As filed
with the Securities and Exchange Commission on July 26,
2007
Registration
No. 333-
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.
20549
Form S-1
REGISTRATION
STATEMENT
UNDER
THE SECURITIES ACT OF
1933
K12 INC.
(Exact name of registrant as
specified in its charter)
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Delaware
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8211
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95-4774688
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(State or Other Jurisdiction
of
Incorporation or Organization)
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(Primary Standard Industrial
Classification Number)
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(IRS Employer
Identification No.)
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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:
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William P.
ONeill, Esq.
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Howard D. Polsky,
Esq.
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Richard D. Truesdell,
Jr., Esq.
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Latham & Watkins
LLP
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Senior Vice President, General
Counsel and Secretary
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Davis Polk &
Wardwell
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555 Eleventh Street,
N.W
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K12 Inc.
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450 Lexington Avenue
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Washington, D.C.
20004
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2300 Corporate Park
Drive
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New York, NY 10017
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(202) 637-2200
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Herndon, VA 20171
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(212) 450-4674
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(703) 483-7000
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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
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Title of Each Class of
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Proposed Maximum
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Amount of
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Securities to be Registered
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Aggregate Offering Price(a)(b)
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Registration Fee
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Common stock, $0.0001 par value
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$172,500,000
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$5,296
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(a)
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Estimated solely for the purpose of
calculating the registration fee in accordance with
Rule 457(o) promulgated under the Securities Act of 1933.
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(b)
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Including shares of common stock
which may be purchased by the underwriters to cover
overallotments, if any.
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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.
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PROSPECTUS
(Subject to Completion)
Issued
July 26, 2007
Shares
K12 INC.
Common Stock
K12 Inc. is
offering shares
of its common stock and the selling stockholders are
offering shares
of common stock. We will not receive any proceeds from the sale
of shares by the selling stockholders. 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 $ and
$ per share.
Investing in our common stock involves risks. See
Risk Factors beginning on page 10 to read about
factors you should consider before buying shares of our common
stock.
We intend to apply to list our common stock on the New York
Stock Exchange under the symbol LRN.
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Underwriting
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Proceeds to
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Discounts and
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Proceeds to
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Selling
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Price to Public
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Commissions
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K12 Inc.
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Stockholders
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Per Share
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$
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$
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$
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$
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Total
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$
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$
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$
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$
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The underwriters may also purchase up to an
additional 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.
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.
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Morgan
Stanley
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Credit
Suisse
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,
2007
TABLE OF
CONTENTS
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F-1
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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 10 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,
K
12
,
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, software 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 $95 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 a virtual
school 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%. From fiscal year 2004 to
fiscal year 2006, we increased revenues from $71.4 million
to $116.9 million, representing a compound annual growth
rate of approximately 28%.
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 or 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
1
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.
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 by public school
students in 16 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.
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
Market
The U.S. market for K-12 education is large and growing.
For example:
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According to the National Center for Education Statistics
(NCES), a division of the U.S. Department of Education,
there were more than 47 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.
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According to the NCES, the public school system alone
encompassed more than 97,000 schools and 17,000 school districts
during the 2005-06 school year.
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According to the NCES, total spending in the public K-12 market
was $536 billion for the 2004-05 school year.
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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 education as an
effective, alternative form of education is growing. As of
September 2006, 38 states had authorized some form of
online
2
education, 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 another approach to online
education 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. 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 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 or 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. A comprehensive analysis of
individual student progression conducted during the
2006-07
school year in Ohio, the first state to conduct such an
analysis, concluded that a virtual public school using our
learning system outperformed 97% and 60% of participating public
schools in reading and mathematics, respectively. Additionally,
in California, the only state to adjust standardized test scores
for student demographics, the virtual public schools we serve
performed in the 70th to 90th percentile of all public
schools in the state during the
2005-06
school year. Among statewide virtual public schools, those using
the
K
12
learning system outperform other providers in terms of
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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
$95 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, we will serve virtual public schools in
16 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 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
K
12
to their friends and family members.
Enhance Curriculum to Include a Complete High School
Offering.
We believe the high school market
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 conducted
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 market-leading position in the K-8 virtual
public schools positions us well for growth in the high school
market. In the 2005-06 and 2006-07 school years, we began
enrolling 9th and 10th grade students, respectively, and with
the planned launch of our 11th and 12th grades in the
2007-08
school year, we will be 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
K
12
Brand.
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
K
12
brand is not as well recognized. We have developed a
comprehensive brand strategy and intend to invest in further
developing awareness of both the
K
12
brand and the core philosophy behind our learning system. The
recent launch of our Unleash the
x
Potential
campaign is a strong first step towards this
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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
K
12
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 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.
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:
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Most of our revenues depend on adequate funding of the virtual
public schools we serve. If our revenues from virtual public
schools are reduced, restricted or delayed, our business,
financial condition, results of operations and cash flows will
be adversely affected.
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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.
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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.
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We have a limited operating history, and sustained 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.
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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.
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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.
5
The
Offering
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Common Stock offered by us
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|
|
|
shares
|
Common Stock offered by selling
stockholders
|
|
|
|
shares
|
|
|
|
|
|
Total
|
|
|
|
shares
|
|
|
|
|
|
Common Stock outstanding after the
offering
|
|
|
|
shares
|
Overallotment option
|
|
|
|
shares
|
|
|
|
Proposed New York Stock Exchange symbol
|
|
LRN
|
|
Use of proceeds from this offering
|
|
We estimate that our net proceeds from this offering will be
approximately $ million,
based on an assumed initial public offering price of
$ per share (which is the midpoint
of the range on the cover page of this prospectus). We intend to
use the net proceeds from this offering for general corporate
purposes, including working capital, capital expenditures and
the development of new courses and product offerings as well as
to repay approximately $6.5 million indebtedness under our
revolving credit facility. We will receive no proceeds from the
sale of common stock by the selling stockholders. See Use
of Proceeds.
|
The number of shares of common stock outstanding after this
offering is based on 111,589,989 shares outstanding as of
March 31, 2007 and:
|
|
|
|
|
gives effect to the automatic conversion of all of the
outstanding shares of our preferred stock into
101,386,536 shares of our common stock immediately prior to
the completion of this offering; and
|
|
|
|
excludes 18,450,344 shares of common stock issuable upon
the exercise of options outstanding as of March 31, 2007 at
a weighted average exercise price of $1.41 per share,
2,328,358 shares of preferred stock (or upon the
consummation of the offering an equivalent amount of common
stock) that may be issued upon the exercise of warrants
outstanding as of March 31, 2007, all of which are
currently exercisable at a purchase price of $1.34 per
share, and 108,649 shares of common stock that may be
issued upon the exercise of warrants outstanding as of
March 31, 2007, all of which are exercisable at a purchase
price of $1.60 per share.
|
Except as otherwise indicated, all information contained in this
prospectus assumes:
|
|
|
|
|
a
for
stock split of our common stock to be effected prior to
completion of this offering;
|
|
|
|
an initial offering price of $ per
share (which is the midpoint of the range on the cover page of
this prospectus); and
|
|
|
|
the underwriters option to purchase up
to additional
shares of common stock is not exercised.
|
6
SUMMARY
CONSOLIDATED FINANCIAL DATA
We derived the summary consolidated financial data presented
below as of June 30, 2005 and 2006 and for each of the
three years ended June 30, 2004, 2005 and 2006, from our
audited consolidated financial statements included elsewhere in
this prospectus. We have derived our summary consolidated
balance sheet data as of June 30, 2004 from our audited
consolidated financial statements that are not included this
prospectus. We have derived our consolidated statement of
operations data for the nine months ended March 31, 2006
and 2007 and consolidated balance sheet data as of
March 31, 2007 from our unaudited consolidated financial
statements. 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands, except per share data)
|
|
|
Consolidated Statement of
Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
71,434
|
|
|
$
|
85,310
|
|
|
$
|
116,902
|
|
|
$
|
90,088
|
|
|
$
|
104,930
|
|
Cost and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
39,943
|
|
|
|
49,130
|
|
|
|
64,828
|
|
|
|
48,473
|
|
|
|
55,103
|
|
Selling, administrative, and other
operating expenses
|
|
|
25,656
|
|
|
|
30,031
|
|
|
|
41,660
|
|
|
|
28,403
|
|
|
|
35,059
|
|
Product development expenses
|
|
|
12,750
|
|
|
|
9,410
|
|
|
|
8,568
|
|
|
|
5,587
|
|
|
|
5,855
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
78,349
|
|
|
|
88,571
|
|
|
|
115,056
|
|
|
|
82,463
|
|
|
|
96,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(6,915
|
)
|
|
|
(3,261
|
)
|
|
|
1,846
|
|
|
|
7,625
|
|
|
|
8,913
|
|
Interest expense, net
|
|
|
(516
|
)
|
|
|
(279
|
)
|
|
|
(488
|
)
|
|
|
(394
|
)
|
|
|
(474
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) before income
taxes
|
|
|
(7,431
|
)
|
|
|
(3,540
|
)
|
|
|
1,358
|
|
|
|
7,231
|
|
|
|
8,439
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(227
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(7,431
|
)
|
|
|
(3,540
|
)
|
|
|
1,358
|
|
|
|
7,231
|
|
|
|
8,212
|
|
Dividends on preferred stock
|
|
|
(2,667
|
)
|
|
|
(5,261
|
)
|
|
|
(5,851
|
)
|
|
|
(4,333
|
)
|
|
|
(4,707
|
)
|
Preferred stock accretion
|
|
|
(15,768
|
)
|
|
|
(15,947
|
)
|
|
|
(18,697
|
)
|
|
|
(13,880
|
)
|
|
|
(16,544
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(25,866
|
)
|
|
$
|
(24,748
|
)
|
|
$
|
(23,190
|
)
|
|
$
|
(10,982
|
)
|
|
$
|
(13,039
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(2.58
|
)
|
|
$
|
(2.46
|
)
|
|
$
|
(2.30
|
)
|
|
$
|
(1.09
|
)
|
|
$
|
(1.28
|
)
|
Basic and diluted (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
$
|
0.01
|
|
|
|
n/a
|
|
|
$
|
0.07
|
|
Weighted average shares used in
computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
10,017,162
|
|
|
|
10,062,587
|
|
|
|
10,083,721
|
|
|
|
10,081,180
|
|
|
|
10,195,440
|
|
Basic (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
106,937,388
|
|
|
|
n/a
|
|
|
|
111,581,976
|
|
Diluted (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
107,055,314
|
|
|
|
n/a
|
|
|
|
111,621,446
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands)
|
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
operating activities
|
|
$
|
(8,020
|
)
|
|
$
|
9,697
|
|
|
$
|
3,625
|
|
|
$
|
1,137
|
|
|
$
|
7,324
|
|
Depreciation and amortization
|
|
$
|
4,922
|
|
|
$
|
5,509
|
|
|
$
|
4,986
|
|
|
$
|
3,574
|
|
|
$
|
4,618
|
|
Capital
expenditures
(2)
|
|
$
|
4,643
|
|
|
$
|
5,133
|
|
|
$
|
10,842
|
|
|
$
|
6,509
|
|
|
$
|
10,350
|
|
EBITDA
(3)
|
|
$
|
(1,993
|
)
|
|
$
|
2,248
|
|
|
$
|
6,832
|
|
|
$
|
11,199
|
|
|
$
|
13,531
|
|
Average
enrollments
(4)
|
|
|
11,158
|
|
|
|
15,097
|
|
|
|
20,220
|
|
|
|
20,183
|
|
|
|
27,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
As of June 30,
|
|
|
March 31,
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands)
|
|
|
Consolidated Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
15,881
|
|
|
$
|
19,953
|
|
|
$
|
9,475
|
|
|
$
|
5,147
|
|
Total assets
|
|
|
42,714
|
|
|
|
41,968
|
|
|
|
48,485
|
|
|
|
64,001
|
|
Total short-term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500
|
|
Total long-term obligations
|
|
|
3,432
|
|
|
|
4,466
|
|
|
|
4,025
|
|
|
|
6,112
|
|
Convertible redeemable preferred
stock
|
|
|
155,069
|
|
|
|
176,277
|
|
|
|
200,825
|
|
|
|
222,076
|
|
Total stockholders deficit
|
|
|
(125,621
|
)
|
|
|
(150,299
|
)
|
|
|
(173,451
|
)
|
|
|
(186,390
|
)
|
Working capital
|
|
|
24,130
|
|
|
|
22,953
|
|
|
|
15,421
|
|
|
|
14,617
|
|
|
|
|
(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 March 31, 2007 and
June 30, 2006, all of our outstanding shares of preferred
stock would convert into 101,386,536 and 96,853,667 shares of
common stock respectively.
|
(2)
|
|
Capital expenditures consist of the
purchase of property and equipment 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
|
8
|
|
|
|
|
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands)
|
|
|
Net income (loss)
|
|
$
|
(7,431
|
)
|
|
$
|
(3,540
|
)
|
|
$
|
1,358
|
|
|
$
|
7,231
|
|
|
$
|
8,212
|
|
Interest expense, net
|
|
|
516
|
|
|
|
279
|
|
|
|
488
|
|
|
|
394
|
|
|
|
474
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
227
|
|
Depreciation and amortization
|
|
|
4,922
|
|
|
|
5,509
|
|
|
|
4,986
|
|
|
|
3,574
|
|
|
|
4,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
(1,993
|
)
|
|
$
|
2,248
|
|
|
$
|
6,832
|
|
|
$
|
11,199
|
|
|
$
|
13,531
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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.
|
9
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 adequate funding of the
virtual public schools we serve. If these schools do not receive
adequate funding, our revenues could be reduced, restricted or
delayed and our business, financial condition, results of
operations and cash flows would 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 virtual public
schools 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 FY
2007-09
education budget appropriation, the Indiana legislature decided
not to fund any virtual public school if it provided for the
online delivery of more than 50 percent of its instruction
to students. 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.
|
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 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. If these few situations cause all virtual public
school providers to be viewed by the public and/or policymakers
unfavorably, we
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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 grow.
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. 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.
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 some 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. The service agreement for
these schools is with the charter holder or the charter board.
For example, 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. If a virtual public school 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.
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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 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 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 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.
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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
16 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. If we are
unable to renew several such contracts or one significant
contract expiring during a given year, 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.
During the nine months ended March 31, 2007, sales of our
products and services to four virtual public schools accounted
for approximately 17%, 12%, 11% and 10% of our 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 timely deployment of new courses in the
2007-08
school year, and the planned 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.
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:
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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;
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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
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our use of our curriculum in classrooms will produce challenges
with respect to adapting our curriculum for effective use in a
traditional classroom setting.
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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 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.
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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.
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.
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.
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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
K
12
.
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
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.
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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:
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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
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the Family Educational Rights and Privacy Act, which imposes
parental or student consent requirements for specified
disclosures of student information, including online information.
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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.
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
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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.
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
18
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 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 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:
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foreign currency fluctuations, which could result in reduced
revenues and increased operating expenses;
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potentially longer payment and sales cycles;
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difficulty in collecting accounts receivable;
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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;
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tariffs and trade barriers;
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general economic and political conditions in each country;
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inadequate intellectual property protection in foreign countries;
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uncertainty regarding liability for information retrieved and
replicated in foreign countries;
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19
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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
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unexpected changes in regulatory requirements.
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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:
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quarterly variations in our operating results compared to market
expectations;
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changes in expectations as to our future financial performance,
including financial estimates or reports by securities analysts;
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changes in market valuations of similar companies;
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liquidity and activity in the market for our common stock;
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sales of our common stock by our stockholders;
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strategic moves by us or our competitors, such as acquisitions
or restructurings;
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general market conditions; and
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domestic and international economic, legal and regulatory
factors unrelated to our performance.
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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 shares
of common stock outstanding
( shares
of common stock outstanding if the underwriters exercise their
overallotment option in full). This number is comprised of all
the shares of our common stock that we and the selling
stockholders are selling in this offering
(including shares
that we expect to be issued upon exercise of stock options by
certain of the selling stockholders and resold in this
offering), which may be resold immediately in the public market.
Subject to certain exceptions described under the caption
Underwriting, we and all of our directors and
executive officers and all 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. 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.
20
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,
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,
( 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.
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. 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
$ per share in the net tangible
book value of our common stock from the assumed initial public
offering price of $ 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 $ 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 a classified board of directors,
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 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
21
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 the New York Stock
Exchange, 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 % of the outstanding
shares of common stock (or
approximately % 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 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 may not use them effectively.
We cannot specify with certainty the particular uses of the net
proceeds we will receive from this offering. 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
22
business. Pending their use, we may invest the net proceeds from
this offering 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.
23
CAUTIONARY
NOTICE REGARDING FORWARD-LOOKING STATEMENTS
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
within the meaning of the Private Securities Litigation Reform
Act of 1995.
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 10 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.
24
USE OF
PROCEEDS
Assuming an initial public offering price of
$ per share, we estimate that we
will receive net proceeds from this offering of approximately
$ million, after deducting
underwriting discounts and commissions and other estimated
expenses of $ million payable
by us. If the underwriters exercise their overallotment option
in full, we estimate that our net proceeds from this offering
will be approximately
$ million. We will not
receive any of the proceeds from the sale of shares by the
selling stockholders. A $1.00 increase (decrease) in the assumed
initial public offering price of $
per share would increase (decrease) the net proceeds to us from
this offering by approximately
$ 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.
We intend to use the net proceeds from this offering 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
$6.5 million of borrowings under our revolving credit
facility, which bears interest at rates of approximately 6.6%,
with various maturity dates on or before October 1, 2007
that may be renewed at the then current interest rate.
Management will have broad discretion in the allocation of the
net proceeds of this offering. 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 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.
25
CAPITALIZATION
The following table sets forth our capitalization as of
March 31, 2007:
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on an actual basis;
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on a pro forma basis, giving effect to the automatic conversion
of all of the outstanding shares of our preferred stock into
101,386,536 shares of our common stock immediately prior to
the completion of this offering; and
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on a pro forma basis as discussed in the prior bullet point, as
adjusted to give effect to 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
$ , 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
our use of proceeds from this offering to repay approximately
$4.5 million of outstanding indebtedness under our
revolving credit facility.
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You should read this table in conjunction with the consolidated
financial statements and the related notes,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and Use of
Proceeds included elsewhere in this prospectus.
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As of March 31, 2007
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Pro forma
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Actual
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Pro forma
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as
adjusted
(1)
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(dollars in thousands)
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Cash and cash
equivalents
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$
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5,147
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$
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5,147
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$
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|
|
|
|
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Total debt
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7,612
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|
|
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7,612
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Redeemable Convertible
Preferred Stock
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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
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87,097
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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
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134,979
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Stockholders
deficit:
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Common stock, par value $0.0001
per share; 170,000,000 shares authorized, 10,203,453 issued
and outstanding, actual; 111,589,989 issued and outstanding, pro
forma; shares
authorized, issued
and outstanding pro forma as adjusted
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1
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|
11
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Additional paid-in capital
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222,066
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Accumulated deficit
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(186,391
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)
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|
(186,391
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Total stockholders (deficit)
equity
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(185,390
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)
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35,686
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Total capitalization
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$
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43,298
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$
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43,298
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$
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|
|
|
|
|
|
|
|
|
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|
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(1)
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A $1.00 increase (decrease) in the
assumed initial public offering price of
$ 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
$ 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.
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26
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 pro forma net tangible book value as of March 31, 2007
was $35.7 million, or $0.32 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. After
giving effect to 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
$ , 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, our pro forma as
adjusted net tangible book value as of March 31, 2007 would
have been approximately
$ million, or
$ per share. This represents an
immediate increase in pro forma net tangible book value of
$ per share to existing
stockholders and an immediate dilution of
$ 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:
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Per Share
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Assumed initial public offering
price per share
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$
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Pro forma net tangible book value
before the offering
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$
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0.32
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Increase per share attributable to
our investors in the offering
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Pro forma net tangible book value
after the offering
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Dilution per share to new investors
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|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
A $1.00 increase (decrease) in the assumed initial public
offering price of $ per share
would increase (decrease), the as adjusted pro forma net
tangible book value per share after this offering by
$ and the dilution per share to
new investors in this offering by
$ , 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 estimated
underwriting discounts and commissions and estimated offering
expenses payable by us.
The following table summarizes on a pro forma as adjusted basis
as of March 31, 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 and for
a
for
stock split which will occur prior to the completion of this
offering:
|
|
|
|
|
the total number of shares of common stock purchased from us by
our existing stockholders and by new investors purchasing shares
in this offering;
|
|
|
|
the total consideration paid to us by our existing stockholders
and by new investors purchasing shares in this offering,
assuming an initial public offering price of
$ per share (before deducting the
estimated underwriting discount and commissions and offering
expenses payable by us in connection with this
offering); and
|
|
|
|
the average price per share paid by existing stockholders and by
new investors purchasing shares in this offering:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Purchased
|
|
|
Total Consideration
|
|
|
Average Price
|
|
|
|
Number
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Per Share
|
|
|
Existing stockholders
|
|
|
111,589,989
|
|
|
|
|
%
|
|
$
|
149,521,516
|
|
|
|
|
%
|
|
$
|
1.34
|
|
Investors in the offering
|
|
|
|
|
|
|
|
%
|
|
|
|
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
100
|
%
|
|
$
|
|
|
|
|
100
|
%
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
27
The tables and calculations above assume no exercise of:
|
|
|
|
|
stock options outstanding as of March 31, 2007 to purchase
18,450,344 shares of common stock at a weighted average
exercise price of $1.80 per share;
|
|
|
|
2,328,358 shares of preferred stock (or upon the
consummation of the offering an equivalent amount of common
stock) that may be issued upon the exercise of warrants
outstanding as of March 31, 2007, all of which are
currently exercisable at a purchase price of $1.34 per
share, and 108,649 shares of common stock that may be
issued upon the exercise of warrants outstanding as of
March 31, 2007, all of which are exercisable at a purchase
price of $1.60 per share; or
|
|
|
|
the underwriters overallotment option.
|
To the extent any of these options are exercised, there will be
further dilution to new investors.
28
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,
2004, 2005 and 2006 and our balance sheet data as of
June 30, 2005 and 2006, 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, 2002 and
2003, and our balance sheet data as of June 30, 2002, 2003
and 2004, from our audited consolidated financial statements
that are not included in this prospectus. We have derived our
selected consolidated statement of operations data for the nine
months ended March 31, 2006 and 2007 and consolidated
balance sheet data as of March 31, 2007 from our unaudited
consolidated financial statements. 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands, except per share data)
|
|
|
Consolidated Statement of
Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
6,693
|
|
|
$
|
30,930
|
|
|
$
|
71,434
|
|
|
$
|
85,310
|
|
|
$
|
116,902
|
|
|
$
|
90,088
|
|
|
$
|
104,930
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
5,818
|
|
|
|
25,580
|
|
|
|
39,943
|
|
|
|
49,130
|
|
|
|
64,828
|
|
|
|
48,473
|
|
|
|
55,103
|
|
Selling, administrative, and other
operating expenses
|
|
|
11,661
|
|
|
|
20,903
|
|
|
|
25,656
|
|
|
|
30,031
|
|
|
|
41,660
|
|
|
|
28,403
|
|
|
|
35,059
|
|
Product development expenses
|
|
|
19,621
|
|
|
|
12,416
|
|
|
|
12,750
|
|
|
|
9,410
|
|
|
|
8,568
|
|
|
|
5,587
|
|
|
|
5,855
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
37,100
|
|
|
|
58,899
|
|
|
|
78,349
|
|
|
|
88,571
|
|
|
|
115,056
|
|
|
|
82,463
|
|
|
|
96,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(30,407
|
)
|
|
|
(27,969
|
)
|
|
|
(6,915
|
)
|
|
|
(3,261
|
)
|
|
|
1,846
|
|
|
|
7,625
|
|
|
|
8,913
|
|
Interest expense, net
|
|
|
(11
|
)
|
|
|
(388
|
)
|
|
|
(516
|
)
|
|
|
(279
|
)
|
|
|
(488
|
)
|
|
|
(394
|
)
|
|
|
(474
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) before taxes
|
|
|
(30,418
|
)
|
|
|
(28,357
|
)
|
|
|
(7,431
|
)
|
|
|
(3,540
|
)
|
|
|
1,358
|
|
|
|
7,231
|
|
|
|
8,439
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(227
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(30,418
|
)
|
|
|
(28,357
|
)
|
|
|
(7,431
|
)
|
|
|
(3,540
|
)
|
|
|
1,358
|
|
|
|
7,231
|
|
|
|
8,212
|
|
Dividends on preferred stock
|
|
|
|
|
|
|
|
|
|
|
(2,667
|
)
|
|
|
(5,261
|
)
|
|
|
(5,851
|
)
|
|
|
(4,333
|
)
|
|
|
(4,707
|
)
|
Preferred stock accretion
|
|
|
(6,628
|
)
|
|
|
(11,912
|
)
|
|
|
(15,768
|
)
|
|
|
(15,947
|
)
|
|
|
(18,697
|
)
|
|
|
(13,880
|
)
|
|
|
(16,544
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(37,046
|
)
|
|
$
|
(40,269
|
)
|
|
$
|
(25,866
|
)
|
|
$
|
(24,748
|
)
|
|
$
|
(23,190
|
)
|
|
$
|
(10,982
|
)
|
|
$
|
(13,039
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(3.70
|
)
|
|
$
|
(4.02
|
)
|
|
$
|
(2.58
|
)
|
|
$
|
(2.46
|
)
|
|
$
|
(2.30
|
)
|
|
$
|
(1.09
|
)
|
|
$
|
(1.28
|
)
|
Basic and diluted (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
$
|
0.01
|
|
|
|
n/a
|
|
|
$
|
0.07
|
|
Weighted average shares used in
computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
10,000,000
|
|
|
|
10,009,906
|
|
|
|
10,017,162
|
|
|
|
10,062,587
|
|
|
|
10,083,721
|
|
|
|
10,081,180
|
|
|
|
10,195,440
|
|
Basic (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
106,937,388
|
|
|
|
n/a
|
|
|
|
111,581,976
|
|
Diluted (pro
forma)
(1)
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
107,055,314
|
|
|
|
n/a
|
|
|
|
111,621,446
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands)
|
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
operating activities
|
|
$
|
(35,016
|
)
|
|
$
|
(15,990
|
)
|
|
$
|
(8,020
|
)
|
|
$
|
9,697
|
|
|
$
|
3,625
|
|
|
$
|
1,137
|
|
|
$
|
7,324
|
|
Depreciation and amortization
|
|
$
|
1,770
|
|
|
$
|
4,005
|
|
|
$
|
4,922
|
|
|
$
|
5,509
|
|
|
$
|
4,986
|
|
|
$
|
3,574
|
|
|
$
|
4,618
|
|
Capital
expenditures
(2)
|
|
$
|
2,547
|
|
|
$
|
4,677
|
|
|
$
|
4,643
|
|
|
$
|
5,133
|
|
|
$
|
10,842
|
|
|
$
|
6,509
|
|
|
$
|
10,350
|
|
EBITDA
(3)
|
|
$
|
(28,637
|
)
|
|
$
|
(23,964
|
)
|
|
$
|
(1,993
|
)
|
|
$
|
2,248
|
|
|
$
|
6,832
|
|
|
$
|
11,199
|
|
|
$
|
13,531
|
|
Average
enrollments
(4)
|
|
|
906
|
|
|
|
5,872
|
|
|
|
11,158
|
|
|
|
15,097
|
|
|
|
20,220
|
|
|
|
20,183
|
|
|
|
27,297
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30,
|
|
|
As of
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
March 31, 2007
|
|
|
|
(dollars in thousands)
|
|
|
Consolidated Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
6,008
|
|
|
$
|
7,727
|
|
|
$
|
15,881
|
|
|
$
|
19,953
|
|
|
$
|
9,475
|
|
|
$
|
5,147
|
|
Total assets
|
|
|
15,755
|
|
|
|
21,331
|
|
|
|
42,714
|
|
|
|
41,968
|
|
|
|
48,485
|
|
|
|
64,001
|
|
Total short-term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500
|
|
Total long-term obligations
|
|
|
270
|
|
|
|
1,697
|
|
|
|
3,432
|
|
|
|
4,466
|
|
|
|
4,025
|
|
|
|
6,112
|
|
Convertible redeemable preferred
stock
|
|
|
70,566
|
|
|
|
111,634
|
|
|
|
155,069
|
|
|
|
176,277
|
|
|
|
200,825
|
|
|
|
222,076
|
|
Total stockholders deficit
|
|
|
(59,502
|
)
|
|
|
(99,762
|
)
|
|
|
(125,621
|
)
|
|
|
(150,299
|
)
|
|
|
(173,451
|
)
|
|
|
(186,390
|
)
|
Working capital
|
|
|
6,240
|
|
|
|
6,823
|
|
|
|
24,130
|
|
|
|
22,953
|
|
|
|
15,421
|
|
|
|
14,617
|
|
|
|
|
(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 March 31, 2007 and
June 30, 2006, all of our outstanding shares of preferred
stock would convert into 101,386,536 and 96,853,667 shares
of common stock respectively.
|
(2)
|
|
Capital expenditures consist of the
purchase of property and equipment 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:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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Nine Months Ended
|
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|
Year Ended June 30,
|
|
|
March 31,
|
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
|
(dollars in thousands)
|
|
|
Net income (loss)
|
|
$
|
(30,418
|
)
|
|
$
|
(28,357
|
)
|
|
$
|
(7,431
|
)
|
|
$
|
(3,540
|
)
|
|
$
|
1,358
|
|
|
$
|
7,231
|
|
|
$
|
8,212
|
|
Interest expense, net
|
|
|
11
|
|
|
|
388
|
|
|
|
516
|
|
|
|
279
|
|
|
|
488
|
|
|
|
394
|
|
|
|
474
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
227
|
|
Depreciation and amortization
|
|
|
1,770
|
|
|
|
4,005
|
|
|
|
4,922
|
|
|
|
5,509
|
|
|
|
4,986
|
|
|
|
3,574
|
|
|
|
4,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
(28,637
|
)
|
|
$
|
(23,964
|
)
|
|
$
|
(1,993
|
)
|
|
$
|
2,248
|
|
|
$
|
6,832
|
|
|
$
|
11,199
|
|
|
$
|
13,531
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
(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.
|
30
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, software 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 $95 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 a virtual
school 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%. From fiscal year 2004 to
fiscal year 2006, we increased revenues from $71.4 million
to $116.9 million, representing a compound annual growth
rate of approximately 28%.
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 by public school
students in 16 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 in California, Idaho, Ohio, Minnesota and Arkansas,
increasing our average enrollment to approximately 5,900
students during the 2002-03 school year. During the
2003-04
and
2004-05
school years, we added 7th and 8th grades,
respectively, and added contracts with 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
31
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 we plan to offer 11th and
12th grades at the start of 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. Revenues consist
principally of product and service revenues derived through our
contracts with these schools. 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 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:
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|
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|
|
the number of states and school districts in which we operate;
|
|
|
|
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 our
product pricing. We track
32
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 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 growth in revenues relative to
the growth in enrollments.
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 and
generally increase at modest levels from year to year. We expect
this trend to continue. Finally, we may generate modest growth
in revenues from increases in the prices of our products. We
evaluate our product 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, 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 nine months ended
March 31, 2007, as compared to the nine months ended
March 31, 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.
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
33
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 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. We expect these expenses, as a percentage of revenues,
to decline over time, reflecting the scalability of our
corporate infrastructure, partially offset by increased levels
of spending on marketing and business development activities.
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. We did
not record any impairment charge in the nine months ended
March 31, 2007. Impairment charges recorded were
$0.4 million and $3.3 million for the years ended
June 30, 2006 and 2005, 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 the
New York Stock Exchange. 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 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
34
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 $0.1 million in stock
compensation expense for the nine months ended March 31,
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. Through March 31,
2007, we provided a 100% valuation allowance for all net
deferred tax assets based on our limited history of generating
taxable income. Our provision for income taxes for the nine
months ended March 31, 2007 was $0.2 million, compared
to no provision for the nine months ended March 31, 2006.
Our tax expense for the nine months ended March 31, 2007 is
primarily related to alternative minimum tax liabilities.
Effectively, no tax expense was recorded in the nine months
ending March 31, 2006 as we were able to utilize net
operating loss carryforwards that were fully reserved for in
prior periods. We do not expect to record any income tax expense
in the next few years other than alternative minimum tax, unless
we decrease the valuation allowance on net deferred tax assets
of $28.5 million as of March 31, 2007.
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
.
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
35
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 is
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 invoice virtual public schools in accordance with the
established contractual terms. Generally, this means that we
invoice each school for the following items: (1) access to
our online school and online lessons; (2) offline learning
kits; (3) student personal computers; and
(4) management and technology services. We apply
SAB No. 104 to each of these items as follows:
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|
|
|
|
Access to the
K
12
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 because service delivery is complete. 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.
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|
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.
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|
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 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 are
recognized because service delivery is complete. 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
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36
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|
|
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. 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.
Under most contracts, we provide the virtual schools we manage
with turnkey management services and take responsibility for any
operating deficits that the schools may incur in a given school
year. 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. These
operating deficits may impair our ability to collect the full
amount invoiced in a period. In these cases, since collection
cannot be reasonably assured, we reduce revenues by the amount
of these deficits. 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. 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. 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.
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
37
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.
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 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.
38
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 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 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
projected 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. 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 March 31, 2007, we had net operating loss
carry-forwards of $57.5 million that expire between 2020
and 2027 if unused. We recorded a full 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 $29.0 million as
of March 31, 2007.
39
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
Nine Months Ended
|
|
|
|
June 30,
|
|
|
March 31,
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2006
|
|
|
2007
|
|
|
Consolidated Statement of
Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
56
|
|
|
|
58
|
|
|
|
55
|
|
|
|
54
|
|
|
|
53
|
|
Selling, administrative, and other
operating expenses
|
|
|
36
|
|
|
|
35
|
|
|
|
36
|
|
|
|
32
|
|
|
|
33
|
|
Product development expenses
|
|
|
18
|
|
|
|
11
|
|
|
|
7
|
|
|
|
6
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
110
|
|
|
|
104
|
|
|
|
98
|
|
|
|
92
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(10
|
)
|
|
|
(4
|
)
|
|
|
2
|
|
|
|
8
|
|
|
|
8
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
before income taxes
|
|
|
(10
|
)
|
|
|
(4
|
)
|
|
|
1
|
|
|
|
8
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax benefit (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(10
|
)%
|
|
|
(4
|
)%
|
|
|
1
|
%
|
|
|
8
|
%
|
|
|
8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of Nine Months Ended March 31, 2007 to Nine Months Ended
March 31, 2006
Revenues.
Our revenues for the nine months
ended March 31, 2007 were $104.9 million, representing
an increase of $14.8 million, or 16.4%, as compared to
revenues of $90.1 million for the nine months ended
March 31, 2006. Average enrollments increased 35.3% to
27,297 for the nine months ended March 31, 2007 from 20,183
average enrollments for the nine months ended March 31,
2006. Primarily offsetting the increased revenues related to
enrollment growth, was a decline in management services revenues
resulting from the impact of a substantial reduction in the
percentage of enrollments associated with schools to which we
provide turnkey management services. For the nine months ended
June 30, 2007, 76.2% of our enrollments were associated
with these schools, down from 91.7% for the corresponding period
in 2006. The increase in average enrollments was primarily
attributable to new school openings in Washington, California,
and Chicago, where we opened our first hybrid school. In
addition, we launched 10th grade in August 2006 attracting
new students as well as prior year 9th grade students.
