SECURITIES AND EXCHANGE
COMMISSION
Washington, DC 20549
Form 10-K
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
June 30, 2008
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission File Number: 001-33883
K12 Inc.
(Exact name of registrant as
specified in its charter)
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Delaware
(State or other jurisdiction
of
incorporation or organization)
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95-4774688
(I.R.S. Employer
Identification No.)
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2300 Corporate Park Drive
Herndon, VA 20171
(Address of principal
executive offices)
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(703) 483-7000
(Registrants telephone
number,
including area code)
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Securities registered pursuant to Section 12(b) of the
Act:
Common Stock, $0.0001 par value
Securities registered pursuant to Section 12(g) of the
Act:
None
(Title of Class)
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined by Rule 405 of the Securities
Act. Yes
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No
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Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
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No
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Indicate by check mark whether the registrant: (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past
90 days. Yes
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No
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Indicate by check mark if disclosure of delinquent filers
pursuant to item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K.
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Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in Rule
12b-2
of the
Exchange Act. (Check one):
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Large
accelerated
filer
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Accelerated
filer
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Non-accelerated
filer
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Smaller
reporting
company
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(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the
Act). Yes
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No
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The aggregate market value of the Registrants voting stock
held by non-affiliates of the Registrant as of December 31,
2007 was approximately $552,575,465.
Number of shares outstanding of each class of common equity as
of September 22, 2008: 28,687,321 shares of Common Stock.
DOCUMENTS
INCORPORATED BY REFERENCE:
The registrant has incorporated by reference into Part III
of this
Form 10-K
specific portions of its proxy statement for the
registrants 2008 Annual Meeting of Stockholders to be held
November 21, 2008.
TABLE OF
CONTENTS
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PART I
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2
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ITEM 1.
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Business
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2
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ITEM 1A.
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Risk Factors
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23
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ITEM 1B.
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Unresolved Staff Comments
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34
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ITEM 2.
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Properties
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ITEM 3.
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Legal Proceedings
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ITEM 4.
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Submission of Matters to a Vote of Security Holders
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Executive Officers of the Registrant
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PART II
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37
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ITEM 5.
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Market for Common Equity and Related Stockholder Matters
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37
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ITEM 6.
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Selected Financial Data
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40
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ITEM 7.
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Managements Discussion and Analysis of Financial Condition
and Results of Operations
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42
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ITEM 7A.
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Quantitative and Qualitative Disclosures about Market Risk
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63
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ITEM 8.
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Consolidated Financial Statements and Supplementary Data
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64
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ITEM 9.
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Changes in and Disagreements with Accountants and Financial
Disclosure
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92
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ITEM 9A.
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Controls and Procedures
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ITEM 9B.
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Other Information
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92
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PART III
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92
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ITEM 10.
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Directors and Executive Officers of the Registrant
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92
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ITEM 11.
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Executive Compensation
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92
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ITEM 12.
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Security Ownership of Certain Beneficial Owners and Management
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ITEM 13.
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Certain Relationships and Related Transactions
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ITEM 14.
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Principal Accountant Fees and Services
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93
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PART IV
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93
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ITEM 15.
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Exhibits, Financial Statement Schedules
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93
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INDEX TO EXHIBITS
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96
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CERTAIN
DEFINITIONS
Unless the context requires otherwise, all references in this
Report to K12,
K
12
,
Company, we, our,
us refer to K12 Inc. and its consolidated
subsidiaries.
SPECIAL
NOTE ON FORWARD-LOOKING STATEMENTS
This Report on
Form 10-K
contains certain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. We have
tried, whenever possible, to identify these forward-looking
statements using words such as anticipates,
believes, estimates,
continues, likely, may,
opportunity, potential,
projects, will, expects,
plans, intends and similar expressions
to identify forward looking statements, whether in the negative
or the affirmative. These statements reflect our current beliefs
and are based upon information currently available to us.
Accordingly, such forward-looking statements involve known and
unknown risks, uncertainties and other factors which could cause
our actual results, performance or achievements to differ
materially from those expressed in, or implied by, such
statements. These risks, uncertainties, factors and
contingencies include, but are not limited to: the reduction of
per pupil funding amounts at the schools we serve; reputation
harm resulting from poor performance or misconduct of other
virtual school operators; challenges from virtual public school
opponents; failure of the schools we serve to comply with
regulations resulting in a loss of funding; discrepancies in
interpretation of legislation by regulatory agencies that may
lead to payment or funding disputes; termination of our
contracts with schools due to a loss of authorizing charter,
failure to renew existing contracts with schools; and increased
competition.
Forward-looking statements reflect our managements
expectations or predictions of future conditions, events or
results based on various assumptions and managements
estimates of trends and economic factors in the markets in which
we are active, as well as our business plans. They are not
guarantees of future performance. By their nature,
forward-looking statements are subject to risks and
uncertainties. Our actual results and financial condition may
differ, possibly materially, from the anticipated results and
financial condition indicated in these forward-looking
statements. There are a number of factors that could cause
actual conditions, events or results to differ materially from
those described in the forward-looking statements contained in
this Report. A discussion of factors that could cause actual
conditions, events or results to differ materially from those
expressed in any forward-looking statements appears in
Part 1 Item 1A Risk
Factors.
Readers are cautioned not to place undue reliance on
forward-looking statements in this Report or that we make from
time to time, and to consider carefully the factors discussed in
Part 1 Item 1A Risk
Factors of this Report in evaluating these forward-looking
statements. These forward-looking statements are representative
only as of the date they are made, and we undertake no
obligation to update any forward-looking statement as a result
of new information, future events or otherwise.
1
PART I
Our
Company
We are a technology-based education company. We offer
proprietary curriculum and educational services created for
online delivery to students in kindergarten through
12th grade, or K-12. Our mission is to maximize a
childs potential by providing access to an engaging and
effective education, regardless of geographic location or
socio-economic background. Since our inception, we have invested
more than $130 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual schools
and other educational applications. From fiscal year 2005 to
fiscal year 2008, we increased average enrollments in the
virtual public schools we serve from approximately 15,100
students to 40,800 students, representing a compound annual
growth rate of approximately 39%. Over the same period, we
increased revenues from $85.3 million to
$226.2 million, representing a compound annual growth rate
of approximately 38%, and increased EBITDA from
$2.2 million to $25.6 million. Also, over that period,
we went from a net loss of $3.5 million to net income of
$33.8 million (inclusive of a one-time tax benefit of
$27.0 million) and from an operating loss of
$3.3 million to operating income of $13.0 million.
We believe we are unique in the education industry because of
our direct involvement in every component of the educational
development and delivery process. Most educational content,
software and service providers typically concentrate on only a
portion of that process, such as publishing textbooks, managing
schools or providing testing and assessment services. This
traditional segmented approach has resulted in an uncoordinated
and unsatisfactory education for many students. Unburdened by
legacy, we have taken a holistic approach to the design of our
learning system. We have developed an engaging curriculum which
includes online lessons delivered over our proprietary school
platform. We combine this with a rigorous system to test and
assess students and processes to manage school performance and
compliance. In addition, our professional development programs
enable teachers to better utilize technology for instruction.
Our end-to-end learning system is designed to maximize the
performance of the schools we serve and enhance student academic
achievement.
As evidence of the benefit of our holistic approach, the virtual
public schools we serve generally test near, and in some cases
above, state averages on standardized achievement tests. These
results have been achieved despite the enrollment of a
significant number of new students each school year who have had
limited exposure to our learning system prior to taking these
required state tests. Students using our learning system for at
least three years usually perform better on standardized tests
relative to state averages than students using it for one year
or less. The efficacy of our learning system has also helped us
achieve high levels of customer satisfaction. According to a
2008 independent survey we commissioned of parents of K-8
students enrolled in virtual public schools we serve,
approximately 96% 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. The survey was conducted by TRC, an independent
research firm, in January 2008.
We deliver our learning system to students primarily through
virtual public schools. As with any public school, these schools
must meet state educational standards, administer proctored
exams and are subject to fiscal oversight. The fundamental
difference is that students attend virtual public schools
primarily over the Internet instead of traveling to a physical
classroom. In their online learning environment, students
receive assignments, complete lessons, and obtain instruction
from certified teachers with whom they interact online,
telephonically, and face-to-face. Many states have embraced
virtual public schools as a means to provide families with a
publicly funded alternative to a traditional classroom-based
education. For parents who believe their child is not thriving
and for whom relocating or private school is not an option,
virtual public schools can provide a compelling choice. This
widespread availability makes them the most public
of schools. From an education policy standpoint, virtual public
schools often represent a savings to the taxpayers when compared
with traditional public schools because they are generally
funded at a lower per pupil level than the per pupil state
average reported by the U.S. Department of Education.
Finally, because parents are not required to pay tuition,
virtual public schools make our learning system available to the
broadest range of students.
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We offer virtual schools our proprietary curriculum, online
learning platform and varying levels of academic and management
services, which can range from targeted programs to complete
turnkey solutions, under long-term contracts. These contracts
provide the basis for a recurring revenue stream as students
progress through successive grades. Additionally, without the
requirement of a physical classroom, virtual schools can be
scaled quickly to accommodate a large dispersed student
population, and allow more capital resources to be allocated
towards teaching, curriculum and technology rather than towards
a physical infrastructure.
Substantially all of our enrollments are served through 32
virtual public schools to which we provide full turnkey
solutions and seven virtual public schools to which we provide
limited management services. For the most part, these schools
are able to enroll students on a statewide basis in
21 states and the District of Columbia. In addition, a
small number of enrollments are served by an additional 29
schools that only enroll students in a single school district.
The services we provide to these districts are designed to
assist them in launching their own distance learning programs
and vary according to the needs of the individual school
districts. These services generally consist of our student
account management systems, administrator and teacher training
programs, and student placement support. Parents can also
purchase our curriculum and online learning platform directly to
facilitate or supplement their childrens education.
Additionally, we have piloted portions of our curriculum in
brick and mortar classrooms with promising academic results.
Finally, in January 2008 we launched the
K
12
International Academy, a private school fully operated by
K
12
and using the
K
12
curriculum. This school enables
K
12
to deliver our learning system to students worldwide.
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 of 2001, which implemented new standards and accountability
requirements for public K-12 education. The convergence of these
concerns and rapid advances in Internet technology created the
opportunity to make a significant impact by deploying a high
quality learning system on a flexible, online platform.
In September 2001, after 18 months of research and
development on our curriculum, we launched our kindergarten
through 2nd grade offering. We initially launched our
learning system in virtual public schools in Pennsylvania and
Colorado, serving approximately 900 students in the two states
combined. During the
2002-03
school year, we added our 3rd through 5th grade
offering and entered into contracts to operate virtual public
schools in California, Idaho, Ohio, Minnesota and Arkansas,
increasing our average enrollment to approximately 5,900
students during the
2002-03
school year. For the
2003-04
school year, we added our 6th and 7th grade offerings
and began serving students in Arizona, Florida, Utah and
Wisconsin. During the
2004-05
school year, we added our 8th grade offering, began serving
students in Kansas, and increased total enrollment to
approximately 15,100 students. In the
2005-06
school year, we initiated service to a virtual public school in
Texas. During the
2006-07
school year, we began serving students in the state of
Washington and implemented a hybrid school offering in Chicago
that combines face-to-face time in the classroom with online
instruction. We recently entered the virtual high school market,
enrolling 9th and 10th grade students at the start of
the
2005-06
and
2006-07
school years, respectively, and enrolling 11th and
12th grade students at the start of the
2007-08
school year. We added contracts to operate virtual public
schools in Georgia and Nevada for the
2007-08
school year and increased average
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enrollment to approximately 40,800 for the year. Finally, for
the
2008-09
school year, we began managing state-wide virtual public schools
in South Carolina, Hawaii and Oregon, as well as a hybrid
program in Indiana.
In October 2007, the Company acquired Power-Glide Knowledge
Courses Inc. (Power-Glide), a provider of online world language
courseware for $4.1 million consisting of shares of common
stock and the assumption of liabilities. We use these courses in
our virtual public schools and believe they have wide
applicability in online learning.
In January 2008, we launched the
K
12
International Academy, an online private school which serves
students in the U.S. and throughout the world. The school
utilizes the same
K
12
curriculum, systems, and teaching practices as the virtual
public schools we serve. The school is accredited by the
Commission on International and Trans-Regional Accreditation
(CITA), the Southern Association of Colleges and Schools (SACS),
and is recognized by the State of Virginia as a degree granting
institution of secondary learning. In addition, the
K
12
International Academy has a branch facility in Dubai which we
operate under a joint venture with a local partner to reach
students in the Gulf Cooperating Countries.
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:
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According to the National Center for Education Statistics
(NCES), a division of the U.S. Department of Education,
49.8 million students will attend K-12 public schools
during the
2008-09
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 will
encompass more than 97,000 schools and 14,000 districts during
the
2008-09
school year.
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The NCES estimates that total spending in the public K-12 market
will be $519 billion for the
2008-09
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 4,100 charter
schools in the U.S. with an estimated enrollment of over
1.2 million students according to the Center for Education
Reform. Similarly, acceptance of online learning initiatives,
including not only virtual schools but also online testing and
Internet-based professional development, has become widespread.
As of June 2008, 42 states had established some form of
online learning initiative, and Michigan recently became the
first state to pass legislation mandating that high school
students take part in an online learning experience
in order to graduate.
Virtual public schools represent one approach to online learning
that is gaining acceptance. According to the Center for
Education Reform, as of January 2007 there were 173 virtual
schools with total enrollment exceeding 92,000 students,
operating in 18 states compared to just 86 virtual schools
in 13 states with total enrollment of 31,000 students in
the
2004-05
school year. Virtual schools can offer a comprehensive
curriculum and flexible delivery model; therefore, we believe
that a growing number of families will pursue virtual public
schools as an
4
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.
Educational
Philosophy
The design, development and delivery of our learning system is
based on the following set of guiding principles:
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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.
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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.
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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 14,000 lessons, designed to teach
concepts to students from kindergarten through 12th grade.
Each lesson is designed to last approximately 45 to 60
5
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.
Most of our courses
utilize a series of offline learning kits in conjunction with
the online lessons to help maximize the effectiveness of our
learning system. In addition to receiving access to our online
lessons through the Internet, each student receives a shipment
of offline materials, including textbooks, art supplies,
laboratory supplies (e.g. microscopes and scales) and other
reference materials which are incorporated throughout our
curriculum. This approach is consistent with our guiding
principle to utilize technology where appropriate in our
learning system. Most of the textbooks we use are proprietary
textbooks that are written in a way that is designed to be
engaging to students and to compliment the online experience. We
believe that our ability to combine online lessons and offline
materials so effectively is a competitive advantage.
Teachers Guides.
All of our courses are
paired with a teachers guide. Each guide outlines the
course objectives, refers back to all of the course content that
is contained in the online and offline course materials,
includes answers and explanations to the exercises that the
students complete and contains suggestions for explaining
difficult concepts to students.
6
Courses
Offered
The following table provide a list of our K-8 and high school
course offerings:
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English and Language Arts
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Mathematics
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Science
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History
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World Languages
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Music/Art/Other
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Elementary 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
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Kindergarten Math
1st Grade Math
2nd Grade Math
3rd Grade Math
4th Grade Math
5th Grade Math
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Kindergarten Science
1st Grade Science
2nd Grade Science
3rd Grade Science
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Kindergarten History
1st Grade History
2nd Grade History
3rd Grade History
4th Grade History
American History Before 1865
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Spanish Elementary Year 1
Spanish Elementary Year 2
French Elementary Year 1
French Elementary Year 2
German Elementary Year 1
German Elementary Year 2
Latin Elementary Year 1
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Kindergarten Art
1st Grade Art
2nd Grade Art
3rd Grade Art
4th Grade Art
Intermediate Art: American A
Preparatory Music
Beginning 1 Music
Beginning 2 Music
Introduction to Music
Intermediate 1 Music
Intermediate 2 Music
Intermediate 3 Music
Exploring Music
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Middle School
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Intermediate Language Skills A
Intermediate Language Skills B
Intermediate Literature A
Intermediate Literature B
Literary Analysis and Composition
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Pre-Algebra A
Pre-Algebra B
Algebra I
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Earth Science
Life Science
Physical Science
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American History Since 1865
Intermediate World History A
Intermediate World History B
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Intermediate Art: American B
Intermediate Art: World A
Intermediate Art: World B
Music Concepts A
Music Concepts B
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High School
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ENG102: Literary Analysis and Composition I
ENG103: Literary Analysis and Composition I
ENG104: Honors Literary Analysis and Composition I
ENG202: Literary Analysis and Composition II
ENG203: Literary Analysis and Composition II
ENG204: Honors Literary Analysis and Composition II
ENG302: American Literature
ENG303: American Literature
ENG304: Honors American Literature
ENG402: British and World Literature
ENG403: British and World Literature
ENG500:
AP
®
English Language and Composition
ENG510:
AP
®
English Literature and Composition
ENG010: Journalism
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MTH102: Math Foundations
MTH112: Pre-Algebra
MTH113: Pre-Algebra
MTH122: Algebra I
MTH123: Algebra I
MTH124: Honors Algebra I
MTH203: Geometry
MTH302: Algebra II
MTH303: Algebra II
MTH312: Business & Consumer Math
MTH403: Pre-Calculus/ Trigonometry
MTH500:
AP
®
Calculus AB
MTH510:
AP
®
Statistics
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SCI102: Physical Science
SCI112: Earth Science
SCI113: Earth Science
SCI202: Biology
SCI203: Biology
SCI302: Chemistry
SCI303: Chemistry
SCI304: Honors Chemistry
SCI403: Physics
SCI500:
AP
®
Biology
SCI510:
AP
®
Chemistry
SCI520:
AP
®
Physics B
SCI010: Environmental Science
SCI020: Life Science: Oceanography
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HST102: World History
HST103: World History
HST203: Modern World Studies
HST212: Geography and World
Cultures
HST213: Geography and World
Cultures
HST302: U.S. History
HST303: U.S. History
HST304: Honors U.S. History
HST402: U.S. Government and
Politics
HST403: U.S. Government and
Politics
HST412: U.S. and Global Economics
HST413: U.S. and Global Economics
HST500:
AP
®
U.S. History
HST510:
AP
®
U.S. Government and Politics
HST520:
AP
®
Macroeconomics
HST530:
AP
®
Microeconomics
HST540:
AP
®
Psychology
HST010: Anthropology
HST020: Psychology
HST030: Macroeconomics
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WLG100: Spanish I
WLG200: Spanish II
WLG300: Spanish III
WLG500:
AP
®
Spanish Language
WLG110: French I
WLG210: French II
WLG310: French III
WLG510:
AP
®
French Language
WLG120: German I
WLG220: German II
WLG130: Latin I
WLG230: Latin II
WLG140: Chinese I
WLG240: Chinese II
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ART010: Fine Art
ART020: Music Appreciation
ORN010: Online
Learning 08-09
ORN020: Finding Your Path
Planning for Career and College
OTH010: Skills for Health
OTH020: Physical Education
OTH030: Career Planning
OTH040: Study Skills and
Learning Strategies
BUS010: Business
Communication and Career
Exploration
BUS020: Business and Personal
Relationships
BUS030: Personal Finance
TCH010: Computer Literacy I TCH020: Computer Literacy II
TCH030: Digital Photography
and Graphics
TCH040: Web Design
TCH050: Digital Video Production
TCH060: C++ Programming
TCH070: Game Design I
TCH080: Game Design II
TCH090: 3D Game Creation
TCH016: Flash Animation
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Notes: Italicized courses are licensed on a per enrollment basis
from third parties for the
2008-09
school year.
7
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 26 courses specifically for use in
Texas public schools. Also, beginning in 2008, we have expanded
the K-8 offering to include elementary and middle school world
language courses in Spanish, French, German, Chinese, and Latin.
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 courses owned
by
K
12
and selected courses licensed from third-parties. In the
2008-09
school year,
K
12
courses will account for over 90% of total high school course
enrollments.
Online
School Platform
Our Online School 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 be adjusted 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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Assessment Tracking Tools:
Independent
third-party assessments will be used in most K12-managed schools
to pinpoint specific individual student strengths and weaknesses
relative to state content standards at the beginning of the
school year. These results enable the teacher to develop a
highly personalized individual learning plan for students. End
of year testing will provide a measure of individual student
growth demonstrating the value-added gains of the school program.
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8
School
Management Systems
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. SAMS is also central to collecting and managing all
administrative data required to operate a virtual public school.
In addition, the information provided by SAMS feeds our
proprietary Order Management System (OMS) that generates orders
for offline learning kits and computers to be delivered to
students. In addition, in 2008 we launched TotalView, which
provides administrators, teachers, parents and students a
unified view of student progress, attendance, document
interaction and learning kit shipment tracking. TotalView also
provides a more sophisticated means of tracking of student
engagement in required classroom activities, identification of
those students struggling with grade level state content
standards, and previous years performance on state tests.
Student
Community Tools
We place a strong emphasis on the importance of building a sense
of community in the schools we manage. We offer tools that
foster communication and interaction among virtual public school
students and parents. We have just launched
thebigthinK
12
,
our secure, online community for
K
12
high school students (age 13 and over), parents, teachers,
school administrative staff and
K
12
staff. It is built using a third party platform and includes the
following capabilities: discussion boards, blogs, document
repository, calendars, RSS feeds, polls, profiles and private
messaging. The community is also professionally monitored by an
independent third party. 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 school we serve in Pennsylvania, between
September 1, 2007 and June 30, 2008 we received
approximately twenty applications for each teaching position
filled.
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.
9
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.
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. We offer our
K
12
Care program to address any questions or concerns that
students and their parents have during the course of their
matriculation. We plan and coordinate social events to offer
students opportunities to meet and socialize with their virtual
public school peers. Finally, in connection with our high school
offering, each student is assigned an advisor
and/or
a
guidance counselor who assists them with academic issues,
college and career planning and other support as needed.
Management
Services
Under many of our contracts, we provide virtual public schools
with turnkey management services. In these circumstances, we
take responsibility for all aspects of the management of the
schools, including monitoring academic achievement, teacher
hiring and training, compensation of school personnel, financial
management, enrollment processing and procurement of curriculum,
equipment and required services. In 2007, the Commission on
International and Trans-regional Accreditation (CITA), a leading
worldwide education accreditation agency, thoroughly evaluated
our school management services and we ultimately received the
prestigious CITA accreditation.
Compliance and Tracking Services.
Operating a
virtual public school entails most of the compliance and
regulatory requirements of a traditional public school. We have
developed management systems and processes designed to ensure
that schools we serve are in compliance with all applicable
requirements, including tracking appropriate student information
and meeting various state reporting requirements. For example,
we collect enrollment related information, monitor attendance
and administer proctored state tests. As we have expanded into
new states, our processes have grown increasingly robust, and we
believe our compliance and tracking processes provide us with a
distinct competitive advantage.
Financial Support Services.
For the schools we
manage, we oversee the preparation of the annual budget and
coordinate 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.
10
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.
11
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.
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.
Education Advisory Committee.
To ensure the
effectiveness of our learning systems, we have established an
external Education Advisory Committee comprised of experienced
leaders in the education industry. The members of this Committee
have the responsibility to review our curriculum and
instructional model, identify the needs of the growing online
education market and propose solutions for consideration by our
management, and discuss ways that we can better implement our
guiding principles. The current members of the Committee include:
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Thomas C. Boysen, Ed.D.,
Senior Vice President, Global
Scholar Inc., and formerly Senior Vice President of K12 Inc.,
Kentucky Commissioner of Education, Chief Operating Officer of
the Los Angeles Unified School District, Senior Vice President
of the Milken Family Foundation and a school district
superintendent in California, Washington and New York.
Mr. Boysen is also the Chair of the Education Advisory
Committee.
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Barbara Byrd-Bennett, Ed.D.,
Executive-In-Residence,
College of Education and Human Services, Cleveland State
University and formerly Chief Executive Officer of the Cleveland
Municipal School District and a school district superintendent
for two school districts in New York City.
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Benjamin Canada, Ph.D.,
Associate Executive
Director, District Services, Texas Association of School Boards
and formerly President of the American Association of School
Administrators and a school district superintendent in Georgia,
Mississippi and Oregon.
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JoLynne DeMary, Ed.D.,
Educational Leadership Director,
Center for School Improvement, Virginia Commonwealth University
and formerly Virginia Superintendent of Public Instruction.
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David Driscoll, Ed.D.,
Education Consultant and formerly
President, Council of Chief State School Officers, Commissioner
of Education, Commonwealth of Massachusetts and a school
district superintendent in Massachusetts. Dr. Driscoll
currently serves on the board of the National Assessment
Governing Board.
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Chester Finn, Ed.D.,
President, Thomas B. Fordham
Foundation and formerly Assistant Secretary for Research and
Improvement & Counselor to the Secretary,
U.S. Department of Education.
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Charles Fowler Ed.D.,
President of School Leadership,
LLC, Executive Secretary of the Suburban School Superintendents,
an Adjunct Professor of School Organization and Leadership,
Teachers College, Columbia University and formerly Chairperson
of State and National Relations for the American Association of
School Administrators and a school district superintendent in
Connecticut, Florida, Illinois and New York.
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Mary Futrell, Ed.D.,
Dean, Graduate School of Education
and Human Development, George Washington University; Director,
K12 Inc.; Co-director, George Washington Institute for
Curriculum, Standards and Technology; founding President of
Education International; and formerly President, World
Confederation of the Organizations of the Teaching Profession;
President, National Education Association, President, Virginia
Education Association, and President, ERAmerica.
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Michael Kirst, Ph.D.,
Professor Emeritus of
Education and Business, Stanford University and formerly
President of the California State Board of Education.
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William Librera, Ph.D,
Presidential Research Professor of
Education for the Rutgers University Graduate School of
Education, formerly Commissioner of Education for the State of
New Jersey.
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Dale Mann, Ph.D.,
Managing Director, Interactive
Inc. and Professor Emeritus of Educational Administration,
Teachers College, Columbia University and formerly Senior
Research Associate, Institute on Education and the Economy,
Teachers College, Columbia University.
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Thomas Payzant, Ed.D.,
Professor of Practice, Harvard
Graduate School of Education and formerly Assistant Secretary
for Elementary and Secondary Education, U.S. Department of
Education and a school district superintendent in California,
Pennsylvania, Massachusetts, Oklahoma and Oregon.
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Betty Rosa, Ed.D.,
Education Consultant and formerly a
school district superintendent in New York City. Ms. Rosa
also serves on the board of the Alumni Council of the Harvard
Graduate School of Education.
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Bernice Stafford, M.A.,
Principal Consultant, Center for
Interactive Learning and Collaboration and formerly Vice
President of School Strategies and Evaluation, PLATO Learning,
Inc. and a co-founder of Lightspan, Inc.
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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.
13
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.
In fiscal year 2008, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy and the Agora Cyber
Charter School in Pennsylvania. In aggregate, these schools
accounted for 26% of our total revenues. We provide our full
turnkey management solutions pursuant to our contracts with the
Ohio Virtual Academy, which terminates June 30, 2017, and
with the Agora Cyber Charter School, pursuant to a contract with
the Cynwyd Group which expires June 30, 2016. Each of the
contracts with these schools provides for termination of the
agreement if the school ceases to hold a valid and effective
charter from the charter-issuing authority in their respective
states or if there is a material reduction in the per enrollment
funding level.
Our direct-to-consumer product is purchased through our customer
call center or online, by parents who desire to educate their
children outside of the public school system or to supplement
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 may purchase our
fractions module. The ability to reconfigure individual lessons
is highly scalable and we believe this opportunity is
significant.
In addition to these primary distribution channels, we are
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 implemented a hybrid offering in Chicago,
and more recently in Indianapolis and Muncie, 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 new jurisdictions within the United
States, we are pursuing international opportunities where we
believe there is significant demand for a quality online
education.
In January 2008, we launched the
K
12
International Academy, an online private school which serves
students in the U.S. and throughout the world. Through
K
12
International Academy, students may study in an academic program
which is virtually identical to a
U.S.-
based
private school and leads ultimately to a recognized high school
diploma. The school utilizes the same
K
12
curriculum, systems, and teaching practices as the virtual
public schools we serve in the U.S. In addition,
K
12
International Academy provides a unique international community
including clubs and events that enrich the student experience by
allowing students to interact with peers from other countries
and cultures. The school is accredited by the Commission on
International and Trans-Regional Accreditation (CITA), the
Southern Association of Colleges and Schools (SACS), and is
recognized by the State of Virginia as a degree granting
institution of secondary learning.
K
12
International Academy also has a branch facility in Dubai to
reach and support students in the Gulf Cooperating Countries. We
operate this through a joint venture with a local partner.
14
Student
Recruitment and Marketing
Our student recruitment and marketing team consisted of
66 employees as of June 30, 2008, and is responsible
for promoting our corporate brand, generating new student
enrollments, generating direct-to-consumer sales, 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 over
3,600 such events during fiscal year 2008. 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
thebigthinK
12
,
an online private global community limited to those parents,
teachers and high school students (age 13 and over), with a
valid
K
12
password and who are subject to a code of conduct. The community
is also professionally monitored by an independent third party.
We also send welcome packages, conduct art contests, conduct
research (qualitative and quantitative), and provide support to
students through online web-based sessions.
Technology
As of June 30, 2008, we employed 89 employees in our
technology department. Our learning system, along with our back
office systems supporting order management, logistics and
e-commerce,
are built on our proprietary Service Oriented Architecture, or
SOA, to ensure high availability and redundancy and allow
flexibility and security to be core principles of our
systems foundation.
Service Oriented Architecture.
All of our
systems leverage our SOA built on top of Enterprise Java that
separates an implemented capability from a request flow that
utilizes those capabilities. This leverage provides us with the
ability to deliver different presentations against a single
request workflow. Additionally, this flexibility allows
iterative solutions to be developed expeditiously to meet both
present and future market needs. Our high availability and
scalability are also facilitated by this architecture. The SOA
also enables seamless integration with third-party solutions in
our platform with ease and efficiency.
Availability and Redundancy.
Our SOA allows
for a hardware topology where primary and secondary equipment
can be utilized at all network and application tiers. Each
application layer is load balanced across multiple servers,
which, along with our sophisticated state management
capabilities, allows for additional hardware to be inserted into
our network providing us with impressive scalability and
availability as evidenced by our greater than 99% 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.
