENSATION
DISCUSSION AND ANALYSIS
Objectives
and Philosophy of Executive Compensation
The Compensation Committee, composed entirely of independent
directors, administers our executive compensation programs. The
Compensation Committees role as described in its charter
is to discharge the boards responsibilities relating to
compensation of our executives, including the named executive
officers, and to oversee and advise the board on the adoption of
policies that govern our compensation and benefit programs. Our
executive compensation programs are designed to:
Attract and retain individuals of superior ability and
managerial talent;
Ensure senior executive compensation is aligned with our
corporate strategies, business objectives and the long-term
interests of our stockholders;
Provide an incentive to achieve key strategic and financial
performance measures by linking incentive award opportunities to
the achievement of performance goals in these areas; and
Enhance the executives incentive to increase our stock
price and maximize stockholder value, as well as promote
retention of key people, by providing a portion of total
compensation opportunities for senior management in the form of
direct ownership in our stock through stock options.
To achieve these objectives, the Compensation Committee has
implemented and maintains compensation plans that tie a
substantial portion of the executives overall compensation
to key strategic financial and operational goals such as our
annual revenues and operating earnings. The Compensation
Committee also evaluates individual executive performance with
the goal of setting compensation at levels the Compensation
Committee believes are comparable with executives in other
companies of similar size and stage of development that operate
in the major education and high-technology industries, taking
into account our relative performance and our strategic goals.
Determination
of Compensation Awards
The Compensation Committee has the authority to determine and
recommend the compensation awards available to our named
executive officers. Historically, we have set base salaries and
annual incentive targets based on both individual performance
and position. Base salaries and annual incentive targets for the
named executive officers are determined as of the date of hire.
Base salaries and annual incentive targets are reviewed annually
by the Compensation Committee and may be adjusted to reflect
individual performance and any changes in position within the
Company to both reward the executives for superior performance
and to further our goals of attracting and retaining managerial
talent. To aid the Compensation Committee in making its
determination, the CEO and COO/CFO provide recommendations
annually to the Compensation Committee regarding the
compensation of all executive officers, excluding themselves.
Each named executive officer other than our CEO and COO/CFO, in
turn, participates in an annual performance review with either
the CEO or the COO/CFO to provide input regarding the named
executive officers contributions to our success for the
period being assessed. The performance of our CEO and COO/CFO is
reviewed annually by the Compensation Committee.
In 2007, the Compensation Committee retained an independent
compensation consultant, Radford Surveys + Consulting, to assist
the Compensation Committee with determining the key elements of
our compensation programs for fiscal year 2008 and future fiscal
years. Radford Surveys + Consulting is an independent consultant
specializing in compensation matters in both the technology and
education industries. The compensation consultant provides
advice to the Compensation Committee with respect to competitive
practices and the amounts and nature of compensation paid to the
named executive officers. The compensation consultant also
advises us on, among other things, structuring our various
compensation programs and determining the appropriate levels of
salary, bonus and other incentive awards payable to our named
executive officers. Based upon the compensation
consultants recommendations, our executive compensation
package continues to consist of a fixed base salary and variable
cash and option-based incentive awards, with a significant
portion weighted towards the variable components to ensure that
total compensation reflects our overall success or failure and
to motivate executive officers to meet appropriate performance
measures, thereby maximizing total return to stockholders.
Within our performance-based compensation program, we aim to
compensate the named executive officers in a manner that is tax
effective for us.
84
Compensation
Benchmarking and Peer Group
For the fiscal year ending in 2008, we set base salary
structures and annual incentive targets at slightly above the
median of a peer group of major education and high-technology
companies. An important component of setting and structuring
compensation for our named executive officers is determining the
compensation packages offered by leading education and
high-technology companies in order for us to offer competitive
compensation within that group of companies. With the assistance
of the compensation consultant, we surveyed the compensation
practices of a peer group of companies in the United States to
assess our competitiveness. The peer group generally consists of
15 leading education companies. This Peer Group of
companies for our fiscal year ending in 2008 includes: Audible,
Inc; Blackboard Inc; Capella Education Company; CNET Networks,
Inc; Corinthian Colleges, Inc.; Courier Corporation; DeVry Inc.;
eCollege.com; Educate, Inc.; IHS Inc.; ITT Educational Services,
Inc.; Learning Tree International, Inc.; PLATO Learning, Inc.;
Renaissance Learning, Inc.; and Strayer Education. Overall, our
independent compensation consultant determined that our
compensation programs, as structured, achieve our market
philosophy relative to our Peer Group.
Elements
of Compensation
Base
Salary
Base salaries for our named executive officers are generally
established in line with the scope of their responsibilities,
taking into account competitive market compensation paid by
other companies for similar positions, and recognizing cost of
living considerations. Base salaries are reviewed at least
annually, and are adjusted from time to time according to
performance and inflation and to realign salaries with market
levels. Based upon competitive data and in keeping with the
compensation philosophy, the named executive officers
respective base salaries at the close of fiscal year 2007 were
at the following ratio to the median of the comparable position
at companies in the Peer Group: Mr. Packard 1.00;
Mr. Baule 1.15; Mr. Davis 1.32; Mr. Saxberg 1.13;
and Ms. Stokes 1.00. Salaries among the named executive officers
reflect the legacy of their position at hire and subsequent
adjustments for parity or new responsibilities assigned. None of
Mr. Packard, Mr. Baule or Mr. Saxberg received
salary increases in fiscal year 2007. Mr. Packard,
Mr. Baule and Mr. Saxberg received increases in the
fourth quarter of fiscal year 2006 when they each acquired
additional responsibilities. Ms. Stokes received a salary
increase in the first quarter of fiscal year 2007. At the time
of their respective salary increases, Mr. Packard was
appointed Chief Executive Officer, Mr. Baule assumed
responsibility for the operations of the enterprise,
Mr. Saxberg assumed a role with expanded customer
interface, and Ms. Stokes assumed responsibility related to
marketing functions. Mr. Davis salary was negotiated
at hire as a combination of external market and internal value
associated with his experience and position.
Annual
Performance Bonus
We maintain an annual cash performance bonus program, the
Executive Bonus Plan, which is intended to reward executive
officers based on our performance and the individual named
executive officers contribution to that performance. In
determining the performance-based compensation awarded to each
named executive officer, the Compensation Committee may
generally evaluate our performance and the executives
performance in a number of areas, which could include revenues,
operating earnings, student retention, efficiency in product and
systems development, marketing investment efficacy, new
enrollment and developing company leaders. The Compensation
Committee believes that the performance bonus program provides
incentives necessary to retain executives and reward them for
our short-term performance.
In 2007, the Compensation Committee implemented a
one-team-one-goal philosophy for awarding annual
bonuses. This approach required all executives to remain
focused, not merely on individual goal-sets, but on the
achievement of these corporate goals. For fiscal year 2007, the
amounts payable under our annual cash performance bonus program
were primarily determined based upon our financial performance
including earnings, revenue and EBITDA factors representing
improvement in comparison to the prior fiscal year and the cash
available for bonus awards. Other key factors considered
included achieving product development goals, enrollment growth
and efforts in preparing the company for an initial public
offering. The performance bonuses were not, however, predicated
or tied to predetermined objective targets for any financial or
other metric. Rather, the Compensation Committee made a
subjective determination regarding the extent to which these
corporate goals were achieved by the executive team
85
as a whole. Part of this determination reflects the fact that
there are material differences in our executive officers
respective spans of control and scope of responsibilities. In
addition to these factors, bonus payments in 2007 took into
account length of service to the Company, employment agreement
terms, individual contributions that exceeded expectations, and
mid-year promotions.
Differences in bonus levels above targets were attributable to
relative position level and impact on the business. Individual
contributions were measured by discrete achievements within the
executives respective department that advanced
company-wide objectives. For example, our Chief Marketing
Officer, Celia Stokes, made a substantial contribution to
achievement of our revenue targets by exceeding the forecasted
student enrollment and retention levels. Our Chief Operating
Officer and Chief Financial Officer, John Baule, received a
bonus higher than the target as a result of effectively managing
our operations to yield a net income above original forecasts.
The difference in bonus amounts is directly attributable to
Ms. Stokes serving as a senior vice president and
Mr. Baule serving as an executive vice president with a
broader span of control and management responsibilities. In this
example, the lower bonus percentage awarded to Ms. Stokes
took into account that she reported to Mr. Baule who
received the higher percentage even though both exceeded
expectations. As noted, we paid a guaranteed bonus to our
Executive Vice President of Worldwide Business Development,
Bruce Davis, for fiscal year 2007 only, as part of his
employment agreement.
For fiscal year 2007, Mr. Packards target bonus was
100% of base salary, Mr. Baules target bonus was 50%
of base salary, Mr. Davis target bonus was 40% of
base salary, Mr. Saxbergs target bonus was 30% of
base salary and Ms. Stokes target bonus was 30% of
base salary. Bonus targets have historically been negotiated at
the time of hire. The legacy of these at-hire negotiations have
clustered bonus targets at the 40% -50% range of base salary for
the Chief Financial Officer and any Executive Vice President,
and 30% for the Senior Vice President roles.
Mr. Davis fiscal year 2007 bonus was guaranteed at
$120,000 as part of his employment agreement to offset an earned
bonus he left behind with his previous employer. The
Compensation Committee determined that Mr. Packard and
Mr. Saxberg received their full target bonus for fiscal
year 2007, Mr. Baule received a bonus equal to 68% of his
base salary in recognition of his expanded role and
Ms. Stokes received a bonus equal to 36% of her base salary
in recognition of her success in product demand creation.
The performance goals for fiscal year 2007 were difficult to
achieve in the view of the Compensation Committee, as executives
were required to improve the financial performance of the
Company while simultaneously focusing on establishing corporate
governance standards, improving accounting practices, creating
effective internal control systems and maintaining operational
stability. The results of performance are set forth in the
section entitled Summary Compensation Table below.
Using peer group data, the Compensation Committee plans to
review each of the executive bonus targets in fiscal year 2008
and set objectively determinable goals for the 2008 fiscal year
to reflect the stated compensation philosophy. Executive bonuses
will be based primarily on the Company achieving revenue and
EBITDA targets and to a lesser extent, on the achievement of
specified individual goals. These Company financial targets for
2008 and the individual functional goals for our executive
officers have yet to be determined. The Compensation Committee
expects that these financial targets are difficult to achieve
because they will require the Company to expand the
jurisdictions in which it operates in order to meet the targeted
growth, which is not assured in any given time period,
particularly in light of factors beyond our control.
Additionally, each executive will have an individual set of
goals (in addition to the corporate objectives) upon which his
or her performance will be measured. In 2008, an Executive will
become eligible to receive his or her individual bonus only if
the Company achieves at least 80% of its financial targets with
a graduated scale thereafter. Although the Compensation
Committee has not established these individual goals for 2008,
we expect these goals to be different for each Executive because
they will be aligned with the Executives functional
responsibilities, leadership tasks and achievement of
department-specific objectives related to operating as a public
company.
Stock
Options
The Companys named executive officers, along with a large
portion of our employees, are eligible to participate in our
Amended and Restated Stock Option Plan, pursuant to which we
grant awards of stock options. We have also granted stock
options to some of our named executive officers pursuant to
stand-alone agreements. Initial stock option grants are
typically made as of the date of hire and then additional stock
options may be granted to realign the recipients stock
option holdings with the stock option holdings of similarly
situated employees.
86
Participants, including the named executive officers, become
eligible for stock option grants based on individual
performance, as determined by the Compensation Committee;
however, historically the amount of stock options granted to
each participant has generally been determined using a procedure
approved by the Compensation Committee based upon several
factors, including our financial performance, measured generally
based on revenue and EBITDA, the value of the stock option at
the time of grant and the recipients contributions to the
Company. Option grants in 2006 were not, however, tied to
objective targets for any financial or other metric. Additional
grants may be made following a significant change in job
responsibility or in recognition of a significant achievement.
In addition, since we hired an independent compensation
consultant, we have begun to review external factors such as
market data and equity award policies of comparable companies
when determining the grants of stock options to participants,
including the named executive officers. Providing long-term
incentive awards through the grant of stock options enhances our
goal of aligning executive compensation with the long-term
interests of our stockholders by linking compensation to our
stock price and maximizing stockholder value.
Stock options granted under our Amended and Restated Stock
Option Plan generally have a four-year vesting schedule in order
to provide an incentive for continued employment. The exercise
price of options granted under the stock option plan is equal to
or greater than 100% of the fair market value of the underlying
stock on the date of grant. During fiscal year 2007,
Messrs. Packard and Davis received stock option grants
pursuant to stand-alone agreements. These stand alone agreements
were used to include vesting and pricing elements that our
standard stock option plan did not accommodate.
Mr. Davis option grant pursuant to his stand alone
agreement is subject to a time-based vesting schedule. However,
to align Mr. Packards equity compensation with our
success, we developed a dual vesting schedule with a portion of
his option grant subject to a time-based vesting schedule and a
portion of his option grant subject to a vesting schedule based
upon the Companys achievement of financial performance
metrics, jurisdictional and enrollment expansion targets or the
fair market value of our common stock reaching a certain price.
Similarly, in connection with board approval of the amendments
of Mr. Packards and Mr. Baules employment
agreements discussed below on July 12, 2007, we granted
options to Mr. Packard and Mr. Baule that utilize this
dual vesting schedule. This dual vesting takes into
consideration Mr. Packards role as Chief Executive
Officer and steward of achieving the corporate goals, as well as
his role as an individual contributor to business development
and revenue generation. The dual vesting model of
Mr. Baules options was designed to align his
incentives with the Chief Executive Officers.
Additionally, the vesting model is reflective of his dual roles,
including both his position as Chief Financial Officer, with the
long term perspective that role implies, and his position as the
Chief Operating Officer, with the quarterly and annual
performance goals resident in that responsibility. For the same
reasons as stated above with respect to the performance metrics
relating to annual performance bonuses for executives, the
Compensation Committee believes the achievement of these
performance metrics will be difficult. Our revenue and EBITDA
targets are in part dependent upon the ability to serve virtual
public schools in more states or the removal of enrollment
restrictions in states where we currently operate. In addition,
Mr. Packards performance-based vesting targets
relating to jurisdictional and enrollment expansion are directly
dependent upon these factors. That typically requires a major
initiative to secure legislation or regulations permitting this
form of public education. These efforts include coordinating
grass-roots support, converting this support into state-specific
legislative proposals, and managing advocacy efforts to ensure
the adoption of enabling legislation. This process often takes
multiple legislative sessions over several years. The difficulty
and uncertainty of this process is a major factor in measuring
Company performance. Certain stock options granted to
Messrs. Packard and Davis have exercise prices in excess of
the fair market value of the underlying stock on the date of
grant. For fiscal year 2007, we granted 950,974 stock options to
Mr. Packard and 98,039 stock options to Mr. Davis as
part of their respective revised and new employment
arrangements. The determination of the amounts of the option
grants for Messrs. Packard and Davis was based on a
combination of market data and internal value ascribed to their
respective positions by the Compensation Committee. The options
granted to Mr. Packard, in addition to reflecting the
Company-wide financial targets, are also based on certain
non-financial objectives that require his direct attention,
significant time commitments, and execution risk.
Messrs. Baule and Saxberg and Ms. Stokes did not
receive option grants during fiscal year 2007 because
Compensation Committee review did not occur for them during the
2007 fiscal year.
87
Deferred
Compensation Plan
While we do not currently maintain a deferred compensation plan,
effective January 2008, members of our senior executive
management team (including our named executive officers) and all
vice presidents will be eligible to defer up to 100% of any cash
component of the annual incentive bonus earned. The amounts may
be deferred up to a maximum of 10 years and are expected to
earn a fixed interest rate. The addition of a deferred
compensation plan provides a means for us to provide benefits to
our executive team to further our philosophy of attracting and
retaining individuals of superior ability.
Defined
Contribution Plan
We maintain a Section 401(k) Savings/Retirement Plan (the 401(k)
Plan), which covers our eligible employees, including our named
executive officers. The 401(k) Plan allows participants to defer
up to 50% of their annual compensation, subject to certain
limitations imposed by the Internal Revenue Code. The
employees elective deferrals are immediately vested and
nonforfeitable upon contribution to the 401(k) Plan. We
currently provide matching contributions equal to $0.25 for each
dollar of participant contributions, up to a maximum of 4% of
the participants annual salary and subject to certain
other limits. Our matching contributions are subject to a
four-year vesting schedule.
Employment,
Severance and Change in Control Arrangements
We currently have employment agreements in place with each of
our named executive officers that provide for severance payments
in connection with certain terminations of employment. During
our fiscal year ending in 2007, Mr. Packard had an
employment agreement with us that provided for salary
continuation for 450 days following a termination of his
employment without cause by us or due to constructive
termination. In addition, each of the other named executive
officers have employment agreements with us that provide for
employment on an at will basis and provide for
severance payments ranging from six months to 12 months
(plus benefit continuation in certain cases) generally in
connection with terminations of employment without cause by us
or for good reason by the executive. These agreements were
generally negotiated at hire and the potential severance
payments were determined considering the following: market data
from the peer group; the executives perceived
marketability; and the desired length of a non-standard
non-competition agreement. On July 12, 2007, our board of
directors approved an amended and restated employment agreement
for Mr. Packard and an amendment to Mr. Baules
employment agreement, which are discussed below.
Mr. Packards employment agreement was amended and
restated and Mr. Baules employment agreement was
amended because both Mr. Packard and Mr. Baule were
promoted to new positions within the company. Mr. Packard
was promoted to Chief Executive Officer and Mr. Baule was
promoted to Chief Operating Officer and Chief Financial Officer.
In addition, Mr. Baules employment agreement reflects
the grant of additional stock options relating to his assumption
of additional responsibilities in March 2006. Their employment
agreements were revised to reflect the new positions and provide
for additional compensation in connection with their undertaking
new roles and responsibilities within the company. Severance is
considered by us and our employees to be an integral part of the
overall compensation package. We provide severance to the
executives as a means to attract and retain individuals with
superior ability and managerial talent. The severance
arrangements impact annual compensation decisions regarding
levels of salary and bonus because the severance is provided in
the form of salary continuation.
While the named executive officers are generally not entitled to
receive payments solely as a result of a change in control of
the Company, upon certain corporate transactions (including a
sale of all or substantially all of the assets, certain mergers
or consolidations and certain sales of our outstanding stock)
all outstanding options will become fully vested and exercisable.
We believe that providing the named executive officers with
severance payments upon certain terminations of employment and
accelerated vesting of stock options upon a change in control
are key retention tools that assist us with remaining
competitive with the companies in our Peer Group, further our
goal of attracting and retaining key
88
executives with superior ability and managerial talent and
protect our intellectual capital and competitive position. These
employment agreements, including the revised terms of
Mr. Packards agreement approved by the board of
directors and change in control arrangements, are further
described below under the section entitled Potential
Payments Upon Termination or Change in Control.
Summary
Compensation Table for 2007
The following table provides information regarding the
compensation that we paid to our named executive officers during
the fiscal year ended June 30, 2007.
Nonequity
Option
Incentive Plan
All Other
Name and Principal Position
Year
Salary
Bonus(2)
Awards(3)
Compensation
Compensation(4)
Total
Ronald J. Packard
2007
$
410,000
$
410,000
$
167,998
$
$
2,050
$
990,048
Chief Executive
Officer(1)
John F.
Baule(1)
2007
300,000
210,000
1,646
511,646
Chief Operating Officer and Chief Financial Officer
Bruce J. Davis
2007
144,423
120,000
(6)
12,760
277,183
Executive Vice President of Worldwide Business
Development(5)
Bror V. H. Saxberg
2007
310,000
93,000
2,711
405,711
Chief Learning Officer
Celia M. Stokes
2007
221,052
80,000
1,847
302,899
Chief Marketing Officer
(1)
Between July 1, 2006 and
May 6, 2007, we did not have a named principal executive
officer but Messrs. Packard and Baule shared the
responsibilities of this position at the direction of the Board
of Directors.
(2)
This column represents cash awards
to the named executive officers for performance with respect to
fiscal year ended June 30, 2007. These awards were paid in
September 2007. These awards were generally based upon corporate
performance, but were not determined based upon the achievement
of specific objective performance targets.
(3)
This column represents the dollar
amount recognized by us for financial statement reporting
purposes of the fair value of stock options granted in fiscal
year ended June 30, 2007, and prior years in accordance
with FAS 123R, assuming no forfeitures. For additional
information, including information regarding the assumptions
used when valuing the stock options, refer to note 9 of our
consolidated financial statements filed herewith. The amounts
set forth in this column reflect our accounting expense for
these awards and do not correspond to the actual value that may
be realized by the named executive officer receiving the awards.
See the Grants of Plan-Based Awards Table for additional
information on stock options granted during fiscal year ended
June 30, 2007.
(4)
The amounts in this column consist
of 401(k) matching contributions paid by us.
(5)
Mr. Davis commenced his
employment with us on January 8, 2007. Amounts included in
the table reflect Mr. Davis compensation from his
date of hire through the end of the fiscal year ended on
June 30, 2007.
(6)
Pursuant to the terms of his
employment agreement, Mr. Davis was entitled to a
guaranteed bonus of $120,000 for fiscal year 2007 which was paid
on July 8, 2007.
89
Grants of
Plan-Based Awards During 2007
The following table provides information regarding grants of
plan-based awards to our named executive officers during the
fiscal year ended June 30, 2007. The awards described in
the following table were granted under our Executive Bonus Plan
and stand-alone stock option agreements. The performance metrics
considered when the awards were granted, if any, are described
in previous subsections of the Compensation Discussion and
Analysis above. No awards were granted to any named executive
officer under our Amended and Restated Stock Option Plan during
the fiscal year ended June 30, 2007.
Estimated
Possible
All
Payouts
Other
Grant
Under
Option
Date
Nonequity
Awards:
Closing
Fair
Incentive
Estimated Future Payouts
Number of
Exercise or
Market
Value
Plan
Under Equity
Securities
Base
Price
of
Awards
Incentive Plan
Awards(1)
Underlying
Price
on Date
Option
Grant
Target
Threshold
Target
Maximum
Options(2)
of Option
of
Awards
Name and Principal Position
Date
($)
(#)
(#)
(#)
(#)
Awards
Grant(3)
($/Sh)
Ronald J. Packard
$
Chief Executive
7/27/2006
68,627
$
7.65
$
2.96
$
14,802
Officer
7/27/2006
117,645
7.65
2.96
87,206
7/27/2006
29,411
7.65
2.96
6,178
7/27/2006
39,215
7.65
2.96
16,715
7/27/2006
39,215
7.65
2.96
19,986
7/27/2006
9,803
7.65
2.96
4,996
7/27/2006
29,411
235,294
7.65
2.96
171,652
7/27/2006
14,705
117,647
7.65
2.96
85,826
7/27/2006
294,117
30.60
2.96
113,217
John F. Baule
Chief Operating Officer and Chief Financial Officer
Bruce J. Davis
2/1/2007
98,039
9.18
4.23
153,117
Executive Vice President of Worldwide Business Development
Bror V. H. Saxberg
Chief Learning Officer
Celia M. Stokes
Chief Marketing Officer
(1)
Stock options were granted pursuant
to stand-alone stock option agreements with exercise prices in
excess of the fair market value of a share of our common stock
subject to such option on the date of grant, expire on
December 31, 2012, and are subject to performance vesting
schedules, as further described in the footnotes to the
Outstanding Equity Awards at Fiscal Year End Table. The stock
options with performance vesting schedules do not have maximum
payout amounts.
(2)
Stock options were granted pursuant
to stand-alone stock option agreements with exercise prices in
excess of the fair market value of a share of our common stock
subject to such option on the date of grant, expire on
December 31, 2014 and are subject to a four year
time-based vesting schedule.
(3)
The closing market price of our
common stock on the date of grant is based upon our analysis of
its fair market value. For a discussion of this analysis, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations Critical
Accounting Policies and Estimates Accounting for
Stock-based Compensation.
90
Outstanding
Equity Awards at Fiscal Year End for 2007
The following table provides information regarding outstanding
equity awards held by our named executive officers as of
June 30, 2007. All such equity awards consist of stock
options granted pursuant to our Amended and Restated Stock
Option Plan or stand-alone stock option agreements, and no
restricted stock awards have been granted to any of the named
executive officers. The section titled Stock Options
in this Compensation Discussion and Analysis section provides
additional information regarding the outstanding equity awards
set forth in this table.
Option Awards
Equity Incentive Plan
Number of
Number of
Awards: Number of
Securities Underlying
Securities Underlying
Securities Underlying
Option
Option
Unexercised Options
Unexercised Options
Unexercised Unearned
Exercise
Expiration
Name and Principal Position
Exercisable
Unexercisable
Options
Price
Date
Ronald J. Packard
68,627
$
7.65
7/27/2014
Chief Executive
Officer(1)
117,645
7.65
7/27/2014
29,411
7.65
7/27/2014
39,215
7.65
7/27/2014
39,215
7.65
7/27/2014
9,803
7.65
7/27/2014
235,294
7.65
7/27/2014
58,824
58,824
7.65
7/27/2014
294,117
30.60
7/27/2014
132,353
6.83
7/1/2011
176,469
6.83
7/23/2010
John F. Baule
19,607
58,824
7.65
6/1/2014
Chief Operating Officer
88,234
68,628
6.83
3/24/2013
and Chief Financial
Officer(2)
Bruce J. Davis
98,039
9.18
2/1/2015
Executive Vice President of Worldwide Business
Development(3)
Bror V. H. Saxberg
14,705
44,118
7.65
4/26/2014
Chief Learning
Officer(4)
9,926
7,721
6.83
3/1/2013
Celia M. Stokes
11,028
28,186
7.65
4/26/2014
Chief Marketing
Officer(5)
(1)
Mr. Packards outstanding
unvested options are subject to performance-based vesting.
39,215 options with exercise prices of $7.65 per share will vest
in each of fiscal year ending June 30, 2008 and 2009
contingent upon our attaining revenues and EBITDA goals during
each of the respective preceeding fiscal years. 9,803 options
with exercise prices of $7.65 per share will vest in fiscal year
ending June 30, 2009 contingent upon Mr. Packard
attaining leadership goals during the preceeding fiscal year.
235,294 options with exercise prices of $7.65 per share will
vest on dates that jurisdictional expansion and related EBITDA
goals are obtained, if any. 58,824 options with exercise prices
of $7.65 per share will vest on dates that jurisdictional
expansion and enrollment targets are achieved. 294,117 options
with exercise prices of $30.60 per share will vest upon the fair
market value of a share of our common stock equaling $30.60.
(2)
Mr. Baules outstanding
unvested options are subject to time-based vesting. 4,901
options with exercise prices of $7.65 per share will vest every
three months beginning on September 1, 2007 through
June 1, 2010. 9,803 options with exercise prices of $6.83
per share will vest every three months beginning on
September 24, 2007 through March 24, 2009.
(3)
Mr. Daviss outstanding
unvested options are subject to time-based vesting. 24,509
options will vest on February 1, 2008 and 6,127 options
will vest every three months thereafter beginning on May 1,
2008 through February 1, 2011.
(4)
Mr. Saxbergs outstanding
unvested options are subject to time-based vesting. 3,676
options will vest every three months beginning on July 27,
2007 through April 27, 2010, and 1,102 will vest every
three months beginning on September 24, 2007 through
March 24, 2009.
(5)
Ms. Stokes outstanding
unvested options are subject to time-based vesting. 1,225
options vest every three months beginning on July 27, 2007
through April 27, 2010, and 1,225 vest every three months
beginning on September 21, 2007 through March 21, 2010.
91
Option
Exercises and Stock Vested
The following table provides information for the named executive
officers regarding the stock options each named executive
officer exercised, and the value realized, if any, during fiscal
year ended June 30, 2007.
Option Awards
Number of
Shares
Acquired
Value Realized
Name and Principal
Position
on
Exercise(1)
on Exercise
Ronald J. Packard
$
Chief Executive Officer
John F. Baule
Chief Operating Officer and Chief Financial Officer
Bruce J. Davis
Executive Vice President of Worldwide Business Development
Bror V. H. Saxberg
39,215
64,000
(2)
Chief Learning Officer
Celia M. Stokes
Chief Marketing Officer
(1)
None of the named executive
officers other than Mr. Saxberg exercised any stock options
during fiscal year ended June 30, 2007.
(2)
Represents the exercise of
39,215 options on May 29, 2007, each with an exercise
price of $6.83 per share. The estimated fair market value of a
share of our common stock on the date of exercise was $8,47 For
a discussion of the analysis of the fair market value of our
common stock, see Managements Discussion and
Analysis of Financial Condition and Results of
Operations Critical Accounting Policies and
Estimates Accounting for Stock-based
Compensation.
Potential
Payments Upon Termination or Change in Control
The Company has employment agreements with each of our named
executive officers that provide for severance payments and, in
some cases, other benefits upon certain terminations of
employment.