Price increases of approximately 2% also generated additional
revenues. Finally, increased operating deficits at certain
schools partially offset the growth in revenues. These deficits
were attributable to greater school operating expenses to
support increased enrollment and high school services as well as
school funding adjustments stemming from enrollment audits in
California and Colorado.
Instructional Costs and Services
Expenses.
Instructional costs and services for
the nine months ended March 31, 2007 were
$55.1 million, representing an increase of
$6.6 million, or 13.6%, as compared to instructional costs
and services of $48.5 million for the nine months ended
March 31, 2006. This increase was primarily attributable to
increased costs to supply books and materials as well as
increased school operating expenses, both primarily a result of
the increase in enrollments. As a percentage of revenues,
instructional costs and services decreased by 1.3% to 52.5% for
the nine months ended March 31, 2007, as compared to 53.8%
for the nine months ended March 31, 2006. The decrease in
instructional costs and services 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 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 the nine months ended March 31, 2007
were $35.1 million, representing an increase of
$6.7 million, or 23.4%, as compared to selling,
administrative and other operating expenses of
$28.4 million for the nine months ended March 31,
2006. This increase is primarily attributable to increases in
marketing staff as well as increased spending on advertising and
other marketing tactics. In addition, expenses increased in
finance, legal and school services as the Company increased its
capabilities in these areas. As a percentage of revenues,
selling,
40
administrative, and other operating expenses increased to 33.4%
for the nine months ended March 31, 2007 compared to 31.5%
for the nine months ended March 31, 2006.
Product Development Expenses.
Product
development expenses for the nine months ended March 31,
2007 were $5.9 million, representing an increase of
$0.3 million, or 5.4%, as compared to product development
expenses of $5.6 million for the nine months ended
March 31, 2006. Contributing to this increase are increases
in employee headcount and contract labor offset by greater
utilization of these resources for capitalized curriculum. As a
percentage of revenues, product development expenses were
relatively stable at 5.6% for the nine months ended
March 31, 2007 compared to 6.2% for the nine months ended
March 31, 2006.
Net Interest Expense.
Net interest expense for
the nine months ended March 31, 2007 was $0.5 million,
an increase of $0.1 million, or 25.0%, from
$0.4 million for the nine months ended March 31, 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 nine months ended March 31, 2007 was
$0.2 million, compared to no provision for the nine months
ended March 31, 2006. Our tax expense for the nine months
ended March 31, 2007 is primarily related to alternative
minimum tax liabilities. Effectively no tax expense was recorded
in the nine months ending March 31, 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 nine months
ended March 31, 2007 was $8.2 million, representing an
increase of $1.0 million, or 13.9%, as compared to net
income of $7.2 million for the nine months ended
March 31, 2006. Net income as a percentage of revenues was
relatively stable at to 7.8% for the nine months ended
March 31, 2007, as compared to 8.0% for the nine months
ended March 31, 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 driven
by the addition of the 9th grade which attracted new students in
addition to students enrolled in 8th grade in the prior year.
Also, average price increases of approximately 4% were
implemented in 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 92.3% for the year ended June 30, 2006 from 94.3% 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.
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
increased costs to supply books, educational materials and
computers to students and school operating expenses as a result
of the increase in enrollments. 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 increases in employee
headcount in sales and marketing staff as well as increased
spending on advertising and other marketing tactics. In
addition, contract labor increased in information technology and
employee headcount increased in finance and human resources as
the company increased its capabilities in these areas. As a
percentage of revenues, selling, administrative, and other
operating expenses remained relatively stable at 35.6% for the
year ended June 30, 2006 compared to 35.2% for the year
ended June 30, 2005.
41
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 8.9%, 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 7.3% 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.
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.
Comparison
of Years Ended June 30, 2005 and 2004
Revenues.
Our revenues for the year ended
June 30, 2005 were $85.3 million, representing an
increase of $13.9 million, or 19.4%, as compared to
revenues of $71.4 million for the year ended June 30,
2004. Average enrollments increased 35.3% to 15,097 for the year
ended June 30, 2006 from 11,158 average enrollments for the
year ended June 30, 2004. Partially offsetting growth in
revenues as compared to growth in enrollments was growth in
enrollments at schools where we earn limited or no services
revenues. In 2004, all of our enrollments were associated with
schools where we provided complete turnkey services. In 2005, we
began to offer schools the opportunity to use our curriculum
without purchasing any services. In fiscal year 2005, 5.7% of
enrollments were associated with schools to which we provided
limited or no management services. Fiscal year 2005 was the
first year in which we offered limited services. Our enrollment
growth benefited from the addition of the 8th grade in
September 2004 which attracted new students in addition to
students enrolled in 7th grade in the prior year. Average
price increases of 7% were implemented in July 2004. In
addition, increased operating deficits partially offset the
growth in revenues. These increased deficits were primarily
attributable to a higher percentage of enrollments associated
with schools in the early stages of development.
Instructional Costs and Services
Expenses.
Instructional costs and services
expenses for the year ended June 30, 2005 were
$49.1 million, representing an increase of
$9.2 million, or 23.0%, as compared to instructional costs
and services expenses of $39.9 million for the year ended
June 30, 2004. This increase was primarily attributable to
increased expenses incurred to operate the schools. Also
contributing to the increase were increased costs to supply
computers to students as a result of the increase in
enrollments. As a percentage of revenues, instructional costs
and services expenses increased to 57.6% for the year ended
June 30, 2005, as compared to 55.9% for the year ended
June 30, 2004. The increase in instruction costs and
services expenses as a percentage of revenues is primarily due
to increased costs to provide computers to students partially
offset by a reduction in fulfillment costs for materials to
students.
Selling, Administrative, and Other Operating
Expenses.
Selling, administrative, and other
operating expenses for the year ended June 30, 2005 were
$30.0 million, representing an increase of
$4.3 million, or 17.1%, as compared to selling,
administrative and other operating expenses of
$25.7 million for the year ended June 30, 2004. This
increase is primarily attributable to increases in employee
headcount in operations and marketing as well as increased
spending on advertising and other marketing tactics. These
increases are partially offset by a decrease in information
technology operating expenses. As a percentage of revenues,
selling, administrative, and other operating expenses remained
relatively stable at 35.2% for the year ended June 30, 2005
compared to 35.9% for the year ended June 30, 2004.
42
Product Development Expenses.
Product
development expenses for the year ended June 30, 2005 were
$9.4 million, representing a decrease of $3.4 million,
or 26.6%, as compared to product development expenses of
$12.8 million for the year ended June 30, 2004. The
decrease is primarily attributable to a year over year decrease
of $1.7 million in impairment charges, a decrease in
employee headcount and an increase in the utilization of labor
for capitalized curriculum. As a percentage of revenues, product
development expenses decreased to 11.0% for the year ended
June 30, 2005 compared to 17.8% for the year ended
June 30, 2004. This decrease is primarily attributable to
the factors described above and our ability to leverage these
costs over an increasing number of enrollments.
Net Interest Expense.
Net interest expense for
the year ended June 30, 2005 was $0.3 million, a
decrease of $0.2 million, or 40.0%, from $0.5 million
for the year ended June 30, 2004. The decrease is primarily
attributable to lower interest charges from lower outstanding
balances of capital lease obligations.
Income Taxes.
We also recorded no income tax
expense for the years ended June 30, 2005 and 2004 as the
company had a net loss.
Net Loss.
Net loss for the year ended
June 30, 2005 was $3.5 million as compared to a net
loss of $7.4 million for the year ended June 30, 2004.
Net loss as a percentage of revenues was 4.1% for the year ended
June 30, 2005, as compared to 10.4% for the year ended
June 30, 2004, as a result of the factors discussed above.
Quarterly
Results of Operations
The following tables set forth selected unaudited quarterly
consolidated statement of operations data for the seven 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
|
|
|
Revenues
|
|
$
|
31,176
|
|
|
$
|
28,245
|
|
|
$
|
30,667
|
|
|
$
|
26,814
|
|
|
$
|
37,743
|
|
|
$
|
32,356
|
|
|
$
|
34,831
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
17,416
|
|
|
|
15,696
|
|
|
|
15,361
|
|
|
|
16,355
|
|
|
|
19,177
|
|
|
|
18,022
|
|
|
|
17,904
|
|
Selling, administrative, and other
|
|
|
8,742
|
|
|
|
8,402
|
|
|
|
11,259
|
|
|
|
13,257
|
|
|
|
11,385
|
|
|
|
11,030
|
|
|
|
12,644
|
|
Product development expenses
|
|
|
1,864
|
|
|
|
1,862
|
|
|
|
1,861
|
|
|
|
2,981
|
|
|
|
2,206
|
|
|
|
1,566
|
|
|
|
2,083
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and
expenses
|
|
|
28,022
|
|
|
|
25,960
|
|
|
|
28,481
|
|
|
|
32,593
|
|
|
|
32,768
|
|
|
|
30,618
|
|
|
|
32,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
operations
|
|
|
3,154
|
|
|
|
2,285
|
|
|
|
2,186
|
|
|
|
(5,779
|
)
|
|
|
4,975
|
|
|
|
1,738
|
|
|
|
2,200
|
|
Interest expense, net
|
|
|
(135
|
)
|
|
|
(127
|
)
|
|
|
(132
|
)
|
|
|
(94
|
)
|
|
|
(94
|
)
|
|
|
(263
|
)
|
|
|
(117
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
3,019
|
|
|
|
2,158
|
|
|
|
2,054
|
|
|
|
(5,873
|
)
|
|
|
4,881
|
|
|
|
1,475
|
|
|
|
2,083
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(146
|
)
|
|
|
(30
|
)
|
|
|
(51
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
3,019
|
|
|
$
|
2,158
|
|
|
$
|
2,054
|
|
|
$
|
(5,873
|
)
|
|
$
|
4,735
|
|
|
$
|
1,445
|
|
|
$
|
2,032
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
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
|
|
|
Revenues
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
56
|
|
|
|
56
|
|
|
|
50
|
|
|
|
61
|
|
|
|
51
|
|
|
|
56
|
|
|
|
52
|
|
Selling, administrative, and other
|
|
|
28
|
|
|
|
30
|
|
|
|
37
|
|
|
|
50
|
|
|
|
30
|
|
|
|
34
|
|
|
|
36
|
|
Product development expenses
|
|
|
6
|
|
|
|
6
|
|
|
|
6
|
|
|
|
11
|
|
|
|
6
|
|
|
|
5
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and
expenses
|
|
|
90
|
|
|
|
92
|
|
|
|
93
|
|
|
|
122
|
|
|
|
87
|
|
|
|
95
|
|
|
|
94
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
operations
|
|
|
10
|
|
|
|
8
|
|
|
|
7
|
|
|
|
(22
|
)
|
|
|
13
|
|
|
|
5
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
10
|
|
|
|
8
|
|
|
|
7
|
|
|
|
(22
|
)
|
|
|
13
|
|
|
|
4
|
|
|
|
6
|
|
Income tax expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
10
|
%
|
|
|
8
|
%
|
|
|
7
|
%
|
|
|
(22
|
)%
|
|
|
13
|
%
|
|
|
4
|
%
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
There are several factors that create seasonal variations in our
balance sheet. In the first fiscal quarter, we ship materials to
students from inventory, generally reducing inventory over this
period. In addition, we invoice for products and services in the
first fiscal quarter, coinciding with the start of the school
year. This creates a significant increase in our accounts
receivable and deferred revenue balances for the quarter. The
virtual schools generally receive their funding over the course
of the school year and we receive payments from them
accordingly. Finally, we increase our inventory for the fall
enrollments beginning in the fourth fiscal quarter.
Liquidity
and Capital Resources
As of March 31, 2007 and June 30, 2006, we had cash
and cash equivalents of $5.1 million and $9.5 million,
respectively. Net cash provided by operating activities during
the nine months ended March 31, 2007, was
44
$7.3 million, primarily due to net income of
$8.2 million, depreciation and amortization of
$4.6 million, an increase in deferred revenues of
$5.9 million and a decrease in inventory of
$4.4 million. This was primarily offset by an increase in
accounts receivable of $12.4 million, a change in accounts
receivable allowance of $1.0 million, and a decrease in
accounts payable and accrued liabilities of $1.7 million.
We financed our operating activities and capital expenditures
during the nine months ended March 31, 2007 through cash
provided by operating activities, capital lease financing and
short-term debt. During the years ended June 30, 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 2001 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.
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 March 31, 2007, we were in
compliance with these covenants.
As of March 31, 2007, $1.5 million of borrowings were
outstanding on the working capital line of credit and
approximately $2.3 million outstanding for letters of
credit. In July 2007, we borrowed an additional
$3.0 million.
One of our subsidiaries has an equipment lease line of credit
for new purchases with Hewlett-Packard Financial Services
Company that expires on July 31, 2007 for new purchases on
the line of credit. We expect to renew this facility. The
interest rate on new borrowings under the equipment lease line
is set quarterly. For the nine months ended March 31, 2007,
we borrowed $6.6 million to finance the purchase of student
computers and related equipment at interest rates ranging from
8.5% to 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.
45
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 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 $17 million to
$25 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. 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, will provide sufficient resources
to meet our projected operating requirements,
start-up
costs to open new schools, and planned capital expenditures for
at least the next 12 months.
Operating
Activities
Net cash provided by operating activities during the nine months
ended March 31, 2007, was $7.3 million. Net cash
provided by operating activities in fiscal year 2006 and 2005
was $3.6 million and $9.7 million, respectively, as
compared to net cash used in operating activities in fiscal year
2004 of $8.0 million.
The cash provided by operations in the nine months ended
March 31, 2007 was primarily due to net income of
$8.2 million, depreciation and amortization of
$4.6 million, an increase in deferred revenues of
$5.9 million and a decrease in inventory of
$4.4 million. This was primarily offset by an increase in
accounts receivable of $12.4 million, a change in accounts
receivable allowance of $1.0 million, and a decrease in
accounts payable and accrued liabilities of $1.7 million.
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.
The cash used in operations in fiscal year 2004 was primarily
due to a net loss of $7.4 million, an increase in accounts
receivable of $10.6 million, and an increase in inventory
and other assets of $2.2 million. This was primarily offset
by depreciation and amortization of $4.9 million,
impairment charges of $5.0 million, an increase in accrued
compensation and benefits of $1.3 million, and an increase
in accrued liabilities of $0.7 million.
Investing
Activities
Net cash used in investing activities for the nine months ended
March 31, 2007 was $10.8 million. Net cash used in
investing activities for the fiscal year 2006, 2005 and 2004 was
$11.5 million, $8.5 million and $5.4 million,
respectively.
Net cash used in investing activities for the nine months ended
March 31, 2007 was due to capitalized curriculum of
$7.0 million and purchases of property and equipment of
$3.8 million. This does not include $6.6 million of
student computers financed with capital leases. Purchases of
property and equipment for the fiscal year ended 2006, 2005 and
2004 were $10.8 million, $4.7 million, and
$0.5 million, respectively. In fiscal year 2005 and 2004,
we also financed with capital leases, purchases of student
computers in the amount of $0.4 million and
$4.1 million, respectively. Capitalized curriculum the
fiscal year ended 2006, 2005 and 2004 were $0.7 million,
$3.8 million, and $4.9 million, respectively.
Financing
Activities
Net cash used in financing activities for the nine months ended
March 31, 2007 was $0.9 million. This was primarily
due to a payment on a related party note payable of
$4.0 million and repayments for capital lease obligations
of $0.7 million. This was partially offset by the release
of cash from a restricted escrow account of
46
$2.3 million and net borrowings from our revolving credit
facility of $1.5 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. Net cash provided by financing
activities for fiscal year 2004 was $21.6 million primarily
due to proceeds from the sale of redeemable convertible
preferred stock of $25.0 million. This was partially offset
by repayments of capital lease obligations of $2.4 million
and cash invested in a restricted escrow account of
$1.0 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 March 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ending March 31,
|
|
|
|
Total
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
Thereafter
|
|
|
|
(dollars in thousands)
|
|
|
Contractual Obligations at
March 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
leases
(1)
|
|
$
|
6,583
|
|
|
$
|
2,476
|
|
|
$
|
2,475
|
|
|
$
|
1,632
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Operating leases
|
|
|
18,221
|
|
|
|
2,174
|
|
|
|
2,106
|
|
|
|
2,147
|
|
|
|
1,451
|
|
|
|
1,372
|
|
|
|
8,971
|
|
Line of
credit
(2)
|
|
|
1,500
|
|
|
|
1,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term obligations
|
|
|
245
|
|
|
|
153
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
commitments
(3)
|
|
|
120
|
|
|
|
120
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
26,669
|
|
|
$
|
6,423
|
|
|
$
|
4,673
|
|
|
$
|
3,779
|
|
|
$
|
1,451
|
|
|
$
|
1,372
|
|
|
$
|
8,971
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes interest expense.
|
(2)
|
|
Pertains to revolving line of
credit and excludes interest expense due to short-term repayment
period.
|
(3)
|
|
For employment agreement.
|
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. We have assessed the likelihood of a claim as
remote, and therefore it has not been included as a commitment
or obligation in the table above.
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, 2006 or the nine months ending
March 31, 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
$5.1 million and $9.5 million as of March 31,
2007 and June 30, 2006, respectively. Unrestricted cash and
cash equivalents are maintained primarily in non-interest
bearing
47
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
March 31, 2007 of $1.5 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
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
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 are
currently evaluating the effect that the adoption of FIN 48
will have 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.
48
BUSINESS
Our
Company
We are a technology-based education company. We offer
proprietary curriculum, software 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 $95 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 a virtual
school 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%. From fiscal year 2004 to
fiscal year 2006, we increased revenues from $71.4 million
to $116.9 million, representing a compound annual growth
rate of approximately 28%.
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 or 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.
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.
49
Our proprietary curriculum is currently used by public school
students in 16 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.
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. During the
2003-04
and
2004-05
school years, we added 7th and 8th grades,
respectively, and added contracts with 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 we plan to offer 11th and
12th grades at the start of 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.
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 47 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 97,000 schools and 17,000 districts during
the 2005-06 school year.
|
50
|
|
|
|
|
According to the NCES, total spending in the public K-12 market
was $536 billion for the 2004-05 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 education as an
effective, alternative form of education is growing. As of
September 2006, 38 states had authorized some form of
online education, 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 another approach to online
education 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. 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 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
51
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 or 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. A comprehensive analysis of
individual student progression conducted during the
2006-07
school year in Ohio, the first state to conduct such an
analysis, concluded that a virtual public school using our
learning system outperformed 97% and 60% of participating public
schools in reading and mathematics, respectively. Additionally,
in California, the only state to adjust standardized test scores
for student demographics, the virtual public schools we serve
performed in the 70th to 90th percentile of all public
schools in the state during the
2005-06
school year. Among statewide virtual public schools, those using
the
K
12
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
$95 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, we will serve virtual public schools in
16 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 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
K
12
to their friends and family members.
Enhance Curriculum to Include a Complete High School
Offering.
We believe the high school market
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 conducted
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 market-leading position in the K-8 virtual
public schools positions us well for growth in the high school
market. In the 2005-06 and 2006-07 school years, we began
enrolling 9th and 10th grade students, respectively, and with
the planned launch of our 11th and 12th grades in the
2007-08
school year, we will be able to provide a complete high school
offering. We are developing our high school curriculum to
satisfy the
52
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
K
12
Brand.
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
K
12
brand is not as well recognized. We have developed a
comprehensive brand strategy and intend to invest in further
developing awareness of both the
K
12
brand and the core philosophy behind our learning system. The
recent launch of our Unleash the
x
Potential
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
K
12
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 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.
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.
|
53
|
|
|
|
|
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.
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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.
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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.
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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.
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Products
and Services
Our
Products
K
12
Curriculum
Our curriculum consists of the
K
12
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.
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.
54
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.
Courses
Offered
The following table provides a list of our proprietary courses
and selected third-party courses that we expect to offer during
2007-08 school year. We also expect to offer an additional 33
third-party courses at the high school level.
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English and Language
Arts
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Mathematics
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Science
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Elementary School
Middle School
High School
Elementary School
Middle School
High School
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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
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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
Algebra Foundations
Algebra I
Algebra II
Geometry
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
Art History
Fine Art and Art Appreciation
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Kindergarten Science
1st Grade Science
2nd Grade Science
3rd Grade Science
4th Grade Science
5th Grade Science
Kindergarten Science (classroom)
1st Grade Science (classroom)
2nd Grade Science (classroom)
3rd Grade Science (classroom)
Earth Science
Life Science
Physical Science
Earth Science Foundations
Physical Science Foundations
Biology Foundations
Earth Science
Physical Science
Biology
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
Learning Online
Spanish I, II, III, AP
French I, II, III, AP
German I, II
Latin I, II
Chinese I
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Courses that appear in italics are
licensed from third-parties.
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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 six proprietary high school courses and
are currently developing 10 additional high school courses for
the 2007-08 school year. We expect the high school students we
serve using our proprietary courses to 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.
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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.
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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.
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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.
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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 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
K
12
Community Chest website for virtual public school students
includes discussion boards, blogs, games, competitions and other
functions. Additionally, our
K
12
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.
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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
K
12
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
16 states and the District of Columbia, 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:
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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.
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Curriculum and Teaching
Specialists
bring deep subject matter
knowledge and experience with a variety of pedagogical
approaches to our course design process.
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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.
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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.
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Graphic Artists/Media Specialists/Flash
Designers
ensure overall visual integrity
of each lesson and build creative and interactive content.
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Print Designers
design and publish our
proprietary textbooks and printed learning materials.
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User Experience Specialists
work closely
with our design teams to ensure that lessons are easy for
students to navigate and understand.
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Training Specialists
concurrent with the
development of the courses, develop training materials and
programs to support the effective delivery of our curriculum by
teachers.
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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.
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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.
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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:
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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;
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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
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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.
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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.
Channel
Development
K
12
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.
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In fiscal year 2005, we had contracts with five schools that
constituted approximately 32%, 17%, 11%, 10% and 6% of our
revenues. In fiscal year 2006, these same schools constituted
approximately 28%, 16%, 10%, 8%, and 7% of our revenues,
respectively. During the nine months ended March 31, 2007,
these same schools constituted approximately 12%, 17%, 11%, 7%
and 10% of our revenues, respectively.
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.
Student
Recruitment and Marketing
Our student recruitment and marketing team consisted of
38 employees as of March 31, 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.
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
K
12
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
K
12
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
K
12
HUG program.
Technology
As of March 31, 2007, we employed 46 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
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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.
We believe that the primary factors on which we compete are:
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track record of academic results and customer satisfaction;
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quality of curriculum and online delivery platform;
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qualifications and experience of teachers;
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comprehensiveness of school management and student support
services; and
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cost of the solution.
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Intellectual
Property
Since our inception, we have invested more than $95 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.
62
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,
K
12
.
In addition, we have applied to the USPTO to register the
trademark Unleash the
x
Potential.
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.
Operations
An essential component of the
K
12
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 March 31, 2007, we had approximately
17,800 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.
63
Employees
As of March 31, 2007, we had 558 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
K
12
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 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.
While we 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, we do not
believe at this time that a loss in either case would have a
material adverse financial impact on our business. 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 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).
On July 3, 2007, the Court of Appeals certified the case
to the Wisconsin Supreme Court for its review because the
questions involved in the case are of first impression and will
have a significant statewide impact on education finance and
policy. 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. We continue to participate in the defense of CVCS
under an indemnity obligation in our service agreement with that
school.
64
REGULATION
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. Virtual
public schools are typically funded by state or local
governments on a per student basis. 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.
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. 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.
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.
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.
65
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); caps
on the total number of students in a virtual school; geographic
limitations on enrollments; 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.
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.
66
Four primary federal laws are directly applicable to the
day-to-day provision of educational services we provide to
virtual public schools:
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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.
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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 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.
67
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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.
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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 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.
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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.
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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.
68
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 July 12, 2007:
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Name
|
|
Age
|
|
Position
|
|
Executive
Officers
|
|
|
|
|
|
|
Ronald J. Packard
|
|
|
43
|
|
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Chief Executive Officer, Founder
and Director
|
John F. Baule
|
|
|
43
|
|
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Chief Operating Officer and Chief
Financial Officer
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Bruce J. Davis
|
|
|
42
|
|
|
Executive Vice President, School
Services
|
Bror V. H. Saxberg
|
|
|
47
|
|
|
Chief Learning Officer
|
Key Employees
|
|
|
|
|
|
|
Bryan W. Flood
|
|
|
41
|
|
|
Senior Vice President, Public
Affairs
|
Nancy Hauge
|
|
|
53
|
|
|
Senior Vice President, Human
Resources
|
Howard D. Polsky
|
|
|
55
|
|
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Senior Vice President, General
Counsel and Secretary
|
Peter G. Stewart
|
|
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38
|
|
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Senior Vice President, School
Development
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Celia M. Stokes
|
|
|
43
|
|
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Chief Marketing Officer
|
Maria A. Szalay
|
|
|
41
|
|
|
Senior Vice President, Product
Development
|
Ray Williams
|
|
|
45
|
|
|
Senior Vice President, Systems and
Technology
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Nonemployee
Directors
|
|
|
|
|
|
|
Andrew H. Tisch
|
|
|
57
|
|
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Chairman
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Liza A. Boyd
|
|
|
32
|
|
|
Director
|
Guillermo Bron
|
|
|
55
|
|
|
Director
|
Steven B. Fink
|
|
|
55
|
|
|
Director
|
Thomas J. Wilford
|
|
|
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Director
|
Executive
Officers
Ronald
J. Packard, Chief Executive Officer, Founder and
Director
Ronald J. Packard started
K
12
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.
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
69
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, School
Services
Bruce J. Davis joined us January 2007, and serves as Executive
Vice President, School Services. 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.
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.
Key
Employees
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.
Nancy
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.
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
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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
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.
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.
Celia
M. Stokes, Chief Marketing Officer
Celia M. Stokes joined us in March 2006, and serves as Chief
Marketing Officer. Before joining
K
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,
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.
Maria
A. Szalay, 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.
Ray
Williams, Senior Vice President, Systems and
Technology
Ray 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 in 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.
71
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.
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 five 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.
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Upon completion of this offering, we expect that our amended and
restated certificate of incorporation will provide for a
classified board of directors consisting of three classes of
directors, each serving staggered three-year terms. As a result,
a portion of our board of directors will be elected each year.
To implement the classified structure, prior to the consummation
of this offering, each of the nominees to the board will be
either appointed to one, two or three-year terms. We expect that
the additional independent directors that we will add in the
year following completion of this offering will replace existing
members of our audit, compensation, and nominating and corporate
governance committees to the extent necessary to comply with the
applicable rules of the New York Stock Exchange and applicable
law. Additionally, our stockholders will have the ability to
remove directors with or without cause by the affirmative vote
of a majority of the common stock.
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 and a
compensation committee. Additionally, upon completion of this
offering, we will establish a nominating and governance
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 the New
York Stock Exchange 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, each of whom is a nonemployee member of
our board of directors. Steven B. Fink is the chairman of
the audit committee.
Nominating and Governance Committee.
Upon
completion of this offering, we will establish a nominating and
governance committee, which will be responsible for assisting
the board of directors in selecting new directors, evaluating
the overall effectiveness of the board of directors, and
reviewing developments in corporate governance compliance.
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 currently
comprises Andrew H. Tisch and Liza A. Boyd, each of
whom is a nonemployee member of our board of directors.
Andrew H. Tisch is the chairman of the compensation
committee.
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
73
personally liable to us or our stockholders for monetary damages
or breach of fiduciary duty as a director, except for liability
for:
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any breach of the directors duty of loyalty to us or our
stockholders;
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any act or omission not in good faith or that involves
intentional misconduct or a knowing violation of law;
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any act related to unlawful stock repurchases, redemptions or
other distributions or payment of dividends; or
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any transaction from which the director derived an improper
personal benefit.
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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:
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we may indemnify our directors, officers and employees to the
fullest extent permitted by the Delaware General Corporation
Law, subject to limited exceptions;
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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
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the rights provided in our amended and restated bylaws are not
exclusive.
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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.
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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:
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Attract and retain individuals of superior ability and
managerial talent;
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Ensure senior executive compensation is aligned with our
corporate strategies, business objectives and the long-term
interests of our stockholders;
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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
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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.
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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.
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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 based on 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 based on performance and
inflation and to realign salaries with market levels. Salaries
were adjusted in the first quarter of fiscal year 2007 after
review of fiscal year 2006 performance by the Compensation
Committee. For our fiscal year ending in 2008, the base salaries
of our named executive officers generally fall around the median
of the Peer Group.
Annual
Performance Bonus
We maintain an annual cash performance bonus program, the
Executive Bonus Plan, 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 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. For our fiscal year
ending in 2007, the amounts payable under our annual cash
performance bonus program were primarily determined based upon
actual performance measured against our achievement of revenues
and earnings targets.
For our fiscal year ending in 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 and Mr. Saxbergs target
bonus was 30% of base salary. The Compensation Committee
believes that the performance bonus program provides incentives
necessary to retain executives and reward them for our
short-term performance. The performance goals for the fiscal
year ending in 2007 were difficult to achieve and the results of
performance are set forth in the section entitled Summary
Compensation Table below.
Stock
Options
The Companys named executive officers, along with a large
portion of our employees, are eligible to participate in our
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. 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
performance (based on achievement of revenues and earnings
targets), the value of the stock option at
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the time of grant and the recipients contributions to the
Company. As a result, 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 plan is equal to or
greater than 100% of the fair market value of the underlying
stock on the date of grant. During the fiscal year ending in
2007, Messrs. Packard and Davis received stock option
grants pursuant to stand-alone agreements. Mr. Davis
option grant is subject to a time-based vesting schedule.
However, to align Mr. Packards equity compensation
with our success, certain of Mr. Packards stock
options vest based upon the Companys achievement of
performance metrics or upon the fair market value of our common
stock reaching a certain price. In addition, certain options for
common stock granted to Mr. Packard and Mr. Davis have
exercise prices in excess of the fair market value of the
underlying stock on the date of grant. For the fiscal year
ending in 2007, we granted 4,850,000 stock options to
Mr. Packard, and 500,000 stock options to Mr. Davis as
part of their respective employment arrangements.
Messrs. Baule and Saxberg did not receive option grants
during our fiscal year ending in 2007.
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.
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. On July 12, 2007, our board of directors
approved an amended and restated employment agreement for
Mr. Packard, which is discussed below. 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.
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.
77
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 and further our
goal of attracting and retaining key executives with superior
ability and managerial talent. 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
|
|
Awards
(1)
|
|
Compensation
(2)
|
|
Compensation
(3)
|
|
Total
|
|
Ronald J. Packard
|
|
|
2007
|
|
|
$
|
410,000
|
|
|
$
|
|
|
|
$
|
116,436
|
|
|
$
|
205,000
|
|
|
$
|
2,050
|
|
|
$
|
733,486
|
|
Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Baule
|
|
|
2007
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
150,000
|
|
|
|
1,646
|
|
|
|
451,646
|
|
Chief Operating Officer and Chief
Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bruce J. Davis
|
|
|
2007
|
|
|
|
144,423
|
|
|
|
120,000
|
(5)
|
|
|
4,791
|
|
|
|
|
|
|
|
|
|
|
|
269,214
|
|
Executive Vice President of School
Services
(4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bror Saxberg
|
|
|
2007
|
|
|
|
310,000
|
|
|
|
|
|
|
|
|
|
|
|
85,000
|
|
|
|
2,713
|
|
|
|
397,713
|
|
Chief Learning Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 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 7 of our
condensed 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.
|
(2)
|
|
This column represents cash awards
to the named executive officers for performance with respect to
fiscal year ended June 30, 2007, under our Executive Bonus
Program. These awards are expected to be paid in September 2007.
See Grants of Plan-Based Awards Table for additional
information regarding these cash awards earned during fiscal
year ended June 30, 2007.
|
(3)
|
|
The amounts in this column consist
of 401(k) matching contributions paid by us.
|
(4)
|
|
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.
|
(5)
|
|
Pursuant to the terms of his
employment agreement, Mr. Davis is entitled to a guaranteed
bonus of $120,000 for fiscal year 2007 paid on July 8, 2007.
|
78
Grants of
Plan-Based Awards During 2007
The following table provides information regarding grants of
plan-based awards to our named executive officers during the
fiscal year ended June 30, 2007. The awards described in
the following table were granted under our Executive Bonus Plan
and stand-alone stock option agreements. The performance metrics
considered when the awards were granted, if any, are described
in previous subsections of the Compensation Discussion and
Analysis above. No awards were granted to any named executive
officer under our Amended and Restated Stock Option Plan during
the fiscal year ended June 30, 2007.
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Possible
|
|
|
|
|
|
|
|
All
|
|
|
|
|
|
|
|
|
|
|
Payouts
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
Grant
|
|
|
|
|
Under
|
|
|
|
|
|
|
|
Option
|
|
|
|
|
|
Date
|
|
|
|
|
Nonequity
|
|
|
|
|
|
|
|
Awards:
|
|
|
|
Closing
|
|
Fair
|
|
|
|
|
Incentive
|
|
Estimated Future Payouts
|
|
Number of
|
|
Exercise or
|
|
Market
|
|
Value
|
|
|
|
|
Plan
|
|
Under Equity
|
|
Securities
|
|
Base
|
|
Price
|
|
of
|
|
|
|
|
Awards
(1)
|
|
Incentive Plan
Awards
(2)
|
|
Underlying
|
|
Price
|
|
on Date
|
|
Option
|
|
|
Grant
|
|
Target
|
|
Threshold
|
|
Target
|
|
Maximum
|
|
Options
(3)
|
|
of Option
|
|
of
|
|
Awards
|
Name and Principal Position
|
|
Date
|
|
($)
|
|
(#)
|
|
(#)
|
|
(#)
|
|
(#)
|
|
Awards
|
|
Grant
|
|
($/Sh)
|
|
Ronald J. Packard
|
|
|
|
|
|
$
|
410,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chief Executive
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
350,000
|
|
|
|
|
|
|
|
|
|
$
|
1.50
|
|
|
$
|
0.58
|
|
|
$
|
17,255
|
|
Officer
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
600,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
53,589
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
150,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
7,213
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
200,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
12,033
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
200,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
14,775
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
50,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
3,694
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
150,000
|
|
|
|
1,200,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
105,061
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
75,000
|
|
|
|
600,000
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
0.58
|
|
|
|
52,531
|
|
|
|
|
7/27/2006
|
|
|
|
|
|
|
|
|
|
|
|
1,500,000
|
|
|
|
|
|
|
|
|
|
|
6.00
|
|
|
|
0.58
|
|
|
|
26,002
|
|
John F. Baule
|
|
|
|
|
|
|
150,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chief Operating Officer and Chief
Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bruce J. Davis
|
|
|
2/1/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
500,000
|
|
|
|
1.80
|
|
|
|
0.58
|
|
|
|
45,992
|
|
Executive Vice President of School
Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bror Saxberg
|
|
|
|
|
|
|
93,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chief Learning Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
This column shows the target payout
for 2007 performance under our Executive Bonus Program as
described in the section titled Annual Performance
Bonus in the Compensation Discussion and Analysis. There
were no threshold or maximum amounts for these performance
bonuses. The bonuses were earned for fiscal year ended
June 30, 2007, and expected to be paid in September 2007.
For each named executive officer other than Mr. Davis, the
performance bonuses were based on such named executive
officers target bonus amount set forth in the named
executive officers employment agreement, and achievement
of performance metrics as described above in the Compensation
Discussion and Analysis. These bonus amounts are set forth in
the column titled Nonequity Incentive Plan
Compensation in the Summary Compensation Table.