15
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; KC
Distance Learning Inc.; Insight Schools, Inc.; Plato Learning,
Inc.; White Hat Management, LLC and National Network of Digital
Schools among others. 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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We are unable to provide meaningful data with respect to our
market share. At a minimum, we believe that we serve the market
for public education, and in any jurisdiction in which we
operate, we generally serve far less than 1% of the public
school students in the geographic area in which virtual school
enrollments are drawn. Defining a more precise relevant market
upon which to base a share estimate would not be meaningful due
to significant limitations on the comparability of data among
jurisdictions. For example, some providers to K-12 virtual
schools serve only the high school segment, others serve the
elementary and middle school segment, and a few serve both.
Furthermore, some school districts offer their own virtual
programs. Parents in search of an alternative to their local
public school also have a number of substitutable choices beyond
virtual schools including private schools, charter schools, home
schooling, and blended public schools. In addition, our
integrated learning system consists of components that face
competition from many different education industry segments,
such as traditional textbook publishers, test and assessment
firms and private education management companies. Finally, our
learning system is designed to operate domestically and
internationally over the Internet, and thus the geographic
addressable market is global and indeterminate in size.
Intellectual
Property
Since our inception, we have invested more than
$130 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. We were granted a patent with the same
name and substantially the same claims (Patent
No. 2007226807) by the Australian Patent Office on
November 8, 2007. In general terms, these patents cover 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 six U.S. and five
international patent applications pending in regards to other
aspects of the patented inventions. Finally, we have two
U.S. and two international patent applications with 10
foreign counterparts pending in selected countries relating to
the inventive aspects of our basal math and science and hybrid
learning environments.
16
We own the copyright to over 14,000 lessons contained in the
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
The offline learning kits that accompany our online lessons are
an essential component of our courses. 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 2008, we assembled approximately
3.0 million items into more than 350,000 kits.
Over our seven 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, we store our inventory, build
our learning kits and ship the kits to students. 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 the future, we plan to establish a second
logistics and fulfillment center in the western portion of the
United States to support our growth and to mitigate
single-location fulfillment risk.
For many of our virtual public school customers, we attempt to
reclaim any materials that are not consumed during the course of
the school year. These items, once returned to our fulfillment
center, are refurbished and included in future learning kits.
This reclamation process allows us to maintain lower materials
costs.
In order to ensure that students in virtual public schools have
access to our OLS, we often provide students with a computer and
all necessary support. We source computers and ship them to
students when they enroll and reclaim the computers at the end
of a school year or upon termination of their enrollment or
withdrawal from the virtual public school in which they are
enrolled. As of June 30, 2008, we had approximately
26,500 personal computers deployed or available for use by
students.
Our fulfillment activities are highly seasonal, and are centered
around the start of school in August or September. Accordingly,
approximately 63% of our annual materials receiving occurs
between April and June and approximately 65% of customer item
fulfillment and shipping occurs between July and October.
Employees
As of June 30, 2008, we had 763 employees including
186 teachers. In addition, there are approximately
950 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
17
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.
Available
Information
Our Companys Internet address is www.k12.com. We make
available, free of charge through our website, our annual
reports on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
and amendments to those reports filed pursuant to
Section 13(a) or 15(d) of the Exchange Act, soon after they
are electronically filed with the SEC. In addition, our earnings
conference calls are web cast live via our website. In addition
to visiting our website, you may read and copy public reports we
file with the SEC at the SECs Public Reference Room at
100 F. Street, NE, Washington DC 20549, or at
www.sec.gov. You may obtain information on the operation of the
Public Reference Room by calling the SEC at
1-800-SEC-0330.
Information contained on our website is expressly not
incorporated by reference into this
Form 10-K.
18
REGULATION
We and the virtual public schools that purchase our curriculum
and management services are subject to regulation by each of the
states in which we operate, including Colorado, Arizona, Idaho,
Florida, Wisconsin, Arkansas, Texas, Illinois, Minnesota,
Kansas, Utah, Nevada, California, Georgia, Ohio, Pennsylvania,
Washington, Oregon, South Carolina, Indiana, Hawaii and the
District of Columbia. The state laws and regulations that
directly impact our business are those that authorize or
restrict our ability to operate virtual public schools, and
those that restrict virtual public school growth and funding. In
addition, there are state laws and regulations that are
applicable to virtual public schools that indirectly affect our
business insofar as they affect these virtual public
schools ability to operate and receive funding. Finally,
to the extent a virtual school obtains federal funds, such as
through a grant program or financial support dedicated for the
education of low-income families, these schools then become
subject to additional federal regulation. These federal
regulations have not had a material impact on our business.
State Laws Authorizing or Restricting Virtual Public
Schools.
The authority to operate a virtual
public school is dependent on the laws and regulations of each
state. Laws and regulations vary significantly from one state to
the next and are constantly evolving. In states that have
implemented specific legislation to support virtual public
schools, the schools are able to operate under these statutes.
Other states provide for virtual public schools under existing
charter school legislation or provide that school districts
and/or
state
education agencies may authorize them. Some states do not
currently have legislation that provides for virtual public
schools or have requirements that effectively prohibit virtual
public schools and, as a result, may require new legislation
before virtual public schools can open in the state. According
to a June 2008 update of state online learning policies by the
North American Council for Online Learning (NACOL),
there are 42 states that have either adopted legislation or
formal rules or have created programs for the purpose of
providing statewide supplemental
and/or
full-time online learning opportunities. We currently serve
virtual schools or school district-led programs in
25 states plus the District of Columbia. NACOL also
identified 8 states that do not currently have either a
state-led program or significant state-level policies for online
education; however, the absence of such conditions has not
precluded us from applying to serve, and in certain cases
serving, schools in some of those states.
Obtaining new legislation in these remaining states can be a
protracted and uncertain process despite their limited number.
When determining whether to pursue expansion into new states in
which the laws are ambiguous, we research the relevant
legislation and political climate and then make an assessment of
the perceived likelihood of success before deciding to commit
resources. Specifically, we take into account numerous factors
including, but not limited to, the regulations of the state
educational authorities, whether the overall political
environment is amenable to school choice, whether current
funding levels for virtual school enrollments are adequate and
accessible, and the presence of non-profit and for-profit
competitors in the state.
State Laws and Regulations Applicable to Virtual Public
Schools.
Virtual public schools that purchase our
curriculum and management services are often governed and
overseen by a non-profit or local or state education agency,
such as an independent charter school board, local school
district or state education authority. We generally receive
funds for products and services rendered to operate virtual
schools under detailed service agreements with that governing
authority. Virtual public schools are typically funded by state
or local governments on a per student basis. A virtual school
that fails to comply with the state laws and regulations
applicable to it may be required to repay these funds and could
become ineligible for receipt of future state funds. Subject to
the outcome of the legal proceedings described in the section
entitled Part I, Item 3 Legal
Proceedings, we are not aware of any material
non-compliance with these state regulations by the virtual
public schools we serve.
To be eligible for state funding, some states require that
virtual schools be organized under not-for-profit charters
exempt from taxation under Section 501(c)(3) of the
Internal Revenue Code. The schools must then be operated
exclusively for charitable educational purposes, and not for the
benefit of private, for-profit management companies. The board
or governing authority of the not-for-profit virtual school must
retain ultimate accountability for the schools operations
to retain its tax-exempt status. It may not delegate its
responsibility and accountability for the schools
operations. Our service agreements with these virtual schools
are therefore structured to ensure the full independence of the
not-for-profit board and preserve its ability to exercise its
fiduciary obligations to operate a virtual public school.
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Laws and regulations affect many aspects of operating a virtual
public school. They can dictate the content and sequence of the
curriculum, the requirements to earn a diploma, use of approved
textbooks, the length of the school year and the school day, the
assessment of student performance, and any accountability
requirements. In addition, a virtual public school may be
obligated to comply with state requirements to offer programs
for specific populations, such as students at risk of dropping
out of school, gifted and talented students, non-English
speaking students, pre-kindergarten students, and students with
disabilities. Tutoring services and the use of technology may
also be regulated. Other state laws and regulations may affect
the schools compulsory attendance requirements, treatment
of absences and
make-up
work, and access by parents to student records and teaching and
testing materials. Additionally, states have various
requirements concerning the reporting of extensive student data
that may apply to the school. A virtual public school may have
to comply with state requirements that school campuses report
various types of data as performance indicators of the success
of the program.
States have laws and regulations concerning certification,
training, experience and continued professional development of
teachers and staff with which a virtual public school may be
required to comply. There are also numerous laws pertaining to
employee salaries and benefits, statewide teacher retirement
systems, workers compensation, unemployment benefits, and
matters related to employment agreements and procedures for
termination of school employees. A virtual public school must
also comply with requirements for performing criminal background
checks on school staff, reporting criminal activity by school
staff and reporting suspected child abuse.
As with any public school, virtual public schools must comply
with state laws and regulations applicable to governmental
entities, such as open meetings laws, which may require the
board of trustees of a virtual public school to hold its
meetings open to the public unless an exception in the law
allows an executive session. Failure to comply with these
requirements may lead to personal civil
and/or
criminal penalties for board members or officers. Virtual public
schools must also comply with public information or open records
laws, which require them to make school records available for
public inspection, review and copying unless a specific
exemption in the law applies. Additionally laws pertaining to
records privacy and retention and to standards for maintenance
of records apply to virtual public schools.
Other types of regulation applicable to virtual public schools
include restrictions on the use of public funds, the types of
investments made with public funds, the collection of and use of
student fees, and controlling accounting and financial
management practices.
There remains uncertainty about the extent to which we may be
required to comply with state laws and regulations applicable to
traditional public schools because the concept of virtual public
schools is relatively new. Although we receive state funds
indirectly, according to the terms of each service agreement
with the local public school entity, our receipt of state funds
subjects us to extensive state regulation and scrutiny. Several
states have commenced audits, some of which are still pending,
to verify enrollment, attendance, fiscal accountability, special
education services, and other regulatory issues. While we may
believe that a virtual public school we serve is compliant with
state law, an agencys different interpretation of law in a
particular state could result in non-compliance, potentially
affecting funding.
Regulations Restricting Virtual Public School Growth and
Funding.
As a new public schooling alternative,
some state and regulatory authorities have elected to proceed
cautiously with virtual public schools while providing
opportunities for taxpayer families seeking this alternative.
Regulations that control the growth of virtual public schools
range from prescribing the number of schools in a state to
limiting the percentage of time students may receive instruction
online. Funding regulations can also have this effect.
Regulations that hinder our ability to serve certain
jurisdictions include: restrictions on student eligibility, such
as mandating attendance at a traditional public school prior to
enrolling in a virtual public school; caps on the total number
of students in a virtual school; restrictions on grade levels
served; 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
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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.
Five 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
21
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.
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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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Communications Decency Act.
The Communications
Decency Act of 1996 (CDA) provides protection for
online service providers against legal action being taken
against them because of certain actions of others. For example,
the CDA states that no provider or user of an interactive
computer service shall be treated as the publisher or speaker of
any data given by another provider of information content.
Further,
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Section 230 of the CDA grants interactive online services
of all types, broad immunity from tort liability so long as the
information at issue is provided or posted by a third party. As
part of our technology services offering, we provide an On-line
School platform on which teachers and students may communicate.
We also conduct live classroom sessions using Internet-based
collaboration software and we offer certain online community
platforms for students and parents. While the CDA affords us
with some protection from liability associated with the
interactive online services we offer, there are exceptions to
the CDA that could result in successful actions against us that
give rise to financial liability.
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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.
Statements made by us in this report and in other reports and
statements released by us that are not historical facts
constitute forward-looking statements. These
forward-looking statements are necessarily estimates reflecting
the best judgment of our senior management based on our current
estimates, expectations, forecasts and projections and include
comments that express our current opinions about trends and
factors that may impact future operating results. Disclosures
that use words such as we believe,
anticipate, estimate,
intend, could, plan,
expect, project or the negative of
these, as well as similar expressions, are intended to identify
forward-looking statements. Such statements rely on a number of
assumptions concerning future events, many of which are outside
of our control, and involve known and unknown risks and
uncertainties that could cause our actual results, performance
or achievements, or industry results, to differ materially from
any future results, performance or achievements, expressed or
implied by such forward-looking statements. Any such
forward-looking statements, whether made in this report or
elsewhere, should be considered in the context of the various
disclosures made by us about our businesses including, without
limitation, the risk factors discussed below. We do not plan to
update any such forward-looking statements and expressly
disclaim any duty to update the information contained in this
filing, except as required by law.
Risks
Related to Government Funding and Regulation of Public
Education
Most
of our revenues depend on per pupil funding amounts remaining
near the levels existing at the time we execute service
agreements with the virtual public schools we serve. If those
funding levels are materially reduced, new restrictions adopted
or payments delayed, our business, financial condition, results
of operations and cash flows could be adversely
affected.
The public schools we contract with are financed with government
funding from federal, state and local taxpayers. Our business is
primarily dependent upon those funds. Budget appropriations for
education at all levels of government are determined through the
political process, which may also be affected by conditions in
the economy at large. As a result, funding for the virtual
public schools we serve may decline. The political process and
general economic conditions create a number of risks that could
have an adverse affect on our business including the following:
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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 biannual education budget for fiscal years 2008 and 2009,
the Indiana legislature decided not to fund any virtual public
school that provided for the online delivery of more than
50 percent of its instruction to students. As a result, we
decided not to open a virtual public school in Indiana that had
already been approved by a chartering authority for the
2007-08
school year, and therefore, the anticipated associated revenues
for
2007-08
were not realized. We ultimately were successful in opening two
hybrid schools in Indiana in
2008-09
that
provide for over 50 percent of classroom instruction and
which thereby qualified for funding under Indiana law. 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;
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as a public company, we are 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
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from time to time, government funding to schools is not provided
when due, which sometimes causes the affected schools to delay
or cease payments to us for our products and services. These
payment delays have occurred in the past and can deprive us of
significant working capital until the matter is resolved, which
could hinder our ability to implement our growth strategies and
conduct our business. For example, in 2003 the Pennsylvania
state legislature withheld monthly payments for every school
because it was unable to approve an education budget for six
months, which necessitated our borrowing of funds to continue
operations.
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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 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. The precise impact of these negative public
perceptions on our business is difficult to discern, in part
because of the number of states in which we operate and the
range of particular malfeasance or performance issues involved.
We have incurred significant lobbying costs in several states
advocating against harmful legislation which, in our opinion,
was aggravated by negative media coverage of particular virtual
school operators. If these few situations, or any additional
misconduct, cause all virtual public school providers to be
viewed by the public
and/or
policymakers unfavorably, we may find it difficult to enter into
or renew contracts to operate virtual schools. In addition, this
perception could serve as the impetus for more restrictive
legislation, which could limit our future business opportunities.
Opponents
of virtual public schools have sought to challenge the
establishment and expansion of such schools through the judicial
process. If these interests prevail, it could damage our ability
to sustain or grow our current business or expand in certain
jurisdictions.
We have been, and will likely continue to be, subject to
lawsuits filed against virtual public schools by those who do
not share our belief in the value of this form of public
education. Legal claims have involved challenges to the
constitutionality of authorizing statutes, methods of
instructional delivery, funding provisions and the respective
roles of parents and teachers. We currently face one such
lawsuit pertaining to the Chicago Virtual Charter School. See
Part I, Item 3 Legal
Proceedings. An adverse judgment in this case could serve
as a negative precedent in other jurisdictions where we do
business, and new lawsuits could result in unexpected
liabilities and limit our ability to sustain or grow our current
business or expand in certain jurisdictions.
The
failure of the virtual public schools we serve to comply with
applicable government regulations could result in a loss of
funding and an obligation to repay funds previously received,
which could adversely affect our business, financial condition
and results of operations.
Once authorized by law, virtual public schools are generally
subject to extensive regulation. These regulations cover
specific program standards and financial requirements including,
but not limited to: (i) student eligibility standards;
(ii) numeric and geographic limitations on enrollments;
(iii) prescribed teacher funding allocations from
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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. 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.
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 many cases, virtual public schools operate under a charter
that is granted by a state or local authority to the charter
holder, such as a community group or an established
not-for-profit corporation, which typically is required by state
law to qualify for student funding. In fiscal year 2008,
approximately 90% of our revenues were derived from virtual
public schools operating under a charter. The service agreement
for these schools is with the charter holder or the charter
board. Non-profit charter schools qualifying for exemption from
federal taxation under Internal Revenue Code
Section 501(c)(3) as charitable organizations must also
operate in accordance with Internal Revenue Service rules and
policies to maintain that status and their funding eligibility.
In addition, all state charter school statutes require periodic
reauthorization. While none of the virtual public schools we
serve have failed to maintain their authorizing charter, if a
virtual public school we serve fails to maintain its tax-exempt
status and funding eligibility, or if its charter is revoked for
non-performance or other reasons that may be due to actions of
the independent charter board completely outside of our control,
our contract with that school would be terminated.
Actual
or alleged misconduct by our senior management and directors
would make it more difficult for us to enter into new contracts
or renew existing contracts.
If any of our directors, officers or key employees are accused
or found to be guilty of serious crimes, including the
mismanagement of public funds, the schools we serve could be
barred from entering into or renewing service agreements with us
or otherwise discouraged from contracting with us and, as a
result, our business and revenues would be adversely affected.
Risks
Related to Our Business and Our Industry
We
have a limited operating history, and sustained cumulative net
losses of approximately $90 million before only recently
achieving profitability. If we fail to remain profitable or
achieve further marketplace acceptance for our products and
services, our business, financial condition and results of
operations will be adversely affected.
The virtual public schools we serve began enrolling students in
the
2001-02
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 recorded cumulative net losses totaling
approximately $90 million until we achieved profitability
in the fiscal year ending 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
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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.
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
2008-09
school year, we have contracts to provide our full range of
products and services to virtual public schools in
21 states and the District of Columbia. Several of these
contracts are scheduled to expire in any given year. For
example, seven such contracts are scheduled to expire at the
completion of the 2008-09 school year, and we usually begin to
engage in renewal negotiations during the final year of these
contracts. In order to renew these contracts, we have to enter
into negotiations with the independent boards of these virtual
public schools. Historically we have been successful in renewing
these contracts, but such renewals typically contain revised
terms, which may be more or less favorable then the terms of the
original contract. For example, a school in Pennsylvania reduced
the term of its contract from five years to three years when
renewing its contract in 2006, whereas a school in Ohio
increased the term of its contract from five years to
10 years upon renewal in 2007. While we have no reason to
believe that schools will not continue to renew their contracts
upon expiration, we recognize that each renegotiation is unique
and, if we are unable to renew several such contracts or one
significant contract expiring during a given year, or if such
renewals have significantly less favorable terms than existing
contracts, our business, financial condition, results of
operations and cash flow could be adversely affected.
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We
generate significant revenues from two virtual public schools,
and the termination, revocation, expiration or modification of
our contracts with these virtual public schools could adversely
affect our business, financial condition and results of
operation.
In fiscal year 2008, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy and the Agora Cyber
Charter School in Pennsylvania. In aggregate, these schools
accounted for 26% of our total revenues. If our contracts with
any of these virtual public schools are terminated, the charters
to operate any of these schools are not renewed or are revoked,
enrollments decline substantially, funding is reduced, or more
restrictive legislation is enacted, our business, financial
condition and results of operations could be adversely affected.
If
student performance falls, NCLB standards are not achieved, 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 ( NCLB). Not all of the
virtual public schools we serve meet the Adequate Yearly
Progress requirements of NCLB, as the underperformance of any
one subgroup can lead to that result for the entire school. 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. Moreover,
Congress may amend the NCLB statute in ways that positively or
negatively impact the schools we serve. Finally, 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.
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.
Our continued expansion into virtual high schools presents us
with a number of challenges and an evolving array of risks that
could affect our financial condition, results of operations and
growth strategy. 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. In addition,
our inability to scale high school operations or achieve
productivity improvements could reduce our operating margins.
Our
growth strategy anticipates that we will create new products and
distribution channels, expand existing distribution channels and
pilot innovative educational programs to enhance academic
performance. If we are unable to effectively manage these
initiatives or they fail to gain acceptance, our business,
financial condition, results of operations and cash flows would
be adversely affected.
As we create new products and distribution channels, expand our
existing distribution channels and pilot new educational
programs, 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 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, tax and currency challenges than those we currently
encounter;
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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; and
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our continual efforts to innovate and pilot new programs to
enhance student learning may not always succeed or may encounter
unanticipated opposition, such as what we experienced in 2008 in
connection with a limited pilot to outsource essay grading and
which the Company thereafter discontinued.
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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. The Company served
schools in 17 states at that time. 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
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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 quarter of our fiscal year.
Our operating expenses are also seasonal. Instructional costs
and services increase in the first fiscal quarter primarily due
to the costs incurred to ship offline learning kits at the
beginning of the school year. These instructional costs may
increase significantly quarter-to-quarter as school operating
expenses increase. The majority of our selling and marketing
expenses are incurred in the first and fourth fiscal quarters,
as our primary enrollment season is July through September.
We expect quarterly fluctuations in our revenues and operating
results to continue. These fluctuations could result in
volatility and adversely affect our cash flow. As our business
grows, these seasonal fluctuations may become more pronounced.
As a result, we believe that quarterly comparisons of our
financial results may not be reliable as an indication of future
performance.
Our
revenues for a fiscal year are based in part on our estimate of
the total funds each school will receive in a particular school
year and our estimate of the full year deficits to be incurred
by each school. As a result, differences between our estimates
and the actual funds received and deficits incurred could have
an adverse impact on our results of operations and cash
flows.
We recognize revenues from certain of our fees ratably over the
course of our fiscal year. To determine the amount of revenues
to recognize, we estimate the total funds each school will
receive in a particular school year. Additionally, we take
responsibility for any operating deficits at most of the virtual
schools we serve. Because these operating deficits may impair
our ability to collect the full amount invoiced in a period and
collection cannot reasonably be assured, we reduce revenues by
the estimated amount of these deficits. We review our estimates
of total funds and operating deficits periodically, and we
revise as necessary, amortizing any adjustments over the
remaining portion of the fiscal year. Actual funding received
and operating deficits incurred may vary from our estimates or
revisions and could adversely impact our results of operation
and cash flows.
The
continued development of our brand identity is important to our
business. If we are not able to maintain and enhance our brand,
our business and operating results may suffer.
Expanding brand awareness is critical to attracting and
retaining students, and for serving additional virtual public
schools. In order to expand brand awareness, we intend to spend
significant resources on a brand-enhancement strategy, which
includes sales and marketing efforts directed to targeted
locations as well as the national marketplace, the educational
community at large, key political groups, image-makers and the
media. We believe that the quality of our curriculum and
management services has contributed significantly to the success
of our brand. As we continue to increase enrollments and extend
our geographic reach, maintaining quality and consistency across
all of our services and products may become more difficult to
achieve, and any significant and well-publicized failure to
maintain this quality and consistency will have a detrimental
effect on our brand. We cannot provide assurances that our new
sales and marketing efforts will be successful in further
promoting our brand in a competitive and cost effective manner.
If we are unable to further enhance our brand recognition and
increase awareness of our products and services, or if we incur
excessive sales and marketing expenses, our business and results
of operations could be adversely affected.
Our
intellectual property rights are valuable, and any inability to
protect them could reduce the value of our products, services
and brand.
Our patent, trademarks, trade secrets, copyrights and other
intellectual property rights are important assets for us. For
example, we have been granted two patents relating to the
hardware and network infrastructure of our online school,
including the system components for creating and administering
assessment tests and our lesson progress tracker. Additionally,
we are the copyright owner of over 14,000 lessons in the courses
comprising our proprietary curriculum and we have registered
copyrights or filed copyright applications that cover nearly all
of these lessons. Various events outside of our control pose a
threat to our intellectual property rights. For example,
effective intellectual property protection may not be available
in every country in which our products and services are
distributed or made available through the Internet. Also, the
efforts we have taken to protect our proprietary rights
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may not be sufficient or effective. Any significant impairment
of our intellectual property rights could harm our business or
our ability to compete. Also, protecting our intellectual
property rights is costly and time consuming. Any unauthorized
use of our intellectual property could make it more expensive to
do business and harm our operating results.
Although we seek to obtain patent protection for our
innovations, it is possible that we may not be able to protect
some of these innovations. In addition, given the costs of
obtaining patent protection, we may choose not to protect
certain innovations that later turn out to be important.
Furthermore, there is always the possibility, despite our
efforts, that the scope of the protection gained will be
insufficient or that an issued patent may be deemed invalid or
unenforceable.
We also seek to maintain certain intellectual property as trade
secrets. This secrecy could be compromised by outside parties,
or by our employees intentionally or accidentally, which would
cause us to lose the competitive advantage resulting from these
trade secrets.
We
must monitor and protect our Internet domain names to preserve
their value.
We own the domain names K12 (.com and .org) and K-12 (.com,
.net, and .org) as well as the service mark
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.
30
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 and internal controls over
access rights 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 receive or be able to access student records and we could be
subject to liability or our business could be interrupted.
Penetration of our network security could have a negative impact
on our reputation and could lead virtual public schools and
parents to choose competitive offerings. As a result, we may be
required to expend significant resources to provide additional
protection from the threat of these security breaches or to
alleviate problems caused by these breaches.
We
rely on the Internet to enroll students and to deliver our
products and services to children, which exposes us to a growing
number of legal risks and increasing regulation.
We collect information regarding students during the online
enrollment process, and a significant amount of our curriculum
content is delivered over the Internet. As a result, specific
federal and state laws that could have an impact on our business
include the following:
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|
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|
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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.
|
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 our users access to our
learning system, and therefore, damage our ability to generate
revenues or provide sufficient documentation to comply with
state laws requiring proof that students completed the required
number of hours of instruction. 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 and printed
educational materials is managed by one logistics vendor and is
located in one warehouse facility. Any material failure to
perform on the part of our logistics vendor or 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
and printed materials is located in one warehouse facility
operated by a third-party logistics vendor which handles
receipt, assembly, and shipping of all physical learning
materials. If this logistics vendor were to fail to meet its
obligations to deliver learning materials to students in a
timely manner, or if such shipments are incomplete or contain
assembly errors, our business and results
31
of operations could be adversely affected. Furthermore, 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 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.
32
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 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.
Although
we do not currently transact a material amount of business in a
foreign country, we intend to expand into international markets,
which will subject us to additional economic, operational and
political risks that could increase our costs and make it
difficult for us to continue to operate
profitably.
One of our growth strategies is to pursue international
opportunities that leverage our current product and service
offerings. The addition of international operations may require
significant expenditure of financial and
33
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 or taxes that
may be duplicative of those imposed in the United States,
notwithstanding steps taken by the Company to address such
matters;
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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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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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ITEM 1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
The Companys headquarters are located in approximately
76,000 square feet of office space in Herndon, Virginia
under a lease that expires in April 2018 and subleases that
expire in September 2009 and July 2010. The Company leases
approximately 46,000 square feet in multiple locations
under individual leases that expire between October 2008
and July 2013.
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ITEM 3.
|
LEGAL
PROCEEDINGS
|
In the ordinary conduct of our business, we are subject to
lawsuits, arbitrations and administrative proceedings from time
to time. We are currently involved in a lawsuit brought by a
teachers union seeking the closure of the virtual public
school we serve in Illinois.
On October 4, 2006, the Chicago Teachers Union and
individual taxpayers (CTU or plaintiffs) 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.
After three dismissals of their complaint on procedural grounds,
the Court granted the plaintiffs Fourth Amended Citizen
Complaint on May 20, 2008. CVCS and the Chicago Board of
Education jointly filed a Motion to Reconsider, which was denied
by Memorandum Opinion and Order dated August 8, 2008. The
case is now in the discovery stage. The Company continues to
participate in the defense of CVCS under an indemnity obligation
in our service agreement with that school, which requires the
Company to indemnify CVCS against certain liabilities arising
out of the performance of the service agreement, and certain
other claims and liabilities, including liabilities arising out
of challenges to the validity of the virtual school charter. The
Company is not able to estimate the range of potential loss if
the plaintiffs were to prevail and a claim was made against the
Company for indemnification. In fiscal year 2007 and for the
year ended June 30, 2008, average enrollments in CVCS were
225 and 407 respectively, and we derived 1.1% and 1.3%,
respectively of our revenues from CVCS.
34
We do not believe that a loss in this case would have a material
adverse impact on our future results of operations, financial
position or cash flows. Depending on the legal theory advanced
by the plaintiffs, however, there is a risk that a loss in this
case 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.
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ITEM 4.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
None.
35
EXECUTIVE
OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning our executive
officers as of June 30, 2008:
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Name
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Age
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Position
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Ronald J. Packard
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45
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Chief Executive Officer, Founder and Director
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John F. Baule
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44
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Chief Operating Officer and Chief Financial Officer
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Bruce J. Davis
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45
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Executive Vice President, Worldwide Business Development
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George B. Hughes, Jr.
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49
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Executive Vice President, School Services
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Howard D. Polsky
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56
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Senior Vice President, General Counsel and Secretary
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Bror V. H. Saxberg
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49
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Chief Learning Officer
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Celia M. Stokes
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44
|
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Executive Vice President and Chief Marketing Officer
|
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Ronald
J. Packard, Chief Executive Officer, Founder and
Director
Ronald J. Packard founded K12 in 2000. Previously,
Mr. Packard served as Vice President of Knowledge Universe
and he served as Chief Executive Officer of Knowledge Schools, a
provider of early childhood education and after school
companies. Mr. Packard has also held positions at
McKinsey & Company and Goldman Sachs in mergers and
acquisitions. Additionally, Mr. Packard served on the
Advisory Board of the Department of Defense Schools from 2002 to
2008, and is a member of the Fairfax Education Foundation Board
of Directors. From 2004 to 2006, Mr. Packard served as a
director of Academy 123 and he is currently a director of
Zumbox. 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, based in Hong Kong. He later served as Director of
International Finance for the BMS Nutritional Division.
Mr. Baule began his career working in the audit services
practice at KPMG from 1986 to 1990. Mr. Baule holds a
B.B.A. in Accounting from the College of William and Mary and he
is a Certified Public Accountant.
Bruce
J. Davis, Executive Vice President, Worldwide Business
Development
Bruce J. Davis joined us January 2007, and serves as Executive
Vice President, Worldwide Business Development. From 2002 until
joining us, Mr. Davis ran his own strategy consultancy
where his clients included Laureate Education, Discovery
Communications, Pearson Publishing, Sylvan Learning Systems,
Educate Inc., AICPA, and USAID. Mr. Davis previously held
the position of Chief Executive Officer at Medasorb
Technologies, a biotechnology company, from 2001 to 2002 and at
Mindsurf Networks, a wireless educational system provider, from
1999 to 2000. He also served as Chief Operating Officer of
Prometric, a computer test administration company, from 1994 to
1999. Prior to Prometric, he was a senior consultant with
Deloitte and Touche from 1985 to 1991 in the Information Systems
Strategy group where he managed their IT practice in Egypt.