Employment
Agreements
Mr. Packards employment agreement, effective as of
January 1, 2006, provides for a term of employment through
January 1, 2009, unless terminated earlier pursuant to the
terms of the agreement. Upon a termination of
Mr. Packards employment by us without cause or due to
a constructive termination (generally, a material
reduction in Mr. Packards duties, responsibilities or
title), Mr. Packard is entitled to salary continuation for
450 days following termination and he may exercise his
outstanding vested stock options until the earlier of
90 days following the expiration of any
lock-up
period applicable to our initial underwritten public offering,
or the expiration of the option term. Upon termination of
Mr. Packards employment due to his death, his estate
will receive salary continuation payments for 180 days
following his death. The agreement also provides that
Mr. Packard is subject to restrictive covenants during the
term of the agreement and for certain periods following
termination of employment, including confidentiality restrictive
covenants during the term and for three years following
termination, intellectual property restrictive covenants during
the term, and nonsolicitation and noncompetition restrictive
covenants during the period that Mr. Packard receives any
compensation from us (including severance) and one year
thereafter.
On July 12, 2007, our board of directors approved an
amended and restated employment agreement for Mr. Packard.
This amended and restated agreement extends the term of
Mr. Packards employment until January 1, 2011,
and provides for (i) an annual base salary of $425,000,
(ii) an annual cash bonus to be awarded by the board of
directors in its discretion with a target amount of 100% of base
salary, (iii) additional stock option grants subject to
both time-based and performance-based vesting, (iv) full
vesting of all outstanding stock options upon a change in
92
control of the Company, and (v) severance upon a
termination of Mr. Packards employment without cause
by us or due to constructive termination equal to
18 months of base salary and the extension of the exercise
date for Mr. Packards outstanding stock options to
the earlier of 90 days following expiration of any
lock-up
period in connection with the Companys initial public
offering and the expiration of the term of the stock options.
Mr. Baules employment agreement, dated March 4,
2005, provides for his employment with us on an
at-will basis. Upon a termination of
Mr. Baules employment for good reason
(generally, a material reduction in Mr. Baules
compensation, assignment of a materially different title and
responsibilities effectively resulting in a demotion, relocation
of Mr. Baules place of work more than 50 miles
from our headquarters, or we otherwise materially breach the
employment agreement), or by us for any reason other than cause,
death or disability, Mr. Baule is entitled to severance
equal to 365 days of his then-current salary, paid in six
monthly installments following termination, and medical and
dental benefit continuation for 365 days, or if earlier,
until eligible for benefits elsewhere (or reimbursement of COBRA
costs to the extent our employee benefit plans do not allow
post-termination participation by Mr. Baule). The agreement
also provides that Mr. Baule will be subject to the terms
of the Companys Confidentiality, Proprietary Rights and
Non-Solicitation Agreement, which generally prohibits the
unauthorized disclosure of our confidential information during
and after the period of employment, ensures our right of
ownership of any intellectual property developed during the
period of employment, prohibits the solicitation of employees
for one year following termination of employment and requires
that any disputes regarding employment or termination of
employment be subject to binding arbitration.
On July 12, 2007, our board of directors approved an amendment
to Mr. Baules employment agreement. This amendment
provides for (i) an annual base salary of $340,000,
(ii) an annual cash bonus to be awarded by the board of
directors in its discretion with a target amount of 70% of base
salary, (iii) additional stock option grants subject to
both time-based and performance-based vesting, and
(iv) full vesting of all stock options upon a change in
control of the company.
Mr. Davis employment agreement, effective as of
January 3, 2007, provides for his employment with us on an
at-will basis. Upon a termination of
Mr. Davis employment for good reason
(generally, a material breach of the employment agreement by us
that is not cured within 60 days, a reduction in base
salary, a diminution or adverse change to title or the person to
whom Mr. Davis reports prior to a change in control of the
Company, a material diminution in authority, responsibilities or
duties, a relocation of place of employment more than
25 miles from our headquarters, a material reduction in
Mr. Davis compensation, assignment of a materially
different title and responsibilities effectively demoting
Mr. Davis, or if the employment agreement is not assumed by
the successor within 90 days following a change in control
of the Company), or by us without cause, Mr. Davis is
entitled to 180 days of salary continuation if the
termination occurs prior to January 1, 2008, and
365 days of salary continuation if the termination occurs
after January 1, 2008. The agreement also provides that
Mr. Davis will be subject to the terms of our
Confidentiality, Proprietary Rights and Non-Solicitation
Agreement which generally prohibits the unauthorized disclosure
of our confidential information during and after the period of
employment, ensures our right of ownership of any intellectual
property developed during the period of employment, prohibits
the solicitation of employees for one year following termination
of employment and requires that any disputes regarding
employment or termination of employment be subject to binding
arbitration.
Mr. Saxbergs employment agreement, dated June 1,
2006, provides for his employment with us on an
at-will basis. Upon a termination of
Mr. Saxbergs employment for good reason
(Mr. Saxbergs resignation within 40 days after
his discovery of a material breach of the agreement by us which
is not cured within 30 days after written notice from
Mr. Saxberg), or by us without cause,
Mr. Saxberg is entitled to 180 days of salary
continuation, reduced by any compensation resulting from new
employment. The agreement also provides that Mr. Saxberg
will be subject to the terms of our Confidentiality, Proprietary
Rights and Non-Solicitation Agreement which generally prohibits
the unauthorized disclosure of our confidential information
during and after the period of employment, ensures our right of
ownership of any intellectual property developed during the
period of employment, prohibits the solicitation of employees
for one year following termination of employment and requires
that any disputes regarding employment or termination of
employment be subject to binding arbitration.
Ms. Stokes employment agreement, dated March 10,
2006, provides for her employment with us on an
at-will
basis. Upon a termination of Ms. Stokes employment
for good reason (Ms. Stokes resignation
within
93
40 days after her discovery of a material breach of the
agreement by us which is not cured within 30 days after
written notice from Ms. Stokes), or by us without
cause, Ms. Stokes is entitled to 180 days of
salary continuation, reduced by any compensation resulting from
new employment. The agreement also provides that Ms. Stokes
will be subject to the terms of our Confidentiality, Proprietary
Rights and Non-Solicitation Agreement which generally prohibits
the unauthorized disclosure of our confidential information
during and after the period of employment, ensures our right of
ownership of any intellectual property developed during the
period of employment, prohibits the solicitation of employees
for one year following termination of employment and requires
that any disputes regarding employment or termination of
employment be subject to binding arbitration.
Change
in Control Arrangements
Except for certain stock options granted to Mr. Packard and
Mr. Baule during our fiscal year ending in 2007, the stock
option agreements for outstanding stock options generally
provide for accelerated and full vesting of unvested stock
options upon certain corporate events. As described above, on
July 12, 2007, our board of directors approved an amended
and restated employment agreement for Mr. Packard, which
provides that all of his outstanding options will become fully
vested upon a change in control of the Company. Additionally, on
July 12, 2007, our board of directors also approved the
terms of a new option agreement for Mr. Baule, which
provides that all of his outstanding options will become fully
vested upon a change in control of the Company. Those events
include a sale of all or substantially all of our assets, a
merger or consolidation which results in the Companys
stockholders immediately prior to the transaction owning less
than 50% of our voting stock immediately after the transaction,
and a sale of our outstanding securities (other than in
connection with an initial public offering) which results in our
stockholders immediately prior to the transaction owning less
than 50% of our voting stock immediately after the transaction.
In addition, as described above, Mr. Davis is entitled to
voluntarily terminate his employment and receive the severance
payments described above if his employment agreement is not
assumed by the successor entity within 90 days following a
change in control of the Company. Other than the foregoing, none
of the named executive officers is entitled to any additional
payments upon a change in control of the Company.
94
Potential
Value of Termination and Change in Control
Benefits
The following table provides the dollar value of potential
payments and benefits that each named executive officer would be
entitled to receive upon certain terminations of employment and
upon a change in control of the Company, assuming that the
termination or change in control occurred on June 30, 2007,
and the price per share of our common stock subject to the stock
options equaled $1.82, the value of a share on June 30,
2007. For a discussion of our analysis of the fair market value
of our common stock, see Managements Discussion and
Analysis of Financial Condition and Results of
Operations Critical Accounting Policies and
Estimates Accounting for Stock-based
Compensation.
Without
Good
Change in
Name
Payment
Death
Cause
Reason
Control
Ronald J.
Packard(1)
Salary continuation
$
202,192
$
505,479
$
505,479
$
Benefit continuation
Option vesting
624,000
John F.
Baule(2)
Salary continuation
300,000
300,000
Benefit continuation
16,734
16,734
Option vesting
264,000
Bruce J. Davis
Salary continuation
147,945
147,945
Benefit continuation
Option vesting
10,000
Bror V. H. Saxberg
Salary continuation
152,877
152,877
Benefit continuation
Option vesting
90,900
Celia M. Stokes
Salary continuation
109,012
109,012
Benefit continuation
Option vesting
46,000
(1)
Amounts do not reflect the terms of
Mr. Packards amended and restated employment agreement
effective July 12, 2007. If Mr. Packards amended
and restated employment agreement was in effect as of
June 30, 2007, Mr. Packards salary continuation
upon death, termination without cause or termination for good
reason would have been $209,589, $637,500 and $637,500,
respectively. The value of Mr. Packards option
vesting would not have changed because the exercise price of the
new stock options would have exceeded the value of a share of
our common stock on such date.
(2)
Amounts do not reflect the terms of
Mr. Baules amended employment agreement or stock
option agreement effective July 12, 2007. If
Mr. Baules amended employment agreement and option
agreement were in effect as of June 30, 2007,
Mr. Baules salary continuation upon termination
without cause or termination for good reason would have been
$340,000. The value of Mr. Baules option vesting
would not have changed because the exercise price of the new
stock options would have exceeded the value of a share of our
common stock on such date. The value of the benefit continuation
would not have changed.
Director
Compensation
For fiscal year ended June 30, 2007, and prior fiscal
years, we compensated our nonemployee directors solely through
grants of stock options. None of our nonemployee directors
received any other form of compensation for service during
fiscal year ended June 30, 2007, such as cash fees for
retainer, committee service, service as chairman of the board of
directors or meeting attendance. For service during fiscal year
ended June 30, 2007, each nonemployee director received
options to purchase 4,901 shares of our common stock. In
addition, members of the Executive Committee of the board during
fiscal year ended June 30, 2007, which included
Messrs. Tisch, Milken, Fink and Ms. Boyd, received
options to purchase an additional 4,901 shares of our
common stock in compensation
95
for their increased time commitments with respect to serving on
the Executive Committee. Directors who are also our employees
receive no additional compensation for serving on the board or
its committees.
Option
Name
Awards(1)
Total(1)
Andrew H. Tisch
$
851(2)
$
851
Arthur H. Bilger
425(3)
425
Chester E. Finn Jr.
425(4)
425
Liza A. Boyd
851(5)
851
Lowell J. Milken
851(6)
851
Steven B. Fink
851(7)
851
Thomas J. Wilford
425(8)
425
(1)
This column represents the dollar
amount recognized by us for financial statement reporting
purposes of the fair value of stock options granted in fiscal
year ended June 30, 2007, and prior years under our Amended
and Restated Stock Option Plan in accordance with FAS 123R,
assuming no forfeitures. For additional information, including
information regarding the assumptions used when valuing the
stock options, refer to note 9 of our consolidated
financial statements filed herewith. The amounts set forth in
this column reflect our accounting expense for these awards and
do not correspond to the actual value that may be realized by
the directors receiving the awards.
(2)
During fiscal year ended
June 30, 2007, Mr. Tisch was granted 9,803 options on
May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Tisch held options to purchase
53,916 shares of common stock, consisting of 9,803 granted
on May 17, 2007; 9,803 granted on April 27, 2006;
9,803 granted on March 24, 2005; 9,803 granted on
March 31, 2004; 9,803 granted on February 10, 2003;
and 4,901 granted on July 23, 2002.
(3)
During fiscal year ended
June 30, 2007, Mr. Bilger was granted 4,901 options on
May 17, 2007 with a fair value of $16,988. As of
June 30, 2007, Mr. Bilger held options to purchase
29,406 shares of common stock, consisting of 4,901 granted
on May 17, 2007; 4,901 granted on April 27, 2006;
4,901 granted on March 24, 2005; 4,901 granted on
March 31, 2004; 4,901 granted on February 10, 2003;
and 4,901 granted on July 23, 2002. Mr. Bilger
resigned from the board of directors on June 29, 2007.
(4)
During fiscal year ended
June 30, 2007, Mr. Finn was granted 4,901 options on
May 17, 2007 with a fair value of $16,988. As of
June 30, 2007, Mr. Finn held options to purchase
41,170 shares of common stock, consisting of 4,901 granted
on May 17, 2007; 4,901 granted on April 27, 2006;
4,901 granted on March 24, 2005; 4,901 granted on
March 31, 2004; 4,901 granted on February 10, 2003;
4,901 granted on July 23, 2002; and 11,764 granted on
August 31, 2000. Mr. Finn resigned from the board of
directors on July 19, 2007.
(5)
Ms. Boyd serves as a director
on behalf of certain funds managed by Constellation Ventures.
During fiscal year ended June 30, 2007, Ms. Boyd was
granted 9,803 options on May 17, 2007 with a fair value of
$33,975, which have been assigned to these funds. The options
granted to the director serving on behalf of these funds in
prior years have also been assigned to these funds. As of
June 30, 2007, these funds held options to purchase
46,564 shares of common stock, consisting of 9,803 granted
on May 17, 2007; 9,803 granted on April 27, 2006;
9,803 granted on March 24, 2005; 9,803 granted on
March 31, 2004; and 7,352 granted on February 10, 2003.
(6)
During fiscal year ended
June 30, 2007, Mr. Milken was granted 9,803 options on
May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Milken held options to purchase
53,916 shares of common stock, consisting of 9,803 granted
on May 17, 2007; 9,803 granted on April 27, 2006;
9,803 granted on March 24, 2005; 9,803 granted on
March 31, 2004; 9,803 granted on February 10, 2003;
and 4,901 granted on July 23, 2002. Mr. Milken
resigned from the board of directors on July 11, 2007.
(7)
During fiscal year ended
June 30, 2007, Mr. Fink was granted 9,803 options on
May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Fink held options to purchase
40,326 shares of common stock, consisting of 9,803 granted
on May 17, 2007; 9,803 granted on April 27, 2006;
9,803 granted on March 24, 2005; 9,803 granted on
March 31, 2004; 188 granted on December 18, 2003; and
926 granted on October 24, 2003.
(8)
During fiscal year ended
June 30, 2007, Mr. Wilford was granted
4,901 options on May 17, 2007 with a fair value of
$16,988. As of June 30, 2007, Mr. Wilford held options
to purchase 24,505 shares of common stock, consisting of
4,901 granted on May 17, 2007; 4,901 granted on
April 27, 2006; 4,901 granted on March 24, 2005; 4,901
granted on March 31, 2004; and 4,901 granted on
February 10, 2003.
Employee
Equity Incentive Plans
Amended
and Restated Stock Option Plan
Our Board of Directors has adopted our Amended and Restated
Stock Option Plan, or the Existing Plan, which was approved by
our stockholders in December 2003. The Board of Directors
subsequently amended the Existing Plan which was approved by our
stockholders in November 2007. Pursuant to that amendment, we
have reserved an aggregate of 3,921,568 shares of our common
stock for issuance under the Existing Plan. The aggregate number
of shares subject to outstanding awards under the Existing Plan
is 3,429,608 shares of our common stock. We do not intend to
grant any additional options under the Existing Plan after the
completion of this offering.
96
2007
Equity Incentive Award Plan
Our Board of Directors has adopted our 2007 Equity Incentive
Award Plan, or the 2007 Plan, which will be submitted to our
shareholders for their approval within twelve months from the
date our Board of Directors approved the 2007 Plan. The 2007
Plan will become effective on the day prior to the effective
date of this offering.
We have initially reserved 784,313 shares of our common
stock for issuance under the 2007 Plan. In addition, the number
of shares initially reserved under the 2007 Plan will be
increased by the number of shares of common stock related to
awards granted under our Existing Plan that are repurchased,
forfeited, expired or are cancelled on or after the effective
date of the 2007 Plan. The 2007 Plan contains an evergreen
provision that allows for an annual increase in the number
of shares available for issuance under the 2007 Plan on July 1
of each year during the ten-year term of the 2007 Plan,
beginning on July 1, 2008. The annual increase in the
number of shares shall be equal to the least of:
4% of our outstanding common stock on the applicable July 1;
2,745,098 shares; or
a lesser number of shares as determined by our Board of
Directors.
Therefore, the 2007 Plan provides for an aggregate limit of
4,213,921 shares of common stock plus the increases in the
shares of stock pursuant to the evergreen provision
that may be issued under the 2007 Plan over the course of its
ten-year term. The material terms of the 2007 Plan are
summarized below. The 2007 Plan is filed as an exhibit to the
registration statement of which this prospectus is a part.
Administration. The Compensation Committee of our Board
of Directors will administer the 2007 Plan (except with respect
to any award granted to independent directors (as
defined in the 2007 Plan), which must be administered by our
full board of directors). To administer the 2007 Plan, our
Compensation Committee must consist of at least two members of
our Board of Directors, each of whom is a non-employee
director for purposes of
Rule 16b-3
under the Securities Exchange Act of 1934, as amended, or the
Exchange Act, and, with respect to awards that are intended to
constitute performance-based compensation under
Section 162(m) of the Internal Revenue Code of 1986, as
amended, an outside director for purposes of
Section 162(m). Subject to the terms and conditions of the
2007 Plan, our Compensation Committee has the authority to
select the persons to whom awards are to be made, to determine
the type or types of awards to be granted to each person, the
number of awards to grant, the number of shares to be subject to
such awards, and the terms and conditions of such awards, and to
make all other determinations and decisions and to take all
other actions necessary or advisable for the administration of
the 2007 Plan. Our Compensation Committee is also authorized to
establish, adopt, amend or revise rules relating to
administration of the 2007 Plan. Our Board of Directors may at
any time revest in itself the authority to administer the 2007
Plan. The full Board of Directors will administer the 2007 Plan
with respect to awards to non-employee directors.
Eligibility. Options, stock appreciation rights, or SARs,
restricted stock and other awards under the 2007 Plan may be
granted to individuals who are then our officers or employees or
are the officers or employees of any of our subsidiaries. Such
awards may also be granted to our non-employee directors and
consultants but only employees may be granted incentive stock
options, or ISOs. The maximum number of shares that may be
subject to awards granted under the 2007 Plan to any individual
in any calendar year cannot exceed 392,156.
Awards. The 2007 Plan provides that our Compensation
Committee (or the Board of Directors, in the case of awards to
non-employee directors) may grant or issue stock options, SARs,
restricted stock, restricted stock units, dividend equivalents,
performance share awards, performance stock units, stock
payments, deferred stock, performance bonus awards,
performance-based awards, and other stock-based awards, or any
combination thereof. The Compensation Committee (or the Board of
Directors, in the case of awards to non-employee directors) will
consider each award grant subjectively, considering factors such
as the individual performance of the recipient and the
anticipated contribution of the recipient to the attainment of
our long-term goals. Each award will be set forth in a separate
agreement with the person receiving the award and will indicate
the type, terms and conditions of the award.
97
Nonqualified stock options, or NQSOs, will provide for the right
to purchase shares of our common stock at a specified price
which may not be less than the greater of the par value of a
share of common stock on the date of grant or 85% of fair market
value, and usually will become exercisable (at the discretion of
our Compensation Committee or the Board of Directors, in the
case of awards to non-employee directors) in one or more
installments after the grant date, subject to the
participants continued employment or service with us
and/or
subject to the satisfaction of performance targets established
by our Compensation Committee (or the Board of Directors, in the
case of awards to non-employee directors). NQSOs may be granted
for any term specified by our Compensation Committee (or the
Board of Directors, in the case of awards to non-employee
directors), but the term may not exceed ten years.
Incentive stock options, or ISOs, will be designed to comply
with the provisions of the Internal Revenue Code and will be
subject to specified restrictions contained in the Internal
Revenue Code. Among such restrictions, ISOs must have an
exercise price of not less than the fair market value of a share
of common stock on the date of grant, may only be granted to
employees, must expire within a specified period of time
following the optionees termination of employment, and
must be exercised within the ten years after the date of grant.
In the case of an ISO granted to an individual who owns (or is
deemed to own) more than 10% of the total combined voting power
of all classes of our capital stock, the 2007 Plan provides that
the exercise price must be more than 110% of the fair market
value of a share of common stock on the date of grant and the
ISO must expire upon the fifth anniversary of the date of its
grant.
Restricted stock may be granted to participants and made subject
to such restrictions as may be determined by our Compensation
Committee (or the Board of Directors, in the case of awards to
non-employee directors). Typically, restricted stock may be
forfeited for no consideration if the conditions or restrictions
are not met, and may not be sold or otherwise transferred to
third parties until restrictions are removed or expire.
Recipients of restricted stock, unlike recipients of options,
may have voting rights and may receive dividends, if any, prior
to the time when the restrictions lapse.
Restricted stock units may be awarded to participants, typically
without payment of consideration or for a nominal purchase
price, but subject to vesting conditions including continued
employment or on performance criteria established by our
Compensation Committee (or the Board of Directors, in the case
of awards to non-employee directors). Like restricted stock,
restricted stock units may not be sold or otherwise transferred
or hypothecated until vesting conditions are removed or expire.
Unlike restricted stock, stock underlying restricted stock units
will not be issued until the restricted stock units have vested,
and recipients of restricted stock units generally will have no
voting or dividend rights prior to the time when vesting
conditions are satisfied.
SARs may be granted in connection with stock options or other
awards, or separately. SARs granted under the 2007 Plan in
connection with stock options or other awards typically will
provide for payments to the holder based upon increases in the
price of our common stock over the exercise price of the related
option or other awards. Except as required by
Section 162(m) of the Internal Revenue Code with respect to
SARs intended to qualify as performance-based compensation,
there are no restrictions specified in the 2007 Plan on the
exercise of SARs or the amount of gain realizable therefrom. Our
Compensation Committee (or the Board of Directors, in the case
of awards to non-employee directors) may elect to pay SARs in
cash or in common stock or in a combination of both.
Dividend equivalents represent the value of the dividends, if
any, per share paid by us, calculated with reference to the
number of shares covered by the stock options, SARs or other
awards held by the participant.
Performance awards (i.e., performance share awards, performance
stock units, performance bonus awards, performance-based awards
and deferred stock) may be granted by our Compensation Committee
(or the Board of Directors, in the case of awards to
non-employee directors) on an individual or group basis.
Generally, these awards will be based upon specific performance
targets and may be paid in cash or in common stock or in a
combination of both. Performance awards may include
phantom stock awards that provide for payments based
upon increases in the price of our common stock over a
predetermined period. Performance awards may also include
bonuses that may be granted by our Compensation Committee (or
the Board of Directors, in the case of awards to non- employee
directors) on an individual or group basis, which
98
may be paid on a current or deferred basis and may be payable in
cash or in common stock or in a combination of both. The maximum
amount of any such bonuses to a covered employee
within the meaning of Section 162(m) of the Internal
Revenue Code must not exceed $1,000,000 for any fiscal year
during the term of the 2007 Plan.
Stock payments may be authorized by our Compensation Committee
(or the Board of Directors, in the case of awards to
non-employee directors) in the form of common stock or an option
or other right to purchase common stock as part of a deferred
compensation arrangement, made in lieu of all or any part of
compensation, including bonuses, that would otherwise be payable
to employees, consultants or members of our Board of Directors.
Corporate
Transactions
In the event of a change of control where the acquiror does not
assume awards granted under the 2007 Plan, awards issued under
the 2007 Plan will be subject to accelerated vesting such that
100% of the awards will become vested and exercisable or
payable, as applicable. Under the 2007 Plan, a change of control
is generally defined as:
a transaction or series of related transactions (other than an
offering of our stock to the general public through a
registration statement filed with the United States Securities
and Exchange Commission, or SEC) whereby any person or entity or
related group of persons or entities (other than us, our
subsidiaries, an employee benefit plan maintained by us or any
of our subsidiaries or a person or entity that, prior to such
transaction, directly or indirectly controls, is controlled by,
or is under common control with, us) directly or indirectly
acquires beneficial ownership (within the meaning of
Rule 13d-3
under the Exchange Act) of more than 50% of the total combined
voting power of our securities outstanding immediately after
such acquisition;
during any two-year period, individuals who, at the beginning of
such period, constitute our Board of Directors together with any
new director(s) whose election by our Board of Directors or
nomination for election by our shareholders was approved by a
vote of at least two-thirds of the directors then still in
office who either were directors at the beginning of the
two-year period or whose election or nomination for election was
previously so approved, cease for any reason to constitute a
majority of our Board of Directors;
our consummation (whether we are directly or indirectly involved
through one or more intermediaries) of (x) a merger,
consolidation, reorganization, or business combination that
results in our outstanding voting securities immediately before
the transaction continuing to represent a majority of the voting
power of the acquiring companys outstanding voting
securities or a merger, consolidation, reorganization, or
business combination after which no person or entity owns 50% of
the successor companys voting power, (y) the sale,
exchange or transfer of all or substantially all of our assets
in any single transaction or series of transactions or
(z) the acquisition of assets or stock of another entity.
Amendment
and Termination of the 2007 Plan
Our Board of Directors or our Compensation Committee may
terminate, amend or modify the 2007 Plan. However, shareholder
approval of any amendment to the 2007 Plan will be obtained to
the extent necessary and desirable to comply with any applicable
law, regulation or stock exchange rule, or for any amendment to
the 2007 Plan that increases the number of shares available
under the 2007 Plan. If not terminated earlier by the
Compensation Committee or the Board of Directors, the 2007 Plan
will terminate on the tenth anniversary of the date of its
initial approval by our Board of Directors.
2007
Employee Stock Purchase Plan
Our Board of Directors has adopted the 2007 Employee Stock
Purchase Plan, or the Purchase Plan, which will be submitted to
our shareholders for their approval within twelve months from
the date our Board of Directors approved the Purchase Plan. The
Purchase Plan is designed to allow our eligible employees and
the eligible employees of our participating subsidiaries to
purchase shares of common stock with accumulated payroll
deductions. However, the Board of Directors will not establish
the first offering period (as further described below) earlier
than the first anniversary and no later than the fourth
anniversary of the date immediately preceding
99
the date of our initial public offering, and the Purchase Plan
will terminate on such fourth anniversary if our Board of
Directors does not take action to commence the first offering
period under the Purchase Plan prior to such date.
We have initially reserved a total of 588,235 shares of our
common stock for issuance under the Purchase Plan. The Purchase
Plan will contain an evergreen provision that allows
for an annual increase in the number of shares available for
issuance under the Purchase Plan on July 1 of each year during
the ten-year term of the Purchase Plan, beginning on July 1
following the fiscal year in which the first offering period
commences. The annual increase shall be equal to the least of:
2% of our outstanding common stock on the applicable July 1;
1,372,549 shares; or
a lesser amount determined by our Board of Directors.
Therefore, the Purchase Plan provides for an aggregate limit of
588,235 shares of common stock plus the share increases as
a result of the evergreen provision which may be
issued under the Purchase Plan over the course of its ten-year
term. The material terms of the Purchase Plan are summarized
below. The Purchase Plan is filed as an exhibit to the
registration statement of which this prospectus is a part.
The Purchase Plan will have consecutive
three-month
offering periods. Under the Purchase Plan, purchases will be
made on the last day of each offering period. The first offering
period will commence no earlier than the first anniversary and
no later than the fourth anniversary of the date immediately
preceding the date of our initial public offering. A new
three-month offering period will commence on each applicable
January 1, April 1, July 1 and October 1 thereafter
during the term of the Purchase Plan. Our Compensation Committee
may change the frequency and duration of offering periods under
the Purchase Plan.
Individuals scheduled to work more than 20 hours per week
for more than five calendar months per year may join an offering
period on the first day of the offering period to the extent
such individual does not, immediately after any rights under the
Purchase Plan are granted, own (directly or through attribution)
stock possessing 5% or more of the total combined voting power
or value of all classes of our common or other stock or of our
parent or a subsidiary. As of June 30, 2007, 439 of our
employees would have been eligible to participate in the
Purchase Plan if it were in effect.
Participants may contribute up to 20% of their cash earnings
through payroll deductions, and the accumulated deductions will
be applied to the purchase of shares on each purchase date. The
purchase price per share will be between 85% and 95% of the fair
market value per share on the first day of the offering period
or on the purchase date, as determined by our Board of
Directors. In each calendar year, no employee is permitted to
purchase more than $25,000 worth of shares at the fair market
value determined as of the first day of the offering period.
In the event of a proposed sale of all or substantially all of
our assets, or our merger with or into another company, the
outstanding rights under the Purchase Plan will be assumed or an
equivalent right substituted by the successor company or its
parent. If the successor company or its parent refuses to assume
the outstanding rights or substitute an equivalent right, then
all outstanding purchase rights will automatically be exercised
prior to the effective date of the transaction. The purchase
price will be equal to between 85% and 95% of the market value
per share on the first day of the offering period in which the
acquisition occurs or the date the purchase rights are
exercised, as determined by our Board of Directors.
The Purchase Plan will terminate no later than the tenth
anniversary of the Purchase Plans initial adoption by our
Board of Directors.