Mr. Davis employment with us commenced on
January 8, 2007, and pursuant to the terms of his
employment agreement, Mr. Davis will receive a guaranteed
bonus of $120,000 for the period January 8, 2007 through
the end of the fiscal year ended June 30, 2007.
Mr. Davis will be entitled to a performance-based annual
bonus similar to the other named executive officers commencing
in our fiscal year ending June 30, 2008.
|
(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, 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.
|
(3)
|
|
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.
|
79
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
|
|
|
350,000
|
|
|
|
|
|
|
|
|
|
|
$
|
1.50
|
|
|
|
7/27/2014
|
|
Chief Executive
Officer
(1)
|
|
|
600,000
|
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
150,000
|
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
200,000
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
200,000
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
50,000
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
1,200,000
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
300,000
|
|
|
|
|
|
|
|
300,000
|
|
|
|
1.50
|
|
|
|
7/27/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500,000
|
|
|
|
6.00
|
|
|
|
7/27/2014
|
|
|
|
|
675,000
|
|
|
|
|
|
|
|
|
|
|
|
1.34
|
|
|
|
7/1/2011
|
|
|
|
|
900,000
|
|
|
|
|
|
|
|
|
|
|
|
1.34
|
|
|
|
7/23/2010
|
|
John F. Baule
|
|
|
100,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
1.50
|
|
|
|
6/1/2014
|
|
Chief Operating Officer
|
|
|
450,000
|
|
|
|
350,000
|
|
|
|
|
|
|
|
1.34
|
|
|
|
3/24/2013
|
|
and Chief Financial
Officer
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bruce J. Davis
|
|
|
|
|
|
|
500,000
|
|
|
|
|
|
|
|
1.80
|
|
|
|
2/1/2015
|
|
Executive Vice President of School
Services
(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bror Saxberg
|
|
|
75,000
|
|
|
|
225,000
|
|
|
|
|
|
|
|
1.34
|
|
|
|
4/26/2014
|
|
Chief Learning
Officer
(4)
|
|
|
50,625
|
|
|
|
39,375
|
|
|
|
|
|
|
|
1.34
|
|
|
|
3/1/2013
|
|
|
|
|
(1)
|
|
Mr. Packards outstanding
unvested options are subject to performance-based vesting.
200,000 options with exercise prices of $1.50 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. 50,000 options
with exercise prices of $1.50 per share will vest in fiscal year
ending June 30, 2009 contingent upon Mr. Packard
attaining leadership goals during the preceeding fiscal year.
150,000 options with exercise prices of $1.50 per share will
vest contingent upon jurisdictional expansion and related EBITDA
goals. 300,000 options with vesting schedules contingent upon
jurisdictional expansion and enrollment targets and with
exercise prices of $1.50 per share have fully vested as of
June 30, 2007. 1,500,000 options with exercise prices of
$6.00 per share will vest upon the fair market value of a share
of our common stock equaling $6.00.
|
(2)
|
|
Mr. Baules outstanding
unvested options are subject to time-based vesting. 25,000
options with exercise prices of $1.50 per share will vest every
three months beginning on September 1, 2007 through
June 1, 2010. 50,000 options with exercise prices of $1.34
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. 125,000
options will vest on February 1, 2008 and 31,250 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. 18,750
options will vest every three months beginning on July 27,
2007 through April 27, 2010, and 5,625 will vest every
three months beginning on September 24, 2007 through
March 24, 2009.
|
80
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 School
Services
|
|
|
|
|
|
|
|
|
Bror Saxberg
|
|
|
300,000
|
|
|
|
0
|
(2)
|
Chief Learning Officer
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
None of the named executive
officers other than Mr. Saxberg exercised any stock options
during fiscal year ended June 30, 2007.
|
(2)
|
|
The exercise price of each of the
stock options exercised by Mr. Saxberg was higher than the
fair market value of a share of
K
12
s
common stock subject to each stock option on the date of
exercise.
|
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
control of the Company, and (v) severance upon a
termination of Mr. Packards employment without cause
by us 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.
81
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.
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.
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
82
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.
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Without
|
|
|
Good
|
|
|
Change in
|
|
Name
|
|
Payment
|
|
Death
|
|
|
Cause
|
|
|
Reason
|
|
|
Control
|
|
|
Ronald J. Packard
|
|
Salary continuation
|
|
$
|
202,192
|
|
|
$
|
505,479
|
|
|
$
|
505,479
|
|
|
$
|
|
|
|
|
Benefit continuation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option vesting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
756,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Baule
|
|
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 Saxberg
|
|
Salary continuation
|
|
|
|
|
|
|
152,877
|
|
|
|
152,877
|
|
|
|
|
|
|
|
Benefit continuation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option vesting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90,900
|
|
Director
Compensation
For fiscal year ended June 30, 2007, and prior fiscal
years, we compensated our nonemployee directors solely through
grants of stock options. 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
|
|
$
|
708
(2)
|
|
|
$
|
708
|
|
Arthur H. Bilger
|
|
|
354
(3)
|
|
|
|
354
|
|
Chester E. Finn Jr.
|
|
|
354
(4)
|
|
|
|
354
|
|
Liza A. Boyd
|
|
|
708
(5)
|
|
|
|
708
|
|
Lowell J. Milken
|
|
|
708
(6)
|
|
|
|
708
|
|
Steven B. Fink
|
|
|
708
(7)
|
|
|
|
708
|
|
Thomas J. Wilford
|
|
|
354
(8)
|
|
|
|
354
|
|
|
|
|
(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
|
83
|
|
|
|
|
stock options, refer to note 7
of our financial condensed consolidated 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 50,000 options on
May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Tisch held options to purchase
275,000 shares of common stock:, consisting of 50,000
granted on May 17, 2007; 50,000 granted on April 27,
2006; 50,000 granted on March 24, 2005; 50,000 granted on
March 31, 2004; 50,000 granted on February 10, 2003;
and 25,000 granted on July 23, 2002.
|
(3)
|
|
During fiscal year ended
June 30, 2007, Mr. Bilger was granted 25,000 options
on May 17, 2007 with a fair value of $16,988. As of
June 30, 2007, Mr. Bilger held options to purchase
150,000 shares of common stock:, consisting of 25,000
granted on May 17, 2007; 25,000 granted on April 27,
2006; 25,000 granted on March 24, 2005; 25,000 granted on
March 31, 2004; 25,000 granted on February 10, 2003;
and 25,000 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 25,000 options on
May 17, 2007 with a fair value of $16,988. As of
June 30, 2007, Mr. Finn held options to purchase
210,000 shares of common stock:, consisting of 25,000
granted on May 17, 2007; 25,000 granted on April 27,
2006; 25,000 granted on March 24, 2005; 25,000 granted on
March 31, 2004; 25,000 granted on February 10, 2003;
25,000 granted on July 23, 2002; and 60,000 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 the Constellation Funds (as defined in
footnote (11) to the Principal and Selling Stockholders
table). During fiscal year ended June 30, 2007,
Ms. Boyd was granted 50,000 options on May 17, 2007
with a fair value of $33,975, which have been assigned to the
Constellation Funds. The options granted to the director serving
on behalf of the Constellation Funds in prior years have also
been assigned to the Constellation Funds. As of June 30,
2007, the Constellation Funds held options to purchase
237,500 shares of common stock:, consisting of 50,000
granted on May 17, 2007; 50,000 granted on April 27,
2006; 50,000 granted on March 24, 2005; 50,000 granted on
March 31, 2004; and 37,500 granted on February 10,
2003.
|
(6)
|
|
During fiscal year ended
June 30, 2007, Mr. Milken was granted 50,000 options
on May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Milken held options to purchase
275,000 shares of common stock:, consisting of 50,000
granted on May 17, 2007; 50,000 granted on April 27,
2006; 50,000 granted on March 24, 2005; 50,000 granted on
March 31, 2004; 50,000 granted on February 10, 2003;
and 25,000 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 50,000 options on
May 17, 2007 with a fair value of $33,975. As of
June 30, 2007, Mr. Fink held options to purchase
205,685 shares of common stock:, consisting of 50,000
granted on May 17, 2007; 50,000 granted on April 27,
2006; 50,000 granted on March 24, 2005; 50,000 granted on
March 31, 2004; 959 granted on December 18, 2003; and
4,726 granted on October 24, 2003.
|
(8)
|
|
During fiscal year ended
June 30, 2007, Mr. Wilford was granted
25,000 options on May 17, 2007 with a fair value of
$16,988. As of June 30, 2007, Mr. Wilford held options
to purchase 125,000 shares of common stock:, consisting of
25,000 granted on May 17, 2007; 25,000 granted on
April 27, 2006; 25,000 granted on March 24, 2005;
25,000 granted on March 31, 2004; and 25,000 granted on
February 10, 2003.
|
84
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.
Policies
and Procedures for Related-Party Transactions
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.
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. It is our intention to
ensure that all future transactions between us and our officers,
directors and principal stockholders and their affiliates, are
approved by a majority of the board of directors, including a
majority of the independent and disinterested members of the
board of directors, and are on terms no less favorable to us
than those that we could obtain 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 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.
85
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.
The agreement initially prohibited sales by Dr. Bennett of
the 1,500,000 shares he was issued in 2000, and now limits
him to sales of no more than 20% of such shares per year.
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.
86
PRINCIPAL
AND SELLING STOCKHOLDERS
The following table provides certain information regarding the
beneficial ownership of our outstanding capital stock as of
June 30, 2007, after giving effect to
a
for stock split, 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
|
|
|
|
to This
|
|
|
Shares to be
|
|
|
Owned After This
|
|
|
|
Offering
(1)
|
|
|
Sold in This
|
|
|
Offering
(1)
|
|
Name of Beneficial
Owner
|
|
Number
|
|
|
Percent
|
|
|
Offering
|
|
|
Number
|
|
|
Percent
|
|
|
Named Executive
Officers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ronald J.
Packard
(2)
|
|
|
4,681,369
|
|
|
|
4.07
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
John F.
Baule
(3)
|
|
|
550,000
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bror
Saxberg
(4)
|
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|
444,375
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
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|
Bruce J. Davis
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|
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Directors
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|
|
|
|
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|
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|
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|
|
|
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|
Andrew H.
Tisch
(5)
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|
5,532,243
|
|
|
|
4.94
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%
|
|
|
|
|
|
|
|
|
|
|
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|
Thomas J.
Wilford
(6)
|
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|
4,206,345
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|
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|
3.76
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%
|
|
|
|
|
|
|
|
|
|
|
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|
Guillermo
Bron
(7)
|
|
|
432,738
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Steven B.
Fink
(8)
|
|
|
105,269
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liza A.
Boyd
(9)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
All Directors and Executive
Officers as a Group (9 persons)
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|
15,952,339
|
|
|
|
13.75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Beneficial Owners of 5% or More
of Our Outstanding Common Stock
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|
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|
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|
|
|
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|
Learning Group
LLC
(10)
|
|
|
27,521,360
|
|
|
|
24.48
|
%
|
|
|
|
|
|
|
|
|
|
|
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|
CV II
Entities
(11)
|
|
|
17,573,842
|
|
|
|
15.70
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Mollusk Holdings,
LLC
(12)
|
|
|
13,002,086
|
|
|
|
11.51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
|
Less than 1% beneficial ownership.
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(1)
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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
June 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 June 30,
2007 is deemed to be 111,798,550, after giving effect to the
conversion of our outstanding preferred stock into
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87
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101,386,536 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 June 30, 2007 are also assumed to be
outstanding.
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(2)
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Includes options for
3,175,000 shares of common stock, warrants to purchase
6,369 shares of common stock and 1,500,000 shares of common
stock. These totals include both shares and options held
individually and in the 2006 Packard Investment Partnership, L.P.
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(3)
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|
Includes options for
550,000 shares of common stock.
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|
(4)
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|
Includes 300,000 shares of
common stock and options for 144,375 shares of common stock.
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(5)
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|
Includes options for
175,000 shares of common stock and warrants to purchase
12,739 shares of common stock. Also includes
1,248,900 shares of common stock issuable upon conversion
of preferred stock held Andrew H. Tisch 1991 Trust #2,
182,130 shares of common stock issuable upon conversion of
preferred stock held by KAL Family Partnership and
182,129 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 3,731,345
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 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.
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(6)
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Includes options for
75,000 shares of common stock. Also includes 4,131,345
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.
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(7)
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Includes 432,738 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.
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(8)
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|
Includes options for
105,269 shares of common stock.
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(9)
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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 (11)). 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.
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(10)
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Includes 23,791,931 shares of
common stock issuable upon conversion of preferred stock,
3,106,714 shares of common stock, warrants to purchase
40,625 shares of common stock and warrants to purchase 582,090
shares of preferred stock convertible into an equivalent amount
of shares of common stock upon consummation of this offering.
The address of this stockholder is 1250 4th Street,
Santa Monica, California 90401.
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(11)
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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.
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The holdings of the CV II Entities
include: (i) 9,220,061 shares of common stock issuable upon
conversion of preferred stock held by CVC II and options for
72,710 shares of common stock assigned to CVC II by
Ms. Boyd or a former director appointed by the
Constellation Funds; (ii) 4,358,964 shares of common stock
issuable upon conversion of preferred stock held by Offshore and
options for 34,375 shares of common stock assigned to Offshore
by Ms. Boyd or a former director appointed by the
Constellation Funds; (iii) 3,652,763 shares of common stock
issuable upon conversion of preferred stock held by BSC and
options for 28,806 shares of common stock assigned to BSC by Ms.
Boyd or a former director appointed by the Constellation Funds;
and (iv) 204,554 shares of common stock issuable upon conversion
of preferred stock held by CVC II Partners and options for 1,609
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.
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(12)
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Includes 7,962,395 shares of
common stock issuable upon conversion of preferred stock held,
3,875,512 shares of common stock and warrants to purchase
1,164,179 shares of preferred stock convertible into an
equivalent amount of 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.
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88
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 June 30, 2007, there were 10,412,014 shares of
common stock outstanding, held of record by
35 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 shares
of common stock, par value $0.0001 per share,
and 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 June 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.
89
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:
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provide that special meetings of the stockholders may be called
only by our Chairman of the Board, Chief Executive Officer or
the board of directors pursuant to a resolution adopted by a
majority of the total number of authorized directors of our
board of directors;
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establish procedures with respect to stockholder proposals and
stockholder nominations, including requiring advance written
notice of a stockholder proposal or director nomination;
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divide our board of directors into three classes. The directors
in each class will serve for a three-year term, one class being
elected each year by our stockholders. This system of electing
and removing directors may tend to discourage a third-party from
making a tender offer or otherwise attempting to obtain control
of us, because it generally makes it more difficult for
stockholders to replace a majority of the directors;
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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;
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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;
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require that the vote of holders of
66
2
/
3
%
of the voting power of the outstanding shares entitled to vote
generally in the election of directors is required to amend
various provisions of our amended and restated certificate of
incorporation and amended and restated bylaws; and
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provide that the board of directors has the power to alter,
amend or repeal the bylaws without stockholder approval.
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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 shares
of preferred stock, par value $0.0001 per share, in one or more
classes or series, and to fix or alter:
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the number of shares constituting any class or series;
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the designations, powers and preferences of each class or series;
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the relative, participating, optional and other special rights
of each class or series; and
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any qualifications, limitations or restrictions on each class or
series.
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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
90
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.
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:
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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;
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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:
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by persons who are directors and also officers, and
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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
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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
66
2
/
3
%
of the outstanding voting stock that is not owned by the
interested stockholder.
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A business combination includes:
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any merger or consolidation involving the corporation and the
interested stockholder;
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any sale, transfer, pledge or other disposition of 10% or more
of the assets of the corporation involving the interested
stockholder;
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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;
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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
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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.
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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.
New York
Stock Exchange
We will apply to list our common stock on the New York Stock
Exchange under the symbol LRN.
Transfer
Agent and Registrar
The transfer agent and registrar for our common stock
is .
91
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:
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banks, insurance companies, or other financial institutions;
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persons subject to the alternative minimum tax;
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tax-exempt organizations;
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dealers in securities or currencies;
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traders in securities that elect to use a mark-to-market method
of accounting for their securities holdings;
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entities treated as partnerships for U.S. federal income
tax purposes or investors in such entities;
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controlled foreign corporations, passive
foreign corporations and corporations that accumulate
earnings to avoid U.S. federal income tax;
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U.S. expatriates or former long-term residents of the
United States;
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persons who hold our common stock as a position in a hedging
transaction, straddle, conversion
transaction or other risk reduction transaction; or
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persons deemed to sell our common stock under the constructive
sale provisions of the Code.
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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:
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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;
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92
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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;
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an estate whose income is subject to U.S. federal income
tax regardless of its source; or
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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.
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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:
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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);
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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
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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.
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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.
93
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.
94
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 shares
of our common stock, assuming no exercise of the
underwriters overallotment option and no exercise of
outstanding options. 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 shares
eligible for sale in the public market as follows:
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Number of
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Shares
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Date
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After days
from the date of this prospectus (subject, in some cases, to
volume limitations).
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At various times after
180 days from the date of this prospectus as described
below under Lock-up Agreements.
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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:
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1% of the number of shares of our common stock then outstanding,
which will equal
approximately shares
immediately after the offering; or
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the average weekly trading volume of our common stock on the New
York Stock Exchange during the four calendar weeks preceding the
filing of a notice on Form 144 with respect to that sale.
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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. The Securities and Exchange
Commission has a proposal pending to shorten the
one-year
holding period to six months.
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 Securities and Exchange
Commission has a proposal pending to shorten the two-year
holding period to six months.
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.
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
95
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 Securities and Exchange Commission 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 Securities Exchange Act of 1934, 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 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.
96
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 have agreed to sell to them, severally, the number of
shares indicated below:
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Number of
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Underwriters
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Shares
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Morgan Stanley & Co.
Incorporated
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Credit Suisse Securities (USA) LLC
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Subtotal
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Total
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The underwriters are offering the shares of common stock subject
to their acceptance of the shares from us 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
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 apply to have the common stock approved for listing
on the New York Stock Exchange under the symbol LRN.
The following table shows the per share and total underwriting
discounts that we and the selling stockholders will pay to the
underwriters:
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Paid by Us
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Paid by Selling Stockholders
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Without
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With
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Without
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With
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Overallotment
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Overallotment
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Overallotment
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Overallotment
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Per Share
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$
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$
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$
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$
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Total
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$
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$
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$
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$
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97
In addition, we estimate that the expenses of this offering
other than underwriting discounts and commissions payable by us
will be
$ .
We, our directors, our executive officers 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:
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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;
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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
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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;
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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:
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the sale of shares to the underwriters;
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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;
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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;
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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;
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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 (other than a filing on Form 4 after
the expiration of the lock-up period or on a Form 5 made
when required)
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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
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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.
In order to facilitate the offering of the common stock, the
underwriters may engage in stabilizing transactions,
overallotment transactions, syndicate covering transactions,
penalty bids.
98
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Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a
specified maximum.
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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.
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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.
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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.
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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 and the underwriters have agreed to indemnify each other
against certain liabilities, including liabilities under the
Securities Act.
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.
99
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:
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the purchaser is entitled under applicable provincial securities
laws to purchase the shares without the benefit of a prospectus
qualified under those securities laws,
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where required by law, that the purchaser is purchasing as
principal and not as agent,
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the purchaser has reviewed the text above under Resale
Restrictions, and
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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.
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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.
100
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.
101
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
102
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.
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.
103
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.
104
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
Audited Financial
Statements:
|
|
|
|
|
|
|
|
F-2
|
|
|
|
|
F-3
|
|
|
|
|
F-4
|
|
|
|
|
F-5
|
|
|
|
|
F-6
|
|
|
|
|
F-7
|
|
|
|
|
|
|
Unaudited Interim Financial
Statements:
|
|
|
|
|
|
|
|
F-21
|
|
|
|
|
F-22
|
|
Consolidated Statements of
Redeemable Convertible Preferred Stock and Stockholders
Deficit for the nine months ended March 31, 2007
|
|
|
F-23
|
|
|
|
|
F-24
|
|
|
|
|
F-25
|
|
Schedule II
Valuation and Qualifying Accounts
|
|
|
F-33
|
|
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, 2006
and 2005 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, 2006. 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, 2006 and
2005, and the results of their operations and their cash flows
for each of the three years in the period ended June 30,
2006, in conformity with accounting principles generally
accepted in the United States of America.
Also, in our opinion, the schedules present fairly, in all
material respects, the information set forth therein.
/s/ BDO Seidman, LLP
Bethesda, Maryland
July 26, 2007
F-2
K12
INC.
CONSOLIDATED
BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(in thousands,
|
|
|
|
except share and
|
|
|
|
per share data)
|
|
|
ASSETS
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
9,475
|
|
|
$
|
19,953
|
|
Restricted cash
|
|
|
2,332
|
|
|
|
129
|
|
Accounts receivable, net of
allowance of $1,440 and $1,716 at June 30, 2006 and
June 30, 2005, respectively
|
|
|
11,449
|
|
|
|
8,456
|
|
Inventories, net
|
|
|
11,110
|
|
|
|
5,712
|
|
Prepaid expenses and other current
assets
|
|
|
568
|
|
|
|
668
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
34,934
|
|
|
|
34,918
|
|
Property and equipment, net
|
|
|
10,388
|
|
|
|
4,355
|
|
Capitalized curriculum development
costs, net
|
|
|
1,470
|
|
|
|
1,399
|
|
Other assets, net
|
|
|
1,054
|
|
|
|
925
|
|
Deposits and other assets
|
|
|
639
|
|
|
|
371
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
48,485
|
|
|
$
|
41,968
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES, REDEEMABLE
CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS DEFICIT
|
Current liabilities
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
6,349
|
|
|
$
|
4,790
|
|
Accrued liabilities
|
|
|
2,643
|
|
|
|
2,521
|
|
Accrued compensation and benefits
|
|
|
5,100
|
|
|
|
3,318
|
|
Deferred revenue
|
|
|
1,396
|
|
|
|
895
|
|
Current portion of capital lease
obligations
|
|
|
|
|
|
|
441
|
|
Notes payable related
party
|
|
|
4,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current
liabilities
|
|
|
19,513
|
|
|
|
11,965
|
|
Deferred rent, net of current
portion
|
|
|
1,598
|
|
|
|
|
|
Notes payable related
party
|
|
|
|
|
|
|
4,025
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
21,111
|
|
|
|
15,990
|
|
|
|
|
|
|
|
|
|
|
Commitments and
contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable convertible
preferred stock
|
|
|
|
|
|
|
|
|
Redeemable Convertible
Series C Preferred stock, par value $0.0001;
45,328,693 shares authorized; 45,328,693 and
41,207,903 shares issued and outstanding at 2006 and 2005,
respectively; liquidation value of $121,481 and $110,437 at 2006
and 2005, respectively
|
|
|
76,211
|
|
|
|
64,293
|
|
Redeemable Convertible
Series B Preferred stock, par value $0.0001;
76,000,000 shares authorized; 51,524,974 shares issued
and outstanding at 2006 and 2005, respectively; liquidation
value of $138,087 at 2006 and 2005
|
|
|
124,614
|
|
|
|
111,984
|
|
Stockholders
deficit
|
|
|
|
|
|
|
|
|
Common stock, par value $0.0001;
152,315,000 shares authorized; 10,194,414 and
10,079,226 shares issued and outstanding at 2006 and 2005,
respectively
|
|
|
1
|
|
|
|
1
|
|
Accumulated deficit
|
|
|
(173,452
|
)
|
|
|
(150,300
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders
deficit
|
|
|
(173,451
|
)
|
|
|
(150,299
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities, redeemable
convertible preferred stock and stockholders
deficit
|
|
$
|
48,485
|
|
|
$
|
41,968
|
|
|
|
|
|
|
|
|
|
|
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-3
K12
INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(in thousands, except per share data)
|
|
|
Revenues
|
|
$
|
116,902
|
|
|
$
|
85,310
|
|
|
$
|
71,434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
64,828
|
|
|
|
49,130
|
|
|
|
39,943
|
|
Selling, administrative, and other
operating expenses
|
|
|
41,660
|
|
|
|
30,031
|
|
|
|
25,656
|
|
Product development expenses
|
|
|
8,568
|
|
|
|
9,410
|
|
|
|
12,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and
expenses
|
|
|
115,056
|
|
|
|
88,571
|
|
|
|
78,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
operations
|
|
|
1,846
|
|
|
|
(3,261
|
)
|
|
|
(6,915
|
)
|
Interest expense, net
|
|
|
(488
|
)
|
|
|
(279
|
)
|
|
|
(516
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
1,358
|
|
|
|
(3,540
|
)
|
|
|
(7,431
|
)
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
1,358
|
|
|
|
(3,540
|
)
|
|
|
(7,431
|
)
|
Dividends on preferred
stock
|
|
|
(5,851
|
)
|
|
|
(5,261
|
)
|
|
|
(2,667
|
)
|
Preferred stock
accretion
|
|
|
(18,697
|
)
|
|
|
(15,947
|
)
|
|
|
(15,768
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(23,190
|
)
|
|
$
|
(24,748
|
)
|
|
$
|
(25,866
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(2.30
|
)
|
|
$
|
(2.46
|
)
|
|
$
|
(2.58
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in
computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
10,083,721
|
|
|
|
10,062,587
|
|
|
|
10,017,162
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2003
|
|
|
|
|
|
$
|
|
|
|
|
70,180,574
|
|
|
$
|
111,634
|
|
|
|
10,014,982
|
|
|
$
|
1
|
|
|
$
|
|
|
|
$
|
(99,762
|
)
|
|
$
|
(99,761
|
)
|
Issuance of Redeemable Convertible
Series C Preferred Stock
|
|
|
18,447,573
|
|
|
|
24,720
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of Bridge Loans to
Shares of Series C Preferred Stock
|
|
|
209,143
|
|
|
|
280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exchange of Series B to
Series C Preferred Stock
|
|
|
18,655,600
|
|
|
|
24,999
|
|
|
|
(18,655,600
|
)
|
|
|
(24,999
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee exercised options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,250
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
6
|
|
Accretion of Preferred Stock
|
|
|
|
|
|
|
1,963
|
|
|
|
|
|
|
|
13,805
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
|
|
(15,762
|
)
|
|
|
(15,768
|
)
|
Series C 10% Stock Dividend
|
|
|
149,414
|
|
|
|
2,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,667
|
)
|
|
|
(2,667
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7,431
|
)
|
|
|
(7,431
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2004
|
|
|
37,461,730
|
|
|
|
54,629
|
|
|
|
51,524,974
|
|
|
|
100,440
|
|
|
|
10,019,232
|
|
|
|
1
|
|
|
|
|
|
|
|
(125,622
|
)
|
|
|
(125,621
|
)
|
Employee exercised options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59,994
|
|
|
|
|
|
|
|
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
|
|
|
|
10,079,226
|
|
|
|
1
|
|
|
|
|
|
|
|
(150,300
|
)
|
|
|
(150,299
|
)
|
Employee exercised options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
115,188
|
|
|
|
|
|
|
|
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
|
|
|
|
10,194,414
|
|
|
$
|
1
|
|
|
$
|
|
|
|
$
|
(173,452
|
)
|
|
$
|
(173,451
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(in thousands)
|
|
|
Cash Flows from Operating
Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
1,358
|
|
|
$
|
(3,540
|
)
|
|
$
|
(7,431
|
)
|
Adjustments to reconcile net
income (loss) to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
expense
|
|
|
4,986
|
|
|
|
5,509
|
|
|
|
4,922
|
|
Provision for doubtful accounts
|
|
|
(275
|
)
|
|
|
1,113
|
|
|
|
(68
|
)
|
Provision for inventory
obsolescence
|
|
|
(39
|
)
|
|
|
(50
|
)
|
|
|
71
|
|
Provision for student computer
shrinkage and obsolescence
|
|
|
174
|
|
|
|
(256
|
)
|
|
|
307
|
|
Impairment of curriculum
development costs
|
|
|
362
|
|
|
|
2,118
|
|
|
|
5,001
|
|
Impairment of software development
costs
|
|
|
|
|
|
|
1,188
|
|
|
|
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2,718
|
)
|
|
|
3,434
|
|
|
|
(10,641
|
)
|
Inventories
|
|
|
(5,359
|
)
|
|
|
(555
|
)
|
|
|
(1,314
|
)
|
Prepaid and other current assets
|
|
|
100
|
|
|
|
(431
|
)
|
|
|
(24
|
)
|
Other assets
|
|
|
(258
|
)
|
|
|
(468
|
)
|
|
|
(844
|
)
|
Deposits
|
|
|
(268
|
)
|
|
|
(56
|
)
|
|
|
(72
|
)
|
Accounts payable
|
|
|
1,559
|
|
|
|
(163
|
)
|
|
|
(47
|
)
|
Accrued liabilities
|
|
|
122
|
|
|
|
1,208
|
|
|
|
707
|
|
Accrued compensation and benefits
|
|
|
1,782
|
|
|
|
994
|
|
|
|
1,277
|
|
Deferred revenue
|
|
|
501
|
|
|
|
(348
|
)
|
|
|
136
|
|
Deferred rent
|
|
|
1,598
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in)
operating activities
|
|
|
3,625
|
|
|
|
9,697
|
|
|
|
(8,020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(10,842
|
)
|
|
|
(4,692
|
)
|
|
|
(536
|
)
|
Capitalized curriculum development
costs
|
|
|
(655
|
)
|
|
|
(3,787
|
)
|
|
|
(4,898
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(11,497
|
)
|
|
|
(8,479
|
)
|
|
|
(5,434
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from issuance of
Redeemable Convertible Series C Preferred stock
|
|
|
|
|
|
|
|
|
|
|
25,000
|
|
Proceeds from notes
payable related party
|
|
|
|
|
|
|
4,025
|
|
|
|
|
|
Repayments for capital lease
obligations
|
|
|
(441
|
)
|
|
|
(3,432
|
)
|
|
|
(2,372
|
)
|
Proceeds from exercise of stock
options
|
|
|
38
|
|
|
|
70
|
|
|
|
6
|
|
Cash invested in restricted escrow
account
|
|
|
(2,203
|
)
|
|
|
2,191
|
|
|
|
(1,026
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by
financing activities
|
|
|
(2,606
|
)
|
|
|
2,854
|
|
|
|
21,608
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
(10,478
|
)
|
|
|
4,072
|
|
|
|
8,154
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
, beginning
of year
|
|
|
19,953
|
|
|
|
15,881
|
|
|
|
7,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
, end of year
|
|
$
|
9,475
|
|
|
$
|
19,953
|
|
|
$
|
15,881
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. The Company typically provides the
students in these schools with access to the K12 on-line
curriculum, offline learning kits, and a 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, 2006, the Company served schools in 16
states and the District of Columbia, providing curriculum for
grades kindergarten through ninth.
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, 2006, 2005 and 2004 were $35.6 million,
$29.6 million and $25.4 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 has generally agreed to absorb any operating losses
of the schools in a given school year. To reflect this, for the
years ended June 30, 2006, 2005 and 2004, the Company has
reduced revenues by $7.0 million, $5.5 million and
$2.3 million, respectively. The Company recognizes revenues
for all services under the contracts pro rata over the period it
performs the service.
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.
F-7
K12
Inc.
Notes to
Consolidated Financial Statements
During the years ended June 30, 2006, 2005 and 2004,
approximately 94%, 96% and 96%, respectively, of the
Companys revenues were recognized from virtual public
schools. 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. In fiscal year 2004, we had contracts with two schools
that individually represented 18% and 11% 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.
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 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 $1.4 million and
$1.7 million as of June 30, 2006 and 2005,
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.
F-8
K12
Inc.
Notes to
Consolidated Financial Statements
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 $1.4 million in
each of the years ended June 30, 2006 and 2005 and
$.5 million for the year ended June 30, 2004. These
amounts are recorded on the balance sheet as part of property
and equipment, net of amortization and impairment charges.
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
F-9
K12
Inc.
Notes to
Consolidated Financial Statements
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
$0.7 million, $3.8 million and $4.9 million for
the years ended June 30, 2006, 2005 and 2004, 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.
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).
For the years ended June 30, 2006, 2005 and 2004 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,
$3.3 million and $5.0 million for the years ended
June 30, 2006, 2005 and 2004, respectively.
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.
Stock-Based
Compensation
The Company accounts for its employee stock-based compensation
plans in accordance with APB Opinion No. 25,
Accounting
for Stock Issued to Employees
and FASB Interpretation (FIN)
No. 44,
Accounting for Certain Transactions Involving
Stock Compensation,
and complies with the disclosure
provisions of SFAS No. 123,
Accounting for
Stock-Based Compensation,
as amended by
SFAS No. 148,
Accounting for Stock-Based
Compensation Transition and Disclosure.
Accordingly, no compensation cost is recognized for any of the
Companys fixed stock options granted to employees when the
exercise price of the option equals or exceeds the fair market
value of the underlying common stock as of the grant date for
each stock option. The Company accounts for equity instruments
issued to non-employees 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
. The Company uses the Black-Scholes
option-pricing model to value options granted to non-employees
at the date of grant, or over the period of performance, as
appropriate.
The Company estimates the fair value of each option grant using
the Black-Scholes option pricing model with the following
assumptions: risk-free interest rate of 4.9% (2006), 4.1%
(2005) and 3.7% (2004), a weighted-average expected life of
the options of 8 years (2006, 2005 and 2004), assumed
dividend yield of 0% (2006, 2005 and 2004), and average
volatility of 0% (2006, 2005 and 2004).
F-10
K12
Inc.
Notes to
Consolidated Financial Statements
Had compensation cost for the employee options been recorded in
accordance with SFAS No. 123, the net income (loss)
would have been as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net income (loss), as reported
|
|
$
|
1,358
|
|
|
$
|
(3,540
|
)
|
|
$
|
(7,431
|
)
|
Deduct: total stock-based
compensation expense determined under fair value based method
for all awards, net of related tax effect
|
|
|
(1,164
|
)
|
|
|
(915
|
)
|
|
|
(703
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss), pro forma
|
|
$
|
194
|
|
|
$
|
(4,455
|
)
|
|
$
|
(8,134
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 $2.9 million,
$2.1 million and $2.0 million during the years ended
June 30, 2006, 2005 and 2004, 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, 2006, 2005 and 2004, the shares of common
stock issuable in connection with convertible preferred stock,
stock options, and warrants of 107,638,157, 100,579,529 and
88,218,106, respectively, were not included in the diluted loss
per common share calculation since their effect was
anti-dilutive.
Recent
Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R
(revised 2004),
Share-Based Payment,
which revised
SFAS No. 123, Accounting for Stock-Based
Compensation
. This statement 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.
SFAS No. 123R will be effective for fiscal years
beginning after December 15, 2005. The Company adopted
SFAS No. 123R for the fiscal year ending June 30,
2007 and recorded stock compensation expense of $0.1 for the
nine months ended March 31, 2007.
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
F-11
K12
Inc.
Notes to
Consolidated Financial Statements
recognized in the financial statements. FIN 48 is effective
for fiscal years beginning after December 15, 2006. The
Company is currently evaluating the effect that the adoption of
FIN 48 will have 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.