Mr. Davis holds a B.S. in Computer Science from Loyola
College and an M.B.A. from Columbia University.
George
B. (Chip) Hughes, Jr., Executive Vice President,
School Services
George B. (Chip) Hughes, Jr. joined us in July
2007, and serves as Executive Vice President, School Services.
From 1997 until joining us, Mr. Hughes was a co-founder and
Managing Director of Blue Capital Management, L.L.C., a
middle-market private equity firm. Mr. Hughes previously
served as a Partner of McKinsey & Company, Inc., a
global management consulting firm, in McKinseys Los
Angeles and New Jersey
36
offices, where he was a member of the firms Strategy and
Health Care practices. Mr. Hughes serves on the National
Board of Recording for the Blind & Dyslexic, and on
the Board of Councilors of the College of Letters,
Arts & Sciences at the University of Southern
California. Previously he was a member of the Board of Trustees
at Big Brothers of Greater Los Angeles and of Big Brothers Big
Sisters of Morris, Bergen, and Passaic Counties (New Jersey).
Mr. Hughes holds a B.A. in Economics from the University of
Southern California and an M.B.A. from Harvard University.
Howard
D. Polsky, Senior Vice President, General Counsel and
Secretary
Howard D. Polsky joined us in June 2004, and serves as Senior
Vice President, General Counsel and Secretary. Mr. Polsky
previously held the position of Vice President and General
Counsel of Lockheed Martin Global Telecommunications from 2000
to 2002. Prior to its acquisition by Lockheed Martin,
Mr. Polsky worked at COMSAT Corporation from 1992 to 2000,
initially serving as Vice President and General Counsel of
COMSATs largest operating division, and subsequently
serving on the executive management team as Vice President of
Federal Policy and Regulation. From 1983 to 1992,
Mr. Polsky was a partner at Wiley, Rein &
Fielding after having worked at Kirkland & Ellis.
Mr. Polsky began his legal career at the Federal
Communications Commission. Mr. Polsky received a B.A. in
Government from Lehigh University, and a J.D. from Indiana
University.
Bror
V. H. Saxberg, Chief Learning Officer
Bror V.H. Saxberg joined us in February 2000, and serves as
Chief Learning Officer. From 1998 to 2000, Dr. Saxberg
served as Vice President of Operations at Knowledge Testing
Enterprises, a developer of web-based assessments for IT skills
owned by Knowledge Universe; he was a Vice President at
Knowledge Universe from 1997 through 2000 as well. Prior to
Knowledge Universe, Dr. Saxberg held the position of
Publisher and General Manager at DK Multimedia, the North
American subsidiary of educational and reference publisher
Dorling Kindersley, from 1995 to 1997. Previously,
Dr. Saxberg also worked as a consultant at
McKinsey & Company from 1990 to 1995. Dr. Saxberg
holds B.S. degrees in Electrical Engineering and Mathematics
from the University of Washington, an M.A. in Mathematics from
Oxford University, an M.A. and Ph.D. in Electrical Engineering
and Computer Science from Massachusetts Institute of Technology,
and an M.D. from Harvard University.
Celia
M. Stokes, Executive Vice President and Chief Marketing
Officer
Celia M. Stokes joined us in March 2006, and serves as Executive
Vice President and Chief Marketing Officer. Before joining K12,
Ms. Stokes served as Vice President of Marketing at
Independence Air from 2003 to 2006. Previously, Ms. Stokes
ran her own marketing firm providing consulting services to
organizations such as Fox TV, PBS, the National Gallery of Art,
JWalter Thompson, and ADP. From 1993 to 1998, Ms. Stokes
served in successive roles leading to Vice President of
Marketing at Bell Atlantic and at a joint venture of Bell
Atlantic and two other Regional Bell Operating Companies. From
1990 to 1993, Ms. Stokes was Manager of Marketing at
Software AG, and from 1988 to 1990, was Client Group Manager at
Targeted Communications, an Ogilvy & Mather Direct
company. Ms. Stokes holds a B.A. in Economics from the
University of Virginia.
PART II
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ITEM 5.
|
MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|
The Companys common stock, par value $0.0001 per share, is
traded on NYSE Arca under the symbol LRN. Set forth
below are the high and low sales prices for our common stock, as
reported on NYSE Arca. As of September 22, 2008, there were
approximately 95 registered holders of common stock.
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High
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Low
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Quarter ended:
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December 31, 2007 (beginning December 13, 2007)
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$
|
31.00
|
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$
|
19.75
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|
March 31, 2008
|
|
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29.43
|
|
|
|
18.61
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|
June 30, 2008
|
|
|
30.20
|
|
|
|
16.50
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|
37
Stock
Performance Graph
The graph below matches the cumulative
7-month
total return of holders of K12 Inc.s common stock with the
cumulative total returns of the S&P 500 index, the NASDAQ
Composite index, the Russell 2000 index and a customized peer
group of seventeen companies. The graph assumes that the value
of the investment in the companys common stock, in each
index, and in the peer group (including reinvestment of
dividends) was $100 on December 13, 2007 and tracks it
through June 30, 2008.
COMPARISON
OF 7 MONTH CUMULATIVE TOTAL RETURN
Among K12 Inc., S&P 500 Index, NASDAQ Composite Index,
Russell 2000 Index and a Peer Group
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Dec-13 2007
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Dec-07
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Jan-08
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Feb-08
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Mar-08
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Apr-08
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May-08
|
|
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Jun-08
|
|
K12 Inc.
|
|
|
100.00
|
|
|
|
105.38
|
|
|
|
93.69
|
|
|
|
110.47
|
|
|
|
80.04
|
|
|
|
103.79
|
|
|
|
111.45
|
|
|
|
87.62
|
|
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Peer Group
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100.00
|
|
|
|
95.43
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88.31
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|
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77.64
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|
|
|
74.64
|
|
|
|
84.40
|
|
|
|
86.09
|
|
|
|
81.88
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S&P 500
|
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100.00
|
|
|
|
98.65
|
|
|
|
92.62
|
|
|
|
89.40
|
|
|
|
88.87
|
|
|
|
93.09
|
|
|
|
94.09
|
|
|
|
86.00
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NASDAQ Composite
|
|
|
100.00
|
|
|
|
99.39
|
|
|
|
89.56
|
|
|
|
85.12
|
|
|
|
85.41
|
|
|
|
90.42
|
|
|
|
94.54
|
|
|
|
85.93
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Russell 2000
|
|
|
100.00
|
|
|
|
99.55
|
|
|
|
92.70
|
|
|
|
89.18
|
|
|
|
89.41
|
|
|
|
93.08
|
|
|
|
97.25
|
|
|
|
89.63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All prices reflect closing prices on last day of trading at the
end of each calendar month except December 13, 2007.
Peer
Group
Apollo Group Inc., Capella Education Company, Career Education
Corp., Corinthian Colleges Inc., Devry Inc., Strayer Education
Inc., ITT Educational Services, New Oriental Education, American
Public Education Inc., Lincoln Educational Services, Universal
Technical Institute, Renaissance Learning, Scientific Learning,
SkillSoft, BlackBoard, McGraw-Hill, and Scholastic.
Dividend
Policy
We have never declared or paid any cash dividends on our common
stock and we currently do not anticipate paying any cash
dividends for the foreseeable future. Instead, we anticipate
that all of our earnings on our common stock will be used to
provide working capital, to support our operations, and to
finance the growth and development of our business, including
potentially the acquisition of, or investment in, businesses,
technologies or products that complement our existing business.
Any future determination relating to dividend policy will be
made at the
38
discretion of our board of directors and will depend on a number
of factors, including, but not limited to, our future earnings,
capital requirements, financial condition, future prospects,
applicable Delaware law, which provides that dividends are only
payable out of surplus or current net profits and other factors
our board of directors might deem relevant.
Stock-based
Incentive Plan Information
The following table provides certain information as of
June 30, 2008, with respect to our equity compensation
plans under which Common Stock is authorized for issuance:
Equity
Compensation Plan Information
as of June 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
|
|
|
|
Securities
|
|
|
|
Number of
|
|
|
|
|
|
Remaining Available
|
|
|
|
Securities to be
|
|
|
|
|
|
for Future Issuance
|
|
|
|
Issued Upon
|
|
|
Weighted-Average
|
|
|
under Equity
|
|
|
|
Exercise of
|
|
|
Exercise Price of
|
|
|
Compensation
|
|
|
|
Outstanding
|
|
|
Outstanding
|
|
|
Plans (Excluding
|
|
|
|
Options, Warrants
|
|
|
Options, Warrants
|
|
|
Securities Reflected
|
|
|
|
and Rights
|
|
|
and Rights
|
|
|
in Column (a))
|
|
Plan Category
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
Equity compensation plans approved by security holders(1)
|
|
|
4,766,849
|
|
|
$
|
11.20
|
|
|
|
878,437
|
|
Equity compensation plans not approved by security holders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,766,849
|
|
|
$
|
11.20
|
|
|
|
878,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes shares under the 2007 Equity Incentive Award Plan
|
The 2007 Equity Incentive Award Plan (the 2007 Plan) adopted in
November 2007 contains an evergreen provision that
allows for an annual increase in the number of shares available
for issuance under the 2007 Plan on July 1 of each year during
the ten-year term of the 2007 Plan, beginning on July 1,
2008. The annual increase in the number of shares shall be equal
to the least of:
|
|
|
|
|
4% of our outstanding common stock on the applicable July 1;
|
|
|
|
2,745,098 shares; or
|
|
|
|
a lesser number of shares as determined by our Board of
Directors.
|
Sales of
unregistered securities
None.
39
|
|
ITEM 6.
|
SELECTED
FINANCIAL DATA
|
The following table sets forth our selected consolidated
statement of operations, balance sheet and other data as of the
dates and for the periods indicated. You should read this data
together with Item 7 Managements
Discussion and Analysis of Financial Condition and Results of
Operations and our consolidated financial statements and
related notes, included elsewhere in this Annual Report of
Form 10-K.
The selected consolidated statement of operations data for each
of the years in the three-year period ended June 30, 2008,
and the selected consolidated balance sheet data as of
June 30, 2008 and 2007, have been derived from our audited
consolidated financial statements, which are included elsewhere
in this Annual Report on
Form 10-K.
The selected consolidated statements of operations data for the
years ended June 30, 2005 and 2004, and selected
consolidated balance sheet data as of June 30, 2006, 2005
and 2004, have been derived from our audited consolidated
financial statements not included in this Annual Report of
Form 10-K.
The pro forma net income per common share amounts for the years
ended June 30, 2008 and June 30, 2007 were derived by
eliminating the one-time tax benefit of $27.0 million from
the reversal of the deferred tax valuation allowance in 2008 and
by giving effect to the automatic conversion of all of our
outstanding shares of our preferred stock into common stock
immediately prior to the completion of our initial public
offering. Our historical results are not necessarily indicative
of future operating results.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Consolidated Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
226,235
|
|
|
$
|
140,556
|
|
|
$
|
116,902
|
|
|
$
|
85,310
|
|
|
$
|
71,434
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
131,282
|
|
|
|
76,064
|
|
|
|
64,828
|
|
|
|
49,130
|
|
|
|
39,943
|
|
Selling, administrative, and other operating expenses
|
|
|
72,393
|
|
|
|
51,159
|
|
|
|
41,660
|
|
|
|
30,031
|
|
|
|
25,656
|
|
Product development expenses
|
|
|
9,550
|
|
|
|
8,611
|
|
|
|
8,568
|
|
|
|
9,410
|
|
|
|
12,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
213,225
|
|
|
|
135,834
|
|
|
|
115,056
|
|
|
|
88,571
|
|
|
|
78,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
13,010
|
|
|
|
4,722
|
|
|
|
1,846
|
|
|
|
(3,261
|
)
|
|
|
(6,915
|
)
|
Interest expense, net
|
|
|
(295
|
)
|
|
|
(639
|
)
|
|
|
(488
|
)
|
|
|
(279
|
)
|
|
|
(516
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before taxes
|
|
|
12,715
|
|
|
|
4,083
|
|
|
|
1,358
|
|
|
|
(3,540
|
)
|
|
|
(7,431
|
)
|
Income tax benefit (expense)
|
|
|
21,058
|
|
|
|
(218
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
33,773
|
|
|
|
3,865
|
|
|
|
1,358
|
|
|
|
(3,540
|
)
|
|
|
(7,431
|
)
|
Dividends on preferred stock
|
|
|
(3,066
|
)
|
|
|
(6,378
|
)
|
|
|
(5,851
|
)
|
|
|
(5,261
|
)
|
|
|
(2,667
|
)
|
Preferred stock accretion
|
|
|
(12,193
|
)
|
|
|
(22,353
|
)
|
|
|
(18,697
|
)
|
|
|
(15,947
|
)
|
|
|
(15,768
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders
|
|
$
|
18,514
|
|
|
$
|
(24,866
|
)
|
|
$
|
(23,190
|
)
|
|
$
|
(24,748
|
)
|
|
$
|
(25,866
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.18
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
|
$
|
(12.54
|
)
|
|
$
|
(13.17
|
)
|
Diluted
|
|
$
|
1.10
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
|
$
|
(12.54
|
)
|
|
$
|
(13.17
|
)
|
Basic (pro forma)(1)
|
|
$
|
0.27
|
|
|
$
|
0.18
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
Diluted (pro forma)(1)
|
|
$
|
0.26
|
|
|
$
|
0.18
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
Weighted average shares used in computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
15,701,278
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
|
|
1,973,053
|
|
|
|
1,964,147
|
|
Diluted
|
|
|
16,850,909
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
|
|
1,973,053
|
|
|
|
1,964,147
|
|
Basic (pro forma)(1)
|
|
|
24,989,323
|
|
|
|
21,881,316
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
Diluted (pro forma)(1)
|
|
|
26,138,954
|
|
|
|
21,888,941
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
$
|
15,535
|
|
|
$
|
5,563
|
|
|
$
|
3,625
|
|
|
$
|
9,697
|
|
|
$
|
(8,020
|
)
|
Depreciation and amortization
|
|
$
|
12,568
|
|
|
$
|
7,404
|
|
|
$
|
4,986
|
|
|
$
|
5,509
|
|
|
$
|
4,922
|
|
Stock-based compensation expense
|
|
$
|
1,464
|
|
|
$
|
218
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Capitalized curriculum development costs
|
|
$
|
11,669
|
|
|
$
|
8,683
|
|
|
$
|
655
|
|
|
$
|
3,787
|
|
|
$
|
4,898
|
|
Capital expenditures(2)
|
|
$
|
17,211
|
|
|
$
|
13,418
|
|
|
$
|
10,842
|
|
|
$
|
5,133
|
|
|
$
|
4,643
|
|
EBITDA(3)
|
|
$
|
25,578
|
|
|
$
|
12,126
|
|
|
$
|
6,832
|
|
|
$
|
2,248
|
|
|
$
|
(1,993
|
)
|
Average enrollments(4)
|
|
|
40,859
|
|
|
|
27,005
|
|
|
|
20,220
|
|
|
|
15,097
|
|
|
|
11,158
|
|
40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
71,682
|
|
|
$
|
1,660
|
|
|
$
|
9,475
|
|
|
$
|
19,953
|
|
|
$
|
15,881
|
|
Total assets
|
|
|
197,324
|
|
|
|
61,212
|
|
|
|
48,485
|
|
|
|
41,968
|
|
|
|
42,714
|
|
Total short-term debt
|
|
|
|
|
|
|
1,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total long-term obligations
|
|
|
13,161
|
|
|
|
7,135
|
|
|
|
4,025
|
|
|
|
4,466
|
|
|
|
3,432
|
|
Convertible redeemable preferred stock
|
|
|
|
|
|
|
229,556
|
|
|
|
200,825
|
|
|
|
176,277
|
|
|
|
155,069
|
|
Total stockholders equity (deficit)
|
|
|
150,288
|
|
|
|
(197,807
|
)
|
|
|
(173,451
|
)
|
|
|
(150,299
|
)
|
|
|
(125,621
|
)
|
Working capital
|
|
|
96,221
|
|
|
|
8,548
|
|
|
|
15,421
|
|
|
|
22,953
|
|
|
|
24,130
|
|
|
|
|
(1)
|
|
Pro forma net income per common share eliminates the one-time
tax benefit of $27.0 million from the reversal of the
deferred tax asset valuation allowance and gives effect to the
automatic conversion of all of our outstanding shares of
preferred stock into common stock immediately prior to the
completion of our initial public offering. Assuming the
completion of the offering on June 30, 2007, all of our
outstanding shares of preferred stock would convert into
19,879,675 shares of common.
|
|
(2)
|
|
Capital expenditures consist of the purchase of property and
equipment, capitalized software and new capital lease
obligations.
|
|
(3)
|
|
EBITDA consists of net income (loss) minus interest income, plus
interest expense, plus income tax expense and plus depreciation
and amortization. Interest income consists primarily of interest
earned on short-term investments or cash deposits. Interest
expense primarily consists of interest expense for capital
leases, long-term and short-term borrowings. We use EBITDA as a
measure of operating performance. However, EBITDA is not a
recognized measurement under U.S. generally accepted accounting
principles, or GAAP, and when analyzing our operating
performance, investors should use EBITDA in addition to, and not
as an alternative for, net income (loss) as determined in
accordance with GAAP. Because not all companies use identical
calculations, our presentation of EBITDA may not be comparable
to similarly titled measures of other companies. Furthermore,
EBITDA is not intended to be a measure of free cash flow for our
managements discretionary use, as it does not consider
certain cash requirements such as tax payments.
|
|
|
|
We believe EBITDA is useful to an investor in evaluating our
operating performance because it is widely used to measure a
companys operating performance without regard to items
such as depreciation and amortization, which can vary depending
upon accounting methods and the book value of assets, and to
present a meaningful measure of corporate performance exclusive
of our capital structure and the method by which assets were
acquired. Our management uses EBITDA:
|
|
|
|
|
|
as a measurement of operating performance because it assists us
in comparing our performance on a consistent basis; 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net income (loss)
|
|
$
|
33,773
|
|
|
$
|
3,865
|
|
|
$
|
1,358
|
|
|
$
|
(3,540
|
)
|
|
$
|
(7,431
|
)
|
Interest expense, net
|
|
|
295
|
|
|
|
639
|
|
|
|
488
|
|
|
|
279
|
|
|
|
516
|
|
Income tax (benefit) expense
|
|
|
(21,058
|
)
|
|
|
218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
12,568
|
|
|
|
7,404
|
|
|
|
4,986
|
|
|
|
5,509
|
|
|
|
4,922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
25,578
|
|
|
$
|
12,126
|
|
|
$
|
6,832
|
|
|
$
|
2,248
|
|
|
$
|
(1,993
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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.
|
41
|
|
ITEM 7.
|
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 annual report on
Form 10-K.
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 annual report on
Form 10-K.
Our
Company
We are a technology-based education company. We offer
proprietary curriculum and educational services created for
online delivery to students in kindergarten through
12th grade, or K-12. Our mission is to maximize a
childs potential by providing access to an engaging and
effective education, regardless of geographic location or
socio-economic background. Since our inception, we have invested
more than $130 million to develop curriculum and an online
learning platform that promotes mastery of core concepts and
skills for students of all abilities. This learning system
combines a cognitive research-based curriculum with an
individualized learning approach well-suited for virtual schools
and other educational applications. From fiscal year 2005 to
fiscal year 2008, we increased average enrollments in the
virtual public schools we serve from approximately 15,100
students to 40,800 students, representing a compound annual
growth rate of approximately 39%. Over the same period, we
increased revenues from $85.3 million to
$226.2 million, representing a compound annual growth rate
of approximately 38%, and increased EBITDA from
$2.2 million to $25.6 million. Over the same
timeframe, we went from a net loss of $3.5 million to net
income of $33.8 million (inclusive of a one-time tax
benefit of $27.0 million) and from an operating loss of
$3.3 million to operating income of $13.0 million.
We deliver our learning system to students primarily through
virtual public schools. Many states have embraced virtual public
schools as a means to provide families with a publicly funded
alternative to a traditional classroom-based education. We offer
virtual schools our proprietary curriculum, online learning
platform and varying levels of academic and management services,
which can range from targeted programs to complete turnkey
solutions, under long-term contracts. These contracts provide
the basis for a recurring revenue stream as students progress
through successive grades. Additionally, without the requirement
of a physical classroom, virtual schools can be scaled quickly
to accommodate a large dispersed student population, and allow
more capital resources to be allocated towards teaching,
curriculum and technology rather than towards a physical
infrastructure.
Our proprietary curriculum is currently used primarily by public
school students in 21 states and the District of Columbia,
including four new states approved for the Fall of 2008. 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 of 2001, which implemented new standards and accountability
requirements for public K-12 education. The convergence of these
concerns and rapid advances in Internet technology created the
opportunity to make a significant impact by deploying a high
quality learning system on a flexible, online platform.
In September 2001, after 18 months of research and
development on our curriculum, we launched our kindergarten
through 2nd grade offering. We initially launched our
learning system in virtual public schools in Pennsylvania and
Colorado, serving approximately 900 students in the two states
combined. During the
2002-03
school year, we added our 3rd through 5th grade
offering and entered into contracts to operate virtual public
schools in California, Idaho, Ohio, Minnesota and Arkansas,
increasing our average enrollment to approximately 5,900
students during the
2002-03
school year. For the
2003-04
school year, we added our 6th and 7th grade offerings
and began
42
serving students in Arizona, Florida, Utah and Wisconsin. During
the
2004-05
school year, we added our 8th grade offering, began serving
students in Kansas, and increased total enrollment to
approximately 15,100 students. In the
2005-06
school year, we added contracts to operate a virtual public
school in Texas. During the
2006-07
school year, we began serving students in the state of
Washington and implemented a hybrid school offering in Chicago
that combines face-to-face time in the classroom with online
instruction. We recently entered the virtual high school market,
enrolling 9th and 10th grade students at the start of
the
2005-06
and
2006-07
school years, respectively, and enrolling 11th and
12th grade students at the start of the
2007-08
school year. We added contracts to operate virtual public
schools in Georgia and Nevada for the
2007-08
school year and increased average enrollment to approximately
40,800 for the year. Finally, for the
2008-09
school year, we have been approved to operate state-wide virtual
public schools in South Carolina, Hawaii and Oregon, as well as
a hybrid program in Indiana.
In October 2007, the Company acquired all of the stock of
Power-Glide, a provider of on-line language courseware, for
$4.1 million in shares of common stock and the assumption
of liabilities. We use these courses in our virtual public
schools and believe they have wide applicability in online
learning.
In December 2007, the Company completed an initial public
offering (IPO) of our common stock in which we sold and issued
4,450,000 shares of our common stock, at an issue price of
$18.00 per share. We raised a total of $80.1 million in
gross proceeds from the IPO, or approximately $71.0 million
in net proceeds after deducting underwriting discounts and
commissions of $5.6 million and other offering costs of
$3.5 million. Upon the closing of the IPO, all shares of
convertible preferred stock outstanding automatically converted
into an aggregate of 19,879,675 shares of common stock.
Concurrently with the closing of the IPO and at the initial
public offering price, we sold 833,333 shares of common
stock at the initial public offering price of $18.00 per share
for an aggregate purchase price of $15.0 million to a
non-U.S. person,
in a private placement transaction outside the United States in
reliance upon Regulation S under the Securities Act. Also
concurrently with the closing of the IPO, the holders of
Redeemable Convertible Series C Preferred stock were paid a
cash dividend of approximately $6.4 million. The amount of
the declared dividend was equal to the pro rata amount of the
annual cumulative dividend that would have normally accrued on
January 2, 2008 under the provisions of the Series C
Preferred stock agreement.
In January 2008, we launched the
K
12
International Academy, an online private school which serves
students in the U.S. and throughout the world. The school
utilizes the same
K
12
curriculum, systems, and teaching practices as the virtual
public schools we serve in the U.S. The school is
accredited by the Commission on International and Trans-Regional
Accreditation (CITA), the Southern Association of Colleges and
Schools (SACS), and is recognized by the State of Virginia as a
degree granting institution of secondary learning. In addition,
the
K
12
International Academy has a branch facility in Dubai which we
operate under a joint venture with a local partner to reach
students in the Gulf Cooperating Countries.
We believe we have significant growth potential. Therefore, over
the last three years, we have put a great deal of effort into
developing the infrastructure necessary to scale our business.
We further developed our logistics and technological
infrastructure and implemented sophisticated financial systems
to allow us to more effectively operate a large and growing
company.
Key
Aspects and Trends of Our Operations
Revenues
We generate a significant portion of our revenues from
enrollments in virtual public schools. In each of the past five
years, more than 90% of our revenues have been derived through
contracts with these schools. We anticipate that these revenues
will continue to represent the bulk of our total revenues over
the next
12-24 months,
although the percentage may decline over the longer term as we
identify new channels through which to market our curriculum and
educational services. These contracts provide the channels
through which we can enroll students into the school, and we
execute marketing and recruiting programs designed to create
awareness and generate enrollments for these schools. We
generate our revenues by providing each student with access to
our online lessons and offline learning kits, including use of a
personal computer. In addition, we provide a variety of
management and academic support services to virtual public
schools, ranging from turnkey end-to-end management solutions to
a single service to meet a schools specific needs. We also
generate revenues from sales of our curriculum and offline
learning kits through other channels, including directly to
consumers and pilots in a traditional classroom environment.
43
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 regardless of the
nature and extent of the management services we provide to the
virtual public school. Generally, students will take five or six
courses, except for some kindergarten students who may
participate in
half-day
programs. We count each
half-day
kindergarten student as an enrollment.
School sessions generally begin in August or September and end
in May or June. We consider the duration of a school year to be
10 months. To ensure that all schools are reflected in our
measure of enrollments, we consider the number of students on
the last day of September to be our opening enrollment level,
and the number of students enrolled on the last day of May to be
our ending enrollment level. To provide comparability, we do not
consider enrollment levels for June, July and August as most
schools are not open during these months. For each period,
average enrollments represent the average of the month-end
enrollment levels for each month that has transpired between
September and the end of the period, up to and including the
month of May. We continually evaluate our enrollment levels by
state, by school and by grade. We track new student enrollments
and withdrawals throughout the year.
We believe that the number of enrollments depends upon the
following:
|
|
|
|
|
the number of states and school districts in which we operate;
|
|
|
|
the appeal of our curriculum and instructional model to students
and families;
|
|
|
|
the effectiveness of our program in delivering favorable
academic outcomes;
|
|
|
|
the quality of the teachers working in the virtual public
schools we serve; and
|
|
|
|
the effectiveness of our marketing and recruiting programs.
|
We continually evaluate our trends in revenues by monitoring the
number of enrollments in total, by state, by school and by
grade, assessing the impact of changes in funding levels and the
pricing of our curriculum and educational services. We track
enrollments throughout the year, as students enroll and
withdraw. We also provide our courses for use in a traditional
classroom setting and we sell our courses directly to consumers.
Our classroom course revenues are generally for single courses.
Consumers typically purchase from one to six courses in a year,
however, we do not monitor the progress of these students. Our
K
12
International Academy can enroll students on a full or part-time
basis. While we believe this offering has significant long-term
opportunity, we anticipate the level of revenues and enrollments
will be immaterial for FY 2009. Therefore, we do not include
classroom, consumer or international academy students in our
enrollment totals.
We closely monitor the financial performance of the virtual
public schools to which we provide turnkey management services.
Under the contracts with these schools, we take responsibility
for any operating deficits that they may incur in a given school
year. These operating deficits represent the excess of costs
over revenues incurred by the virtual public schools as
reflected on their financial statements. The costs include our
charges to the schools. These operating deficits may result from
a combination of cost increases or funding reductions
attributable to the following: 1) costs associated with new
schools including the initial hiring of teachers, administrators
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
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. In three of the last four 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
44
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
invoiced amounts and are independent of the total funds received
by the school from a state or district. As a result, changes in
the number of enrollments associated with schools operating
under turnkey arrangements relative to total enrollments may
have a disproportionate impact on average revenues per
enrollment and growth in revenues relative to the growth in
enrollments.
The percentage of enrollments associated with turnkey management
service schools was 82% for the year ended June 30, 2008 as
compared to 77% for the year ended June 30, 2007. This
increase was primarily attributable to the enrollments at new
schools in Georgia and Nevada. The percentage of enrollments
associated with turnkey management service schools was 77% in
fiscal year 2007 as compared to 92% in fiscal year 2006. This
decline was attributable to a reduction in management services
in one large school. Changes in the mix of enrollments
associated with turnkey management services compared with
limited management services may change the average revenues per
enrollment and accordingly impact total revenues. As we renew
our existing management contracts, the extent of the management
services we provide may change. Where it is beneficial to do so,
management intends to renew these contracts as they expire. Our
turnkey management contracts have terms from three to ten years
and none expire prior to the completion of the
2008-09
school year. We are providing turnkey management services to new
schools in South Carolina, Hawaii, Oregon and Indiana in 2009.
Consequently, we anticipate that the percentage of enrollments
associated with turnkey management services will increase
slightly for fiscal year 2009 versus the prior year. Considered
in isolation, this would cause average revenues per enrollment
to increase slightly in fiscal year 2009 as compared to fiscal
year 2008.
In fiscal year 2008, we derived more than 10% of our revenues
from each of the Ohio Virtual Academy and the Agora Cyber
Charter School in Pennsylvania. In aggregate, these schools
accounted for 26% of our total revenues. We provide our full
turnkey management solution pursuant to our contract with the
Ohio Virtual Academy, which terminates June 30, 2017. We
provide our full turnkey solution to the Agora Cyber Charter
School, pursuant to a contract with the Cynwyd Group which
expires June 30, 2016. Each of the contracts with these
schools provides for termination of the agreement if the school
ceases to hold a valid and effective charter from the
charter-issuing authority in their respective states or if there
is a material reduction in the per enrollment funding level. The
annual revenues generated under each of these contracts
represent a material portion of our total revenues in fiscal
year 2008 and we expect this to continue in fiscal year 2009.
Our annual growth in revenues will also be impacted by changes
in state or district per enrollment funding levels. These
funding levels are typically established on an annual basis, are
usually consistent from grade to grade, and generally increase
at modest levels from year to year. Over our operating history,
per enrollment funding levels have increased annually in almost
every school we operate. These increases are essential to enable
schools to provide for an annual increase in teachers
wages and to offset the impact of inflation on other school
operating costs. For these reasons, we anticipate that per
enrollment funding levels will continue to increase at modest
levels over time.