CERTAIN
RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS
The following is a summary of transactions since July 1,
2004 to which we have been a party in which the amount involved
exceeded $120,000 and in which any of our executive officers,
directors or beneficial holders of more than 5% of our capital
stock had or will have a direct or indirect material interest,
other than compensation arrangements that are described under
the section of this prospectus entitled Compensation
Discussion and Analysis.
100
Policies
and Procedures for Related-Party Transactions
We recognize that related party transactions present a
heightened risk of conflicts of interest and in connection with
this offering, have adopted a policy to which all related party
transactions shall be subject. Pursuant to the policy, the audit
committee of our board of directors, or in the case of a
transaction in which the aggregate amount is, or is expected to
be, in excess of $250,000, the board of directors will review
the relevant facts and circumstances of all related party
transactions, including, but not limited to, (i) whether
the transaction is on terms comparable to those that could be
obtained in arms length dealings with an unrelated third
party and (ii) the extent of the related partys
interest in the transaction. Pursuant to the policy, no
director, including the chairman of the audit committee may
participate in any approval of a related party transaction to
which he or she is a related party.
The audit committee will then, in its sole discretion, either
approve or disapprove the transaction.
Certain types of transactions, which would otherwise require
individual review, have been pre-approved by the audit
committee. These types of transactions include, for example,
(i) compensation to an officer or director where such
compensation is required to be disclosed in our proxy statement,
(ii) transactions where the interest of the related party
arises only by way of a directorship or minority stake in
another organization that is a party to the transaction and
(iii) transactions involving competitive bids or fixed
rates. Additionally, pursuant to the terms of our related party
transaction policy, all related party transactions are required
to be disclosed in the Companys applicable filings as
required by the Securities Act and the Exchange Act and related
rules. Furthermore, any material related party transactions are
required to be disclosed to the full Board of Directors. In
connection with becoming a public company, we will establish new
internal policies relating to disclosure controls and
procedures, which we expect will include policies relating to
the reporting of related party transactions that are
pre-approved under our related party transactions policy.
All of the transactions set forth below were approved by a
majority of the board of directors, including a majority of the
independent and disinterested members of the board of directors
prior to the adoption of our related party transaction policy.
We believe that we have executed all of the transactions set
forth below on terms no less favorable to us than we could have
obtained from unaffiliated third parties.
Loan
From Director Stockholders
On June 28, 2005, the Company entered into a loan
commitment with certain of its director stockholders and their
affiliates. The loan, which was made to supplement our working
capital, entitled us to borrow up to $8.050 million in two
installments. In June 2005, we borrowed $4.025 million. The
loan was secured by our accounts receivable and certain other
assets and was to mature on December 31, 2006. However, we
paid the loan in full, including $1.0 million in interest, on
December 21, 2006 and all obligations relating to the loan
have since been released.
Stockholders
Agreement
We entered into a Second Amended and Restated Stockholders
Agreement, dated December 19, 2003, with the holders of our
common stock and the holders of our Series B and
Series C preferred stock. We refer to this agreement below
as the stockholders agreement. The stockholders agreement
contains certain transfer restrictions, preemptive rights and
drag-along rights, each of which will terminate upon completion
of this offering.
Pursuant to the stockholders agreement, holders of shares of our
common stock and preferred stock have the registration rights
described below. These registration rights are subject to
certain conditions and limitations, including the right of the
underwriters of an offering to limit the number of shares
included in such registration and our right to postpone a
requested registration for a period of no more than
120 days if our board determines such registration would be
detrimental to us.
The holders of at least one-third of the shares of our common
stock issued or issuable to our preferred stockholders upon
conversion of their preferred stock, subject to certain
exceptions, may require us to file a registration statement
under the Securities Act at our expense with respect to such
shares of common stock. We are not obligated to take any action
to effect any registration demanded pursuant to the stockholders
agreement during
101
the period starting 60 days prior to and ending six months
following the effective date of any registration statement
pertaining to any of our securities. The stockholders agreement
grants three such demand registration rights.
Beginning six months after this offering, if we propose to
register any shares of our common stock, persons owning or
having the right to acquire shares of our common stock are
entitled to notice of such registration and are entitled to
include shares of their common stock therein.
We are obligated to pay all registration expenses, other than
underwriting commissions, brokerage fees or transfer taxes
related to any demand or piggyback registration. Each holder
agrees not to undertake any public sale or distribution of
shares of our common stock during the
180-day
period following the closing of an initial public offering of
our common stock. The stockholders agreement contains customary
indemnification provisions.
Individual
Stockholder Agreements
We entered into a Stockholder Agreement with our Chief Executive
Officer, Ronald J. Packard, and Knowledge Universe Learning,
Inc. (KULI) dated April 26, 2000. Pursuant to that
agreement, Mr. Packard granted to KULI an irrevocable proxy
to vote
and/or give
written consents with respect to any and all shares of the
Company owned by Mr. Packard
and/or
standing in the name of Mr. Packard on the books and
records of the Company or with respect to which Mr. Packard
otherwise may be entitled to vote at any and all annual or
special meetings of the stockholders of the Company or by
written consent. Upon the completion of this offering, this
agreement shall automatically terminate.
We entered into a Stockholder Agreement with William J. Bennett
and KULI on February 20, 2000. Dr. Bennett resigned as
a director and our Chairman in October 2005, at which time
certain terms of this agreement were amended in connection with
his resignation. Upon the closing of the offering, any
antidilution rights that remain in the agreement will terminate.
Employment
Agreements
We have entered into employment with certain of our executive
officers. For more information regarding these agreements. See
Compensation Discussion and Analysis
Employment Agreements.
102
PRINCIPAL
AND SELLING STOCKHOLDERS
The following table provides certain information regarding the
beneficial ownership of our outstanding capital stock as of
September 30, 2007, after giving effect to the 1 for
5.10 reverse stock split that was affected on
November 2, 2007, for:
each person or group who beneficially owns more than 5% of our
capital stock on a fully diluted basis;
each of the executive officers named in the Summary Compensation
Table;
each of our directors;
each of the selling stockholders; and
all of our directors and executive officers as a group.
Unless otherwise noted, the address for each director and
executive officer is c/o K12 Inc., 2300 Corporate Park
Drive, Herndon, VA 20171.
Shares Beneficially
Owned Prior
Shares Beneficially
Shares Beneficially Owned
to This
Shares to
Owned After This
Shares to be
After this Offering with
Offering(1)
be Sold in
Offering
Sold in the
the Over-Allotment
Name of Beneficial Owner
Number
Percent
This Offering
Number
Percent
Over-Allotment
Number
Percent
Executive Officers
Ronald J.
Packard(2)
917,908
4.07
%
917,908
3.29
%
917,908
3.29
%
John F.
Baule(3)
122,547
*
122,547
*
122,547
*
Bror V. H.
Saxberg(4)
91,910
*
91,910
*
91,910
*
Howard
D. Polsky(5)
22,253
*
22,253
*
22,253
*
Nancy
Hauge(6)
15,808
*
15,808
*
15,808
*
Celia M.
Stokes(7)
14,704
*
14,704
*
14,704
*
Bruce J. Davis
George B. Hughes, Jr.
Directors
Andrew H.
Tisch(8)
1,087,195
4.95
%
1,087,195
3.98
%
1,087,195
3.98
%
Thomas J.
Wilford(9)
825,993
3.76
%
825,993
3.03
%
825,993
3.03
%
Guillermo
Bron(10)
84,850
*
84,850
*
84,850
*
Steven B.
Fink(11)
23,157
*
23,157
*
23,157
*
Liza A.
Boyd(12)
Dr. Mary H. Futrell
All Directors and Executive Officers as a Group (14 persons)
3,206,325
14.04
%
3,206,325
11.38
%
3,206,325
11.38
%
Beneficial Owners of 5% or More of Our Outstanding Common
Stock
Learning Group
LLC(13)
5,274,254
24.06
%
5,274,254
19.35
%
5,274,254
19.35
%
CV II
Entities(14)
3,448,294
15.71
%
3,448,294
12.64
%
3,448,294
12.64
%
Mollusk Holdings,
LLC(15)
2,549,427
11.51
%
2,549,427
9.28
%
2,549,427
9.28
%
First Dallas International
Ltd.(16)
1,566,468
7.14
%
1,207,175
4.43
%
1,110,128
4.07
%
Locke
Limited(16)
1,566,468
7.14
%
299,379
1,207,175
4.43
%
33,954
1,110,128
4.07
%
Stargate,
Ltd.(16)
1,566,468
7.14
%
1,207,175
4.43
%
1,110,128
4.07
%
Tallulah,
Ltd.(16)
1,566,468
7.14
%
59,914
1,207,175
4.43
%
63,093
1,110,128
4.07
%
103
Shares Beneficially
Owned Prior
Shares Beneficially
Shares Beneficially Owned
to This
Shares to
Owned After This
Shares to be
After this Offering with
Offering(1)
be Sold in
Offering
Sold in the
the Over-Allotment
Name of Beneficial Owner
Number
Percent
This Offering
Number
Percent
Over-Allotment
Number
Percent
Other Selling Stockholders
Alscott Investments,
LLC(17)
825,993
3.77
%
278,699
547,294
2.01
%
126,334
420,960
1.54
%
Continental Casualty
Company(18)
731,636
3.34
%
251,716
479,920
1.76
%
114,102
365,818
1.34
%
Bennett Family Investment Limited Partnership
II(19)
588,233
2.68
%
101,189
487,044
1.79
%
106,558
380,486
1.40
%
Madison West Associates
Corp.(20)
341,430
1.56
%
117,467
223,963
*
123,699
100,264
*
Irani Family Limited Partnership
II(21)
304,502
1.39
%
34,921
269,581
*
36,773
232,808
*
MBNA Community Development
Corporation(22)
292,654
1.33
%
100,686
191,968
*
106,028
85,940
*
Adase Partners,
L.P.(23)
249,834
1.14
%
41,682
203,883
*
203,883
*
AT Investors,
LLC(24)
249,834
1.14
%
4,269
203,833
*
203,883
*
RS
Associates(25)
178,765
*
29,411
149,354
*
149,354
*
LexMap,
LLC(26)
166,377
*
57,241
109,136
*
60,278
48,858
*
Westbury Capital,
L.P.(27)
152,456
*
52,452
100,004
*
55,235
44,769
*
David F. Nathanson,
Trustee(28)
83,188
*
28,620
54,568
*
30,139
24,429
*
Douglas I. Lovison IRA Bear Sterns Sec. Corp.
Custodian(29)
73,163
*
18,235
54,928
*
54,928
*
David William Hanna,
Trustee(30)
73,162
*
10,068
48,085
*
10,603
21,676
*
Violet Hanna & David W. Hanna,
Trustees(31)
73,162
*
10,068
48,085
*
10,603
21,676
*
Hanna Ventures,
LLC(32)
73,162
*
4,941
48,085
*
5,203
21,676
*
Peter W.
May(33)
48,775
*
16,258
32,517
*
32,517
*
Nelson
Peltz(34)
48,775
*
16,258
32,517
*
32,517
*
BuenaVentura
Communications(35)
47,556
*
16,361
31,195
*
17,229
13,966
*
David S.
Kyman(36)
478
*
165
313
*
169
144
*
*
Less than 1% beneficial ownership.
(1)
Beneficial ownership of shares is
determined in accordance with the rules of the Securities and
Exchange Commission and generally includes any shares over which
a person exercises sole or shared voting or investment power.
Except as indicated by footnote, and subject to applicable
community property laws, to our knowledge, each stockholder
identified in the table possesses sole voting and investment
power with respect to all shares of common stock shown as
beneficially owned by the stockholder. The number of shares
beneficially owned by a person includes shares of common stock
subject to options and warrants held by that person that are
currently exercisable or exercisable within 60 days of
September 30, 2007 and not subject to repurchase as of that
date. Shares issuable pursuant to options and warrants are
deemed outstanding for calculating the percentage ownership of
the person holding the options and warrants but are not deemed
outstanding for the purposes of calculating the percentage
ownership of any other person. For purposes of this table, the
number of shares of common stock outstanding as of
September 30, 2007 is deemed to be 21,924,892 after giving
effect to the conversion of our outstanding preferred stock into
19,879,675 shares of common stock immediately prior to the
closing of this offering. For purposes of calculating the
percentage beneficially owned by any person, shares of common
stock issuable to such person upon the exercise of any options
or warrants exercisable within 60 days of
September 30, 2007 are also assumed to be outstanding.
(2)
Includes options for
622,543 shares of common stock and warrants to purchase
1,248 shares of common stock. These totals include both shares
and options held individually and in the 2006 Packard Investment
Partnership, L.P.
(3)
Includes options for
122,547 shares of common stock.
(4)
Includes options for
33,087 shares of common stock.
(5)
Includes options for
22,253 shares of common stock.
(6)
Includes options for
15,808 shares of common stock.
(7)
Includes options for
14,704 shares of common stock.
(8)
Includes options for
36,758 shares of common stock and warrants to purchase
2,497 shares of common stock. Also includes
244,882 shares of common stock issuable upon conversion of
preferred stock held by Andrew H. Tisch 1991 Trust #2,
35,711 shares of common stock issuable upon conversion of
preferred stock held by KAL Family Partnership and
35,711 shares of common stock issuable upon conversion of
preferred stock held by KSC Family Partnership. Mr. Tisch
has voting and investment control with respect to the shares
held by these entities. The address of these stockholders is
c/o Loews
Corporation, 667 Madison Avenue, 7th Floor,
New York, New York 10021. Also includes 731,636 shares
of common stock issuable upon conversion of preferred stock held
by Continental Casualty Company. Mr. Tisch is on the board
of directors of CNA Financial Corporation, which is affiliated
with Continental Casualty Company. Mr. Tisch disclaims
104
beneficial ownership of the shares
held by Continental Casualty Company. The address for
Continental Casualty Company is c/o CNA Financial Corporation,
CNA Center, Chicago, Illinois 60685.
(9)
Includes options for
15,926 shares of common stock. Also includes 810,067 shares
of common stock held by Alscott Investments, LLC.
Mr. Wilford has voting and investment power with respect to
shares held by this stockholder. The address of Alscott
Investments, LLC is 501 Baybrook Court, Boise, Idaho 83706.
Mr. Wilford disclaims beneficial ownership of the shares
held by Alscott Investment, LLC except to the extent of his
pecuniary interest therein.
(10)
Includes 84,850 shares of common
stock issuable upon conversion of preferred stock held by The
Bron Trust, dated July 27, 1998. Mr. Bron is not the
trustee of The Bron Trust, however, he is the beneficiary of The
Bron Trust and, therefore, is deemed to beneficially own such
shares. Mr. Bron disclaims beneficial ownership of the
shares held by The Bron Trust except to the extent of his
pecuniary interest, if any, therein.
(11)
Includes options for
23,157 shares of common stock. Does not include the shares
of common stock or preferred stock held by Mollusk Holdings,
LLC. Mr. Fink is the Chief Executive Officer of Lawrence
Investments, LLC. Lawrence Investments, LLC is a managing member
of Mollusk Holdings, LLC. Mr. Fink does not have voting
power nor investment power with respect to the common stock
directly or beneficially owned by Mollusk Holdings, LLC.
(12)
Does not include the shares of
preferred stock or options to acquire common stock held by
Constellation Venture Capital II, L.P., Constellation Venture
Capital Offshore II, L.P., The BSC Employee Fund IV, L.P.
and CVC II Partners, LLC (See note (14)). Ms. Boyd is a
Managing Director of Constellation Ventures. Ms. Boyd does
not have voting power nor investment power with respect to the
common stock beneficially owned by such funds.
(13)
Includes 4,665,083 shares of
common stock issuable upon conversion of preferred stock.
Learning Group LLC may be deemed to be controlled by Michael R.
Milken and/or Lowell J. Milken and as such, Michael R. Milken
and/or Lowell J. Milken may be deemed to have the power to
exercise investment and voting control over, and to share in the
beneficial ownership of, the shares beneficially owned by
Learning Group LLC. The address for Messrs. M. Milken and
L. Milken and Learning Group LLC is 1250 Fourth Street, Santa
Monica, CA 90401.
(14)
The CV II Entities consist of
(i) Constellation Venture Capital II, L.P. (CVC II),
(ii) Constellation Venture Capital Offshore II, L.P.
(Offshore), (iii) The BSC Employee Fund IV, L.P. (BSC)
and (iv) CVC II Partners, LLC (CVC II Partners, and
together with CVC II, Offshore and BSC, the Constellation
Funds). Constellation Ventures Management II LLC is the
sole general partner of CVC II, the sole general partner of
Offshore and the sole managing general partner of BSC. Bear
Stearns Asset Management Inc. is the managing member of CVC II
Partners and the investment adviser to each Constellation Fund.
Clifford Friedman is a member of Constellation Ventures
Management II, LLC and a senior managing director of Bear
Stearns Asset Management Inc. The Bear Stearns Companies Inc., a
registered broker-dealer, is the sole managing member of
Constellation Ventures Management II, LLC and the parent
corporation of Bear Stearns Asset Management Inc. Constellation
Ventures Management II, LLC, Bear Stearns Asset Management Inc.
and Mr. Friedman share investment and voting control of
shares beneficially owned by CVC II, Offshore and BSC. Bear
Stearns Asset Management Inc. exercises sole investment and
voting control of the shares beneficially owned by CVC II
Partners. The address for each such entity and person is 237
Park Avenue, New York, New York 10017.
The holdings of the CV II Entities
include: (i) 1,807,854 shares of common stock issuable upon
conversion of preferred stock held by CVC II and options for
15,550 shares of common stock assigned to CVC II by
Ms. Boyd or a former director appointed by the
Constellation Funds; (ii) 854,698 shares of common stock
issuable upon conversion of preferred stock held by Offshore and
options for 7,352 shares of common stock assigned to
Offshore by Ms. Boyd or a former director appointed by the
Constellation Funds; (iii) 716,227 shares of common stock
issuable upon conversion of preferred stock held by BSC and
options for 6,160 shares of common stock assigned to BSC by
Ms. Boyd or a former director appointed by the Constellation
Funds; and (iv) 40,108 shares of common stock issuable upon
conversion of preferred stock held by CVC II Partners and
options for 345 shares of common stock assigned to CVC II
Partners by Ms. Boyd or a former director appointed by the
Constellation Funds. Ms. Boyd is affiliated with the
Constellation Funds but disclaims beneficial ownership of the
shares held by them. The CV II Entities has informed us that it
purchased the shares being registered on their behalf in the
ordinary course of business and, at the time of their purchase,
had no agreement or understanding, directly or indirectly, with
any person to distribute those shares.
(15)
Includes 1,561,253 shares of
common stock issuable upon conversion of preferred stock and
warrants to purchase shares of preferred stock convertible into
228,270 shares of common stock upon consummation of this
offering. The address of this stockholder is 101 Ygnacio
Valley Road, Suite 310, Walnut Creek, California 94596.
Cephalopod Corporation and Lawrence Investments, LLC are the
members of Mollusk Holdings, LLC. Cephalopod Corporation is the
managing member of Mollusk Holdings, LLC. Mr. Lawrence J.
Ellison is the Chief Executive Officer of Cephalopod
Corporation. The Lawrence J. Ellison Revocable Trust U/D/D
12/8/95 (Ellison Trust), Philip B. Simon and Steven
B. Fink are the members of Lawrence Investments, LLC.
Mr. Fink is the Chief Executive Officer of Lawrence
Investments, LLC and Mr. Simon is the President of Lawrence
Investments, LLC. Mr. Ellison is the sole beneficiary and
co-trustee of the Ellison Trust. Mr. Simon is the other
co-trustee. Mr. Ellison may be deemed to exercise
investment and voting control over the shares beneficially owned
by Mollusk Holdings, LLC. The address for Mr. Ellison is
500 Oracle Parkway, Redwood Shores, California 94065.
(16)
The general partner of Tallulah,
Ltd. (Tallulah) is Mr. Sam Wyly. Mr. Sam Wylys
children are contingent beneficiaries of a trust that is the
owner of all of the shares of stock of Locke Limited (Locke).
The general partner of Stargate, Ltd. (Stargate) is The Charles
J. Wyly, Jr. and Caroline D. Wyly Revocable Trust of which
Mr. Charles J. Wyly, Jr. is a trustee. Mr. Charles J.
Wyly, Jr.s children or Mr. Charles J. Wyly, Jr., his
spouse and his issue are present or contingent beneficiaries of
certain trusts that own subsidiaries that are the owners of all
of the shares of stock of First Dallas International Ltd. (First
Dallas). First Dallas is under voluntary liquidation under the
direction of Kinetic Partners Cayman LLP. Mr. Sam Wyly and
Mr. Charles J. Wyly, Jr. are brothers. Collectively, Sam
Wyly, Charles J. Wyly, Jr., Tallulah, Stargate, Locke and First
Dallas may be deemed to beneficially own, for purposes of
Section 13(d) of the Exchange Act, 1,566,472 shares of
common stock issuable upon conversion of preferred stock. The
address for each of Tallulah, and Stargate is
c/o Highland
Stargate, Ltd., 300 Crescent Court, Suite 1000, Dallas,
Texas 75201. The address for Locke is International House,
Castle Hill, Victoria Road, Douglas, Isle of Man IM2 4RB. The
address for First Dallas is
c/o Kinetic
Partners, P.O. Box 10387, Grand Cayman Islands
KY1-1004.
Includes 435,217 shares of
common stock issuable upon conversion of preferred stock held by
First Dallas, 870,175 shares of common stock issuable upon
conversion of preferred stock held by Locke, 86,938 shares
of common stock issuable upon conversion of preferred stock held
by Stargate and 174,138 common stock issuable upon conversion of
preferred stock held by Tallulah. Locke disclaims beneficial
ownership of the shares held by First Dallas, Stargate and
Tallulah.
(17)
Includes 810,067 shares of
common stock issuable upon conversion of preferred stock and
options for 15,926 shares of common stock. Thomas Wilford
has voting and investment power with respect to shares held by
Alscott Investments, LLC. In addition, J.B. Scott, by way of
his ownership of the managing member of Alscott Investments,
LLC, may also be deemed to have voting and investment power with
respect to shares owned by Alscott Investments, LLC.
105
(18)
Includes 731,636 shares of
common stock issuable upon conversion of preferred stock.
Continental Casualty Company is a subsidiary of CNA Financial
Corporation, a NYSE listed and traded company. As such, CNA
Financial Corporation may also be deemed to have voting and
investment power with respect to shares owned by Continental
Casualty Company. Continental Casualty Company is affiliated
with CNA Investor Services, Inc., a limited purpose
broker-dealer that does not participate in initial public
offerings. Continental Casualty Company has informed us that it
purchased the shares being registered on its behalf in the
ordinary course of business and, at the time of its purchase,
had no agreement or understanding, directly or indirectly, with
any person to distribute those shares.
(19)
Includes options for
294,116 shares of common stock. William J. Bennett is the
general partner of Bennett Family Investment Limited
Partnership II and as such, Mr. Bennett may be deemed
to have voting and investment power with respect to shares owned
by Bennett Family Investment Limited Partnership II.
(20)
Includes 341,430 shares of
common stock issuable upon conversion of preferred stock.
Madison West Associates Corp. is a subsidiary of Triarc
Companies, Inc. The Capital and Investment Committee of the
Board of Directors of Triarc Companies, Inc. has voting and
investment power with respect to shares owned by Madison West
Associated Corp. The members of the committee are Nelson Peltz,
Chairman of Triarc Companies, Inc., Peter W. May, Vice Chairman
of Triarc Companies, Inc., and Roland C. Smith, Chief Executive
Officer of Triarc Companies, Inc.
(21)
Includes 101,500 shares of
common stock issuable upon conversion of preferred stock. Also
includes 203,002 shares of common stock issuable upon
conversion of preferred stock held by Ray R. Irani, Trustee of
the Ray R. Irani Declaration of Trust dtd 11/13/90. Dr. Ray
R. Irani is the managing member of the general partner of the
Irani Family Limited Partnership II and as such,
Dr. Irani may be deemed to have voting and investment power
with respect to shares owned by the Irani Family Limited
Partnership II.
(22)
Includes 292,654 shares of
common stock issuable upon conversion of preferred stock. MBNA
Community Development Corporation is a direct wholly-owned
subsidiary of Bank of America Corporation, a NYSE listed and
traded company. As such, Bank of America Corporation may also be
deemed to have voting and investment power with respect to
shares owned by MBNA Community Development Corporation. In
addition, Bank of America Securities LLC, Banc of America
Investment Services, Inc., Banc of America Finance Services,
Inc., Columbia Management Distributors, Inc., UST Securities
Corp. and LaSalle Financial Services, Inc. (collectively, the
Members), each of which is a member of the NASD, is each an
affiliate of Bank of America Corporation. As a result, MBNA
Community Development Corporation may be deemed to be an
affiliate of the Members. MBNA Community Development Corporation
has informed us that it purchased the shares being registered on
its behalf in the ordinary course of business and, at the time
of its purchase, had no agreement or understanding, directly or
indirectly, with any person to distribute those shares.
(23)
Includes 166,729 shares of
common stock issuable upon conversion of preferred stock. Also
includes 17,075 shares of common stock issuable upon
conversion of preferred stock held by AT Investors, LLC,
45,202 shares of common stock issuable upon conversion of
preferred stock held by Bahram Nour-Omid and options for
20,828 shares of common stock held by Arthur Bilger. Arthur
Bilger has voting and investment power with respect to shares
owned by both Adase Partners, L.P. and AT Investors, LLC.
(24)
Includes 17,075 shares of
common stock issuable upon conversion of preferred stock. Also
includes 166,729 shares of common stock issuable upon
conversion of preferred stock held by Adase Partners, L.P.,
45,202 shares of common stock issuable upon conversion of
preferred stock held by Bahram Nour-Omid and options for
20,828 shares of common stock held by Arthur Bilger. Arthur
Bilger has voting and investment power with respect to shares
owned by both Adase Partners, L.P. and AT Investors, LLC.
(25)
Includes 178,765 shares of
common stock issuable upon conversion of preferred stock. Ralph
Finerman has voting and investment power with respect to shares
owned by RS Associates.
(26)
Includes 166,377 shares of
common stock issuable upon conversion of preferred stock. Marc
Nathanson and Lou Gonda have voting and investment power with
respect to shares owned by LexMap, LLC.
(27)
Includes 152,456 shares of
common stock issuable upon conversion of preferred stock. J.G.
Fogg & Co. is the general partner of Westbury Capital,
L.P. and Joseph G. Fogg III is the majority owner of J.G.
Fogg & Co. As such, Mr. Fogg may be deemed to
have voting and investment power with respect to shares owned by
Westbury Capital, L.P.
(28)
Includes 83,188 shares of
common stock issuable upon conversion of preferred stock.
Mr. Nathanson is the trustee for the David F.
Nathanson Revocable Trust dtd 7/22/06.
(29)
Includes 73,163 shares of
common stock issuable upon conversion of preferred stock.
Douglas I. Lovison has voting and investment power with respect
to shares owned by Douglas I. Lovison IRA, Bear Stearns
Securities Corporation, Custodian.
(30)
Includes 29,265 shares of
common stock issuable upon conversion of preferred stock. Also
includes 29,265 shares of common stock issuable upon
conversion of preferred stock held by Violet Hanna &
David W. Hanna, Trustees for the Hanna Living Trust dtd
7/7/83 and
14,632 shares of common stock issuable upon conversion of
preferred stock held by Hanna Ventures, LLC. Mr. Hanna is the
trustee for the David William Hanna Trust dtd 10/30/89.
(31)
Includes 29,265 shares of
common stock issuable upon conversion of preferred stock. Also
includes 29,265 shares of common stock issuable upon
conversion of preferred stock held by David William Hanna,
Trustee for the David William Hanna Trust dtd
10/30/89 and
14,632 shares of common stock issuable upon conversion of
preferred stock held by Hanna Ventures, LLC. Ms. Hanna and Mr.
Hanna are the trustees for the Hanna Living Trust dtd 7/7/83.
(32)
Includes 14,632 shares of
common stock issuable upon conversion of preferred stock. Also
includes 29,265 shares of common stock issuable upon
conversion of preferred stock held by David William Hanna,
Trustee for the David William Hanna Trust dtd
10/30/89 and
29,265 shares of common stock issuable upon conversion of
preferred stock held by Violet Hanna & David W. Hanna,
Trustees for the Hanna Living Trust dtd
7/7/83.
David W. Hanna and Virginia Hanna are the principals of Hanna
Ventures, LLC and as such, they may be deemed to have voting and
investment power with respect to shares owned by Hanna Ventures,
LLC.
(33)
Includes 48,775 shares of
common stock issuable upon conversion of preferred stock.
(34)
Includes 48,775 shares of
common stock issuable upon conversion of preferred stock.
(35)
Includes 47,556 shares of
common stock issuable upon conversion of preferred stock. David
D. Villanueva and Daniel L. Villanueva, in their capacity as
officers of BuenaVentura Communications, Inc., may be deemed to
have voting and investment power with respect to shares owned by
BuenaVentura Communications, Inc.
(36)
Includes 365 shares of common
stock issuable upon conversion of preferred stock.
