STRIDE, INC.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") contains certain forward-looking statements within the
meaning of Section 21E of the Exchange Act. Historical results may not indicate
future performance. Our forward-looking statements reflect our current views
about future events, are based on assumptions, and are subject to known and
unknown risks and uncertainties that could cause actual results to differ
materially from those contemplated by these statements. Factors that may cause
differences between actual results and those contemplated by forward-looking
statements include, but are not limited to, those discussed in "Risk Factors" in
Part I, Item 1A, of this Annual Report. We undertake no obligation to publicly
update or revise any forward-looking statements, including any changes that
might result from any facts, events, or circumstances after the date hereof that
may bear upon forward-looking statements. Furthermore, we cannot guarantee
future results, events, levels of activity, performance, or achievements.
This MD&A is intended to assist in understanding and assessing the trends and
significant changes in our results of operations and financial condition. As
used in this MD&A, the words, "we," "our" and "us" refer to K12 Inc. and its
consolidated subsidiaries. This MD&A should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
Annual Report. The following overview provides a summary of the sections
included in our MD&A:
? Executive Summary-a general description of our business and key highlights of
the year ended
? Key Aspects and Trends of Our Operations-a discussion of items and trends that
may impact our business in the upcoming year.
? Critical Accounting Policies and Estimates-a discussion of critical accounting
policies requiring judgments and estimates.
? Results of Operations-an analysis of our results of operations in our
consolidated financial statements.
Liquidity and Capital Resources-an analysis of cash flows, sources and uses of
? cash, commitments and contingencies, seasonality in the results of our
operations, the impact of inflation, and quantitative and qualitative
disclosures about market risk.
Executive Summary
We are a technology-based education company and offer proprietary and
third-party curriculum, software systems and educational services designed to
facilitate individualized learning for students primarily in kindergarten
through 12th grade, or K-12. Our learning systems combine curriculum,
instruction and related support services to create an individualized learning
approach. Our learning systems are well suited for virtual and blended public
schools, school districts, charter schools, and private schools that utilize
varying degrees of online and traditional classroom instruction, and other
educational applications. These products and services are provided through three
lines of business: (i) Managed Public School Programs; (ii) Institutional; and
(iii) Private Pay Schools and Other.
K12's career readiness education ("CRE") initiative offers online curriculum and
career services to middle and high school students, under the Destinations
Career Academy ("DCA") brand name, which can provide services to all of our
lines of business. The initiative is designed to give students a head start on
their career goals by providing them with content pathways toward an industry
certification, college credits, and work experiences.
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Managed Public School
Programs Institutional Private Pay Schools and Other
? Virtual public schools ? Non-managed public school programs ? Private schools
-K12 Private Academy
(formerly,
Academy)
? Blended public schools ? Institutional software and services -
Online High School
? Destinations Career -The Keystone School
Academies / Career ? Destinations Career Academies /
readiness education Career readiness course offerings
? Destinations Career
Academies (Private)
? Galvanize
Our Managed Public School Programs offer an integrated package of systems, services, products, and professional expertise that we administer to support an online or blended public school. Customers for these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning system platforms and instructional services under the terms of a negotiated service agreement. We provide our Managed Public School Programs and DCA programs to virtual and blended public charter schools and school districts. These contracts are negotiated with and approved by the governing authorities of the customer. The duration of theManaged Public School Program service and product agreements are typically 2-5 years, and most provide for automatic renewals absent a customer notification within a negotiated time frame. During any fiscal year, we may enter into newManaged Public School agreements, receive non-automatic renewal notices, and negotiate replacement agreements, terminate the contract or receive notice of termination, or transition a school between a Managed Public School Program and a Non-managed Public School Program. The governing boards may also establish school policies and other terms and conditions over the course of a contract, such as enrollment parameters. The authorizers who issue the charters to ourManaged Public School customers can renew, revoke, or modify those charters as well. For the 2019-2020 school year, we provided our Managed Public School Programs to 76 schools in 30 states and theDistrict of Columbia . During this fiscal year, we entered into three new contracts in three states to open Managed Public School Programs, auto-renewed six agreements for schools in five states, mutually agreed to terminate the service agreement with one school, and completed renewal negotiations in five states, with varying degrees of contract modifications. During this fiscal year, at two schools the authorizer invoked its contractual right to not renew its district program for the upcoming 2020-2021 school year. One school elected not to renew their service agreement with us for the 2022-2023 school year and thereafter. Our Institutional business includes Non-managed public school programs and Institutional software and services where K12 offers curriculum, including career technical education ("CTE") electives, and technology for full-time virtual and blended programs. In addition, we offer options whereby the school contracts with us for instruction, curriculum, supplemental courses, marketing, enrollment and other educational services and products. Unlike Managed Public School Programs, the Institutional business does not offer primary administrative support services, which remain the responsibility of the school district or the school customer. In addition to curriculum, platforms and programs, the services we offer to Institutional clients also can assist them in launching their own online and blended learning programs tailored to their own requirements and may include instructional support, reporting tools and content libraries. We work closely as a partner with school districts, public schools, charter schools, private companies, and private schools to provide them with educational solutions. For the 2019-20 school year, we served school districts or schools in all 50 states and theDistrict of Columbia . Our Private Pay Schools and Other business includes three accredited, tuition-based private schools that meet a range of student needs from individual course credit recovery to college preparatory programs. These schools are: (i)K12 Private Academy (formerly,K12 International Academy ) and its DCA program, an online private school that enables us to offer students worldwide the same full-time education programs and curriculum that we provide to the virtual and blended public schools, (ii)The Keystone School , a private school that offers online and correspondence courses, and (iii) theGeorge Washington University Online High School , a school that offers a college preparatory program and is designed for middle and high school students who are seeking a challenging academic experience. Our Private Pay Schools and Other business also includesGalvanize, Inc. ("Galvanize"), which is discussed in more detail below. 53 Table of Contents For the year endedJune 30, 2020 , revenues increased to$1,040.8 million from$1,015.8 million for the year endedJune 30, 2019 , an increase of 2.5% primarily due to our Managed Public School Programs. Over the same period, operating income decreased to$32.5 million from$45.5 million for the year endedJune 30, 2019 , a decrease of 28.6%; net income attributable to common stockholders decreased to$24.5 million from$37.2 million for the year endedJune 30, 2019 , a decrease of 34.1%; and Adjusted EBITDA, a non-GAAP measure (see reconciliation of income from operations to Adjusted EBITDA in "Item 6-Selected Financial Data"), decreased to$128.2 million from$133.6 million for the year endedJune 30, 2019 , a decrease of 4.0%.