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,
|
|
|
|
2006
|
|
|
2005
|
|
|
Computer hardware
|
|
$
|
6,615
|
|
|
$
|
5,401
|
|
Student computers
|
|
|
12,617
|
|
|
|
8,650
|
|
Computer software
|
|
|
4,127
|
|
|
|
3,087
|
|
Capitalized software development
costs
|
|
|
1,717
|
|
|
|
327
|
|
Leasehold improvements
|
|
|
2,130
|
|
|
|
50
|
|
Office equipment
|
|
|
1,083
|
|
|
|
753
|
|
Furniture and fixtures
|
|
|
752
|
|
|
|
106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29,041
|
|
|
|
18,374
|
|
Less accumulated depreciation and
amortization
|
|
|
(18,653
|
)
|
|
|
(14,019
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
10,388
|
|
|
$
|
4,355
|
|
|
|
|
|
|
|
|
|
|
The Company recorded depreciation expense related to property
and equipment reflected in selling, administrative and other
operating expenses of $1.1 million, $0.8 million and
$2.0 million during the years ended June 30, 2006,
2005 and 2004, respectively. Depreciation expense of
$3.5 million, $3.9 million and $2.0 million
related primarily to computers leased to students reflected in
instructional costs and services was recorded during the years
ended June 30, 2006, 2005 and 2004, respectively.
Amortization expense of $0.1 million, $0.2 million and
$0.1 million related to capitalized software development
reflected in product development expenses was recorded during
the years ended June 30, 2006, 2005 and 2004, respectively.
In the course of its normal operations, the Company incurs
maintenance and repair expenses. Those are expensed as incurred
and amounted to $0.2 million, $0.1 million and
$0.2 million for the years ended June 30, 2006, 2005
and 2004, respectively.
F-12
K12
Inc.
Notes to
Consolidated Financial Statements
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,
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
25,445
|
|
|
$
|
25,023
|
|
Intangible assets
|
|
|
5,247
|
|
|
|
6,057
|
|
Reserves
|
|
|
935
|
|
|
|
991
|
|
Property and equipment
|
|
|
857
|
|
|
|
803
|
|
Accrued expenses
|
|
|
671
|
|
|
|
1,174
|
|
Charitable contributions
carryforward
|
|
|
130
|
|
|
|
50
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
33,285
|
|
|
|
34,098
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Capitalized development costs
|
|
|
(522
|
)
|
|
|
|
|
Other assets
|
|
|
(236
|
)
|
|
|
(232
|
)
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(758
|
)
|
|
|
(232
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset
|
|
|
32,527
|
|
|
|
33,866
|
|
Valuation allowance
|
|
|
(32,527
|
)
|
|
|
(33,866
|
)
|
|
|
|
|
|
|
|
|
|
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,
2006, the Company has available net operating loss carryforwards
of $63.6 million that expire between 2020 and 2026 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,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Tax expense (benefit) at statutory
rates
|
|
$
|
452
|
|
|
$
|
(1,239
|
)
|
|
$
|
(2,601
|
)
|
Permanent items
|
|
|
720
|
|
|
|
715
|
|
|
|
35
|
|
State tax benefit
|
|
|
167
|
|
|
|
(75
|
)
|
|
|
(367
|
)
|
Change in valuation allowance
|
|
|
(1,339
|
)
|
|
|
599
|
|
|
|
2,933
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-13
K12
Inc.
Notes to
Consolidated Financial Statements
As of June 30, 2006, all capital leases for computer
equipment and software have expired. As of June 30, 2005,
computer equipment and software under capital leases are
recorded at a cost of $0.4 million and accumulated
depreciation of $0.1 million. In March 2005, the Company
made a lump sum payment of $2.4 million to pay off certain
capital leases with one of its vendors. As a result, restricted
cash held in escrow for the guarantee of lease payments was
released.
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. Rent expense was $1.8 million,
$1.4 million and $1.3 million for the years ended
June 30, 2006, 2005 and 2004, respectively.
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.
Future minimum lease payments under noncancelable operating
leases with initial terms of one year or more as follows:
|
|
|
|
|
|
|
Year Ending
|
|
|
|
June 30,
|
|
|
2007
|
|
$
|
1,857
|
|
2008
|
|
|
1,875
|
|
2009
|
|
|
1,897
|
|
2010
|
|
|
1,346
|
|
2011
|
|
|
1,143
|
|
|
|
|
|
|
Total future minimum lease payments
|
|
$
|
8,118
|
|
|
|
|
|
|
All of the warrants for Series B Preferred Stock and common
stock are still outstanding at June 30, 2006. 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) 108,649 warrants to purchase an equivalent number of
common stock at a price of $1.60 per share that expire in
March 2010. For the years ended June 30, 2006, 2005 and
2004 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.
F-14
K12
Inc.
Notes to
Consolidated Financial Statements
Common
Stock
On July 27, 2001, all holders of Class A Common stock
(1,500,000 shares outstanding) and Class B Common
stock (8,500,000 shares outstanding) converted these shares
into 10,000,000 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.
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
F-15
K12
Inc.
Notes to
Consolidated Financial Statements
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.
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
13,000,000 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 2,000,000 as of June 30, 2006.
A summary of the Companys stock option activity including
stand-alone agreements is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
|
Outstanding, June 30, 2004
|
|
|
8,152,987
|
|
|
$
|
1.32
|
|
Granted
|
|
|
3,846,615
|
|
|
|
1.37
|
|
Exercised
|
|
|
(59,994
|
)
|
|
|
1.17
|
|
Canceled
|
|
|
(1,481,991
|
)
|
|
|
1.34
|
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2005
|
|
|
10,457,617
|
|
|
|
1.34
|
|
Granted
|
|
|
3,121,000
|
|
|
|
1.47
|
|
Exercised
|
|
|
(114,959
|
)
|
|
|
0.32
|
|
Canceled
|
|
|
(647,140
|
)
|
|
|
1.38
|
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2006
|
|
|
12,816,518
|
|
|
$
|
1.38
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes information about stock options
outstanding, including those related to stand-alone agreements,
as of June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted-
|
|
|
|
|
|
Weighted-
|
|
Range of
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Exercise
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Number
|
|
|
Exercise
|
|
Prices
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
|
$.20 - $1.50
|
|
|
12,816,518
|
|
|
|
5.8 years
|
|
|
$
|
1.38
|
|
|
|
7,879,390
|
|
|
$
|
1.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9.
|
Commitments
and Contingencies
|
Litigation
In the ordinary conduct of our business, we are subject to
lawsuits and other legal proceedings from time to time. There
are currently two pending lawsuits in which we are involved,
Johnson v. Burmaster
and
Illinois v.
F-16
K12
Inc.
Notes to
Consolidated Financial Statements
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.
While we 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, we do not
believe at this time that a loss in either case would have a
material adverse financial impact on our business. 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 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).
On July 3, 2007, the Court of Appeals certified the case
to the Wisconsin Supreme Court for its review because the
questions involved in the case are of first impression and will
have a significant statewide impact on education finance and
policy. 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. We continue to participate in the defense of CVCS
under an indemnity obligation in our service agreement with that
school.
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, our 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,
F-17
K12
Inc.
Notes to
Consolidated Financial Statements
2007, our 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.
|
|
10.
|
Related
Party Transactions
|
Affiliates of the Company, controlled by a major investor,
rendered $0.1 million, $0.1 million and
$0.2 million of professional services to the Company during
the years ended June 30, 2006, 2005 and 2004, 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. (See
Note 6). 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.
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, 2006, 2005 and 2004.
|
|
12.
|
Supplemental
Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Cash paid for interest
|
|
$
|
33
|
|
|
$
|
446
|
|
|
$
|
596
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non
cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
New capital lease obligations
|
|
$
|
|
|
|
$
|
441
|
|
|
$
|
4,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
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 (the Certificate of Amendment).
Financing
In October 2006, the Company entered into an equipment lease
line of credit with Hewlett-Packard Financial Services Company
that expires on July 31, 2007 for new purchases on this
line of credit. We expect to renew this
F-18
K12
Inc.
Notes to
Consolidated Financial Statements
facility. The interest rate on new advances under the equipment
lease line is set quarterly. Interest rates typically range from
8.5% to 8.8%. Borrowings include a
36-month
payment term with a $1 purchase option at the end of the term.
The Company has pledged 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.
In December 2006, the Company entered into a $15 million
revolving credit agreement with PNC Bank (Credit Agreement).
Included under the Credit Agreement is a provision allowing for
the issuance of letters of credit up to $5 million.
Issuances of letters of credit reduce the availability of
permitted borrowings under 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.
The Credit Agreement limits the Companys ability to pay
dividends or other distributions on its common stock. 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. In March
2007, restricted cash held as collateral for certain letters of
credit in the amount of $2.3 million in connection with an
operating lease commenced in May 2006 and an operating lease
commenced in January 2006 was released. The letters of credit
were reissued under our revolving credit facility. As of
June 30, 2007, $1.5 million was outstanding on the
working capital line of credit including approximately
$2.3 million under the letter of credit facility. In July
2007, the Company borrowed additional funds of $5.0 million
under the Credit Agreement. As of July 6, 2007,
$6.5 million was outstanding on the working capital line of
credit.
In December 2006, the Company repaid a $4.0 million loan
outstanding including accrued interest from certain shareholders
(see Note 6).
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.
Letter
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 300,000 shares of the common stock
of the Company. Socratic is an education company whose primary
asset is its India based tutoring and development center.
F-19
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 3,287,965
stock options with an exercise price of $2.68 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 13 million to 20 million.
F-20
K12
INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
(in thousands,
|
|
|
|
except share and
|
|
|
|
per share data)
|
|
|
ASSETS
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
5,147
|
|
|
$
|
9,475
|
|
Restricted cash
|
|
|
|
|
|
|
2,332
|
|
Accounts receivable, net of
allowance of $485 and $1,440 at March 31, 2007 and
June 30, 2006, respectively
|
|
|
24,803
|
|
|
|
11,449
|
|
Inventories, net
|
|
|
6,444
|
|
|
|
11,110
|
|
Prepaid expenses and other current
assets
|
|
|
968
|
|
|
|
568
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
37,362
|
|
|
|
34,934
|
|
Property and equipment, net
|
|
|
16,547
|
|
|
|
10,388
|
|
Capitalized curriculum development
costs, net
|
|
|
8,198
|
|
|
|
1,470
|
|
Other assets, net
|
|
|
1,477
|
|
|
|
1,054
|
|
Deposits and other assets
|
|
|
417
|
|
|
|
639
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
64,001
|
|
|
$
|
48,485
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES, REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS
DEFICIT
|
Current liabilities
|
|
|
|
|
|
|
|
|
Line of credit
|
|
$
|
1,500
|
|
|
$
|
|
|
Accounts payable
|
|
|
5,521
|
|
|
|
6,349
|
|
Accrued liabilities
|
|
|
1,817
|
|
|
|
2,643
|
|
Accrued compensation and benefits
|
|
|
4,439
|
|
|
|
5,100
|
|
Deferred revenue
|
|
|
7,262
|
|
|
|
1,396
|
|
Current portion of capital lease
obligations
|
|
|
2,053
|
|
|
|
|
|
Notes payable
|
|
|
153
|
|
|
|
|
|
Notes payable related
party
|
|
|
|
|
|
|
4,025
|
|
|
|
|
|
|
|
|
|
|
Total current
liabilities
|
|
|
22,745
|
|
|
|
19,513
|
|
Deferred rent
|
|
|
1,664
|
|
|
|
1,598
|
|
Capital lease obligations
|
|
|
3,814
|
|
|
|
|
|
Notes payable
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
28,315
|
|
|
|
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 March 31,
2007 and June 30, 2006, respectively; liquidation value of
$133,629 and $121,481 at March 31, 2007 and June 30,
2006, respectively
|
|
|
87,097
|
|
|
|
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 March 31, 2007 and June 30, 2006,
respectively; liquidation value of $138,087 at March 31,
2007 and June 30, 2006, respectively
|
|
|
134,979
|
|
|
|
124,614
|
|
Stockholders
deficit
|
|
|
|
|
|
|
|
|
Common stock, par value $0.0001;
170,000,000 shares authorized; 10,203,453 and
10,194,414 shares issued and outstanding at March 31,
2007 and June 30, 2006, respectively
|
|
|
1
|
|
|
|
1
|
|
Accumulated deficit
|
|
|
(186,391
|
)
|
|
|
(173,452
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders
deficit
|
|
|
(186,390
|
)
|
|
|
(173,451
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities, redeemable
convertible preferred stock and stockholders
deficit
|
|
$
|
64,001
|
|
|
$
|
48,485
|
|
|
|
|
|
|
|
|
|
|
See notes to unaudited condensed consolidated financial
statements.
F-21
K12
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended March 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(in thousands, except per share data)
|
|
|
Revenues
|
|
$
|
104,930
|
|
|
$
|
90,088
|
|
|
|
|
|
|
|
|
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
55,103
|
|
|
|
48,473
|
|
Selling, administrative, and other
operating expenses
|
|
|
35,059
|
|
|
|
28,403
|
|
Product development expenses
|
|
|
5,855
|
|
|
|
5,587
|
|
|
|
|
|
|
|
|
|
|
Total costs and
expenses
|
|
|
96,017
|
|
|
|
82,463
|
|
|
|
|
|
|
|
|
|
|
Income from
operations
|
|
|
8,913
|
|
|
|
7,625
|
|
Interest expense, net
|
|
|
(474
|
)
|
|
|
(394
|
)
|
|
|
|
|
|
|
|
|
|
Net income before income tax
expense
|
|
|
8,439
|
|
|
|
7,231
|
|
Income tax expense
|
|
|
(227
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
8,212
|
|
|
|
7,231
|
|
Dividends on preferred
stock
|
|
|
(4,707
|
)
|
|
|
(4,333
|
)
|
Preferred stock
accretion
|
|
|
(16,544
|
)
|
|
|
(13,880
|
)
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders
|
|
$
|
(13,039
|
)
|
|
$
|
(10,982
|
)
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common
stockholders per share:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(1.28
|
)
|
|
$
|
(1.09
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in
computing per share amounts:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
10,195,440
|
|
|
|
10,081,180
|
|
|
|
|
|
|
|
|
|
|
See notes to unaudited condensed consolidated financial
statements.
F-22
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, 2006
|
|
|
45,328,693
|
|
|
$
|
76,211
|
|
|
|
51,524,974
|
|
|
$
|
124,614
|
|
|
|
10,194,414
|
|
|
$
|
1
|
|
|
$
|
|
|
|
$
|
(173,452
|
)
|
|
$
|
(173,451
|
)
|
Employee exercised options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,039
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
12
|
|
Accretion of Preferred Stock
|
|
|
|
|
|
|
6,179
|
|
|
|
|
|
|
|
10,365
|
|
|
|
|
|
|
|
|
|
|
|
(100
|
)
|
|
|
(16,444
|
)
|
|
|
(16,544
|
)
|
Series C 10% Stock Dividend
|
|
|
4,532,869
|
|
|
|
4,707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,707
|
)
|
|
|
(4,707
|
)
|
Stock compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88
|
|
|
|
|
|
|
|
88
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,212
|
|
|
|
8,212
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2007
|
|
|
49,861,562
|
|
|
$
|
87,097
|
|
|
|
51,524,974
|
|
|
$
|
134,979
|
|
|
|
10,203,453
|
|
|
$
|
1
|
|
|
$
|
|
|
|
$
|
(186,391
|
)
|
|
$
|
(186,390
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to unaudited condensed consolidated financial
statements.
F-23
K12
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended March 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(in thousands)
|
|
|
Cash Flows from Operating
Activities
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
8,212
|
|
|
$
|
7,231
|
|
Adjustments to reconcile net
income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
expense
|
|
|
4,618
|
|
|
|
3,574
|
|
Stock based compensation expense
|
|
|
88
|
|
|
|
|
|
Provision for doubtful accounts
|
|
|
(956
|
)
|
|
|
230
|
|
Provision for inventory
obsolescence
|
|
|
285
|
|
|
|
(131
|
)
|
Provision for student computer
shrinkage and obsolescence
|
|
|
(90
|
)
|
|
|
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(12,398
|
)
|
|
|
(13,264
|
)
|
Inventories
|
|
|
4,381
|
|
|
|
(844
|
)
|
Prepaid and other current assets
|
|
|
(400
|
)
|
|
|
(234
|
)
|
Other assets
|
|
|
(255
|
)
|
|
|
(258
|
)
|
Deposits and other assets
|
|
|
221
|
|
|
|
(637
|
)
|
Accounts payable
|
|
|
(827
|
)
|
|
|
587
|
|
Accrued liabilities
|
|
|
(826
|
)
|
|
|
92
|
|
Accrued compensation and benefits
|
|
|
(661
|
)
|
|
|
731
|
|
Deferred revenue
|
|
|
5,866
|
|
|
|
4,060
|
|
Deferred rent
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
7,324
|
|
|
|
1,137
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(3,807
|
)
|
|
|
(6,509
|
)
|
Capitalized curriculum development
costs
|
|
|
(6,957
|
)
|
|
|
(382
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(10,764
|
)
|
|
|
(6,891
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities
|
|
|
|
|
|
|
|
|
Payment on notes
payable related party
|
|
|
(4,025
|
)
|
|
|
(27
|
)
|
Payments on notes payable
|
|
|
(31
|
)
|
|
|
|
|
Net borrowings from revolving
credit facility
|
|
|
1,500
|
|
|
|
|
|
Repayments for capital lease
obligations
|
|
|
(676
|
)
|
|
|
(441
|
)
|
Proceeds from exercise of stock
options
|
|
|
12
|
|
|
|
12
|
|
Release of cash from restricted
escrow account
|
|
|
2,332
|
|
|
|
|
|
Cash invested in restricted escrow
account
|
|
|
|
|
|
|
(2,871
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in financing
activities
|
|
|
(888
|
)
|
|
|
(3,327
|
)
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash
equivalents
|
|
|
(4,328
|
)
|
|
|
(9,081
|
)
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
, beginning
of period
|
|
|
9,475
|
|
|
|
19,953
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
, end of
period
|
|
$
|
5,147
|
|
|
$
|
10,872
|
|
|
|
|
|
|
|
|
|
|
See notes to unaudited condensed consolidated financial
statements.
F-24
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
The accompanying condensed consolidated balance sheet as of
March 31, 2007, the condensed consolidated statements of
operations and cash flows for the nine months ended
March 31, 2007 and 2006 and the condensed consolidated
statement of shareholders equity for the nine months ended
March 31, 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 nine months ended March 31, 2007 and 2006. The
financial data and other information disclosed in these notes to
the financial statements related to the nine month periods are
unaudited. The results of the nine months ended March 31,
2007 are not necessarily indicative of the results to be
expected for the year ending June 30, 2007 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
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 March 31, 2007 and June 30, 2006, the shares of
common stock issuable in connection with convertible preferred
stock, stock options, and warrants of 117,517,682 and
107,638,157, respectively, were not included in the diluted loss
per common share calculation since their effect was
anti-dilutive.
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. The
Company is currently evaluating the effect that the adoption of
FIN 48 will have on its financial position and results of
operations.
F-25
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
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.
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 nine months ended March 31, 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.
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 March 31, 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%.
F-26
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
In July 2007, the Company borrowed additional funds of
$5.0 million under the Credit Agreement at an interest rate
of 6.6%. As of July 23, 2007, $6.5 million was
outstanding on the working capital line of credit and
$2.3 million was outstanding related to letters of credit.
At June 30, 2006, we had a loan outstanding of
$4.0 million from certain shareholders. The loan had an
original term of thirteen months and an interest rate of 15%. In
July 2006, the term for repayment of the loan amount was
extended to December 31, 2006. In December 2006, the
Company repaid the loan and all accrued interest.
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.
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:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
22,994
|
|
|
$
|
25,445
|
|
Intangible assets
|
|
|
3,720
|
|
|
|
5,247
|
|
Accrued expenses
|
|
|
1,720
|
|
|
|
671
|
|
Reserves
|
|
|
631
|
|
|
|
935
|
|
Property and equipment
|
|
|
866
|
|
|
|
857
|
|
Charitable contributions
carryforward
|
|
|
131
|
|
|
|
130
|
|
Alternative minimum tax credit
|
|
|
116
|
|
|
|
|
|
Stock compensation expense
|
|
|
35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
30,213
|
|
|
|
33,285
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Capitalized development costs
|
|
|
(1,372
|
)
|
|
|
(522
|
)
|
Other assets
|
|
|
(380
|
)
|
|
|
(236
|
)
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(1,752
|
)
|
|
|
(758
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset
|
|
|
28,461
|
|
|
|
32,527
|
|
|
|
|
|
|
|
|
|
|
Valuation allowance
|
|
|
(28,461
|
)
|
|
|
(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 March 31,
2007, the Company has
F-27
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
available net operating loss carryforwards of approximately
$57.5 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 loss before income taxes as follows:
|
|
|
|
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
|
March 31,
|
|
|
|
2007
|
|
|
Tax benefit at statutory rates
|
|
$
|
2,953
|
|
Permanent items
|
|
|
688
|
|
State tax benefit
|
|
|
652
|
|
Change in valuation allowance
|
|
|
(4,066
|
)
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
227
|
|
|
|
|
|
|
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. 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 December 31, 2006 and 2005 and a
discussion of the Companys methodology for developing each
of the assumptions used in the valuation model follows:
|
|
|
|
|
Nine Months Ended
|
|
|
March 31, 2007
|
|
Dividend yield
|
|
0.0%
|
Expected volatility
|
|
42%
|
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%
|
F-28
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
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 most recent public filings.
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 nine months ended March 31, 2007.
Forfeiture rate This is the estimated percentage of
options granted that are expected to be forfeited or canceled on
an annual basis before becoming fully vested. The Company uses a
forfeiture rate that is based on historical 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 7,350,000 as of March 31, 2007.
Stock option activity including stand-alone agreements during
the nine months ended March 31, 2007 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
|
Outstanding, June 30, 2006
|
|
|
12,816,518
|
|
|
$
|
1.38
|
|
Granted
|
|
|
6,097,185
|
|
|
|
2.65
|
|
Exercised
|
|
|
(9,268
|
)
|
|
|
1.34
|
|
Canceled
|
|
|
(454,091
|
)
|
|
|
1.39
|
|
|
|
|
|
|
|
|
|
|
Outstanding, March 31, 2007
|
|
|
18,450,344
|
|
|
$
|
1.80
|
|
|
|
|
|
|
|
|
|
|
F-29
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
A summary of the Companys unvested stock options,
including those related to stand-alone agreements, as of
June 30, 2006 and changes during the nine months ended
March 31, 2007 are presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Unvested
|
|
|
Grant Date
|
|
|
|
|
|
|
Options
|
|
|
Fair Value
|
|
|
Amount
|
|
|
Unvested options outstanding,
June 30, 2006
|
|
|
4,937,128
|
|
|
$
|
1.42
|
|
|
$
|
7,021
|
|
Granted
|
|
|
6,097,185
|
|
|
|
2.65
|
|
|
|
16,184
|
|
Vested
|
|
|
(1,971,489
|
)
|
|
|
1.45
|
|
|
|
(2,851
|
)
|
Canceled
|
|
|
(454,091
|
)
|
|
|
1.39
|
|
|
|
(630
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested options outstanding,
March 31, 2007
|
|
|
8,608,733
|
|
|
$
|
2.29
|
|
|
$
|
19,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes information about stock options
outstanding, including those related to stand-alone agreements,
as of March 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted-
|
|
|
|
|
|
Weighted-
|
|
Range of
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Exercise
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Number
|
|
|
Exercise
|
|
Prices
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
|
$.20 - $1.80
|
|
|
16,950,344
|
|
|
|
5.4 years
|
|
|
$
|
1.43
|
|
|
|
9,841,611
|
|
|
$
|
1.37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$6.00
|
|
|
1,500,000
|
|
|
|
5.8 years
|
|
|
$
|
6.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2007, there was $0.3 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 2.8 years. The
total fair value of shares vested during the nine months ended
March 31, 2007 was $2.8 million. During the nine
months ended March 31, 2007, the Company recognized
$0.1 million of stock based compensation.
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 our assets of us,
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 of us (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.
As of March 31, 2007, computer equipment and software under
capital leases are recorded at a cost of $6.6 million and
accumulated depreciation of $1.0 million. The Company has
an equipment lease line of credit with Hewlett-Packard Financial
Services Company that expires on July 31, 2007 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.
F-30
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
The following is a summary as of March 31, 2007 of the
present value of the net minimum lease payments on capital
leases under the Companys commitments:
|
|
|
|
|
|
|
Capital
|
|
March 31,
|
|
Leases
|
|
|
2008
|
|
$
|
2,476
|
|
2009
|
|
|
2,475
|
|
2010
|
|
|
1,632
|
|
|
|
|
|
|
Total minimum lease payments
|
|
|
6,583
|
|
Less amount representing interest
(imputed interest rate of 8.6%)
|
|
|
(716
|
)
|
|
|
|
|
|
Net minimum lease payments
|
|
|
5,867
|
|
Less current portion
|
|
|
(2,053
|
)
|
|
|
|
|
|
Present value of net minimum
payments, less current portion
|
|
$
|
3,814
|
|
|
|
|
|
|
|
|
9.
|
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 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.
While we 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, we do not
believe at this time that a loss in either case would have a
material adverse financial impact on our business. 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 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).
On July 3, 2007, the Court of Appeals certified the case
to the Wisconsin Supreme Court for its review because the
questions involved in the case are of first impression and will
have a significant statewide impact on education finance and
policy. 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
F-31
K12
Inc.
Notes to
Condensed Consolidated Financial Statements
(unaudited)
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. We continue to participate in the defense of CVCS
under an indemnity obligation in our service agreement with that
school.
|
|
10.
|
Supplemental
Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Period Ended March 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Cash paid for interest
|
|
$
|
1,175
|
|
|
$
|
33
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non
cash investing and financing activities:
|
|
|
|
|
|
|
|
|
New capital lease obligations
|
|
$
|
6,574
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
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.
Letter
of Intent
On July 3, 2007, the Company entered into a non-binding
letter of intent 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 300,000 shares of the common stock
of the Company. Socratic is an education company whose primary
asset is its India based tutoring and development center.
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 3,287,965
stock options with an exercise price of $2.68 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 13 million to 20 million.
F-32
SCHEDULE II
K12
INC
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 2006, 2005 AND 2004
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, 2006
|
|
$
|
1,715,781
|
|
|
|
174,895
|
|
|
|
450,177
|
|
|
$
|
1,440,499
|
|
June 30, 2005
|
|
$
|
602,919
|
|
|
|
1,407,143
|
|
|
|
294,281
|
|
|
$
|
1,715,781
|
|
June 30, 2004
|
|
$
|
670,675
|
|
|
|
|
|
|
|
67,756
|
|
|
$
|
602,919
|
|
INVENTORY
RESERVE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Charged to
|
|
|
Deductions
|
|
|
|
|
|
|
Beginning of
|
|
|
Cost and
|
|
|
Shrinkage and
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Expenses
|
|
|
Obsolescence
|
|
|
of Period
|
|
|
June 30, 2006
|
|
$
|
270,611
|
|
|
|
|
|
|
|
38,556
|
|
|
$
|
232,055
|
|
June 30, 2005
|
|
$
|
320,809
|
|
|
|
19,572
|
|
|
|
69,770
|
|
|
$
|
270,611
|
|
June 30, 2004
|
|
$
|
250,000
|
|
|
|
161,370
|
|
|
|
90,561
|
|
|
$
|
320,809
|
|
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, 2006
|
|
$
|
490,533
|
|
|
|
173,653
|
|
|
|
|
|
|
$
|
664,186
|
|
June 30, 2005
|
|
$
|
746,294
|
|
|
|
(255,761
|
)
|
|
|
|
|
|
$
|
490,533
|
|
June 30, 2004
|
|
$
|
439,351
|
|
|
|
306,943
|
|
|
|
|
|
|
$
|
746,294
|
|
|
|
|
(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.
|
INCOME
TAX VALUATION ALLOWANCE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Changes in Net
|
|
|
|
|
|
|
|
|
|
Beginning of
|
|
|
Deferred
|
|
|
Income Tax
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Tax Assets
|
|
|
Benefit Realized
|
|
|
of Period
|
|
|
June 30, 2006
|
|
$
|
33,866
|
|
|
|
(1,339
|
)
|
|
|
|
|
|
$
|
32,527
|
|
June 30, 2005
|
|
$
|
33,267
|
|
|
|
599
|
|
|
|
|
|
|
$
|
33,866
|
|
June 30, 2004
|
|
$
|
30,334
|
|
|
|
2,933
|
|
|
|
|
|
|
$
|
33,267
|
|
F-33
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 the New York Stock Exchange 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
|
|
$
|
5,296
|
|
NYSE listing fee
|
|
|
*
|
|
NASD fee
|
|
|
17,750
|
|
Printing and engraving expenses
|
|
|
*
|
|
Legal fees and expenses
|
|
|
*
|
|
Accounting fees and expenses
|
|
|
*
|
|
Transfer agent and registrar fees
|
|
|
*
|
|
Miscellaneous
|
|
|
*
|
|
|
|
|
|
|
Total
|
|
$
|
*
|
|
|
|
|
|
|
|
|
|
*
|
|
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 11,677,765 shares of common stock to current
and prior employees and directors at a weighted average exercise
price of exercise prices of $2.06 per share, of which 3,836,278
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 7,350,000 shares of our common
stock to current and prior employees and directors at a weighted
average exercise price of $2.42 per share.
3. In December 2003, we issued and sold an aggregate of
18,656,158 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.
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
and 3 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 and 3 were
accredited or sophisticated investors and had adequate access,
through employment, business or other relationships, to
information about us.
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
|
|
|
|
|
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*
|
|
Form of Amended and Restated
Certificate of Incorporation to be effective upon completion of
this offering
|
|
3
|
.4*
|
|
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
|
II-2
|
|
|
|
|
Exhibit No.
|
|
Description of
Exhibit
|
|
|
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
|
|
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*
|
|
Stock Option Agreement of
Ronald J. Packard
|
|
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*
|
|
Employment Agreement of
Ronald J. Packard
|
|
10
|
.10*
|
|
Employment Agreement of
John F. Baule
|
|
10
|
.11*
|
|
Employment Agreement of
Bruce J. Davis
|
|
10
|
.12*
|
|
Employment Agreement of Bror V. H.
Saxberg
|
|
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 (included in
signature pages)
|
|
|
|
*
|
|
To be filed by amendment.
|
(b)
Financial Statement Schedules:
See Schedule II Valuation and
Qualifying Accounts contained on
page F-33.
All other schedules are omitted as the information is not
required or is included in the Registrants financial
statements and related notes.
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
II-3
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 July 26, 2007.
K12 INC.
|
|
|
|
By:
|
/s/
Ronald
J. Packard
|
|
|
|
|
Name:
|
Ronald J. Packard
|
|
Title:
|
Chief Executive Officer
|
Power of
Attorney
Each person whose signature appears below authorizes Ronald J.
Packard and Howard D. Polsky, or any of them, as his true and
lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, to execute in his name and on
his behalf, in any and all capacities, this Registrants
registration statement on
Form S-1
relating to the common stock and any amendments thereto (and any
additional registration statement related thereto permitted by
Rule 462(b) promulgated under the Securities Act of 1933
(and all further amendments, including post-effective amendments
thereto)), necessary or advisable to enable the Registrant to
comply with the Securities Act of 1933, and any rules,
regulations and requirements of the Securities and Exchange
Commission, in respect thereof, in connection with the
registration of the securities which are the subject of such
registration statement, which amendments may make such changes
in such registration statement as such attorney may deem
appropriate, and with full power and authority to perform and do
any and all acts and things whatsoever which any such attorney
or substitute may deem necessary or advisable to be performed or
done in connection with any or all of the above-described
matters, as fully as each of the undersigned could do if
personally present and acting, hereby ratifying and approving
all acts of any such attorney or substitute.