106
DESCRIPTION
OF CAPITAL STOCK
The following description of our capital stock is only a
summary, and is qualified in its entirety by reference to the
actual terms and provisions of the capital stock contained in
our Amended and Restated Certificate of Incorporation, as
amended, Bylaws, as amended, and other agreements to which we
and our stockholders are parties.
As of September 30, 2007, there were 2,045,217 shares
of common stock outstanding, held of record by
40 stockholders, and there were 51,524,974 shares of
Series B preferred stock and 49,861,562 shares of
Series C preferred stock outstanding, held of record by 62
and 39 stockholders, respectively.
Immediately prior to the completion of this offering, all
outstanding shares of our preferred stock will be converted into
shares of our common stock pursuant to the terms thereof without
any further action required by us or the holders of the
preferred stock. Upon completion of this offering, our
authorized capital stock will consist of 100,000,000 shares
of common stock, par value $0.0001 per share, and
10,000,000 shares of preferred stock, par value
$0.0001 per share, all of which shares of preferred stock
will be undesignated.
Common
Stock
The holders of our common stock are entitled to the following
rights:
Voting
Rights
Each share of our common stock entitles its holder to one vote
per share on all matters to be voted upon by the stockholders.
There is no cumulative voting, which means that a holder or
group of holders of more than 50% of the shares of our common
stock can elect all of our directors.
Dividend
Rights
The holders of our common stock are entitled to receive
dividends when and as declared by our board of directors from
legally available sources, subject to any restrictions in our
Amended and Restated Certificate of Incorporation, as amended,
or prior rights of the holders of our preferred stock. See
Dividend Policy.
Liquidation
Rights
In the event of our liquidation or dissolution, the holders of
our common stock are entitled to share ratably in the assets
available for distribution after the payment of all of our debts
and other liabilities, subject to the prior rights of the
holders of our preferred stock.
Other
Matters
The holders of our common stock have no subscription, redemption
or conversion privileges. Our common stock does not entitle its
holders to preemptive rights. All of the outstanding shares of
our common stock are fully paid and nonassessable. The rights,
preferences and privileges of the holders of our common stock
are subject to the rights of the holders of shares of any series
of preferred stock which we may issue in the future.
Preferred
Stock
Our board of directors has the authority to issue preferred
stock in one or more classes or series and to fix the
designations, powers, preferences, and rights, and the
qualifications, limitations or restrictions thereof including
dividend rights, dividend rates, conversion rights, voting
rights, terms of redemption, redemption prices, liquidation
preferences and the number of shares constituting any class or
series, without further vote or action by the stockholders. The
issuance of preferred stock may have the effect of delaying,
deferring, or preventing a change in control of our company
without further action by the stockholders and may adversely
affect the voting and other rights of the holders of our common
stock. As of September 30, 2007, there was
51,524,974 shares of Series B preferred stock and
49,861,562 of Series C preferred stock issued and
outstanding.
107
Governing
Documents and Delaware Law that May Have an Antitakeover
Effect
The provisions of (1) Delaware law, (2) our amended
and restated certificate of incorporation to be effective upon
completion of this offering, and (3) our amended and
restated bylaws to be effective upon completion of this
offering, which are discussed below, could discourage or make it
more difficult to accomplish a proxy contest or other change in
our management or the acquisition of control by a holder of a
substantial amount of our voting stock.
Amended
and Restated Certificate of Incorporation and Amended and
Restated Bylaws
Upon consummation of the offering, we expect that our amended
and restated certificate of incorporation and amended and
restated bylaws will contain provisions that could have the
effect of discouraging potential acquisition proposals or tender
offers or delaying or preventing a change of control of the
Company. In particular, we expect that our amended and restated
certificate of incorporation and amended and restated bylaws, as
applicable, among other things, will:
provide that special meetings of the stockholders may be called
only by our Chairman of the Board, Chief Executive Officer, by
the request in writing of a majority of the members of the board
of directors or by the request in writing of stockholders
holding in aggregate at least 40 % of the number of shares
outstanding;
establish procedures with respect to stockholder proposals and
stockholder nominations, including requiring advance written
notice of a stockholder proposal or director nomination;
not permit action by stockholders by written consent in lieu of
a meeting of stockholders;
not include a provision for cumulative voting in the election of
directors. Under cumulative voting, a minority stockholder
holding a sufficient number of shares may be able to ensure the
election of one or more directors. The absence of cumulative
voting may have the effect of limiting the ability of minority
stockholders to effect changes in the board of directors and, as
a result, may have the effect of deterring a hostile takeover or
delaying or preventing changes in control or management of our
company;
provide that vacancies on our board of directors may be filled
by a majority of directors in office, although less than a
quorum, and not by the stockholders;
require that the vote of holders of
662/3%
of the voting power of the outstanding shares entitled to vote
generally in the election of directors is required to amend our
amended and restated certificate of incorporation and amended
and restated bylaws; and
provide that the board of directors has the power to alter,
amend or repeal the bylaws without stockholder approval.
Following the completion of this offering, our amended and
restated certificate of incorporation will authorize our board
of directors, without further vote or action by the
stockholders, to issue up to 10,000,000 shares of preferred
stock, par value $0.0001 per share, in one or more classes or
series, and to fix or alter:
the number of shares constituting any class or series;
the designations, powers and preferences of each class or series;
the relative, participating, optional and other special rights
of each class or series; and
any qualifications, limitations or restrictions on each class or
series.
The above provisions are intended to promote continuity and
stability in the composition of our board of directors and in
the policies formulated by the board, and to discourage certain
types of transactions that may involve an actual or threatened
change of control. These provisions are expected to reduce our
vulnerability to unsolicited acquisition attempts as well as
discourage certain tactics that may be used in proxy fights.
Such provisions, however, could discourage others from making
tender offers for our shares and, as a consequence, may also
inhibit fluctuations in the market price of our common stock
that could result from actual or rumored takeover attempts.
These provisions could also operate to prevent changes in our
management.
108
Delaware
Takeover Statute
We are subject to the provisions of Section 203 of the
Delaware General Corporation Law, or the DGCL. Subject to
certain exceptions, Section 203 prohibits a Delaware
corporation from engaging in a business combination
with an interested stockholder for a period of three
years after the time that the stockholder became an interested
stockholder, unless:
prior to the date of the business combination, the board of
directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder
becoming an interested stockholder;
on consummation of the transaction that resulted in the
stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced,
excluding for purposes of determining the voting stock
outstanding (but not the outstanding voting stock of the
interested stockholder) those shares owned:
by persons who are directors and also officers, and
by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held
subject to the plan will be tendered in a tender or exchange
offer; or
at or subsequent to such time, the business combination is
approved by the board of directors and authorized at an annual
or special meeting of stockholders, and not by written consent,
by the affirmative vote of at least
662/3%
of the outstanding voting stock that is not owned by the
interested stockholder.
A business combination includes:
any merger or consolidation involving the corporation and the
interested stockholder;
any sale, transfer, pledge or other disposition of 10% or more
of the assets of the corporation involving the interested
stockholder;
subject to certain exceptions, any transaction that results in
the issuance or transfer by the corporation of any stock of the
corporation to the interested stockholder;
any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or
series of the corporation beneficially owned by the interested
stockholder; or
the receipt by the interested stockholder of the benefit of any
loans, advances, guarantees, pledges or other financial benefits
provided by or through the corporation.
Subject to various exceptions, an interested
stockholder is an entity or person who, together with
affiliates and associates, owns (or within three years from the
date of determination, did own) 15% or more of the
corporations outstanding voting stock. This statute could
delay, defer or prohibit a merger or other takeover or a change
of control of the Company.
NYSE
Arca
We intend to list our common stock on the NYSE Arca under the
symbol LRN.
Transfer
Agent and Registrar
The transfer agent and registrar for our common stock will be
Registrar and Transfer Company.
109
CERTAIN
UNITED STATES FEDERAL INCOME TAX
CONSIDERATIONS TO
NON-U.S.
HOLDERS
The following is a summary of the material U.S. federal
income tax consequences to
non-U.S. holders
of the ownership and disposition of our common stock, but does
not purport to be a complete analysis of all the potential tax
considerations relating thereto. This summary is based upon the
provisions of the Internal Revenue Code of 1986, as amended, or
the Code, U.S. Department of the Treasury regulations
promulgated thereunder, administrative rulings and judicial
decisions, all as of the date hereof. These authorities may be
changed, possibly retroactively, so as to result in
U.S. federal income tax consequences different from those
set forth below. This summary is applicable only to
non-U.S. holders
who hold our common stock as a capital asset (generally, an
asset held for investment purposes). We have not sought any
ruling from the Internal Revenue Service, or the IRS, with
respect to the statements made and the conclusions reached in
the following summary, and there can be no assurance that the
IRS will agree with such statements and conclusions.
This summary also does not address the tax considerations
arising under the laws of any foreign, state or local
jurisdiction. In addition, this discussion does not address tax
considerations applicable to an investors particular
circumstances or to investors that may be subject to special tax
rules, including, without limitation:
banks, insurance companies, or other financial institutions;
persons subject to the alternative minimum tax;
tax-exempt organizations;
dealers in securities or currencies;
traders in securities that elect to use a mark-to-market method
of accounting for their securities holdings;
entities treated as partnerships for U.S. federal income
tax purposes or investors in such entities;
controlled foreign corporations, passive
foreign investment companies and corporations that
accumulate earnings to avoid U.S. federal income tax;
U.S. expatriates or former long-term residents of the
United States;
persons who hold our common stock as a position in a hedging
transaction, straddle, conversion
transaction or other risk reduction transaction; or
persons deemed to sell our common stock under the constructive
sale provisions of the Code.
In addition, if a partnership or other entity treated as a
partnership for U.S. federal income tax purposes holds our
common stock, the tax treatment of a partner generally will
depend on the status of the partner and upon the activities of
the partnership. Accordingly, partnerships which hold our common
stock and partners in such partnerships should consult their tax
advisors.
This discussion is for general information only and is not
tax advice. You are urged to consult your tax advisor with
respect to the application of the U.S. federal income tax
laws to your particular situation, as well as any tax
consequences of the purchase, ownership and disposition of our
common stock arising under the U.S. federal estate or gift
tax rules or under the laws of any state, local, foreign or
other taxing jurisdiction or under any applicable tax treaty.
Non-U.S.
Holder Defined
For purposes of this discussion, you are a
non-U.S. holder
if you are a holder that, for U.S. federal income tax
purposes, is not a U.S. person. For purposes of this
discussion, you are a U.S. person if you are:
an individual who is a citizen or resident of the United States,
including an alien individual who is a lawful permanent resident
of the United States or who meets the substantial
presence test under Section 7701(b) of the Code;
110
a corporation, or other entity taxable as a corporation for
U.S. tax purposes, created or organized in the United
States or under the laws of the United States or of any state
therein or the District of Columbia;
an estate whose income is subject to U.S. federal income
tax regardless of its source; or
a trust (1) whose administration is subject to the primary
supervision of a U.S. court and which has one or more
U.S. persons who have the authority to control all
substantial decisions of the trust or (2) which has made an
election to be treated as a U.S. person.
Distributions
As discussed under Dividend Policy above, we do not
currently expect to pay dividends or other distributions on our
common stock.
If distributions are made on shares of our common stock, those
payments will constitute dividends for U.S. tax purposes to
the extent paid from our current or accumulated earnings and
profits, as determined under U.S. federal income tax
principles. To the extent those distributions exceed both our
current and our accumulated earnings and profits, they will
constitute a return of capital and will first reduce your basis
in our common stock, but not below zero, and then will be
treated as gain from the sale of stock.
Any dividend paid to you generally will be subject to
U.S. withholding tax either at a rate of 30% of the gross
amount of the dividend or such lower rate as may be specified by
an applicable tax treaty. In order to receive a reduced treaty
rate, you must provide the appropriate withholding agent with an
IRS
Form W-8BEN
or other appropriate version of IRS
Form W-8
certifying qualification for the reduced rate.
Dividends received by you that are effectively connected with
your conduct of a U.S. trade or business (and, where a tax
treaty applies, are attributable to a U.S. permanent
establishment maintained by you) are exempt from such
withholding tax. In order to obtain this exemption, you must
provide the appropriate withholding agent with an IRS
Form W-8ECI
properly certifying such exemption. Such effectively connected
dividends, although not subject to withholding tax, are taxed at
the same graduated rates applicable to U.S. persons, net of
any allowable deductions and credits. In addition, if you are a
corporate
non-U.S. holder,
dividends you receive that are effectively connected with your
conduct of a U.S. trade or business may also be subject to
a branch profits tax at a rate of 30% or such lower rate as may
be specified by an applicable tax treaty.
If you are eligible for a reduced rate of withholding tax
pursuant to a tax treaty, you may obtain a refund of any excess
amounts currently withheld if you file an appropriate claim for
refund with the IRS in a timely manner.
Gain on
Disposition of Common Stock
You generally will not be required to pay U.S. federal
income tax on any gain realized upon the sale or other
disposition of our common stock unless:
the gain is effectively connected with your conduct of a
U.S. trade or business (and, where a tax treaty applies, is
attributable to a U.S. permanent establishment maintained
by you);
you are an individual who is present in the United States for a
period or periods aggregating 183 days or more during the
calendar year in which the sale or disposition occurs and
certain other conditions are met; or
our common stock constitutes a U.S. real property interest
by reason of our status as a United States real property
holding corporation (a USRPHC) for U.S. federal
income tax purposes at any time within the shorter of the
five-year period preceding the disposition or your holding
period for our common stock.
We believe that we are not currently and will not become a
USRPHC. However, because the determination of whether we are a
USRPHC depends on the fair market value of our U.S. real
property relative to the fair market value of our other business
assets, there can be no assurance that we will not become a
USRPHC in the future. Even if we become USRPHC, however, as long
as our common stock is regularly traded on an established
securities market, such common stock will be treated as
U.S. real property interests only if you actually or
constructively hold more than 5% of our common stock.
111
If you are a
non-U.S. holder
described in the first bullet above, you will be required to pay
tax on the net gain derived from the sale under regular
graduated U.S. federal income tax rates, and corporate
non-U.S. holders
described in the first bullet above may be subject to the branch
profits tax at a 30% rate or such lower rate as may be specified
by an applicable income tax treaty. If you are an individual
non-U.S. holder
described in the second bullet above you will be required to pay
a flat 30% tax on the gain derived from the sale, which tax may
be offset by U.S. source capital losses. You should consult
any applicable income tax treaties that may provide for
different rules.
Backup
Withholding and Information Reporting
Generally, we must report annually to the IRS the amount of
dividends paid to you, your name and address, and the amount of
tax withheld, if any. A similar report will be sent to you.
These information reporting requirements apply even if
withholding is not required. Pursuant to tax treaties or other
agreements, the IRS may make its reports available to tax
authorities in your country of residence.
Payments of dividends made to you will not be subject to backup
withholding if you establish an exemption, for example, by
properly certifying your
non-U.S. status
on a
Form W-8BEN
or another appropriate version of
Form W-8.
Notwithstanding the foregoing, backup withholding at a current
rate of 28%, may apply if either we or our paying agent has
actual knowledge, or reason to know, that you are a
U.S. person.
Payments of the proceeds from a disposition of our common stock
effected outside the United States by a
non-U.S. holder
made by or through a foreign office of a broker generally will
not be subject to information reporting or backup withholding.
However, information reporting (but not backup withholding) will
apply to such a payment if the broker is a U.S. person, a
controlled foreign corporation for U.S. federal income tax
purposes, a foreign person 50% or more of whose gross income is
effectively connected with a U.S. trade or business for a
specified three-year period, or a foreign partnership with
certain connections with the United States, unless the broker
has documentary evidence in its records that the beneficial
owner is a
non-U.S. holder
and specified conditions are met or an exemption is otherwise
established.
Payments of the proceeds from a disposition of our common stock
by a
non-U.S. holder
made by or through the U.S. office of a broker is generally
subject to information reporting and backup withholding unless
the
non-U.S. holder
certifies as to its
non-U.S. holder
status under penalties of perjury or otherwise establishes an
exemption from information reporting and backup withholding.
Backup withholding is not an additional tax. Rather, the
U.S. income tax liability of persons subject to backup
withholding will be reduced by the amount of tax withheld. If
withholding results in an overpayment of taxes, a refund or
credit may be obtained, provided that the required information
is furnished to the IRS in a timely manner.
112
SHARES
ELIGIBLE FOR FUTURE SALE
If our stockholders sell substantial amounts of our common
stock, including shares issued upon the exercise of outstanding
options or warrants, in the public market following the
offering, the market price of our common stock could decline.
These sales also might make it more difficult for us to sell
equity or equity-related securities in the future at a time and
price that we deem appropriate.
Upon completion of the offering, we will have outstanding an
aggregate of 27,257,244 shares of our common stock,
assuming no exercise of the underwriters overallotment
option and no exercise of outstanding options and assuming the
sale of 882,352 shares of common stock in the
Regulation S Transaction (based on an assumed initial
public offering price of $17.00 per share, the midpoint of the
range set forth on the cover page of this prospectus). Of these
shares, all of the shares sold in the offering will be freely
tradable without restriction or further registration under the
Securities Act, unless the shares are purchased by
affiliates as that term is defined in Rule 144
under the Securities Act. This leaves 21,257,244 shares
eligible for sale in the public market as follows:
Number of
Shares
Date
359,755
At various times after the date of this prospectus, as described
below under Rule 144 and
Rule 144(k).
20,897,489
At various times after 180 days from the date of this
prospectus as described below under Lock-up
Agreements.
Rule 144
In general, under Rule 144 as currently in effect,
beginning 90 days after the date of this prospectus, a
person who has beneficially owned shares of our common stock for
at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the
greater of:
1% of the number of shares of our common stock then outstanding,
which will equal approximately 272,572 shares immediately
after the offering; or
the average weekly trading volume of our common stock on NYSE
Arca during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to that sale.
Sales under Rule 144 are also subject to manner of sale
provisions and notice requirements and to the availability of
current public information about us. On November 15, 2007,
the SEC adopted amendments to Rule 144 which shorten the
holding period described above from one year to six months and
allow a person who has beneficially owned restricted shares of
our common stock for at least six months to sell shares without
complying with the volume limitation, manner of sale or notice
provisions described above, provided that such person is
not deemed to have been an affiliate of ours at the time of, or
at any time during the three months preceding, such sale. Any
such sales must comply with the public information provision of
Rule 144 until our common stock has been held for one year.
The amendments will become effective 60 days after
publication in the Federal Register.
Rule 144(k)
Under Rule 144(k), a person who is not deemed to have been
one of our affiliates at any time during the three months
preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years, including the
holding period of any prior owner other than an affiliate, is
entitled to sell those shares without complying with the manner
of sale, public information, volume limitation or notice
provisions of Rule 144. The SEC has a proposal pending to
shorten the two-year holding period to six months.
The
Regulation S Transaction
Assuming an initial public offering price of $17.00 per share,
the midpoint of the range set forth on the cover page of this
prospectus, we will sell 882,352 shares of common stock in
the Regulation S Transaction. The shares to be sold in the
Regulation S Transaction are not registered by the
registration statement of which this prospectus is a part and
have not otherwise been registered under the Securities Act.
Pursuant to the terms of Regulation S these
113
shares may not be resold in the United States for a year
following the closing date of the Regulation S Transaction,
and may be offered or sold only pursuant to an effective
registration statement, pursuant to an available exemption from
the registration requirements of the Securities Act or in
compliance with Regulation S and Rule 144. Upon the
expiration of six months following the closing date of the
Regulation S Transaction, at the demand of the investor, we
are required to register the resale of the shares under the
Securities Act. Additionally, the shares to be sold in the
Regulation S Transaction are subject to a lock-up pursuant
to which the investor has agreed not to offer, sell or agree to
sell, directly or indirectly, any shares of common stock for a
period of 180 days from the date of this prospectus without
the prior written consent of Morgan Stanley & Co.
Incorporated and Credit Suisse Securities (USA) LLC on behalf of
the underwriters.
Lock-Up
Agreements
All of our officers and directors and certain of our
stockholders have entered into
lock-up
agreements under which they agreed not to transfer or dispose
of, directly or indirectly, any shares of our common stock or
any securities convertible into or exercisable or exchangeable
for shares of our common stock, except for shares sold in this
offering by the selling stockholders, for a period of
180 days after the date of this prospectus without the
prior written consent of Morgan Stanley & Co. Incorporated
and Credit Suisse Securities (USA) LLC on behalf of the
underwriters.
In addition, at our request, Morgan Stanley & Co.
Incorporated has reserved for sale, at the initial public
offering price, up to 10% of the shares of common stock offered
for sale pursuant to this prospectus for sale to our directors,
officers, employees, business associates and related persons in
a directed share program. Any of these directed shares purchased
by our directors, executive officers, employees and business
associates, such as clients or suppliers, will be subject to a
180-day
lock-up
restriction. Accordingly, the number of shares freely
transferable upon completion of this offering will be reduced by
the number of directed shares purchased by our directors,
executive officers, employees and business associates, and there
will be a corresponding increase in the number of shares that
become eligible for sale after 180 days from the date of
this prospectus.
Rule 701
In general, under Rule 701 of the Securities Act as
currently in effect, any of our employees, consultants or
advisors who purchase shares of our common stock from us in
connection with a compensatory stock or option plan or other
written agreement is eligible to resell those shares
90 days after the effective date of the offering in
reliance on Rule 144, but without compliance with some of
the restrictions, including the holding period, contained in
Rule 144.
The SEC has indicated that Rule 701 will apply to typical
stock options granted by an issuer before it becomes subject to
the reporting requirements of the Exchange Act, along with the
shares acquired upon exercise of such options, including
exercises after the date of this prospectus. Securities issued
in reliance on Rule 701 are restricted securities and,
subject to the contractual restrictions described above,
beginning 90 days after the date of this prospectus, may be
sold by persons other than affiliates, as defined in
Rule 144, subject only to the manner of sale provisions of
Rule 144 and by affiliates under Rule 144
without compliance with its one-year minimum holding period
requirement.
Following the offering, we intend to file a registration
statement on
Form S-8
under the Securities Act covering approximately
6,233,521 shares of common stock issued or issuable upon
the exercise of stock options, subject to outstanding options or
reserved for issuance under our employee and director stock
benefit plans. Accordingly, shares registered under the
registration statement will, subject to Rule 144 provisions
applicable to affiliates, be available for sale in the open
market, except to the extent that the shares are subject to
vesting restrictions or the contractual restrictions described
above. See Compensation Discussion and
Analysis Elements of Compensation Stock
Options.
114
UNDERWRITING
Under the terms and subject to the conditions contained in an
underwriting agreement dated the date of this prospectus, the
underwriters named below, for whom Morgan Stanley &
Co. Incorporated and Credit Suisse Securities (USA) LLC are
acting as representatives, have severally agreed to purchase,
and we and the selling stockholders have agreed to sell to them,
severally, the number of shares indicated below:
Number of
Underwriters
Shares
Morgan Stanley & Co. Incorporated
Credit Suisse Securities (USA) LLC
Merrill Lynch, Pierce, Fenner & Smith Incorporated
Robert W. Baird & Co. Incorporated
BMO Capital Markets Corp.
ThinkEquity Partners LLC
Subtotal
Total
6,000,000
The underwriters are offering the shares of common stock subject
to their acceptance of the shares from us and the selling
stockholders and subject to prior sale. The underwriting
agreement provides that the obligations of the several
underwriters to pay for and accept delivery of the shares of
common stock offered by this prospectus are subject to the
approval of certain legal matters by their counsel and to
certain other conditions. The underwriters are obligated to take
and pay for all of the shares of common stock offered by this
prospectus if any such shares are taken. However, the
underwriters are not required to take or pay for the shares
covered by the underwriters overallotment option described
below.
The underwriters initially propose to offer part of the shares
of common stock directly to the public at the public offering
price listed on the cover page of this prospectus and part to
certain dealers at a price that represents a concession not in
excess of $ a share under the
public offering price. Any underwriter may allow, and such
dealers may reallow, a concession not in excess of
$ a share to other underwriters or
to certain dealers. After the initial offering of the shares of
common stock, the offering price and other selling terms may
from time to time be varied by the representatives.
The selling stockholders have granted to the underwriters an
option, exercisable for 30 days from the date of this
prospectus, to purchase up to an aggregate of 900,000 additional
shares of common stock at the public offering price listed on
the cover page of this prospectus, less underwriting discounts
and commissions. The underwriters may exercise this option
solely for the purpose of covering overallotments, if any, made
in connection with the offering of the shares of common stock
offered by this prospectus. They may exercise this option during
the 30-day
period from the date of this prospectus. To the extent the
option is exercised, each underwriter will become obligated,
subject to certain conditions, to purchase approximately the
same percentage of the additional shares of common stock as the
number listed next to the underwriters name in the
preceding table bears to the total number of shares of common
stock listed next to the names of all underwriters in the
preceding table. If the underwriters option is exercised
in full, the total price to the public would be
$ , the total underwriters
discounts and commissions would be
$ , total proceeds to us would be
$ and total proceeds to the
selling stockholders would be $ .
The underwriters have informed us that they do not intend sales
to discretionary accounts to exceed 5% of the total number of
shares of common stock offered by them.
We intend to list our common stock on NYSE Arca under the symbol
LRN.
115
The following table shows the per share and total underwriting
discounts and commissions that we and the selling stockholders
are to pay to the underwriters in connection with this offering.
These amounts are shown assuming both no exercise and full
exercise of the underwriters option to purchase additional
shares of our common stock from the selling stockholders.
Paid by Us
Paid by Selling Stockholders
Total
Full
Full
Full
No Exercise
Exercise
No Exercise
Exercise
No Exercise
Exercise
Per Share
$
$
$
$
$
$
Total
$
$
$
$
$
$
We will pay all of the expenses of the offering, including those
of the selling stockholders from this offering or if the
underwriters exercise their overallotment option (other than
underwriting discounts and commissions relating to the shares
sold by the selling stockholders). We estimate that the expenses
of this offering other than underwriting discounts and
commissions payable by us will be $3.0 million.
We, our directors, our executive officers, the selling
stockholders and certain of our stockholders have agreed that
subject to certain exceptions, without the prior written consent
of Morgan Stanley & Co. Incorporated and Credit Suisse
Securities (USA) LLC on behalf of the underwriters, we and they
will not, during the period ending 180 days after the date
of this prospectus:
offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, lend, or
otherwise transfer or dispose of directly or indirectly, any
shares of common stock or any securities convertible into or
exercisable or exchangeable for common stock;
file any registration statement with the Securities and Exchange
Commission relating to the offering of any shares of common
stock or any securities convertible into or exercisable or
exchangeable for common stock; or
enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences
of ownership of the common stock;
whether any such transaction described above is to be settled by
delivery of common stock or such other securities, in cash or
otherwise. The restrictions described in this paragraph do not
apply to:
the sale of shares to the underwriters;
the issuance by us of shares of common stock upon the exercise
of an option or a warrant or the conversion of a security
outstanding on the date of this prospectus of which the
underwriters have been advised in writing;
any shares of common stock issued upon the exercise of options
granted under existing employee option plans, grants of employee
stock options or restricted stock in accordance with the terms
in effect on the date hereof and the filing by the Company of
any registration statement with the SEC on
Form S-8
relating to the offering of securities pursuant to the terms of
a plan in effect on the date hereof;
the issuance by us of shares of common stock or any security
convertible into shares of common stock in connection with a
bona fide merger or acquisition transaction; provided, however,
that the aggregate number of shares issued in these transactions
shall not exceed 5% of the total shares offered in this offering
and that any recipient of these shares executes a copy of the
lock-up
agreement;
transactions relating to shares of common stock or other
securities acquired in open market transactions after completion
of this offering, provided, however, that no filing under the
Securities Exchange Act of 1934, as amended (Exchange Act),
shall be required or shall be voluntarily made in connection
with such transaction
116
(other than a filing on Form 4 after the expiration of the
lock-up period or on a Form 5 made when required); or
the transfer of shares of common stock (i) pursuant to a
will, other testamentary document or applicable laws of descent,
(ii) as a bona fide gift or (iii) to a family member
or trust, provided that, in each case, the transferee agrees to
be bound in writing by the terms of the
lock-up
agreement prior to such transfer and no filing by any party
(donor, donee, transferor or transferee) under the Exchange Act
shall be required or shall be voluntarily made in connection
with such transfer (other than a filing on a Form 5 made
when required) and such transfer does not involve a disposition
for value.
The 180-day
restricted period described above is subject to extension such
that, in the event that either (1) during the last
17 days of the restricted period, we issue an earnings
release or material news or a material event relating to us
occurs or (2) prior to the expiration of the restricted
period, we announce that we will release earnings results during
the 16-day
period beginning on the last day of the applicable restricted
period, the
lock-up
restrictions described above will, subject to limited
exceptions, continue to apply until the expiration of the
18-day
period beginning on the earnings release or the occurrence of
the material news or material event.
As of November 14, 2007, approximately 21.6 million of
our outstanding shares were subject to lock-up agreements.
In order to facilitate the offering of the common stock, the
underwriters may engage in stabilizing transactions,
overallotment transactions, syndicate covering transactions,
penalty bids.
Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a
specified maximum.