Recent Developments
OnJanuary 27, 2020 , we acquired Galvanize in exchange for$165.0 million , plus working capital. Galvanize provides talent development for individuals and enterprises in information technology fields. The acquisition of Galvanize expands the Company's offerings to include post-secondary skills training in data science and software engineering, technology staffing and developing talent and capabilities for companies. The Company also plans to use Galvanize's curriculum to create appropriate content to offer high school students.
Key Aspects and Trends of Our Operations
Revenues-Overview
We generate a significant portion of our revenues from the sale of curriculum, administration support and technology services to virtual and blended public schools. We anticipate that these revenues will continue to represent the majority of our total revenues over the next several years. However, we also expect revenues in other aspects of our business to stabilize, then increase over time as we execute on our growth strategy. Our growth strategy includes increasing revenues in other distribution channels, adding enrollments in our private schools and expanding our Institutional business, and pursuing international opportunities to offer our learning systems. Combined revenues from these other sectors were significantly smaller than those from the Managed Public School Programs in the year endedJune 30, 2020 . Our success in executing our strategies will impact future growth. We provide products and services primarily to three lines of business: Managed Public School Programs; Institutional; and Private Pay Schools and Other.
Factors affecting our revenues include:
(i) the number of enrollments;
(ii) the mix of enrollments across grades and states;
(iii) administrative services and curriculum sales provided to the schools and
school districts;
(iv) state or district per student funding levels and attendance requirements;
(v) prices for our products and services;
(vi) growth in our other customer types; and
(vii) revenues from new initiatives, mergers and acquisitions.
Managed Public School Programs
We define an enrollment as any student enrolled in a virtual or blended public
school which qualifies as a Managed Public School Program. Generally, students
will take four to six courses, except for some kindergarten students who may
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. To ensure that all schools are reflected in our measure of
enrollments, we consider the number of students on the first Wednesday of
October to be our opening enrollment level, and the number of students enrolled
on the last day of May to be our ending enrollment level. For each period,
average enrollments represent the average of the month-end enrollment levels for
each school month in the period. We continually
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evaluate our enrollment levels by state, by school and by grade. We track new student enrollments and withdrawals throughout the year.
We believe that our revenue growth from enrollments depends upon the following:
? the number of states and school districts in which we operate;
? the mix of students served;
? the restrictive terms of local laws or regulations, including enrollment caps;
? the appeal of our curriculum and instructional model to students and families;
? the specific school or school district requirements including credit recovery
or special needs;
? the effectiveness of our program in delivering favorable academic outcomes;
? the quality of the teachers working in the schools we serve;
? the effectiveness of our marketing and recruiting programs to attract new
enrollments; and
? retention of students through successive grade levels.
In fiscal year 2020, total average student enrollments inManaged Public School Programs increased by 3,030 or 2.6%, to 118,591 as compared to total average student enrollments of 115,561 in fiscal year 2019. We continually evaluate our trends in revenues by monitoring the number of student enrollments in total, by state, by school and by grade, assessing the impact of changes in school funding levels and the pricing of our curriculum and educational services. In fiscal years 2020 and 2019, the growth rate of our Managed Public School Program revenues exceeded the growth in our Managed Public School Programs average student enrollments primarily due to increases in the per pupil achieved funding, school mix (distribution of enrollments by school), and other factors, including changes in state funding rates and higher utilization in federal and state restricted funding per student. During the years endedJune 30, 2020 and 2019, we had zero and one contracts, respectively, that represented greater than 10% of total revenues. Approximately 88% of our revenues were derived from Managed Public School Programs during the year endedJune 30, 2020 . Enrollments in Managed Public School Programs on average generate substantially more revenues than enrollments served through our Institutional business where we provide limited or no administrative services. Similarly, revenues earned per pupil across our private school programs vary. As we continue to focus on our Institutional business and increase enrollment in Private Pay Schools and Other, enrollment mix is expected to shift and may impact growth in revenues relative to the growth in enrollments.
Institutional
While Managed Public School Programs constitute the majority of our revenues,
there is potential demand by public school districts, public schools and other
educational institutions for more limited components of our online services and
products than are used in Managed Public School Programs. Sales to those
entities are conducted through our Institutional business organization. While we
pursue opportunities in our Institutional business, the sector continues to
experience significant competitive pricing pressures.
The Institutional business portfolio provides curriculum and technology
solutions packaged in a portfolio of flexible learning and delivery models
mapped to specific student, school and district needs. This portfolio provides a
continuum of delivery models, from full Non-managed Public School Programs to
individual course sales and supplemental options that can be used in traditional
classrooms to differentiate instruction. The Institutional business course
catalog is extensive and addresses specific student needs, including Advanced
Placement ("AP"), honors programs, world languages, English language learners,
adaptive math, remediation, credit recovery, alternative education, career and
technology electives and college readiness. In connection with these solutions,
we also offer state-certified teachers, training for school personnel in online
instruction methods, and professional development and other support services as
needed by our customers.