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.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/
Ronald
J. Packard
Ronald
J. Packard
|
|
Chief Executive Officer
(Principal Executive Officer)
|
|
July 26, 2007
|
|
|
|
|
|
/s/
John
F. Baule
John
F. Baule
|
|
Chief Operating Officer and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
|
|
July 26, 2007
|
|
|
|
|
|
/s/
Andrew
H. Tisch
Andrew
H. Tisch
|
|
Chairman of the Board and Director
|
|
July 26, 2007
|
|
|
|
|
|
/s/
Guillermo
Bron
Guillermo
Bron
|
|
Director
|
|
July 26, 2007
|
|
|
|
|
|
/s/
Liza
A. Boyd
Liza
A. Boyd
|
|
Director
|
|
July 26, 2007
|
II-5
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/
Steven
B. Fink
Steven
B. Fink
|
|
Director
|
|
July 26, 2007
|
|
|
|
|
|
/s/
Thomas
J. Wilford
Thomas
J. Wilford
|
|
Director
|
|
July 26, 2007
|
II-6
Exhibit 10.1
REVOLVING CREDIT AGREEMENT
AMONG
K12 INC.,
SCHOOL LEASING CORPORATION,
AND
AMERICAN SCHOOL SUPPLY CORPORATION
AND
PNC BANK, NATIONAL ASSOCIATION
AS LENDER AND L/C ISSUER
December 21, 2006
TABLE OF CONTENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page
|
|
|
1.
|
|
Definitions; Interpretation
|
|
|
1
|
|
|
|
1.1
|
|
Definitions
|
|
|
1
|
|
|
|
1.2
|
|
Interpretation
|
|
|
15
|
|
|
|
1.3
|
|
Change in Accounting Principles
|
|
|
15
|
|
2.
|
|
The Credit Facilities
|
|
|
16
|
|
|
|
2.1
|
|
Commitment
|
|
|
16
|
|
|
|
2.2
|
|
Letters of Credit
|
|
|
16
|
|
|
|
2.3
|
|
Applicable Interest Rates
|
|
|
17
|
|
|
|
2.4
|
|
Manner of Borrowing Loans and Designating Applicable Interest Rates
|
|
|
18
|
|
|
|
2.5
|
|
Minimum Borrowing Amounts; Maximum Eurodollar Loans
|
|
|
19
|
|
|
|
2.6
|
|
Maturity of Loans
|
|
|
20
|
|
|
|
2.7
|
|
Prepayments
|
|
|
20
|
|
|
|
2.8
|
|
Place and Application of Payments
|
|
|
20
|
|
|
|
2.9
|
|
Voluntary Commitment Terminations
|
|
|
21
|
|
|
|
2.10
|
|
The Note
|
|
|
21
|
|
|
|
2.11
|
|
Fees
|
|
|
22
|
|
3.
|
|
Conditions Precedent
|
|
|
22
|
|
|
|
3.1
|
|
All Credit Events
|
|
|
22
|
|
|
|
3.2
|
|
Initial Credit Event
|
|
|
23
|
|
4.
|
|
The Collateral and Guaranties
|
|
|
24
|
|
|
|
4.1
|
|
Collateral
|
|
|
24
|
|
|
|
4.2
|
|
Guaranties
|
|
|
25
|
|
|
|
4.3
|
|
Further Assurances
|
|
|
25
|
|
5.
|
|
Representations and Warranties
|
|
|
25
|
|
|
|
5.1
|
|
Organization and Qualification
|
|
|
25
|
|
|
|
5.2
|
|
Authority and Enforceability
|
|
|
26
|
|
|
|
5.3
|
|
Financial Reports
|
|
|
26
|
|
|
|
5.4
|
|
No Material Adverse Change
|
|
|
26
|
|
|
|
5.5
|
|
Litigation and other Controversies
|
|
|
26
|
|
|
|
5.6
|
|
True and Complete Disclosure
|
|
|
27
|
|
|
|
5.7
|
|
Use of Proceeds; Margin Stock
|
|
|
27
|
|
|
|
5.8
|
|
Taxes
|
|
|
27
|
|
-ii-
TABLE OF CONTENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page
|
|
|
|
|
5.9
|
|
ERISA
|
|
|
27
|
|
|
|
5.10
|
|
Subsidiaries
|
|
|
27
|
|
|
|
5.11
|
|
Compliance with Laws
|
|
|
27
|
|
|
|
5.12
|
|
Environmental Matters
|
|
|
28
|
|
|
|
5.13
|
|
Investment Company
|
|
|
28
|
|
|
|
5.14
|
|
Intellectual Property
|
|
|
28
|
|
|
|
5.15
|
|
Good Title
|
|
|
28
|
|
|
|
5.16
|
|
Labor Relations
|
|
|
28
|
|
|
|
5.17
|
|
Capitalization
|
|
|
29
|
|
|
|
5.18
|
|
Other Agreements
|
|
|
29
|
|
|
|
5.19
|
|
Governmental Authority and Licensing
|
|
|
29
|
|
|
|
5.20
|
|
Approvals
|
|
|
29
|
|
|
|
5.21
|
|
Affiliate Transactions
|
|
|
29
|
|
|
|
5.22
|
|
Solvency
|
|
|
29
|
|
|
|
5.23
|
|
OFAC
|
|
|
29
|
|
|
|
5.24
|
|
Patriot Act
|
|
|
29
|
|
6.
|
|
Covenants
|
|
|
30
|
|
|
|
6.1
|
|
Information Covenants
|
|
|
30
|
|
|
|
6.2
|
|
Inspections
|
|
|
32
|
|
|
|
6.3
|
|
Maintenance of Property, Insurance, etc
|
|
|
32
|
|
|
|
6.4
|
|
Preservation of Existence
|
|
|
32
|
|
|
|
6.5
|
|
Compliance with Laws
|
|
|
32
|
|
|
|
6.6
|
|
ERISA
|
|
|
32
|
|
|
|
6.7
|
|
Payment of Taxes
|
|
|
33
|
|
|
|
6.8
|
|
Contracts With Affiliates
|
|
|
33
|
|
|
|
6.9
|
|
No Changes in Fiscal Year
|
|
|
33
|
|
|
|
6.10
|
|
Change in the Nature of Business
|
|
|
33
|
|
|
|
6.11
|
|
Indebtedness
|
|
|
33
|
|
|
|
6.12
|
|
Liens
|
|
|
34
|
|
|
|
6.13
|
|
Consolidation, Merger, Sale of Assets, etc
|
|
|
35
|
|
|
|
6.14
|
|
Advances, Investments and Loans
|
|
|
36
|
|
|
|
6.15
|
|
Restricted Payments by Parent
|
|
|
36
|
|
-iii-
TABLE OF CONTENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page
|
|
|
|
|
6.16
|
|
Limitation on Restrictions
|
|
|
36
|
|
|
|
6.17
|
|
Limitation on Issuances of New Equity by Subsidiaries
|
|
|
37
|
|
|
|
6.18
|
|
Limitation on the Creation of Subsidiaries
|
|
|
37
|
|
|
|
6.19
|
|
OFAC
|
|
|
37
|
|
|
|
6.20
|
|
Operating Accounts
|
|
|
37
|
|
|
|
6.21
|
|
Financial Covenants
|
|
|
37
|
|
7.
|
|
Events of Default and Remedies
|
|
|
38
|
|
|
|
7.1
|
|
Events of Default
|
|
|
38
|
|
|
|
7.2
|
|
Non-Bankruptcy Defaults
|
|
|
40
|
|
|
|
7.3
|
|
Bankruptcy Defaults
|
|
|
40
|
|
|
|
7.4
|
|
Collateral for Undrawn Letters of Credit
|
|
|
40
|
|
|
|
7.5
|
|
Expenses
|
|
|
41
|
|
8.
|
|
Change in Circumstances and Contingencies
|
|
|
41
|
|
|
|
8.1
|
|
Funding Indemnity
|
|
|
41
|
|
|
|
8.2
|
|
Illegality
|
|
|
42
|
|
|
|
8.3
|
|
Unavailability of Deposits or Inability to Ascertain, or Inadequacy of, LIBOR42
|
|
|
|
|
|
|
8.4
|
|
Yield Protection
|
|
|
42
|
|
|
|
8.5
|
|
Lending Offices
|
|
|
44
|
|
|
|
8.6
|
|
Discretion of Lender as to Manner of Funding
|
|
|
44
|
|
|
|
8.7
|
|
Hedging Liability and Funds Transfer and Deposit Account Liability Arrangements
|
|
|
44
|
|
9.
|
|
Miscellaneous
|
|
|
44
|
|
|
|
9.1
|
|
Withholding Taxes
|
|
|
44
|
|
|
|
9.2
|
|
No Waiver, Cumulative Remedies
|
|
|
45
|
|
|
|
9.3
|
|
Non-Business Days
|
|
|
45
|
|
|
|
9.4
|
|
Documentary Taxes
|
|
|
45
|
|
|
|
9.5
|
|
Survival of Representations
|
|
|
45
|
|
|
|
9.6
|
|
Survival of Indemnities
|
|
|
45
|
|
|
|
9.7
|
|
Notices
|
|
|
45
|
|
|
|
9.8
|
|
Counterparts
|
|
|
46
|
|
|
|
9.9
|
|
Successors and Assigns; Assignments and Participations
|
|
|
46
|
|
-iv-
TABLE OF CONTENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page
|
|
|
|
|
9.10
|
|
Amendments
|
|
|
48
|
|
|
|
9.11
|
|
Headings
|
|
|
48
|
|
|
|
9.12
|
|
Costs and Expenses; Indemnification
|
|
|
48
|
|
|
|
9.13
|
|
Set-off
|
|
|
49
|
|
|
|
9.14
|
|
Entire Agreement
|
|
|
49
|
|
|
|
9.15
|
|
Governing Law
|
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49
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|
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9.16
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|
Severability of Provisions
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|
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49
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9.17
|
|
Excess Interest
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|
49
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|
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|
9.18
|
|
Construction
|
|
|
50
|
|
|
|
9.19
|
|
USA Patriot Act
|
|
|
50
|
|
|
|
9.20
|
|
Submission to Jurisdiction; Waiver of Jury Trial
|
|
|
50
|
|
-v-
EXHIBITS
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Exhibit
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Description
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Section
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A
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Form of Compliance Certificate
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1.1
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B
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Notice of Borrowing
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2.4
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(a)
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C
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Notice of Continuation/Conversion
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2.4
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(a)
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D
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Form of Promissory Note
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2.10
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(a)
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SCHEDULES
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Schedule
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Description
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Section
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6.11
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Existing Indebtedness
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1.1
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5.4
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No Material Adverse Change
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5.4
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5.5
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Litigation and Other Controversies
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5.5
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5.10
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Subsidiaries
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5.10
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5.17
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Capitalization
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5.17
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5.21
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Affiliate Transactions
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5.21
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6.12(i)
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Liens Securing Existing Indebtedness
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6.12
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(i)
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-vi-
REVOLVING CREDIT AGREEMENT
This Revolving Credit Agreement dated December 21, 2006, is among
K12 Inc.
, a
Delaware corporation (Parent),
School Leasing Corporation
, a Delaware corporation, and
American School Supply Corporation
, a Delaware corporation (together with Parent,
collectively, and individually, each Borrower) and
PNC Bank, National Association
, a
national banking association as Lender and L/C Issuer.
Borrower has requested, and Lender has agreed to extend, certain credit facilities on the
terms and conditions of this Agreement. In consideration of the mutual agreements set forth in
this Agreement, the parties to this Agreement agree as follows:
1.
Definitions; Interpretation
.
1.1 Definitions
. The following terms when used herein shall have the following meanings:
Accumulated Cash means, at any measurement date, the total of (a) (1) with respect to the
December 31, 2006 measurement date, $8,638,000 and (2) with respect to all other measurement dates,
Accumulated Cash at the end of the Fiscal Quarter preceding the measurement date plus (b) EBITDA
for the Fiscal Quarter ended on the measurement date minus (c) the sum of (1) 1.2 times Fixed
Charges for the Fiscal Quarter ended on the measurement date and (2) Product Development
Expenditures for the Fiscal Quarter ended on the measurement date and (3) Permitted Acquisition
Cash Purchase Price for the Fiscal Quarter ended on the measurement date. Solely for purposes of
determining Accumulated Cash, EBITDA for the Fiscal Quarter ended June 30, 2007 shall be increased
by $3,000,000 (which amount shall remain in Accumulated Cash for all calculations made thereafter),
and EBITDA for the Fiscal Quarter ended September 30, 2007 shall be reduced by $3,000,000 (which
amount shall remain in Accumulated Cash for all calculations made thereafter).
Acquired Business means the entity or assets acquired by any Borrower or a Subsidiary in an
Acquisition, whether before or after the date hereof.
Acquisition means any transaction or series of related transactions for the purpose of or
resulting, directly or indirectly, in (a) the acquisition of all or substantially all of the assets
of a Person (other than a Person that is a Subsidiary prior to such transaction or series of
transactions), or of any business or division of a Person (other than a Person that is a Subsidiary
prior to such transaction or series of transactions), (b) the acquisition of in excess of 50% of
the capital stock, partnership interests, membership interests or equity of any Person (other than
a Person that is a Subsidiary prior to such transaction or series of transactions), or otherwise
causing any Person to become a Subsidiary, or (c) a merger or consolidation or any other
combination with another Person (other than a Person that is a Subsidiary prior to such transaction
or series of transactions), provided that a Borrower or the Subsidiary is the surviving entity.
Adjusted LIBOR means, for any Borrowing of Eurodollar Loans, a rate per annum equal to the
quotient of (a) LIBOR, divided by (b) one minus the Reserve Percentage.
Affiliate means any Person directly or indirectly controlling or controlled by, or under
direct or indirect common control with, another Person. A Person shall be deemed to control
another Person for the purposes of this definition if such Person possesses, directly or
indirectly, the power to direct, or cause the direction of, the management and policies of the
other Person, whether through the ownership of voting securities, common directors, trustees or
officers, by contract or otherwise; provided that, in any event for purposes of this definition,
any Person that owns, directly or indirectly, 40% or more of the securities having the ordinary
voting power for the election of directors or governing body of a corporation or 40% or more of the
partnership or other ownership interest of any other Person (other than as a limited partner of
such other Person) will be deemed to control such corporation or other Person.
Agreement means this Revolving Credit Agreement, as the same may be amended, modified,
restated or supplemented from time to time pursuant to the terms hereof.
Applicable Margin means, with respect to Loans and letter of credit fees payable under
Section 2.11, expressed in basis points:
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Level I
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Level II
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Level III
|
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|
Borrowers Total
|
|
|
Borrowers Total
|
|
|
Borrowers Total
|
|
|
|
Debt to EBITDA is
|
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|
Debt to EBITDA is
|
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|
Debt to EBITDA is
|
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|
less than or equal
|
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|
greater than 1.0 to
|
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greater than 2.0 to
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to1.0 to 1.
|
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1 but less than or
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1
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equal to 2.0 to 1.
|
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Commitment Fee
|
|
|
15.0
|
|
|
|
20.0
|
|
|
|
25.0
|
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|
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|
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Eurodollar Loans
|
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125.0
|
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150.0
|
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|
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175.0
|
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Base Rate Loans
|
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0.0
|
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0.0
|
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0.0
|
|
Changes to the Applicable Margin shall be effective with respect to Base Rate Loans and
letter of credit fees on the first day of the month following the Lenders receipt of Parents
financial statements required by Section 6.1 for the applicable Fiscal Quarter and with respect to
Eurodollar Loans for Interest Periods beginning after the first day of the month following Lenders
receipt of Parents financial statements required by Section 6.1 for the applicable Fiscal Quarter.
If Borrower shall not have timely delivered the financial statement required by Section 6.1,
Applicable Margins shall be at Level III until such failure is cured.
Application is defined in Section 2.2(b).
Authorized Representative means those persons shown on the list of officers provided by
Parent, as agent for Borrower, pursuant to Section 3.2(i) or on any update of any such list
provided by Parent to the Lender, or any further or different officers of Parent so named by any
Authorized Representative of Parent in a written notice to the Lender.
-2-
Base Rate means for any day the greater of: (i) the rate of interest announced by the
Lender from time to time as its prime rate as in effect on such day, with any change in the Base
Rate resulting from a change in said prime rate to be effective as of the date of the relevant
change in said prime rate (it being acknowledged that such rate may not be the Lenders best or
lowest rate) and (ii) the sum of (x) the Federal Funds Rate, plus (y) 1/2 of 1%.
Base Rate Loan means a Loan bearing interest at a rate specified in Section 2.3(a).
Borrower is defined in the introductory paragraph of this Agreement.
Borrowing means the total of Loans of a single type advanced, continued for an additional
Interest Period, or converted from a different type into such type by the Lender on a single date
and, in the case of Eurodollar Loans, for a single Interest Period. A Borrowing is advanced on
the day the Lender advances funds comprising such Borrowing to Borrower, is continued on the date
a new Interest Period for the same type of Loans commences for such Borrowing, and is converted
when such Borrowing is changed from one type of Loan to the other, all as requested by Borrower
pursuant to Section 2.4(a).
Business Day means any day (other than a Saturday or Sunday) on which banks are not
authorized or required to close in Washington, D.C. and, if the applicable Business Day relates to
the advance or continuation of, or conversion into, or payment of a Eurodollar Loan, on which banks
are dealing in U.S. Dollar deposits in the interbank eurodollar market in London, England.
Capital Lease means any lease of Property which in accordance with GAAP is required to be
capitalized on the balance sheet of the lessee.
Capital Stock means, of any Person, any and all shares, interests, participations, or other
equivalents (however designated) of such Persons capital stock whether now issued or issued after
the date of this Agreement.
Capitalized Lease Obligation means, for any Person, the amount of the liability shown on the
balance sheet of such Person in respect of a Capital Lease determined in accordance with GAAP.
Cash Equivalents shall mean, as to any Person: (a) investments in direct obligations of the
United States of America or of any agency or instrumentality thereof whose obligations constitute
full faith and credit obligations of the United States of America, provided that any such
obligations shall mature within one year of the date of issuance thereof; (b) investments in
commercial paper rated at least P-1 by Moodys and at least A-1 by S&P maturing within one year of
the date of issuance thereof; (c) investments in certificates of deposit issued by the Lender or by
any United States commercial bank having capital and surplus of not less than $100,000,000 which
have a maturity of one year or less; (d) investments in repurchase obligations with a term of not
more than 7 days for underlying securities of the types described in clause (a) above entered into
with any bank meeting the qualifications specified in clause (c) above, provided all such
agreements require physical delivery of the securities securing such repurchase agreement, except
those delivered through the Federal Reserve Book Entry System; (e) investments in money market
funds that invest solely, and which are restricted by their
-3-
respective charters to invest solely, in investments of the type described in the immediately
preceding subsections (a), (b), (c), and (d) above.
CERCLA means the Comprehensive Environmental Response, Compensation and Liability Act of
1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C. §§9601 et
seq., and any future amendments.
Change of Control means either of (a) the acquisition by any person or group (as such
terms are used in sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) at
any time of beneficial ownership of 51% or more of the outstanding equity interests of any Borrower
or any Subsidiary on a fully-diluted basis, or (b) any change of control (or words of like
import), as defined in any Material Agreement, shall occur.
Closing Date means the date of this Agreement.
Code means the Internal Revenue Code of 1986, as amended, and any successor statute thereto.
Collateral means all properties, rights, interests, and privileges from time to time subject
to the Liens granted to the Lender, or any security trustee therefor, by the Collateral Documents.
Collateral Account is defined in Section 7.4(b).
Collateral Documents means the Security Agreements, Pledge Agreements and all other
mortgages, deeds of trust, security agreements, pledge agreements, assignments, financing
statements and other documents as shall from time to time secure or relate to the Obligations, the
Hedging Liability, and the Funds Transfer and Deposit Account Liability, or any part thereof.
Commitment means, as to the Lender, the obligation to make Revolving Loans and to issue
Letters of Credit for the account of Borrowers hereunder in an aggregate principal or face amount
at any one time outstanding not to exceed $15,000,000, as the same may be reduced or modified at
any time or from time to time pursuant to the terms hereof.
Contemplated Subordinated Debt means Indebtedness of Parent in the maximum principal amount
of $6,700,000 that Parent expects to constitute Subordinated Debt, the proceeds of which are used
to fund the Specified Restricted Payment or the purchase price of a Permitted Acquisition.
Contingent Obligation shall mean as to any Person, any obligation of such Person
guaranteeing or intended to guarantee any Indebtedness, leases, dividends or other obligations
(primary obligations) of any other Person (the primary obligor) in any manner, whether directly
or indirectly, including, without limitation, any obligation of such Person, whether or not
contingent, (a) to purchase any such primary obligation or any Property constituting direct or
indirect security therefor, (b) to advance or supply funds (1) for the purchase or payment of any
such primary obligation or (2) to maintain working capital or equity capital of the primary obligor
or otherwise to maintain the net worth or solvency of the primary obligor, (c) to purchase
property, securities or services primarily for the purpose of assuring the owner of any such
-4-
primary obligation of the ability of the primary obligor to make payment of such primary
obligation or (d) otherwise to assure or hold harmless the holder of such primary obligation
against loss in respect thereof; provided, however, that the term Contingent Obligation shall not
include endorsements of instruments for deposit or collection in the ordinary course of business.
The amount of any Contingent Obligation shall be deemed to be an amount equal to the stated or
determinable amount of the primary obligation in respect of which such Contingent Obligation is
made or, if not stated or determinable, the maximum reasonably anticipated liability in respect
thereof (assuming such Person is required to perform thereunder) as determined by such Person in
good faith.
Controlled Group means all members of a controlled group of corporations and all trades or
businesses (whether or not incorporated) under common control which, together with Borrowers or
Parent, are treated as a single employer under Section 414 of the Code.
Credit Event means the advancing of any Loan, the continuation of or conversion into a
Eurodollar Loan, or the issuance of, or extension of the expiration date or increase in the amount
of, any Letter of Credit.
Damages means all damages including, without limitation, punitive damages, liabilities,
costs, expenses, losses, judgments, diminutions in value, fines, penalties, demands, claims, cost
recovery actions, lawsuits, administrative proceedings, orders, response action, removal and
remedial costs, compliance costs, investigation expenses, consultant fees, attorneys and
paralegals fees and litigation expenses.
Default means any event or condition the occurrence of which would, with the passage of time
or the giving of notice, or both, constitute an Event of Default.
Dollars and $ each means the lawful currency of the United States of America.
EBITDA means, with reference to any period, Net Income for such period plus the sum of all
amounts deducted in arriving at such Net Income amount in respect of (a) Interest Expense for such
period, (b) federal, state, and local income taxes for such period, (c) depreciation of fixed and
other tangible assets for such period, (d) amortization of intangible assets and capitalized
curriculum development costs for such period, and (e) non-cash impairment charges, non-cash stock
option expenses and one-time, non-cash charges for such period, minus the sum of (x) all amounts
added in arriving at such Net Income in respect of federal, state and local income tax refunds and
other similar tax benefits for such period and (y) one-time, non-cash benefits for such period.
Environmental Claim means any investigation, notice, violation, demand, allegation, action,
suit, injunction, judgment, order, consent decree, penalty, fine, lien, proceeding or claim
(whether administrative, judicial or private in nature) arising (a) pursuant to, or in connection
with an actual or alleged violation of, any Environmental Law, (b) in connection with any Hazardous
Material, (c) from any abatement, removal, remedial, corrective or response action in connection
with a Hazardous Material, Environmental Law or order of a governmental authority or (d) from any
actual or alleged damage, injury, threat or harm to health, safety, natural resources or the
environment.
-5-
Environmental Law means any current or future Legal Requirement pertaining to (a) the
protection of health, safety and the indoor or outdoor environment, (b) the conservation,
management, production, mining or use of natural resources and wildlife, (c) the protection or use
of surface water or groundwater, (d) the management, manufacture, possession, presence, use,
generation, transportation, treatment, storage, disposal, Release, threatened Release, abatement,
removal, remediation or handling of, or exposure to, any Hazardous Material or (e) pollution
(including any Release to air, land, surface water or groundwater), and any amendment, rule,
regulation, order or directive issued thereunder.
ERISA means the Employee Retirement Income Security Act of 1974, as amended, or any
successor statute thereto.
Eurodollar Loan means a Loan bearing interest at the rate specified in Section 2.3(b).
Event of Default means any event or condition identified as such in Section 7.1.
Existing Indebtedness shall mean that Indebtedness described on Schedule 6.11 attached
hereto.
Federal Funds Rate means for any day the rate determined by the Lender to be the average
(rounded upward, if necessary, to the next higher 1/100 of 1%) of the rates per annum quoted to the
Lender at approximately 10:00 a.m. (Washington, D.C. time) (or as soon thereafter as is
practicable) on such day (or, if such day is not a Business Day, on the immediately preceding
Business Day) by two or more Federal funds brokers selected by the Lender for sale to the Lender at
face value of Federal funds in the secondary market in an amount equal or comparable to the
principal amount owed to the Lender for which such rate is being determined.
Fiscal Quarter means any of the fiscal quarters during a fiscal year ending March 31, June
30, September 30 and December 31, respectively.
Fiscal Year means the fiscal year of Parent beginning on July 1 of each calendar year and
ending on June 30 of the next calendar year.
Fixed Charges means, with reference to any period, the sum of (a) all payments of principal
made during such period with respect to Indebtedness of Parent and its Subsidiaries other than (1)
principal payments of the Loans and (2) principal payments made with respect to the Shareholder
Loan, (b) Interest Expense paid in cash during such period (excluding interest paid with respect to
the Shareholder Loan), (c) federal, state, and local income taxes paid in cash by Parent and its
Subsidiaries during such period, (d) Restricted Payments other than any Specified Restricted
Payment paid during such period, and (e) Maintenance Capital Expenditures with respect to such
period.
Foreign Subsidiary means each Subsidiary which (a) is organized under the laws of a
jurisdiction other than the United States of America or any state thereof, (b) conducts
substantially all of its business outside of the United States of America, and (c) has
substantially all of its assets outside of the United States of America.
-6-
Funds Transfer and Deposit Account Liability means the liability of Parent or any of its
Subsidiaries owing to the Lender, or any Affiliates of the Lender, arising out of (a) the execution
or processing of electronic transfers of funds by automatic clearing house transfer, wire transfer
or otherwise to or from the deposit accounts of Parent, Borrower and/or any Subsidiary now or
hereafter maintained with the Lender or its Affiliates, (b) the acceptance for deposit or the
honoring for payment of any check, draft or other item with respect to any such deposit accounts,
and (c) any other deposit, disbursement, and cash management services afforded to Parent, Borrower
or any such Subsidiary by the Lender or its Affiliates.
GAAP means generally accepted accounting principles set forth from time to time in the
opinions and pronouncements of the Accounting Principles Board and the American Institute of
Certified Public Accountants and statements and pronouncements of the Financial Accounting
Standards Board (or agencies with similar functions of comparable stature and authority within the
U.S. accounting profession), which are applicable to the circumstances as of the date of
determination.
Guarantor means any party to a Guaranty.
Guaranty and Guaranties each is defined in Section 4.2 hereof.
Hazardous Material means any substance, chemical, compound, product, solid, gas, liquid,
waste, byproduct, pollutant, contaminant or material which is hazardous or toxic, and includes,
without limitation, (a) asbestos, polychlorinated biphenyls and petroleum (including crude oil or
any fraction thereof) and (b) any material classified or regulated as hazardous or toxic or
words of like import pursuant to an Environmental Law.
Hedging Liability means the liability of Parent, Borrower or any Subsidiary to the Lender,
or any Affiliates of the Lender, in respect of any interest rate, currency or commodity swap
agreements, cap agreements, collar agreements, floor agreements, exchange agreements, forward
contracts, option contracts, or other similar interest rate or currency or commodity hedging
arrangements as Parent, Borrower or such Subsidiary, as the case may be, may from time to time
enter into with the Lender or its Affiliates.
Hostile Acquisition means the acquisition of the capital stock or other equity interests of
a Person through a tender offer or similar solicitation of the owners of such capital stock or
other equity interests which has not been approved (prior to such acquisition) by resolutions of
the Board of Directors of such Person or by similar action if such Person is not a corporation, and
as to which such approval has not been withdrawn.
Indebtedness means for any Person (without duplication) (a) all indebtedness of such Person
for borrowed money, whether current or funded, or secured or unsecured, (b) all indebtedness for
the deferred purchase price of Property or services (including, without limitation any payment of
the purchase price of the TW Acquisition made after the closing date thereof), (c) all indebtedness
created or arising under any conditional sale or other title retention agreement with respect to
Property acquired by such Person (even though the rights and remedies of the seller or lender under
such agreement in the event of a default are limited to repossession or sale of such Property), (d)
all indebtedness secured by a purchase money
-7-
mortgage or other Lien to secure all or part of the purchase price of Property subject to such
mortgage or Lien, (e) all obligations under leases which shall have been or must be, in accordance
with GAAP, recorded as Capital Leases in respect of which such Person is liable as lessee, (f) any
liability in respect of bankers acceptances or letters of credit, (g) any indebtedness, whether or
not assumed, secured by Liens on Property acquired by such Person at the time of acquisition
thereof, (h) all obligations under any so-called synthetic lease transaction entered into by such
Person, (i) all obligations under any so-called asset securitization transaction entered into by
such Person, and (j) all Contingent Obligations, it being understood that the term Indebtedness
shall not include trade payables, accrued expenses or other similar liabilities (including those
incurred on the basis of recurring journal entries made from time to time) arising in the ordinary
course of business.
Interest Expense means, with reference to any period, the sum of all interest charges
(including imputed interest charges with respect to Capitalized Lease Obligations and all
amortization of debt discount and expense) of Parent and its Subsidiaries for such period
determined on a consolidated basis in accordance with GAAP.
Interest Period means the period commencing on the date a Borrowing of Loans is advanced,
continued or created by conversion and ending: (a) in the case of Base Rate Loans, on the last day
of the calendar month in which such Borrowing is advanced, continued or created by conversion (or
on the last day of the following calendar month if such Loan is advanced, continued or created by
conversion on the last day of a calendar month) and (b) in the case of a Eurodollar Loan, 1, 2, 3
or 6 months thereafter; provided, however, that:
(1) any Interest Period for a Borrowing of Revolving Loans consisting of Base Rate
Loans that otherwise would end after the Termination Date shall end on the Termination Date;
(2) no Interest Period with respect to any Revolving Loan shall extend beyond the
Termination Date;
(3) whenever the last day of any Interest Period would otherwise be a day that is not
a Business Day, the last day of such Interest Period shall be extended to the next
succeeding Business Day, provided that, if such extension would cause the last day of an
Interest Period for a Borrowing of Eurodollar Loans to occur in the following calendar
month, the last day of such Interest Period shall be the immediately preceding Business Day;
and
(4) for purposes of determining an Interest Period for a Borrowing of Eurodollar
Loans, a month means a period starting on one day in a calendar month and ending on the
numerically corresponding day in the next calendar month; provided, however, that if there
is no numerically corresponding day in the month in which such an Interest Period is to end
or if such an Interest Period begins on the last Business Day of a calendar month, then such
Interest Period shall end on the last Business Day of the calendar month in which such
Interest Period is to end.
-8-
Inventory means all finished goods held for sale and raw materials and work in process in
which the relevant Borrower or the relevant Subsidiary now has or hereafter acquires title to.
L/C Issuer means PNC Bank, National Association, a national banking association.
L/C Obligations means the aggregate undrawn face amounts of all outstanding Letters of
Credit and all unpaid Reimbursement Obligations.
L/C Sublimit means the lesser of (a) $5,000,000 and (b) the Commitment, as reduced pursuant
to the terms hereof.
Legal Requirement means any treaty, convention, statute, law, regulation, ordinance,
license, permit, governmental approval, injunction, judgment, order, consent decree or other
requirement of any governmental authority, whether federal, state, or local.
Lender means PNC Bank, National Association, a national banking association.
Lending Office is defined in Section 8.5.
Letter of Credit is defined in Section 2.2(a).
Leverage Ratio means, at any time the same is to be determined, the ratio of Total Debt at
such time to EBITDA for the four Fiscal Quarter period ended at such time.
LIBOR means, for an Interest Period for a Borrowing of Eurodollar Loans, (a) the LIBOR Index
Rate for such Interest Period, if such rate is available, and (b) if the LIBOR Index Rate cannot be
determined, the arithmetic average of the rates of interest per annum (rounded upwards, if
necessary, to the nearest 1/100 of 1%) at which deposits in Dollars in immediately available funds
are offered to the Lender at 11:00 a.m. (London, England time) 2 Business Days before the beginning
of such Interest Period by 3 or more major banks in the interbank eurodollar market selected by the
Lender for delivery on the first day of and for a period equal to such Interest Period and in an
amount equal or comparable to the principal amount of the Eurodollar Loan scheduled to be made by
the Lender as part of such Borrowing.
LIBOR Index Rate means, for any Interest Period, the rate per annum (rounded upwards, if
necessary, to the next higher one hundred-thousandth of a percentage point) for deposits in Dollars
for a period equal to such Interest Period, which appears on the Telerate Page 3750 as of 11:00
a.m. (London, England time) on the day 2 Business Days before the commencement of such Interest
Period.
Lien means any mortgage, lien, security interest, pledge, charge or encumbrance of any kind
in respect of any Property, including the interests of a vendor or lessor under any conditional
sale, Capital Lease or other title retention arrangement.
Loan means any Revolving Loan, whether outstanding as a Base Rate Loan or Eurodollar Loan or
otherwise as permitted hereunder, each of which is a type of Loan hereunder.
-9-
Loan Documents means this Agreement, the Note, the Applications, the Collateral Documents,
the Guaranties, and each other instrument or document to be delivered hereunder or thereunder or
otherwise in connection therewith.
Maintenance Capital Expenditures means, with respect to any period, the aggregate amount of
all expenditures of Parent and its Subsidiaries during that period with respect to fixed or capital
assets (including replacements, capitalized repairs, and improvements) which should be capitalized
on the balance sheet of such Person in accordance with GAAP as depreciable assets for the ongoing
use or maintenance of the corporate information technology systems of Parent and its Subsidiaries
(as opposed to expenditures that expand or enhance the capabilities thereof); provided, however,
there shall be excluded from Maintenance Capital Expenditures those expenditures that are financed
through Indebtedness permitted by Sections 6.11(d), 6.11(e) or 6.11(g).
Material Adverse Effect means (a) a material adverse change in, or material adverse effect
upon, the operations, business, Property or condition (financial or otherwise) of Parent, Borrower
or one or more of their Subsidiaries taken as a whole, (b) a material impairment of the ability of
Parent, Borrower and their Subsidiaries taken as a whole to perform their obligations under any
Loan Document or (c) a material adverse effect upon (1) the legality, validity, binding effect or
enforceability against Parent, Borrower or any Subsidiary of any Loan Document or the rights and
remedies of the Lender thereunder or (2) the perfection or priority of any Lien granted under any
Collateral Document.
Material Agreement means (a) any indenture, agreement, lease, note or other document
governing or relating to any material Indebtedness, and (b) any other agreement the breach,
termination or loss of which would reasonably be expected to result in a Material Adverse Effect.
Moodys means Moodys Investors Service, Inc.
Net Income means, with reference to any period, the net income (or net loss) of Parent and
its Subsidiaries for such period computed on a consolidated basis in accordance with GAAP; provided
that there shall be excluded from Net Income (a) the net income (or net loss) of any Person accrued
prior to the date it becomes a Subsidiary of, or has merged into or consolidated with, Parent or
another Subsidiary, and (b) the net income (or net loss) of any Person (other than a Subsidiary) in
which Parent or any of its Subsidiaries has an equity interest in, except to the extent of the
amount of dividends or other distributions actually paid to Parent or any of its Subsidiaries
during such period.
Net Worth means, at any time the same is to be determined, the total shareholders equity
(including capital and accumulated surplus or deficit) that would appear on the balance sheet of
Parent and its Subsidiaries determined on a consolidated basis in accordance with GAAP.
Note means the Revolving Note.
Obligations means all obligations of Borrower to pay principal and interest on the Loans,
all Reimbursement Obligations owing under the Applications, all fees and charges
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payable hereunder, and all other payment obligations of Parent, Borrower or any of their
Subsidiaries arising under or in relation to any Loan Document, in each case whether now existing
or hereafter arising, due or to become due, direct or indirect, absolute or contingent, and
howsoever evidenced, held or acquired.
Parent is defined in the introductory paragraph of this Agreement.
Participant has the meaning assigned to such term in Section 9.9(b).
Patriot Act is defined in Section 5.24.
PBGC means the Pension Benefit Guaranty Corporation or any Person succeeding to any or all
of its functions under ERISA.
Permitted Acquisition means any Acquisition with respect to which all of the following
conditions shall have been satisfied:
(1) the Acquired Business is engaged predominantly in the business of providing educational
content or curricula management systems;
(2) if a new Subsidiary is formed or acquired as a result of or in connection with the
Acquisition, Borrower shall have complied with the requirements of Section 4 in connection
therewith;
(3) after giving effect to the Acquisition, no Default or Event of Default shall exist,
including with respect to the covenants contained in Section 6.21 on a pro forma basis and Parent
shall have delivered to the Lender a compliance certificate in the form of Exhibit A evidencing
such compliance with Section 6.21;
(4) either the Acquisition is the TW Acquisition or the aggregate purchase price of such
Acquisition and all other Permitted Acquisitions other than the TW Acquisition does not exceed
$10,000,000 plus the value of an unrestricted amount of Capital Stock of Parent which is not
Redeemable Capital Stock;
(5) if the Acquired Business has its primary operations within the United States of America,
the purchase price of such Acquisition does not exceed $5,000,000 plus the value of an unrestricted
amount of Capital Stock of Parent which is not Redeemable Capital Stock; and
(6) if the Acquired Business does not have its primary operations within the United States of
America, either the Acquisition is the TW Acquisition or the purchase price of such Acquisition
does not exceed $2,000,000 plus the value of an unrestricted amount of Capital Stock of Parent
which is not Redeemable Capital Stock.
Permitted Acquisition Cash Purchase Price means, with respect to any period, the amount of
the cash portion of the purchase price of all Permitted Acquisitions paid at the closing of each
such Permitted Acquisition during such period in excess of the cash proceeds of any Indebtedness
provided by third parties incurred by Parent or any Subsidiary within 60 days of the
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closing of such Permitted Acquisition to finance such cash portion of the purchase price of
such Permitted Acquisitions.
Permitted Lien is defined in Section 6.12.
Person means any natural person, partnership, corporation, limited liability company,
association, trust, unincorporated organization or any other entity or organization, including a
government or agency or political subdivision thereof.
Plan means any employee pension benefit plan covered by Title IV of ERISA or subject to the
minimum funding standards under Section 412 of the Code that either (a) is maintained by a member
of the Controlled Group for employees of a member of the Controlled Group or (b) is maintained
pursuant to a collective bargaining agreement or any other arrangement under which more than one
employer makes contributions and to which a member of the Controlled Group is then making or
accruing an obligation to make contributions or has within the preceding five plan years made
contributions.