Overallotment involves sales by the underwriters of shares in
excess of the number of shares the underwriters are obligated to
purchase, which creates a syndicate short position. The short
position may be either a covered short position or a naked short
position. In a covered short position, the number of shares
over-allotted by the underwriters is not greater than the number
of shares that they may purchase in the overallotment option. In
a naked short position, the number of shares involved is greater
than the number of shares in the overallotment option. The
underwriters may close out any covered short position by either
exercising their overallotment option
and/or
purchasing shares in the open market.
Syndicate covering transactions involve purchases of the common
stock in the open market after the distribution has been
completed in order to cover syndicate short positions. In
determining the source of shares to close out the short
position, the underwriters will consider, among other things,
the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through
the overallotment option. If the underwriters sell more shares
than could be covered by the over-allotment option, a naked
short position, the position can only be closed out by buying
shares in the open market. A naked short position is more likely
to be created if the underwriters are concerned that there could
be downward pressure on the price of the shares in the open
market after pricing that could adversely affect investors who
purchase in the offering.
Penalty bids permit the representatives to reclaim a selling
concession from a syndicate member when the common stock
originally sold by the syndicate member is purchased in a
stabilizing or syndicate covering transaction to cover syndicate
short positions.
These stabilizing transactions, syndicate covering transactions
and penalty bids may have the effect of raising or maintaining
the market price of our common stock or preventing or retarding
a decline in the market price of the common stock. As a result,
the price of our common stock may be higher than the price that
might otherwise exist in the open market. The underwriters are
not required to engage in these activities, and may end any of
these activities at any time.
We, the selling stockholders and the underwriters have agreed to
indemnify each other against certain liabilities, including
liabilities under the Securities Act.
117
Directed
Share Program
At our request, Morgan Stanley & Co. Incorporated has
reserved for sale, at the initial public offering price, up to
10% of the shares offered in this prospectus for our directors,
officers, employees, business associates and related persons.
The number of shares of common stock available for sale to the
general public will be reduced to the extent such persons
purchase such reserved shares. Any reserved shares which are not
so purchased will be offered by Morgan Stanley & Co.
Incorporated to the general public on the same basis as the
other shares offered in this prospectus.
Pricing
of the Offering
Prior to this offering, there has been no public market for the
shares of common stock. The initial public offering price will
be determined by negotiations among us and the representatives.
Among the factors to be considered in determining the initial
public offering price will be the future prospects of us and our
industry in general and our sales, earnings and certain other
financial operating information in recent periods, and the
price-earnings ratios, price-sales ratios, market prices of
securities and certain financial and operating information of
companies engaged in activities similar to us. The estimated
initial public offering price range set forth on the cover page
of this preliminary prospectus is subject to change as a result
of market conditions and other factors.
118
NOTICE TO
CANADIAN RESIDENTS
Resale
Restrictions
The distribution of the shares in Canada is being made only on a
private placement basis exempt from the requirement that we
prepare and file a prospectus with the securities regulatory
authorities in each province where trades of the shares are
made. Any resale of the shares in Canada must be made under
applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made
under available statutory exemptions or under a discretionary
exemption granted by the applicable Canadian securities
regulatory authority. Purchasers are advised to seek legal
advice prior to any resale of the shares.
Representations
of Purchasers
By purchasing shares in Canada and accepting a purchase
confirmation, a purchaser is representing to us and the dealer
from whom the purchase confirmation is received that:
the purchaser is entitled under applicable provincial securities
laws to purchase the shares without the benefit of a prospectus
qualified under those securities laws,
where required by law, that the purchaser is purchasing as
principal and not as agent,
the purchaser has reviewed the text above under Resale
Restrictions, and
the purchaser acknowledges and consents to the provision of
specified information concerning its purchase of the shares to
the regulatory authority that by law is entitled to collect the
information.
Further details concerning the legal authority for this
information is available on request.
Rights of
Action Ontario Purchasers Only
Under Ontario securities legislation, certain purchasers who
purchase a security offered by this prospectus during the period
of distribution will have a statutory right of action for
damages, or while still the owner of the shares, for rescission
against us in the event that this prospectus contains a
misrepresentation without regard to whether the purchaser relied
on the misrepresentation. The right of action for damages is
exercisable not later than the earlier of 180 days from the
date the purchaser first had knowledge of the facts giving rise
to the cause of action and three years from the date on which
payment is made for the shares. The right of action for
rescission is exercisable not later than 180 days from the
date on which payment is made for the shares. If a purchaser
elects to exercise the right of action for rescission, the
purchaser will have no right of action for damages against us.
In no case will the amount recoverable in any action exceed the
price at which the shares were offered to the purchaser and if
the purchaser is shown to have purchased the securities with
knowledge of the misrepresentation, we will have no liability.
In the case of an action for damages, we will not be liable for
all or any portion of the damages that are proven to not
represent the depreciation in value of the shares as a result of
the misrepresentation relied upon. These rights are in addition
to, and without derogation from, any other rights or remedies
available at law to an Ontario purchaser. The foregoing is a
summary of the rights available to an Ontario purchaser. Ontario
purchasers should refer to the complete text of the relevant
statutory provisions.
Enforcement
of Legal Rights
All of our directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may
not be possible for Canadian purchasers to effect service of
process within Canada upon us or those persons. All or a
substantial portion of our assets and the assets of those
persons may be located outside of Canada and, as a result, it
may not be possible to satisfy a judgment against us or those
persons in Canada or to enforce a judgment obtained in Canadian
courts against us or those persons outside of Canada.
Taxation
and Eligibility for Investment
Canadian purchasers of the shares should consult their own legal
and tax advisors with respect to the tax consequences of an
investment in the shares in their particular circumstances and
about the eligibility of the shares for investment by the
purchaser under relevant Canadian legislation.
119
SALES
OUTSIDE THE UNITED STATES OTHER THAN CANADA
No common stock has been offered to the public or will be
offered to the public in the United Kingdom prior to the
publication of a prospectus in relation to the common stock and
the approval of the offer by the Financial Services Authority
(FSA) or, where appropriate, approval in another Member State
and notification to the FSA, all in accordance with the
Prospectus Directive, except that an offer of the stock may be
made to persons who fall within the definition of
qualified investor as that term is defined in
Section 86(1) of the Financial Services and Markets Act
2000 (FSMA) or otherwise in circumstances which do not result in
an offer of transferable securities to the public in the United
Kingdom within the meaning of the FSMA;
Each underwriter has only communicated or caused to be
communicated and will only communicate or cause to be
communicated any invitation or inducement to engage in
investment activity (within the meaning of Section 21 of
the FSMA) received by it in connection with the issue or sale of
any stock in circumstances in which Section 21(1) of the
FSMA does not apply to us or to persons who have professional
experience in matters relating to investments falling within
Article 19(5) of the FSMA; and
Each underwriter has complied and will comply with all
applicable provisions of the FSMA with respect to anything done
by it in relation to the stock in, from or otherwise involving
the United Kingdom.
No prospectus (including any amendment, supplement or
replacement thereto) has been prepared in connection with the
offering of the shares of our common stock that has been
approved by Frances Autorité des marchés
financiers or by the competent authority of another state that
is a contracting party to the Agreement on the European Economic
Area and notified to the Autorité des marchés
financiers; no shares of our common stock have been offered or
sold and will be offered or sold, directly or indirectly, to the
public in France except to permitted investors (Permitted
Investors) consisting of persons licensed to provide the
investment service of portfolio management for the account of
third parties, qualified investors (investisseurs
qualifiés) acting for their own account
and/or
investors belonging to a limited circle of investors (cercle
restraint dinvestisseurs) acting for their own account,
with qualified investors and limited circle of
investors having the meaning ascribed to them in
Articles L. 411-2,
D. 411-1,
D. 411-2,
D. 411-4,
D. 734-1,
D. 744-1,
D. 754-1
and
D. 764-1
of the French Code Monétaire et Financier and applicable
regulations thereunder; none of this prospectus or any other
materials related to the offering or information contained
therein relating to the shares of our common stock has been
released, issued or distributed to the public in France except
to Permitted Investors; and the direct or indirect resale to the
public in France of any Securities acquired by any Permitted
Investors may be made only as provided by
Articles L. 411-1,
L. 411-2,
L. 412-l
and
L. 621-8
to
L. 621-8-3
of the French Code Monétaire et Financier and applicable
regulations thereunder.
The offering of shares of our common stock has not been cleared
by the Italian Securities Exchange Commission (Commissione
Nazionale per le Società e la Borsa, the CONSOB) pursuant
to Italian securities legislation and, accordingly, each
underwriter acknowledges and agrees that the shares of our
common stock may not and will not be offered, sold or delivered,
nor may or will copies of this prospectus or any other documents
relating to the shares of our common stock be distributed in
Italy, except (i) to professional investors (operatori
qualificati), as defined in Article 31, second paragraph,
of CONSOB Regulation No. 11522 of July 1, 1998,
as amended (the Regulation No. 11522), or (ii) in
other circumstances which are exempted from the rules on
solicitation of investments pursuant to Article 100 of
Legislative Degree No. 58 of February 24, 1998 (the
Financial Service Act) and Article 33, first paragraph, of
CONSOB Regulation No. 11971 of May 14, 1999, as
amended.
Any offer, sale or delivery of shares of our common stock or
distribution of copies of this prospectus or any other document
relating to the shares of our common stock in Italy may and will
be effected in accordance with all Italian securities, tax,
exchange control and other applicable laws and regulations, and,
in particular, will be: (1) made by an investment firm,
bank or financial intermediary permitted to conduct such
activities in Italy in accordance with the Financial Services
Act, Legislative Decree No. 385 of September 1, 1993,
as amended (the Italian Banking Law),
Regulation No. 11522 and any other applicable laws and
regulations; (2) in compliance with Article 129 of the
Italian Banking Law and the implementing guidelines of the Bank
of Italy; and (3) in compliance with any other applicable
notification requirement or limitation which may be imposed by
CONSOB or the Bank of Italy.
120
In relation to each Member State of the European Economic Area
which has implemented the Prospectus Directive (each, a Relevant
Member State), and effective as of the date on which the
Prospectus Directive is implemented in that Relevant Member
State (the Relevant Implementation Date), no common stock have
been offered to the public in that Relevant Member State prior
to the publication of a prospectus in relation to the common
stock which has been approved by the competent authority in that
Relevant Member State or, where appropriate, approved in another
Relevant Member State and brought to the attention of the
competent authority in that Relevant Member State, all in
accordance with the Prospectus Directive. Notwithstanding the
foregoing, an offer of common stock may be made effective as of
the Relevant Implementation Date to the public in that Relevant
Member State at any time:
(1) to legal entities which are authorized or regulated to
operate in the financial markets or, if not so authorized or
regulated, whose corporate purpose is solely to invest in
securities;
(2) to any legal entity which has two or more of
(a) an average of at least 250 employees during the
last financial year; (b) a total balance sheet of more than
43,000,000 and (c) an annual net turnover of more
than 50,000,000, as shown in its last annual or
consolidated accounts; or
(3) in any other circumstances which do not require the
publication by the issuer of a prospectus pursuant to
Article 3 of the Prospectus Directive. For the purposes of
this paragraph, the expression an offer of common stock to
the public in relation to any common stock in any Relevant
Member State means the communication in any form and by any
means of sufficient information on the terms of the offer and
the common stock to be offered so as to enable an investor to
decide to purchase or subscribe for the common stock, as the
same may be varied in that Member State by any measure
implementing the Prospectus Directive in that Member State and
the expression Prospectus Directive means Directive 2003/71/EC
and includes any relevant implementing measure in each Relevant
Member State.
This prospectus does not constitute a public offer to sell any
common stock to any member of the public in the Cayman Islands.
The common stock may not be offered or sold in Hong Kong, by
means of any document, other than to persons whose ordinary
business is to buy or sell stock or debentures, whether as
principal or agent, or in circumstances which do not constitute
an offer to the public within the meaning of the Companies
Ordinance (Cap. 32) of Hong Kong. No advertisement,
invitation or document relating to the common stock, whether in
Hong Kong or elsewhere, may be issued, which is directed at, or
the contents of which are likely to be accessed or read by, the
public of Hong Kong (except if permitted to do so under the
securities laws of Hong Kong) other than with respect to common
stock which are or are intended to be disposed of only to
persons outside Hong Kong or only to professional
investors within the meaning of the Securities and Futures
Ordinance (Cap. 571) of Hong Kong and any rules made
thereunder.
The common stock have not been and will not be registered under
the Securities and Exchange Law of Japan (Law No. 235 of
1948 as amended) (the Securities Exchange Law) and disclosure
under the Securities Exchange Law has not been and will not be
made with respect to the common stock. Accordingly, the common
stock may not be, directly or indirectly, offered or sold in
Japan or to, or for the benefit of, any resident of Japan or to
others for re-offering or re-sale, directly or indirectly in
Japan or to, or for the benefit of, any resident of Japan except
pursuant to an exemption from the registration requirements of,
and otherwise in compliance with, the Securities Exchange Law
and other relevant laws, regulations and ministerial guidelines
of Japan. As used in this paragraph, resident of
Japan means any person residing in Japan, including any
corporation or other entity organized under the laws of Japan.
This prospectus has not been and will not be registered as a
prospectus with the Monetary Authority of Singapore under the
Securities and Futures Act (Cap. 289) of Singapore, or the
Securities and Futures Act. Accordingly, the common stock may
not be offered or sold or made the subject of an invitation for
subscription or purchase nor may this prospectus or any other
document or material in connection with the offer or sale, or
invitation for subscription or purchase of such common stock be
circulated or distributed, whether directly or indirectly, to
the public or any members of the public in Singapore other than:
(1) to an institutional investor or other person falling
within Section 274 of the Securities and Futures Act,
(2) to a sophisticated investor, and in accordance
121
with the conditions specified in Section 275 of the
Securities and Futures Act or (3) pursuant to, and in
accordance with the conditions of any other applicable provision
of the Securities and Futures Act.
The common stock have not been registered under the South Korean
Securities and Exchange Law. The common stock has not been
offered, sold or delivered and will not be offered, sold or
delivered, directly or indirectly, in South Korea or to, or for
the account or benefit of, any resident of South Korea, except
as otherwise permitted by applicable South Korean laws and
regulations; and any securities dealer to whom any Underwriter
sells common stock will agree that it will not offer any common
stock, directly or indirectly, in South Korea or to any resident
of South Korea, except as permitted by applicable South Korean
laws and regulations, or to any other dealer who does not so
represent and agree.
The underwriters will not circulate or distribute this
prospectus in the Peoples Republic of China (PRC) and have
not offered or sold, and will not offer or sell to any person
for re-offering or resale directly or indirectly, any securities
to any resident of the PRC except pursuant to applicable laws
and regulations of the PRC.
The offer of the shares has not been approved or licensed by the
UAE Central Bank or any other relevant licensing authorities or
governmental agencies in the United Arab Emirates. This document
is strictly private and confidential and has not been reviewed,
deposited or registered with any licensing authority or
governmental agency in the United Arab Emirates, and is being
issued to a limited number of institutional and/or private
investors and must not be provided to any person other than the
original recipient and may not be reproduced or used for any
other purpose. The shares may not be offered or sold directly or
indirectly to the public in the United Arab Emirates.
This statement relates to an Exempt Offer in accordance with the
Offered Securities Rules of the Dubai Financial Services
Authority.
This statement is intended for distribution only to Persons of a
type specified in those rules. It must not be delivered to, or
relied on by, any other Person.
The Dubai Financial Services Authority has no responsibility for
reviewing or verifying any documents in connection with Exempt
Offers. The Dubai Financial Services Authority has not approved
this document nor taken steps to verify the information set out
in it, and has no responsibility for it.
The Securities to which this document relates may be illiquid
and/or
subject to restrictions on their resale. Prospective purchasers
of the Securities offered should conduct their own due diligence
on the Securities.
If you do not understand the contents of this document you
should consult an authorised financial adviser.
No action may be taken in any jurisdiction other than the United
States that would permit a public offering of the common stock
or the possession, circulation or distribution of this
prospectus in any jurisdiction where action for that purpose is
required. Accordingly, the common stock may not be offered or
sold, directly or indirectly, and neither the prospectus nor any
other offering material or advertisements in connection with the
common stock may be distributed or published in or from any
country or jurisdiction except under circumstances that will
result in compliance with any applicable rules and regulations
of any such country or jurisdiction.
122
LEGAL
MATTERS
The validity of the shares of common stock offered hereby will
be passed upon for us by our counsel, Latham & Watkins
LLP, Washington, DC. Various legal matters relating to this
offering will be passed upon for the underwriters by Davis
Polk &Wardwell, New York, New York.
EXPERTS
The consolidated financial statements and schedules included in
this Prospectus and in the Registration Statement have been
audited by BDO Seidman, LLP, an independent registered public
accounting firm, to the extent and for the periods set forth in
their report appearing elsewhere herein and in the Registration
Statement, and are included in reliance upon such report given
upon the authority of said firm as experts in auditing and
accounting.
WHERE
YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a
registration statement under the Securities Act of 1933, as
amended with respect to the shares of our common stock offered
by this prospectus. This prospectus, filed as a part of the
registration statement, does not contain all of the information
set forth in the registration statement or the exhibits and
schedules thereto as permitted by the rules and regulations of
the SEC. For further information about us and our common stock,
you should refer to the registration statement. This prospectus
summarizes provisions that we consider material of certain
contracts and other documents to which we refer you. Because the
summaries may not contain all of the information that you may
find important, you should review the full text of those
documents. We have included copies of those documents as
exhibits to the registration statement.
The registration statement and the exhibits thereto filed with
the SEC may be inspected, without charge, and copies may be
obtained at prescribed rates, at the public reference facility
maintained by the SEC at 100 F Street, NE, Washington, DC 20549.
You may obtain information on the operation of the public
reference room by calling the SEC at 1-800-SEC-0330. The
registration statement and other information filed by us with
the SEC are also available at the SECs website at
www.sec.gov.
As a result of the offering, we and our stockholders will become
subject to the proxy solicitation rules, annual and periodic
reporting requirements, restrictions of stock purchases and
sales by affiliates and other requirements of the Securities
Exchange Act of 1934. We will furnish our stockholders with
annual reports containing audited consolidated financial
statements by an independent registered accounting firm and
quarterly reports containing unaudited financial statements for
the first three quarters of each fiscal year.
123
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
Audited Financial Statements:
Report of Independent Registered Public Accounting Firm
F-2
Consolidated Balance Sheets as of June 30, 2007 and 2006
F-3
Consolidated Statements of Operations for the years ended
June 30, 2007, 2006 and 2005
F-4
Consolidated Statements of Redeemable Convertible Preferred
Stock and Stockholders Deficit for the years ended
June 30, 2007, 2006 and 2005
F-5
Consolidated Statements of Cash Flows for the years ended
June 30, 2007, 2006 and 2005
F-6
Notes to Consolidated Financial Statements
F-7
Unaudited Interim Financial Statements
Condensed Consolidated Balance Sheets as of September 30,
2007
F-24
Condensed Consolidated Statements of Operations for the three
months ended September 30, 2007 and 2006
F-25
Condensed Consolidated Statements of Redeemable Convertible
Preferred Stock and Stockholders Deficit for the three
months ended September 30, 2007
F-26
Condensed Consolidated Statements of Cash Flows for the three
months ended September 30, 2007 and 2006
F-27
Notes to Condensed Consolidated Financial Statements
F-28
Schedule II Valuation and Qualifying Accounts
F-38
F-1
Report
of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
K12 Inc.
Herndon, Virginia
We have audited the accompanying consolidated balance sheets of
K12 Inc. and subsidiaries (the Company) as of June 30, 2007
and 2006 and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders
deficit, and cash flows for each of the three years in the
period ended June 30, 2007. We have also audited the
schedules listed in the accompanying index. These financial
statements and schedules are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements and schedules based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and
schedules are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits
included consideration of internal control over financial
reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we
express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements and schedules, assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall presentation of the financial
statements and schedules. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of K12 Inc. and subsidiaries at June 30, 2007 and
2006, and the results of their operations and their cash flows
for each of the three years in the period ended June 30,
2007, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 2 to the consolidated financial
statements, effective July 1, 2006, the Company adopted
Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment.
Also, in our opinion, the schedules present fairly, in all
material respects, the information set forth therein.
/s/ BDO Seidman, LLP
Bethesda, Maryland
September 25, 2007, except for Note 15,
as to which date is November 2, 2007
F-2
K12
INC.
CONSOLIDATED
BALANCE SHEETS
June 30,
2007
2006
(in thousands,
except share and
per share data)
ASSETS
Current assets
Cash and cash equivalents
$
1,660
$
9,475
Restricted cash
2,332
Accounts receivable, net of allowance of $589 and $1,440 at
June 30, 2007 and June 30, 2006, respectively
15,455
11,449
Inventories, net
13,804
11,110
Prepaid expenses and other current assets
1,245
568
Total current assets
32,164
34,934
Property and equipment, net
17,234
10,388
Capitalized curriculum development costs, net
9,671
1,470
Other assets, net
1,182
1,054
Deposits and other assets
961
639
Total assets
$
61,212
$
48,485
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS DEFICIT
Current liabilities
Bank overdraft
$
1,577
$
Line of credit
1,500
Accounts payable
6,928
6,349
Accrued liabilities
1,819
2,643
Accrued compensation and benefits
6,200
5,100
Deferred revenue
2,620
1,396
Current portion of capital lease obligations
2,780
Current portion of notes payable
192
Notes payable related party
4,025
Total current liabilities
23,616
19,513
Deferred rent, net of current portion
1,684
1,598
Capital lease obligations, net of current portion
3,974
Notes payable, net of current portion
189
Total liabilities
29,463
21,111
Commitments and contingencies
Redeemable convertible preferred stock
Redeemable Convertible Series C Preferred stock, par value
$0.0001; 55,000,000 shares authorized; 49,861,562 and
45,328,693 shares issued and outstanding at 2007 and 2006,
respectively; liquidation value of $133,629 and $121,481 at 2007
and 2006, respectively
91,122
76,211
Redeemable Convertible Series B Preferred stock, par value
$0.0001; 76,000,000 shares authorized;
51,524,974 shares issued and outstanding at 2007 and 2006,
respectively; liquidation value of $138,087 at 2007 and 2006
138,434
124,614
Stockholders deficit
Common stock, par value $0.0001; 33,362,500 shares
authorized; 2,041,604 and 1,998,896 shares issued and
outstanding at 2007 and 2006, respectively
1
1
Accumulated deficit
(197,808
)
(173,452
)
Total stockholders deficit
(197,807
)
(173,451
)
Total liabilities, redeemable convertible preferred stock and
stockholders deficit
$
61,212
$
48,485
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-3
K12
INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
Year Ended June 30,
2007
2006
2005
(in thousands, except per share data)
Revenues
$
140,556
$
116,902
$
85,310
Cost and expenses
Instructional costs and services
76,064
64,828
49,130
Selling, administrative, and other operating expenses
51,159
41,660
30,031
Product development expenses
8,611
8,568
9,410
Total costs and expenses
135,834
115,056
88,571
Income (loss) from operations
4,722
1,846
(3,261
)
Interest expense, net
(639
)
(488
)
(279
)
Income (loss) before income taxes
4,083
1,358
(3,540
)
Income tax expense
(218
)
Net income (loss)
3,865
1,358
(3,540
)
Dividends on preferred stock
(6,378
)
(5,851
)
(5,261
)
Preferred stock accretion
(22,353
)
(18,697
)
(15,947
)
Net loss attributable to common stockholders
$
(24,866
)
$
(23,190
)
$
(24,748
)
Net loss attributable to common stockholders per share:
Basic and diluted
$
(12.42
)
$
(11.73
)
$
(12.54
)
Weighted average shares used in computing per share
amounts:
Basic and diluted
2,001,661
1,977,195
1,973,053
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-4
K12
INC.
CONSOLIDATED
STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS DEFICIT
Redeemable
Redeemable
Stockholders Deficit
Convertible Series C
Convertible Series B
Additional
Preferred Stock
Preferred Stock
Common Stock
Paid-in
Accumulated
Shares
Amount
Shares
Amount
Shares
Amount
Capital
Deficit
Total
(dollars in thousands)
Balance, June 30, 2004
37,461,730
$
54,629
51,524,974
$
100,440
1,964,552
$
1
$
$
(125,622
)
$
(125,621
)
Employee exercised options
11,760
70
70
Accretion of Preferred Stock
4,403
11,544
(70
)
(15,877
)
(15,947
)
Series C 10% Stock Dividend
3,746,173
5,261
(5,261
)
(5,261
)
Net loss
(3,540
)
(3,540
)
Balance, June 30, 2005
41,207,903
64,293
51,524,974
111,984
1,976,312
1
(150,300
)
(150,299
)
Employee exercised options
22,584
38
38
Accretion of Preferred Stock
6,067
12,630
(38
)
(18,659
)
(18,697
)
Series C 10% Stock Dividend
4,120,790
5,851
(5,851
)
(5,851
)
Net income
1,358
1,358
Balance, June 30, 2006
45,328,693
76,211
51,524,974
124,614
1,998,896
1
(173,452
)
(173,451
)
Employee exercised options
42,708
292
292
Record stock compensation expense
218
218
Accretion of Preferred Stock
8,533
13,820
(510
)
(21,843
)
(22,353
)
Series C 10% Stock Dividend
4,532,869
6,378
(6,378
)
(6,378
)
Net Income
3,865
3,865
Balance, June 30, 2007
49,861,562
$
91,122
51,524,974
$
138,434
2,041,604
$
1
$
$
(197,808
)
$
(197,807
)
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-5
K12
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Year Ended June 30,
2007
2006
2005
(in thousands)
Cash Flows from Operating Activities
Net income (loss)
$
3,865
$
1,358
$
(3,540
)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization expense
7,404
4,986
5,509
Stock based compensation expense
218
Provision for (reduction of) doubtful accounts
(852
)
(275
)
1,113
Provision for (reduction of) inventory obsolescence
95
(39
)
(50
)
Provision for (reduction of) student computer shrinkage and
obsolescence
(48
)
174
(256
)
Impairment of curriculum development costs
362
2,118
Impairment of software development costs
1,188
Changes in assets and liabilities:
Accounts receivable
(3,154
)
(2,718
)
3,434
Inventories
(2,790
)
(5,359
)
(555
)
Prepaid and other current assets
(763
)
100
(431
)
Other assets
(255
)
(258
)
(468
)
Deposits
(322
)
(268
)
(56
)
Accounts payable
579
1,559
(163
)
Accrued liabilities
(824
)
122
1,208
Accrued compensation and benefits
1,100
1,782
994
Deferred revenue
1,224
501
(348
)
Deferred rent
86
1,598
Net cash provided by operating activities
5,563
3,625
9,697
Cash flows from investing activities
Purchase of property and equipment
(5,366
)
(10,842
)
(4,692
)
Capitalized curriculum development costs
(8,683
)
(655
)
(3,787
)
Net cash used in investing activities
(14,049
)
(11,497
)
(8,479
)
Cash flows from financing activities
Proceeds (payments on) from notes payable related
party
(4,025
)
4,025
Proceeds from notes payable
441
Payments on notes payable
(62
)
Net borrowings from revolving credit facility
1,500
Repayments for capital lease obligations
(1,384
)
(441
)
(3,432
)
Proceeds from exercise of stock options
292
38
70
Bank overdraft
1,577
Cash invested in restricted escrow account
2,332
(2,203
)
2,191
Net cash provided by (used in) financing activities
671
(2,606
)
2,854
Net change in cash and cash equivalents
(7,815
)
(10,478
)
4,072
Cash and cash equivalents, beginning of year
9,475
19,953
15,881
Cash and cash equivalents, end of year
$
1,660
$
9,475
$
19,953
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-6
K12
Inc.
Notes to
Consolidated Financial Statements
1.
Description
of the Business
K12 Inc. and its subsidiaries (K12 or the Company) sell on-line
curriculum and educational books and materials designed for
students in grades K-12 and provide management and technology
services to virtual public schools. The K12 proprietary
curriculum is research based and combines content with
innovative technology to allow students to receive an
outstanding education regardless of geographic location. The
Company provides complete management and technology services to
virtual public schools. Through these schools, the Company
typically provides students with access to the K12 on-line
curriculum, offline learning kits, and use of a personal
computer. In addition, the company sells access to its on-line
curriculum and offline learning kits directly to individual
consumers. For the year ended June 30, 2007, the Company
served schools in 15 states and the District of Columbia,
providing curriculum for grades kindergarten through tenth.
Basis
of Presentation
The consolidated financial statements include our accounts and
those of our wholly-owned subsidiaries. Intercompany accounts
and transactions have been eliminated in consolidation.
2.