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Given the variables discussed in further detail below, we believe that the best performance metric for the Institutional business is revenues. The customers served by the Institutional business organizations purchase curriculum in a variety of ways, making consistent comparisons on the basis of enrollments less relevant. For example, we serve not only full-time students, but also students taking semester-long courses, students who recover credits through concentrated four to eighteen-week programs, students who are using our curricula as a supplemental enhancement to their traditional textbook, and teachers who may present our lessons on an interactive whiteboard as either the core of their instruction or as an engaging supplement to their lecture. Given all these variables, it is therefore difficult to identify a single metric (such as a full time equivalent or "FTE"), or combination of metrics (such as course enrollments or programs sold), that can accurately capture the Institutional business. Therefore, our efforts to do so led us to the conclusion that at this time, revenues are the best performance metric for the Institutional business.
Sales opportunities in the Institutional business are driven by a number of factors in a diverse customer population, which determine the deliverable and price. These factors include:
? Type of Customer-A customer can be a
school, charter school, early childhood learning center or corporate partner.
Curriculum Needs-We sell our curriculum solutions based on the scope of the
? customer need, and a solution is generally purchased as end-user access to a
complete catalog, individual course or supplemental content title.
License Options-Depending on the scope of the solution, a license can be
? purchased for individual course enrollments, annual seat, school or
district-wide site licenses or a perpetual license (a prepaid lifetime
license). We may charge incrementally if we are hosting the solution.
Hosting-Customers may host curricula themselves or license our hosted solution.
We are able to track all students for customers who use our hosted solution.
? However, more often in large-scale, district-wide implementations, a customer
may choose to host the curriculum, and in that case, we have no visibility of
individual student usage for counting enrollments.
Services Menu-Instructional services may be provided and priced per-enrollment
? or bundled in the overall price of the solution. Additional services, including
professional development, title maintenance and support may also be provided
and are priced based on the scope of services.
Private Pay Schools and Other
Private schools are schools where tuition is paid directly by the family of the student. We receive no public funds for students in our private schools. We operate three accredited private online schools at differing price points and service levels. Our revenues are derived from tuition receipts that are a function of course enrollments and program price. In some circumstances, a third-party school may elect to enroll one of its students in a K12 private school course as a supplement to the student's regular on-campus instruction. In such cases, the third-party school may pay the K12 private school tuition.
Our Private Pay Schools and Other business also includes Galvanize, which provides talent development for individuals and enterprises in information technology fields.
We believe our revenue growth depends primarily on the recruitment of students into our programs through effective marketing and word-of-mouth referral based on the quality of our service. In addition, through high service quality, we seek to retain existing students and increase the total number of courses each student takes with us. In some cases, students return each summer and take only one course. In other cases, students choose a K12 private school as their principal form of education and may stay for many years. The flexibility of our programs, the quality of our curriculum and teaching, and the student community features lead to customer satisfaction and therefore, retention. We have entered into agreements that enable us to distribute our products and services to our international school partners who use our courses to provide electives offerings and dual diploma programs.
Instructional Costs and Services Expenses
Instructional costs and services expenses include expenses directly attributable to the educational products and services we provide. The public schools we administer are the primary drivers of these costs, including teacher and
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administrator salaries and benefits and expenses of related support services. We also employ teachers and administrators for instruction and oversight in our Institutional business and Private Pay Schools and Other business. Instructional costs also include fulfillment costs of student textbooks and materials, depreciation and reclamation costs of computers provided for student use, the cost of any third-party online courses and the amortization of capitalized curriculum and related systems. Our instructional costs are variable and are based directly on our number of schools and 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) generally lower student-to-teacher ratios; (ii) higher compensation costs for some teaching positions requiring subject-matter expertise; (iii) ancillary costs for required student support services, including college placement, SAT preparation and guidance counseling; (iv) use of third-party courses to augment our proprietary curriculum; and (v) use of a third-party learning management system to service high school students. Over time, we may partially offset these factors by obtaining productivity gains in our high school instructional model, replacing third-party high school courses with proprietary content, replacing our third-party learning management system with another third-party system, leveraging our school infrastructure and obtaining purchasing economies of scale. We have deployed and are continuing to develop new delivery models, including blended schools, where students receive limited face-to-face instruction in a learning center to complement their online instruction, and other programs that utilize brick and mortar facilities. The maintenance, management and operations of these facilities necessitate additional costs, which are generally not required to operate typical virtual public schools. We are pursuing expansion into new states for both virtual public and other specialized charter schools. If we are successful, we will incur start-up costs and other expenses associated with the initial launch of a school, including the funding of building leases and leasehold improvements.
Selling, General and Administrative Expenses
Selling, general, and administrative expenses include the salaries and benefits of employees engaged in business development, public affairs, sales and marketing, and administrative functions, and transaction and due diligence expenses related to mergers and acquisitions.
Also included are product development expenses which include research and development costs and overhead costs associated with the management of both our curriculum development and internal systems development teams. In addition, product development expenses include the amortization of internal systems. 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 rates to evaluate our workforce efficiency. We plan to continue to invest in additional curriculum development and related software in the future. We capitalize selected costs incurred to develop our curriculum, beginning with application development, through production and testing into capitalized curriculum development costs. We capitalize certain costs incurred to develop internal systems into capitalized software development costs.