Finally, we may generate modest growth in revenues from
increases in the prices of our curriculum and educational
services. We evaluate our pricing annually against market
benchmarks and conditions and raise them as we deem appropriate.
We do not expect our price increases to have a significant
incremental impact as they are encompassed within increases in
per enrollment funding levels.
Instructional
Costs and Services Expenses
Instructional costs and services expenses include expenses
directly attributable to the educational products and services
we provide. The virtual public schools we manage are the primary
drivers of these costs, including teacher
45
and administrator salaries and benefits and expenses of related
support services. Instructional costs also include fulfillment
costs of student textbooks and materials, depreciation and
reclamation costs of computers provided for student use, and the
cost of any third-party online courses. In addition, we include
in instructional costs the amortization of capitalized
curriculum and related systems. We measure, track and manage
instructional costs and services as a percentage of revenues and
on a per enrollment basis as these are key indicators of
performance and operating efficiency.
As a percentage of revenues, instructional costs and services
expenses increased for the year ended June 30, 2008, as
compared to the year ended June 30, 2007 primarily due to
an increase in enrollments associated with managed schools
compared with non-managed schools. Managed school enrollments
have higher costs as a percentage of revenues due to the high
level of support services provided to the school. Also
contributing to the increase was the rapid growth in high school
enrollments relative to total enrollments. The high school
instructional model has not yet attained scale and the costs of
teacher and administrative support on a per student basis are
higher than those of K-8 students. Reflecting the impact of
these items, instructional costs and services expenses increased
to 58.0% of revenues for the year ended June 30, 2008
compared with 54.1% for the year ended June 30, 2007.
Over time, we expect high school enrollments to grow as a
percentage of total enrollments. Our high school offering
requires increased instructional costs as a percentage of
revenues compared to our kindergarten to 8th grade
offering. This is due to the following: (i) generally lower
student-to-teacher ratios; (ii) higher compensation costs
for some teaching positions requiring subject-matter expertise;
(iii) ancillary costs for required student support services
including college placement, SAT preparation and guidance
counseling; and (vi) use of third-party courses to augment
our proprietary curriculum. Over time, we anticipate offsetting
these factors by obtaining productivity gains in our high school
instructional model, replacing third-party high school courses
with proprietary content, leveraging our school infrastructure
and obtaining purchasing economies of scale.
We are developing new delivery models, including a hybrid model,
where students receive both face-to-face and online instruction.
These models necessitate additional costs including facilities
related costs and additional administrative support, which are
generally not required to operate typical virtual public
schools. In addition, development costs may include
instructional research and curriculum development. As a result,
instructional costs as a percentage of revenues may be higher
than our kindergarten through eighth grade 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. In addition, we include rent expense for our
corporate headquarters and stock compensation expense. 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. From fiscal year 2005 through fiscal year 2007, our
selling, administrative and other operating expenses as a
percentage of revenues remained relatively stable as we
significantly increased our marketing and selling expenses and
expanded our management team and administrative staff over this
period. For fiscal year 2008, our selling, administrative and
other operating expenses as a percentage of revenues were 32.0%,
a decrease of 4.4% versus the prior year. Over the past year, we
continued to increase our marketing and student recruitment
programs, pursue schools in new states and explore new business
opportunities. However, we were able to support growth in
revenues and enrollments without a corresponding increase in
expenses for our management and administrative infrastructure,
which includes executive management, and personnel in the areas
of finance, legal, information technology, facilities, human
resources and logistics management. Going forward, we believe we
will gain greater leverage on our corporate overhead and selling
resources and expect our selling, administrative and other
operating expenses to decline over time as a percentage of
revenues.
46
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
of 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. There
were no impairment charges for the years ended June 30,
2008 and 2007. In fiscal year 2006, we recognized an impairment
charge of $0.4 million as the potential to earn revenues
from the use of our curriculum in a traditional classroom was
uncertain.
Other
Factors That May Affect Comparability
Public Company Expenses.
Upon the completion
of our initial public offering, we became a public company, and
our shares of common stock are publicly traded on NYSE Arca
under the symbol LRN. As a result, we 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 NYSE Arca. Compliance with
the requirements of being a public company require us to
increase our general and administrative expenses in order to pay
our employees, legal counsel and independent registered public
accountants to assist us in, among other things, instituting and
monitoring a more comprehensive compliance and board governance
function, establishing and maintaining internal control over
financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act of 2002 and preparing and distributing
periodic public reports in compliance with our obligations under
the federal securities laws. In addition, as a public company,
it is 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 $1.5 million and
$0.2 million in stock compensation expense for the years
ended June 30, 2008 and 2007, respectively. 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. However, in each of the past three years, the
Company has generated increasing enrollments, revenue and
operating profit. As a result, the Company determined it was
more likely than not that substantially all of our net deferred
tax asset will be utilized. For the year ended June 30,
2008, we recognized a net income tax benefit of
$21.1 million. This reflects the net effect of a
$27.0 million tax benefit from the reversal of the
valuation allowance on net deferred tax assets and an income tax
expense of $5.9 million, or 46.6% of pretax income.
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.
47
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 the following conditions are 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 support services
required for their complete education. In most cases, we are
also responsible for providing complete management and
technology services required for the operation of the school.
The revenues derived from these long-term agreements are
primarily dependent upon the number of students enrolled, the
extent of the management services contracted for by the school,
and the level of funding provided to the school for each student.
We have determined that the elements of our contracts are
valuable to schools in combination, but do not have standalone
value. In addition, we have determined that we do not have
objective and reliable evidence of fair value for each element
of our contracts. As a result, the elements within our
multiple-element contracts do not qualify for treatment as
separate units of accounting. Accordingly, we account for
revenues received under multiple element arrangements as a
single unit of accounting and recognize the entire arrangement
based upon the approximate rate at which we incur the costs
associated with each element.
We invoice virtual public schools in accordance with the
established contractual terms. Generally, this means that for
each enrolled student, we invoice their school on a per student
basis for the following items: (1) access to our online
school and online lessons; (2) offline learning kits; and
(3) student personal computers. We also invoice for
management and technology services. We apply
SAB No. 104 to each of these items as follows:
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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
ratably over the remaining months of the school year. The
monthly fees are recognized in the month in which they are
earned.
|
The majority of our enrollments occur at the beginning of the
school year in August or September, depending upon the state.
Because upfront fees are generally charged at the beginning of
the school year, the balance in our deferred revenue account
tends to be at its highest point at the end of the first
quarter.
48
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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|
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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 the use of a personal computer, complete
technical support through our call center, and reclamation
services when a student withdraws or a computer needs to be
exchanged. Schools are invoiced on a per student basis for each
enrolled student to whom we have provided a personal computer.
This may include an upfront fee at the beginning of the school
year or at the time a student enrolls and a monthly fee for each
month during the school year in which the student is enrolled. A
school year generally consists of 10 months. The upfront
fee is initially recorded as deferred revenue and is recognized
as revenues ratably over the remaining months of the current
school year. If a student withdraws prior to the end of a school
year, any remaining deferred revenue related to the upfront fee
is recognized ratably over the remaining months of the school
year. All deferred revenue will be recognized by the end of our
fiscal year, June 30. The monthly fees are recognized in
the month in which they are earned.
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Management and Technology Services.
Under most
of our school contracts, we provide the boards of the virtual
public schools we serve with turnkey management and technology
services. We take responsibility for all academic and fiscal
outcomes. This includes responsibility for all aspects of the
management of the schools, including monitoring academic
achievement, teacher recruitment and training, compensation of
school personnel, financial management, enrollment processing
and procurement of curriculum, equipment and required services.
Management and technology fees are generally determined based
upon a percentage of the funding received by the virtual public
school. We generally invoice schools for management and
technology services in the month in which they receive such
funding.
|
We recognize the revenues from turnkey management and technology
fees ratably over the course of our fiscal year. We use
12 months as a basis for recognition because administrative
offices of the school remain open for the entire year. To
determine the amount of revenues to recognize in our fiscal
year, we estimate the total funds that each school will receive
in a particular school year, and our related fees associated
with the estimated funding. Our management and technology
service fees are generally a contracted percentage of yearly
school revenues. We review our estimates of funding
periodically, and revise as necessary, amortizing any
adjustments over the remaining portion of the fiscal year.
Actual school funding may vary from these estimates or
revisions, and the impact of these differences could have a
material impact on our results of operations. Since the end of
the school year coincides with the end of our fiscal year, we
are generally able to base our annual revenues on actual school
revenues. As a result, on an annual basis, we have not had to
make any material adjustments to our estimates of revenue over
the last three years.
Under most contracts, we provide the virtual schools we manage
with turnkey management services and agree to operate the school
within per enrollment funding levels. This includes assuming
responsibility for any operating deficits that the schools may
incur in a given school year. These operating deficits represent
the excess of costs over revenues incurred by the virtual public
schools as reflected on their financial statements. The costs
include our charges to the schools. Such deficits may arise from
school
start-up
costs, from funding shortfalls, from temporary or long-term
incremental cost requirements for a particular school, or due to
specific one-time expenses that a school may incur. Up to the
level of school revenues, our collections are reasonably
assured. We consider the operating deficits to estimate any
impairment of collection, and our recognized revenue reflects
this impairment. The fact that a school has an operating
49
deficit does not mean we anticipate losing money on the
contract. We recognize the impact of these operating deficits by
estimating the full year revenues and full year deficits of
schools at the beginning of the fiscal year. We amortize the
estimated deficits against recognized revenues based upon the
percentage of actual revenues in the period to total estimated
revenues for the fiscal year. We periodically review our
estimates of full year school revenues and full year operating
deficits and amortize the impact of any changes to these
estimates over the remainder of our fiscal year. Actual school
operating deficits may vary from these estimates or revisions,
and the impact of these differences could have a material impact
on our results of operations. Since the end of the school year
coincides with the end of our fiscal year, we are generally able
to base our annual revenues on actual school revenues and use
actual costs incurred in our calculation of school operating
deficits. As a result, on an annual basis, we have not had to
make any material adjustments to our estimates of realizable
revenue over the last three years.
The amount of revenues we record is determined in accordance
with
EITF 99-19.
For the schools where we provide turnkey management services, 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. We
currently generate revenues from
K
12
International Academy, although the amounts are immaterial.
These revenues are recognized ratably over the semester or
school year as defined by the course or enrollment.
Capitalized
Curriculum Development Costs
Our curriculum is primarily developed by our employees and to a
lesser extent, by independent contractors. Generally, our
courses cover traditional subjects and utilize examples and
references designed to remain relevant for long periods of time.
The online nature of our curriculum allows us to incorporate
user feedback rapidly and make ongoing corrections and
improvements. For these reasons, we believe that our courses,
once developed, have an extended useful life, similar to
computer software. We also create textbooks and other offline
materials. Our curriculum is integral to our learning system.
Our customers do not acquire our curriculum or future rights
to it.
We capitalize curriculum development costs incurred during the
application development stage in accordance with Statement of
Position (SOP)
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use.
SOP 98-1
provides guidance for the treatment of costs associated with
computer software development and defines those costs to be
capitalized and those to be expensed. Costs that qualify for
capitalization are external direct costs, payroll, and
payroll-related 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
50
five years. This is consistent with the capitalization period
used by others in our industry and corresponds with our product
development lifecycle. Included in capitalized curriculum
development is the November 2007 purchase of a perpetual license
of curriculum for $3 million. The purchase agreement
includes a provision for future royalty payments. This
curriculum will be included as part of our high school offering
and will be amortized over five years.
Software
Developed or Obtained for Internal Use
We develop our own proprietary computer software programs to
provide specific functionality to support both our unique
education offering and the student and school management
services. These programs enable us to develop courses, process
student enrollments, meet state documentation requirements,
track student academic progress, deliver online courses to
students, coordinate and track the delivery of course-specific
materials to students and provide teacher support and training.
These applications are integral to our learning system and we
continue to enhance existing applications and create new
applications. Our customers do not acquire our software or
future rights to it.
We capitalize software development costs incurred during the
development stage of these applications in accordance with
SOP 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use
. These development costs are
generally amortized over three years.
Impairment
of Long-lived Assets
Long-lived assets include property, equipment, capitalized
curriculum and software developed or obtained for internal use.
In accordance with Statement of Financial Accounting Standards
No. 144 (SFAS No. 144),
Accounting for the
Impairment or Disposal of Long-Lived Assets
, we review our
recorded long-lived assets for impairment annually or whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be fully recoverable. We determine
the extent to which an asset may be impaired based upon our
expectation of the assets future usability as well as on a
reasonable assurance that the future cash flows associated with
the asset will be in excess of its carrying amount. If the total
of the expected undiscounted future cash flows is less than the
carrying amount of the asset, a loss is recognized for the
difference between fair value and the carrying value of the
asset.
Accounting
for Stock-based Compensation
Prior to July 1, 2006, we accounted for stock-based
compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25,
Accounting
for Stock Issued to Employees
, or APB No. 25 and
related interpretations. Accordingly, compensation cost for
stock options generally was measured as the excess, if any, of
the estimated fair value of our common stock over the amount an
employee must pay to acquire the common stock on the date that
both the exercise price and the number of shares to be acquired
pursuant to the option are fixed. We had adopted the
disclosure-only provisions of SFAS No. 123 which was
released in May 1995, and used the minimum value method of
valuing stock options as allowed for non-public companies.
In December 2004, SFAS No. 123R revised
SFAS No. 123 and superseded APB No. 25.
SFAS No. 123R requires the measurement of the cost of
employee services received in exchange for an award of equity
instruments based on the fair value of the award on the
measurement date of grant, with the cost being recognized over
the applicable requisite service period. In addition,
SFAS No. 123R requires an entity to provide certain
disclosures in order to assist in understanding the nature of
share-based payment transactions and the effects of those
transactions on the financial statements. The provisions of
SFAS No. 123R are required to be applied as of the
beginning of the first interim or annual reporting period of the
entitys first fiscal year that begins after
December 15, 2005.
Effective July 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123R using the
prospective transition method, which requires the Company to
apply the provisions of SFAS No. 123R only to awards
granted, modified, repurchased or cancelled after the effective
date. Under this transition method, stock- based compensation
expense recognized beginning July 1, 2006 is based on the
fair value of stock awards as of the grant date. As the Company
had used the minimum value method for valuing its stock options
under the disclosure requirements of SFAS No. 123, all
options granted prior to July 1, 2006 continue to be
accounted for under APB No. 25.
51
The Company uses the Black-Scholes option pricing model method
to calculate the fair value of stock options. Depending on
certain substantive characteristics of the stock option, the
Company, where appropriate, utilizes a binomial model. The use
of option valuation models requires the input of highly
subjective assumptions, including the expected stock price
volatility and the expected term of the option.
Option valuation models also require a determination of the fair
value of our common stock at various dates. As a public company,
fair value is readily observable in the market price of our
common stock. Before the completion of our IPO, such
determinations required complex and subjective judgments. During
this pre-IPO period, we considered several methodologies to
estimate our enterprise value, including guideline public
company analysis, an analysis of comparable company
transactions, and a discounted cash flow analysis. The results
of the public company and comparable company transactions
components of the analyses vary not only with factors such as
our revenue, EBITDA, and income levels, but also with the
performance and public market valuation of the companies and
transactions used in the analyses. Although the market-based
analyses did not include companies directly comparable to us,
the analysis provided useful benchmarks.
We also considered several equity allocation methodologies to
allocate the estimate of enterprise value to our redeemable
convertible preferred stock and common stock including the
current value method, the option pricing method, and the
probability weighted expected return method (PWERM). The final
valuation conclusion was based upon the PWERM equity allocation
because it considers the value that would be attributable to
each equity interest under different scenarios.
The PWERM assessed the value of common stock based upon possible
scenarios including completion of an initial public offering, an
advantageous strategic sale of the Company, and remaining a
private company. The significant factors included preliminary
estimates of the public offering price range from underwriters,
the value of comparable company transactions, and discounted
cash flow analysis. Key assumptions included the relative
probability of the three scenarios. The relative probabilities
were based upon where the Company was in the initial public
offering registration process, empirical analysis of companies
that go public after the registration process, and qualitative
characteristics of the Company. The value of common stock was
estimated by applying the relative probability to the value of
common stock under each scenario. Based upon the foregoing, we
believe the analysis provides a reasonable basis for valuing the
common stock.
For the three months ended September 30, 2007, all option
grants took place in the month of July. For the year ended
June 30, 2007, we granted stock options in July 2006,
February 2007 and May 2007. The significant factor contributing
to the difference between the fair value as of the date of each
grant and our public offering price is the probability of
completing a public offering used in the PWERM. The probability
of completing an initial public offering at each grant date was
determined based on the progression of the Company in the
initial public offering process. As the probability increased
the relative fair value of the option increased. Specifically,
for the options granted on February 1, February 27,
May 17, July 3 and July 12, 2007, we discounted the
value of our common stock by 70.8%, 62.6%, 47.1%, 39.1% and
39.1%, respectively, to account for the probability that a
public offering would not occur. The amount of these discounts
reflect, in February, a very low but increasing likelihood of
completing such an offering as the Board had not yet
affirmatively determined to pursue a public offering, in May, a
higher likelihood of completing a public offering following the
Boards determination to pursue the offering and the
Companys progress in preparing its registration statement,
and in July, a much higher likelihood of completing a public
offering as a majority of the work in preparing for the initial
filing of a registration statement had been completed.
The Company accounts for equity instruments issued to
non-employees in accordance with the provisions of
SFAS No. 123R and
EITF 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services
.
Deferred
Tax Asset Valuation Allowance
We account for income taxes as prescribed by Statement of
Financial Accounting Standards No. 109
(SFAS No. 109),
Accounting for Income Taxes
.
SFAS No. 109 prescribes the use of the asset and
liability method to compute the differences between the tax
bases of assets and liabilities and the related financial
amounts, using currently enacted tax laws. If necessary, a
valuation allowance is established, based on the weight of
available
52
evidence, to reduce deferred tax assets to the amount that is
more likely than not to be realized. Realization of the deferred
tax assets, net of deferred tax liabilities, is principally
dependent upon achievement of sufficient future taxable income.
We exercise significant judgment in determining our provisions
for income taxes, our deferred tax assets and liabilities and
our future taxable income for purposes of assessing our ability
to utilize any future tax benefit from our deferred tax assets.
However, our ability to forecast sufficient future taxable
income is subject to certain market factors that we may not be
able to control such as a material reduction in per pupil
funding levels, legislative budget cuts reducing or eliminating
the products and services we provide and government regulation.
Since inception, the Company has generated significant losses.
However, in the past three years, the Company has generated
increasing operating profit; 1.2% of revenue in fiscal year
2006, 2.9% of revenue in fiscal year 2007 and 5.8% of revenue in
fiscal year 2008. In addition, the Companys revenue is
dependent upon the number of student enrollments, the majority
of which are generated in the first quarter of the fiscal year
in conjunction with the start of the school year. For the year
ended June 30, 2008, the Company generated a significant
increase in enrollments with average enrollments climbing to
40,859, an increase of 51.3% with a corresponding revenue
increase of 61.0% from the year ended June 30, 2007. During
the recruiting season for fall 2008, the Company has received
enrollment applications from its existing and new schools that
will provide for additional growth in the coming year. When
considering this positive evidence of future profitability, the
Company believes that our recent history of generating positive
pre-tax income is sustainable and is expected to continue to
grow as a result of the increasing revenues primarily from
virtual public schools. Consequently, we believe that it is more
likely than not that we will be able to utilize substantially
all of our net deferred tax asset. Therefore, for the year ended
June 30, 2008, we have reversed approximately
$27.0 million of the valuation allowance on our net
deferred tax asset.
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 June 30, 2008, we had federal net operating loss
carryforwards of $70.8 million that expire between 2020 and
2028 if unused. The Company maintains a valuation allowance on
net deferred tax assets of $0.6 million as of June 30,
2008 related to state income taxes as the Company believes it is
more likely than not that we will not be able to utilize these
deferred tax assets. During 2008, the Company changed its tax
treatment of certain capitalized costs which resulted in an
increase in its net operating loss carryforwards. Due to these
net operating loss carryforwards, the Company does not expect to
pay federal income taxes in the next twelve months.
Goodwill
and Other Intangibles
We record as goodwill the excess of purchase price over the fair
value of the identifiable net assets acquired. The determination
of fair value of the identifiable net assets acquired was
determined by management utilizing various valuation
methodologies. Intangible assets subject to amortization include
trade names, domain names, and non-compete agreements. Such
intangible assets are amortized on a straight-line basis over
their estimated useful lives, which are considered to be two
years.
Statements of Financial Accounting Standards (SFAS)
No. 142,
Goodwill and Other Intangible Assets
,
prescribes a two-step process for impairment testing of goodwill
and intangibles with indefinite lives, which is performed
annually, as well as when an event triggering impairment may
have occurred. The first step tests for impairment, while the
second step, if necessary, measures the impairment. Goodwill and
intangible assets deemed to have an indefinite life are tested
for impairment on an annual basis, or earlier when events or
changes in circumstances suggest the carrying amount may not be
fully recoverable. The Company has elected to perform its annual
assessment on May 31st. For the year ended June 30,
2008, no impairment to goodwill was recorded.
53
Results
of Operations
The following table sets forth average enrollment data for each
of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Total enrollments
|
|
|
40,859
|
|
|
|
27,005
|
|
|
|
20,220
|
|
Enrollments associated with managed schools as a percentage of
total enrollments
|
|
|
82.0
|
%
|
|
|
76.9
|
%
|
|
|
91.7
|
%
|
High School enrollments as a percentage of total enrollments
|
|
|
13.5
|
%
|
|
|
8.7
|
%
|
|
|
5.0
|
%
|
The following table sets forth statements of operations data for
each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Consolidated Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
226,235
|
|
|
$
|
140,556
|
|
|
$
|
116,902
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
131,282
|
|
|
|
76,064
|
|
|
|
64,828
|
|
Selling, administrative, and other operating expenses
|
|
|
72,393
|
|
|
|
51,159
|
|
|
|
41,660
|
|
Product development expenses
|
|
|
9,550
|
|
|
|
8,611
|
|
|
|
8,568
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
213,225
|
|
|
|
135,834
|
|
|
|
115,056
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
13,010
|
|
|
|
4,722
|
|
|
|
1,846
|
|
Interest expense, net
|
|
|
(295
|
)
|
|
|
(639
|
)
|
|
|
(488
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations before income taxes
|
|
|
12,715
|
|
|
|
4,083
|
|
|
|
1,358
|
|
Income tax benefit (expense)
|
|
|
21,058
|
|
|
|
(218
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
33,773
|
|
|
$
|
3,865
|
|
|
$
|
1,358
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Consolidated Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
58.0
|
|
|
|
54.1
|
|
|
|
55.5
|
|
Selling, administrative, and other operating expenses
|
|
|
32.0
|
|
|
|
36.4
|
|
|
|
35.6
|
|
Product development expenses
|
|
|
4.2
|
|
|
|
6.1
|
|
|
|
7.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
94.2
|
|
|
|
96.6
|
|
|
|
98.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
5.8
|
|
|
|
3.4
|
|
|
|
1.6
|
|
Interest expense, net
|
|
|
(0.1
|
)
|
|
|
(0.5
|
)
|
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations before income taxes
|
|
|
5.7
|
|
|
|
2.9
|
|
|
|
1.2
|
|
Income tax benefit (expense)
|
|
|
9.3
|
|
|
|
(0.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
15.0
|
%
|
|
|
2.7
|
%
|
|
|
1.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of Years Ended June 30, 2008 and 2007
Revenues.
Our revenues for the year ended
June 30, 2008 were $226.2 million, representing an
increase of $85.7 million, or 61.0%, as compared to
revenues of $140.6 million for the year ended June 30,
2007. Average
54
enrollments increased 51.3% to 40,859 for the year ended
June 30, 2008 from 27,005 for the year ended June 30,
2007. The increase in average enrollments was primarily
attributable to 40.5% enrollment growth in existing states. New
school openings in Georgia and Nevada contributed approximately
10.8% to enrollment growth. In new and existing states combined,
high school enrollments contributed approximately 11.7% to
enrollment growth. In addition, we launched 11th and
12th grade in August 2007 attracting new students as well
as prior year 10th grade students. High school enrollments
comprised approximately 13.5% of our total average enrollment
for the year ended June 30, 2008 as compared to 8.7% in the
prior period. Also contributing to the growth in revenues was a
6.4% increase in average revenues per enrollment. This increase
was primarily attributable to an increase in the percentage of
enrollments associated with managed schools, which generate
higher revenue per enrollment than non-managed school
enrollments. The percentage of enrollments associated with
managed schools increased to 82.0% for the year ended
June 30, 2008 from 76.9% for the year ended June 30,
2007.
Instructional Costs and Services
Expenses.
Instructional costs and services
expenses for the year ended June 30, 2008 were
$131.3 million, representing an increase of
$55.2 million, or 72.6% as compared to instructional costs
and services of $76.1 million for the year ended
June 30, 2007. This increase was primarily attributable to
a $40.6 million increase in expenses to operate and manage
the schools and a $13.6 million increase in costs to supply
books, educational materials and computers to students,
including depreciation and amortization. As a percentage of
revenues, instructional costs increased to 58.0% for the year
ended June 30, 2008, as compared to 54.1% for the year
ended June 30, 2007. The increase in instructional cost and
service expenses as a percentage of revenues is primarily due to
an increase in enrollments associated with managed schools,
which have higher costs as a percentage of revenues than
non-managed school, higher per student costs for high school
because our instructional model has not yet attained scale, and
higher costs to procure and supply materials due to greater than
anticipated enrollments.
Selling, Administrative, and Other Operating
Expenses.
Selling, administrative, and other
operating expenses for year ended June 30, 2008 were
$72.4 million, representing an increase of
$21.2 million, or 41.5%, as compared to selling,
administrative and other operating expenses of
$51.2 million for the year ended June 30, 2007. This
increase is primarily attributable to an $8.9 million
increase in personnel costs primarily due to increased headcount
and a $4.7 million increase in professional services. As a
percentage of revenues, selling, administrative, and other
operating expenses decreased to 32.0% for the year ended
June 30, 2008 as compared to 36.4% for the year ended
June 30, 2007 as we gained greater leverage on our
corporate overhead and selling resources.
Product Development Expenses.
Product
development expenses for the year ended June 30, 2008 were
$9.6 million, representing an increase of
$1.0 million, or 10.9%, as compared to product development
expenses of $8.6 million for the year ended June 30,
2007. Employee headcount and contract labor increased, but was
offset by greater utilization of these resources for capitalized
curriculum. As a percentage of revenues, product development
expenses decreased to 4.2% for the year ended June 30, 2008
as compared to 6.1% for the year ended June 30, 2007.
Net Interest Expense.
Net interest expense for
the year ended June 30, 2008 was $0.3 million, a
decrease of $0.3 million, from $0.6 million for the
year ended June 30, 2007. The decrease in net interest
expense is primarily due to interest income generated on the net
cash proceeds from our IPO, partially offset by an increase in
interest charges on increased capital lease obligations.
Income Taxes.
Income tax benefit for the year
ended June 30, 2008 was $21.1 million compared to
income tax expense of $0.2 million for the year ended
June 30, 2007. Our provision for income taxes for the year
ended June 30, 2008 was $5.9 million, or 46.6% of
income before income taxes. The tax provision was offset by a
$27.0 million tax benefit we recognized as we were able to
reverse the valuation allowance on net deferred tax assets
generated by our net operating losses that were fully reserved
for in prior periods. For the year ended June 30, 2007
income tax expense was $0.2 million, as we were able to
utilize the deferred tax assets which were generated from our
net operating losses and for which a full reserve was maintained
in prior periods.
Net Income.
Net income for the year ended
June 30, 2008 was $33.8 million, representing an
increase of $29.9 million, as compared to net income of
$3.9 million for the year ended June 30, 2007. Net
income as a percentage of revenues increased to 15.0% for the
year ended June 30, 2008, as compared to 2.7% for the year
ended June 30, 2007, as a result of the factors discussed
above. Excluding the $27.0 million income tax benefit in
fiscal year 2008, net income for the year ended June 30,
2008 would have been $6.8 million, representing an increase
of $2.9 million or 75.9% as compared to net income of
$3.9 million for the year ended June 30, 2007.
Excluding the
55
income tax benefit, net income as a percentage of revenues would
have increased to 3.0% for the year ended June 30, 2008 as
compared to 2.7% for the year ended June 30, 2007.
Comparison
of Years Ended June 30, 2007 and 2006
Revenues.
Our revenues for the year ended
June 30, 2007 were $140.6 million, representing an
increase of $23.7 million, or 20.3%, as compared to
revenues of $116.9 million for the year ended June 30,
2006. Average enrollments increased 33.6% to 27,005 for the year
ended June 30, 2007 from 20,220 for the year ended
June 30, 2006. The increase in average enrollments was
primarily attributable to 26.1% enrollment growth in existing
states. New school openings in Washington and in Chicago, where
we opened our first hybrid school, contributed approximately
7.5% to enrollment growth. In addition, we launched
10th grade in August 2006 attracting new students as well
as prior year 9th grade students. High school enrollments
contributed approximately 8% to overall enrollment growth. High
school enrollments comprised approximately 8.7% of our total
average enrollment for the year ended June 30, 2007 as
compared to 5.0% in the prior period. Primarily offsetting the
increased revenues related to enrollment growth, was a decline
in average revenues per enrollment resulting from the impact of
a substantial reduction in the percentage of enrollments
associated with schools to which we provide turnkey management
services, as a school to which we formerly provided turnkey
management services switched to limited service contracts. For
the year ended June 30, 2007, 76.9% of our enrollments were
associated with turnkey management service schools, down from
91.7% for the corresponding period in 2006. The increase in
average enrollments was primarily attributable to enrollment
growth in existing states. Average price increases of
approximately 2% for per student fees were implemented in July
2006. Finally, increased operating deficits at certain schools
partially offset the growth in revenues. These deficits were
attributable to greater school operating expenses required to
support increased enrollment and high school services as well as
school funding adjustments of approximately $1.0 million
each in schools we operate in California and Colorado resulting
from enrollment audits.
Instructional Costs and Services
Expenses.