Summary
of Significant Accounting Policies
Use of
Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions affecting
the amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
Revenue
Recognition and Concentration of Revenues
Revenues are principally earned from long-term contractual
agreements to provide on-line curriculum, books, materials,
computers and management services to public charter schools and
school districts. In addition to providing the curriculum, books
and materials, under most contracts, the Company is responsible
to the virtual public schools for all aspects of the management
of schools, including monitoring academic achievement, teacher
hiring and training, compensation of school personnel, financial
management, enrollment processing and procurement of curriculum,
equipment and required services. The schools receive funding on
a per student basis from the state in which the public school or
school district is located. Where the Company has determined
that they are the primary obligor for substantially all expenses
under these contracts, the Company records the associated per
student revenue received by the school from its state funding
school district up to the expenses incurred in accordance with
Emerging Issues Task Force (EITF)
99-19,
Reporting Revenue Gross as a Principal Versus Net as an
Agent. As a result, amounts recorded as revenues and
instructional costs and services for the years ended
June 30, 2007, 2006 and 2005 were $38.5 million,
$35.6 million and $29.6 million, respectively. For
contracts in which the Company is not the primary obligor, the
Company records revenue based on its net fees earned per the
contractual agreement.
The Company generates revenues under contracts with public
virtual schools which include multiple elements. These elements
include providing each of a schools students with access
to the Companys on-line school and the on-line component
of lessons; offline learning kits which include books and
materials designed to complement and supplement the on-line
lessons; the use of a personal computer and associated
reclamation services; internet access and technology support
services; the services of a state-certified teacher and; all
management and technology services required to operate a public
virtual school.
We have determined that the elements of our contracts are
valuable to schools in combination, but do not have standalone
value. In addition, we have determined that we do not have
objective and reliable evidence of fair value for each element
of our contracts. As a result, the elements within our
multiple-element contracts do not qualify for
F-7
K12
Inc.
Notes to
Consolidated Financial Statements
treatment as separate units of accounting. Accordingly, we
account for revenues received under multiple element
arrangements as a single unit of accounting and recognize the
entire arrangement based upon the approximate rate at which we
incur the costs associated with each element.
Under the contracts with the schools where the Company provides
turnkey management services, the Company has generally agreed to
absorb any operating deficits of the schools in a given school
year. These operating deficits represent the excess of costs
over revenues incurred by the virtual public schools as
reflected on their financial statements. The costs include
Company charges to the schools. These operating deficits may
impair the Companys ability to collect invoices in full.
Accordingly, the Companys amount of recognized revenue
reflects this impairment. For the years ended June 30,
2007, 2006 and 2005, the Companys revenue reflected
impairment from these operating deficits of $13.7 million,
$7.0 million and $5.5 million, respectively. Included
in these deficits is the impact of certain disallowed
enrollments stemming from regulatory audits in Colorado totaling
$0.9 million in 2006 and $1.0 million in 2007, and
$1.0 million in California in 2007.
Other revenues are generated from individual customers who
prepay and have access for 12 or 24 months to curriculum
via the Companys Web site. The Company recognizes these
revenues pro rata over the maximum term of the customer
contract, which is either 12 or 24 months. Revenues from
associated offline learning kits are recognized upon shipment.
During the years ended June 30, 2007, 2006 and 2005,
approximately 97%, 94% and 96%, respectively, of the
Companys revenues were recognized from virtual public
schools. In fiscal year 2007, we had contracts with four schools
that individually represented 16%, 11%, 11% and 11% of revenues.
In fiscal year 2006, we had contracts with three schools that
individually represented 28%, 16% and 10% of revenues. In fiscal
year 2005, we had contracts with four schools that individually
represented 32%, 17%, 11% and 10% of revenues.
Research
and Development Costs
All research and development costs are expensed as incurred in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 2, Accounting for Research and Development
Costs.
Cash
and Cash Equivalents
Cash and cash equivalents generally consist of cash on hand and
cash held in money market and demand deposit accounts. For
purposes of the statements of cash flows, the Company considers
all highly liquid investments with maturities of three months or
less when purchased to be cash equivalents. The Company
maintains funds in accounts in excess of FDIC insurance limits;
however, management believes it minimizes risk by maintaining
deposits in well-capitalized financial institutions.
Restricted
Cash
Restricted cash consists primarily of cash held in escrow
related to the lease on our primary office facility. There was
no balance in restricted cash as of June 30, 2007, as the
result of the release of certain letters of credit related to
operating leases. The letters of credit were incorporated into
our revolving credit facility (see Note 6).
Fair
Value of Financial Instruments
The carrying values reflected in our consolidated balance sheets
for cash and cash equivalents, receivables, inventory and short
and long term debt approximate their fair values.
Allowance
for Doubtful Accounts
The Company maintains an allowance for uncollectible accounts
primarily for estimated losses resulting from the inability,
failure or refusal of individual customers to make required
payments. These losses have been within
F-8
K12
Inc.
Notes to
Consolidated Financial Statements
managements expectations. The Company analyzes accounts
receivable, historical percentages of uncollectible accounts and
changes in payment history when evaluating the adequacy of the
allowance for uncollectible accounts. Management believes that
an allowance for doubtful accounts of $0.6 million and
$1.4 million as of June 30, 2007 and 2006,
respectively, is adequate. However, actual write-offs might
exceed the recorded allowance.
Inventory
Inventory consists primarily of schoolbooks and curriculum
materials, a majority of which are leased to virtual schools and
utilized directly by students. Inventory represents items that
are purchased and held for sale and are recorded at the lower of
cost
(first-in,
first-out method) or market value.
Other
Assets
Other assets consist primarily of schoolbooks and curriculum
materials which have been returned to the Company upon the
completion of the school year. These assets are amortized over a
period of two years which is included in instructional costs and
services on the accompanying consolidated statement operations.
Materials not returned are expensed as part of instructional
costs and services.
Property
and Equipment
Property and equipment, which includes capitalized software
development, are stated at cost less accumulated depreciation
and amortization. Depreciation expense is calculated using the
straight-line method over the estimated useful life of the asset
(or the lesser of the term of the lease and the estimated useful
life of the asset for fixed assets under capital leases).
Amortization of assets capitalized under capital lease
arrangements is included in depreciation expense. Property and
equipment are depreciated over the following lives:
Useful Life
Computer hardware
3 years
Computer software and capitalized software development costs
3 years
Office equipment
5-6 years
Furniture and fixtures
5-6 years
Leasehold Improvements
3-12 years
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 Statement
of Financial Accounting Standards No. 13 (FAS 13),
Accounting for Leases, as the fixed non-cancelable term
of the lease plus all periods for which failure to renew the
lease imposes a penalty on the lessee in an amount such that
renewal appears, at the inception of the lease, to be reasonably
assured. Accordingly, the Company has determined the lease term
as defined herein to be twelve years.
Software
Developed or Obtained for Internal Use
The Company develops software for internal use. Software
development costs incurred during the application development
stage are capitalized in accordance with Statement of Position
(SOP) 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. The Company amortizes these costs
over the estimated useful life of the software which is
generally three years.
Software development costs incurred totaled $3.1 million,
$1.4 million and $0.5 million for the years ended
June 30, 2007 and 2006 and 2005, respectively. These
amounts are recorded on the balance sheet as part of property
and equipment, net of amortization and impairment charges. The
estimated aggregate amortization expense for each of the three
succeeding years ending June 30, 2008, 2009 and 2010 is $1.2
million, $1.0 million and $0.6 million, respectively.
F-9
K12
Inc.
Notes to
Consolidated Financial Statements
Capitalized
Curriculum Development Costs
The Company internally develops its curriculum, which is
provided as web content and accessed via the Internet.
We capitalize curriculum development costs incurred during the
application development stage in accordance with Statement of
Position (SOP)
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use.
SOP 98-1
provides guidance for the treatment of costs associated with
computer software development and defines those costs to be
capitalized and those to be expensed. Costs that qualify for
capitalization are external direct costs, payroll,
payroll-related costs, and interest costs. Costs related to
general and administrative functions are not capitalizable and
are expensed as incurred. We capitalize curriculum development
costs when the projects under development reach technological
feasibility. Many of our new courses leverage off of proven
delivery platforms and are primarily content, which has no
technological hurdles. As a result, a significant portion of our
courseware development costs qualify for capitalization due to
the concentration of our development efforts on the content of
the courseware. Technological feasibility is established when we
have completed all planning, designing, coding, and testing
activities necessary to establish that a course can be produced
to meet its design specifications. Capitalization ends when a
course is available for general release to our customers, at
which time amortization of the capitalized costs begins. The
period of time over which these development costs will be
amortized is generally five years. This is consistent with the
capitalization period used by others in our industry and
corresponds with our product development lifecycle.
Total capitalized curriculum development costs incurred were
$8.7 million, $0.7 million and $3.8 million for
the years ended June 30, 2007, 2006 and 2005, respectively.
These amounts are recorded on the accompanying consolidated
balance sheet, net of amortization and impairment charges.
Amortization and impairment charges are recorded in product
development expenses on the accompanying consolidated statement
of operations. The estimated aggregate amortization expense for
each of the five succeeding years ending June 30, 2008, 2009,
2010, 2011 and 2012 is $1.6 million, $1.6 million, $1.5 million,
$1.4 million and $1.2 million, respectively.
Web
Site Development Costs
The Company accounts for web site development costs in
accordance with Emerging Issues Task Force Issue
No. 00-2,
Accounting for Web Site Development Costs
(EITF 00-2).
Total capitalized web site development costs incurred for the
year ended June 30, 2007 were $0.4 million. For the
years ended June 30, 2006 and 2005 all web site development
costs occurred in the operating stage and were expensed as
incurred.
Impairment
of Long-Lived Assets
Long-lived assets include property, equipment, capitalized
curriculum and software developed or obtained for internal use.
In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the Company
reviews its recorded long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be fully recoverable. If the total of
the expected undiscounted future cash flows is less than the
carrying amount of the asset, a loss is recognized for the
difference between fair value and the carrying value of the
asset. Impairment charges recorded were $0.4 million and
$3.3 million for the years ended June 30, 2006 and
2005, respectively. There was no impairment for the year ended
June 30, 2007.
Income
Taxes
The Company accounts for income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes.
Under SFAS No. 109, 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.
SFAS No. 109 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.
F-10
K12
Inc.
Notes to
Consolidated Financial Statements
Stock-Based
Compensation
The Company adopted SFAS No. 123(R), Share-Based
Payment (Revised 2004), as of July 1, 2006, which
replaces SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes Accounting Principles Board
Opinion No. 25 (APB No. 25), Accounting for Stock
Issued to Employees. The Company adopted SFAS 123(R)
using the prospective application method. SFAS No. 123(R)
eliminates the intrinsic value method that was previously used
by the Company as an alternative method of accounting for
stock-based compensation. SFAS No. 123(R) requires an
entity to recognize the grant date fair value of stock options
and other equity-based compensation issued to employees in the
consolidated statement of operations. The Company applied
SFAS 123(R) to all new awards granted after July 1,
2006.
Advertising
and Marketing Expenses
Advertising and marketing costs consist primarily of print media
and brochures and are expensed when incurred. The advertising
and marketing expenses recorded were $5.2 million,
$2.9 million and $2.1 million during the years ended
June 30, 2007, 2006 and 2005, respectively.
Net
Loss Per Common Share
The Company calculates net income (loss) per share in accordance
with SFAS No. 128, Earnings Per Share. Under
SFAS No. 128, 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. Diluted net income (loss) per common share
includes the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or
converted into common stock. The potentially dilutive securities
consist of convertible preferred stock, stock options and
warrants.
As of June 30, 2007, 2006 and 2005, the shares of common
stock issuable in connection with convertible preferred stock,
stock options, and warrants of 118,626,692, 107,638,157 and
100,579,529, respectively, were not included in the diluted loss
per common share calculation since their effect was
anti-dilutive.
Recent
Accounting Pronouncements
In February 2006, FASB issued SFAS No. 155,
Accounting for Certain Hybrid Financial
Instruments An Amendment of FASB Statements
No. 133 and 140. This Statement is effective for all
financial instruments acquired or issued after the beginning of
an entitys first fiscal year that begins after
September 15, 2006. At adoption, any difference between the
total carrying amount of the individual components of the
existing bifurcated hybrid financial instrument and the fair
value of the combined hybrid financial instrument should be
recognized as a cumulative effect adjustment to beginning
retained earnings. The Company does not believe that the
adoption of SFAS No. 155 will have a material impact
on its consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation (FIN) 48,
Accounting for Uncertainty in Income Taxes An
Interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in an enterprises financial statements in
accordance with SFAS No. 109, Accounting for Income
Taxes. This interpretation defines the minimum recognition
threshold a tax position is required to meet before being
recognized in the financial statements. FIN 48 is effective
for fiscal years beginning after December 15, 2006. The
Company will adopt FIN 48 on July 1, 2007. The
Companys adoption of this guidance will not have a
material effect on its financial position and results of
operations.
In September 2006, the FASB issued Statement of Financial
Accounting Standard No. 157 (SFAS No. 157),
Fair Value Measurements, which defines fair value,
establishes a framework for measuring fair value, and expands
disclosures about fair value measurements.
SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007. The Company is in the process of
evaluating the impact of this statement on the consolidated
financial statements.
F-11
K12
Inc.
Notes to
Consolidated Financial Statements
In February 2007, the FASB issued Statement of Financial
Accounting Standard No. 159 (SFAS No. 159),
The Fair Value Option for Financial Assets and Financial
Liabilities. This Statement permits companies and
not-for-profit organizations to make a one-time election to
carry eligible types of financial assets and liabilities at fair
value, even if fair value measurement is not required under
GAAP. SFAS No. 159 is effective for fiscal years beginning
after November 15, 2007. Early adoption is permitted if the
decision to adopt the standard is made after the issuance of the
Statement but within 120 days after the first day of the
fiscal year of adoption, provided no financial statements have
yet been issued for any interim period and provided the
requirements of SFAS No. 157, Fair Value Measurements, are
adopted concurrently with SFAS No. 159. The Company does
not believe that it will adopt the provisions of this Statement.
3.
Property
and Equipment
Property and equipment consists of the following at:
June 30,
2007
2006
Student computers
$
20,208
$
12,617
Computer hardware
5,811
6,615
Computer software
3,390
4,127
Capitalized software and web site development costs
4,905
1,717
Leasehold improvements
2,270
2,130
Furniture and fixtures
809
752
Office equipment
784
1,083
38,177
29,041
Less accumulated depreciation and amortization
(20,943
)
(18,653
)
$
17,234
$
10,388
The Company recorded depreciation expense related to property
and equipment reflected in selling, administrative and other
operating expenses of $1.9 million, $1.1 million and
$0.8 million during the years ended June 30, 2007,
2006 and 2005, respectively. Depreciation expense of
$5.1 million, $3.5 million and $3.9 million
related primarily to computers leased to students reflected in
instructional costs and services was recorded during the years
ended June 30, 2007, 2006 and 2005, respectively. Included
in depreciation expense reflected in instructional costs and
services for the year ended June 30, 2007 was
$0.5 million of depreciation related to the reduction in
useful life of a portion of our software related to our on-line
school. Amortization expense of $0.4 million,
$0.1 million and $0.2 million related to capitalized
software development reflected in product development expenses
was recorded during the years ended June 30, 2007, 2006 and
2005, respectively.
In the course of its normal operations, the Company incurs
maintenance and repair expenses. Those are expensed as incurred
and amounted to $0.4 million, $0.2 million and
$0.1 million for the years ended June 30, 2007, 2006
and 2005, respectively.
F-12
K12
Inc.
Notes to
Consolidated Financial Statements
4.
Income
Taxes
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amount of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the
Companys net deferred income taxes consists of the
following:
June 30,
2007
2006
Deferred tax assets:
Net operating loss carryforwards
$
25,376
$
25,445
Intangible assets
4,202
5,247
Reserves
613
935
Property and equipment
491
857
Accrued expenses
486
671
Deferred rent
180
Charitable contributions carryforward
131
130
Stock compensation expense
87
Total deferred tax assets
31,566
33,285
Deferred tax liabilities:
Capitalized development costs
(1,378
)
(522
)
Other assets
(262
)
(236
)
Total deferred tax liabilities
(1,640
)
(758
)
Deferred tax asset
29,926
32,527
Valuation allowance
(29,926
)
(32,527
)
Net deferred tax asset
$
$
The Company requires a valuation allowance to reduce the
deferred tax assets reported if, based on the weight of the
evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The utilization of
recorded net operating loss carryforwards and other deferred tax
assets is subject to the Companys ability to generate
future taxable income. As the Company has historically generated
tax losses and therefore has no tax earnings history, the net
deferred tax assets have been fully reserved. At June 30,
2007, the Company has available net operating loss carryforwards
of $63.4 million that expire between 2020 and 2027 if
unused. When the Company begins to generate taxable income, a
change in the Companys ownership of outstanding classes of
stock as defined in Internal Revenue Code Section 382 could
prohibit or limit the Companys ability to utilize its net
operating losses.
The provision for income taxes can be reconciled to the income
tax that would result from applying the statutory rate to the
net income (loss) before income taxes as follows:
Year Ended June 30,
2007
2006
2005
U.S. federal tax at statutory rates
35.00
%
35.00
%
35.00
%
Permanent items
20.22
55.77
(20.19
)
State taxes, net of federal benefit
13.65
12.98
2.12
Change in valuation allowance
(63.56
)
(103.75
)
(16.93
)
Provision for income taxes
5.31
%
%
%
F-13
K12
Inc.
Notes to
Consolidated Financial Statements
5.
Lease
Commitments
As of June 30, 2007, computer equipment and software under
capital leases are recorded at a cost of $8.1 million and
accumulated depreciation of $1.7 million. The Company has
an equipment lease line of credit with Hewlett-Packard Financial
Services Company that expires on March 31, 2008 for new
purchases on the line of credit. The interest rate on new
advances under the equipment lease line is set quarterly. Prior
borrowings under the equipment lease line had interest rates
ranging from 8.5% to 8.8%. The prior borrowings include a
36-month payment term with a $1 purchase option at the end of
the term. The Company has pledged the assets financed with the
equipment lease line to secure the amounts outstanding. The
Company entered into a guaranty agreement with Hewlett-Packard
Financial Services Company to guarantee the obligations under
this equipment lease and financing agreement.
The following is a summary as of June 30, 2007 of the
present value of the net minimum lease payments on capital
leases under the Companys commitments:
Year ending June 30,
2008
$
3,238
2009
2,888
2010
1,399
2011
6
Total minimum lease payments
7,531
Less amount representing interest (imputed interest rate of 8.6%)
(777
)
Net minimum lease payments
6,754
Less current portion
(2,780
)
Present value of net minimum payments, less current portion
$
3,974
The Company has fixed non-cancelable operating leases expiring
in 2013. Office leases generally contain renewal options and
certain leases provide for scheduled rate increases over the
lease terms.
In December 2005, the Company entered into an operating lease
for non-owned facilities commencing in May 2006. The term of the
lease is seven years with the option to extend the lease for two
five year periods. In accordance with the lease terms, the
Company delivered to the landlord an unconditional and
irrevocable letter of credit in the amount of $2.1 million
for a term ending 90 days after the expiration of the
lease. The letter of credit can be reduced up to 25% on the
first day of each of the fourth, fifth and sixth years if
certain covenants are met. Additionally, in December 2005, the
Company entered into an operating sublease for non-owned
facilities commencing in January 2006. The term of the sublease
is through September 2009. In accordance with the lease terms,
the Company delivered to the sublandlord an unconditional and
irrevocable letter of credit in the amount of $0.2 million
for a term ending 60 days after the expiration of the
lease. In November 2006, the Company entered into an operating
lease for non-owned facilities commencing in January 2007. The
term of the lease is through April 2013. Rent expense was
$2.1 million, $1.8 million and $1.4 million for
the years ended June 30, 2007, 2006 and 2005, respectively.
F-14
K12
Inc.
Notes to
Consolidated Financial Statements
Future minimum lease payments under noncancelable operating
leases with initial terms of one year or more as follows:
Year Ending
June 30,
2008
$
2,138
2009
2,127
2010
1,576
2011
1,386
2012
1,367
Thereafter
8,627
Total future minimum lease payments
$
17,221
6.
Line of
Credit
In December 2006, the Company entered into a $15 million
revolving credit agreement with PNC Bank (the Credit
Agreement). Pursuant to the terms of the Credit Agreement,
the proceeds of the term loan facility were to be used primarily
for working capital requirements and other general business or
corporate purposes. Because of the seasonality of our business
and timing of funds received from the state, expenditures are
higher in relation to funds received in certain periods during
the year. The Credit Agreement provides the ability to fund
these periods until cash is received from the schools;
therefore, borrowings against the Credit Agreement are primarily
going to be short term.
Borrowings under the Credit Agreement bear interest based upon
the term of the borrowings. Interest is charged, at either:
(i) the higher of (a) the rate of interest announced
by PNC Bank 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 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 as defined in
Regulation D as promulgated by the Board of Governors of
the Federal Reserve System, plus the applicable margin for such
loans, which ranges between 1.250% and 1.750%, based on the
leverage ratio (as defined in the Credit Agreement).
The Company pays a commitment fee on the unused portion of the
Credit Agreement, quarterly in arrears, during the term of the
credit agreement which varies between 0.150% and 0.250%
depending on the leverage ratio. The commitment fees incurred
for the year ended June 30, 2007 were minimal. We are also
required to pay certain letter of credit and audit fees.
The working capital line includes a $5.0 million letter of
credit facility. Issuances of letters of credit reduce the
availability of permitted borrowings under the Credit Agreement.
Borrowings under the Credit Agreement are secured by
substantially all of our assets of the Company. 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 its subsidiaries, or
make capital expenditures above specified limits and engage in
other matters customarily restricted in senior secured credit
facilities. We must also maintain a minimum net worth (as
defined in the Credit Agreement) and maximum debt leverage
ratios. These covenants are subject to certain qualifications
and exceptions.
In March 2007, certain letters of credit in the amount of
$2.3 million in connection with an operating lease
commenced in May 2006 and an operating sublease that commenced
in January 2006 were cancelled and reissued under our Credit
Agreement.
F-15
K12
Inc.
Notes to
Consolidated Financial Statements
As of June 30, 2007, $1.5 million was outstanding on
the working capital line of credit at an interest rate of 8.25%
and approximately $2.3 million under the letter of credit
facility with an interest rate of 1.25%.
From July 1, 2007 to September 15, 2007, the Company
borrowed additional funds of $11.0 million under the Credit
Agreement at interest rates of 6.6% to 7.1%. As of
September 15, 2007, $12.5 million was outstanding on
the working capital line of credit and $2.3 million was
outstanding related to letters of credit.
7.
Debt and
Warrants
All of the warrants for Series B Preferred Stock and common
stock are still outstanding at June 30, 2007. These
consisted of (i) 2,328,358 warrants to purchase an
equivalent number of Series B Preferred Stock at a price of
$1.34 per share that expire in April 2008 and
(ii) 21,299 warrants to purchase an equivalent number of
common stock at a price of $8.16 per share that expire in
March 2010. For the years ended June 30, 2007, 2006 and
2005 there were no warrants issued or exercised.
In June 2005, the Company closed on an $8.1 million loan
from certain shareholders, $4.0 million of which was funded
at closing and the remainder to be funded, at the Companys
option, within 120 days of the closing date. The
outstanding loan amount has a term of thirteen months and an
interest rate of 15%. During the 120 day period during
which funds are committed but not yet provided, the commitment
carries an interest rate of 2% on an annual basis. The Company
has chosen not to call upon the remaining portion of the loan.
The loan is secured by assets of the Company and there are no
penalties for prepayment.
In July 2006, the term for repayment of the outstanding loan
amount was extended to December 31, 2006. In December 2006,
the Company repaid the loan and all accrued interest.
In January and April 2007, the Company entered into a two
financing arrangements totaling $0.4 million for software
purchases and hardware maintenance support, respectively. The
payment terms range from 24 to 36 months at interest rates
ranging up to 11.4%. The balance outstanding on these financing
arrangements at June 30, 2007 is $0.4 million.
8.
Equity
Common
Stock
On July 27, 2001, all holders of Class A Common stock
(294,117 shares outstanding) and Class B Common stock
(1,666,667 shares outstanding) converted these shares into
1,960,784 shares of common stock. The Company has reserved
sufficient shares of common stock for potential issuance from
exercise of stock options and warrants and conversion of
Redeemable Convertible Series B and Series C Preferred
stock.
Redeemable
Convertible Series B Preferred Stock
During the years ended June 30, 2003 and 2002, K12 issued
approximately 21.6 million and 40.1 million shares of
Redeemable Convertible Series B Preferred stock
(Series B Preferred), respectively.
The Series B Preferred shares are convertible into common
stock at a conversion rate equal to the original amount invested
divided by $1.34. The Series B Preferred shares convert
automatically upon certain events, including a qualified initial
public offering by the Company. These shares have a liquidation
preference over common stock shares equal to the greater of
(i) two times the invested amount per share and
(ii) the amount the Series B shareholders would have
received had they converted their Series B shares into
common stock immediately prior to the Liquidation. The
Series B Preferred shares have voting rights equal to the
number of common stock shares into which the Series B
Preferred shares are convertible. The Series B Preferred
shares are entitled to dividends when and if declared by the
board of directors and are not cumulative. In the event the
Board declares a dividend on the common stock, the Series B
Preferred shareholders will receive dividends equal to the
amount of such dividend had the shares been converted into
common stock.
F-16
K12
Inc.
Notes to
Consolidated Financial Statements
The Series B Preferred shares are redeemable at the option
of the holder on December 31, 2006 at a price of two times
the amount invested to the extent the Series B Preferred
shares have not been previously converted into common shares. It
is classified as temporary equity on the balance sheet based
upon guidance in EITF Topic D-98, Classification and
Measurement of Redeemable Securities. The Company accounts
for the difference between the invested amount and the
redemption value by increasing the book value under the
effective interest method, charging the accretion to accumulated
deficit each period. As discussed below, the redemption date for
the Series B Preferred shares was extended to December 2008.
Redeemable
Convertible Series C Preferred Stock
The Series C Preferred shares are convertible into common
stock at a conversion rate equal to the original amount invested
divided by $1.34. The Series C Preferred shares convert
automatically upon certain events, including a qualified initial
public offering by the Company. These shares have a liquidation
preference over common stock shares equal to the greater of
(i) two times the invested amount per share and
(ii) the amount the Series C shareholders would have
received had they converted their Series C shares into
common stock immediately prior to the Liquidation. The
Series C shares have voting rights equal to the number of
common stock shares into which the Series C shares are
convertible.
The Series C shares are entitled to dividends, which accrue
at the rate of 10% per annum, compounded annually and shall be
paid on January 2 of each year in additional Series C
shares or, at the option of the Company, in cash. No dividends
are paid to any other classes of capital stock unless any and
all accrued but unpaid dividends on the Series C shares
have been declared and paid in full. For any other dividends or
similar distributions, the Series C shares participate with
Common Stock on an as-if-converted basis.
The Series C shares are redeemable at the option of the
holder on December 31, 2008 at a price of two times the
amount invested, to the extent the Series C shares had not
previously been converted into common stock. It is classified as
temporary equity on the balance sheet based upon guidance in
EITF Topic D-98, Classification and Measurement of Redeemable
Securities. The Company accounts for the difference between
the invested amount and the redemption value by increasing the
book value using the effective interest method, charging the
accretion to accumulated deficit each period.
In accordance with the Series C placement, the redemption
date for the Series B shares was extended to
December 31, 2008.
In July 2006, the Company amended its Certificate of
Incorporation, to effect an increase in the authorized number of
shares of Series C Convertible Preferred Stock to
55,000,000 as well as a corresponding increase in the authorized
number of shares of Preferred Stock and Common Stock into which
such shares are convertible.
9.
Stock
Option Plan
The Company adopted a Stock Option Plan (the Plan) in May 2000.
Under the Plan, employees, outside directors and independent
contractors are able to participate in the Companys future
performance through the awards of nonqualified stock options to
purchase common stock. In December 2003, the Board increased the
total number of common stock shares reserved and available for
grant and issuance pursuant to the Plan to
2,549,019 shares. Each stock option is exercisable pursuant
to the vesting schedule set forth in the stock option agreement
granting such stock option, generally over four years. Unless a
shorter period is provided by the Board or a stock option
agreement, each stock option may be exercisable until
December 31, 2009, the term of the Plan. No stock option
shall be exercisable after the expiration of its option term.
The Company also grants stock options to executive officers
under stand-alone agreements outside the Plan. These options
totaled 1,441,168 as of June 30, 2007.
Effective July 1, 2006, the Company adopted the fair value
recognition provisions of SFAS No. 123 (revised 2004),
Share-Based Payment
(SFAS 123R), using the prospective transition
method which requires the
F-17
K12
Inc.
Notes to
Consolidated Financial Statements
Company to apply the provisions of SFAS 123R only to awards
granted, modified, repurchased or cancelled after the effective
date. Equity-based compensation expense for all equity-based
compensation awards granted after July 1, 2006 is based on
the grant-date fair value estimated in accordance with the
provisions of SFAS 123R. The Company recognizes these
compensation costs on a straight-line basis over the requisite
service period, which is generally the vesting period of the
award.
The Company uses the Black-Scholes-Merton method to calculate
the fair value of stock options. The use of option valuation
models requires the input of highly subjective assumptions,
including the expected stock price volatility and the expected
term of the option. In March 2005, the Securities and Exchange
Commission (SEC) issued SAB No. 107 (SAB 107)
regarding the SECs interpretation of SFAS 123R and
the valuation of share-based payments for public companies. For
options issued subsequent to July 1, 2006, the Company has
applied the provisions of SAB 107 in its adoption of
SFAS 123R. Under SAB 107, the Company has estimated
the expected term of granted options to be the weighted average
mid-point between the vesting date and the end of the
contractual term. The Company estimates the volatility rate
based on historical closing stock prices.