Expense Management
We are constantly searching for ways to deliver more value at a lower cost for our customers and we take pride in our ability to deliver highly-individualized, effective education solutions at significant savings to taxpayers. We have sought to increase efficiencies whenever possible without affecting educational quality. We believe our scale and infrastructure investment positions us for greater efficiency in future periods while allowing us to deliver more value for students.
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 withU.S. GAAP. 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 57
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critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:
Contracts with Customers
Revenues are principally earned from contractual agreements to provide educational services to students through an integrated package of online curriculum, books, materials, computers and management services to virtual and blended schools, traditional public schools, school districts, and private schools through our three lines of business: Managed Public School Programs, Institutional, and Private Pay Schools and Other. We provide an integrated package of systems, services, products, and professional expertise that are administered together to support an online or blended public school. Contractual agreements generally span multiple years with performance obligations being isolated to annual periods which generally coincide with our fiscal year. Customers of these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning systems platforms and instructional services under the terms of a negotiated service agreement. The schools receive funding on a per student basis from the state in which the public school or school district is located. Shipments of materials for schools that occur in the fourth fiscal quarter and for the upcoming school year are recorded in deferred revenue. To determine the pro rata amount of revenue to recognize in a fiscal quarter, we estimate the total expected funds each school will receive in a particular school year. Total funds for a school are primarily a function of the number of students enrolled in the school and established per enrollment funding levels, which are generally published on an annual basis by the state or school district. We review our estimates of funding periodically, and update as necessary, by adjusting our year-to-date earned revenues to be proportional to the total expected revenues to be earned during the fiscal year. Actual school funding may vary from these estimates and the impact of these differences could impact our results of operations. Since the end of the school year coincides with the end of our fiscal year, annual revenues are generally based on actual school funding and actual costs incurred (including costs for our services to the schools plus other costs the schools may incur). Our schools' reported results are subject to annual school district financial audits, which incorporate enrollment counts, funding and other routine financial audit considerations. The results of these audits are incorporated into our monthly funding estimates for the current and prior periods. For the years endedJune 30, 2019 , 2018 and 2017, our aggregate funding estimates differed from actual reimbursements impacting total reported revenue by approximately 0.6%, 0.4%, and (0.3)%, respectively. Each state and/or school district has variations in the school funding formulas and methodologies that it uses to estimate funding for revenue recognition at its respective schools. As we estimate funding for each school, we take into account the state definition for count dates on which reported enrollment numbers will be used for per pupil funding. The parameters we consider in estimating funding for revenue recognition purposes include school district count definitions, withdrawal rates, average daily attendance, special needs enrollment, academic progress and historical completion, student location, funding caps and other state specified categorical program funding. Under the contracts where we provide products and services to schools, we are responsible for substantially all of the expenses incurred by the school and have generally agreed to absorb any operating losses of the schools in a given school year. These school operating losses represent the excess of costs incurred over revenues earned by the virtual or blended public school (the school's expected funding), as reflected in its respective financial statements, including our charges to the schools. To the extent a school does not receive sufficient funding for each student enrolled in the school, the school would still incur costs associated with serving the unfunded enrollment. If losses due to unfunded enrollments result in a net operating loss for the year that loss is reflected as a reduction in the revenues and net receivables that we collect from the school. A school net operating loss in one year does not necessarily mean we anticipate losing money on the entire contract with the school. However, a school's net operating loss may reduce our ability to collect our management fees in full and recognized revenues are constrained to reflect the expected cash collections from such schools. We record the school's estimated net operating loss against revenues based upon the percentage of actual revenues in the period to total estimated revenues for the fiscal year. Actual school net operating losses may vary from these estimates or revisions, and the impact of these differences could have a material impact on results of operations. 58
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Allowance for Doubtful Accounts
We maintain an allowance for uncollectible accounts primarily for estimated losses resulting from the inability or failure of individual customers to make required payments. We analyze accounts receivable, historical percentages of uncollectible accounts, and changes in payment history when evaluating the adequacy of the allowance for uncollectible accounts. We write-off accounts receivable based on the age of the receivable and the facts and circumstances surrounding the customer and reasons for non-payment. We record an allowance for estimated uncollectible accounts in an amount approximating probable losses. Actual write-offs might differ from the recorded allowance.
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. We also publish textbooks and other offline materials. Our curriculum is integral to our learning systems. Our customers generally do not acquire our curriculum or future rights to it. Due to the similarity in development stages and long economic life of curriculum to computer software, we capitalize curriculum development costs incurred during the application development stage in accordance with ASC 350, Intangibles -Goodwill and Other ("ASC 350"). ASC 350 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 and payroll-related costs. Costs related to general and administrative functions are not capitalizable and are expensed as incurred. We capitalize curriculum development costs during the design, development and deployment phases of the project. 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. Capitalization ends when a course is available for general release to our customers, at which time amortization of the capitalized costs begins. Capitalized costs are recorded in capitalized curriculum development costs. 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.
Capitalized Software Costs
We develop our own proprietary computer software programs to provide specific functionality to support both our unique education offerings 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 systems 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 development in accordance with ASC 350. Capitalized costs are recorded in capitalized software costs and are generally amortized over three years.
Impairment of Long-Lived Assets
Long-lived assets include property, equipment, right-of-use assets, capitalized
curriculum and software developed or obtained for internal use. In accordance
with ASC 360, Property, Plant and Equipment ("ASC 360"), 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 asset's future usability, as well as on a reasonable
assurance that the future cash flows associated with the asset will be in excess
of its carrying amount. If the total of the expected undiscounted future cash
flows is less than the carrying amount of the asset, a loss is recognized for
the difference between fair value and the carrying value of the asset.