Instructional costs and services
expenses for the year ended June 30, 2007 were
$76.1 million, representing an increase of
$11.3 million, or 17.4% as compared to instructional costs
and services of $64.8 million for the year ended
June 30, 2006. This increase was primarily attributable to
a $6.6 million increase in expenses to operate and manage
the schools and a $4.7 million increase in costs to supply
books, educational materials and computers to students,
including depreciation and amortization. As a percentage of
revenues, instructional costs decreased to 54.1% for the year
ended June 30, 2007, as compared to 55.5% for the year
ended June 30, 2006. The decrease in instructional cost and
service expenses as a percentage of revenues is primarily due to
lower costs associated with a renegotiated management and
services agreement, partially offset by a shift in the mix of
enrollments to schools with higher operating costs and the
start-up
costs of new schools.
Selling, Administrative, and Other Operating
Expenses.
Selling, administrative, and other
operating expenses for year ended June 30, 2007 were
$51.2 million, representing an increase of
$9.5 million, or 22.8%, as compared to selling,
administrative and other operating expenses of
$41.7 million for the year ended June 30, 2006. This
increase is primarily attributable to a $2.9 million
increase in marketing, advertising and selling expenses and a
$3.1 million increase in professional services. In
addition, there was a $2.7 million increase in personnel
costs primarily due to increased headcount and higher average
salaries due to annual salary increases in fiscal year 2007. As
a percentage of revenues, selling, administrative, and other
operating expenses increased to 36.4% for the year ended
June 30, 2007 as compared to 35.6% for the year ended
June 30, 2006.
Product Development Expenses.
Product
development expenses for the year ended June 30, 2007 were
$8.6 million, relatively stable compared to product
development expenses of $8.6 million for the year ended
June 30, 2006. Employee headcount and contract labor
increased, but was offset by greater utilization of these
resources for capitalized curriculum. As a percentage of
revenues, product development expenses declined to 6.1% for the
year ended June 30, 2007 as compared to 7.3% for the year
ended June 30, 2006. Capitalized curriculum development
costs for the year ended June 30, 2007 were
$8.7 million, representing an increase of
$8.0 million, as compared to capitalized curriculum
development costs of $0.7 million for the year ended
June 30, 2006. This increase was primarily attributable to
the development of courses for our high school offering.
56
Net Interest Expense.
Net interest expense for
the year ended June 30, 2007 was $0.6 million, an
increase of $0.1 million, from $0.5 million for the
year ended June 30, 2006. The increase in net interest
expense is primarily due to interest charges on increased
capital lease obligations.
Income Taxes.
Our provision for income taxes
for the year ended June 30, 2007 was $0.2 million,
compared with no provision for the year ended June 30,
2006. Our tax expense for the year ended June 30, 2007 is
primarily attributable to state tax liabilities. No tax expense
was recorded for the year ended June 30, 2006, as we were
able to utilize the deferred tax assets which were generated
from our net operating losses.
Net Income.
Net income for the year ended
June 30, 2007 was $3.9 million, representing an
increase of $2.5 million, as compared to net income of
$1.4 million for the year ended June 30, 2006. Net
income as a percentage of revenues increased to 2.7% for the
year ended June 30, 2007, as compared to 1.2% for the year
ended June 30, 2006, as a result of the factors discussed
above.
Quarterly
Results of Operations
The following tables set forth selected unaudited quarterly
consolidated statement of operations data for the eight most
recent quarters, as well as each line item expressed as a
percentage of total revenues. The information for each of these
quarters has been prepared on the same basis as the audited
consolidated financial statements included in this
Form 10-K
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 annual report. These quarterly operating
results are not necessarily indicative of our operating results
for any future period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2006
|
|
|
2006
|
|
|
Total Enrollments
|
|
|
40,033
|
|
|
|
42,048
|
|
|
|
40,675
|
|
|
|
39,493
|
|
|
|
26,558
|
|
|
|
27,908
|
|
|
|
26,898
|
|
|
|
26,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Enrollments associated with managed schools as a percentage of
total enrollments
|
|
|
82.3
|
%
|
|
|
82.6
|
%
|
|
|
81.5
|
%
|
|
|
80.8
|
%
|
|
|
79.2
|
%
|
|
|
76.9
|
%
|
|
|
75.8
|
%
|
|
|
75.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High School enrollments as a percentage of total enrollments
|
|
|
12.8
|
%
|
|
|
13.8
|
%
|
|
|
13.5
|
%
|
|
|
14.5
|
%
|
|
|
7.8
|
%
|
|
|
8.5
|
%
|
|
|
9.1
|
%
|
|
|
9.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2006
|
|
|
2006
|
|
|
Revenues
|
|
$
|
56,475
|
|
|
$
|
56,016
|
|
|
$
|
54,391
|
|
|
$
|
59,353
|
|
|
$
|
35,626
|
|
|
$
|
34,831
|
|
|
$
|
32,356
|
|
|
$
|
37,743
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
32,462
|
|
|
|
32,062
|
|
|
|
31,980
|
|
|
|
34,778
|
|
|
|
20,961
|
|
|
|
17,904
|
|
|
|
18,022
|
|
|
|
19,177
|
|
Selling, administrative, and other
|
|
|
22,712
|
|
|
|
17,032
|
|
|
|
16,610
|
|
|
|
16,039
|
|
|
|
16,100
|
|
|
|
12,644
|
|
|
|
11,030
|
|
|
|
11,385
|
|
Product development expenses
|
|
|
2,021
|
|
|
|
2,542
|
|
|
|
2,460
|
|
|
|
2,527
|
|
|
|
2,756
|
|
|
|
2,083
|
|
|
|
1,566
|
|
|
|
2,206
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
57,195
|
|
|
|
51,636
|
|
|
|
51,050
|
|
|
|
53,344
|
|
|
|
39,817
|
|
|
|
32,631
|
|
|
|
30,618
|
|
|
|
32,768
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(720
|
)
|
|
|
4,380
|
|
|
|
3,341
|
|
|
|
6,009
|
|
|
|
(4,191
|
)
|
|
|
2,200
|
|
|
|
1,738
|
|
|
|
4,975
|
|
Interest expense, net
|
|
|
88
|
|
|
|
309
|
|
|
|
(388
|
)
|
|
|
(304
|
)
|
|
|
(165
|
)
|
|
|
(117
|
)
|
|
|
(263
|
)
|
|
|
(94
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(632
|
)
|
|
|
4,689
|
|
|
|
2,953
|
|
|
|
5,705
|
|
|
|
(4,356
|
)
|
|
|
2,083
|
|
|
|
1,475
|
|
|
|
4,881
|
|
Income tax benefit (expense)
|
|
|
17,735
|
|
|
|
(2,229
|
)
|
|
|
(1,565
|
)
|
|
|
7,117
|
|
|
|
9
|
|
|
|
(51
|
)
|
|
|
(30
|
)
|
|
|
(146
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
17,103
|
|
|
$
|
2,460
|
|
|
$
|
1,388
|
|
|
$
|
12,822
|
|
|
$
|
(4,347
|
)
|
|
$
|
2,032
|
|
|
$
|
1,445
|
|
|
$
|
4,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57
The following table sets forth statements of operations data as
a percentage of revenues for each of the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2006
|
|
|
2006
|
|
|
Revenues
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
57.5
|
|
|
|
57.2
|
|
|
|
58.8
|
|
|
|
58.6
|
|
|
|
58.8
|
|
|
|
51.4
|
|
|
|
55.7
|
|
|
|
50.8
|
|
Selling, administrative, and other
|
|
|
40.2
|
|
|
|
30.4
|
|
|
|
30.5
|
|
|
|
27.0
|
|
|
|
45.2
|
|
|
|
36.3
|
|
|
|
34.1
|
|
|
|
30.2
|
|
Product development expenses
|
|
|
3.6
|
|
|
|
4.6
|
|
|
|
4.5
|
|
|
|
4.3
|
|
|
|
7.7
|
|
|
|
6.0
|
|
|
|
4.8
|
|
|
|
5.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
101.3
|
|
|
|
92.2
|
|
|
|
93.8
|
|
|
|
89.9
|
|
|
|
111.7
|
|
|
|
93.7
|
|
|
|
94.6
|
|
|
|
86.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(1.3
|
)
|
|
|
7.8
|
|
|
|
6.2
|
|
|
|
10.1
|
|
|
|
(11.7
|
)
|
|
|
6.3
|
|
|
|
5.4
|
|
|
|
13.2
|
|
Interest expense, net
|
|
|
0.2
|
|
|
|
0.6
|
|
|
|
(0.7
|
)
|
|
|
(0.5
|
)
|
|
|
(0.5
|
)
|
|
|
(0.3
|
)
|
|
|
(0.8
|
)
|
|
|
(0.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(1.1
|
)
|
|
|
8.4
|
|
|
|
5.5
|
|
|
|
9.6
|
|
|
|
(12.2
|
)
|
|
|
6.0
|
|
|
|
4.6
|
|
|
|
13.0
|
|
Income tax benefit (expense), net
|
|
|
31.4
|
|
|
|
(4.0
|
)
|
|
|
(2.9
|
)
|
|
|
12.0
|
|
|
|
0.0
|
|
|
|
(0.1
|
)
|
|
|
(0.1
|
)
|
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
30.3
|
%
|
|
|
4.4
|
%
|
|
|
2.6
|
%
|
|
|
21.6
|
%
|
|
|
(12.2
|
)%
|
|
|
5.9
|
%
|
|
|
4.5
|
%
|
|
|
12.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 fiscal quarter, we ship materials to students for
the beginning of the school year. New students will enroll after
the start of the school year, but in significantly smaller
numbers. This generally results in higher materials revenues and
margin in the first quarter versus other 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. Management and
technology service revenues are recognized ratably over the
course of our fiscal year. The combined effect of these factors
results in higher revenues in the first fiscal quarter than in
the subsequent quarters.
Operating expenses are also seasonal. Instructional costs and
services expenses 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, proctored exam related
expenses, and community events,) impacting the quarterly change
in instructional costs. The majority of our recruiting and
selling expenses are incurred in the first and fourth fiscal
quarters, as our primary enrollment season is July through
September. A significant portion of our overhead expenses does
not vary with the school year or enrollment season.
Discussion
of Seasonality of Financial Condition
Certain accounts in our balance sheet are subject to seasonal
fluctuations. As our enrollments and revenues grow, we expect
these seasonal trends to be amplified. The bulk of our materials
are shipped to students prior to the beginning of the school
year, usually in July or August. In order to prepare for the
upcoming school year, we generally build up inventories during
the fourth quarter of our fiscal year. Therefore, inventories
tend to be at the highest levels at the end of our fiscal year.
In the first quarter of our fiscal year, inventories tend to
decline
58
significantly as materials are shipped to students. We generally
have payment terms with our inventory suppliers, therefore the
fourth quarter purchases of inventory typically will increase
accounts payable.
Accounts receivable balances tend to be at the highest levels in
the first quarter of our fiscal year as we begin billing for all
enrolled students and our billing arrangements include upfront
fees for many of the elements of our offering. These upfront
fees result in seasonal fluctuations to our deferred revenue
balances. In a few cases, virtual public schools may have funds
to pay these invoices in a timely manner and this provides the
Company with liquidity. Generally, deferred revenue has not been
a significant source of funds to the Company since most schools
receive their funding over the course of the year and pay their
invoices in a corresponding manner. Since the upfront fees are
charged to the schools at the time of enrollment, deferred
revenue balances related to the schools tend to be highest in
the first quarter, when the majority of students enroll. Since
the deferred revenue is amortized over the course of the school
year, which ends in June, the balance would be at its lowest at
the end of our fiscal year.
The deferred revenue related to our
direct-to-consumer
business results from advance payments for twelve and
twenty-four month subscriptions to our on-line school. These
advance payments are amortized over the life of the subscription
and tend to be highest at the end of the fourth quarter and
first quarter, when the majority of subscriptions are sold. Year
end balances in deferred revenue are primarily related to the
direct-to-consumer
sales. Billings related to the
direct-to-consumer
sales are small relative to those of public virtual schools;
however, they do represent a source of liquidity.
Liquidity
and Capital Resources
As of June 30, 2008 and June 30, 2007, we had cash and
cash equivalents of $71.7 million and $1.7 million,
respectively. Net cash provided by operating activities during
the year ended June 30, 2008, was $15.5 million. After
the completion of our initial public offering, excess cash has
been invested primarily in overnight bank deposits. In the
future, we may also invest in money market accounts, government
securities, corporate debt securities and similar investments.
We financed our operating activities and capital expenditures
during the year ended June 30, 2008 through cash provided
by operating activities, capital lease financing and the net
proceeds from the completion of our initial public offering and
private placement transaction. During the years ended
June 30, 2007, 2006 and 2005, we financed our operating
activities and capital expenditures through a combination of
cash provided by operating activities, long-term debt and
capital lease financing. Prior to 2005, we financed our
operating activities and capital expenditures primarily with
sales of equity to private investors. From the Companys
founding in 2000 through December 2003, we raised over
$115 million from the sale of equity.
In December 2006, we entered into a $15 million revolving
credit agreement with PNC Bank (the Credit Agreement). Pursuant
to the terms of the Credit Agreement, we agreed that the
proceeds of the term loan facility were to be used primarily for
working capital requirements. 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 1.25% and 1.75%, based on the leverage
ratio (as defined in the Credit Agreement). We pay a quarterly
commitment fee which varies between 0.15% and 0.25% on the
unused portion of the credit agreement (depending on the
leverage ratio). The working capital line includes a
$5.0 million letter of credit facility. Issuances of
letters of credit reduce the availability of permitted
borrowings under the Credit Agreement.
Borrowings under the Credit Agreement are secured by
substantially all of our assets. The Credit Agreement contains a
number of financial and other covenants that, among other
things, restrict our and our subsidiaries
59
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
June 30, 2008, we were in compliance with these covenants.
As of June 30, 2008, no borrowings were outstanding on the
working capital line of credit and approximately
$2.3 million was outstanding for letters of credit. On
October 5, 2007, we amended the Credit Agreement to
increase the borrowing limit from $15 million to
$20 million under substantially the same terms. This
agreement expires on December 20, 2009.
One of our subsidiaries has an equipment lease line of credit
for new purchases with Hewlett-Packard Financial Services
Company that expires on April 30, 2009 for new purchases on
the line of credit. The interest rate on new borrowings under
the equipment lease line is set quarterly. The rate on new
borrowings for the three months ending September 30, 2008
is approximately 6.4%. For the year ended June 30, 2008, we
borrowed $10.6 million to finance the purchase of student
computers and related equipment at an interest rate ranging from
7.0% to 8.3%. 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.
Upon the closing of the IPO, the holders of Redeemable
Convertible Series C Preferred stock were paid a cash
dividend of approximately $6.4 million from the net
proceeds of the offering. The amount of the declared dividend
was equal to the pro rata amount of the annual cumulative
dividend that would have normally accrued on January 2,
2008 under the provisions of the Series C Preferred stock
agreement. Also concurrently with the closing of the IPO, all
shares of convertible preferred stock outstanding automatically
converted into an aggregate of 19,879,675 shares of common
stock thereby also eliminating the associated future annual
dividend accrual.
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. The amount of funding is dependent upon
per enrollment funding levels for the state and school
enrollment. Funding receipts by an individual school may vary
over the year and may be in arrears. Because our receivables
represent obligations indirectly due from governments, we have
not historically had an issue with non-payment and believe the
risk of non-payment is minimal although we cannot guarantee this
will continue.
Our cash 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. In the next twelve months, we expect our capital
expenditures for student computers to correlate with the growth
in enrollments and expenditures for capital curriculum, related
systems and other fixed assets to increase relative to FY 2008.
We expect to be able to fund these capital expenditures with
cash on hand, cash generated from operations 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. Based on our current operating and capital
expenditure forecasts, we believe that the combination of funds
currently available and funds to be generated from operations
will be adequate to finance our ongoing operations for the
foreseeable future.
Operating
Activities
Net cash provided by operating activities for the year ended
June 30, 2008 was $15.5 million, compared to
$5.6 million for the year ended June 30, 2007. This
increase was primarily due to an $29.9 million increase in
net income, a $5.2 million increase in depreciation and
amortization, an $6.8 million increase in accounts payable,
and a $2.7 million increase in accrued compensation and
benefits. The increase in accounts payable was primarily
attributable amounts due on fourth quarter purchases of
inventory and marketing activities. This was partially offset by
a $21.1 million increase in deferred income taxes, a
$11.4 million increase in accounts receivable, due to the
60
growth in revenues and the timing of customer receipts, and a
$4.5 million increase in inventories acquired in
anticipation of the fall enrollment season.
Net cash provided by operating activities for the year ended
June 30, 2007 was $5.6 million, compared to
$3.6 million for the year ended June 30, 2006. The
increase was primarily due the $2.5 million increase in net
income and a $2.4 million increase in depreciation and
amortization. This was partially offset by a $0.6 million
increase in 2007 of various working capital items and a
$0.6 million change in the provision for doubtful accounts.
This change in the accounts receivable allowance related to the
write-off of accounts receivable that were fully reserved in
prior years and attempts to collect were unsuccessful. Because
these accounts were fully reserved in prior years, there was no
impact on our results of operations for the year ended
June 30, 2007.
Investing
Activities
Net cash used in investing activities for the fiscal year 2008,
2007 and 2006 was $18.5 million, $14.0 million and
$11.5 million, respectively.
Purchases of property and equipment for the fiscal year ended
2008, 2007 and 2006 were $6.5 million, $5.4 million
and $10.8 million, respectively. In fiscal year 2008 and
2007, we also financed, with capital leases, purchases of
property and equipment and student computers of
$10.6 million and $8.1 million, respectively.
Capitalized curriculum for the fiscal year ended 2008, 2007 and
2006 were $11.7 million, $8.7 million and
$0.7 million, respectively. The fiscal year 2008 amount
includes the purchase of a perpetual license of curriculum for
$3.0 million.
Financing
Activities
Net cash provided by financing activities for the year ended
June 30, 2008 was $73.0 million. This was primarily
due to the net proceeds from our IPO and private placement
transaction.
In December, 2007, we completed the initial public offering of
our common stock in which we sold and issued
4,450,000 shares of our common stock, at an issue price of
$18.00 per share. We raised a total of $80.1 million in
gross proceeds from the IPO, or approximately $70.5 million
in net proceeds after deducting underwriting discounts and
commissions of $5.6 million and other offering costs of
$4.0 million.
Concurrently with the closing of the IPO and at the initial
public offering price, we sold 833,333 shares of common
stock at the initial public offering price of $18.00 per share
for an aggregate purchase price of $15.0 million to a
non-U.S. person,
in a private placement transaction outside the United States in
reliance upon Regulation S under the Securities Act of 1933.
Also concurrently with the closing of the IPO, the holders of
Redeemable, Convertible Series C Preferred stock were paid
a cash dividend of $6.4 million. The amount of the declared
dividend was equal to the pro rata amount of the annual
cumulative dividend that would have normally accrued on
January 2, 2008
For the year ended June 30, 2008, net cash used for the
repayment of short term debt was $1.5 million and cash used
for the repayment of capital leases and bank overdraft was
$4.8 million and $1.6 million, respectively. As of
June 30, 2008, there were no borrowings outstanding on our
$20 million line of credit.
Net cash provided by financing activities for the year ended
June 30, 2007 was $0.7 million. This was primarily due
to the release of cash from a restricted escrow account of
$2.3 million, a bank overdraft of $1.6 million, and
net borrowings from our revolving credit facility of
$1.5 million. This was offset by a payment on a related
party note payable of $4.0 million and repayments of
capital lease obligations of $1.4 million. Net cash used in
financing activities for fiscal year 2006 was $2.6 million
primarily attributable to cash invested in a restricted escrow
account of $2.2 million and repayments for capital lease
obligations of $0.4 million.
61
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 June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For Years Ended June 30,
|
|
|
|
Total
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
2013
|
|
|
Thereafter
|
|
|
|
(Dollars in thousands)
|
|
|
Contractual Obligations at June 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital leases(1)
|
|
$
|
13,742
|
|
|
$
|
6,933
|
|
|
$
|
5,318
|
|
|
$
|
1,491
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Operating leases
|
|
|
17,875
|
|
|
|
2,929
|
|
|
|
2,250
|
|
|
|
1,854
|
|
|
|
1,847
|
|
|
|
1,740
|
|
|
|
7,255
|
|
Long-term obligations(1)
|
|
|
614
|
|
|
|
418
|
|
|
|
196
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
32,231
|
|
|
$
|
10,280
|
|
|
$
|
7,764
|
|
|
$
|
3,345
|
|
|
$
|
1,847
|
|
|
$
|
1,740
|
|
|
$
|
7,255
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes interest expense.
|
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.
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, 2008. We cannot assure you that
future inflation will not have an adverse impact on our
operating results and financial condition.
Recent
Accounting Pronouncements
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. On February 12,
2008, the FASB issued Staff Position
No. SFAS 157-2,
Effective Date of FASB Statement No. 157
, which
delayed the effective date of SFAS 157 for non-financial
assets and liabilities to fiscal years beginning after
November 15, 2008. We have not yet assessed the impact of
adopting SFAS 157.
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 the provisions of this statement
will have a material effect on its financial statements.
In December 2007, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 141R (revised 2007),
Business Combinations
, which replaces SFAS No 141.
The statement retains the purchase method of accounting for
acquisitions, but requires a number of changes, including
changes in the way assets and liabilities are recognized in the
purchase accounting. It also changes the
62
recognition of assets acquired and liabilities assumed arising
from contingencies, requires the capitalization of in-process
research and development at fair value, and requires the
expensing of acquisition-related costs as incurred.
SFAS No. 141R is effective for the Company beginning
July 1, 2009 and will apply prospectively to business
combinations completed on or after that date.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB 51
, which changes the
accounting and reporting for minority interests. Minority
interests will be recharacterized as noncontrolling interests
and will be reported as a component of equity separate from the
parents equity, and purchases or sales of equity interests
that do not result in a change in control will be accounted for
as equity transactions. In addition, net income attributable to
the noncontrolling interest will be included in consolidated net
income on the face of the income statement and, upon a loss of
control, the interest sold, as well as any interest retained,
will be recorded at fair value with any gain or loss recognized
in earnings. SFAS No. 160 is effective for the Company
beginning July 1, 2009 and will apply prospectively, except
for the presentation and disclosure requirements, which will
apply retrospectively. We are currently assessing the potential
impact that adoption of SFAS No. 160 would have on our
financial statements.
In March 2008, FASB issued SFAS No. 161,
Disclosures About Instruments and Hedging
Activities
amendment of FASB Statement
No. 133 (SFAS No. 161). SFAS No. 161
changes the disclosure requirements for derivative instruments
and hedging activities. SFAS No. 161 is effective for
financial statements issued for fiscal years beginning after
November 15, 2008. As SFAS No. 161 relates only
to disclosure, management anticipates that the adoption of
SFAS No. 161 will not have a material effect on our
consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162,
The
Hierarchy of Generally Accepted Accounting Principles
(SFAS 162). SFAS 162 identifies the
sources of accounting principles and the framework for selecting
the principles used in the preparation of financial statements
of nongovernmental entities that are presented in conformity
with generally accepted accounting principles in the United
States. SFAS shall be effective 60 days following the
SECs approval of the Public Company Accounting Oversight
Board amendments to AU Section 411,
The Meaning of
Present Fairly in Conformity with General Accepted Accounting
Principles.
We have not yet assessed the impact of adopting
SFAS 162.
|
|
ITEM 7A.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
Interest
Rate Risk
At June 30, 2008 and June 30, 2007, we had cash and
cash equivalents totaling $71.7 million and
$1.7 million, respectively. Future interest and investment
income is subject to the impact of interest rate changes and we
may be subject to changes in the fair value of our investment
portfolio as a result of changes in interest rates.
Our short-term debt obligations under our revolving credit
facility are subject to interest rate exposure, however as we
had no outstanding balance on this facility as of June 30,
2008, fluctuations in interest rates would not have a material
impact on our interest expense.
Foreign
Currency Exchange Risk
We currently operate in a foreign country, but we do not
transact a material amount of business in a foreign currency and
therefore fluctuations in exchange rates will not have a
material impact on our financial statements. However, we are
pursuing opportunities in international markets. 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.
63
PART II
|
|
ITEM 8.
|
CONSOLIDATED
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
Page
|
|
Report of Independent Registered Public Accounting Firm
|
|
65
|
Consolidated Balance Sheets as of June 30, 2008 and 2007
|
|
66
|
Consolidated Statements of Operations for the years ended
June 30, 2008, 2007 and 2006
|
|
67
|
Consolidated Statements of Redeemable Preferred Stock and
Stockholders Equity (Deficit) for the years ended
June 30, 2008, 2007 and 2006
|
|
68
|
Consolidated Statements of Cash Flows for the years ended
June 30, 2008, 2007 and 2006
|
|
69
|
Notes to Consolidated Financial Statements
|
|
70
|
Schedule II Valuation and Qualifying Accounts
|
|
91
|
64
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, 2008
and 2007 and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders
equity (deficit), and cash flows for each of the three years in
the period ended June 30, 2008. 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, 2008 and
2007, and the results of their operations and their cash flows
for each of the three years in the period ended June 30,
2008, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 3 to the consolidated financial
statements, effective July 1, 2006, the Company adopted
Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment.
Also, in our opinion, the schedules present fairly, in all
material respects, the information set forth therein.
Bethesda, Maryland
September 26, 2008
65
K12
INC.
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands, except per share data)
|
|
|
ASSETS
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
71,682
|
|
|
$
|
1,660
|
|
Accounts receivable, net of allowance of $1,458 and $589 at
June 30, 2008 and June 30, 2007, respectively
|
|
|
30,630
|
|
|
|
15,455
|
|
Inventories, net
|
|
|
20,672
|
|
|
|
13,804
|
|
Current portion of deferred tax asset
|
|
|
8,344
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
3,648
|
|
|
|
1,245
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
134,976
|
|
|
|
32,164
|
|
Property and equipment, net
|
|
|
24,536
|
|
|
|
17,234
|
|
Capitalized curriculum development costs, net
|
|
|
21,366
|
|
|
|
9,671
|
|
Deferred tax asset, net of current portion
|
|
|
12,749
|
|
|
|
|
|
Goodwill
|
|
|
1,754
|
|
|
|
|
|
Other assets, net
|
|
|
1,943
|
|
|
|
2,143
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
197,324
|
|
|
$
|
61,212
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS EQUITY (DEFICIT)
|
Current liabilities
|
|
|
|
|
|
|
|
|
Bank overdraft
|
|
$
|
|
|
|
$
|
1,577
|
|
Line of credit
|
|
|
|
|
|
|
1,500
|
|
Accounts payable
|
|
|
14,388
|
|
|
|
6,928
|
|
Accrued liabilities
|
|
|
4,684
|
|
|
|
1,819
|
|
Accrued compensation and benefits
|
|
|
10,049
|
|
|
|
6,200
|
|
Deferred revenue
|
|
|
3,114
|
|
|
|
2,620
|
|
Current portion of capital lease obligations
|
|
|
6,107
|
|
|
|
2,780
|
|
Current portion of notes payable
|
|
|
413
|
|
|
|
192
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
38,755
|
|
|
|
23,616
|
|
Deferred rent, net of current portion
|
|
|
1,640
|
|
|
|
1,684
|
|
Capital lease obligations, net of current portion
|
|
|
6,445
|
|
|
|
3,974
|
|
Notes payable, net of current portion
|
|
|
196
|
|
|
|
189
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
47,036
|
|
|
|
29,463
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
Redeemable convertible preferred stock
|
|
|
|
|
|
|
|
|
Redeemable Convertible Series C Preferred stock, par value
$0.0001; no shares authorized, issued or outstanding at
June 30, 2008; 10,784,313 shares authorized and
9,776,756 shares issued and outstanding at June 30,
2007; liquidation value of $133,629 at June 30, 2007
|
|
|
|
|
|
|
91,122
|
|
|
|
|
|
|
|
|
|
|
Redeemable Convertible Series B Preferred stock, par value
$0.0001; no shares authorized, issued or outstanding at
June 30, 2008; 14,901,960 shares authorized and
10,102,899 shares issued and outstanding at June 30,
2007; liquidation value of $138,087 at June 30, 2007
|
|
|
|
|
|
|
138,434
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity (deficit)
|
|
|
|
|
|
|
|
|
Common stock, par value $0.0001; 100,000,000 shares
authorized; 27,944,826 and 2,041,604 shares issued and
outstanding at June 30, 2008 and June 30, 2007,
respectively
|
|
|
3
|
|
|
|
1
|
|
Additional paid-in capital
|
|
|
323,621
|
|
|
|
|
|
Accumulated deficit
|
|
|
(173,336
|
)
|
|
|
(197,808
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity (deficit)
|
|
|
150,288
|
|
|
|
(197,807
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities, redeemable convertible preferred stock and
stockholders equity (deficit)
|
|
$
|
197,324
|
|
|
$
|
61,212
|
|
|
|
|
|
|
|
|
|
|
See accompanying summary of accounting policies and notes to
consolidated financial statements.
66
K12
INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands, except per share data)
|
|
|
Revenues
|
|
$
|
226,235
|
|
|
$
|
140,556
|
|
|
$
|
116,902
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
131,282
|
|
|
|
76,064
|
|
|
|
64,828
|
|
Selling, administrative, and other operating expenses
|
|
|
72,393
|
|
|
|
51,159
|
|
|
|
41,660
|
|
Product development expenses
|
|
|
9,550
|
|
|
|
8,611
|
|
|
|
8,568
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
213,225
|
|
|
|
135,834
|
|
|
|
115,056
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
13,010
|
|
|
|
4,722
|
|
|
|
1,846
|
|
Interest expense, net
|
|
|
(295
|
)
|
|
|
(639
|
)
|
|
|
(488
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
12,715
|
|
|
|
4,083
|
|
|
|
1,358
|
|
Income tax benefit (expense)
|
|
|
21,058
|
|
|
|
(218
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
33,773
|
|
|
|
3,865
|
|
|
|
1,358
|
|
Dividends on preferred stock
|
|
|
(3,066
|
)
|
|
|
(6,378
|
)
|
|
|
(5,851
|
)
|
Preferred stock accretion
|
|
|
(12,193
|
)
|
|
|
(22,353
|
)
|
|
|
(18,697
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders
|
|
$
|
18,514
|
|
|
$
|
(24,866
|
)
|
|
$
|
(23,190
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.18
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
1.10
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing per share amounts
(see note 3):
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
15,701,278
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
16,850,909
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying summary of accounting policies and notes to
consolidated financial statements.
67
K12
INC.