The following weighted-average assumptions were used for options
granted in the year ended June 30, 2007 and a discussion of
the Companys methodology for developing each of the
assumptions used in the valuation model follows:
Year Ended
June 30, 2007
Dividend yield
0.0%
Expected volatility
51%
Risk-free interest rate
4.53% to 5.01%
Expected life of the option term (in years)
3.25 6.40
Forfeiture rate
20% to 30%
Dividend yield The Company has never declared or
paid dividends on its common stock and has no plans to do so in
the foreseeable future.
Expected volatility Volatility is a measure of the
amount by which a financial variable such as a share price has
fluctuated (historical volatility) or is expected to fluctuate
(expected volatility) during a period. Since the Company s
common shares are not publicly traded, the basis for the
standard option volatility calculation is derived from known
publicly traded comparable companies. The annual volatility for
these companies is derived from their historical stock price
data.
Risk-free interest rate The assumed risk free rate
used is a zero coupon U.S. Treasury security with a
maturity that approximates the expected term of the option.
Expected life of the option term This is the period
of time that the options granted are expected to remain
unexercised. Options granted during the quarter have a maximum
term of eight years. The Company estimates the expected life of
the option term based on an average life between the dates that
options become fully vested and the maximum life of options
granted in the year ended June 30, 2007.
Forfeiture rate This is the estimated percentage of
options granted that are expected to be forfeited or canceled
before becoming fully vested. The Company uses a forfeiture rate
that is based on historical forfeitures at various
classification levels with the Company.
On a contemporaneous basis, the Company estimated the value of
its common stock as of December 31, 2006, March 31,
2007 and June 27, 2007. The fair value applied to the
option grants in July 2006 was based on the December 31,
2006 valuation applied retrospectively. The fair value applied
to option grants in February 2007 and May 2007 was based on the
contemporaneous valuations.
F-18
K12
Inc.
Notes to
Consolidated Financial Statements
SFAS 123(R) requires management to make assumptions
regarding the expected life of the options, the expected
liability of the options and other items in determining
estimated fair value. Changes to the underlying assumptions may
have significant impact on the underlying value of the stock
options, which could have a material impact on our financial
statements.
The Company also grants stock options to executive officers
under stand-alone agreements outside the plan. These options
totaled 1,141,168 and 392,155 as of June 30, 2007 and 2006,
respectively.
A summary of the Companys stock option activity including
stand-alone agreements is as follows:
Weighted-
Average
Exercise
Shares
Price
Outstanding, June 30, 2005
2,050,299
$
6.83
Granted
611,903
7.50
Exercised
(22,584
)
1.65
Canceled
(126,812
)
7.01
Outstanding, June 30, 2006
2,512,806
7.03
Granted
1,249,409
13.35
Exercised
(42,708
)
6.84
Canceled
(96,657
)
7.06
Outstanding, June 30, 2007
3,622,850
$
9.21
The total intrinsic value of options exercised during the years
ended June 30, 2007 and 2006 was $0.1 million and $0,
respectively.
The following table summarizes the option grant activity for the
year ended June 30, 2007:
Weighted-Average
Options
Weighted-Average
Grant-Date
Grant date
Granted
Exercise Price
Fair Value
Intrinsic Value
July 2006
1,007,113
$
14.35
$
2.96
$
0.00
February 2007
188,381
$
9.18
$
4.84
$
0.00
May 2007
53,915
$
9.18
$
8.06
$
0.00
A summary of the Companys unvested stock options,
including those related to stand-alone agreements, as of
June 30, 2006 and changes during the year ended
June 30, 2007 are presented below:
Weighted-Average
Grant-Date
Shares
Fair Value
Unvested options outstanding, June 30, 2006
968,004
$
7.25
Granted
1,249,409
3.46
Vested
(560,673
)
4.92
Exercised
(42,708
)
6.84
Canceled
(96,657
)
6.99
Unvested options outstanding, June 30, 2007
1,517,375
$
5.02
F-19
K12
Inc.
Notes to
Consolidated Financial Statements
As of June 30, 2007, there was $0.7 million of total
unrecognized compensation expense related to unvested stock
options granted under the Plan. The cost is expected to be
recognized over weighted average period of 3.1 years. The
total fair value of shares vested during the year ended
June 30, 2007 was $4.2 million. During the year ended
June 30, 2007, the Company recognized $0.2 million of
stock based compensation.
The stock option agreements generally provide for accelerated
and full vesting of unvested stock options upon certain
corporate events. Those events include a sale of all or
substantially all of the Companys assets, a merger or
consolidation which results in the Companys stockholders
immediately prior to the transaction owning less than 50% of the
Companys voting stock immediately after the transaction,
and a sale of the Companys outstanding securities (other
than in connection with an initial public offering) which
results in the Companys stockholders immediately prior to
the transaction owning less than 50% of the Companys
voting stock immediately after the transaction.
The following table summarizes information about stock options
outstanding, including those related to stand-alone agreements,
as of June 30, 2007:
Weighted-
Average
Weighted-
Weighted-
Range of
Remaining
Average
Average
Exercise
Number
Contractual
Exercise
Number
Exercise
Prices
Outstanding
Life
Price
Exercisable
Price
$1.02 - $9.18
3,328,733
5.3 years
$
7.32
2,105,475
$
7.05
$30.60
294,117
5.5 years
$
30.60
The total intrinsic value of options outstanding and exercisable
at June 30, 2007 was $6.5 million and
$4.7 million, respectively.
10.
Commitments
and Contingencies
Litigation
In the ordinary conduct of the Companys business, we are
subject to lawsuits and other legal proceedings from time to
time. There are currently two pending lawsuits in which the
Company is involved, Johnson v. Burmaster and Illinois
v. Chicago Virtual Charter School that, in each case, have
been brought by teachers unions seeking the closure of the
virtual public schools the Company serves in Wisconsin and
Illinois, respectively.
While the Company prevailed on summary judgment at the circuit
court level in Johnson v. Burmaster, and recently won a
preliminary motion in Illinois v. Chicago Virtual Charter
School, it is not possible to predict the final outcome of
these matters with any degree of certainty. Even so, the Company
does not believe at this time that a loss in either case would
have a material adverse impact on our future results of
operations, financial position or cash flows. Depending on the
legal theory advanced by the plaintiffs, however, there is a
risk that a loss in these cases could have a negative
precedential effect if like claims were to be advanced and
succeed under similar laws in other states where the Company
operates. The cumulative effect under those circumstances could
be material.
Johnson
v. Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the
State of Wisconsin established a virtual public school, the
Wisconsin Virtual Academy (WIVA), and entered into a service
agreement with us for online curriculum and school management
services. On January 6, 2004, Stan Johnson, et al.,
and the Wisconsin Education Association Council (WEAC) filed
suit in the Circuit Court of Ozaukee County against the
Superintendent of the Department of Public Instruction (DPI),
Elizabeth Burmaster, the NOSD and K12 Inc. The plaintiffs
alleged that the NOSD violated the state charter school, open
enrollment and teacher-licensure statutes when it authorized
WIVA.
F-20
K12
Inc.
Notes to
Consolidated Financial Statements
On March 16, 2006, the Circuit Court issued a Decision and
Order upholding on Summary Judgment that WIVA complies with
applicable law
(No. 04-CV-12
). WEAC and DPI filed an appeal in the Wisconsin Court of
Appeals, District II
(No. 2006-AP/01380).
Should the plaintiff prevail, and state funding of open
enrollment payments to the NOSD are enjoined, a claim could be
made that the Company must indemnify the NOSD for expenses
approximating $2.5 million.
Illinois
v. Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed
a citizen taxpayers lawsuit in the Circuit Court of Cook County
challenging the decision of the Illinois State Board of
Education to certify the Chicago Virtual Charter School (CVCS)
and to enjoin the disbursement of state funds to the Chicago
Board of Education under its contract with the CVCS.
Specifically, the CTU alleges that the Illinois charter school
law prohibits any home-based charter schools and
that CVCS does not provide sufficient direct
instruction by certified teachers of at least five clock
hours per day to qualify for funding. K12 Inc. and K12 Illinois
LLC were also named as defendants. On May 16, 2007, the
Court dismissed K12 Inc. and K12 Illinois LLC from the case and
on June 15, 2007, the plaintiffs filed a second amended
complaint. The Company continues to participate in the defense
of CVCS under an indemnity obligation in the Companys
service agreement with that school, which requires the
Company to indemnify CVCS against certain liabilities arising
out of the performance of the service agreement and certain
other claims and liabilities, including liabilities arising out
of challenges to the validity of the virtual school charter. The
Company is not able to estimate the range of potential loss if
the plaintiff were to prevail and a claim was made against the
Company for indemnification.
The Company expenses legal costs as incurred in connection with
a loss contingency.
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 one agreement that has a three year
term, all other agreements provide for employment on an
at-will basis. If the employee is terminated for
good reason or without cause, the employee is
entitled to salary continuation, and in some cases benefit
continuation, for varying periods depending on the agreement.
On July 12, 2007, the Companys board of directors
approved an amended and restated employment agreement for an
executive officer. The amended and restated agreement extends
the term of employment until January 1, 2011 and amended
certain elements of compensation including salary, stock options
and severance. Additionally, on July 12, 2007, the
Companys board of directors also approved the terms of a
new option agreement for an executive officer which provides
that all outstanding options will become fully vested upon a
change in control of Company.
The Company maintains an annual cash performance bonus program
that is intended to reward executive officers based on our
performance and the individual named executive officers
contribution to that performance. In determining the
performance-based compensation awarded to each named executive
officer, the Company may generally evaluate the Companys
and the executives performance in a number of areas, which
could include revenues, operating earnings, student retention,
efficiency in product and systems development, marketing
investment efficacy, new enrollment and developing company
leaders.
Vendor
Payment Commitments
In April 2007, the Company entered into a master services and
license agreement with a third party that provides for the
Company to license their proprietary computer system. The
agreement is effective through July 2010. In exchange for the
license of the computer system, the Company agrees to pay a
service fee per enrollment. In the event the fees paid over the
term of the contract do not exceed $1 million (the minimum
commitment fee), the Company agrees to pay the difference
between the actual fees paid and the minimum commitment fee.
F-21
K12
Inc.
Notes to
Consolidated Financial Statements
11.
Related
Party Transactions
Affiliates of the Company, controlled by a major investor,
rendered $0.3 million, $0.1 million and
$0.1 million of professional services to the Company during
the years ended June 30, 2007, 2006 and 2005, respectively.
These costs include administrative operations, consulting and
curriculum development services, and other operating charges.
In June 2005, the Company closed on an $8.1 million loan
from certain shareholders, $4.0 million of which was funded
at closing and the remainder to be funded, at the Companys
option, within 120 days of the closing date. The Company
has chosen not to call upon the remaining portion of the loan.
In July 2006, the term for repayment of the outstanding loan
amount was extended to December 31, 2006. In
December 2006, the Company repaid the loan and all accrued
interest.
12.
Employee
Benefits
The Company is party to a Section 401(k) Salary Deferral
Plan (the 401(k) Plan). Under the 401(k) Plan, employees at
least 18 years of age having been employed for at least
30 days may voluntarily contribute up to 15% of their
compensation. The 401(k) Plan provides for a matching Company
contribution of 25% of the first 4% of each participants
compensation, which begins following six months of service and
vests after three years of service. Under the 401(k) Plan, the
Company expensed $0.1 million during each of the years
ended June 30, 2007, 2006 and 2005.
13.
Supplemental
Disclosure of Cash Flow Information
Year Ended June 30,
2007
2006
2005
Cash paid for interest
$
1,317
$
33
$
446
Supplemental disclosure of non cash investing and financing
activities:
New capital lease obligations
$
8,052
$
$
441
14.
Subsequent
Events
Letters
of Intent
On July 3, 2007, the Company entered into a non-binding
letter of intent (LOI) with Socratic Network L.P., Socratic
Learning, Inc. and Tutors Worldwide (India) Private Ltd.
(individually and collectively referred to as Socratic) to
acquire all, substantially all or a selected set of assets (as
determined in the Companys sole discretion) of Socratic,
or all the equity interest in Socratic or any of its affiliates
or subsidiaries, for the aggregate purchase price of
$2.2 million plus 58,823 shares of the common stock of
the Company. Socratic is an eduction company whose primary asset
is its India based tutoring and development center.
On August 2, 2007, the Company entered into a non-binding letter
of intent (LOI) with a curriculum content developer to acquire
substantially all of its assets or all of the equity interest in
the developer (as determined in the Companys sole
discretion) for the aggregate purchase price of up to 196,078
shares of the Companys common stock and the assumption of
up to $1.2 million in liabilities.
F-22
K12
Inc.
Notes to
Consolidated Financial Statements
Initial
Public Offering
On July 12, 2007, the Companys Board of Directors
authorized management to file a
Form S-1
Registration Statement Under the Securities Act of
1933 in order to pursue a public offering of the
Companys common stock. Immediately prior to the completion
of this offering, all outstanding shares of Redeemable
Convertible Series B and Series C preferred stock will
be converted into shares of our common stock without any further
action required by us or the holders of the preferred stock.
Stock
Options
On July 3, 2007, the Board approved the grant of 640,304
stock options with an exercise price of $13.67 per share subject
to amendment of the Stock Option Plan. On July 12, 2007,
the Board authorized the Company to seek shareholder approval to
amend the Stock Option Plan by increasing the number of shares
reserved for issuance from 2.5 million to 3.9 million.
15.
Subsequent
Event Reverse Stock Split
Reverse Stock Split On
October 30, 2007, the Board approved a
1-for-5.1
reverse split of the Companys common stock. On
October 31, 2007, the reverse split was further approved by
a majority of the shareholders. The stock split was effective on
November 2, 2007. In conjunction with this, the number of
authorized shares of common stock was amended to 33,362,500. All
share and per share amounts related to common stock, options and
common stock warrants included in the consolidated financial
statements have been retroactively adjusted for all periods
presented to give effect to the stock split.
F-23
K12
INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
September 30,
June 30,
2007
2007
(unaudited)
(in thousands,
except share and
per share data)
ASSETS
Current assets
Cash and cash equivalents
$
2,903
$
1,660
Accounts receivable, net of allowance of $610 and $589 at
September 30, 2007 and June 30, 2007, respectively
49,682
15,455
Inventories, net
6,768
13,804
Current portion of deferred tax asset
1,141
Prepaid expenses and other current assets
983
1,245
Total current assets
61,477
32,164
Property and equipment, net
23,427
17,234
Capitalized curriculum development costs, net
10,881
9,671
Deferred tax asset, net of current portion
5,976
Other assets, net
2,416
1,182
Deposits and other assets
2,025
961
Total assets
$
106,202
$
61,212
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS DEFICIT
Current liabilities
Bank overdraft
$
$
1,577
Line of credit
12,500
1,500
Accounts payable
11,028
6,928
Accrued liabilities
4,193
1,819
Accrued compensation and benefits
3,321
6,200
Deferred revenue
15,191
2,620
Current portion of capital lease obligations
5,111
2,780
Current portion of notes payable
194
192
Total current liabilities
51,538
23,616
Deferred rent, net of current portion
1,667
1,684
Capital lease obligations, net of current portion
7,959
3,974
Notes payable, net of current portion
142
189
Total liabilities
61,306
29,463
Commitments and contingencies
Redeemable convertible preferred stock
Redeemable Convertible Series C Preferred stock, par value
$0.0001; 55,000,000 shares authorized;
49,861,562 shares issued and outstanding at
September 30, 2007 and June 30, 2007, respectively;
liquidation value of $133,629 at September 30, 2007 and
June 30, 2007, respectively
95,571
91,122
Redeemable Convertible Series B Preferred stock, par value
$0.0001; 76,000,000 shares authorized;
51,524,974 shares issued and outstanding at
September 30, 2007 and June 30, 2007, respectively;
liquidation value of $138,087 at September 30, 2007 and
June 30, 2007, respectively
142,216
138,434
Stockholders deficit
Common stock, par value $0.0001; 33,362,500 shares
authorized; 2,045,217 and 2,041,604 shares issued and
outstanding at September 30, 2007 and June 30, 2007,
respectively
1
1
Accumulated deficit
(192,892
)
(197,808
)
Total stockholders deficit
(192,891
)
(197,807
)
Total liabilities, redeemable convertible preferred stock and
stockholders deficit
$
106,202
$
61,212
See notes to unaudited condensed consolidated financial
statements.
F-24
K12
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30,
2007
2006
(in thousands, except per share data)
Revenues
$
59,353
$
37,743
Cost and expenses
Instructional costs and services
34,778
19,177
Selling, administrative, and other operating expenses
16,039
11,385
Product development expenses
2,527
2,206
Total costs and expenses
53,344
32,768
Income from operations
6,009
4,975
Interest expense, net
(304
)
(94
)
Net income before income tax expense
5,705
4,881
Income tax benefit (expense)
7,117
(146
)
Net income
12,822
4,735
Dividends on preferred stock
(1,671
)
(1,519
)
Preferred stock accretion
(6,560
)
(5,367
)
Net income (loss) attributable to common stockholders
$
4,591
$
(2,151
)
Net income (loss) attributable to common stockholders per
share:
Basic
$
2.25
$
(1.08
)
Diluted
$
0.20
$
(1.08
)
Weighted average shares used in computing per share
amounts:
Basic
2,043,589
1,998,853
Diluted
22,744,525
1,998,853
See notes to unaudited condensed consolidated financial
statements.
F-25
K12
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS DEFICIT
(UNAUDITED)
Stockholders Deficit
Redeemable Convertible
Redeemable Convertible
Additional
Series C Preferred Stock
Series B Preferred Stock
Common Stock
Paid-in
Accumulated
Shares
Amount
Shares
Amount
Shares
Amount
Capital
Deficit
Total
(dollars in thousands, except share amounts)
Balance, June 30, 2007
49,861,562
$
91,122
51,524,974
$
138,434
2,041,604
$
1
$
$
(197,808
)
$
(197,807
)
Employee exercised options
3,613
25
25
Accretion of Preferred Stock
2,778
3,782
(325
)
(6,235
)
(6,560
)
Accrued Series C 10% Stock Dividend
1,671
(1,671
)
(1,671
)
Record stock compensation expense
300
300
Net income
12,822
12,822
Balance, September 30, 2007
49,861,562
$
95,571
51,524,974
$
142,216
2,045,217
$
1
$
$
(192,892
)
$
(192,891
)
See notes to unaudited condensed consolidated financial
statements.
F-26
K12
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended September 30,
2007
2006
(in thousands)
Cash Flows from Operating Activities
Net income
$
12,822
$
4,735
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Depreciation and amortization expense
2,252
1,224
Stock based compensation expense
300
41
Deferred tax benefit
(7,117
)
Provision for (reduction of) doubtful accounts
21
(958
)
Provision for (reduction of) inventory obsolescence
7
(31
)
Provision for (reduction of) student computer shrinkage and
obsolescence
161
(153
)
Changes in assets and liabilities:
Accounts receivable
(34,248
)
(20,397
)
Inventories
7,029
3,680
Prepaid expenses and other current assets
261
(75
)
Other assets
(933
)
(1,112
)
Deposits and other assets
557
34
Accounts payable
4,100
3,187
Accrued liabilities
2,374
3,321
Accrued compensation and benefits
(2,880
)
(2,074
)
Deferred revenue
12,571
11,963
Deferred rent
(17
)
13
Net cash (used in) provided by operating activities
(2,740
)
3,398
Cash flows from investing activities
Purchase of property and equipment
(1,530
)
(4,784
)
Purchase of domain name
(250
)
Capitalized curriculum development costs
(1,622
)
(2,066
)
Net cash used in investing activities
(3,402
)
(6,850
)
Cash flows from financing activities
Deferred initial public offering costs
(1,371
)
Payments on notes payable
(44
)
Net borrowings from revolving credit facility
11,000
Repayments for capital lease obligations
(648
)
Proceeds from exercise of stock options
25
Repayment of bank overdraft
(1,577
)
Net cash provided by financing activities
7,385
Net change in cash and cash equivalents
1,243
(3,452
)
Cash and cash equivalents, beginning of period
1,660
9,475
Cash and cash equivalents, end of period
$
2,903
$
6,023
See notes to unaudited condensed consolidated financial
statements.
F-27
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
1.
Basis of
Presentation
The accompanying condensed consolidated balance sheet as of
September 30, 2007, the condensed consolidated statements
of operations and cash flows for the three months ended
September 30, 2007 and 2006 and the condensed consolidated
statement of shareholders equity for the three months
ended September 30, 2007 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
Companys financial position and results of operations and
cash flows for the three months ended September 30, 2007
and 2006. The financial data and other information disclosed in
these notes to the financial statements related to the three
month periods are unaudited. The results of the three months
ended September 30, 2007 are not necessarily indicative of
the results to be expected for the year ending June 30,
2008 or for any other interim period or for any other future
year.
The consolidated financial statements include the accounts of
the Company and all of its wholly owned subsidiaries. All
significant intercompany transactions and balances have been
eliminated in consolidation.
2.
Summary
of Significant Accounting Policies
Stock-Based
Compensation
The Company adopted SFAS No. 123(R), Share-Based
Payment (Revised 2004), as of July 1, 2006, which
replaces SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes Accounting Principles Board
Opinion No. 25 (APB No. 25), Accounting for Stock
Issued to Employees. The Company adopted SFAS 123(R)
using the prospective application method. SFAS No. 123(R)
eliminates the intrinsic value method that was previously used
by the Company as an alternative method of accounting for
stock-based compensation. SFAS No. 123(R) requires an
entity to recognize the grant date fair value of stock options
and other equity-based compensation issued to employees in the
consolidated statement of operations. The Company applied
SFAS 123(R) to all new awards granted after July 1,
2006.
Net
Income (Loss) Per Common Share
The Company calculates net income (loss) per share in accordance
with SFAS No. 128, Earnings Per Share. Under
SFAS No. 128, 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. Diluted net income (loss) per common share
includes the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or
converted into common stock. The potentially dilutive securities
consist of convertible preferred stock, stock options and
warrants.
Recent
Accounting Pronouncements
In June 2006, the FASB issued FASB Interpretation (FIN) 48,
Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in an enterprises financial statements in
accordance with SFAS No. 109, Accounting for Income
Taxes. This interpretation defines the minimum recognition
threshold a tax position is required to meet before being
recognized in the financial statements. FIN 48 is effective
for fiscal years beginning after December 15, 2006.
Accordingly, the Company has implemented FIN 48 in the first
quarter of the fiscal year which will end on June 30, 2008.
The Company did not have any unrecognized tax benefits and there
was no effect on our financial condition or results of
operations as a result of implementing FIN 48.
F-28
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
The Company files income tax returns in the U.S. federal
jurisdiction and various state jurisdictions. The Company does
not believe there will be any material changes in its
unrecognized tax positions over the next twelve months.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements, which defines fair value,
establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. SFAS 157 is
effective for fiscal years beginning after November 15,
2007. The Company is in the process of evaluating the impact of
this statement on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities. This statement permits companies and
not-for-profit organizations to make a one-time election to
carry eligible types of financial assets and liabilities at fair
value, even if fair value measurement is not required under
GAAP. SFAS 159 is effective for fiscal years beginning
after November 15, 2007. Early adoption is permitted if the
decision to adopt the standard is made after the issuance of the
statement but within 120 days after the first day of the
fiscal year of adoption, provided no financial statements have
yet been issued for any interim period and provided the
requirements of statement 157, Fair Value Measurements, are
adopted concurrently with SFAS 159. The Company does not
believe that it will adopt the provisions of this statement.
3.
Line of
Credit
In December 2006, the Company entered into a $15 million
revolving credit agreement with PNC Bank (Credit Agreement).
Pursuant to the terms of the Credit Agreement, the proceeds of
the term loan facility were to be used primarily for working
capital requirements and other general business or corporate
purposes. Because of the seasonality of our business and timing
of funds received from the state, expenditures are higher in
relation to funds received in certain periods during the year.
The Credit Agreement provides the ability to fund these periods
until cash is received from the schools; therefore, borrowings
against the Credit Agreement are primarily going to be short
term.
Borrowings under the Credit Agreement bear interest based upon
the term of the borrowings. Interest is charged, at either:
(i) the higher of (a) the rate of interest announced
by PNC Bank 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 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 as defined in
Regulation D as promulgated by the Board of Governors of
the Federal Reserve System, plus the applicable margin for such
loans, which ranges between 1.250% and 1.750%, based on the
leverage ratio (as defined in the credit agreement).
The Company pays a commitment fee on the unused portion of the
credit agreement, quarterly in arrears, during the term of the
credit agreement which varies between 0.150% and 0.250%
depending on the leverage ratio. The commitment fees incurred
for the three months ended September 30, 2007 were minimal.
We are also required to pay certain letter of credit and audit
fees.
The working capital line includes a $5.0 million letter of
credit facility. Issuances of letters of credit reduce the
availability of permitted borrowings under the credit agreement.
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 its subsidiaries, or
make capital expenditures above specified limits and engage in
other matters customarily restricted in senior secured credit
facilities. We must also maintain a minimum net worth (as
defined in the credit agreement) and maximum debt leverage
ratios. These covenants are subject to certain qualifications
and exceptions.
F-29
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
In March 2007, certain letters of credit in the amount of
$2.3 million in connection with an operating lease
commenced in May 2006 and an operating sublease that commenced
in January 2006 were released and incorporated into our
revolving credit facility.
As of September 30, 2007, $12.5 million was
outstanding on the working capital line of credit at interest
rates of 6.4% to 7.0% and approximately $2.3 million under
the letter of credit facility with an interest rate of 1.25%.
On October 5, 2007, the Company amended the Credit Agreement
increasing the commitment level to $20 million. This agreement
expires on December 20, 2009. From October 1, 2007 to
October 31, 2007, the Company borrowed additional funds of $4.0
million under the Credit Agreement at an interest rate of 6.4%.
On November 2, 2007, the Company repaid $1.5 million
of the outstanding balance on the working capital line of
credit.
4.
Income
Taxes
Through the year ended June 30, 2007, the Company had
recorded a valuation allowance against deferred tax assets. A
valuation allowance is recorded when it is more likely than not
that some or all of the deferred tax assets will not be
realized. Negative evidence, such as a history of pre-tax losses
through fiscal year 2005, recent marginal pre-tax income for
fiscal years 2006 and 2007 and difficulty in projecting
operating results until enrollments are determined at the end of
the first quarter, suggested that a valuation allowance was
needed. However, positive evidence in the three months ended
September 30, 2007, such as strong enrollment growth and
positive taxable income as well as the Companys
projections for the years ended June 30, 2008 and June 30, 2009
indicate that the Company will be able to utilize a portion of
its net operating loss. As a result, in the three months ended
September 30, 2007, the Company determined that only a
partial valuation allowance was necessary and reversed
$9.7 million of its valuation allowance based upon
projected taxable income over the next two years. This was
offset by the income tax expense on
pre-tax
earnings for the three months ended September 30, 2007 of
$2.6 million resulting in a deferred tax asset of
$7.1 million. As of September 30, 2007, the Company
had net operating loss carry-forwards of $59.2 million that
expire between 2020 and 2028 if unused.
5.
Stock
Option Plan
Effective July 1, 2006, the Company adopted the fair value
recognition provisions of SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS 123R), using
the prospective transition method which requires the Company to
apply the provisions of SFAS No. 123R only to awards
granted, modified, repurchased or cancelled after the effective
date. Equity-based compensation expense for all equity-based
compensation awards granted after July 1, 2006 is based on
the grant-date fair value estimated in accordance with the
provisions of SFAS 123R. The Company recognizes these
compensation costs on a straight-line basis over the requisite
service period, which is generally the vesting period of the
award.
The Company uses the Black-Scholes-Merton method to calculate
the fair value of stock options. Depending on certain
substantive characteristics of the stock option, the Company,
where appropriate, utilizes a binomial model. The use of option
valuation models requires the input of highly subjective
assumptions, including the expected stock price volatility and
the expected term of the option. In March 2005, the Securities
and Exchange Commission (SEC) issued SAB No. 107
(SAB 107) regarding the SECs interpretation of
SFAS 123R and the valuation of share-based payments for
public companies. For options issued subsequent to July 1,
2006, the Company has applied the provisions of SAB 107 in
its adoption of SFAS 123R. Under SAB 107, the Company
has estimated the expected term of granted options to be the
weighted average mid-point between the vesting date and the end
of the contractual term. The Company estimates the volatility
rate based on historical closing stock prices.
F-30
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
The following weighted-average assumptions were used for
calculating the fair value of each option at the date of grant
for the three months ended September 30, 2007 and a
discussion of the Companys methodology for developing each
of the assumptions used in the valuation model follows:
Three Months Ended
September 30, 2007
Dividend yield
0.0%
Expected volatility
41% 47%
Risk-free interest rate
4.93% 4.97%
Expected term, in years
4.05 5.76
Dividend yield The Company has never declared or
paid dividends on its common stock and has no plans to do so in
the foreseeable future.