Leases
Our principal leasing activities include student computers and peripherals, classified as finance leases, and facilities, classified as operating leases.
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Finance Leases
We enter into agreements to finance the purchase of student computers and
peripherals provided to students of our schools. Individual leases typically
include 1 to 3-year payment terms, at varying rates, with a $1 purchase option
at the end of each lease term. We pledge the assets financed to secure theoutstanding leases. Operating Leases We enter into agreements for facilities that serve as offices for our headquarters, sales and enrollment teams, and school operations. Initial lease terms vary between 1 and 17 years. Certain leases include renewal options, usually based upon current market rates, as well as termination rights. We perform an evaluation of each lease to determine if the lease payments included in the renewal option should be included in the initial measurement of the lease liability. As of the adoption date, the remaining lease terms varied between 1 and 5 years and we concluded that renewal options on the existing leases would be excluded from the determination of the initial lease liability. The remaining lease terms related to leases acquired from Galvanize vary between 1 and 11
years. Discount Rate
For our finance leases, the stated rate is defined within the lease terms; while for our operating leases, the rate is not implicit. For operating leases, we use our incremental borrowing rate as the discount rate; determined as our borrowing rate on a collateralized basis for a similar term and amount to the term and amount of the lease. Based on our current population of operating lease liabilities, a 1% change in the incremental borrowing rate would result in a$4.3 million change in the initial present value of the operating lease liability.
Income Taxes
We account for income taxes in accordance with ASC 740, Income Taxes ("ASC
740"). ASC 740 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. 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.
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.
We have a valuation allowance on net deferred tax assets of$5.0 million and$4.5 million as ofJune 30, 2020 and 2019, respectively, for the amount that will likely not be realized. Stock-based Compensation We recognize stock-based compensation expense under the provisions of ASC 718, Compensation-Stock Compensation ("ASC 718"). The fair value of restricted stock awards is the fair market value on the date of grant. Certain restricted stock awards with a market-based performance component are valued using a Monte Carlo simulation model that considers a variety of factors including, but not limited to, our common stock price, risk-free rate, and expected stock price volatility over the expected life of awards. We recognize these compensation costs on a straight-line basis over the requisite service period, which is generally the vesting period of the award. 60
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We record as goodwill the excess of the purchase price over the fair value of the identifiable net assets acquired. Finite-lived intangible assets acquired in business combinations subject to amortization are recorded at their fair value. Finite-lived intangible assets include the trade names, acquired customers and distributors, developed technology and non-compete agreements. Such intangible assets are amortized on a straight-line basis over their estimated useful lives. We periodically evaluate the remaining useful lives of intangible assets and adjust our amortization period if it is determined that such intangible assets have a shorter useful life. We evaluate the recoverability of our recorded goodwill and other intangible assets annually, or whenever a triggering event of impairment may occur, based on one reporting unit. ASC 350 prescribes a two-step process for impairment testing of goodwill and intangibles with indefinite lives are assessed for impairment annually, as well as when an event triggering impairment may have occurred. ASC 350 also allows preparers to qualitatively assess goodwill impairment through a screening process which would permit companies to forgo Step 1 of their annual goodwill impairment process. This qualitative screening process is referred to as "Step 0". We perform our annual assessment onMay 31st , which is then updated for any changes in conditions as ofJune 30th . Under the two-step process, the first step tests for potential impairment by comparing the fair value of reporting units with reporting units' net asset values. If the fair value of a reporting unit exceeds the carrying value of the reporting unit's net assets, then goodwill is not impaired and no further testing is required. If the fair value of reporting unit is below the reporting unit's carrying value, then the second step is required to measure the amount of potential impairment. The second step requires an assignment of the reporting unit's fair value to the reporting unit's assets and liabilities, using the initial acquisition accounting guidance related to business combinations, to determine the implied fair value of the reporting unit's goodwill. The implied fair value of the reporting unit's goodwill is then compared with the carrying amount of the reporting unit's goodwill to determine the goodwill impairment loss to be recognized, if any. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, an impairment loss equal to the difference is recorded.
Results of Operations
Impact of COVID-19 to K12's Business
The impact of the global emergence of COVID-19 on our business is currently not estimable or determinable. We are conducting business as usual with some modifications to employee travel, employee work locations, and cancellation of certain events. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders. It is not clear what the potential effects any such alterations or modifications may have on our business, including the effects on our customers and prospects, or on our financial results for fiscal year 2021.
Lines of Business
We operate in one operating and reportable business segment as a technology-based education company providing proprietary and third-party curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade. The Chief Operating Decision Maker evaluates profitability based on consolidated results. We have three lines of business: (1)Managed Public School Programs; (2) Institutional; and (3) Private Pay Schools and Other.