Pledge Agreements mean the Pledge Agreements of even date herewith executed by Parent and
any Guarantor in favor of the Lender pledging equity interests in Borrower and any other
Subsidiary, as the same may be amended, modified, supplemented or restated from time to time, and
Pledge Agreement means any of the Pledge Agreements.
Product Development Expenditures means, with respect to any period, those expenditures of
Parent and its Subsidiaries capitalized in accordance with GAAP for the design, development or
improvement of Parents proprietary educational content and curricula.
Property means, as to any Person, all types of real, personal, tangible, intangible or mixed
property owned by such Person whether or not included in the most recent balance sheet of such
Person and its Subsidiaries under GAAP.
RCRA means the Solid Waste Disposal Act, as amended by the Resource Conservation and
Recovery Act of 1976 and Hazardous and Solid Waste Amendments of 1984, 42 U.S.C. §§6901 et seq.,
and any future amendments.
Receivables means all rights to the payment of a monetary obligation now or hereafter owing
to Parent, Borrower or any Subsidiary, evidenced by accounts or instruments.
Redeemable Capital Stock means any Capital Stock that, either by its terms, by the terms of
any security into which it is convertible or exchangeable or otherwise, (a) is, or upon the
happening or an event or passage of time would be, required to be redeemed on or prior to the
Termination Date; (b) is redeemable at the option of the holder thereof at any time prior to the
Termination Date; or (c) is convertible into or exchangeable for debt securities at any time prior
to the Termination Date; provided, however, that Redeemable Capital Stock shall not include shares
of Parents Series C Preferred Stock issued as Series C PIK Dividends (in each case as defined in
Parents certificate of incorporation as in effect on the date of this Agreement).
Reimbursement Obligation is defined in Section 2.2(c).
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Related Parties means, with respect to any Person, such Persons Affiliates and the
partners, members, directors, officers and employees of such Person and of such Persons
Affiliates.
Release shall mean any spilling, leaking, pumping, pouring, emitting, emptying, discharging,
injecting, escaping, leaching, dumping, disposing or migration into the environment.
Reserve Percentage means, for any Borrowing of Eurodollar Loans, the daily average for the
applicable Interest Period of the maximum rate, expressed as a decimal, at which reserves
(including, without limitation, any supplemental, marginal, and emergency reserves) are imposed
during such Interest Period by the Board of Governors of the Federal Reserve System (or any
successor) on eurocurrency liabilities, as defined in such Boards Regulation D (or in respect of
any other category of liabilities that includes deposits by reference to which the interest rate on
Eurodollar Loans is determined or any category of extensions of credit or other assets that include
loans by non-United States offices of the Lender to United States residents), subject to any
amendments of such reserve requirement by such Board or its successor, taking into account any
transitional adjustments thereto. For purposes of this definition, the Eurodollar Loans shall be
deemed to be eurocurrency liabilities as defined in Regulation D without benefit or credit for
any prorations, exemptions or offsets under Regulation D.
Responsible Officer means each of the following officers of Parent: chief executive officer,
chief operating officer and chief financial officer.
Restricted Payment means:
(a) the payment of any dividend on, or distribution in respect of, any shares of Parents
Capital Stock (other than dividends or distributions payable in shares of Parents Capital Stock or
in options, warrants or other rights to purchase such Capital Stock, but excluding dividends or
distributions payable in Redeemable Capital Stock or in options, warrants or other rights to
purchase Redeemable Capital Stock);
(b) the purchase, redemption, retirement for value, or other acquisition of and Capital Stock
of Parent or any options, warrants or other rights to acquire such Capital Stock (other than
Capital Stock issued upon the exercise of stock options and warrants in an aggregate amount after
the date of this Agreement not in excess of $500,000); and
(c) any principal payment on or voluntary repurchase, redemption, defeasement or other
acquisition or retirement for value, prior to any scheduled principal payment, sinking fund payment
or maturity, on or with respect to Subordinated Debt.
Revolving Credit means the credit facility for making Revolving Loans and issuing Letters of
Credit described in Sections 2.1 and 2.2.
Revolving Loan is defined in Section 2.1 and, as so defined, includes a Base Rate Loan and a
Eurodollar Loan, each of which is a type of Revolving Loan hereunder.
Revolving Note is defined in Section 2.10(a).
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S&P means Standard & Poors Ratings Services Group, a division of The McGraw-Hill Companies,
Inc.
Security Agreement means that certain Security Agreement dated the date of this Agreement
between, as the case may be, Borrower or any Guarantor and the Lender, as the same may be amended,
modified, supplemented or restated from time to time; and each Rider to Security Agreement between
a Borrower or any Guarantor and the Lender as the same may be amended, modified, supplemented or
restated from time to time; and Security Agreements means every Security Agreement.
Shareholder Loan mean the Indebtedness of Parent to certain of its shareholders and their
Affiliates in the outstanding amount of approximately $5,000,000 due December 31, 2006.
Specified Restricted Payment means a cash dividend with respect to Parents Series C
Convertible Preferred Stock to be paid from the proceeds of the Contemplated Subordinated Debt.
Subordinated Debt means all Indebtedness of Borrower or Guarantor for money borrowed which
is subject to, and is only entitled to the benefits of, terms and provisions (including maturity,
amortization, acceleration, interest rate, sinking fund, collateral, covenant, default and
subordination provisions) satisfactory in form and substance to the Lender, in each case as
evidenced by its written approval thereof.
Subsidiary means, as to any particular parent corporation or organization, any other
corporation or organization more than 50% of the outstanding Voting Stock of which is at the time
directly or indirectly owned by such parent corporation or organization or by any one or more other
entities which are themselves subsidiaries of such parent corporation or organization. Unless
otherwise expressly noted herein, the term Subsidiary means a Subsidiary of Parent or of any of
its direct or indirect Subsidiaries.
Telerate Page 3750 means the display designated as Page 3750 on the Telerate Service (or
such other page as may replace Page 3750 on that service or such other service as may be nominated
by the British Bankers Association as the information vendor for the purpose of displaying British
Bankers Association Interest Settlement Rates for U.S. Dollar deposits).
Termination Date means December 20, 2009 or such earlier date on which the Commitment is
terminated in whole pursuant to Section 2.9, 7.2 or 7.3.
Total Debt means, at any time the same is to be determined, the aggregate of all
Indebtedness of Parent and its Subsidiaries at such time determined on a consolidated basis in
accordance with GAAP.
Total Debt to EBITDA means, as of the last day of each Fiscal Quarter, Total Debt as of the
determination date divided by EBITDA for the four Fiscal Quarters ended on the determination date.
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TW Acquisition means Parents proposed acquisition of 100% of the outstanding equity
interests in Tutoring Worldwide, Inc. (a) for a purchase price not to exceed $7,000,000, (b) no
more than $3,000,000 of which purchase price is payable in the form of cash or Indebtedness and (c)
the balance of which purchase price is payable in the form of Capital Stock of Parent which is not
Redeemable Capital Stock.
Unfunded Vested Liabilities means, for any Plan at any time, the amount (if any) by which
the present value of all vested nonforfeitable accrued benefits under such Plan exceeds the fair
market value of all Plan assets allocable to such benefits, all determined as of the then most
recent valuation date for such Plan, but only to the extent that such excess represents a potential
liability of a member of the Controlled Group to the PBGC or the Plan under Title IV of ERISA.
Voting Stock of any Person means capital stock or other equity interests of any class or
classes (however designated) having ordinary power for the election of directors or other similar
governing body of such Person, other than stock or other equity interests having such power only by
reason of the happening of a contingency.
Welfare Plan means a welfare plan as defined in Section 3(1) of ERISA.
Wholly-owned Subsidiary means a Subsidiary of which all of the issued and outstanding shares
of Capital Stock (other than directors qualifying shares as required by law) or other equity
interests are owned by Parent and/or one or more Wholly-owned Subsidiaries within the meaning of
this definition.
1.2 Interpretation
. The foregoing definitions are equally applicable to both the singular
and plural forms of the terms defined. The words hereof, herein, and hereunder and words of
like import when used in this Agreement shall refer to this Agreement as a whole and not to any
particular provision of this Agreement. All references to time of day herein are references to
Washington, D.C., time unless otherwise specifically provided. Where the character or amount of
any asset or liability or item of income or expense is required to be determined or any
consolidation or other accounting computation is required to be made for the purposes of this
Agreement, it shall be done in accordance with GAAP except where such principles are inconsistent
with the specific provisions of this Agreement. All terms that are used in this Agreement which
are defined in the Uniform Commercial Code of the Commonwealth of Virginia as in effect from time
to time (UCC) shall have the same meanings herein as such terms are defined in the UCC, unless
this Agreement shall otherwise specifically provide.
1.3 Change in Accounting Principles
. If, after the date of this Agreement, there shall occur
any change in GAAP from those used in the preparation of the financial statements referred to in
Section 5.3 and such change shall result in a change in the method of calculation of any financial
covenant, standard or term found in this Agreement, Borrower or the Lender may by notice to the
Lender and Borrower, respectively, require that the Lender and Borrower negotiate in good faith to
amend such covenants, standards, and term so as equitably to reflect such change in accounting
principles, with the desired result being that the criteria for evaluating the financial condition
of Parent and its Subsidiaries shall be the same as if such change had not been made. No delay by
Borrower or the Lender in requiring such negotiation shall limit their right to so
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require such a negotiation at any time after such a change in accounting principles. Until
any such covenant, standard, or term is amended in accordance with this Section 1.3, financial
covenants shall be computed and determined in accordance with GAAP in effect prior to such change
in accounting principles. Without limiting the generality of the foregoing, Borrower shall neither
be deemed to be in compliance with any financial covenant hereunder nor out of compliance with any
financial covenant hereunder if such state of compliance or noncompliance, as the case may be,
would not exist but for the occurrence of a change in accounting principles after the date hereof.
2.
The Credit Facilities
.
2.1 Commitment
. Prior to the Termination Date, the Lender agrees, subject to the terms and
conditions hereof, to make revolving loans (each individually a Revolving Loan and, collectively,
the Revolving Loans) in Dollars to Borrower from time to time up to the amount of the Commitment.
As provided in Section 2.4(a), and subject to the terms hereof, Borrower may elect that each
Borrowing of Revolving Loans be either Base Rate Loans or Eurodollar Loans. Revolving Loans may be
repaid and reborrowed before the Termination Date, subject to the terms and conditions hereof.
2.2 Letters of Credit
.
(a) General Terms
. Subject to the terms and conditions hereof, as part of the Revolving
Credit, the L/C Issuer shall issue letters of credit (each a Letter of Credit) for Borrowers
account in an aggregate undrawn face amount up to the L/C Sublimit.
(b) Applications
. At any time before the Termination Date, the L/C Issuer shall, at the
request of Borrower, issue one or more Letters of Credit in Dollars, in form and substance
reasonably acceptable to the L/C Issuer, with expiration dates no later than the earlier of 12
months from the date of issuance (or which are cancelable not later than 12 months from the date of
issuance and each renewal) or 30 days prior to the Termination Date, in an aggregate face amount as
set forth above, upon the receipt of a duly executed application for the relevant Letter of Credit
in the form then customarily prescribed by the L/C Issuer for the Letter of Credit requested (each
an Application). Notwithstanding anything contained in any Application to the contrary: (1)
Borrower shall pay fees in connection with each Letter of Credit as set forth in Section 2.11(c),
and (2) if the L/C Issuer is not timely reimbursed for the amount of any drawing under a Letter of
Credit on the date such drawing is paid, Borrowers obligation to reimburse the L/C Issuer for the
amount of such drawing shall bear interest (which Borrower hereby promises to pay) from and after
the date such drawing is paid at a rate per annum equal to the sum of 2% plus the Applicable Margin
plus the Base Rate from time to time in effect (computed on the basis of a year of 365 or 366 days,
as the case may be, and the actual number of days elapsed). Without limiting the foregoing, the
L/C Issuers obligation to issue, amend or extend the expiration date of a Letter of Credit is
subject to the terms or conditions of this Agreement (including the conditions set forth in Section
3.1 and the other terms of this Section 2.2).
(c) The Reimbursement Obligations
. Subject to Section 2.2(b), the obligations of Borrower to
reimburse the L/C Issuer for all drawings under a Letter of Credit (a Reimbursement Obligation)
shall be governed by the Application related to such Letter of
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Credit, except that reimbursement shall be made by no later than 12:00 Noon (Washington, D.C.
time) on the date when each drawing is to be paid if Borrower has been informed of such drawing by
the L/C Issuer on or before 11:30 a.m. (Washington, D.C. time) on the date when such drawing is to
be paid or, if notice of such drawing is given to Borrower after 11:30 a.m. (Washington, D.C. time)
on the date when such drawing is to be paid, by the end of such day, in immediately available funds
at the L/C Issuers principal office in Washington, D.C. or such other office as the L/C Issuer may
designate in writing to Borrower. In addition, Borrower agrees that, notwithstanding any provision
of any Application, its obligations under this Section 2.2(c) and each Application shall be
absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the
terms of this Agreement and the Applications, under all circumstances whatsoever, including without
limitation (1) any lack of validity or enforceability of any Loan Document; (2) any amendment or
waiver of or any consent to departure from all or any of the provisions of any Loan Document; (3)
the existence of any claim, set-off, defense or other right Borrower may have at any time against a
beneficiary of a Letter of Credit (or any Person for whom a beneficiary may be acting), the L/C
Issuer or any other Person, whether in connection with this Agreement, another Loan Document, the
transaction related to the Letter of Credit or Application or any unrelated transaction; (4) any
statement or any other document presented under a Letter of Credit proving to be forged,
fraudulent, invalid or insufficient in any respect or any statement therein being untrue or
inaccurate in any respect; (5) payment by the L/C Issuer under a Letter of Credit against
presentation to the L/C Issuer of a draft or certificate that does not comply with the terms of the
Letter of Credit, provided that the L/C Issuers determination that documents presented under the
Letter of Credit comply with the terms thereof did not constitute fraud, gross negligence or
willful misconduct of the L/C Issuer; or (6) any other act or omission to act or delay of any kind
by the L/C Issuer or any other Person or any other event or circumstance whatsoever that might, but
for the provisions of this Section 2.2(c), constitute a legal or equitable discharge of Borrowers
obligations hereunder or under an Application.
(d) Manner of Requesting a Letter of Credit
. Borrower shall provide at least five (5)
Business Days advance written notice to the L/C Issuer of each request for the issuance of a
Letter of Credit, each such notice to be accompanied by a properly completed and executed
Application for the requested Letter of Credit and, in the case of an extension or an increase in
the amount of a Letter of Credit, a written request therefor, in a form reasonably acceptable to
the L/C Issuer, in each case, together with the fees called for by this Agreement.
2.3 Applicable Interest Rates
.
(a) Base Rate Loans
. Each Base Rate Loan made or maintained by the Lender shall bear
interest during each Interest Period it is outstanding (computed on the basis of a year of 365 or
366 days, as the case may be, and the actual days elapsed) on the unpaid principal amount thereof
from the date such Loan is advanced, continued or created by conversion from a Eurodollar Loan
until maturity (whether by acceleration or otherwise) at a rate per annum equal to the sum of the
Applicable Margin plus the Base Rate from time to time in effect, payable on the last day of its
Interest Period and at maturity (whether by acceleration or otherwise).
(b) Eurodollar Loans
. Each Eurodollar Loan made or maintained by the Lender shall bear
interest during each Interest Period it is outstanding (computed on the basis of
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a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the
date such Loan is advanced, continued or created by conversion from a Base Rate Loan until maturity
(whether by acceleration or otherwise) at a rate per annum equal to the sum of the Applicable
Margin plus the Adjusted LIBOR applicable for such Interest Period, payable on the last day of its
Interest Period and at maturity (whether by acceleration or otherwise).
(c) Default Rate
. While any Event of Default exists or after acceleration, Borrower shall
pay interest (after as well as before entry of judgment thereon to the extent permitted by law) on
the principal amount of all Loans owing by it at a rate per annum equal to:
(1)
for any Base Rate Loan, the sum of 2.0% per annum plus the Applicable Margin plus
the Base Rate from time to time in effect; and
(2)
for any Eurodollar Loan, the sum of 2.0% per annum plus the rate of interest in
effect thereon at the time of such default until the end of the Interest Period applicable
thereto and, thereafter, at a rate per annum equal to the sum of 2.0% plus the Applicable
Margin for Base Rate Loans plus the Base Rate from time to time in effect;
provided, however, that in the absence of acceleration, any adjustments pursuant to this Section
2.3(c) shall be made at the election of the Lender, with written notice to Borrower. While any
Event of Default exists or after acceleration, interest shall be paid on demand of the Lender.
(d) Rate Determinations
. The Lender shall determine each interest rate applicable to the
Loans and the Reimbursement Obligations hereunder, and its determination thereof shall be
conclusive and binding except in the case of manifest error.
2.4 Manner of Borrowing Loans and Designating Applicable Interest Rates
.
(a) Notice to the Lender
. Borrower shall give notice to the Lender by no later than 10:00
a.m. (Washington, D.C. time): (1) at least 3 Business Days before the date on which Borrower
requests the Lender to advance a Borrowing of Eurodollar Loans and (2) on the date Borrower
requests the Lender to advance a Borrowing of Base Rate Loans. The Loans included in each
Borrowing shall bear interest initially at the type of rate specified in such notice. Thereafter,
Borrower may from time to time elect to change or continue the type of interest rate borne by each
Borrowing or, subject to Section 2.5 hereof, a portion thereof, as follows: (x) if such Borrowing
is of Eurodollar Loans, on the last day of the Interest Period applicable thereto, Borrower may
continue part or all of such Borrowing as Eurodollar Loans or convert part or all of such Borrowing
into Base Rate Loans or (y) if such Borrowing is of Base Rate Loans, on any Business Day, Borrower
may convert all or part of such Borrowing into Eurodollar Loans for an Interest Period or Interest
Periods specified by Borrower. Borrower shall give all such notices requesting the advance,
continuation or conversion of a Borrowing to the Lender by telephone or facsimile transmission
(which notice shall be irrevocable once given and, if by telephone, shall be promptly confirmed in
writing), substantially in the form attached hereto as Exhibit B (Notice of Borrowing) or Exhibit C
(Notice of Continuation/Conversion), as applicable, or in such other form acceptable to the Lender.
Notice of the continuation of a Borrowing of Eurodollar Loans for an additional Interest Period or
of the conversion of part or all of a Borrowing of Base Rate Loans into Eurodollar Loans must be
given by no later than 10:00 a.m. (Washington, D.C. time)
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at least 3 Business Days before the date of the requested continuation or conversion. All
notices concerning the advance, continuation or conversion of a Borrowing shall specify the date of
the requested advance, continuation or conversion of a Borrowing (which shall be a Business Day),
the amount of the requested Borrowing to be advanced, continued or converted, the type of Loans to
comprise such new, continued or converted Borrowing and, if such Borrowing is to be comprised of
Eurodollar Loans, the Interest Period applicable thereto. Borrower agrees that the Lender may rely
on any such telephonic or telecopy notice given by any person the Lender in good faith believes is
an Authorized Representative without the necessity of independent investigation (Borrower hereby
indemnifies the Lender from any liability or loss ensuing from such good faith reliance except to
the extent caused by the Lenders gross negligence) and, in the event any such notice by telephone
conflicts with any written confirmation, such telephonic notice shall govern if the Lender has
acted in good faith reliance thereon.
(b) Notice to Borrower
. If a notice from Borrower received pursuant to Section 2.4(a)
requests the Lender to make Eurodollar Loans, the Lender shall give notice to Borrower of the
interest rate applicable thereto promptly after the Lender has made such determination.
(c) Borrowers Failure to Notify; Automatic Continuations and Conversions
. Any outstanding
Borrowing of Base Rate Loans shall automatically be continued for an additional Interest Period on
the last day of its then current Interest Period unless Borrower has properly notified the Lender
that Borrower intends to convert such Borrowing, subject to Section 3.1, into a Borrowing of
Eurodollar Loans or such Borrowing is prepaid in accordance with Section 2.7(a). If Borrower fails
to give proper notice of the continuation or conversion of any outstanding Borrowing of Eurodollar
Loans before the last day of its then current Interest Period within the period required by Section
2.4(a) or, whether or not such notice has been given, one or more of the conditions set forth in
Section 3.1 for the continuation or conversion of a Borrowing of Eurodollar Loans would not be
satisfied, and such Borrowing is not prepaid in accordance with Section 2.7(a), such Borrowing
shall automatically be converted into a Borrowing of Base Rate Loans. In the event Borrower fails
to give notice pursuant to Section 2.4(a) of a Borrowing equal to the amount of a Reimbursement
Obligation and has not notified the Lender by 1:00 p.m. (Washington, D.C. time) on the day such
Reimbursement Obligation becomes due that it intends to repay such Reimbursement Obligation through
funds not borrowed under this Agreement, Borrower shall be deemed to have requested a Borrowing of
Base Rate Loans under the Revolving Credit on such day in the amount of the Reimbursement
Obligation then due, which Borrowing shall be applied to pay the Reimbursement Obligation then due.
(d) Disbursement of Loans
. Not later than 1:00 p.m. (Washington, D.C. time) on the date of
any requested advance of a new Borrowing, subject to Section 3, the Lender shall make the proceeds
of each new Borrowing available to Borrower by crediting such proceeds to an account maintained
with the Lender specified by Borrower in its notice requesting a Loan.
2.5 Minimum Borrowing Amounts; Maximum Eurodollar Loans
. Each Borrowing of Base Rate Loans
shall be in an amount not less than $100,000. Each Borrowing of Eurodollar Loans advanced,
continued or converted shall be in an amount equal to $500,000 or such greater
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amount which is an integral multiple of $250,000. Without the Lenders consent, there shall not be more than 5
Borrowings of Eurodollar Loans outstanding at any one time.
2.6 Maturity of Loans
. Each Revolving Loan, both for principal and interest, shall mature
and become due and payable by Borrower on the Termination Date.
2.7 Prepayments
.
(a) Voluntary
. Borrower may prepay without premium or penalty (except as set forth in
Section 8.1) and in whole or in part any Borrowing of Eurodollar Loans at any time upon 3 Business
Days prior notice by Borrower to the Lender or, in the case of a Borrowing of Base Rate Loans,
notice delivered by Borrower to the Lender no later than 10:00 a.m. (Washington, D.C. time) on the
date of prepayment, such prepayment to be made by the payment of the principal amount to be prepaid
and, in the case of any Eurodollar Loans, accrued interest thereon to the date fixed for prepayment
plus any amounts due the Lender under Section 8.1; provided, however, except in the case where
Borrower wishes to pay in full an outstanding Eurodollar Loan or all Base Rate Loans and except for
any prepayment described in Section 2.7(b), Borrower may not partially repay a Borrowing (1) if
such Borrowing is of Base Rate Loans, in a principal amount less than $100,000, (2) if such
Borrowing is of Eurodollar Loans, in a principal amount less than $250,000, and (3) in each case,
unless it is in an amount such that the minimum amount required for a Borrowing pursuant to Section
2.5 remains outstanding.
(b) Mandatory
.
(1)
Borrower shall, on each date the Commitment is reduced pursuant to Section 2.9,
prepay the Revolving Loans and, if necessary, prefund the L/C Obligations by the amount, if
any, necessary to reduce the sum of the aggregate principal amount of Revolving Loans and
L/C Obligations then outstanding to the amount to which the Commitment has been so reduced.
(2)
Unless Borrower otherwise directs, prepayments of Loans under this Section 2.7(b)
shall be applied first to Borrowings of Base Rate Loans until payment in full thereof with
any balance applied to Borrowings of Eurodollar Loans in the order in which their Interest
Periods expire. Each prepayment of Loans under this Section 2.7(b) shall be made by the
payment of the principal amount to be prepaid and, in the case of any Eurodollar Loans,
accrued interest thereon to the date of prepayment together with any amounts due the Lender
under Section 8.1. Each prefunding of L/C Obligations shall be made in accordance with
Section 7.4.
2.8 Place and Application of Payments
. All payments of principal of and interest on the
Loans and the Reimbursement Obligations, and of all other Obligations payable by Borrower under
this Agreement and the other Loan Documents, shall be made by Borrower to the Lender by no later
than 12:00 Noon (Washington, D.C. time) on the due date thereof at the office of the Lender in
Washington, D.C. (or such other location as the Lender may designate in writing to Borrower). Any
payments received after such time shall be deemed to have been received by the Lender on the next
Business Day. All such payments shall be made in Dollars, in immediately available funds at the
place of payment, in each case without set-off or counterclaim
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Anything contained herein to the contrary notwithstanding, (a) pursuant to the exercise of
remedies under Sections 7.2 and 7.3 or (b) after the occurrence and during the continuation of an Event of Default, all payments and collections received in respect of the
Obligations and all proceeds of the Collateral received by the Lender shall be applied as follows:
(1)
first, to the payment of any outstanding costs and expenses incurred by the
Lender, and any security trustee therefor, in accordance with the terms and conditions of
the Loan Documents, in monitoring, verifying, protecting, preserving or enforcing the Liens
on the Collateral, in protecting, preserving or enforcing rights under the Loan Documents,
and in any event all costs and expenses of a character which Borrower has agreed to pay the
Lender under Section 9.12;
(2)
second, to the payment of any outstanding interest and fees due under the Loan
Documents;
(3)
third, to the payment of principal on the Note, unpaid Reimbursement Obligations,
together with amounts to be held by the L/C Issuer as collateral security for any
outstanding L/C Obligations pursuant to Section 7.4 (until the L/C Issuer is holding an
amount of cash equal to the then outstanding amount of all such L/C Obligations), and
Hedging Liability;
(4)
fourth, to the payment of all other unpaid Obligations and all other indebtedness,
obligations, and liabilities of Parent, Borrower and their Subsidiaries secured by the
Collateral Documents (including, without limitation, Funds Transfer and Deposit Account
Liability); and
(5)
fifth, to Borrower or whoever else may be lawfully entitled thereto.
2.9 Voluntary Commitment Terminations
. Borrower shall have the right at any time and from
time to time, upon 3 Business Days prior written notice to the Lender, to terminate the Commitment
in whole or in part, any partial termination to be in an amount not less than $500,000 or such
greater amount which is an integral multiple of $100,000, provided that the Commitment may not be
reduced to an amount less than the sum of the aggregate principal amount of Revolving Loans, and of
L/C Obligations then outstanding. Any termination of the Commitment below the L/C Sublimit then in
effect shall reduce the L/C Sublimit by a like amount. Any termination of the Commitment pursuant
to this Section 2.9 may not be reinstated.
2.10 The Note
.
(a) Issuance
. The Revolving Loans made to Borrower by the Lender shall be evidenced by a
single promissory note of Borrower issued to the Lender in the form of Exhibit D. Such promissory
note is hereinafter referred to as a Revolving Note.
(b) Outstanding Amount
. The Lender shall record on its books and records or on a schedule to
its Note the amount and type of each Loan advanced, continued or converted by it, all payments of
principal and interest and the principal balance from time to time outstanding thereon, and, for
any Eurodollar Loan, the Interest Period and the interest rate applicable thereto. The Lenders
record thereof, whether shown on its books and records or on a schedule to the relevant Note, shall
be prima facie evidence as to all such matters; provided, however, that the failure of the Lender
to record any of the foregoing or any error in any such record shall not limit
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or otherwise affect the obligation of Borrower to repay all Loans made to it together with
accrued interest thereon. At the request of the Lender and upon the Lenders tendering to Borrower
the Note to be replaced, Borrower shall furnish a new Note to the Lender to replace any outstanding
Note, and at such time the first notation appearing on a schedule on the reverse side of, or
attached to, such new Note shall set forth the aggregate unpaid principal amount of all Loans, if
any, then outstanding thereon.
2.11 Fees
.
(a) Closing Fee
. Borrower shall pay to the Lender a closing fee on the date hereof in the
amount of $25,000.
(b) Commitment Fee
. Borrower shall pay to the Lender an unused commitment fee equal to the
Applicable Margin applied to the daily average unused portion of the Commitment, payable quarterly
in arrears commencing on December 31, 2006 and on the last day of each calendar quarter thereafter
and when the Loans are due. The unused commitment fee shall be computed on the basis of a 365/366
day year (as the case may be).
(c) Letter of Credit Fees
. On the date of issuance or extension, or increase in the amount,
of any Letter of Credit pursuant to Section 2.2, Borrower shall pay to the L/C Issuer a letter of
credit fee at a rate per annum equal to the Applicable Margin for Eurodollar Loans (computed on the
basis of a year of 360 days and the actual number of days) applied to the face amount of such
Letter of Credit and the term thereof. In addition, Borrower shall pay the L/C Issuers standard
issuance, drawing, negotiation, amendment, transfer and other administrative fees for each Letter
of Credit. Such standard fees referred to in the preceding sentence may be established by the L/C
Issuer from time to time.
(d) Audit Fees
. Borrower shall pay to the Lender charges for audits of the Collateral
performed by the Lender or its agents or representatives in such amounts as the Lender may from
time to time reasonably request (the Lender acknowledging and agreeing that such charges shall be
computed in the same manner as it at the time customarily uses for the assessment of charges for
similar collateral audits); provided, however, that in the absence of any Default and Event of
Default (1) Borrower shall not be required to pay for any such audit if no Loans or L/C Obligations
are outstanding at the time of such audit, and (2) Borrower shall not be required to pay for more
than one such audit in any 12 month period.
3.
Conditions Precedent
. The obligation of the Lender to advance, continue or
convert any Loan (other than the continuation of, or conversion into, a Base Rate Loan) or of the
L/C Issuer to issue, extend the expiration date (including by not giving notice of non-renewal) of
or increase the amount of any Letter of Credit under this Agreement, shall be subject to the
following conditions precedent:
3.1 All Credit Events
. At the time of each Credit Event hereunder:
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(a) Representations Correct
. Each of the representations and warranties set forth herein and
in the other Loan Documents shall be and remain true and correct in all material respects as of
said time, except to the extent the same expressly relate to an earlier date.
(b) No Default
. Parent, Borrower and each Subsidiary shall be in compliance with all of the
terms and conditions hereof and of the other Loan Documents, and no Default or Event of Default
shall have occurred and be continuing or would occur as a result of such Credit Event.
(c) Within Commitment
. After giving effect to any requested extension of credit, the
aggregate principal amount of all Revolving Loans and L/C Obligations under this Agreement shall
not exceed the Commitment.
(d) Notices
. In the case of a Borrowing the Lender shall have received the notice required
by Section 2.4(a), in the case of the issuance of any Letter of Credit the L/C Issuer shall have
received a duly completed Application together with any fees called for by Section 2.11, and, in
the case of an extension or increase in the amount of a Letter of Credit, a written request
therefor in a form acceptable to the L/C Issuer together with fees called for by Section 2.11.
(e) No Violation
. Such Credit Event shall not violate any order, judgment or decree of any
court or other authority or any provision of law or regulation applicable to the Lender or the
Lender (including, without limitation, Regulation U of the Board of Governors of the Federal
Reserve System) as then in effect.
Each request for a Borrowing hereunder and each request for the issuance of, increase in the
amount of, or extension of the expiration date of, a Letter of Credit shall be deemed to be a
representation and warranty by Borrower on the date of such Credit Event as to the facts specified
in Sections 3.1(a) through 3.1(d).
3.2 Initial Credit Event
. Before or concurrently with the initial Credit Event:
(a) Note
. The Lender shall have received a duly executed Note of Borrower dated the date
hereof and otherwise in compliance with the provisions of Section 2.10.
(b) Guaranties
. The Lender shall have received the Guaranties duly executed by each
Guarantor.
(c) Security Agreements
. The Lender shall have received the Security Agreements duly
executed by Borrower and the Guarantors, together with (1) UCC financing statements to be filed
against each of them, as debtor, in favor of the Lender, as secured party, and (2) deposit account,
securities account, and commodity account control agreements to the extent requested by the Lender;
(d) Pledge Agreements
. The Lender shall have received the Pledge Agreements duly executed by
Parent and any Guarantor together with the documents required by the Pledge Agreements.
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(e) Evidence of Insurance
. The Lender shall have received evidence of insurance required to
be maintained under the Loan Documents, naming the Lender as lender loss payee.
(f) Governing Documents
. The Lender shall have received copies of each Borrowers and
Guarantors articles of incorporation and bylaws (or comparable organizational documents) and any
amendments thereto, certified in each instance;
(g) Authorizing Resolutions
. The Lender shall have received copies of resolutions of each
Borrowers and Guarantors governing body authorizing the execution, delivery and performance of
this Agreement and the other Loan Documents to which it is a party and the consummation of the
transactions contemplated hereby and thereby, together with incumbency certificates and specimen
signatures of the persons authorized to execute such documents on Borrowers or Guarantors behalf,
all certified in each instance;
(h) Good Standing
. The Lender shall have received copies of the certificates of existence or
good standing, as appropriate, for each Borrower and Guarantor (dated no earlier than 30 days prior
to the date hereof) from the office of the secretary of state or other appropriate governmental
department or agency of the state of its incorporation or organization and of each state in which
it is qualified to do business as a foreign organization.
(i) Authorized Representatives
. The Lender shall have received a list of the Authorized
Representatives.
(j) Fees
. The Lender shall have received the initial fees called for by Section 2.11.
(k) Diligence
. The Lender shall have received such evaluations and certifications as it may
reasonably require in order to satisfy itself as to the value of the Collateral, the financial
condition of Parent and Borrower, and the lack of material contingent liabilities of Parent and
Borrower.
(l) Lien Searches
. The Lender shall have received financing statement, tax, and judgment
lien search results against the Property of Borrower and each Guarantor evidencing the absence of
Liens on its respective Property except for Permitted Liens.
(m) Opinion of Counsel
. The Lender shall have received the favorable written opinion of
counsel to Borrower, in form and substance satisfactory to the Lender.
(n) Other Documents
. The Lender shall have received such other agreements, instruments,
documents, certificates, and opinions as it may reasonably request.
4.
The Collateral and Guaranties
.
4.1 Collateral
. The Obligations, Hedging Liability, and Funds Transfer and Deposit Account
Liability shall be secured by valid, perfected, and enforceable Liens on all right, title, and
interest of Borrower and each Subsidiary in all Inventory, Receivables, monies and deposit
accounts, tangible personal property, real estate, contract rights (to the extent permissible under
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applicable law and the terms of the underlying contracts), chattel paper and general intangibles
whether now owned or hereafter acquired or arising, and all proceeds thereof; provided, however,
that until a Default or Event of Default has occurred and is continuing and thereafter until
otherwise required by the Lender, Liens on local petty cash deposit accounts maintained by
Borrower and the Subsidiaries in proximity to their operations need not be perfected, provided
that the total amount on deposit at any one time not so perfected shall not exceed $50,000 in the
aggregate and Liens on payroll accounts maintained by Borrower and the Subsidiaries need not be
perfected, provided that the total amount on deposit at any time does not exceed the current amount
of their payroll obligations. Borrower acknowledges and agrees that the Liens on the Collateral
shall be valid and perfected first priority Liens subject, however, to the Permitted Liens and the
proviso appearing at the end of the immediately preceding sentence, in each case pursuant to one or
more Collateral Documents from such Persons, each in form and substance satisfactory to the Lender.
4.2 Guaranties
. The payment and performance of all Obligations, Hedging Liability, and Funds
Transfer and Deposit Account Liability shall at all times be guaranteed by each direct and indirect
Subsidiary of Parent (other than a Borrower) pursuant to one or more guaranty agreements in form
and substance acceptable to the Lender, as the same may be amended, modified or supplemented from
time to time (individually a Guaranty and collectively the Guaranties).