CONSOLIDATED
STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable
|
|
|
Redeemable
|
|
|
Stockholders Equity (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
|
|
|
|
(In thousands, except share data)
|
|
|
Balance, June 30, 2005
|
|
|
8,079,961
|
|
|
$
|
64,293
|
|
|
|
10,102,899
|
|
|
$
|
111,984
|
|
|
|
1,976,312
|
|
|
$
|
1
|
|
|
$
|
|
|
|
$
|
(150,300
|
)
|
|
$
|
(150,299
|
)
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22,584
|
|
|
|
|
|
|
|
38
|
|
|
|
|
|
|
|
38
|
|
Accretion of Preferred Stock
|
|
|
|
|
|
|
6,067
|
|
|
|
|
|
|
|
12,630
|
|
|
|
|
|
|
|
|
|
|
|
(38
|
)
|
|
|
(18,659
|
)
|
|
|
(18,697
|
)
|
Series C 10% Stock Dividend
|
|
|
807,998
|
|
|
|
5,851
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,851
|
)
|
|
|
(5,851
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,358
|
|
|
|
1,358
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2006
|
|
|
8,887,959
|
|
|
|
76,211
|
|
|
|
10,102,899
|
|
|
|
124,614
|
|
|
|
1,998,896
|
|
|
|
1
|
|
|
|
|
|
|
|
(173,452
|
)
|
|
|
(173,451
|
)
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42,708
|
|
|
|
|
|
|
|
292
|
|
|
|
|
|
|
|
292
|
|
Stock compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
218
|
|
|
|
|
|
|
|
218
|
|
Accretion of Preferred Stock
|
|
|
|
|
|
|
8,533
|
|
|
|
|
|
|
|
13,820
|
|
|
|
|
|
|
|
|
|
|
|
(510
|
)
|
|
|
(21,843
|
)
|
|
|
(22,353
|
)
|
Series C 10% Stock Dividend
|
|
|
888,797
|
|
|
|
6,378
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,378
|
)
|
|
|
(6,378
|
)
|
Net Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,865
|
|
|
|
3,865
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2007
|
|
|
9,776,756
|
|
|
|
91,122
|
|
|
|
10,102,899
|
|
|
|
138,434
|
|
|
|
2,041,604
|
|
|
|
1
|
|
|
|
|
|
|
|
(197,808
|
)
|
|
|
(197,807
|
)
|
Exercise of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
221,914
|
|
|
|
|
|
|
|
1,510
|
|
|
|
|
|
|
|
1,510
|
|
Stock compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,464
|
|
|
|
|
|
|
|
1,464
|
|
Accretion of Preferred Stock
|
|
|
|
|
|
|
5,164
|
|
|
|
|
|
|
|
7,029
|
|
|
|
|
|
|
|
|
|
|
|
(5,958
|
)
|
|
|
(6,235
|
)
|
|
|
(12,193
|
)
|
Series C 10% Stock Dividend
|
|
|
|
|
|
|
1,671
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,671
|
)
|
|
|
(1,671
|
)
|
Issuance of stock related to acquisition of Power-Glide
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
186,266
|
|
|
|
|
|
|
|
2,660
|
|
|
|
|
|
|
|
2,660
|
|
Conversion of Preferred Stock
|
|
|
(9,776,756
|
)
|
|
|
(97,957
|
)
|
|
|
(10,102,899
|
)
|
|
|
(145,463
|
)
|
|
|
19,879,675
|
|
|
|
2
|
|
|
|
238,406
|
|
|
|
5,011
|
|
|
|
243,419
|
|
Purchase of common stock Reg S transaction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
833,333
|
|
|
|
|
|
|
|
15,000
|
|
|
|
|
|
|
|
15,000
|
|
Initial public offering, net of transaction costs and expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,450,000
|
|
|
|
|
|
|
|
70,539
|
|
|
|
|
|
|
|
70,539
|
|
Payment of Series C cash dividend
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,406
|
)
|
|
|
(6,406
|
)
|
Exercise of stock warrants on cashless provision
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
332,034
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33,773
|
|
|
|
33,773
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2008
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
|
|
27,944,826
|
|
|
$
|
3
|
|
|
$
|
323,621
|
|
|
$
|
(173,336
|
)
|
|
$
|
150,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying summary of accounting policies and notes to
consolidated financial statements.
68
K12
INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
33,773
|
|
|
$
|
3,865
|
|
|
$
|
1,358
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense
|
|
|
12,568
|
|
|
|
7,404
|
|
|
|
4,986
|
|
Stock based compensation expense
|
|
|
1,464
|
|
|
|
218
|
|
|
|
|
|
Deferred income taxes
|
|
|
(21,093
|
)
|
|
|
|
|
|
|
|
|
Provision for (reduction of) doubtful accounts
|
|
|
867
|
|
|
|
(852
|
)
|
|
|
(275
|
)
|
Provision for (reduction of) inventory obsolescence
|
|
|
407
|
|
|
|
95
|
|
|
|
(39
|
)
|
Provision for (reduction of) student computer shrinkage and
obsolescence
|
|
|
162
|
|
|
|
(48
|
)
|
|
|
174
|
|
Impairment of capitalized curriculum development cost
|
|
|
|
|
|
|
|
|
|
|
362
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(15,322
|
)
|
|
|
(3,154
|
)
|
|
|
(2,718
|
)
|
Inventories
|
|
|
(7,275
|
)
|
|
|
(2,790
|
)
|
|
|
(5,359
|
)
|
Prepaid expenses and other current assets
|
|
|
(2,403
|
)
|
|
|
(763
|
)
|
|
|
100
|
|
Other assets
|
|
|
97
|
|
|
|
(255
|
)
|
|
|
(258
|
)
|
Deposits and other assets
|
|
|
(154
|
)
|
|
|
(322
|
)
|
|
|
(268
|
)
|
Accounts payable
|
|
|
7,375
|
|
|
|
579
|
|
|
|
1,559
|
|
Accrued liabilities
|
|
|
1,557
|
|
|
|
(824
|
)
|
|
|
122
|
|
Accrued compensation and benefits
|
|
|
3,828
|
|
|
|
1,100
|
|
|
|
1,782
|
|
Deferred revenue
|
|
|
(273
|
)
|
|
|
1,224
|
|
|
|
501
|
|
Deferred rent
|
|
|
(44
|
)
|
|
|
86
|
|
|
|
1,598
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
15,534
|
|
|
|
5,563
|
|
|
|
3,625
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(6,476
|
)
|
|
|
(5,366
|
)
|
|
|
(10,842
|
)
|
Purchase of domain name
|
|
|
(250
|
)
|
|
|
|
|
|
|
|
|
Acquisition of Power-Glide
|
|
|
(119
|
)
|
|
|
|
|
|
|
|
|
Capitalized curriculum development costs
|
|
|
(11,669
|
)
|
|
|
(8,683
|
)
|
|
|
(655
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(18,514
|
)
|
|
|
(14,049
|
)
|
|
|
(11,497
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash received from issuance of common stock, net of underwriters
commission
|
|
|
74,493
|
|
|
|
|
|
|
|
|
|
Cash received from issuance of common stock
Regulation S transaction
|
|
|
15,000
|
|
|
|
|
|
|
|
|
|
Deferred initial public offering costs
|
|
|
(3,954
|
)
|
|
|
|
|
|
|
|
|
Net borrowings from (repayments on) revolving credit facility
|
|
|
(1,500
|
)
|
|
|
1,500
|
|
|
|
|
|
Repayments on notes payable related party
|
|
|
|
|
|
|
(4,025
|
)
|
|
|
|
|
Repayments on capital lease obligations
|
|
|
(4,767
|
)
|
|
|
(1,384
|
)
|
|
|
(441
|
)
|
Payments on notes payable
|
|
|
(180
|
)
|
|
|
(62
|
)
|
|
|
|
|
Proceeds from notes payable
|
|
|
408
|
|
|
|
441
|
|
|
|
|
|
Proceeds from exercise of stock options
|
|
|
1,485
|
|
|
|
292
|
|
|
|
38
|
|
Payment of cash dividend Preferred Stock
|
|
|
(6,406
|
)
|
|
|
|
|
|
|
|
|
Bank overdraft
|
|
|
(1,577
|
)
|
|
|
1,577
|
|
|
|
|
|
Cash invested in restricted escrow account
|
|
|
|
|
|
|
2,332
|
|
|
|
(2,203
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
73,002
|
|
|
|
671
|
|
|
|
(2,606
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
70,022
|
|
|
|
(7,815
|
)
|
|
|
(10,478
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
, beginning of year
|
|
|
1,660
|
|
|
|
9,475
|
|
|
|
19,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
, end of year
|
|
$
|
71,682
|
|
|
$
|
1,660
|
|
|
$
|
9,475
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying summary of accounting policies and notes to
consolidated financial statements.
69
K12
Inc.
|
|
1.
|
Description
of the Business
|
K12 Inc. and its subsidiaries (K12 or the Company) sell online
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. In
contracting with a virtual public school, the Company typically
provides students with access to the K12 on-line curriculum,
offline learning kits, and use of a personal computer. As of
June 30, 2008, the Company served schools in 17 states
and the District of Columbia, providing curriculum for grades
kindergarten through twelfth. The Company expanded into four new
states for fiscal year 2009: Hawaii, Indiana, Oregon, and South
Carolina. In addition, the Company sells access to its on-line
curriculum and offline learning kits directly to individual
consumers.
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.
|
|
3.
|
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. On an ongoing basis, we evaluate
our estimates and assumptions, including those related to
allowance for doubtful accounts, inventory reserves,
amortization periods, the allocation of purchase price to the
fair value of net assets and liabilities acquired in connection
with business combinations, fair values used in asset impairment
evaluations, valuation of long-lived assets, contingencies,
income taxes and stock-based compensation expense. We base our
estimates on historical experience and on various other
assumptions that we believe are 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 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, 2008, 2007 and 2006 were $62.2 million,
$38.3 million and $35.6 million, respectively. For
contracts in which the Company is not the primary obligor, the
Company records revenue based on its net fees earned per the
contractual agreement.
The Company generates revenues under contracts with public
virtual schools which include multiple elements. These elements
include providing each of a schools students with access
to the Companys on-line
70
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
school and the on-line component of lessons; offline learning
kits which include books and materials designed to complement
and supplement the on-line lessons; the use of a personal
computer and associated reclamation services; internet access
and technology support services; the services of a
state-certified teacher and; all management and technology
services required to operate a public virtual school.
We have determined that the elements of our contracts are
valuable to schools in combination, but do not have standalone
value. In addition, we have determined that we do not have
objective and reliable evidence of fair value for each element
of our contracts. As a result, the elements within our
multiple-element contracts do not qualify for treatment as
separate units of accounting. Accordingly, we account for
revenues received under multiple element arrangements as a
single unit of accounting and recognize the entire arrangement
based upon the approximate rate at which we incur the costs
associated with each element.
Under the contracts with the schools where the Company provides
turnkey management services, the Company has generally agreed to
absorb any operating deficits of the schools in a given school
year. These operating deficits represent the excess of costs
over revenues incurred by the virtual public schools as
reflected on their financial statements. The costs include
Company charges to the schools. These operating deficits may
impair the Companys ability to collect invoices in full.
Accordingly, the Companys amount of recognized revenue
reflects this impairment. For the years ended June 30,
2008, 2007 and 2006, the Companys revenue reflected
impairment from these operating deficits of $9.1 million,
$13.7 million and $7.0 million, respectively. Included
in these deficits is a reserve for the potential impact of
certain disallowed enrollments stemming from regulatory audits
in Colorado totaling $0.9 million in 2006 and
$1.0 million in 2007, and California totaling
$1.0 million in 2007 and $1.0 million in 2008.
Other revenues are generated from individual customers who
prepay and have access for 12 or 24 months to curriculum
via the Companys Web site. The Company recognizes these
revenues pro rata over the maximum term of the customer
contract, which is either 12 or 24 months. Revenues from
associated offline learning kits are recognized upon shipment.
During the years ended June 30, 2008, 2007 and 2006,
approximately 97%, 97% and 94%, respectively, of the
Companys revenues were recognized from virtual public
schools. In fiscal year 2008, we had contracts with two schools
that individually represented 14% and 12% of revenues. In fiscal
year 2007, we had contracts with four schools that individually
represented 16%, 11%, 11% and 11% of revenues. In fiscal year
2006, we had contracts with three schools that individually
represented 28%, 16% and 10% of revenues.
Shipping
and handling costs
Shipping and handling costs are expensed when incurred and are
classified as cost of goods sold in the accompanying
consolidated statements of operations. Shipping and handling
charges are invoiced to the customer and are included in gross
revenues.
Research
and Development Costs
All research and development costs are expensed as incurred
including patent application costs 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.
71
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
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 $1.5 million and
$0.6 million as of June 30, 2008 and 2007,
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. Excess and obsolete inventory
reserves are established based upon the evaluation of the
quantity on hand relative to demand. The excess and obsolete
inventory reserve at June 30, 2008 and 2007 was
$0.7 million and $0.3 million, respectively.
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. Other assets also include intangible assets,
net of amortization, of $0.1 million and $0 at
June 30, 2008 and 2007, respectively and deposits and other
assets of $0.7 million and $1.0 million at
June 30, 2008 and 2007, respectively.
Property
and Equipment
Property and equipment, which includes capitalized software and
web site 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
|
|
|
3 years
|
|
Capitalized software and web site 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.
72
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
Capitalized
Software and Web Site Development Costs
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 $5.5 million,
$3.1 million and $1.4 million for the years ended
June 30, 2008 and 2007 and 2006, respectively. These
amounts are recorded on the accompanying consolidated balance
sheet as part of property and equipment, net of amortization and
impairment charges. The estimated aggregate amortization expense
for each of the three succeeding years ending June 30,
2009, 2010 and 2011 is $1.1 million, $0.6 million and
$0.1 million, respectively.
The Company accounts for web site development costs in
accordance with Emerging Issues Task Force Issue
No. 00-2
(EITF 00-2)
, Accounting for Web Site Development Costs
. Total
capitalized web site development costs incurred for the years
ended June 30, 2008 and 2007 were $0.3 million and
$0.4 million, respectively. For the year ended
June 30, 2006 all web site development costs occurred in
the operating stage and were expensed as incurred. These amounts
are recorded on the accompanying consolidated balance sheet as
part of property and equipment, net of amortization and
impairment charges. The estimated aggregate amortization expense
for each of the three succeeding years ending June 30,
2009, 2010 and 2011 is $0.2 million, $0.2 million and
$0.1 million, respectively.
Capitalized
Curriculum Development Costs
The Company internally develops curriculum, which is primarily
provided as web content and accessed via the Internet. The
Company also creates textbooks and other offline materials.
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 and
payroll-related 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. Included in capitalized
curriculum development is the November 2007 purchase of a
perpetual license of curriculum for $3 million of which
$2.8 million was paid in cash and $0.2 million is
included in accrued liabilities on the accompanying consolidated
balance sheet. The balance due under the agreement is expected
to be paid within the next twelve months as certain milestones
within the agreement are met. The agreement includes a provision
for future royalty payments. The curriculum will be included as
part of our high school offering and will be amortized over five
years.
Total capitalized curriculum development costs incurred were
$11.7 million, $8.7 million and $0.7 million for
the years ended June 30, 2008, 2007 and 2006, respectively.
These amounts are recorded on the accompanying consolidated
balance sheet, net of amortization and impairment charges.
Amortization and impairment charges are recorded in product
development expenses on the accompanying consolidated statement
of operations. The
73
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
estimated aggregate amortization expense for each of the five
succeeding years ending June 30, 2009, 2010, 2011, 2012 and
2013 is $2.8 million, $2.7 million, $2.3 million,
$1.9 million and $0.4 million, respectively.
Goodwill
and Other Intangibles
We record as goodwill the excess of purchase price over the fair
value of the identifiable net assets acquired. The determination
of fair value of the identifiable net assets acquired was
determined by management utilizing various valuation
methodologies.
Intangible assets subject to amortization include the trade
name, domain name and non-compete agreements. Such intangible
assets are amortized on a straight-line basis over their
estimated useful lives, which are considered to be no more than
two years.
Statements of Financial Accounting Standards (SFAS )
No. 142,
Goodwill and Other Intangible Assets
,
prescribes a two-step process for impairment testing of goodwill
and intangibles with indefinite lives, which is performed
annually, as well as when an event triggering impairment may
have occurred. The first step tests for impairment, while the
second step, if necessary, measures the impairment. Goodwill and
intangible assets deemed to have an indefinite life are tested
for impairment on an annual basis, or earlier when events or
changes in circumstances suggest the carrying amount may not be
fully recoverable. The Company has elected to perform its annual
assessment on May 31st. For the year ended June 30,
2008, no impairment to goodwill was recorded.
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 for
the year ended June 30, 2006. There was no impairment for
the years ended June 30, 2008 and 2007.
Income
Taxes
The Company accounts for income taxes in accordance with
SFAS No. 109,
Accounting for Income Taxes.
Under SFAS No. 109, deferred tax assets and
liabilities are computed based on the difference between the
financial reporting and income tax bases of assets and
liabilities using the enacted marginal tax rate.
SFAS No. 109 requires that the net deferred tax asset
be reduced by a valuation allowance if, based on the weight of
available evidence, it is more likely than not that some portion
or all of the net deferred tax asset will not be realized.
The Company adopted the provisions of FASB Interpretation
No. 48 (FIN 48),
Accounting for Uncertainty
in Income Taxes
effective July 1, 2007.
FIN 48 provides a comprehensive model for how a company
should recognize, measure, present and disclose in its financial
statements uncertain tax positions that the company has taken or
expects to take on a tax return. The Company recognizes interest
and penalties, if any, related to unrecognized tax benefits in
income tax expense. The Company did not have any unrecognized
tax benefits and there was no effect on its financial condition
or results of operations as a result of implementing FIN 48.
74
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
The Company or one of its subsidiaries files income tax returns
in the U.S. federal and various states jurisdictions. For
income tax returns filed by the Company, the Company is no
longer subject to U.S. federal, state and local income tax
examinations by tax authorities for years before 2002, although
carryforward tax attributes that were generated prior to
2002 may still be adjusted upon examination by tax
authorities if they either have been or will be utilized. The
Company does not believe there will be any material changes in
its unrecognized tax positions over the next twelve months.
Sales
Taxes
The Company reports sales taxes collected from clients and
remitted to governmental authorities on a net basis. Sales tax
collected from customers is excluded from revenues. Collected
but unremitted sales tax is included as part of accrued expenses
in the accompanying consolidated balance sheets. Revenues do not
include sales tax as the Company considers itself a pass-through
conduit for collecting and remitting sales tax.
Stock-Based
Compensation
The Company adopted SFAS No. 123(R),
Share-Based
Payment (Revised 2004)
, as of July 1, 2006, which
replaces SFAS No. 123,
Accounting for Stock-Based
Compensation,
and supersedes Accounting Principles Board
Opinion No. 25 (APB No. 25),
Accounting for Stock
Issued to Employees
. The Company adopted SFAS 123(R)
using the prospective application method.
SFAS No. 123(R) eliminates the intrinsic value method
that was previously used by the Company as an alternative method
of accounting for stock-based compensation.
SFAS No. 123(R) requires an entity to recognize the
grant date fair value of stock options and other equity-based
compensation issued to employees in the consolidated statement
of operations. The Company applied SFAS 123(R) to all new
awards granted after July 1, 2006.
Advertising
and Marketing Expenses
Advertising and marketing costs consist primarily of print media
and brochures and are expensed when incurred. The advertising
and marketing expenses recorded were $8.4 million,
$5.2 million and $2.9 million during the years ended
June 30, 2008, 2007 and 2006, respectively.
Net
Income (Loss) Per Common Share
The Company calculates net income (loss) per share in accordance
with SFAS No. 128,
Earnings Per Share
. Under
SFAS No. 128, basic net income (loss) per common share
is calculated by dividing net income (loss) by the
weighted-average number of common shares outstanding during the
reporting period. Diluted net income (loss) per common share
includes the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or
converted into common stock. The potentially dilutive securities
consist of convertible preferred stock, stock options and
warrants.
Basic earnings per share is computed by dividing net income
available to common stockholders by the weighted average number
of shares of common stock outstanding during the period. Diluted
earnings per share reflects the potential dilution that could
occur assuming conversion or exercise of all dilutive
unexercised stock options and warrants. The dilutive effect of
stock options was determined using the treasury stock method.
Under the treasury stock method, the proceeds received from the
exercise of stock options, the amount of compensation cost for
future service not yet recognized by the Company, and the amount
of tax benefits that would be recorded in additional paid-in
capital when the stock options become deductible for income tax
purposes are all assumed to be used to repurchase shares of the
Companys common stock. Stock options are not included in
the computation of diluted earnings per share when they are
antidilutive.
75
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
The following schedule presents the calculation of basic and
diluted net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands except per shares and
|
|
|
|
per share data)
|
|
|
Net income (loss) available to common shareholders
basic and diluted
|
|
$
|
18,514
|
|
|
$
|
(24,866
|
)
|
|
$
|
(23,190
|
)
|
Weighted average common shares outstanding basic
|
|
|
15,701,278
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
Weighted average common shares outstanding diluted
|
|
|
16,850,909
|
|
|
|
2,001,661
|
|
|
|
1,977,195
|
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.18
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
Diluted
|
|
$
|
1.10
|
|
|
$
|
(12.42
|
)
|
|
$
|
(11.73
|
)
|
The basic and diluted weighted average common shares outstanding
for the year ended June 30, 2008 reflect the weighted
average effect of the conversion of preferred stock to common
stock upon the closing of the initial public offering on
December 18, 2007. The number of shares of common stock
outstanding at June 30, 2008 is 27,944,826.
As of June 30, 2008, 2007 and 2006, the shares of common
stock issuable in connection with convertible preferred stock,
stock options, and warrants of 378,300, 23,260,070 and
21,105,437, respectively, were not included in the diluted loss
per common share calculation since their effect was
anti-dilutive.
Recent
Accounting Pronouncements
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. On February 12,
2008, the FASB issued Staff Position
No. SFAS 157-2,
Effective Date of FASB Statement No. 157
, which
delayed the effective date of SFAS 157 for non-financial
assets and liabilities to fiscal years beginning after
November 15, 2008. We have not yet assessed the impact of
adopting SFAS 157.
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 the
provisions of this statement will have a material effect on its
financial statements.
In December 2007, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 141R (revised 2007),
Business Combinations
, which replaces SFAS No 141.
The statement retains the purchase method of accounting for
acquisitions, but requires a number of changes, including
changes in the way assets and liabilities are recognized in the
purchase accounting. It also changes the recognition of assets
acquired and liabilities assumed arising from contingencies,
requires the capitalization of in-process research and
development at fair value, and requires the expensing of
acquisition-related costs as incurred. SFAS No. 141R
is effective for the Company beginning July 1, 2009 and
will apply prospectively to business combinations completed on
or after that date.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB 51
, which changes the
accounting and reporting for minority interests. Minority
76
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
interests will be recharacterized as noncontrolling interests
and will be reported as a component of equity separate from the
parents equity, and purchases or sales of equity interests
that do not result in a change in control will be accounted for
as equity transactions. In addition, net income attributable to
the noncontrolling interest will be included in consolidated net
income on the face of the income statement and, upon a loss of
control, the interest sold, as well as any interest retained,
will be recorded at fair value with any gain or loss recognized
in earnings. SFAS No. 160 is effective for the Company
beginning July 1, 2009 and will apply prospectively, except
for the presentation and disclosure requirements, which will
apply retrospectively. The Company is in the process of
evaluating the potential impact that adoption of
SFAS No. 160 would have on its consolidated financial
statements.
In March 2008, FASB issued SFAS No. 161,
Disclosures About Instruments and Hedging
Activities
amendment of FASB Statement
No. 133 (SFAS No. 161). SFAS No. 161
changes the disclosure requirements for derivative instruments
and hedging activities. SFAS No. 161 is effective for
financial statements issued for fiscal years beginning after
November 15, 2008. As SFAS No. 161 relates only
to disclosure, the Company anticipates that the adoption of
SFAS No. 161 will not have a material effect on its
consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162,
The
Hierarchy of Generally Accepted Accounting Principles
(SFAS 162). SFAS 162 identifies the
sources of accounting principles and the framework for selecting
the principles used in the preparation of financial statements
of nongovernmental entities that are presented in conformity
with generally accepted accounting principles in the United
States. SFAS shall be effective 60 days following the
SECs approval of the Public Company Accounting Oversight
Board amendments to AU Section 411,
The Meaning of
Present Fairly in Conformity with General Accepted Accounting
Principles.
The Company has not yet assessed the impact of
adopting SFAS 162.
|
|
4.
|
Property
and Equipment
|
Property and equipment consists of the following at:
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Student computers
|
|
$
|
30,126
|
|
|
$
|
20,208
|
|
Capitalized software and web site development costs
|
|
|
10,648
|
|
|
|
4,905
|
|
Computer hardware
|
|
|
6,738
|
|
|
|
5,811
|
|
Computer software
|
|
|
4,051
|
|
|
|
3,390
|
|
Leasehold improvements
|
|
|
2,467
|
|
|
|
2,270
|
|
Office equipment
|
|
|
899
|
|
|
|
784
|
|
Furniture and fixtures
|
|
|
896
|
|
|
|
809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
55,825
|
|
|
|
38,177
|
|
Less accumulated depreciation and amortization
|
|
|
(31,289
|
)
|
|
|
(20,943
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24,536
|
|
|
$
|
17,234
|
|
|
|
|
|
|
|
|
|
|
The Company recorded depreciation expense related to property
and equipment reflected in selling, administrative and other
operating expenses of $2.6 million, $1.9 million and
$1.1 million during the years ended June 30, 2008,
2007 and 2006, respectively. Depreciation expense of
$9.2 million, $5.1 million and $3.5 million
related primarily to computers leased to students and
amortization of capitalized curriculum development reflected in
instructional costs and services was recorded during the years
ended June 30, 2008, 2007 and 2006, respectively.
Amortization expense of $0.8 million, $0.4 million and
$0.1 million related to capitalized software development
reflected in product development expenses was recorded during
the years ended June 30, 2008, 2007 and 2006, respectively.
77
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
In the course of its normal operations, the Company incurs
maintenance and repair expenses. Those are expensed as incurred
and amounted to $0.5 million, $0.4 million and
$0.2 million for the years ended June 30, 2008, 2007
and 2006, respectively.
The provision for income taxes is based on earnings reported in
the consolidated financial statements. A deferred income
tax asset or liability is determined by applying currently
enacted tax laws and rates to the expected reversal of the
cumulative temporary differences between the carrying value of
assets and liabilities for financial statement and income tax
purposes. Deferred income tax expense or benefit is measured by
the change in the deferred income tax asset or liability during
the year.
Deferred tax assets and liabilities result primarily from
temporary differences in book versus tax basis accounting.
Deferred tax assets and liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforward
|
|
$
|
25,481
|
|
|
$
|
25,376
|
|
Capitalized curriculum development
|
|
|
|
|
|
|
4,202
|
|
Reserves
|
|
|
1,977
|
|
|
|
613
|
|
Property and equipment
|
|
|
837
|
|
|
|
491
|
|
Stock compensation expense
|
|
|
656
|
|
|
|
87
|
|
Accrued expenses
|
|
|
609
|
|
|
|
486
|
|
Deferred rent
|
|
|
231
|
|
|
|
180
|
|
Deferred revenue
|
|
|
144
|
|
|
|
|
|
Charitable contributions carryforward
|
|
|
128
|
|
|
|
131
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
30,063
|
|
|
|
31,566
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Capitalized curriculum development
|
|
|
(4,747
|
)
|
|
|
|
|
Capitalized software and website development costs
|
|
|
(3,160
|
)
|
|
|
(1,378
|
)
|
Other assets
|
|
|
(452
|
)
|
|
|
(262
|
)
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(8,359
|
)
|
|
|
(1,640
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset
|
|
|
21,704
|
|
|
|
29,926
|
|
Valuation allowance
|
|
|
(611
|
)
|
|
|
(29,926
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
21,093
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Company analyzed the positive and negative evidence to
determine if it is more likely than not that some portion or all
of the deferred tax assets will not be realized. Based on the
weight of the evidence which includes a recent history of
positive pre-tax income, the Company concluded that all federal
deferred tax assets will be realized. Accordingly, the Company
determined that it is appropriate to reduce the deferred tax
asset valuation allowance by approximately $29.3 million as
of June 30, 2008. The net change in total valuation
allowance for the year ended June 30, 2007 was a decrease
of $2.6 million. The Company maintains a valuation
allowance on net deferred tax assets of $0.6 million as of
June 30, 2008 related to state income taxes as the Company
believes it is more likely than not that we will not be able to
utilize these deferred tax assets. At June 30, 2008, the
Company has available federal net operating loss carryforwards
of $70.8 million that expire between 2020 and 2028 if
unused.
78
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
During 2008, the Company changed its tax treatment of certain
capitalized costs which resulted in an increase in its net
operating loss carryforwards.
The Company has evaluated whether 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. As a
result of this study, the Company has concluded it is more
likely than not that the Company will be able to fully utilize
its net operating losses subject to the Section 382
limitation.
The related components of the income tax (benefit) expense for
the years ended June 30, 2008, 2007 and 2006 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
State and other
|
|
$
|
35
|
|
|
$
|
218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current
|
|
|
35
|
|
|
|
218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(20,081
|
)
|
|
|
|
|
|
|
|
|
State and other
|
|
|
(1,012
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred
|
|
|
(21,093
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax (benefit) expense
|
|
$
|
(21,058
|
)
|
|
$
|
218
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
U.S. federal tax at statutory rates
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
Permanent items
|
|
|
7.78
|
|
|
|
20.22
|
|
|
|
55.77
|
|
State taxes, net of federal benefit
|
|
|
3.61
|
|
|
|
13.65
|
|
|
|
12.98
|
|
Change in valuation allowance
|
|
|
(212.18
|
)
|
|
|
(63.56
|
)
|
|
|
(103.75
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
(165.79
|
)%
|
|
|
5.31
|
%
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.
|
Lease
Commitments and Notes Payable
|
Capital
leases
As of June 30, 2008, computer equipment and software under
capital leases are recorded at a cost of $18.6 million and
accumulated depreciation of $7.1 million. The Company has
an equipment lease line of credit with Hewlett-Packard Financial
Services Company that expires on April 30, 2009 for new
purchases on the line of credit. The interest rate on new
advances under the equipment lease line is set quarterly. Prior
borrowings under the equipment lease line had interest rates
ranging from 7.0% to 8.83%. 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.
79
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
Notes
payable
The Company has purchased computer software licenses and
maintenance services through notes payable arrangements with
various vendors at interest rates ranging up to 11.4% and
payment terms ranging from eighteen months to three years.