Consolidation of Noncontrolling Interest
Our consolidated financial statements reflect the results of operations of our LearnBop joint venture. InJanuary 2018 , we consummated the acquisition of the remaining 49% of LearnBop. Earnings or losses attributable to our partner are classified as "net loss attributable to noncontrolling interest" in the accompanying consolidated statements of operations. Net income or net loss attributable to noncontrolling interest adjusts our consolidated net results of operations to reflect only our share of the after-tax earnings or losses of
an affiliated company. Enrollment Data
The following table sets forth total enrollment data for students in our
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services, products, and professional expertise that we administer to support an online or blended public school. Customers for these programs can obtain the administrative support, information technology, academic support services, online curriculum, learning system platforms and instructional services under the terms of a negotiated service agreement.Unlike Managed Public School Programs, Non-managed Public School Programs do not offer comprehensive administrative support services, which remain the responsibility of the school district or the school customer. Rather, Non-Managed Public School Programs offer options whereby the school can contract for instruction, curriculum, supplemental courses, marketing, enrollment and other educational services. Enrollments in Managed Public School Programs on average generate more revenues than enrollments served through our Institutional business where we provide limited or no management services. We do not award or permit incentive compensation to be paid to our public school program enrollment staff or contractors based on the number of students enrolled. If the mix of enrollments changes, our revenues will be impacted to the extent the average revenues per enrollments are significantly different. Year Ended June 30, 2020 / 2019 2019 / 2018 2020 2019 2018 Change Change % Change Change % (In thousands, except percentages)Managed Public School Programs (1)(2) 118.6 115.6 108.7 3.0 2.6% 6.9 6.3%Non-managed Public School Programs (1) 15.8 23.9 23.9 (8.1) (33.9%) - 0.0%
If a school changes from a Managed to a Non-managed Public School Program, (1) the corresponding enrollment classification would change in the period in
which the contract arrangement changed.
(2) Managed Public School Programs include enrollments for which K12 receives no
public funding or revenue.
Revenue by Business Lines
Revenues are captured by business line based on the underlying customer contractual agreements. Periodically, a customer may change business line classification. Alternatively, aManaged Public School may become aNon-managed Public School and seek to renegotiate an existing contract or the scope of services we provide to the school. A re-classification of a public school from one business line to another would be reflected in our disclosure of revenues and total student enrollment between the two business lines. For example, a district that purchases a single course (Institutional business customer) may decide to convert to a full-time virtual school program (Managed Public School customer). Changes in business line classification occur at the time the contractual agreement is modified. The mix of our revenue between our Managed Public School Programs and our Institutional business could change as one or more of our managed schools transitions to a self-managed model such that we would provide only selected services to the school. This transition could occur due to a change in focus sought by the independent school board, or by state legislative or regulatory developments, and thus reducing revenue we generate from the school. The following represents our revenues for each of the periods indicated: Year EndedJune 30 ,
Change 2020 / 2019 Change 2019 / 2018
2020 2019 2018 $ % $ %
(In thousands, except percentages)
Managed Public School
Programs $ 920,080 $ 890,275 $ 780,797 $ 29,805 3.3% $ 109,478 14.0%
Institutional
Non-managed Public
School Programs 36,195 50,623 56,784 (14,428) (28.5%) (6,161) (10.8%)
Institutional Software &
Services 38,765 39,330 43,852 (565) (1.4%) (4,522) (10.3%)
Total Institutional 74,960 89,953 100,636 (14,993) (16.7%) (10,683) (10.6%)
Private Pay Schools and
Other 45,725 35,524 36,301 10,201 28.7% (777) (2.1%)
Total Revenues $ 1,040,765 $ 1,015,752 $ 917,734 $ 25,013 2.5% $ 98,018 10.7%
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Financial Information
The following table sets forth statements of operations data and the amounts as a percentage of revenues for each of the periods indicated:
Year Ended June 30,
2020 2019 2018
(In thousands, except percentages)
Revenues $ 1,040,765 100.0 % $ 1,015,752 100.0 % $ 917,734 100.0 %
Instructional costs and
services 693,232 66.6 663,437 65.3 592,495 64.6
Gross margin 347,533 33.4 352,315 34.7 325,239 35.4
Selling, general, andadministrative expenses 315,076 30.3 306,829 30.2 299,694 32.7 Income from operations 32,457 3.1 45,486
4.5 25,545 2.8 Interest income, net 698 0.1 2,761 0.3 965 0.1 Other income, net 272 0.0 114 0.0 - - Income before income taxes and loss from equity method investments 33,427 3.2 48,361 4.8 26,510 2.9 Income tax (expense) benefit (8,541) (0.8) (10,520) (1.0) 910 0.1 Loss from equity method investments (380) (0.0) (632) (0.1) - - Net income 24,506 2.4 37,209 3.7 27,420 3.0 Add net loss attributable to
noncontrolling interest - - - - 200 0.0 Net income attributable to common stockholders$ 24,506 2.4 %$ 37,209
3.7 %$ 27,620 3.0 %
Comparison of the Years Ended
Revenues. Our revenues for the year endedJune 30, 2020 were$1,040.8 million , representing an increase of$25.0 million , or 2.5%, from$1,015.8 million for the year endedJune 30, 2019 . Managed Public School Program revenues increased$29.8 million , or 3.3%, year over year. The increase inManaged Public School Program revenues was primarily due to the 2.6% increase in enrollments and increases in the per pupil achieved funding, school mix (distribution of enrollments by school), and other factors. Total Institutional revenues decreased$15.0 million , or 16.7%, primarily due to a 33.9% decline in enrollments in our Non-managed Public School Programs. Private Pay Schools and Other revenues increased$10.2 million , or 28.7%, over the prior year period as a result of the acquisition of Galvanize. Instructional costs and services expenses. Instructional costs and services expenses for the year endedJune 30, 2020 were$693.2 million , representing an increase of$29.8 million , or 4.5%, from$663.4 million for the year endedJune 30, 2019 . This increase in expense was primarily due to the incremental personnel and related benefit costs associated with supporting higher enrollments, as well as costs associated with serving Galvanize's customers. Instructional costs and services expenses were 66.6% of revenues during the year endedJune 30, 2020 , an increase from 65.3% for the year endedJune 30, 2019 . Selling, general, and administrative expenses. Selling, general and administrative expenses for the year endedJune 30, 2020 were$315.1 million , representing an increase of$8.3 million , or 2.7% from$306.8 million for the year endedJune 30, 2019 . This increase was primarily due to an increase in professional services expenses. Selling, general, and administrative expenses were 30.3% of revenues during the year endedJune 30, 2020 , an increase from 30.2% for the year endedJune 30, 2019 . Income tax (expense) benefit. We had an income tax expense of$8.5 million for the year endedJune 30, 2020 , or 25.8% of income before taxes, as compared to$10.5 million , or 22.0% of income before taxes for the year endedJune 30, 2019 .