4.3 Further Assurances
. Borrowers agree that each of them shall, and shall cause each
Subsidiary to, from time to time at the reasonable request of the Lender, execute and deliver such
documents and do such acts and things as the Lender may reasonably request in order to provide for
or perfect or protect such Liens on the Collateral. If Borrower or any Subsidiary forms or
acquires any other Subsidiary after the date hereof, such Person shall promptly upon such formation
or acquisition cause such newly formed or acquired Subsidiary to execute a Guaranty and such
Collateral Documents as the Lender may then reasonably require, and Borrower shall also deliver to
the Lender, or cause such Subsidiary to deliver to the Lender, at Borrowers cost and expense, such
other instruments, documents, certificates, and opinions reasonably required by the Lender in
connection therewith.
5.
Representations and Warranties
. Borrower represents and warrants to the Lender
and agrees, that all representations and warranties of and by Borrower made in the Loan Documents
or any instruments or documents delivered pursuant thereto constitute the joint and several
representations and warranties of and by each and all Borrowers, except to the extent explicitly
otherwise provided, and further that:
5.1 Organization and Qualification
. Parent and each of its Subsidiaries (1) is duly
organized, validly existing and in good standing under the laws of the jurisdiction of its
organization, (2) has the power and authority to own its property and to transact the business in
which it is engaged and (3) is duly qualified and in good standing in each jurisdiction where the
ownership, leasing or operation of property or the conduct of its business requires such
qualification and where the lack of such qualification or good standing could reasonably be
expected to have a Material Adverse Effect.
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5.2 Authority and Enforceability
. Each of Parent and Borrower has full right and authority
to enter into this Agreement and the other Loan Documents executed by it, to make the borrowings
herein provided for, to issue its Note in evidence thereof, to grant to the Lender the Liens
described in the Collateral Documents executed by such Person, and to perform all of its
obligations hereunder and under the other Loan Documents executed by it. Each Subsidiary that
is not also Borrower, if any, has full right and authority to enter into the Loan Documents
executed by it, to guarantee the Obligations, Hedging Liability, and Funds Transfer and Deposit
Account Liability, to grant to the Lender the Liens described in the Collateral Documents executed
by such Person, and to perform all of its obligations under the Loan Documents executed by it. The
Loan Documents delivered by Borrower and by each Subsidiary that is not also Borrower, if any, have
been duly authorized, executed, and delivered by such Person and constitute valid and binding
obligations of such Person enforceable against it in accordance with their terms, except as
enforceability may be limited by bankruptcy, insolvency, fraudulent conveyance or similar laws
affecting creditors rights generally and general principles of equity (regardless of whether the
application of such principles is considered in a proceeding in equity or at law); and this
Agreement and the other Loan Documents do not, nor does the performance or observance by Borrower
or any Subsidiary of any of the matters and things herein or therein provided for, (a) contravene
or constitute a default under any provision of law or any judgment, injunction, order or decree
binding upon Borrower or any Subsidiary or any provision of the organizational documents (e.g.,
charter, articles of organization or incorporation or by-laws, articles of association or operating
agreement, partnership agreement or other similar document) of Borrower or any Subsidiary, (b)
contravene or constitute a default under any covenant, indenture or agreement of or affecting
Borrower or any Subsidiary or any of its Property, in each case where such contravention or
default, individually or in the aggregate, could reasonably be expected to have a Material Adverse
Effect or (c) result in the creation or imposition of any Lien on any Property of Borrower or any
Subsidiary other than the Liens granted in favor of the Lender pursuant to the Collateral
Documents.
5.3 Financial Reports
. The audited consolidated financial statements of Parent dated June
30, 2005, the unaudited consolidated financial statements of Parent dated June 30, 2006, and the
unaudited interim consolidated financial statements of Parent dated September 30, 2006, for the 3
months then ended, heretofore furnished to the Lender, fairly present in all material respects the
consolidated financial condition of Parent and its Subsidiaries at said dates and the consolidated
results of their operations and cash flows for the periods then ended in conformity with GAAP
applied on a consistent basis, except that such unaudited statements to not contain the footnote
disclosures required by GAAP and that such unaudited interim statements may exclude immaterial
adjustments (that are to be reflected in year-end adjustments). Neither Parent nor any Subsidiary
has contingent liabilities or judgments, orders or injunctions against it that are material to it
other than as indicated on the notes to the audited consolidated financial statements of Parent
dated June 30, 2005, or, with respect to future periods, on the financial statements furnished
pursuant to Section 6.1.
5.4 No Material Adverse Change
. Since June 30, 2006, except as set forth on Schedule 5.4,
there has been no Material Adverse Effect.
5.5 Litigation and other Controversies
. Except as set forth on Schedule 5.5, there is no
litigation, arbitration or governmental proceeding pending or, to the knowledge of Parent and its
Subsidiaries, threatened against Parent or any of its Subsidiaries that could reasonably be
expected to have a Material Adverse Effect.
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5.6 True and Complete Disclosure
. To their best knowledge, all information furnished by or
on behalf of Parent or any of its Subsidiaries in writing to the Lender for purposes
of or in connection with this Agreement, or any transaction contemplated herein, is true and
accurate in all material.
5.7 Use of Proceeds; Margin Stock
. (a) All proceeds of Loans shall be used by Borrower for
working capital purposes and other general business or corporate purposes of Parent and its
Subsidiaries. No part of the proceeds of any Loan or other extension of credit hereunder will be
used by Parent or any Subsidiary thereof to purchase or carry any margin stock (within the meaning
of Regulation U of the Board of Governors of the Federal Reserve System) or to extend credit to
others for the purpose of purchasing or carrying any margin stock. Neither the making of any Loan
or other extension of credit hereunder nor the use of the proceeds thereof will violate or be
inconsistent with the provisions of Regulations T, U or X of the Board of Governors of the Federal
Reserve System and any successor to all or any portion of such regulations. Margin Stock (as
defined above) constitutes less than 25% of the value of those assets of Parent and its
Subsidiaries that are subject to any limitation on sale, pledge or other restriction hereunder.
5.8 Taxes
. Parent and each of its Subsidiaries has timely filed or caused to be timely
filed (or filed, or caused to be filed, a proper extension to allow later filing of) all tax
returns required to be filed by Parent and/or any of its Subsidiaries and the failure of which
could reasonably be expected to result in a Material Adverse Effect. Parent and each of its
Subsidiaries has paid all taxes, assessments and other governmental charges payable by them other
than taxes, assessments and other governmental charges which are not delinquent or are being
contested in good faith with adequate reserves established therefor in accordance with GAAP and as
to which no Liens exist, except for Permitted Liens.
5.9 ERISA
. Parent and each other member of its Controlled Group has fulfilled its
obligations under the minimum funding standards of, and is in compliance in all material respects
with, ERISA and the Code to the extent applicable to it and, other than a liability for premiums
under Section 4007 of ERISA, has not incurred any liability to the PBGC or a Plan under Title IV of
ERISA. Parent and its Subsidiaries have no contingent liabilities with respect to any
post-retirement benefits under a welfare plan, as defined in Section 3(1) of ERISA, other than
liability for continuation coverage described in article 6 of Title 1 of ERISA.
5.10 Subsidiaries
. Schedule 5.10 correctly sets forth, as of the Closing Date, each
Subsidiary of Parent, its respective jurisdiction of organization and the percentage ownership
(direct and indirect) of Parent in each class of Capital Stock or other equity interests of each of
its Subsidiaries and also identifies the direct owner thereof.
5.11 Compliance with Laws
. Parent and each of its Subsidiaries is in compliance with all
applicable statutes, regulations and orders of, and all applicable restrictions imposed by, all
governmental authority, or any subdivision thereof, in respect of the conduct of their businesses
and the ownership of their property, except such noncompliances as could not reasonably be expected
to have, either individually or in the aggregate, a Material Adverse Effect.
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5.12 Environmental Matters
. To the best of its knowledge, Parent and each of its
Subsidiaries is in compliance with all applicable Environmental Laws and the requirements of any
permits issued under Environmental Laws, except to the extent that the aggregate effect of all
noncompliances could not reasonably be expected to have a Material Adverse Effect. There are
no pending with respect to which it has received written notice or, to the best knowledge of
Parent and its Subsidiaries, threatened Environmental Claims, including any such claims (regardless
of materiality) for liabilities under CERCLA relating to the disposal of Hazardous Materials,
against Parent or any of its Subsidiaries or any real property, including leaseholds, owned or
operated by Parent or any of its Subsidiaries. There are no facts, circumstances, conditions or
occurrences on any real property, including leaseholds, owned or operated by Parent or any of its
Subsidiaries that, to the best knowledge of Parent and its Subsidiaries, could reasonably be
expected (1) to form the basis of an Environmental Claim against Parent or any of its Subsidiaries
or any such real property, or (2) to cause any such real property to be subject to any restrictions
on the ownership, occupancy, use or transferability of such real property by Parent or any of its
Subsidiaries under any applicable Environmental Law. Hazardous Materials have not been Released on
or from any real property, including leaseholds, owned or operated by Parent or any of its
Subsidiaries where such Release, individually, may reasonably be expected to require Parent or any
of its Subsidiaries to expend in excess of $10,000 in response costs under any applicable
Environmental Law.
5.13 Investment Company
. Neither Parent nor any Subsidiary is an investment company or a
company controlled by an investment company within the meaning of the Investment Company Act of
1940, as amended.
5.14 Intellectual Property
. Parent and each of its Subsidiaries owns all the patents,
trademarks, permits, service marks, trade names, copyrights, franchises and formulas, or rights
with respect to the foregoing, or each has obtained licenses of all other rights of whatever nature
necessary for the present conduct of its businesses, in each case without any known conflict with
the rights of others which, or the failure to obtain which, as the case may be, could reasonably be
expected to result in a Material Adverse Effect.
5.15 Good Title
. Parent and its Subsidiaries have good and marketable title, or valid
leasehold interests, to their material assets as reflected on Parents most recent consolidated
balance sheet provided to the Lender, except for sales of assets in the ordinary course of
business, subject to no Liens, other than Permitted Liens.
5.16 Labor Relations
. Neither Parent nor any of its Subsidiaries is engaged in any unfair
labor practice that could reasonably be expected to have a Material Adverse Effect. There is (1)
no strike, labor dispute, slowdown or stoppage pending against Parent or any of its Subsidiaries
or, to the best knowledge of Parent and its Subsidiaries, threatened against Parent or any of its
Subsidiaries and (2) to the best knowledge of Parent and its Subsidiaries, no union representation
proceeding is pending with respect to the employees of Parent or any of its Subsidiaries and no
union organizing activities are taking place, except (with respect to any matter specified in
clause (1) or (2) above) such as could not reasonably be expected to have a Material Adverse
Effect.
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5.17 Capitalization
. All outstanding equity interests of Parent and each Subsidiary have
been duly authorized and validly issued, and are fully paid and nonassessable, and there are no
outstanding commitments or other obligations of Parent or any Subsidiary to issue, and no rights of
any Person to acquire, any equity interests in Parent or any Subsidiary except as set forth on
Schedule 5.17.
5.18 Other Agreements
. Neither Parent nor any Subsidiary is in default under the terms of
any covenant, indenture or agreement of or affecting Parent, any Subsidiary or any of their
Property, which default if uncured could reasonably be expected to have a Material Adverse Effect.
5.19 Governmental Authority and Licensing
. Parent and its Subsidiaries have received all
licenses, permits, and approvals of all federal, state, local, and foreign governmental
authorities, if any, necessary to conduct their businesses, in each case where the failure to
obtain or maintain the same could reasonably be expected to have a Material Adverse Effect. No
investigation or proceeding that, if adversely determined, could reasonably be expected to result
in revocation or denial of any material license, permit or approval is pending and for which Parent
or any of its Subsidiaries has received written notice or, to the knowledge of Parent and its
Subsidiaries, threatened.
5.20 Approvals
. No authorization, consent, license or exemption from, or filing or
registration with, any court or governmental department, agency or instrumentality, nor any
approval or consent of any other Person, is or will be necessary to the valid execution, delivery
or performance by Parent or any Subsidiary of any Loan Document, except for such approvals which
have been obtained prior to the date of this Agreement and remain in full force and effect.
5.21 Affiliate Transactions
. Except as set forth on Schedule 5.21, neither Parent nor any
Subsidiary is a party to any contracts or agreements with any of its Affiliates (other than with
Borrower or Wholly-owned Subsidiaries) on terms and conditions which are less favorable to Parent
or such Subsidiary than would be usual and customary in similar contracts or agreements between
Persons not affiliated with each other.
5.22 Solvency
. Parent and its Subsidiaries are solvent, able to pay their debts as they
become due, and have sufficient capital to carry on their business.
5.23 OFAC
. Neither Parent nor any of its Subsidiaries is (1) a person whose property or
interest in property is blocked or subject to blocking pursuant to Section 1 of Executive Order
13224 of September 23, 2001 Blocking Party and Prohibiting Transactions With Persons Who Commit,
Threaten to Commit, or Support Terrorism (66 Fed. Reg. 49079 (2001)), (2) a person who engages in
any dealings or transactions prohibited by Section 2 of such executive order, or is otherwise
associated with any such person in any manner violative of Section 2, or (3) a person on the list
of Specially Designated Nationals and Blocked Persons or subject to the limitations or prohibitions
under any other U.S. Department of Treasurys Office of Foreign Assets Control regulation or
executive order.
5.24 Patriot Act
. Parent and each of its Subsidiaries is in compliance, in all material
respects, with the USA Patriot Act (Title III of Pub. L. 107-56 (signed into law October 26,
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2001)) (the Patriot Act). No part of the proceeds of the Loans will be used, directly or indirectly,
for any payments to any governmental official or employee, political party, official of a political
party, candidate for political office, or anyone else acting in an official capacity, in order to
obtain, retain or direct business or obtain any improper advantage, in violation of the United
States Foreign Corrupt Practices Act of 1977, as amended.
6.
Covenants
. Each Borrower covenants and agrees, jointly and severally, that, so
long as any Loans or Letter of Credit are available to Borrower hereunder and until all Obligations
are paid in full:
6.1 Information Covenants
. Parent will furnish to the Lender:
(a) Quarterly Reports
. Within 45 days after the end of each Fiscal Quarter, Parents
consolidated and consolidating balance sheet as at the end of such quarter and the related
consolidated and consolidating statement of operations for such quarter and for the elapsed portion
of the Fiscal Year-to-date period then ended, each in reasonable detail, prepared in accordance
with GAAP, setting forth comparative consolidated figures for the corresponding periods in the
prior Fiscal Year of Parent and comparable consolidated budgeted figures for the current Fiscal
Quarter and the elapsed portion of the Fiscal Year-to-date period then ended, all of which shall be
certified by the chief financial officer or other officer of Parent, acceptable to the Lender that
they fairly present in all material respects in accordance with GAAP the financial condition of
Parent and its Subsidiaries as of the dates indicated and the results of their operations for the
periods indicated, subject to normal year-end audit adjustments and the absence of footnotes.
(b) Annual Statements
. Within 120 days after the close of each Fiscal Year of Parent, a copy
of Parents consolidated and consolidating balance sheet as of the last day of the Fiscal Year then
ended and Parents consolidated and consolidating statement of operations and consolidated
statements of shareholders equity and cash flows for the Fiscal Year then ended, and accompanying
notes thereto, each in reasonable detail showing in comparative form the consolidated figures for
the previous Fiscal Year, accompanied by an unqualified opinion of a firm of independent public
accountants of recognized national standing, selected by Parent and reasonably acceptable to the
Lender, to the effect that the consolidated financial statements have been prepared in accordance
with GAAP and present fairly in accordance with GAAP the consolidated financial condition of Parent
and its Subsidiaries as of the close of such Fiscal Year and the results of their operations and
cash flows for the Fiscal Year of Parent then ended and that the examination by such accountants in
connection with such financial statements has been made in accordance with generally accepted
auditing standards.
(c) Officers Certificates
. At the time of the delivery of the financial statements provided
for in Sections 6.1(a) and 6.1(b), a certificate of the chief financial officer or other officer of
Parent acceptable to the Lender in the form of Exhibit A (x) stating no Default or Event of Default
has occurred during the period covered by such statements or, if a Default or Event of Default
exists, a detailed description of the Default or Event of Default and all actions Borrower is
taking with respect to such Default or Event of Default, (y) confirming that the representations
and warranties stated in Section 5 remain true and correct in all material respects (except to the
extent such representations and warranties relate to an earlier date, in which case
-30-
they are true and correct in all material respects as of such date), and (z) showing Borrowers compliance with
the covenants set forth in Section 6.21.
(d) Budgets
. As soon as available, but in any event at least 90 days after the first day of
each Fiscal Year of Parent, a budget in form reasonably satisfactory to the Lender (including
budgeted consolidated statements of operations and cash flows for Parent and its
Subsidiaries) of Parent and its Subsidiaries in reasonable detail for the four Fiscal Quarters
of the current Fiscal Year of Parent and, with appropriate discussion, the principal assumptions
upon which such budget is based.
(e) Contract Backlog Report
. As soon as available, but in any event at least 90 days after
the first day of each Fiscal Year of Parent, a contract backlog report for all contracts that
generate at least $1,000,000 in annual revenue in form reasonably satisfactory to the Lender
(including, without limitation, a summary of all such contract terms) of Parent and its
Subsidiaries in reasonable detail as of the first day of each such Fiscal Year of Parent.
(f) Notice of Default or Litigation
. Promptly, and in any event within three Business Days
after any Responsible Officer of Parent or Borrower obtains knowledge thereof, notice of (1) the
occurrence of any event which constitutes a Default or an Event of Default or any other event which
could reasonably be expected to have a Material Adverse Effect, which notice shall specify the
nature thereof, the period of existence thereof and what action Borrower proposes to take with
respect thereto, (2) the commencement of, or threat of, or any significant development in, any
litigation, labor controversy, arbitration or governmental proceeding pending against Parent or any
of its Subsidiaries which, if adversely determined, could reasonably be expected to have a Material
Adverse Effect.
(g) Management Letters
. Promptly upon presentation to Parent or Parents audit committee, a
copy of each report or any management letter submitted to Parent or any of its Subsidiaries by
its certified public accountants and the managements responses thereto.
(h) Environmental Matters
. Promptly upon, and in any event within five Business Days after
any Responsible Officer of Parent or Borrower obtains knowledge thereof, notice of one or more of
the following environmental matters which may reasonably be expected to have a Material Adverse
Effect: (1) any notice of Environmental Claim against Parent or any of its Subsidiaries or any real
property owned or operated by Parent or any of its Subsidiaries; (2) any condition or occurrence on
or arising from any real property owned or operated by Parent or any of its Subsidiaries that (A)
results in noncompliance by Parent or any of its Subsidiaries with any applicable Environmental Law
or (B) could reasonably be expected to form the basis of an Environmental Claim against Parent or
any of its Subsidiaries or any such real property; (3) any condition or occurrence on any real
property owned or operated by Parent or any of its Subsidiaries that could reasonably be expected
to cause such real property to be subject to any restrictions on the ownership, occupancy, use or
transferability by Parent or any of its Subsidiaries of such real property under any Environmental
Law; and (4) any removal or remedial actions to be taken in response to the actual or alleged
presence of any Hazardous Material on any real property owned or operated by Parent or any of its
Subsidiaries as required by any Environmental Law or any governmental or other administrative
agency. All such notices shall describe in reasonable detail the nature of the claim,
investigation, condition,
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occurrence or removal or remedial action and Parents or such
Subsidiarys response thereto. In addition, Parent and Borrower agree to provide the Lender with
copies of all material written communications by Parent or any of its Subsidiaries with any Person,
government or governmental agency relating to any of the matters set forth in clauses (1)-(4)
above, and such detailed reports relating to any of the matters set forth in clauses (1)-(4) above
as may reasonably be requested by the Lender.
(i) Other Information
. From time to time, such other information or documents (financial or
otherwise) as the Lender may reasonably request in writing.
6.2 Inspections
. Parent will, and will cause each Subsidiary to, permit officers,
representatives and agents of the Lender, to visit and inspect any Property of Parent or such
Subsidiary, and, subject to Section 2.11(d), to examine the books of account of Parent or such
Subsidiary and discuss the affairs, finances and accounts of Parent or such Subsidiary with its and
their executive officers and independent accountants, all at such reasonable times and with
reasonable notice as the Lender may request.
6.3 Maintenance of Property, Insurance, etc
. Parent will, and will cause each of its
Subsidiaries to, (1) keep its material property, plant and equipment in reasonably good repair,
working order and condition, normal wear and tear excepted, and shall from time to time make all
necessary and proper repairs, renewals, replacements, extensions, additions, betterments and
improvements thereto so that at all times such property, plant and equipment are reasonably
preserved and maintained and (2) maintain in full force and effect with financially sound and
reputable insurance companies insurance which provides substantially the same (or greater) coverage
and against at least such risks as is in accordance with industry practice, and shall furnish to
the Lender upon written request full information as to the insurance so carried. In any event,
Parent shall, and shall cause each of its Subsidiaries to, maintain insurance on the Collateral to
the extent required by the Collateral Documents.
6.4 Preservation of Existence
. Parent will, and will cause each of its Subsidiaries to, do
or cause to be done, all things necessary to preserve and keep in full force and effect its
existence and, except where the failure to do so would not reasonably be expected to have a
Material Adverse Effect, its franchises, authority to do business, permits, licenses, patents,
trademarks, copyrights and other proprietary rights; provided, however, that nothing in this
Section 6.4 shall prevent, to the extent permitted by Section 6.13, sales of assets by Parent or
any of its Subsidiaries, or the merger or consolidation between or among the Subsidiaries of
Parent.
6.5 Compliance with Laws
. Parent shall, and shall cause each of its Subsidiaries to, comply
in all respects with the requirements of all federal, state, local, and foreign laws, rules,
regulations, ordinances and orders applicable to its property or business operations, where any
such non-compliance could reasonably be expected to have a Material Adverse Effect or result in a
Lien upon any of its material Property.
6.6 ERISA
. Parent shall, and shall cause each of its Subsidiaries to, promptly pay and
discharge all obligations and liabilities arising under ERISA of a character which if unpaid or
unperformed could reasonably be expected to have a Material Adverse Effect or result in a Lien upon
any of its material Property. Parent shall, and shall cause each of its Subsidiaries to,
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promptly notify the Lender of: (a) the occurrence of any material reportable event (as defined in ERISA)
with respect to a Plan, (b) receipt of any notice from the PBGC of its intention to seek
termination of any material Plan or appointment of a trustee therefor, (c) its intention to
terminate or withdraw from any material Plan, and (d) the occurrence of any event with respect to
any Plan which would result in the incurrence by Parent or any Subsidiary of any material
liability, fine or penalty, or any material increase in the contingent liability of Parent or any
Subsidiary with respect to any post-retirement Welfare Plan benefit.
6.7 Payment of Taxes
. Parent will, and will cause each of its Subsidiaries to, pay and
discharge, all taxes, assessments, fees and other governmental charges imposed upon it or any of
its Property, before becoming delinquent and before any penalties accrue thereon, unless and to the
extent that the same are being contested in good faith and by proper proceedings and as to which
appropriate reserves are provided therefor, unless and until any Lien resulting therefrom attaches
to any of its Property.
6.8 Contracts With Affiliates
. Except with respect to contracts, agreements and business
arrangements solely among Borrower and Guarantors, Parent shall not, nor shall it permit any of its
Subsidiaries to, enter into any contract, agreement or business arrangement with any of its
Affiliates on terms and conditions which are less favorable to Parent or such Subsidiary than would
be usual and customary in similar contracts, agreements or business arrangements between Persons
not affiliated with each other.
6.9 No Changes in Fiscal Year
. Parent shall not, nor shall it permit any of its Subsidiaries
to, change the Fiscal Year from its present basis.
6.10 Change in the Nature of Business
. Parent shall not, nor shall it permit any of its
Subsidiaries to, engage in any business or activity if as a result the general nature of the
business of Parent or any Subsidiary would be changed in any material respect from the general
nature of the business engaged in by it as of the Closing Date.
6.11 Indebtedness
. Parent will not, and will not permit any of its Subsidiaries to,
contract, create, incur, assume or suffer to exist any Indebtedness, except;
(a) To Lender
. The Obligations, Hedging Liability, and Funds Transfer and Deposit Account
Liability of Parent and its Subsidiaries owing to the Lender (and its Affiliates);
(b) Existing Indebtedness
. Existing Indebtedness;
(c) Intercompany Indebtedness
. intercompany Indebtedness among Parent and its Subsidiaries
to the extent permitted by Section 6.14;
(d) Purchase Money Indebtedness
. purchase money Indebtedness (excluding Capitalized Lease
Obligations) of Parent and its Subsidiaries in an amount not to exceed $1,000,000 in the aggregate
at any one time outstanding;
(e) Capitalized Lease Obligations
. Capitalized Lease Obligations of Parent and its
Subsidiaries in an amount not to exceed the amounts set forth below at the times set forth below
in the aggregate at any one time outstanding:
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|
|
|
|
|
Period
|
|
Limitation
|
|
From the Closing Date through June 30, 2007
|
|
$
|
6,500,000
|
|
From July 1, 2007 through June 30, 2008
|
|
$
|
13,000,000
|
|
From July 1, 2008 through the Termination Date
|
|
$
|
15,500,000
|
|
(f) Subordinated Debt
. the Contemplated Subordinated Debt; and
(g) Other Indebtedness
. unsecured Indebtedness of Parent and its Subsidiaries not otherwise
permitted by this Section in an amount not to exceed $1,000,000 in the aggregate at any one time
outstanding.
6.12 Liens
. Parent will not, nor will it permit any of its Subsidiaries to, create, incur or
suffer to exist any Lien on any of its Property; provided that the foregoing shall not prevent the
following (the Liens described below, the Permitted Liens):
(a) Taxes
. inchoate Liens for the payment of taxes which are not yet due and payable or the
payment of which is not required by Section 6.7 or, if such taxes are due and payable, the Person
owing such taxes is contesting such taxes in good faith and by appropriate proceedings and
appropriate reserves have been provided for such taxes;
(b) Statutory Liens
. Liens arising by statute in connection with workers compensation,
unemployment insurance, old age benefits, social security obligations, taxes, assessments,
statutory obligations or other similar charges (other than Liens arising under ERISA), good faith
cash deposits in connection with tenders, contracts or leases to which Parent or any Subsidiary is
a party or other cash deposits required to be made in the ordinary course of business other than
deposits securing Reclamation Bonds, provided in each case that the obligation is not for borrowed
money and that the obligation secured is not overdue or, if overdue, is being contested in good
faith by appropriate proceedings which prevent enforcement of the matter under contest and adequate
reserves have been established therefor;
(c) Mechanics Liens
. mechanics, workmens, materialmens, landlords, carriers or other
similar Liens arising in the ordinary course of business with respect to obligations which are not
due or which are being contested in good faith by appropriate proceedings which prevent enforcement
of the matter under contest;
(d) To Lender
. Liens created by or pursuant to this Agreement and the Collateral Documents;
(e) Operating Leases
. any interest or title of a lessor under any operating lease;
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(f) Other Permitted Liens
. Liens on property of Parent or any Subsidiary created solely for
the purpose of securing indebtedness permitted by Sections 6.11(d) or 6.11(e) representing or
incurred to finance the purchase price of Property, provided that no such Lien shall extend to or
cover other Property of Parent or such Subsidiary other than the respective Property so acquired,
and the principal amount of indebtedness secured by any such Lien shall at no time exceed the
purchase price of such Property, as reduced by repayments of principal thereon;
(g) Easement
. easements, rights-of-way, restrictions, and other similar encumbrances against
real property incurred in the ordinary course of business which, in the aggregate, are not
substantial in amount and which do not materially detract from the value of the Property subject
thereto or materially interfere with the ordinary conduct of the business of Parent or any
Subsidiary;
(h) Contemplated Subordinated Debt
. Liens on the Collateral subordinate to the Lien of the
Lender securing the Contemplated Subordinated Debt; and
(i) Existing Indebtedness
. those Liens described on Schedule 6.12 hereto securing Existing
Indebtedness.
6.13 Consolidation, Merger, Sale of Assets, etc
. Parent will not, nor will it permit any of
its Subsidiaries to, wind up, liquidate or dissolve its affairs or agree to any merger or
consolidation, or convey, sell, lease or otherwise dispose of all or any part of its property,
including any disposition as part of any sale-leaseback transactions except that this Section shall
not prevent:
(a) Inventory
. the sale and lease of Inventory in the ordinary course of business;
(b) Obsolete Property
. the sale, transfer or other disposition of any tangible personal
property that, in the reasonable judgment of Parent or any of its Subsidiaries, has become
uneconomic, obsolete or worn out;
(c) Intercompany Sales
. the sale, transfer, lease, or other disposition of Property of
Parent and its Wholly-owned Subsidiaries (except any Foreign Subsidiaries) to one another;
(d) Permitted Acquisitions
. any merger or consolidation as part of a Permitted Acquisition;
(e) Intercompany Mergers
. the merger of any Wholly-owned Subsidiary (except any Foreign
Subsidiaries) with and into Parent or any other Wholly-owned Subsidiary (except any Foreign
Subsidiaries), provided that, in the case of any merger involving Parent, Parent is the legal
entity surviving the merger; and
(f) Other Sales
. the sale, transfer, lease, or other disposition of Property of Parent or
any Subsidiary (including any disposition of Property as part of a sale and leaseback
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transaction) aggregating for Parent and its Subsidiaries not more than $4,000,000 during any Fiscal Year of
Parent.
6.14 Advances, Investments and Loans
. Parent will not, nor will it permit any of its
Subsidiaries to, directly or indirectly, make loans or advances to or make, retain or have
outstanding any investments (whether through purchase of equity interests or obligations or
otherwise) in, any Person or enter into any partnerships or joint ventures, or purchase or own a
futures contract or otherwise become liable for the purchase or sale of currency or other
commodities at a future date in the nature of a futures contract, except that this Section
shall not prevent:
(a) Receivables
. Receivables created in the ordinary course of business and payable or
dischargeable in accordance with customary trade terms;
(b) Contract Advances
. Advances made in the ordinary course of business and pursuant to
contractual terms to schools or school districts in an amount not to exceed $5,000,000 in the
aggregate at any one time outstanding;
(c) Cash Equivalents
. investments in Cash Equivalents;
(d) Disputed Amounts
. investments (including debt obligations) received in connection with
the bankruptcy or reorganization of suppliers and customers and in settlement of delinquent
obligations of, and other disputes with, customers and suppliers arising in the ordinary course of
business;
(e) Subsidiaries
. Parents investments from time to time in its Subsidiaries that are also
Borrowers or Guarantors, and investments made from time to time by a Subsidiary in one or more of
its Subsidiaries that are also Borrowers or Guarantors;
(f) Intercompany
. intercompany advances made from time to time among Borrower and any one or
more Subsidiaries that are also Guarantors in the ordinary course of business;
(g) Permitted Acquisitions
. Permitted Acquisitions;
(h) Hedging Liability
. Hedging Liability; and
(i) Other
. Other investments, loans and advances in addition to those otherwise permitted by
this Section 6.14 in an amount not to exceed $500,000 in the aggregate at any one time outstanding.
6.15 Restricted Payments by Parent
. Parent shall not make any Restricted Payments other than
the Specified Restricted Payment.
6.16 Limitation on Restrictions
. Parent will not, nor will it permit any of its Subsidiaries
to, directly or indirectly, create or otherwise cause or suffer to exist or become effective any
restriction on the ability of any such Subsidiary to (a) pay dividends or make any other
distributions on its Capital Stock or other equity interests owned by Parent or any other
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Subsidiary, (b) pay or repay any Indebtedness owed to Parent or any other Subsidiary, (c) make
loans or advances to Parent or any other Subsidiary, (d) transfer any of its Property to Parent or
any other Subsidiary, (e) encumber or pledge any of its assets to or for the benefit of the Lender
or (f) guaranty the Obligations, Hedging Liability and Funds Transfer and Deposit Account
Liability.
6.17 Limitation on Issuances of New Equity by Subsidiaries
. Parent will not permit any of
its Subsidiaries to issue any new Capital Stock (including by way of sales of treasury
stock) or other equity interests or any options or warrants to purchase, or securities
convertible into, Capital Stock or other equity interests, except for transfers and replacements of
then outstanding shares of Capital Stock or other equity interests.
6.18 Limitation on the Creation of Subsidiaries
. Notwithstanding anything to the contrary
contained in this Agreement, Parent will not, nor will it permit any of its Subsidiaries to,
establish, create or acquire after the Closing Date any Subsidiary; provided that each Borrower and
its Wholly-owned Subsidiaries shall be permitted to establish or create Wholly-owned Subsidiaries
so long as at least 30 days written notice thereof is given to the Lender from the time such
Subsidiary is formed, and Parent and its Subsidiaries timely comply with the requirements of
Section 4 (at which time Section 5.10 shall be deemed to include a reference to such Subsidiary).
6.19 OFAC
. Parent will not, nor will it permit any of its Subsidiaries to, (1) become a
person whose property or interests in property are blocked or subject to blocking pursuant to
Section 1 of Executive Order 13224 of September 23, 2001 Blocking Party and Prohibiting
Transactions With Persons Who Commit, Threaten to Commit or Support Terrorism (66 Fed. Reg.
49079(2001), (2) engage in any dealings or transactions prohibited by Section 2 of such executive
order, or be otherwise associated with any such person in any manner violative of Section 2, or (3)
become a person on the list of Specially Designated Nationals and Blocked Persons or subject to the
limitations or prohibitions under any other U.S. Department of Treasurys Office of Foreign Assets
Control regulation or executive order.
6.20 Operating Accounts
. Parent and each of its Subsidiaries shall maintain all of its
primary or substantial operating and depository accounts at the Lender; provided, however, Parent
and its Subsidiaries may maintain depository accounts having insignificant balances in
jurisdictions in which they operate and in which the Lender does not maintain a presence.
6.21 Financial Covenants
.
(a) Maximum Leverage Ratio
. Borrower shall not, as of the last day of each Fiscal Quarter of
Parent, permit the Leverage Ratio to be more than 2.50 to 1.00.
(b) Minimum Net Worth
. Borrower shall not, as of the last day of each Fiscal Year of Parent,
permit Net Worth to be less than the total of (1) 85% of Net Worth as of the Closing Date plus (2)
50% of cumulative Net Income of Parent from the Closing Date to the determination date minus (3)
85% of all Specified Restricted Payments made by Parent.
(c) Minimum Accumulated Cash
. Borrower shall not, as of the last day of each Fiscal Quarter,
permit the Accumulated Cash to be less than $0.
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7.
Events of Default and Remedies
.