The following is a summary as of June 30, 2008 of the
present value of the net minimum lease payments on capital
leases and notes payable under the Companys commitments:
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
2009
|
|
$
|
7,351
|
|
2010
|
|
|
5,514
|
|
2011
|
|
|
1,491
|
|
|
|
|
|
|
Total minimum lease payments
|
|
|
14,356
|
|
Less amount representing interest (imputed interest rate of 8.6)%
|
|
|
(1,195
|
)
|
|
|
|
|
|
Net minimum lease payments
|
|
|
13,161
|
|
Less current portion
|
|
|
(6,520
|
)
|
|
|
|
|
|
Present value of net minimum payments, less current portion
|
|
$
|
6,641
|
|
|
|
|
|
|
Operating
leases
The Company has fixed non-cancelable operating leases with terms
expiring through 2018. Office leases generally contain renewal
options and certain leases provide for scheduled rate increases
over the lease terms.
In December 2005, the Company entered into an operating lease
for non-owned facilities commencing in May 2006. The term
of the lease is seven years with the option to extend the lease
for two five year periods. In accordance with the lease terms,
the Company delivered to the landlord an unconditional and
irrevocable letter of credit in the amount of $2.1 million
for a term ending 90 days after the expiration of the
lease. The letter of credit can be reduced up to 25% on the
first day of each of the fourth, fifth and sixth years if
certain covenants are met. Additionally, in December 2005, the
Company entered into an operating sublease for non-owned
facilities commencing in January 2006. The term of the sublease
is through September 2009. In accordance with the lease terms,
the Company delivered to the sublandlord an unconditional and
irrevocable letter of credit in the amount of $0.2 million
for a term ending 60 days after the expiration of the
lease. In November 2006, the Company entered into an operating
lease for non-owned facilities commencing in January 2007. The
term of the lease is through April 2018 with the option to
extend for one additional five year term. In July 2008, the
Company entered into an operating sublease for non-owned
facilities commencing in August 2008. The term of the lease is
through July 2010. Rent expense was $2.5 million,
$2.1 million and $1.8 million for the years ended
June 30, 2008, 2007 and 2006, respectively.
80
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
Future minimum lease payments under noncancelable operating
leases with initial terms of one year or more as follows:
|
|
|
|
|
|
|
Year Ended
|
|
|
|
June 30,
|
|
|
2009
|
|
$
|
2,929
|
|
2010
|
|
|
2,250
|
|
2011
|
|
|
1,854
|
|
2012
|
|
|
1,847
|
|
2013
|
|
|
1,740
|
|
Thereafter
|
|
|
7,255
|
|
|
|
|
|
|
Total future minimum lease payments
|
|
$
|
17,875
|
|
|
|
|
|
|
In December 2006, the Company entered into a $15 million
revolving credit agreement with PNC Bank (the Credit
Agreement). Pursuant to the terms of the Credit Agreement,
the proceeds of the term loan facility were to be used primarily
for working capital requirements and other general business or
corporate purposes. Because of the seasonality of our business
and timing of funds received from the state, expenditures are
higher in relation to funds received in certain periods during
the year. The Credit Agreement provides the ability to fund
these periods until cash is received from the schools;
therefore, borrowings against the Credit Agreement are primarily
going to be short term.
Borrowings under the Credit Agreement bear interest based upon
the term of the borrowings. Interest is charged, at either:
(i) the higher of (a) the rate of interest announced
by PNC Bank from time to time as its prime rate and
(b) the federal funds rate plus 0.5% or (ii) the
applicable London interbank offered rate divided by a number
equal to 1.00 minus the maximum aggregate reserve requirement
which is imposed on member banks of the Federal Reserve System
against eurocurrency liabilities as defined in
Regulation D as promulgated by the Board of Governors of
the Federal Reserve System, plus the applicable margin for such
loans, which ranges between 1.250% and 1.750%, based on the
leverage ratio (as defined in the Credit Agreement).
The Company pays a commitment fee on the unused portion of the
Credit Agreement, quarterly in arrears, during the term of the
credit agreement which varies between 0.150% and 0.250%
depending on the leverage ratio. The commitment fees incurred
for the year ended June 30, 2008 were minimal.
The working capital line includes a $5.0 million letter of
credit facility. Issuances of letters of credit reduce the
availability of permitted borrowings under the Credit Agreement.
Borrowings under the Credit Agreement are secured by
substantially all of our assets of the Company. The Credit
Agreement contains a number of financial and other covenants
that, among other things, restrict our and our
subsidiaries abilities to incur additional indebtedness,
grant liens or other security interests, make certain
investments, become liable for contingent liabilities, make
specified restricted payments including dividends, dispose of
assets or stock, including the stock of its subsidiaries, or
make capital expenditures above specified limits and engage in
other matters customarily restricted in senior secured credit
facilities. We must also maintain a minimum net worth (as
defined in the Credit Agreement) and maximum debt leverage
ratios. These covenants are subject to certain qualifications
and exceptions. As of June 30, 2008, the Company was in
compliance with all covenants.
In October 2007, the Company increased the Credit Agreement from
$15 million to $20 million under substantially the
same terms. As of June 30, 2008, there was no outstanding
balance on the working capital line of credit and approximately
$2.3 million was outstanding under the letter of credit
facility with an interest rate of 1.25%.
81
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
Warrants for common stock are outstanding at June 30, 2008
consist of 21,299 warrants to purchase an equivalent number of
common stock at a price of $8.16 per share that expire in March
2010. These warrants were issued in March 2003 in conjunction
with promissory notes issued by the Company for funds borrowed
from existing shareholders. In March 2008, certain shareholders
exercised stock purchase warrants with a strike price of $6.83
per share for an aggregate net issuance of 332,034 shares
of common stock. These previously disclosed warrants were
exercised on a cashless basis, as provided for under the terms
of the warrant agreement. The warrants were set to expire in
April 2008. For the years ended June 30, 2007 and 2006
there were no warrants issued or exercised.
Reverse
Stock Split
On October 30, 2007, the Board approved a
1-for-5.1
reverse split of the Companys common stock. On
October 31, 2007, the reverse split was further approved by
a majority of the shareholders. The stock split was effective on
November 2, 2007. In conjunction with these actions, the
number of authorized shares of common stock was adjusted to
33,362,500. All share and per share amounts related to common
stock, options and common stock warrants included in the
consolidated financial statements have been retroactively
adjusted for all periods presented to give effect to the stock
split.
Amended
and Restated Certificate of Incorporation
On October 30, 2007, the Board approved an amendment and
restatement of the Companys Second Amended and Restated
Certificate of Incorporation, which was adopted by the majority
of the shareholders of the Company on October 31, 2007 (the
Third Amended and Restated Certificate of
Incorporation or Certificate). The Certificate
authorizes the Company to issue 100,000,000 shares of
Common Stock and 10,000,000 shares of Preferred Stock. The
Certificate became effective on December 18, 2007, upon its
filing with the Secretary of State of the State of Delaware.
This Certificate superseded the Companys previous
Certificate of Incorporation. The Redeemable Convertible
Series B and Series C Preferred Stock are no longer
authorized effective December 18, 2007.
Series C
Dividend
On November 5, 2007, the Companys Board unanimously
declared a cash dividend to the holders of Redeemable
Convertible Series C Preferred stock effective immediately
prior to and contingent upon the closing of an Initial Public
Offering (the IPO) and payable from the proceeds of
the offering.
Concurrently with the closing of the IPO, the holders of
Redeemable Convertible Series C Preferred stock were paid a
cash dividend of $6.4 million. The amount of the declared
dividend was equal to the pro rata amount of the annual ten
percent cumulative dividend that would have normally accrued on
January 2, 2008 under the provisions of the preferred stock
agreement.
Prior to declaration of the cash dividend, the Company accrued
$5.0 million toward the annual cumulative dividend which
was reversed in the recording of the cash dividend.
On November 16, 2007, PNC Bank consented to waive the
restriction of dividends in its credit agreement with the
Company for the purposes of this dividend. The PNC agreement
amended certain other covenants.
Private
Placement of Shares
On November 6, 2007, the Company entered into an agreement
to sell to a
non-U.S. person
in a transaction outside the United States in reliance upon
Regulation S under the Securities Act of 1933, as amended
(Securities Act), concurrently with and contingent upon the
closing of the IPO and at the IPO price, $15,000,000 worth of
82
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
shares of the Companys common stock. On December 18,
2007, the Company closed on its initial public offering and
issued 833,333 shares to this investor at the offering
price of $18.00 per share.
Initial
Public Offering
In December 2007, the Company completed the IPO of its common
stock in which it sold and issued 4,450,000 shares of its
common stock, at an issue price of $18.00 per share. The Company
raised a total of $80.1 million in gross proceeds from the
IPO, or approximately $71.0 million in net proceeds after
deducting underwriting discounts and commissions of
$5.6 million and other offering costs of $3.5 million.
Upon the closing of the IPO, all shares of convertible preferred
stock outstanding automatically converted into an aggregate of
19,879,675 shares of common stock.
The Company adopted a Stock Option Plan (the Plan) in May 2000.
Under the Plan, employees, outside directors and independent
contractors are able to participate in the Companys future
performance through the awards of nonqualified stock options to
purchase common stock. In December 2003, the Board increased the
total number of common stock shares reserved and available for
grant and issuance pursuant to the Plan to
2,549,019 shares. In November 2007, the Board adopted the
2007 Plan increasing the number of common stock shares reserved
to 4,213,921 shares plus the increases in the shares
pursuant to the evergreen provision that may be
issued under the 2007 Plan over the course of its ten-year term.
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. No stock option shall
be exercisable after the expiration of its option term. The
Company has granted stock options under the 2007 Plan. The
Company also grants stock options to executive officers under
stand-alone agreements outside the Plan. These options totaled
1,441,168 as of June 30, 2008.
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 July 1,
2006. 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 option pricing model method
to calculate the fair value of stock options. Depending on
certain substantive characteristics of the stock option, the
Company, where appropriate, utilizes a binomial model. The use
of option valuation models requires the input of highly
subjective assumptions, including the expected stock price
volatility and the expected term of the option. In March 2005,
the Securities and Exchange Commission (SEC) issued
SAB No. 107 (SAB 107) regarding the
SECs interpretation of SFAS 123R and the valuation of
share-based payments for public companies. For options issued
subsequent to July 1, 2006, the Company has applied the
provisions of SAB 107 in its adoption of SFAS 123R.
Under SAB 107, the Company has estimated the expected term
of granted options to be the weighted average mid-point between
the vesting date and the end of the contractual term. The
Company estimates the volatility rate based on historical
closing stock prices of a pool of comparable companies. The
dividend yield is zero as the Company has no present intention
to pay cash dividends.
SFAS 123R 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 its consolidated financial statements.
83
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
The fair value of our service-based stock options was estimated
as of the date of grant using the Black-Scholes option pricing
model with the following assumptions:
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
2008
|
|
2007
|
|
Dividend yield
|
|
0.0%
|
|
0.0%
|
Expected volatility
|
|
46%
|
|
51%
|
Risk-free interest rate
|
|
2.69% to 4.95%
|
|
4.53% to 5.01%
|
Expected life of the option term (in years)
|
|
4.64 - 5.76
|
|
3.25 - 6.40
|
Forfeiture rate
|
|
20% to 30%
|
|
20% to 30%
|
The fair value of the options granted for the years ended
June 30, 2008 and 2007 was $5.3 million and
$1.0 million, respectively. This amount will be expensed
over the expected vesting.
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 have recently been publicly traded
and therefore does not have sufficient historical data, the
basis for the standard option volatility calculation is derived
from known publicly traded comparable companies. The annual
volatility for these companies is derived from their historical
stock price data.
Risk-free interest rate
The assumed risk free
rate used is a zero coupon U.S. Treasury security with a
maturity that approximates the expected term of the option.
Expected life of the option term
This is the
period of time that the options granted are expected to remain
unexercised. Options granted during the year 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.
Forfeiture rate
This is the estimated
percentage of options granted that are expected to be forfeited
or canceled before becoming fully vested. The Company uses a
forfeiture rate that is based on historical forfeitures at
various classification levels with the Company.
Stock option activity including stand-alone agreements during
the year ended June 30, 2008 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Value
|
|
|
Outstanding, June 30, 2006
|
|
|
2,512,806
|
|
|
$
|
7.03
|
|
|
|
5.76
|
|
|
$
|
36,385
|
|
Granted
|
|
|
1,249,409
|
|
|
|
13.35
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(42,708
|
)
|
|
|
6.84
|
|
|
|
|
|
|
|
|
|
Canceled
|
|
|
(96,657
|
)
|
|
|
7.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2007
|
|
|
3,622,850
|
|
|
|
9.21
|
|
|
|
5.28
|
|
|
$
|
44,551
|
|
Granted
|
|
|
1,477,747
|
|
|
|
15.38
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(221,914
|
)
|
|
|
6.81
|
|
|
|
|
|
|
|
|
|
Canceled
|
|
|
(111,834
|
)
|
|
|
11.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2008
|
|
|
4,766,849
|
|
|
$
|
11.20
|
|
|
|
5.19
|
|
|
$
|
49,167
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable at June 30, 2008
|
|
|
2,437,503
|
|
|
$
|
7.59
|
|
|
|
4.04
|
|
|
$
|
33,937
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
84
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
The aggregate intrinsic value in the table above represents the
total pre-tax intrinsic value (the difference between the
Companys closing stock price on the last day of the year
and the exercise price, multiplied by the number of in-the-money
options) that would have been received by the option holders had
all option holders exercised their options on June 30,
2008. The amount of aggregate intrinsic value will change based
on the fair market value of the Companys stock.
The total intrinsic value of options exercised for the years
ended June 30, 2008 and 2007 was $3.7 million and
$0.1 million, respectively.
The following table summarizes the option grant activity for the
year ended June 30, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
Options
|
|
|
Weighted-Average
|
|
|
Grant-Date
|
|
|
Intrinsic
|
|
Grant Date
|
|
Granted
|
|
|
Exercise Price
|
|
|
Fair Value
|
|
|
Value
|
|
|
July 2007
|
|
|
1,209,811
|
|
|
$
|
13.66
|
|
|
$
|
9.28
|
|
|
$
|
|
|
August 2007
|
|
|
1,838
|
|
|
$
|
13.66
|
|
|
$
|
11.78
|
|
|
$
|
|
|
February 2008
|
|
|
210,847
|
|
|
$
|
22.82
|
|
|
$
|
22.82
|
|
|
$
|
|
|
May 2008
|
|
|
55,250
|
|
|
$
|
24.78
|
|
|
$
|
24.78
|
|
|
$
|
|
|
As of June 30, 2008, there was $4.4 million of total
unrecognized compensation expense related to unvested stock
options granted under the Stock Option Plans adopted in May 2000
and November 2007. The cost is expected to be recognized over a
weighted average period of 2.1 years. The total fair value
of shares vested during the years ended June 30, 2008 and
2007 was $3.6 million and $4.2 million, respectively.
During the years ended June 30, 2008, the Company
recognized $1.5 million of stock based compensation. The
total income tax benefit recognized in the statement of
operations related to stock options exercised during the years
ended June 30, 2008 and 2007 was $1.4 million and $0
respectively.
|
|
11.
|
Business
Combinations
|
On October 1, 2007, the Company acquired all of the stock
of Power-Glide Knowledge Courses, Inc.
(Power-Glide), a Utah corporation, for
$4.1 million, which included approximately
$0.1 million in acquisition costs. In addition, the former
shareholders of Power-Glide have the right to receive an
additional 19,602 of the Companys common shares subject to
obtaining certain milestones as defined in the acquisition
agreement. As of June 30, 2008, 9,801 shares were
considered earned and recognized as additional acquisition cost.
The Company believes the addition of Power-Glide will provide
cost saving benefits associated with K12s foreign language
curriculum and assist the Company in expanding the content of
their academic offerings. The results of Power-Glides
operations have been included in the consolidated financial
statements since October 1, 2007.
The purchase price consists of the following (in thousands):
|
|
|
|
|
Issuance of the Companys common shares
|
|
$
|
2,660
|
|
Assumption of operating liabilities
|
|
|
1,271
|
|
Transaction costs
|
|
|
119
|
|
|
|
|
|
|
|
|
$
|
4,050
|
|
|
|
|
|
|
This transaction was accounted for as a business combination in
accordance with the provisions of SFAS No. 141,
Business Combinations.
The estimated determination of the purchase price allocation was
based on the fair values of the acquired assets and liabilities
assumed including acquired intangible assets. The estimated
determination was made by management utilizing various valuation
methodologies including an income-based approach and relief of
royalty.
85
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
The following table summarizes the estimated fair values of the
assets acquired and liabilities assumed at the date of
acquisition (in thousands):
|
|
|
|
|
Net working capital
|
|
$
|
(190
|
)
|
Property and equipment
|
|
|
33
|
|
Capitalized curriculum development costs existing
and in-process developed technology assets (estimated useful
life of 5 years)
|
|
|
2,263
|
|
Intangible assets:
|
|
|
|
|
Marketing related for trade name (estimated useful life of
2 years)
|
|
|
50
|
|
Contract related for non-compete agreements (estimated useful
life of 2 years)
|
|
|
139
|
|
|
|
|
|
|
Total intangible assets
|
|
|
189
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
(936
|
)
|
Goodwill
|
|
|
2,691
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
4,050
|
|
|
|
|
|
|
Pro
Forma Information
The unaudited pro forma information below sets forth summary
results of operations as if the acquisition of Power-Glide
(acquired October 1, 2007) had taken place at the
beginning of our fiscal year 2007, after giving effect to
certain adjustments directly attributable to the transaction.
The pro forma information for the years 2008 and 2007 has been
prepared for comparative purposes only and does not purport to
be indicative of what would have occurred had the acquisitions
occurred at the beginning of 2007 or of results which may occur
in the future (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenue
|
|
$
|
226,376
|
|
|
$
|
143,952
|
|
Net income
|
|
$
|
32,777
|
|
|
$
|
4,886
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.12
|
|
|
$
|
(11.92
|
)
|
Diluted
|
|
$
|
1.04
|
|
|
$
|
(11.92
|
)
|
|
|
12.
|
Commitments
and Contingencies
|
Litigation
In the ordinary conduct of our business, we are subject to
lawsuits, arbitrations and administrative proceedings from time
to time. We are currently involved in a lawsuit brought by a
teachers union seeking the closure of the virtual public
school we serve in Illinois.
On October 4, 2006, the Chicago Teachers Union and
individual taxpayers (CTU or plaintiffs) 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.
After three dismissals of their complaint on procedural grounds,
the Court granted the plaintiffs Fourth Amended Citizen
Complaint on May 20, 2008. CVCS and the Chicago Board of
Education jointly filed a
86
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
Motion to Reconsider, which was denied by Memorandum Opinion and
Order dated August 8, 2008. The case is now in the
discovery stage. The Company continues to participate in the
defense of CVCS under an indemnity obligation in our service
agreement with that school, which requires the Company to
indemnify CVCS against certain liabilities arising out of the
performance of the service agreement, and certain other claims
and liabilities, including liabilities arising out of challenges
to the validity of the virtual school charter. The Company is
not able to estimate the range of potential loss if the
plaintiffs were to prevail and a claim was made against the
Company for indemnification. In fiscal year 2007 and for the
year ended June 30, 2008, average enrollments in CVCS were
225 and 407 respectively, and we derived 1.1% and 1.3%,
respectively of our revenues from CVCS. We do not believe that a
loss in this case would have a material adverse impact on our
future results of operations, financial position or cash flows.
The Company expenses legal costs as incurred in connection with
a loss contingency.
Employment
Agreements
The Company has entered into employment agreements with certain
executive officers that provide for severance payments and, in
some cases other benefits, upon certain terminations of
employment. Except for one agreement that has a three year term,
all other agreements provide for employment on an
at-will basis. If the employee is terminated for
good reason or without cause, the employee is
entitled to salary continuation, and in some cases benefit
continuation, for varying periods depending on the agreement.
On July 12, 2007, the Companys board of directors
approved an amended and restated employment agreement for an
executive officer. The amended and restated agreement extends
the term of employment until January 1, 2011 and amended
certain elements of compensation including salary, stock options
and severance. Additionally, on July 12, 2007, the
Companys board of directors also approved the terms of a
new option agreement for an executive officer which provides
that all outstanding options will become fully vested upon a
change in control of Company.
The Company maintains an annual cash performance bonus program
that is intended to reward executive officers based on our
performance and the individual named executive officers
contribution to that performance. In determining the
performance-based compensation awarded to each named executive
officer, the Company may generally evaluate the Companys
and the executives performance in a number of areas, which
could include revenues, operating earnings, student retention,
efficiency in product and systems development, marketing
investment efficacy, new enrollment and developing company
leaders.
Vendor
Payment Commitments
In April 2007, the Company entered into a master services and
license agreement with a third party that provides for the
Company to license their proprietary computer system. The
agreement is effective through July 2010. In exchange for
the license of the computer system, the Company agrees to pay a
service fee per enrollment. In the event the fees paid over the
term of the contract do not exceed $1 million (the minimum
commitment fee), the Company agrees to pay the difference
between the actual fees paid and the minimum commitment fee. As
of June 30, 2008, the Company believes actual fees paid
will exceed the minimum commitment fee.
|
|
13.
|
Related
Party Transactions
|
Affiliates of the Company, rendered $0.4 million,
$0.3 million and $0.1 million of professional services
to the Company during the years ended June 30, 2008, 2007
and 2006, respectively. These costs include administrative
operations, consulting and curriculum development services,
other operating charges and the purchase of our domain name.
87
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
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 $0.2 million, $0.1 million and
$0.1 million during each of the years ended June 30,
2008, 2007 and 2006, respectively.
|
|
15.
|
Supplemental
Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Cash paid for interest
|
|
$
|
1,256
|
|
|
$
|
1,317
|
|
|
$
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for taxes
|
|
$
|
161
|
|
|
$
|
244
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non-cash investing and financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
New capital lease obligations
|
|
$
|
10,564
|
|
|
$
|
8,052
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash receipts in transit from exercise of stock options
|
|
$
|
25
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business Combination:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net working capital
|
|
$
|
(190
|
)
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
$
|
33
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capitalized curriculum development costs
|
|
$
|
2,263
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
$
|
189
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
$
|
(936
|
)
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
2,691
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assumed liabilities
|
|
$
|
1,271
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
$
|
2,660
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of preferred stock to common stock upon initial
public offering
|
|
$
|
238,408
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of perpetual license agreement/accrued liabilities
|
|
$
|
150
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
|
|
16.
|
Quarterly
Results of Operations (Unaudited)
|
The unaudited consolidated interim financial information
presented should be read in conjunction with other information
included in our consolidated financial statements. The following
unaudited consolidated financial information reflects all
adjustments necessary for the fair presentation of the results
of interim periods. The following tables set forth selected
unaudited quarterly financial information for each of our last
eight quarters.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
2007
|
|
|
2007
|
|
|
Consolidated Quarterly Statements of Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
56,475
|
|
|
$
|
56,016
|
|
|
$
|
54,391
|
|
|
$
|
59,353
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
32,462
|
|
|
|
32,062
|
|
|
|
31,980
|
|
|
|
34,778
|
|
Selling, administrative, and other
|
|
|
22,712
|
|
|
|
17,032
|
|
|
|
16,610
|
|
|
|
16,039
|
|
Product development expenses
|
|
|
2,021
|
|
|
|
2,542
|
|
|
|
2,460
|
|
|
|
2,527
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
57,195
|
|
|
|
51,636
|
|
|
|
51,050
|
|
|
|
53,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(720
|
)
|
|
|
4,380
|
|
|
|
3,341
|
|
|
|
6,009
|
|
Interest expense, net
|
|
|
88
|
|
|
|
309
|
|
|
|
(388
|
)
|
|
|
(304
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(632
|
)
|
|
|
4,689
|
|
|
|
2,953
|
|
|
|
5,705
|
|
Income tax benefit (expense)
|
|
|
17,735
|
|
|
|
(2,229
|
)
|
|
|
(1,565
|
)
|
|
|
7,117
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
17,103
|
|
|
|
2,460
|
|
|
|
1,388
|
|
|
|
12,822
|
|
Dividends on preferred stock
|
|
|
|
|
|
|
|
|
|
|
(1,395
|
)
|
|
|
(1,671
|
)
|
Preferred stock accretion
|
|
|
|
|
|
|
|
|
|
|
(5,633
|
)
|
|
|
(6,560
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders
|
|
$
|
17,103
|
|
|
$
|
2,460
|
|
|
$
|
(5,640
|
)
|
|
$
|
4,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.62
|
|
|
$
|
0.09
|
|
|
$
|
(0.98
|
)
|
|
$
|
2.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.59
|
|
|
$
|
0.09
|
|
|
$
|
(0.98
|
)
|
|
$
|
0.20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing per share
amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
27,793,003
|
|
|
|
27,449,893
|
|
|
|
5,777,767
|
|
|
|
2,043,589
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
29,125,372
|
|
|
|
28,780,389
|
|
|
|
5,777,767
|
|
|
|
22,744,525
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89
K12
Inc.
Notes to
Consolidated Financial
Statements (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
Jun 30,
|
|
|
Mar 31,
|
|
|
Dec 31,
|
|
|
Sep 30,
|
|
|
|
2007
|
|
|
2007
|
|
|
2006
|
|
|
2006
|
|
|
Consolidated Quarterly Statements of Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
35,626
|
|
|
$
|
34,831
|
|
|
$
|
32,356
|
|
|
$
|
37,743
|
|
Cost and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instructional costs and services
|
|
|
20,961
|
|
|
|
17,904
|
|
|
|
18,022
|
|
|
|
19,177
|
|
Selling, administrative, and other
|
|
|
16,100
|
|
|
|
12,644
|
|
|
|
11,030
|
|
|
|
11,385
|
|
Product development expenses
|
|
|
2,756
|
|
|
|
2,083
|
|
|
|
1,566
|
|
|
|
2,206
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
39,817
|
|
|
|
32,631
|
|
|
|
30,618
|
|
|
|
32,768
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(4,191
|
)
|
|
|
2,200
|
|
|
|
1,738
|
|
|
|
4,975
|
|
Interest expense, net
|
|
|
(165
|
)
|
|
|
(117
|
)
|
|
|
(263
|
)
|
|
|
(94
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(4,356
|
)
|
|
|
2,083
|
|
|
|
1,475
|
|
|
|
4,881
|
|
Income tax benefit (expense)
|
|
|
9
|
|
|
|
(51
|
)
|
|
|
(30
|
)
|
|
|
(146
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(4,347
|
)
|
|
|
2,032
|
|
|
|
1,445
|
|
|
|
4,735
|
|
Dividends on preferred stock
|
|
|
(1,670
|
)
|
|
|
(1,670
|
)
|
|
|
(1,519
|
)
|
|
|
(1,519
|
)
|
Preferred stock accretion
|
|
|
(5,810
|
)
|
|
|
(5,810
|
)
|
|
|
(5,366
|
)
|
|
|
(5,367
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders
|
|
$
|
(11,827
|
)
|
|
$
|
(5,448
|
)
|
|
$
|
(5,440
|
)
|
|
$
|
(2,151
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common stockholders per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(5.89
|
)
|
|
$
|
(2.72
|
)
|
|
$
|
(2.72
|
)
|
|
$
|
(1.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
(5.89
|
)
|
|
$
|
(2.72
|
)
|
|
$
|
(2.72
|
)
|
|
$
|
(1.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing per share
amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2,009,374
|
|
|
|
1,999,343
|
|
|
|
1,999,106
|
|
|
|
1,998,853
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
2,009,374
|
|
|
|
1,999,343
|
|
|
|
1,999,106
|
|
|
|
1,998,853
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On August 15, 2008 a subsidiary of the Company entered into
an agreement to establish a joint venture with a Middle East
partner. Our initial cash investment into this joint venture was
approximately $1 million. The purpose of the joint venture
is to develop and manage the distribution of our learning system
in the Gulf Cooperating Countries.
90
SCHEDULE II
|
|
1.
|
ALLOWANCE
FOR DOUBTFUL ACCOUNTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Charged to
|
|
|
Deductions
|
|
|
|
|
|
|
Beginning of
|
|
|
Cost and
|
|
|
from
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Expenses
|
|
|
Allowance
|
|
|
of Period
|
|
|
June 30, 2008
|
|
$
|
588,971
|
|
|
$
|
915,730
|
|
|
$
|
48,329
|
|
|
$
|
1,456,372
|
|
June 30, 2007
|
|
$
|
1,440,499
|
|
|
|
106,038
|
|
|
|
957,566
|
|
|
$
|
588,971
|
|
June 30, 2006
|
|
$
|
1,715,781
|
|
|
|
174,895
|
|
|
|
450,177
|
|
|
$
|
1,440,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Charged to
|
|
|
Deductions
|
|
|
|
|
|
|
Beginning of
|
|
|
Cost and
|
|
|
Shrinkage and
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Expenses
|
|
|
Obsolescence
|
|
|
of Period
|
|
|
June 30, 2008
|
|
$
|
327,608
|
|
|
|
781,104
|
|
|
|
373,885
|
|
|
$
|
734,827
|
|
June 30, 2007
|
|
$
|
232,055
|
|
|
|
320,960
|
|
|
|
225,407
|
|
|
$
|
327,608
|
|
June 30, 2006
|
|
$
|
270,611
|
|
|
|
|
|
|
|
38,556
|
|
|
$
|
232,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
|
|
|
(Deductions)
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Charged to
|
|
|
Deductions
|
|
|
|
|
|
|
Beginning of
|
|
|
Cost and
|
|
|
Shrinkage and
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Expenses
|
|
|
Obsolescence
|
|
|
of Period
|
|
|
June 30, 2008
|
|
$
|
616,361
|
|
|
|
162,428
|
|
|
|
|
|
|
$
|
778,789
|
|
June 30, 2007
|
|
$
|
664,186
|
|
|
|
(47,825
|
)
|
|
|
|
|
|
$
|
616,361
|
|
June 30, 2006
|
|
$
|
490,533
|
|
|
|
173,653
|
|
|
|
|
|
|
$
|
664,186
|
|
|
|
|
(1)
|
|
A reserve account is maintained against potential shrinkage and
obsolescence for those computers provided to our students. The
reserve is calculated based upon several factors including
historical percentages, the net book value and remaining useful
life.
|
|
|
4.
|
INCOME
TAX VALUATION ALLOWANCE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions to
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
Net Deferred
|
|
|
Deductions in Net
|
|
|
|
|
|
|
Beginning of
|
|
|
Tax Assets
|
|
|
Deferred Tax Asset
|
|
|
Balance at End
|
|
|
|
Period
|
|
|
Allowance
|
|
|
Allowance
|
|
|
of Period
|
|
|
June 30, 2008
|
|
$
|
29,925,898
|
|
|
|
|
|
|
|
29,314,944
|
|
|
$
|
610,954
|
|
June 30, 2007
|
|
$
|
32,527,019
|
|
|
|
|
|
|
|
2,601,121
|
|
|
$
|
29,925,898
|
|
June 30, 2006
|
|
$
|
33,866,482
|
|
|
|
|
|
|
|
1,339,463
|
|
|
$
|
32,527,019
|
|
91
|
|
ITEM 9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
DISCLOSURE
|
None.
|
|
ITEM 9A.
|
CONTROLS
AND PROCEDURES
|
Evaluation
of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in
Exchange Act
Rule 13a-15(f))
that are designed to ensure that information required to be
disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the
SECs rules and forms and that such information is
accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls
and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired
control objectives, and management necessarily was required to
apply its judgment in evaluating the cost benefit relationship
of possible controls and procedures.