The increase in the effective tax rate for the year ended
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compensation.
Net income. Net income was
Comparison of the Years Ended
Revenues. Our revenues for the year endedJune 30, 2019 were$1,015.8 million , representing an increase of$98.1 million , or 10.7%, from$917.7 million for the year endedJune 30, 2018 . Managed Public School Program revenues increased$109.5 million , or 14.0%, year over year. The increase inManaged Public School Programs revenues was primarily due to the 6.3% increase in enrollments and increases in the per pupil achieved funding, school mix (distribution of enrollments by school), and other factors. Institutional revenues decreased$10.7 million , or 10.6%, primarily due to a change in mix of enrollments in our Non-managed Public Schools Programs, as well as a decline in software sales. Private Pay Schools and Other revenues decreased$0.8 million , or 2.1%, over the prior year period. Instructional costs and services expenses. Instructional costs and services expenses for the year endedJune 30, 2019 were$663.4 million , representing an increase of$70.9 million , or 12.0%, from$592.5 million for the year endedJune 30, 2018 . This increase in expense was primarily due to the incremental personnel and related benefit costs due to supporting higher enrollments. Instructional costs and service expenses were 65.3% of revenues during the year endedJune 30, 2019 , an increase from 64.6% for the year endedJune 30, 2018 . Selling, general, and administrative expenses. Selling, general, and administrative expenses for the year endedJune 30, 2019 were$306.8 million , representing an increase of$7.1 million , or 2.4%, from$299.7 million for the year endedJune 30, 2018 . This increase was primarily due to increases in professional services, advertising and marketing expenses, partially offset by a decrease in salaries. Selling, general, and administrative expenses were 30.2% of revenues during the year endedJune 30, 2019 , a decrease from 32.7% for
the year endedJune 30, 2018 .
Income tax (expense) benefit. We had an income tax expense of$10.5 million for the year endedJune 30, 2019 , or 22.0% of income before taxes, as compared to a benefit of$0.9 million , or (3.4%) of income before taxes for the year endedJune 30, 2018 . The increase in the effective tax rate for the year endedJune 30, 2019 was primarily due to the impact of the Tax Cuts and Job Act (the "Tax Act") in the prior year.
Net income. Net income was
Discussion of Seasonality of Financial Condition
Certain accounts in our balance sheet are subject to seasonal fluctuations. As
our enrollments and revenues grow, we expect these seasonal trends to be
amplified. 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.
In our fourth quarter, inventory purchases and the extent to which we utilize
early payment discounts will impact the level of accounts payable.
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 result in seasonal fluctuations to our deferred
revenue balances. We routinely monitor state legislative activity and regulatory
proceedings that might impact the funding received by the schools we serve and
to the extent possible, factor potential outcomes into our business planning
decisions.
The deferred revenue related to our direct-to-consumer business results from
advance payments for twelve month subscriptions to our online 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.
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Liquidity and Capital Resources
As ofJune 30, 2020 , we had net working capital, or current assets minus current liabilities, of$227.9 million . Our working capital includes cash and cash equivalents of$212.3 million and accounts receivable of$236.1 million . Our working capital provides a significant source of liquidity for our normal operating needs. Our accounts receivable balance fluctuates throughout the fiscal year based on the timing of customer billings and collections and tends to be highest in our first fiscal quarter as we begin billing for students. In addition, our cash and accounts receivable were significantly in excess of our accounts payable and short-term accrued liabilities atJune 30, 2020 . OnJanuary 27, 2020 , we entered into a$100.0 million senior secured revolving credit facility ("Credit Facility") to be used for general corporate operating purposes withPNC Capital Markets LLC . The Credit Facility has a five-year term and incorporates customary financial and other covenants, including, but not limited to, a maximum leverage ratio and a minimum interest coverage ratio. The majority of our borrowings under the Credit Facility are at LIBOR plus an additional rate ranging from 0.875% - 1.50% based on our leverage ratio as defined in the agreement. The Credit Facility is secured by our assets. As ofJune 30, 2020 , we were in compliance with the financial covenants. As ofJune 30, 2020 , we had$100.0 million outstanding on the Credit Facility. The Credit Facility also includes a$200.0 million accordion feature. We are a lessee under finance lease obligations for student computers and peripherals under loan agreements withPNC Equipment Finance, LLC ("PNC") andBanc of America Leasing & Capital, LLC ("BALC"). As ofJune 30, 2020 and 2019, the finance lease liability ("capital leases" as ofJune 30, 2019 ) was$17.9 million and$24.6 million , respectively, with lease interest rates ranging
from 1.52% to 3.87%. Individual leases under the agreement with PNC include 36-month payment terms at varying rates, with a$1 purchase option at the end of each lease term. We have pledged the assets financed to secure the outstanding leases. We entered into an agreement with BALC inFebruary 2019 for$25.0 million to provide financing for our leases throughDecember 2019 at varying rates. We entered into an additional$25.0 million agreement inApril 2020 to provide financing for our leases throughMarch 2021 at varying rates. InJuly 2020 , the limit was increased from$25.0 million to$41.0 million at the same terms. Individual leases with BALC include 12-month and 36-month payment terms, fixed rates ranging from 1.52% to 3.58%, and a$1 purchase option at the end of each lease term. We pledged the assets financed to secure the outstanding leases. Our cash requirements consist primarily of day-to-day operating expenses, capital expenditures and contractual obligations with respect to office facility leases, capital equipment leases and other operating leases. We expect to make future payments on existing leases from cash generated from operations. We believe that the combination of funds to be generated from operations, borrowing on our Credit Facility and net working capital on hand will be adequate to finance our ongoing operations for the foreseeable future. In addition, to a lesser degree, we continue to explore acquisitions, strategic investments and joint ventures related to our business that we may acquire using cash, stock, debt, contribution of assets or a combination thereof.