7.1 Events of Default
. Any one or more of the following shall constitute an Event of
Default hereunder:
(a) Payment
. default in the payment when due (whether at the stated maturity thereof or at
any other time provided for in this Agreement) of all or any part of the principal of or interest
on any Note or any other Obligation payable hereunder or under any other Loan Document, provided, however that if Parent has in effect an auto-debit arrangement with the
Lender with respect to periodic interest payments due on the Loans, no such default shall
constitute an Event of Default until 2 Business Days shall have elapsed;
(b) Covenants
. default in the observance or performance of any covenant set forth in Section
6.9, 6.11, 6.12, 6.13, 6.14, 6.16, 6.18, 6.19, 6.20 or 6.21 or of any provision in any Loan
Document dealing with the use, disposition or remittance of the proceeds of Collateral or requiring
the maintenance of insurance thereon;
(c) Other Loan Document Agreements
. default in the observance or performance of any other
provision hereof or of any other Loan Document which is not remedied within 30 days after the
earlier of (i) the date on which such failure shall first become known to any Responsible Officer
or (ii) written notice thereof is given to Borrower by the Lender;
(d) Representations and Warranties
. any representation or warranty made herein or in any
other Loan Document or in any certificate delivered to the Lender pursuant hereto or thereto or in
connection with any transaction contemplated hereby or thereby proves untrue in any material
respect as of the date of the making or deemed making thereof;
(e) Other Loan Documents
. any event occurs or condition exists (other than those described
in Sections 7.1(a) through 7.1(d)) which is specified as an event of default under any of the other
Loan Documents, or any of the Loan Documents shall for any reason not be or shall cease to be in
full force and effect or is declared to be null and void, or any of the Collateral Documents shall
for any reason fail to create a valid and perfected first priority Lien in favor of the Lender in
any Collateral purported to be covered thereby except as expressly permitted by the terms thereof,
or Parent, any Guarantor or any Subsidiary takes any action for the purpose of terminating,
repudiating or rescinding any Loan Document executed by it or any of its obligations thereunder;
(f) Other Obligations to Lender
. default shall occur under any Indebtedness or other
obligation of Parent or any Subsidiary in favor of the Lender or its Affiliates;
(g) Cross Default
. default shall occur under any Indebtedness of Parent or any Subsidiary
aggregating in excess of $1,000,000, or under any indenture, agreement or other instrument under
which the Indebtedness aggregating in excess of $1,000,000 may be issued, and such default shall
continue for a period of time sufficient to permit the acceleration of the maturity of any such
Indebtedness (whether or not such maturity is in fact accelerated), or any such Indebtedness shall
not be paid when due (whether by demand, lapse of time, acceleration or otherwise);
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(h) Judgments
. any judgment or judgments, writ or writs or warrant or warrants of
attachment, or any similar process or processes, shall be entered or filed against Parent or any
Subsidiary, or against any of its Property, in an aggregate amount in excess of $1,000,000 (except
to the extent fully covered by insurance pursuant to which the insurer has accepted liability
therefor in writing), and which remains undischarged, unvacated, unbonded or unstayed for a period
of 30 days;
(i) Pension Liabilities
. Parent or any Subsidiary, or any member of its Controlled Group,
shall fail to pay when due an amount or amounts aggregating in excess of $500,000 which it shall
have become liable to pay to the PBGC or to a Plan under Title IV of ERISA; or notice of intent to
terminate a Plan or Plans having aggregate Unfunded Vested Liabilities in excess of $500,000
(collectively, a Material Plan) shall be filed under Title IV of ERISA by Parent or any
Subsidiary, or any other member of its Controlled Group, any plan administrator or any combination
of the foregoing; or the PBGC shall institute proceedings under Title IV of ERISA to terminate or
to cause a trustee to be appointed to administer any Material Plan or a proceeding shall be
instituted by a fiduciary of any Material Plan against Parent or any Subsidiary, or any member of
its Controlled Group, to enforce Section 515 or 4219(c)(5) of ERISA and such proceeding shall not
have been dismissed within 60 days thereafter; or a condition shall exist by reason of which the
PBGC would be entitled to obtain a decree adjudicating that any Material Plan must be terminated;
(j) Material Adverse Effect
. in the exercise of the Lenders good faith judgment, the Lender
shall have determined that a Material Adverse Effect has occurred or will occur, provided, however,
that if Lender shall have so determined that a Material Adverse Effect will occur, it shall provide
Parent with prior written notice reasonable under the circumstances of such determination;
(k) Change of Control
. any Change of Control shall occur;
(l) Insolvency
. Parent, any Guarantor or any Subsidiary shall (1) have entered involuntarily
against it an order for relief under the United States Bankruptcy Code, as amended, (2) not pay, or
admit in writing its inability to pay, its debts generally as they become due, (3) make an
assignment for the benefit of creditors, (4) apply for, seek, consent to or acquiesce in, the
appointment of a receiver, custodian, trustee, examiner, liquidator or similar official for it or
any substantial part of its Property, (5) institute any proceeding seeking to have entered against
it an order for relief under the United States Bankruptcy Code, as amended, to adjudicate it
insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, adjustment
or composition of it or its debts under any law relating to bankruptcy, insolvency or
reorganization or relief of debtors or fail to file an answer or other pleading denying the
material allegations of any such proceeding filed against it, (6) take any business or corporate
action in furtherance of any matter described in parts (1) through (5) above, or (7) fail to
contest in good faith any appointment or proceeding described in Section 7.1(l);
(m) Appointment of Receiver
. a custodian, receiver, trustee, examiner, liquidator or similar
official shall be appointed for Parent or any Subsidiary, or any substantial part of any of its
Property, or a proceeding described in Section 7.1(l)(5) shall be instituted against Parent or any
Subsidiary, and such appointment continues undischarged or such proceeding continues undismissed or
unstayed for a period of 60 days;
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(n) Extension of Mandatory Redemption Date
. Parents failure on or before September 30, 2008
to extend the mandatory redemption date of Parents preferred stock to a date after March 15, 2010;
or
(o) Extension of Maturity Dates
. Parents failure on or before October 15 of each year
during the term of the Commitment to extend the maturity of the Contemplated Subordinated Debt to a
date at least 14
1
/
2
months after such October 15.
7.2 Non-Bankruptcy Defaults
. When any Event of Default other than those described in
Sections 7.1(l) or 7.1(m) has occurred and is continuing, the Lender may, by written notice to
Borrower: (a) terminate the remaining Commitment and all other obligations of the Lender hereunder
on the date stated in such notice (which may be the date thereof); (b) declare the principal of and
the accrued interest on all outstanding Notes to be forthwith due and payable and thereupon all
outstanding Notes, including both principal and interest thereon, shall be and become immediately
due and payable together with all other amounts payable under the Loan Documents without further
demand, presentment, protest or notice of any kind; and (c) demand that Borrower immediately pay to
the Lender the full amount then available for drawing under each or any Letter of Credit, and
Borrower agrees to immediately make such payment and acknowledge and agree that the Lender would
not have an adequate remedy at law for failure by Borrower to honor any such demand and that the
Lender shall have the right to require Borrower to specifically perform such undertaking whether or
not any drawings or other demands for payment have been made under any Letter of Credit.
7.3 Bankruptcy Defaults
. When any Event of Default described in Sections 7.1(l) or 7.1(m)has
occurred and is continuing, then all outstanding Notes shall immediately become due and payable
together with all other amounts payable under the Loan Documents without presentment, demand,
protest or notice of any kind, the obligation of the Lender to extend further credit pursuant to
any of the terms hereof shall immediately terminate and Borrower shall immediately pay to the
Lender the full amount then available for drawing under all outstanding Letters of Credit, Borrower
acknowledging and agreeing that the Lender would not have an adequate remedy at law for failure by
Borrower to honor any such demand and that the Lender shall have the right to require Borrower to
specifically perform such undertaking whether or not any draws or other demands for payment have
been made under any of the Letters of Credit.
7.4 Collateral for Undrawn Letters of Credit
.
(a) Obligation to Provide
. If the prepayment of the amount available for drawing under any
or all outstanding Letters of Credit is required under Section 2.7(b) or under Section 7.2 or 7.3,
Borrower shall forthwith pay the amount required to be so prepaid, to be held by the Lender as
provided in Section 7.4(b).
(b) Use of Collateral
. All amounts prepaid pursuant to Section 7.4(a) shall be held by the
Lender in one or more separate collateral accounts (each such account, and the credit balances,
properties, and any investments from time to time held therein, and any substitutions
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for such account, any certificate of deposit or other instrument evidencing any of the foregoing and all
proceeds of and earnings on any of the foregoing being collectively called the Collateral
Account) as security for, and for application by the Lender (to the extent available) to, the
reimbursement of any payment under any Letter of Credit then or thereafter made by the Lender, and
to the payment of the unpaid balance of any other Obligations. The Collateral Account shall be
held in the name of and subject to the exclusive dominion and control of the Lender. If and when
requested by Borrower, the Lender shall invest funds held in the Collateral Account from
time to time in direct obligations of, or obligations the principal of and interest on which
are unconditionally guaranteed by, the United States of America with a remaining maturity of one
year or less, provided that the Lender is irrevocably authorized to sell investments held in the
Collateral Account when and as required to make payments out of the Collateral Account for
application to amounts due and owing from Borrower to the L/C Issuer; provided, however, that if
(1) Borrower shall have made payment of all such obligations referred to in subsection (a) above,
(2) all relevant preference or other disgorgement periods relating to the receipt of such payments
have passed, and (3) no Letters of Credit, Commitment, Loans or other Obligations remain
outstanding hereunder, then the Lender shall release to Borrower any remaining amounts held in the
Collateral Account.
7.5 Expenses
. Borrower agrees to pay to the Lender, and any other holder of any Note
outstanding hereunder, all costs and expenses reasonably incurred or paid by the Lender or any such
holder, including reasonable attorneys fees and court costs, in connection with any Default or
Event of Default by Borrower hereunder or in connection with the enforcement of any of the Loan
Documents (including all such costs and expenses incurred in connection with any proceeding under
the United States Bankruptcy Code involving Parent or any Subsidiary as a debtor thereunder).
8.
Change in Circumstances and Contingencies
.
8.1 Funding Indemnity
. If the Lender shall incur any loss, cost or expense (including,
without limitation, any loss of profit, and any loss, cost or expense incurred by reason of the
liquidation or re-employment of deposits or other funds acquired by the Lender to fund or maintain
any Eurodollar Loan or the relending or reinvesting of such deposits or amounts paid or prepaid to
the Lender or by reason of breakage of interest rate swap agreements or the liquidation of other
hedging contracts or agreements) as a result of:
(1)
any payment, prepayment or conversion of a Eurodollar Loan on a date other than
the last day of its Interest Period,
(2)
any failure (because of a failure to meet the conditions of Section 3 or
otherwise) by Borrower to borrow or continue a Eurodollar Loan, or to convert a Base Rate
Loan into a Eurodollar Loan, on the date specified in a notice given pursuant to Section
2.4(a),
(3)
any failure by Borrower to make any payment of principal on any Eurodollar Loan
when due (whether by acceleration or otherwise), or
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(4)
any acceleration of the maturity of a Eurodollar Loan as a result of the
occurrence of any Event of Default hereunder,
then, upon the demand of the Lender, Borrower shall pay to the Lender such amount as will reimburse
the Lender for such loss, cost or expense. If the Lender makes such a claim for compensation, it
shall provide to Borrower a certificate setting forth the amount of such loss, cost or expense in
reasonable detail (including an explanation of the basis for and the computation of such loss, cost
or expense) and the amounts shown on such certificate shall be conclusive absent manifest error.
8.2 Illegality
. Notwithstanding any other provisions of this Agreement or any Note, if at
any time any change in applicable law, rule or regulation or in the interpretation thereof makes it
unlawful for the Lender to make or continue to maintain any Eurodollar Loans or to perform its
obligations as contemplated hereby, the Lender shall promptly give notice thereof to Borrower and
the Lenders obligations to make or maintain Eurodollar Loans under this Agreement shall be
suspended until it is no longer unlawful for the Lender to make or maintain Eurodollar Loans.
Borrower shall prepay on demand the outstanding principal amount of any such affected Eurodollar
Loans, together with all interest accrued thereon and all other amounts then due and payable to the
Lender under this Agreement; provided, however, subject to all of the terms and conditions of this
Agreement, Borrower may then elect to borrow the principal amount of the affected Eurodollar Loans
from the Lender by means of Base Rate Loans.
8.3 Unavailability of Deposits or Inability to Ascertain, or Inadequacy of, LIBOR
. If on or
prior to the first day of any Interest Period for any Borrowing of Eurodollar Loans the Lender
determines that:
(1)
deposits in Dollars (in the applicable amounts) are not being offered to it in the
interbank eurodollar market for such Interest Period, or that by reason of circumstances
affecting the interbank eurodollar market adequate and reasonable means do not exist for
ascertaining the applicable LIBOR, or
(2)
(A) LIBOR as determined by the Lender will not adequately and fairly reflect the
cost to the Lender of funding its Eurodollar Loans for such Interest Period or (B) the
making or funding of Eurodollar Loans has become impracticable,
then the Lender shall forthwith give notice thereof to Borrower, whereupon until the Lender
notifies Borrower that the circumstances giving rise to such suspension no longer exist, the
obligations of the Lender to make Eurodollar Loans shall be suspended.
8.4 Yield Protection
.
(a) Taxes and Reserves
. If, on or after the date hereof, the adoption of any applicable law,
rule or regulation, or any change therein, or any change in the interpretation or administration
thereof by any governmental authority, central bank or comparable agency charged with the
interpretation or administration thereof, or compliance by the Lender (or its Lending Office) with
any request or directive (whether or not having the force of law) of any such authority, central
bank or comparable agency:
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(1)
shall subject the Lender (or its Lending Office) to any tax, duty or other charge
with respect to its Eurodollar Loans, its Note, its Letter(s) of Credit, any Reimbursement
Obligations owed to it or its obligation to make Eurodollar Loans, issue a Letter of Credit,
or shall change the basis of taxation of payments to the Lender (or its Lending Office) of
the principal of or interest on its Eurodollar Loans, Letter(s) of Credit or any other
amounts due under this Agreement or any other Loan Document in respect of its Eurodollar
Loans, Letter(s) of Credit, any Reimbursement Obligations owed to it, or its obligation to
make Eurodollar Loans, or issue a Letter of Credit (except for changes in the rate of tax on
the overall net income of the Lender or its Lending Office imposed
by the jurisdiction in which the Lenders principal executive office or Lending Office
is located); or
(2)
shall impose, modify or deem applicable any reserve, special deposit or similar
requirement (including, without limitation, any such requirement imposed by the Board of
Governors of the Federal Reserve System, but excluding with respect to any Eurodollar Loans
any such requirement included in an applicable Reserve Percentage) against assets of,
deposits with or for the account of, or credit extended by, the Lender (or its Lending
Office) or shall impose on the Lender (or its Lending Office) or on the interbank market any
other condition affecting its Eurodollar Loans, its Note, its Letter(s) of Credit, any
Reimbursement Obligation owed to it, or its obligation to make Eurodollar Loans, or to issue
a Letter of Credit;
and the result of any of the foregoing is to increase the cost to the Lender (or its Lending
Office) of making or maintaining any Eurodollar Loan, issuing or maintaining a Letter of Credit, or
to reduce the amount of any sum received or receivable by the Lender (or its Lending Office) under
this Agreement or under any other Loan Document with respect thereto, by an amount deemed by the
Lender to be material, then, within 15 days after demand by the Lender (accompanied by a
certificate of the Lender explaining such increase in cost and the calculation thereof in
reasonable detail), Borrower shall be obligated to pay to the Lender such additional amount or
amounts as will compensate the Lender for such increased cost or reduction.
(b) Capital
. If, after the date hereof, the Lender shall have determined that the adoption
of any applicable law, rule or regulation regarding capital adequacy, or any change therein, or any
change in the interpretation or administration thereof by any governmental authority, central bank
or comparable agency charged with the interpretation or administration thereof, or compliance by
the Lender (or its Lending Office) or any corporation controlling the Lender with any request or
directive regarding capital adequacy (whether or not having the force of law) of any such
authority, central bank or comparable agency, has had the effect of reducing the rate of return on
the Lenders or such corporations capital as a consequence of its obligations hereunder to a level
below that which the Lender or such corporation could have achieved but for such adoption, change
or compliance (taking into consideration the Lenders or such corporations policies with respect
to capital adequacy) by an amount deemed by the Lender to be material, then from time to time,
within 15 days after demand by the Lender (accompanied by a certificate of the Lender explaining
such reduction and the calculation thereof in reasonable detail), Borrower shall pay to the Lender
such additional amount or amounts as will compensate the Lender for such reduction.
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(c) Certificate
. A certificate of the Lender claiming compensation under this Section 8.4
and setting forth the additional amount or amounts to be paid to it hereunder shall be conclusive
absent manifest error. In determining such amount, the Lender may use any reasonable averaging and
attribution methods.
8.5 Lending Offices
. The Lender may, at its option, elect to make its Loans hereunder at the
branch, office or affiliate specified on the appropriate signature page hereof (each a Lending
Office) for each type of Loan available hereunder or at such other of its branches, offices or
affiliates as it may from time to time elect and designate in a written notice to
Borrower. To the extent reasonably possible, the Lender shall designate an alternative branch
or funding office with respect to its Eurodollar Loans to reduce any liability of Borrower to the
Lender under Section 8.4 or to avoid the unavailability of Eurodollar Loans under Section 8.3, so
long as such designation is not disadvantageous to the Lender.
8.6 Discretion of Lender as to Manner of Funding
. Notwithstanding any other provision of
this Agreement, the Lender shall be entitled to fund and maintain its funding of all or any part of
the Loans in any manner it sees fit, it being understood, however, that for the purposes of this
Agreement all determinations hereunder with respect to Eurodollar Loans shall be made as if the
Lender had actually funded and maintained each Eurodollar Loan through the purchase of deposits in
the interbank eurodollar market having a maturity corresponding to such Loans Interest Period, and
bearing an interest rate equal to LIBOR for such Interest Period.
8.7 Hedging Liability and Funds Transfer and Deposit Account Liability Arrangements
. By
virtue of the Lenders execution of this Agreement, any Affiliate of the Lender with whom Parent or
any Subsidiary has entered into an agreement creating Hedging Liability or Funds Transfer and
Deposit Account Liability shall be deemed a Lender party hereto, it being understood and agreed
that the rights and benefits of such Affiliate under the Loan Documents consist exclusively of such
Affiliates right to share in payments and collections out of the Collateral and the Guaranties as
more fully set forth in Section 2.8 and Section 4 hereof.
9.
Miscellaneous
.
9.1 Withholding Taxes
. Each payment by Borrower under this Agreement or the other Loan
Documents shall be made without withholding for or on account of any present or future taxes (other
than overall net income taxes on the recipient imposed by the jurisdiction in which its principal
executive office or Lending Office is located) imposed by or within the jurisdiction in which
Borrower is domiciled, any jurisdiction from which Borrower makes any payment, or (in each case)
any political subdivision or taxing authority thereof or therein. If any such withholding is so
required, Borrower shall make the withholding, pay the amount withheld to the appropriate
governmental authority before penalties attach thereto or interest accrues thereon and forthwith
pay such additional amount as may be necessary to ensure that the net amount actually received by
the Lender free and clear of such taxes (including such taxes on such additional amount) is equal
to the amount that the Lender would have received had such withholding not been made. If the
Lender pays any amount in respect of any such taxes, penalties or interest, Borrower shall
reimburse the Lender for that payment on demand in the currency in which such payment was made. If
Borrower pays any such taxes, penalties or interest, it shall
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deliver official tax receipts evidencing that payment or certified copies thereof to the Lender on or before the thirtieth day
after payment.
9.2 No Waiver, Cumulative Remedies
. No delay or failure on the part of the Lender or on the
part of the holder or holders of any of the Obligations in the exercise of any power or right under
any Loan Document shall operate as a waiver thereof or as an acquiescence in any default, nor shall
any single or partial exercise of any power or right preclude any other or further exercise thereof
or the exercise of any other power or right. The rights and remedies hereunder of the Lender and
of the holder or holders of any of the Obligations are cumulative to, and not exclusive of, any
rights or remedies which any of them would otherwise have.
9.3 Non-Business Days
. If any payment hereunder becomes due and payable on a day which is
not a Business Day, the due date of such payment shall be extended to the next succeeding Business
Day on which date such payment shall be due and payable. In the case of any payment of principal
falling due on a day which is not a Business Day, interest on such principal amount shall continue
to accrue during such extension at the rate per annum then in effect, which accrued amount shall be
due and payable on the next scheduled date for the payment of interest.
9.4 Documentary Taxes
. Borrower agrees to pay on demand any documentary, stamp or similar
taxes payable in respect of this Agreement or any other Loan Document, including interest and
penalties, in the event any such taxes are assessed, irrespective of when such assessment is made
and whether or not any credit is then in use or available hereunder.
9.5 Survival of Representations
. All representations and warranties made herein or in any
other Loan Document or in certificates given pursuant hereto or thereto shall survive the execution
and delivery of this Agreement and the other Loan Documents, and shall continue in full force and
effect with respect to the date as of which they were made as long as any credit is in use or
available hereunder.
9.6 Survival of Indemnities
. All indemnities and other provisions relative to reimbursement
to the Lender of amounts sufficient to protect the yield of the Lender with respect to the Loans
and Letters of Credit, including, but not limited to, Sections 8.1, 8.4, and 9.12, shall survive
the termination of this Agreement and the other Loan Documents and the payment of the Obligations.
9.7 Notices
.
(a) Addresses and Times
. Except as otherwise specified herein, all notices hereunder and
under the other Loan Documents shall be in writing (including, without limitation, notice by
telecopy) and shall be given to the relevant party at its address or facsimile number set forth
below, or such other address or facsimile number as such party may hereafter specify by notice to
the Lender and Borrower given by courier, by United States certified or registered mail, by
facsimile or by other telecommunication device capable of creating a written record of such notice
and its receipt.
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If to Parent or Borrower:
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K12 Inc.
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2300 Corporate Park Drive
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Herndon, Virginia 20171
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Attention: Chief Financial Officer
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With a copy (which shall not constitute
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K12 Inc.
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notice) to:
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2300 Corporate Park Drive
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Herndon, Virginia 20171
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Attention: General Counsel
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and to:
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Kelley Drye & Warren LLP
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8000 Towers Crescent Drive, Suite 1200
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Vienna, Virginia 22182
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Attention: Joseph B. Hoffman
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If to Lender:
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PNC Bank, National Association
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808 17
th
Street NW
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Washington, D.C. 20006-3944
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Attention: Christine E. Whitney
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With a copy (which shall not constitute
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Greenebaum Doll & McDonald PLLC
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notice) to:
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255 East Fifth Street, Suite 2800
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Cincinnati, Ohio 45202
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Attention: Michael H. Brown
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Each such notice, request or other communication shall be effective (1) if given by facsimile,
when such facsimile is transmitted to the facsimile number specified in this Section prior to 5:00
pm Washington, D.C. time on a Business Day and otherwise on the next Business Day and a
confirmation of such facsimile has been received by the sender, (2) if given by mail, 5 days after
such communication is deposited in the mail, certified or registered with return receipt requested,
addressed as aforesaid or (3) if given by any other means, when delivered at the addresses
specified in this Section or on the signature pages hereof prior to 5:00 pm Washington, D.C. time
on a Business Day and otherwise on the next Business Day; provided that any notice given pursuant
to Section 2 hereof shall be effective only upon receipt.
(b) Electronic Mail
. Electronic mail and internet and intranet websites may be used only to
distribute routine communications, such as financial statements, and to distribute Loan Documents
for execution by the parties thereto, and may not be used for any other purpose.
9.8 Counterparts
. This Agreement may be executed in any number of counterparts, and by the
different parties hereto on separate counterpart signature pages, and all such counterparts taken
together shall be deemed to constitute one and the same instrument.
9.9 Successors and Assigns; Assignments and Participations
.
(a) Successors and Assigns Generally
. The provisions of this Agreement shall be binding upon
and inure to the benefit of the parties hereto and their respective successors and
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assigns permitted hereby, except that neither Borrower nor Parent may assign or otherwise transfer any of
its rights or obligations under any Loan Document without the prior written consent of the Lender,
and Lender may not assign or otherwise transfer any of its rights or obligations hereunder except
(1) by way of participation in accordance with the provisions of Section 9.9(b) or (2) by way of
pledge or assignment of a security interest subject to the restrictions of Section 9.9(d) (and any
other attempted assignment or transfer by any party hereto shall be null and void). Nothing in
this Agreement, expressed or implied, shall be construed to confer upon any Person (other than the
parties hereto, their respective successors and assigns permitted hereby, Participants to the
extent provided in Section 9.9(b) and, to the extent expressly contemplated hereby, the Related Parties of the Lender) any legal or equitable
right, remedy or claim under or by reason of this Agreement.
(b) Participations
. Lender may at any time, without the consent of, or notice to, Borrower,
sell participations to any Person (other than a natural person or Borrower or any of Borrowers
Affiliates or Subsidiaries) (each, a Participant) in all or a portion of the Lenders rights
and/or obligations under this Agreement (including all or a portion of its Commitment and/or the
Loans owing to it); provided that (1) the Lenders obligations under this Agreement shall remain
unchanged, (2) the Lender shall remain solely responsible to the other parties hereto for the
performance of such obligations and (3) Borrower and L/C Issuer shall continue to deal solely and
directly with the Lender in connection with the Lenders rights and obligations under this
Agreement.
Any agreement or instrument pursuant to which the Lender sells such a participation shall
provide that the Lender shall retain the sole right to enforce this Agreement and to approve any
amendment, modification or waiver of any provision of this Agreement; provided that such agreement
or instrument may provide that the Lender will not, without the consent of the Participant, agree
to any amendment or waiver described in Section 9.10 that affects such Participant. Subject to
Section 9.9(c), Borrower agrees that each Participant shall be entitled to the benefits of Sections
8.1 and 8.4(b) to the same extent as if it were the Lender. To the extent permitted by law, each
Participant also shall be entitled to the benefits of Section 9.13 as though it were the Lender.
(c) Limitations upon Participant Rights
. A Participant shall not be entitled to receive any
greater payment under Section 8.4(a) than the Lender would have been entitled to receive with
respect to the participation sold to such Participant, unless the sale of the participation to such
Participant is made with Borrower prior written consent. A Participant that is not a United
States person (as such term is defined in Section 7701(a)(30) of the Code) if it were the Lender
shall not be entitled to the benefits of Section 9.1 unless the sale of the participation to such
Participant is made with Borrower prior written consent.
(d) Certain Pledges
. The Lender may at any time pledge or assign a security interest in all
or any portion of its rights under this Agreement to secure obligations of the Lender, including
any pledge or assignment to secure obligations to a Federal Reserve Bank; provided that no such
pledge or assignment shall release the Lender from any of its obligations hereunder or substitute
any such pledgee or assignee for the Lender as a party hereto.
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9.10 Amendments
. Any provision of this Agreement or the other Loan Documents may be amended
or waived if, but only if, such amendment or waiver is in writing and is signed by (a) Borrower,
(b) the Lender, and (c) if the rights or duties of the L/C Issuer are affected thereby, the L/C
Issuer.
9.11 Headings
. Section headings used in this Agreement are for reference only and shall not
affect the construction of this Agreement.
9.12 Costs and Expenses; Indemnification
.
(a) Obligation to Pay
. Borrowers agree to pay all costs and expenses of the Lender payable
to third parties in connection with the preparation, negotiation, and administration of the Loan
Documents, including, without limitation, the reasonable fees and disbursements of outside counsel
to the Lender, in connection with the preparation and execution of the Loan Documents, and any
amendment, waiver or consent related thereto, whether or not the transactions contemplated herein
are consummated, together with any fees and charges suffered or incurred by the Lender and payable
to third parties in connection with periodic collateral filing fees and lien searches. Borrower
further agrees to indemnify the Lender, and its directors, officers, employees, agents, financial
advisors, and consultants against all Damages (including, without limitation, all expenses of
litigation or preparation therefor, whether or not the indemnified Person is a party thereto, or
any settlement arrangement arising from or relating to any such litigation) which any of them may
reasonably pay or incur arising out of or relating to any Loan Document or any of the transactions
contemplated thereby or the direct or indirect application or proposed application of the proceeds
of any Loan or Letter of Credit, other than those which arise from the fraud, gross negligence or
willful misconduct of the party claiming indemnification. Borrower, upon demand by the Lender at
any time, shall reimburse the Lender for any reasonable legal or other expenses incurred and
payable to third parties in connection with investigating or defending against any of the foregoing
(including any settlement costs relating to the foregoing) except if the same is directly due to
the fraud, gross negligence or willful misconduct of the party to be indemnified. The obligations
of Borrower under this Section 9.12 shall survive the termination of this Agreement.
(b) Indemnity
. Borrower unconditionally agrees to forever indemnify, defend and hold
harmless, and covenant not to sue for any claim for contribution against, the Lender for any
Damages, costs, loss or expense, including without limitation, response, remedial or removal costs,
arising out of any of the following: (1) any presence, release, threatened release or disposal of
any hazardous or toxic substance or petroleum by Parent, Borrower or any Subsidiary or otherwise
occurring on or with respect to its Property (whether owned or leased), (2) the operation or
violation of any environmental law, whether federal, state, or local, and any regulations
promulgated thereunder by Parent, Borrower or any Subsidiary or otherwise occurring on or with
respect to its Property (whether owned or leased), (3) any claim for personal injury or property
damage in connection with Parent, Borrower or any Subsidiary or otherwise occurring on or with
respect to its Property (whether owned or leased), and (4) the inaccuracy or breach of any
environmental representation, warranty or covenant by Parent, Borrower or any Subsidiary made
herein or in any other Loan Document evidencing or securing any Obligations or setting forth terms
and conditions applicable thereto or otherwise relating thereto, except for Damages arising from
the fraud, willful misconduct or gross negligence of the party claiming
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indemnification. This indemnification shall survive the payment and satisfaction of all Obligations and the termination
of this Agreement, and shall remain in force beyond the expiration of any applicable statute of
limitations and payment or satisfaction in full of any single claim under this indemnification.
This indemnification shall be binding upon the successors and assigns of Borrower and shall inure
to the benefit of the Lender, its directors, officers, employees, agents, and collateral trustees,
and their successors and assigns.
9.13 Set-off
. In addition to any rights now or hereafter granted under applicable law and
not by way of limitation of any such rights, upon the occurrence and during the continuance of any
Event of Default, Lender and each subsequent holder of any Obligation is hereby
authorized by each of Parent and Borrower at any time or from time to time, without notice to
Parent, Borrower or to any other Person, any such notice being hereby expressly waived, to set-off
and to appropriate and to apply any and all deposits (general or special, including, but not
limited to, indebtedness evidenced by certificates of deposit, whether matured or unmatured, but
not including trust accounts, and in whatever currency denominated) and any other indebtedness at
any time held or owing by the Lender or that subsequent holder to or for the credit or the account
of Parent or Borrower, whether or not matured, against and on account of the Obligations of
Borrower to the Lender or that subsequent holder under the Loan Documents, including, but not
limited to, all claims of any nature or description arising out of or connected with the Loan
Documents, irrespective of whether or not (a) the Lender or that subsequent holder shall have made
any demand hereunder or (b) the principal of or the interest on the Loans or Note and other amounts
due hereunder shall have become due and payable pursuant to Section 7 and although said obligations
and liabilities, or any of them, may be contingent or unmatured.
9.14 Entire Agreement
. The Loan Documents constitute the entire understanding of the parties
thereto with respect to the subject matter thereof and any prior agreements, whether written or
oral, with respect thereto are superseded hereby.
9.15 Governing Law
. This Agreement and the other Loan Documents, and the rights and duties
of the parties hereto, shall be construed and determined in accordance with the internal laws of
the Commonwealth of Virginia.
9.16 Severability of Provisions
. Any provision of any Loan Document which is unenforceable
in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such
unenforceability without invalidating the remaining provisions hereof or affecting the validity or
enforceability of such provision in any other jurisdiction. All rights, remedies and powers
provided in this Agreement and the other Loan Documents may be exercised only to the extent that
the exercise thereof does not violate any applicable mandatory provisions of law, and all the
provisions of this Agreement and other Loan Documents are intended to be subject to all applicable
mandatory provisions of law which may be controlling and to be limited to the extent necessary so
that they will not render this Agreement or the other Loan Documents invalid or unenforceable.
9.17 Excess Interest
. Notwithstanding any provision to the contrary contained herein or in
any other Loan Document, no such provision shall require the payment or permit the collection of
any amount of interest in excess of the maximum amount of interest permitted by applicable law to
be charged for the use or detention, or the forbearance in the collection, of all or
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any portion of the Loans or other obligations outstanding under this Agreement or any other Loan Document (Excess
Interest). If any Excess Interest is provided for, or is adjudicated to be provided for, herein
or in any other Loan Document, then in such event (a) the provisions of this Section shall govern
and control, (b) no Borrower, guarantor or endorser shall be obligated to pay any Excess Interest,
(c) any Excess Interest that the Lender may have received hereunder shall, at the option of the
Lender, be (1) applied as a credit against the then outstanding principal amount of Obligations
hereunder and accrued and unpaid interest thereon (not to exceed the maximum amount permitted by
applicable law), (2) refunded to Borrower, or (3) any combination of the foregoing, (d) the
interest rate payable hereunder or under any other Loan Document shall be automatically subject to
reduction to the maximum lawful contract rate allowed under applicable usury laws (the Maximum Rate), and this Agreement and the other Loan Documents shall be
deemed to have been, and shall be, reformed and modified to reflect such reduction in the relevant
interest rate, and (e) no Borrower, guarantor or endorser shall have any action against the Lender
for any Damages whatsoever arising out of the payment or collection of any Excess Interest.
Notwithstanding the foregoing, if for any period of time interest on any of Borrowers Obligations
is calculated at the Maximum Rate rather than the applicable rate under this Agreement, and
thereafter such applicable rate becomes less than the Maximum Rate, the rate of interest payable on
such Obligations shall remain at the Maximum Rate until the Lender has received the amount of
interest which the Lender would have received during such period on such Obligations had the rate
of interest not been limited to the Maximum Rate during such period.
9.18 Construction
. The parties acknowledge and agree that the Loan Documents shall not be
construed more favorably in favor of any party hereto based upon which party drafted the same, it
being acknowledged that all parties hereto contributed substantially to the negotiation of the Loan
Documents. Nothing contained herein shall be deemed or construed to permit any act or omission
which is prohibited by the terms of any Collateral Document, the covenants and agreements contained
herein being in addition to and not in substitution for the covenants and agreements contained in
the Collateral Documents.
9.19 USA Patriot Act
. The Lender hereby notifies Borrower that pursuant to the requirements
of the Patriot Act it is required to obtain, verify and record information that identifies
Borrower, which information includes the name and address of Borrower and other information that
will allow the Lender to identify Borrower in accordance with the Patriot Act.
9.20 Submission to Jurisdiction; Waiver of Jury Trial
. Each of the Lender, Parent and
Borrower hereby submits to the nonexclusive jurisdiction of the United States District Court for
the Eastern District of Virginia and of any Virginia State court sitting in Fairfax County,
Virginia for purposes of all legal proceedings arising out of or relating to this Agreement, the
other Loan Documents or the transactions contemplated hereby or thereby. Each of the Lender,
Parent and Borrower irrevocably waives, to the fullest extent permitted by law, any objection which
it may now or hereafter have to the laying of the venue of any such proceeding brought in such a
court and any claim that any such proceeding brought in such a court has been brought in an
inconvenient forum. Parent, Borrower and the Lender hereby irrevocably waive any and all right to
trial by jury in any legal proceeding arising out of or relating to any Loan Document or the
transactions contemplated thereby.
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[Signature Page to Follow]
-51-
In Witness Whereof
, the parties have entered into this Agreement as of the date first
written above.
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K12 Inc.
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By:
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John F. Baule, Executive Vice President
(Borrower)
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School Leasing Corporation
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By:
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John F. Baule, Executive Vice President
(Borrower)
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American School Supply Corporation
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By:
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John F. Baule, Executive Vice President
(Borrower)
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PNC Bank, National Association
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By:
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Christine E. Whitney, Vice President
(Lender and L/C Issuer)
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