Expected volatility Volatility is a measure of the
amount by which a financial variable such as a share price has
fluctuated (historical volatility) or is expected to fluctuate
(expected volatility) during a period. Since the Company s
common shares are not publicly traded, the basis for the
standard option volatility calculation is derived from known
publicly traded comparable companies. The annual volatility for
these companies is derived from their historical stock price
data.
Risk-free interest rate The assumed risk free rate
used is a zero coupon U.S. Treasury security with a
maturity that approximates the expected term of the option.
Expected term of the option This is the period of
time that the options granted are expected to remain
unexercised. Options granted during the quarter have a maximum
term of eight years. The Company estimates the expected life of
the option term based on the weighted average life between the
dates that options become fully vested and the maximum life of
options granted in the three months ended September 30,
2007.
In order to compute stock compensation expense after determining
the fair value of an individual option, the Company applies a
forfeiture rate to the total number of options granted
representing those options that are expected to be forfeited or
canceled before becoming fully vested. The forfeiture rate is
based on historical trends at various classification levels with
the Company.
SFAS 123(R) requires management to make assumptions
regarding the expected life of the options, the expected
liability of the options and other items in determining
estimated fair value. Changes to the underlying assumptions may
have significant impact on the underlying value of the stock
options, which could have a material impact on our financial
statements.
The Company also grants stock options to executive officers
under stand-alone agreements outside the plan. These options
totaled 1,441,168 as of September 30, 2007.
F-31
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
Stock option activity including stand-alone agreements during
the three months ended September 30, 2007 was as follows:
Weighted-
Average
Exercise
Shares
Price
Outstanding, June 30, 2007
3,622,850
$
9.21
Granted
1,257,948
13.66
Exercised
(3,613
)
6.85
Canceled
(16,212
)
8.12
Outstanding, September 30, 2007
4,860,973
$
10.37
The total intrinsic value of options exercised during the three
months ended September 30, 2007 was $0.1 million.
The following table summarizes the option grant activity for the
three months ended September 30, 2007.
Weighted Average
Options
Weighted-Average
Grant-Date
Intrinsic
Grant date
Granted
Exercise Price
Fair Value
Value
July 2007
1,257,948
$
13.66
$
9.28
$
0.00
A summary of the Companys unvested stock options,
including those related to stand-alone agreements, as of
June 30, 2007 and changes during the three months ended
September 30, 2007 are presented below:
Weighted
Average
Unvested
Grant Date
Options
Fair Value
Unvested options outstanding, June 30, 2007
1,517,375
$
5.02
Granted
1,257,948
9.28
Vested
(102,326
)
6.16
Exercised
(3,613
)
6.85
Canceled
(16,212
)
3.52
Unvested options outstanding, September 30, 2007
2,653,172
$
7.00
As of September 30, 2007, there was $3.9 million of
total unrecognized compensation expense related to unvested
stock options granted under the Stock Option Plan
(Plan) adopted in May 2000. The cost is expected to
be recognized over a weighted average period of 3.0 years.
The total fair value of shares vested during the three months
ended September 30, 2007 was $0.8 million. During the
three months ended September 30, 2007, the Company
recognized $0.3 million of stock based compensation.
On July 3, 2007, the Board approved the grant of
640,304 stock options with an exercise price of $13.67 per
share, subject to the amendment of the Stock Option Plan. On
July 12, 2007, the Board authorized the Company to seek
shareholder approval to amend the Stock Option Plan by
increasing the number of shares reserved for issuance from
approximately 2.549 million to 3.922 million. The
Board also approved the grant of 617,644 options to certain
officers of the Company with an exercise price of $13.66 per
share subject to amendment of the Plan. On November 5,
2007, the shareholders approved the amendment to the Stock
Option Plan to increase the number of shares reserved for
issuance.
F-32
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
The stock option agreements for outstanding stock options
generally provide for accelerated and full vesting of unvested
stock options upon certain corporate events. Those events
include a sale of all or substantially all of the Companys
assets, a merger or consolidation which results in the
Companys stockholders immediately prior to the transaction
owning less than 50% of the Companys voting stock
immediately after the transaction, and a sale of the
Companys outstanding securities (other than in connection
with an initial public offering) which results in the
Companys stockholders immediately prior to the transaction
owning less than 50% of the Companys voting stock
immediately after the transaction.
The following table summarizes information about stock options
outstanding, including those related to stand-alone agreements,
as of September 30, 2007:
Weighted-
Average
Weighted-
Weighted-
Range of
Remaining
Average
Average
Exercise
Number
Contractual
Exercise
Number
Exercise
Prices
Outstanding
Life
Price
Exercisable
Price
$1.02 - $9.18
3,310,201
5.1 years
$
7.32
2,206,821
$
7.07
$13.66
1,256,655
7.8 years
$
13.66
980
$
13.66
$30.60
294,117
5.3 years
$
30.60
6.
Lease
Commitments
As of September 30, 2007, computer equipment and software
under capital leases are recorded at a cost of
$13.9 million and accumulated depreciation of
$2.5 million. The Company has an equipment lease line of
credit with Hewlett-Packard Financial Services Company that
expires on March 31, 2008 for new purchases on the line of
credit. We expect to renew this facility. The interest rate on
new advances under the equipment lease line is set quarterly.
Prior borrowings under the equipment lease line had interest
rates ranging from 8.5% to 8.8%. The prior borrowings include a
36-month payment term with a $1 purchase option at the end of
the term. The Company has pledged the assets financed with the
equipment lease line to secure the amounts outstanding. The
Company entered into a guaranty agreement with Hewlett-Packard
Financial Services Company to guarantee the obligations under
this equipment lease and financing agreement.
The following is a summary as of September 30, 2007 of the
present value of the net minimum lease payments on capital
leases under the Companys commitments:
Capital
September 30,
Leases
2008
$
6,072
2009
5,520
2010
3,061
Total minimum lease payments
14,653
Less amount representing interest (imputed interest rate of 8.7%)
(1,583
)
Net minimum lease payments
13,070
Less current portion
(5,111
)
Present value of net minimum payments, less current portion
$
7,959
F-33
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
7.
Commitments
and Contingencies
In the ordinary conduct of our business, we are subject to
lawsuits and other legal proceedings from time to time. There
are currently two significant pending lawsuits in which we are
involved; Johnson v. Burmaster and
Illinois v. Chicago Virtual Charter School that, in
each case, have been brought by teachers unions seeking
the closure of the virtual public schools we serve in Wisconsin
and Illinois, respectively.
As described more fully below, we intend to appeal a recent
ruling against us by the Court of Appeals in Johnson v.
Burmaster, and we recently won a preliminary motion in
Illinois v. Chicago Virtual Charter School.
Nevertheless, it is not possible to predict the final outcome of
these matters with any degree of certainty. Even so, we do not
believe at this time that a loss in either case would have a
material adverse impact on our future results of operations,
financial position or cash flows. Depending on the legal theory
advanced by the plaintiffs, however, there is a risk that a loss
in these cases could have a negative precedential effect if like
claims were to be advanced and succeed under similar laws in
other states where we operate. The cumulative effect under those
circumstances could be material.
Johnson v.
Burmaster
In 2003, the Northern Ozaukee School District (NOSD) in the
State of Wisconsin established a virtual public school, the
Wisconsin Virtual Academy (WIVA), and entered into a service
agreement with us for online curriculum and school management
services. On January 6, 2004, Stan Johnson, et al., and the
Wisconsin Education Association Council (WEAC) filed suit in the
Circuit Court of Ozaukee County against the Superintendent of
the Department of Public Instruction (DPI), Elizabeth Burmaster,
the NOSD and K12 Inc. The plaintiffs alleged that the NOSD
violated the state charter school, open enrollment and
teacher-licensure statutes when it authorized WIVA.
On March 16, 2006, the Circuit Court issued a decision and
order finding that nothing in these three statutes prohibits
virtual schools like WIVA. Specifically, the Court concluded
that: (i) WIVA was located in NOSD because its offices,
where WIVAs administration operates the school and
establishes policies, are in the district and thus comply with
the charter school law; (ii) that lessons and instruction
delivered over the Internet to non-resident students constitute
attendance because the open-enrollment law does not mandate a
students physical presence; and (iii) that
WIVAs certified teachers satisfy the requirement for
licensed teachers in public schools, whereas the parents
role does not constitute teaching as defined in the Wisconsin
Administrative Code. The Court thus granted the defendants
motion for summary judgment (Case
No. 04-CV-12).
On June 5, 2006, WEAC and DPI filed an appeal in the
Wisconsin Court of Appeals, District II
(No. 2006-AP/01380).
On December 5, 2007, the Court of Appeals reversed the
Circuit Court decision and held that WIVA is not in compliance
with these statutes; granted summary judgment to WEAC and DPI;
and ordered the Circuit Court to enter a declaratory ruling that
NOSD and K12 are in violation of the applicable statutes and to
enjoin the DPI from making pupil transfer payments based on
students enrolled in WIVA. Specifically, the court found that
(i) at least part of WIVA was not within the physical
boundaries of its chartering school district because a majority
of the students and teachers are not located there, and that
such a separation violates the charter school law,
(ii) WIVAs non-resident pupils attend school outside
the district (based on its prior conclusion that WIVA is
partially located outside the district), and therefore that WIVA
does not qualify for open-enrollment funding, and
(iii) although WIVA utilizes certified teachers, the
activities of WIVA parents (including working
one-on-one
with a pupil, presenting the lesson, answering questions and
assessing progress) also fall within the applicable definition
of teaching under the Wisconsin Administrative Code,
and therefore that WIVA violated Wisconsins teacher
licensure requirements.
Under Wisconsin law, the order of the Court of Appeals will be
automatically stayed for 30 days to provide us an
opportunity to appeal the decision to the Wisconsin Supreme
Court. We intend to appeal the decision to the Wisconsin Supreme
Court, which in its discretion may decide whether or not to hear
our appeal. Upon the filing of
F-34
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
our petition with the Wisconsin Supreme Court, the order of the
Court of Appeals will remain without effect until the Wisconsin
Supreme Court either determines not to hear our appeal or issues
a ruling in the case.
While our appeal remains pending before the Wisconsin Supreme
Court, WIVA will continue to operate and we will continue to
provide our curriculum and school management services to WIVA.
We estimate that revenue from WIVA for fiscal year 2008 will be
approximately $5.0 million, of which $1.6 million was
recognized in the fiscal quarter ended September 30, 2007.
We believe we will be entitled to full payment from WIVA for the
curriculum and school management services we provide in fiscal
2008. However, if we determine that it is probable that DPI will
cease making open enrollment payments to WIVA for students
enrolled in WIVA, we will be required to establish a reserve in
fiscal year 2008 of up to $5.0 million, though we would
still seek to collect payment in full for curriculum and
services provided to WIVA in fiscal 2008. If we ultimately do
not prevail in this case, we will not be able to continue to
manage WIVA or any other statewide virtual public school in
Wisconsin unless the state legislature adopts legislation to
allow us to do so. In fiscal year 2007 and the fiscal quarter
ended September 30, 2007, average enrollments in WIVA were
677 and 840, respectively, and we derived 3.0% and 2.7%,
respectively, of our revenues from WIVA.
Illinois v.
Chicago Virtual Charter School
On October 4, 2006, the Chicago Teachers Union (CTU) filed
a citizen taxpayers lawsuit in the Circuit Court of Cook County
challenging the decision of the Illinois State Board of
Education to certify the Chicago Virtual Charter School (CVCS)
and to enjoin the disbursement of state funds to the Chicago
Board of Education under its contract with the CVCS.
Specifically, the CTU alleges that the Illinois charter school
law prohibits any home-based charter schools and
that CVCS does not provide sufficient direct
instruction by certified teachers of at least five clock
hours per day to qualify for funding. K12 Inc. and K12 Illinois
LLC were also named as defendants. On May 16, 2007, the
Court dismissed K12 Inc. and K12 Illinois LLC from the case and
on June 15, 2007, the plaintiffs filed a second amended
complaint which the court dismissed on October 30, 2007
with leave to re-plead. The Company continues to participate in
the defense of CVCS under an indemnity obligation in our service
agreement with that school, which requires the Company to
indemnify CVCS against certain liabilities arising out of the
performance of the service agreement, and certain other claims
and liabilities, including liabilities arising out of challenges
to the validity of the virtual school charter. The Company is
not able to estimate the range of potential loss if the
plaintiff were to prevail and a claim was made against the
Company for indemnification. In fiscal year 2007 and the fiscal
quarter ended September 30, 2007, average enrollments in
CVCS were 225 and 407, respectively, and we derived 1.1% and
1.3%, respectively of our revenues from CVCS.
The Company expenses legal costs as incurred in connection with
a loss contingency.
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 one agreement that has a three year term,
all other agreements provide for employment on an
at-will basis. If the employee is terminated for
good reason or without cause, the employee is
entitled to salary continuation, and in some cases benefit
continuation, for varying periods depending on the agreement.
On July 12, 2007, the Companys board of directors
approved an amended and restated employment agreement for an
executive officer. The amended and restated agreement extends
the term of employment until January 1, 2011 and amended
certain elements of compensation including salary, stock options
and severance. Additionally, on July 12, 2007, the
Companys board of directors also approved the terms of a
new agreement for an executive officer which provides that all
outstanding options will become fully vested upon a change in
control of the Company.
The Company maintains an annual cash performance bonus program
that is intended to reward executive officers based on the
Companys performance and the individual named executive
officers contribution to that
F-35
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
performance. In determining the performance-based compensation
awarded to each named executive officer, the Company may
generally evaluate the Companys and the executives
performance in a number of areas, which could include revenues,
operating earnings, student retention, efficiency in product and
systems development, marketing investment efficacy, new
enrollment and developing company leaders.
Vendor
Payment Commitments
In April 2007, the Company entered into a master services and
license agreement with a third party that provides for the
Company to license its proprietary computer system. The
agreement is effective through July 2010. In exchange for the
license of the computer system, the Company agrees to pay a
service fee per enrollment. In the event the fees paid over the
term of the contract do not exceed $1 million (the minimum
commitment fee), the Company agrees to pay the difference
between the actual fees paid and the minimum commitment fee.
Letter
of Intent
On September 28, 2007, the Company discontinued discussions
with Socratic Network L.P., Socratic Learning, Inc. and Tutors
Worldwide (India) Private Ltd. (individually and collectively
referred to as Socratic) related to a non-binding letter of
intent.
8.
Supplemental
Disclosure of Cash Flow Information
Three Months Period Ended September 30,
2007
2006
Cash paid for interest
$
281
$
Supplemental disclosure of non cash investing and financing
activities:
New capital lease obligations
$
6,964
$
9.
Subsequent
Events
Acquisition
On October 1, 2007, and related to the August 2, 2007
non-binding letter of intent, the Company acquired all of the
equity interest in Power-Glide Language Courses, Inc., a
curriculum content developer, for the aggregate purchase price
of 196,078 shares of the Companys common stock and
the assumption of up to $1.2 million in liabilities.
Private
Placement of Shares
On November 6, 2007, the Company entered into an agreement
to sell to a
non-U.S. person
in a transaction outside the United States in reliance upon
Regulation S under the Securities Act, concurrently with
and contingent upon the closing of the initial public offering
and at the initial public offering price, $15,000,000 worth of
shares of the Companys common stock.
Series C
Dividend
On November 5, 2007, the Companys Board unanimously
declared a cash dividend to the holders of Redeemable,
Convertible Series C Preferred stock effective immediately
prior to and contingent upon the closing of an initial public
offering and payable from the proceeds of the offering. The
amount of the declared dividend is equal to the pro rata amount
of the annual cumulative dividend that would have normally
accrued on January 2, 2008.
F-36
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
Letter
of Intent
On November 14, 2007, the Company entered into a
non-binding letter of intent to establish a joint venture in the
Middle East. A subsidiary of the Company would own a majority of
the shares in the joint venture and would contribute its
proprietary curriculum and $1,000,000 of initial capital to fund
the joint ventures operations.
10.
Subsequent
Event Reverse Stock Split
Reverse Stock Split On
October 30, 2007, the Board approved a
1-for-5.1
reverse split of the Companys common stock. On
October 31, 2007, the reverse split was further approved by
a majority of the shareholders. The stock split was effective on
November 2, 2007. In conjunction with this, the number of
authorized shares of common stock was amended to 33,362,500. All
share and per share amounts related to common stock, options and
common stock warrants included in the consolidated financial
statements have been retroactively adjusted for all periods
presented to give effect to the stock split.
F-37
SCHEDULE II
K12
INC
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 2006, 2005 AND 2004
1. ALLOWANCE
FOR DOUBTFUL ACCOUNTS
Additions
Balance at
Charged to
Deductions
Beginning of
Cost and
from
Balance at End
Period
Expenses
Allowance
of Period
June 30, 2007
$
1,440,499
106,038
957,566
$
588,971
June 30, 2006
$
1,715,781
174,895
450,177
$
1,440,499
June 30, 2005
$
602,919
1,407,143
294,281
$
1,715,781
2. INVENTORY
RESERVE
Additions
Balance at
Charged to
Deductions
Beginning of
Cost and
Shrinkage and
Balance at End
Period
Expenses
Obsolescence
of Period
June 30, 2007
$
232,055
320,960
225,407
$
327,608
June 30, 2006
$
270,611
38,556
$
232,055
June 30, 2005
$
320,809
19,572
69,770
$
270,611
3. COMPUTER
RESERVE (1)
Additions
(Deductions)
Balance at
Charged to
Deductions
Beginning of
Cost and
Shrinkage and
Balance at End
Period
Expenses
Obsolescence
of Period
June 30, 2007
$
664,186
(47,825
)
$
616,361
June 30, 2006
$
490,533
173,653
$
664,186
June 30, 2005
$
746,294
(255,761
)
$
490,533
(1)
A reserve account is maintained against potential shrinkage and
obsolescence for those computers provided to our students. The
reserve is calculated based upon several factors including
historical percentages, the net book value and remaining useful
life.
4. INCOME
TAX VALUATION ALLOWANCE
Additions to
Balance at
Net Deferred
Deductions in Net
Beginning of
Tax Assets
Deferred Tax Asset
Balance at End
Period
Allowance
Allowance
of Period
June 30, 2007
$
32,527,019
2,601,121
$
29,925,898
June 30, 2006
$
33,866,482
1,339,463
$
32,527,019
June 30, 2005
$
33,267,514
598,968
$
33,866,482
F-38
PART II
INFORMATION
NOT REQUIRED IN THE PROSPECTUS
Item 13.
Other
Expenses of Issuance and Distribution
Set forth below is a table of the registration fee for the
Securities and Exchange Commission, the filing fee for the
National Association of Securities Dealers, Inc., the listing
fee for NYSE Arca and estimates of all other expenses to be
incurred in connection with the issuance and distribution of the
securities described in the registration statement, other than
underwriting discounts and commissions:
SEC registration fee
$
3,813
NYSE Arca listing fee
100,000
NASD fee
17,750
Printing and engraving expenses
500,000
Legal fees and expenses
1,600,000
Accounting fees and expenses
750,000
Transfer agent and registrar fees
5,000
Miscellaneous
23,437
Total
$
3,000,000
*
To be completed by amendment.
Item 14.
Indemnification
of Directors and Officers
K12 Inc. is incorporated under the laws of the State of
Delaware. Reference is made to Section 102(b)(7) of the
Delaware General Corporation Law, or DGCL, which enables a
corporation in its original certificate of incorporation or an
amendment thereto to eliminate or limit the personal liability
of a director for violations of the directors fiduciary
duty, except (1) for any breach of the directors duty
of loyalty to the corporation or its stockholders, (2) for
acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (3) pursuant to
Section 174 of the DGCL, which provides for liability of
directors for unlawful payments of dividends of unlawful stock
purchase or redemptions or (4) for any transaction from
which a director derived an improper personal benefit.
Reference is also made to Section 145 of the DGCL, which
provides that a corporation may indemnify any person, including
an officer or director, who is, or is threatened to be made,
party to any threatened, pending or completed legal action, suit
or proceeding, whether civil, criminal, administrative or
investigative, other than an action by or in the right of such
corporation, by reason of the fact that such person was an
officer, director, employee or agent of such corporation or is
or was serving at the request of such corporation as a director,
officer, employee or agent of another corporation or enterprise.
The indemnity may include expenses (including attorneys
fees), judgments, fines and amounts paid in settlement actually
and reasonably incurred by such person in connection with such
action, suit or proceeding, provided such officer, director,
employee or agent acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the
corporations best interest and, for criminal proceedings,
had no reasonable cause to believe that his conduct was
unlawful. A Delaware corporation may indemnify any officer or
director in an action by or in the right of the corporation
under the same conditions, except that no indemnification is
permitted without judicial approval if the officer or director
is adjudged to be liable to the corporation. Where an officer or
director is successful on the merits or otherwise in the defense
of any action referred to above, the corporation must indemnify
him against the expenses that such officer or director actually
and reasonably incurred.
Our Amended and Restated Certificate of Incorporation provides
for, and upon consummation of this offering, our amended and
restated bylaws will provide for indemnification of the officers
and directors to the full extent permitted by applicable law.
The Underwriting Agreement provides for indemnification by the
underwriters of the registrant and its officers and directors
for certain liabilities arising under the Securities Act of
1933, as amended, or otherwise.
II-1
Item 15.
Recent
Sales of Unregistered Securities
Set forth in chronological order is information regarding all
securities sold and employee stock options granted from June
2004 to date by the Company. Also included is the consideration,
if any, received for such securities, and information relating
to the section of the Securities Act and the rules of the
Securities and Exchange Commission pursuant to which the
following issuances were exempt from registration. None of these
securities were registered under the Securities Act. No award of
options involved any sale under the Securities Act. No sale of
securities involved the use of an underwriter and no commissions
were paid in connection with the sales of any securities.
1. At various times during the period from July 2004
through July 2007, we granted options to purchase an
aggregate of 2,432,206 shares of common stock to current
and prior employees and directors at a weighted average exercise
price of exercise prices of $10.66 per share, of which 1,257,948
are subject to shareholder approval.
2. In addition to the foregoing option grants, at various
times during the period from July 2004 through July 2007, we
granted options to purchase 1,441,168 shares of our common
stock to current and prior employees related to stand-alone
agreements at a weighted average exercise price of $12.35 per
share.
3. In December 2003, we issued and sold an aggregate of
18,656,716 shares of Series C Preferred Stock.
Pursuant to the payment in kind dividend feature of
Series C Preferred Stock, we have issued an aggregate of
12,399,833 additional shares of Series C Preferred Stock
through a series of stock dividends to existing Series C
Preferred stockholders from January 2005 through January 2007.
4. In October 2007, we issued an aggregate of
196,078 shares of common stock in connection with our
acquisition of Power-Glide Language Courses, Inc. to the
stockholders thereof.
5. On November 6, 2007, the Company entered into an
agreement to sell to a
non-U.S. person
in a transaction outside the United States in reliance upon
Regulation S under the Securities Act, concurrently with
and contingent upon the closing of the initial public offering
and at the initial public offering price, $15,000,000 worth of
shares of the Companys common stock.
The issuances of the securities described in paragraph 1
were exempt from registration under the Securities Act under
Rule 701, as transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under
such Rule 701. The recipients of such options and common
stock were related to compensation. Appropriate legends were
affixed to any share certificates issued in such transactions.
All recipients either received adequate information from us or
had adequate access, through their employment with us or
otherwise, to information about us.
The issuances of the securities described in paragraphs 2,
3 and 4 were exempt from registration under the Securities Act
in reliance on Section 4(2) because the issuance of
securities to recipients did not involve a public offering. The
recipient of securities in each such transaction represented
their intention to acquire the securities for investment only
and not with a view to resale or distribution thereof, and
appropriate legends were affixed to share certificates and
warrants issued in such transactions. Each of the recipients of
securities in the transactions described in paragraphs 2, 3
and 4 were accredited or sophisticated investors and had
adequate access, through employment, business or other
relationships, to information about us.
Upon issuance and sale, the securities described in
paragraph 5 will be exempt from registration under the
Securities Act pursuant to the terms of Regulation S
promulgated thereunder.
All of the shares of Series C Preferred Stock described in
paragraph 3 will automatically convert into shares of
common stock prior to completion of this offering.
Item 16.
Exhibits
and Financial Statement Schedule
(a) Exhibits
II-2
Exhibit No.
Description of
Exhibit
1
.1
Form of Underwriting Agreement
3
.1*
Amended and Restated Certificate of Incorporation
3
.2*
Bylaws (as amended)
3
.3*
Certificate of Amendment, dated December 15, 2006, to
Second Amended and Restated Certificate of Incorporation
3
.4
Certificate of Amendment to Second Amended and Restated
Certificate of Incorporation dated November 2, 2007, and
Certificate of Correction related thereto
3
.5*
Form of Third Amended and Restated Certificate of Incorporation
to be effective upon completion of this offering
3
.6
Form of Amended and Restated Bylaws to be effective upon
completion of this offering
4
.1*
Form of stock certificate of common stock
4
.2*
Amended and Restated Stock Option Plan and Amendment thereto
4
.3*
Form of Stock Option Contract Employee
4
.4*
Form of Stock Option Contract Director
4
.5*
Form of Second Amended and Restated Stockholders Agreement
4
.6*
Form of Common Stock Warrant Agreement
4
.7*
Form of Series B Convertible Preferred Stock Warrant Agreement
4
.8*
2007 Equity Incentive Award Plan
4
.9*
2007 Employee Stock Purchase Plan
5
.1
Opinion of Latham & Watkins LLP
10
.1*
Revolving Credit Agreement and Certain Other Loan Documents by
and among K12 Inc., School Leasing Corporation, American
School Supply Corporation and PNC Bank, N.A.
10
.2*
Stockholders Agreement dated as of April 26, 2000 (as
amended) by and among Premierschool.com, Inc., Knowledge
Universe Learning, Inc. and Ronald J. Packard
10
.3*
Stockholders Agreement dated as of February 20, 2000 (as
amended) by and among Premierschool.com, Inc., Knowledge
Universe Learning, Inc. and William J. Bennett
10
.4*
Series B Convertible Preferred Stock Warrant Agreement of
Mollusk Holdings LLC
10
.5
Amended and Restated Stock Option Agreement of Ronald J.
Packard dated as of July 12, 2007
10
.6*
Stock Option Agreement of Bruce J. Davis
10
.7*
Stock Option Agreement of John Baule
10
.8*
Stock Option Agreement of Bror Saxberg
10
.9
Amended and Restated Employment Agreement of Ronald J.
Packard
10
.10*
Employment Agreement of John F. Baule and Amendment thereto
10
.11*
Employment Agreement of Bruce J. Davis
10
.12*
Employment Agreement of Bror V. H. Saxberg
10
.13*
Deed of Lease by and between ACP/2300 Corporate Park Drive, LLC
and K12 Inc.
10
.14*
Sublease between France Telecom Long Distance USA, LLC and K12
Inc.
10
.15*
Employment Agreement of Celia M. Stokes
10
.16*
Employment Agreement of Howard D. Polsky
10
.17
Stock Option Agreement of Ronald J. Packard dated as of
July 12, 2007
10
.18*
First Amendment to Employment Agreement of Howard D. Polsky
II-3
Exhibit No.
Description of
Exhibit
10
.19*
Amendment No.1 to Revolving Credit Agreement by and among K12
Inc., School Leasing Corporation, American School Supply
Corporation and PNC Bank N.A.
10
.20*
Stock Subscription Agreement dated as of November 1, 2007
by and among K12 Inc. and KB Education Investments Limited
10
.21*
Second Amended and Restated Educational Products, and
Administrative, and Technology Services Agreement between the
Ohio Virtual Academy and K12 Ohio L.L.C.
21
.1*
Subsidiaries of K12 Inc.
23
.1
Consent of BDO Seidman, LLP
23
.2
Consent of Latham & Watkins LLP (included in
Exhibit 5.1)
24
.1*
Power of Attorney (excluding Dr. Mary H. Futrell)
24
.2*
Power of Attorney of Dr. Mary H. Futrell
*
Previously filed.
Portions omitted pursuant to a
request for confidential treatment. The omitted information has
been filed separately with the Securities and Exchange
Commission.
(b) Financial Statement Schedules:
See Schedule II Valuation and
Qualifying Accounts contained on
page F-37.
All other schedules are omitted as the information is not
required or is included in the Registrants financial
statements and related notes.
Item 17.
Undertakings
Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that
in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid
by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant
will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in
the Securities Act and will be governed by the final
adjudication of such issues.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the
Securities Act, the information omitted from the form of
prospectus filed as part of this registration statement in
reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this registration statement as
of the time it was declared effective.
(2) For the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a
form of prospectus shall be deemed to be a new registration
statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes to provide to the
underwriters at the closing specified in the Underwriting
Agreement, certificates in such denomination and registered in
such names as required by the underwriters to permit prompt
delivery to each purchaser.
II-4
Signatures
Pursuant to the requirements of the Securities Act of 1933, as
amended, the Registrant has duly caused this registration
statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Herndon, Commonwealth
of Virginia on December 10, 2007.
K12 INC.
By:
/s/ Ronald
J. Packard
Name:
Ronald J. Packard
Title:
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons
in the capacities and on the dates indicated.