Operating Activities
Net cash provided by operating activities for the years ended
Net cash provided by operating activities for the year endedJune 30, 2020 was$80.4 million compared to$141.6 million for the year endedJune 30, 2019 . The$61.2 million decrease in cash provided by operations between periods was primarily due to a decrease in working capital of$63.3 million . The decrease in other assets and liabilities was primarily due to decreases in accounts payable, as well as increases in accounts receivable, and inventory, prepaid expenses and other assets. Net cash provided by operating activities for the year endedJune 30, 2019 was$141.6 million compared to$105.4 million for the year endedJune 30, 2018 . The$36.2 million increase in cash provided by operations between periods was primarily due to an increase in net income and an increase in working capital of$25.3 million . The increase in other assets and liabilities was primarily due to increases in accounts payable and accrued liabilities, as well as a decrease in inventory, prepaid expenses and other assets; partially offset by an increase in accounts receivable. 65 Table of Contents
Net cash provided by operating activities for the year endedJune 30, 2018 was$105.4 million compared to$88.7 million for the year endedJune 30, 2017 . The$16.7 million increase in cash provided by operations between periods was primarily due to an increase in net income, partially offset by a decrease in working capital of$3.5 million . The decrease in other assets and liabilities was primarily due to decreases in payables, deferred revenue and other liabilities, partially offset by an increase in accrued compensation and benefits.
Investing Activities
Net cash used in investing activities for the years ended
Net cash used in investing activities for the year endedJune 30, 2020 increased$156.3 million from the year endedJune 30, 2019 . The increase is primarily due to our investment in Galvanize of$165.0 million , plus working capital, net of cash. Net cash used in investing activities for the year endedJune 30, 2019 increased$10.6 million from the year endedJune 30, 2018 . This increase was primarily due to an increase in capitalized expenditures of$5.3 million and our$11.7 million investment in Tallo in the year endedJune 30, 2019 compared to the$4.0 million investment in Modern Teacher and the$2.8 million investment in Big Universe in the year endedJune 30, 2018 . Net cash used in investing activities for the year endedJune 30, 2018 decreased$6.7 million from the year endedJune 30, 2017 . This decrease was due primarily to the$9.1 million payment toMiddlebury College in the year endedJune 30, 2017 for the remaining 40% interest in Middlebury Interactive Languages and the$11.6 million decrease in capitalized software and curriculum development expenses as a result of lower unit costs of producing curriculum, partially offset by the$6.5 million increase in the purchase of property and equipment. We also made$7.3 million of investments during the year endedJune 30, 2018 .
Financing Activities
Net cash provided by financing activities for the year endedJune 30, 2020 was$65.6 million . Net cash used in financing activities for the years endedJune 30, 2019 and 2018 was$29.0 million and$52.7 million , respectively. For the year endedJune 30, 2020 , our cash provided by financing activities consisted primarily of borrowings from the credit facility of$105.0 million offset by payments on finance lease obligations incurred for the acquisition of student computers totaling$27.7 million and for the purchase of restricted stock from employees for income tax withholdings upon vesting of$6.8 million . For the year endedJune 30, 2019 , our cash used in financing activities consisted primarily of the payments on finance lease obligations incurred for the acquisition of student computers totaling$21.0 million and for the purchase of restricted stock from employees for income tax withholdings upon vesting of$10.0 million . For the year endedJune 30, 2018 , our cash used in financing activities consisted primarily of the purchase of treasury stock totaling$27.5 million , payments on finance lease obligations incurred for the acquisition of student computers totaling$13.3 million and for the purchase of restricted stock from employees for income tax withholdings upon vesting of$10.3 million . 66 Table of Contents Contractual Obligations
Our contractual obligations consist primarily of operating leases for office
facilities and finance leases for equipment. The following summarizes our
long-term contractual obligations as of
Contractual Obligations-Payments due by period
Total < 1 year 1 - 3 years 3 - 5 years > 5 years
(In thousands)
Contractual obligations at June 30, 2020
Finance leases (1) $ 18,280 $ 13,587 $ 4,693 $ - $ -
Operating leases (1) 129,055 23,626 38,167 28,718 38,544
Total $ 147,335 $ 37,213 $ 42,860 $ 28,718 $ 38,544
(1) Includes interest.
For the schools to which we provide administrative services, we typically take
responsibility for any school operating losses that the school may incur. These
individual school operating losses, if they occur, are recorded at the time as a
reduction in revenues. Potential school operating losses are not included as a
commitment or obligation in the above table as they cannot be determined at this
time and many may not even occur.
Off-Balance Sheet Arrangements
As of
In addition, we contractually guarantee that certain schools under our management will not have annual operating deficits and our management fees from these schools may be reduced accordingly to cover any school operating deficits.
Other than these lease and operating deficit guarantees, we did 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.
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
Recent Accounting Pronouncements
For information regarding, "Recent Accounting Pronouncements," please refer to Note 3, "Summary of Significant Accounting Policies," contained within our consolidated financial statements in Part II, Item 8, of this Annual Report on Form 10-K.
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