We carried out an evaluation, under the supervision and with the
participation of management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as required by
Rules 13a-15(e)
and
15d-15(e)
of
the Exchange Act. Based on this review, our Chief Executive
Officer and Chief Financial Officer concluded that these
disclosure controls and procedures were effective as of
June 30, 2008 at the reasonable assurance level.
Changes
in Internal Control Over Financial Reporting
This annual report does not include a report of
managements assessment regarding internal control over
financial reporting or an attestation report of the
companys registered public accounting firm due to a
transition period established by rules of the Securities and
Exchange Commission for newly public companies.
During the quarter ended June 30, 2008, there were no
changes in our internal control over financial reporting that
have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
|
|
ITEM 9B.
|
OTHER
INFORMATION
|
None
PART III
|
|
ITEM 10.
|
DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT
|
Information relating to directors and officers of K12 is
incorporated by reference to our proxy statement for our annual
stockholders meeting. Certain information regarding our
executive officers required by this item is set forth in
Part I of this Annual Report on Form 10-K.
|
|
ITEM 11.
|
EXECUTIVE
COMPENSATION
|
Information regarding compensation of officers and directors of
K12 is incorporated by reference to our proxy statement for our
annual stockholders meeting.
|
|
ITEM 12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
|
Information regarding ownership of K12 common stock is
incorporated by reference to our proxy statement for our annual
stockholders meeting.
92
|
|
ITEM 13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
|
Information regarding certain relationships, related
transactions with K12, and director independence is incorporated
by reference to our proxy statement for our annual stockholders
meeting.
|
|
ITEM 14.
|
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|
Information regarding principal accountant fees and services is
incorporated by reference to our proxy statement for our annual
stockholders meeting.
PART IV
|
|
ITEM 15.
|
EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
|
(a)(1)
All financial statements.
The
information required by this item is incorporated herein by
reference to the financial statements and notes thereto listed
in Item 8 of Part II and included in this
Form 10-K.
(a)(2)
Financial statement schedules.
All
financial statement schedules are omitted because the required
information is included in the financial statements and notes
thereto listed in Item 8 of Part II and included in
this
Form 10-K.
(b)
Exhibits.
An index to exhibits has been filed as part of this Report and
is incorporated herein by reference.
93
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
K12 INC.
|
|
|
|
By:
|
/s/
Ronald
J. Packard
|
Name: Ronald J. Packard
|
|
|
|
Title:
|
Chief Executive Officer
|
Date: September 26, 2008
POWER OF
ATTORNEY
Know all persons by these presents, that each person whose
signature appears below constitutes and appoints Ronald J.
Packard, John F. Baule and Howard D. Polsky, and each
of them severally, his or her true and lawful attorney-in-fact
with power of substitution and resubstitution to sign in his or
her name, place and stead, in any and all capacities, to do any
and all things and execute any and all instruments that such
attorney may deem necessary or advisable under the Securities
Exchange Act of 1934 and any rules, regulations and requirements
of the U.S. Securities and Exchange Commission in connection
with the Annual Report on
Form 10-K
and any and all amendments hereto, as fully for all intents and
purposes as he or she might or could do in person, and hereby
ratifies and confirms all said attorneys-in-fact and agents,
each acting alone, and his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/
Ronald
J. Packard
Ronald
J. Packard
|
|
Chief Executive Officer
(Principal Executive Officer)
|
|
September 26, 2008
|
|
|
|
|
|
/s/
John
F. Baule
John
F. Baule
|
|
Chief Operating Officer
and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
|
|
September 26, 2008
|
|
|
|
|
|
/s/
Andrew
H. Tisch
Andrew
H. Tisch
|
|
Chairman of the Board and Director
|
|
September 26, 2008
|
|
|
|
|
|
/s/
Guillermo
Bron
Guillermo
Bron
|
|
Director
|
|
September 26, 2008
|
|
|
|
|
|
/s/
Steven
B. Fink
Steven
B. Fink
|
|
Director
|
|
September 26, 2008
|
|
|
|
|
|
/s/
Dr. Mary
H. Futrell
Dr. Mary
H. Futrell
|
|
Director
|
|
September 26, 2008
|
94
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/
Jane
M. Swift
Jane
M. Swift
|
|
Director
|
|
September 26, 2008
|
|
|
|
|
|
/s/
Thomas
J. Wilford
Thomas
J. Wilford
|
|
Director
|
|
September 26, 2008
|
95
INDEX TO
EXHIBITS
|
|
|
|
|
Exhibit
|
|
|
No.
|
|
Description of Exhibit
|
|
|
3
|
.1
|
|
Third Amended and Restated Certificate of Incorporation of K12
Inc. (Incorporated by reference to Exhibit 3.1 to K12s
Quarterly Report on Form 10-Q (Commission file number 001-33883)
for the quarter ended December 31, 2007).
|
|
3
|
.2
|
|
Amended and Restated Bylaws of K12 Inc. (Incorporated by
reference to Exhibit 3.2 to K12s Quarterly Report on Form
10-Q (Commission file number 001-33883) for the quarter ended
December 31, 2007).
|
|
4
|
.1
|
|
Form of stock certificate of common stock (Incorporated by
reference to Exhibit 4.1 to K12s Amendment No. 4 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
4
|
.2
|
|
Amended and Restated Stock Option Plan and Amendment thereto
(Incorporated by reference to Exhibit 4.2 to K12s
Registration Statement on Form S-1, File No. 333-144894).
|
|
4
|
.3
|
|
Form of Stock Option Contract Employee (Incorporated
by reference to Exhibit 4.3 to K12s Registration Statement
on Form S-1, File No. 333-144894).
|
|
4
|
.4
|
|
Form of Stock Option Contract Director (Incorporated
by reference to Exhibit 4.4 to K12s Registration Statement
on Form S-1, File No. 333-144894).
|
|
4
|
.5
|
|
Form of Second Amended and Restated Stockholders Agreement
(Incorporated by reference to Exhibit 4.5 to K12s
Registration Statement on Form S-1, File No. 333-144894).
|
|
4
|
.6
|
|
Form of Common Stock Warrant Agreement (Incorporated by
reference to Exhibit 4.6 to K12s Registration Statement on
Form S-1, File No. 333-144894).
|
|
4
|
.7
|
|
K12 Inc. 2007 Equity Incentive Award Plan (Incorporated by
reference to Exhibit 4.8 to K12s Amendment No. 4 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
4
|
.8
|
|
K12 Inc. 2007 Employee Stock Purchase Plan (Incorporated by
reference to Exhibit 4.9 to K12s Amendment No. 4 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
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. (Incorporated by reference
to Exhibit 10.1 to K12s Registration Statement on Form
S-1, File No. 333-144894).
|
|
10
|
.2*
|
|
Amended and Restated Stock Option Agreement of Ronald J. Packard
dated as of July 12, 2007 (Incorporated by reference to Exhibit
10.5 to K12s Amendment No. 6 to Registration Statement on
Form S-1, File No. 333-144894).
|
|
10
|
.3
|
|
Stock Option Agreement of Bruce J. Davis (Incorporated by
reference to Exhibit 10.6 to K12s Registration Statement
on Form S-1, File No. 333-144894).
|
|
10
|
.4
|
|
Stock Option Agreement of John Baule (Incorporated by reference
to Exhibit 10.7 to K12s Registration Statement on Form
S-1, File No. 333-144894).
|
|
10
|
.5
|
|
Stock Option Agreement of Bror Saxberg (Incorporated by
reference to Exhibit 10.8 to K12s Registration Statement
on Form S-1, File No. 333-144894).
|
|
10
|
.6*
|
|
Employment Agreement of Ronald J. Packard (Incorporated by
reference to Exhibit 10.9 to K12s Amendment No. 6 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.7
|
|
Employment Agreement of John F. Baule (Incorporated by reference
to Exhibit 10.10 to K12s Amendment No. 2 to Registration
Statement on Form S-1, File No. 333-144894).
|
|
10
|
.8
|
|
Employment Agreement of Bruce J. Davis (Incorporated by
reference to Exhibit 10.11 to K12s Amendment No. 1 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.9
|
|
Employment Agreement of Bror V. H. Saxberg (Incorporated by
reference to Exhibit 10.12 to K12s Amendment No. 1 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.10
|
|
Deed of Lease by and between ACP/2300 Corporate Park Owner, LLC
and K12 Inc., dated December 7, 2005 (Incorporated by reference
to Exhibit 10.13 to K12s Amendment No. 1 to Registration
Statement on Form S-1, File No. 333-144894).
|
|
10
|
.11
|
|
Sublease by and between France Telecom Long Distance USA, LLC,
and K12 Inc., dated December 9, 2005 (Incorporated by reference
to Exhibit 10.14 to K12s Amendment No. 1 to Registration
Statement on Form S-1, File No. 333-144894).
|
|
10
|
.12
|
|
Employment Agreement of Celia Stokes (Incorporated by reference
to Exhibit 10.15 to K12s Amendment No. 1 to Registration
Statement on Form S-1, File No. 333-144894).
|
96
|
|
|
|
|
Exhibit
|
|
|
No.
|
|
Description of Exhibit
|
|
|
10
|
.13
|
|
Employment Agreement of Howard D. Polsky (Incorporated by
reference to Exhibit 10.16 to K12s Amendment No. 1 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.14*
|
|
Stock Option Agreement between K12 Inc. and Ronald J. Packard
dated as of July 12, 2007 (Incorporated by reference to Exhibit
10.17 to K12s Amendment No. 6 to Registration Statement on
Form S-1, File No. 333-144894).
|
|
10
|
.15
|
|
First Amendment to Employment Agreement of Howard D. Polsky
(Incorporated by reference to Exhibit 10.18 to K12s
Amendment No. 4 to Registration Statement on Form S-1, File No.
333-144894).
|
|
10
|
.16
|
|
Amendment No. 1 to Revolving Credit Agreement (Incorporated by
reference to Exhibit 10.19 to K12s Amendment No. 4 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.17
|
|
Stock Subscription Agreement between K12 Inc. and KB Education
Investments Limited, dated November 6, 2007 (Incorporated by
reference to Exhibit 10.20 to K12s Amendment No. 4 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.18
|
|
Second Amended and Restated Educational Products and,
Administrative, and Technology Services Agreement between the
Ohio Virtual Academy and K12 Ohio LLC (Incorporated by reference
to Exhibit 10.21 to K12s Amendment No. 4 to Registration
Statement on Form S-1, File No. 333-144894).
|
|
10
|
.19
|
|
Stock Option Agreement of John Baule (Incorporated by reference
to Exhibit 10.22 to K12s Amendment No. 7 to Registration
Statement on Form S-1, File No. 333-144894).
|
|
10
|
.20
|
|
Stock Option Agreement of Richard Rasmus (Incorporated by
reference to Exhibit 10.23 to K12s Amendment No. 7 to
Registration Statement on Form S-1, File No. 333-144894).
|
|
10
|
.21
|
|
First Amendment to Deed of Lease by and between ACP/2300
Corporate Park Owner, LLC and K12 Inc., dated as of November 30,
2006.
|
|
10
|
.22
|
|
Second Amendment to Deed of Lease by and between ACP/2300
Corporate Park Owner, LLC and K12 Inc., dated as of March 26,
2007.
|
|
10
|
.23
|
|
Sublease by and between DIECA Communications Inc. and K12 Inc.,
dated June 25, 2008.
|
|
21
|
.1
|
|
Subsidiaries of K12 Inc.
|
|
23
|
.1
|
|
Consent of BDO Seidman, LLP.
|
|
24
|
.1
|
|
Power of Attorney (included in signature pages).
|
|
31
|
.1
|
|
Certification of Principal Executive Officer Required Under Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.
|
|
31
|
.2
|
|
Certification of Principal Financial Officer Required Under Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.
|
|
32
|
.1
|
|
Certification of Principal Executive Officer and Principal
Financial Officer Required Under Rule 13a-14(b) of the
Securities Exchange Act of 1934, as amended, and 18 U.S.C.
Section 1350.
|
|
|
|
*
|
|
Portions omitted pursuant to a request for confidential
treatment. The omitted information has been filed separately
with the Securities and Exchange Commission.
|
97
Exhibit 10.23
SUBLEASE AGREEMENT
This Sublease Agreement (this Sublease) is made as of the 25
th
day of June, 2008
(the Effective Date) between DIECA COMMUNICATIONS INC., a Virginia corporation (Tenant), and
K12 INC., a Delaware corporation (Subtenant).
R
E
C
I
T
A
L
S
:
A. By a certain Deed of Lease dated July 8, 2002, made between TST Woodland Funding I, L.L.C.
(Original Landlord), and Tenant, as amended pursuant to the First Amendment To Deed of Lease (the
First Amendment) dated March 31, 2005 by ACP/300 Corporate Park Drive, LLC, a Delaware limited
liability company, successor in interest to Original Landlord (the Master Landlord) and Tenant
(collectively, the Master Lease), a copy of which is attached hereto as Exhibit A, the Master
Landlord leased to Tenant a portion of the property located at 2300 Corporate Park Drive in
Herndon, Virginia (the Master Premises).
B. Tenant desires to sublet to Subtenant and Subtenant desires to sublet from Tenant a portion
of the Master Premises. Specifically, Subtenant desires to sublet from Tenant approximately 6,192
rentable square feet on the fourth (4
th
) floor of the building (the Subleased
Premises), a copy of the floor plan detailing the Subleased Premises is attached hereto as Exhibit
B, per the terms and conditions contained herein. Such Premises shall not be remeasured by Tenant
during the Term, and if remeasured by Master Landlord, in no event shall Subtenants costs
associated with the rentable square footage increase or decrease.
NOW, THEREFORE, in consideration of the mutual agreements herein contained, and for other
valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties
hereto agree as follows:
A
G
R
E
E
M
E
N
T
:
1.
MASTER LEASE
A. Tenant represents and warrants to Subtenant that attached hereto as Exhibit A is a true,
correct and complete copy of the Master Lease and all amendments thereto.
B. Unless otherwise defined herein, all capitalized terms shall have the defined meanings
ascribed to them in the Master Lease.
C. Except as set forth below and except as otherwise provided in this Sublease, the terms and
conditions of this Sublease shall include all of the terms of the Master Lease and such terms are
incorporated into this Sublease as if fully set forth herein, except to the extent they are
inapplicable to, inconsistent with, or modified by the
terms of this Sublease and except that: (i)
each reference in such incorporated sections to Lease shall be deemed a reference to this
Sublease; (ii) each reference to Landlord and Tenant shall be deemed a reference to Tenant
and Subtenant, respectively, except as otherwise expressly set forth herein; (iii) with respect
to work, services, utilities, electricity, repairs (or damage caused by Master Landlord),
restoration, insurance, indemnities, reimbursements, representations, warranties or the performance
of any other obligation of Master Landlord under the Master Lease, whether or not incorporated
herein, the sole obligation of Tenant shall be to request the same in writing from Master Landlord
as and when requested to do so by Subtenant, and to use Tenants commercially reasonable efforts
(which shall not include the
institution of legal proceedings by Tenant, but which may include allowing Subtenant, at
Subtenants sole cost and expense, to institute legal proceedings in Tenants name (if necessary),
by attorneys approved by Tenant, which approval shall not be unreasonably withheld, conditioned or
delayed) to obtain Master Landlords performance; (iv) with respect to any obligation of Tenant to
be performed under this Sublease, wherever the Master Lease grants to Tenant a specified number
of days to perform its obligations under the Master Lease, except as otherwise provided herein,
Subtenant shall have three (3) fewer days to perform the obligation, including, without limitation,
curing any defaults; (v) with respect to any approval required to be obtained from the Landlord
under the Master Lease, such approval must be obtained from both Master Landlord and Tenant, and
Tenants withholding of approval shall in all events be deemed reasonable if for any reason Master
Landlords approval is not obtained; (vi) in any case where the Landlord reserves or is granted
the right to manage, supervise, control, repair, alter, regulate the use of, enter or use the
Subleased Premises or any areas beneath, above or adjacent thereto, such reservation or grant of
right of entry shall be deemed to be for the benefit of both Master Landlord and Tenant; (vii) in
any case where Tenant is to indemnify, release or waive claims against Landlord, such
indemnity, release or waiver shall be deemed to run from Subtenant to both Master Landlord and
Tenant; and (viii) in any case where Tenant is to execute and deliver certain documents or
notices to Landlord, such obligation shall be deemed to run from Subtenant to both Master
Landlord and Tenant.
D. This Sublease is and at all times shall be subject and subordinate to the Master Lease and
the rights of Master Landlord thereunder. Subtenant hereby expressly assumes and agrees for the
benefit of the Master Landlord: (i) to comply with all provisions of the Master Lease which are
assumed by Subtenant hereunder; and (ii) to perform all the obligations on the part of the Tenant
to be performed under the terms of the Master Lease with respect to the Subleased Premises during
the term of this Sublease. In the event the Master Lease is terminated or cancelled for any reason
whatsoever, this Sublease shall terminate simultaneously with such termination or cancellation and,
unless it is determined in a final, non-appealable judgment that such termination is a result of
Tenants default under the Master Lease, or Tenants gross negligence or willful misconduct,
without any liability of Tenant to Subtenant. In the event of a conflict between the provisions of
this Sublease and the Master Lease, as between Tenant and Subtenant, the provisions of this
Sublease shall control.
2
E. The parties acknowledge and agreement that notwithstanding anything to the contrary in this
Sublease or the Master Lease, Section 18 of the First Amendment shall not apply and have no force
nor effect with regard to the Subtenant.
2.
WARRANTY BY LESSOR
Tenant warrants and represents to Subtenant that the Master Lease is in full force and effect, has
not been amended or modified except as expressly set forth herein, that all obligations of Tenant
have been satisfied, that Tenant is not now, and as of the commencement of the Term hereof will not
be, in default or breach of any of the provisions of the Master Lease, nor to the best of Tenants
knowledge is there any event with which the giving of notice or the passage of time or both would
become a default or breach under the Master Lease and that Tenant has no knowledge of any claim by
Master Landlord that Tenant is in default or breach of any of the provisions of the Master Lease.
Tenant has not received written notice of any violation or alleged violation of law, including but
not limited to the Americans with Disabilities Act of 1990, as may be amended (ADA) with respect
to the Subleased Premises. Tenant, as of the Effective Date, has not received written notice of
any mechanics liens charged against the Premises. During the Term of this Sublease, the Tenant
agrees not to amend or modify the Master Lease in such a manner as to increase Subtenants
obligations under this Sublease or adversely impact Subtenants rights under this Sublease without
prior written notice to and
reasonable approval by Subtenant. During the Term of this Sublease, Tenant shall not voluntarily
terminate the Master Lease with respect to the Subleased Premises, nor will Tenant knowingly act or
knowingly fail to act in such a manner as to cause the termination of the Master Lease. Should
Tenant receive written notice from Master Landlord regarding any default or other material issue
under the Master Lease or notices of any violations, mechanics liens or any other notices
affecting the Subleased Premises, Tenant shall provide a copy such notice(s) to Subtenant within
two (2) business days of Tenants receipt of said notice(s).
3.
SUBLEASED PREMISES
Tenant hereby subleases to Subtenant on the terms and conditions set forth in this Sublease the
Subleased Premises. Subtenant accepts the Subleased Premises in their present As-Is condition and
shall be responsible, at its cost and expense, for all alterations, improvements, additions and
other work desired for its use and occupancy of the Subleased Premises, except as specifically
stated in this Sublease. For the avoidance of doubt, Tenant shall have no obligation whatsoever to
make or pay the cost of any alterations, improvements or repairs to the Subleased Premises,
including, without limitation, any improvement or repair required to comply with any law,
regulation, building code or ordinance (including the ADA). In addition, Tenant shall have no
obligation to perform any repairs or any other obligation of Master Landlord required to be
performed by Master Landlord under the terms of the Master Lease and Subtenant shall look solely to
Master Landlord for performance of said obligations. Tenant shall, however, request performance of
the same in writing from Master Landlord promptly
3
after being requested to do so by Subtenant, and
shall use Tenants commercially reasonable efforts (which shall not include the institution of
legal proceedings by Tenant, but which may include allowing Subtenant, at Subtenants sole cost and
expense, to institute legal proceedings in Tenants name (if necessary), by attorneys approved by
Tenant, which approval shall not be unreasonably withheld, conditioned or delayed) to obtain Master
Landlords performance. Tenant hereby assigns to Subtenant, for so long as this Sublease shall be
in force and effect, any and all rights of Tenant under the Master Lease with respect to the
Subleased Premises and causes of action which Tenant may have against Master Landlord with respect
to the Subleased Premises due to default by Master Landlord under the Master Lease.
4.
TERM
The term of this Sublease shall commence on the later of: (a) July 1, 2008; and (b) the date that
Master Landlord consents to this Sublease or possession of the Subleased Premises is delivered to
Subtenant (Commencement Date), and end on July 31, 2010 (Termination Date), unless otherwise
sooner terminated in accordance with the provisions of this Sublease. In the event the Term
commences on a date other than the Commencement Date, Tenant and Subtenant shall execute a
memorandum setting forth the actual date of commencement of the term. Possession of the Subleased
Premises shall be delivered to Subtenant on the Commencement Date; provided, however, once the
Master Landlord consents to this Sublease, Subtenant shall be permitted access to the Subleased
Premises within five (5) business days of such consent in order for Subtenant to complete (through
Subtenants contractor or vendor or by Subtenants employees or other agents) the cabling of
telephone, computer, security systems, office equipment and the like; provided that Tenant shall
not be required to provide Subtenant with such access unless Subtenant has demonstrated its
compliance with the insurance requirements provided in Section 13 of this Sublease.
Notwithstanding anything to the contrary in this Sublease, if Tenant fails, for any reason other
than the acts or omissions of either Subtenant or the Master Landlord (including without limitation
the Master Landlords failure to timely consent to this Sublease) or the agents or employees of
Subtenant or Master Landlord, to provide possession of the Subleased Premises on the Commencement
Date, the date the Rent (as defined below) commences will be extended for each day of delay beyond
such date and provided further that if Tenant fails to provide possession of the Subleased Premises
on or before August 1, 2008 (subject to the exceptions set forth above),
then Subtenant shall have the right to terminate this Sublease by written notice delivered to
Tenant on or before August 15, 2008, upon which the parties shall have no further obligations to
each other under this Sublease.
5.
RENT
Subtenant does hereby agree, without notice, deduction or offset, to pay to Tenant, as the monthly
rent for the Subleased Premises (Rent), the following
amounts for the term of the Sublease:
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July 1, 2008 June 30, 2009:
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$14,964.00 each month
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July 1, 2009 June 30, 2010:
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$15,562.56 each month
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July 1, 2010 July 31, 2010:
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$16,185.06 each month
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Rent includes all Operating Expenses and Taxes contemplated under the Master Lease and Tenant
hereby acknowledges and agrees that Subtenant shall not be responsible for any other costs not
specifically and expressly provided for herein, including but not limited to costs or charges for
Building or common area maintenance, utilities or taxes. However, except as otherwise expressly
provided in this Sublease, Subtenant shall pay any other additional costs or expenses incurred
under the Master Lease related to the Sublease Premises or Subtenants occupancy thereof
(including, without limitation, the cost of all overtime HVAC, energy and other services costs
provided to Subtenant and/or the Sublease Premises and not included in Operating Expenses or
Taxes). Unless such costs and expenses can be paid directly to Master Landlord, Subtenant shall
reimburse Tenant for such other amounts within ten (10) business days of receipt of an invoice
(attaching the charges of the Master Landlord) from Tenant therefor. For the purposes of this
Sublease and all of Subtenants obligations hereunder, Rent and any other sums due to Tenant from
Subtenant under this Sublease shall together constitute Rent.
All payments of Rent due under this Sublease shall be paid in advance at least three (3) business
days prior to when the corresponding payments are due and payable under the Master Lease. Said
payment shall be made to Tenant, and shall be mailed to the address of Tenant or any other address
which Tenant may in writing designate. The first months rent payment in the amount of $14,964.00
shall be due and payable by Subtenant to Tenant upon Subtenants execution of this Sublease.
6.
USE OF PREMISES; ACCESS
Notwithstanding anything contrary to the Master Lease, the Subleased Premises shall be used and
occupied only for general office purposes in accordance with the applicable zoning regulations and
for no other use or purpose. Subtenant shall not use, store or dispose of, in or from the
Subleased Premises, any substances, materials, chemicals or gases which are defined and regulated
as being hazardous or toxic under applicable federal, state or local laws and regulations except
for such substances, materials, chemicals or gases in small amounts as used in the ordinary course
of the operation of Subtenants business which use shall at all times be in strict adherence to and
compliance with all applicable environmental laws and the terms of the Master Lease. Subject to
the terms and conditions of the Master Lease, Subtenant shall have access to the Subleased Premises
twenty-four (24) hours per each day of the year. Tenant shall provide fifty (50) of its electronic
access cards for the Subleased Premises and shall, at its sole cost and expense, cause the Master
Landlord to reprogram the electric access system such that only the foregoing 50 cards shall
provide access to the Subleased Premises (except with respect to the Master Landlord and Tenant as
permitted and limited by this Sublease), and pay the costs associated with obtaining such cards if
such cards provide access to the Master Premises in excess of the Subleased Premises.
5
7.
AGENCY DISCLOSURE
Subtenant and Tenant each warrant that they have dealt with no other real estate broker(s),
finder(s), or other person(s) in connection with this transaction other than The Staubach Company
Northeast, Inc., as Subtenants broker, and CresaPartners, as Tenants agent, both of which shall
be compensated by Tenant pursuant to a separate agreement. Tenant and Subtenant each shall
indemnify and hold the other harmless from any breach by it of this representation.
8.
ATTORNEYS FEES
If Tenant or Subtenant shall commence an action against the other arising out of or in connection
with this Sublease, the prevailing party shall be entitled to recover its costs of suit and
reasonable attorneys fees.
9.
FURNITURE
Subtenant shall have the right to utilize certain of the existing workstations and furniture within
the Subleased Premises through the term of the Sublease at no cost to the Subtenant (excluding
certain personal property of the Tenant). The Master Landlord owns the furniture and workstations
and therefore Tenant and Subtenant have no rights to the furniture after the expiration of the
Sublease term. Attached as Exhibit C is a list of the items of furniture within the Subleased
Premises that Subtenant will retain (the Sublease Furniture). Any items of furniture that had
been in the Subleased Premises but are not listed on Exhibit C as Sublease Furniture shall have
been removed by Tenant, at its sole cost and expense, from the Subleased Premises prior to the
Commencement Date. Subtenant shall have no further obligation to Tenant or Master Landlord
regarding such items of furniture.
10.
NOTICES
All notices and demands which may or are to be required or permitted to be given by either party on
the other hereunder shall be in writing. All notices and demands by the Tenant to Subtenant shall
be sent by United States Mail, postage prepaid, or by nationally recognized overnight carrier
addressed to the Subtenant at the Subleased Premises, and to the address hereinbelow, or to such
other place as Subtenant may from time to time designate in a notice to the Tenant. All notices
and demands by the Subtenant to Tenant shall be sent by United States Mail, postage prepaid, or by
recognized overnight carrier addressed to the Tenant at the address set forth herein, and to such
other person or place as the Tenant may from time to time designate in a notice to the Subtenant.
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To Tenant:
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Covad Communications Company
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110 Rio Robles
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San Jose, CA 95134
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Attn: Contract Management/Legal
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To Subtenant:
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K12 Inc.
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2300 Corporate Park Drive
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Herndon, VA 20171
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Attn: Legal Department
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11.
REMOVAL OF ALTERATIONS
Notwithstanding anything in the Master Lease or this Sublease to the contrary, Subtenant shall not
be required at the termination of the Sublease to remove alterations, fixtures, equipment and other
property at the Subleased Premises unless such items or alterations are installed by or at the
request of Subtenant. Unless the Master Landlord does not require such restoration or removal,
Subtenant shall be solely responsible for the restoration of any items or alterations that are
removed by or at the request of Subtenant and/or the removal of any items or alterations that are
installed by or at the request of Subtenant.
12.
CONSENTS
Each of the signatories set forth below represents and warrants that it is duly authorized to
execute and deliver this Sublease, to bind the person for which such signatory signs and that such
person has obtained all consents and approvals necessary to execute and deliver this Sublease.
Additionally, except for the consent of the Master Landlord, each party represents and warrants to
each of the other parties that it has obtained all consents and approvals necessary to execute and
deliver this Sublease.
13.
INSURANCE
A. Subtenant agrees that Subtenant will, at all times during the Term of this Sublease,
maintain and pay for such insurance as is required under the Master Lease, naming the Master
Landlord and Tenant as additional insureds under the policy or policies carried by Subtenant.
The Subtenant further covenants that in the event that the insurance policy evidenced in the
certificate is canceled or materially amended it will advise the Tenant in writing to this effect
forthwith. In the event that Subtenant fails to maintain the insurance required by this Section,
then the Tenant shall have the right to obtain such insurance on behalf of Subtenant. In the event
that Tenant obtains such insurance on behalf of Subtenant, then Subtenant shall reimburse Tenant
for the cost thereof within five (5) business days of Tenants demand for reimbursement.
B. Tenant and Subtenant each hereby releases all causes of action and rights of recovery
against each other and their respective agents, officers and employees for any loss, regardless of
cause or origin, to the extent of any recovery to either party from any policy(s) of insurance
carried or required to be carried hereunder. Tenant and Subtenant agree that any policies
presently existing or obtained on or after the date hereof (including
7
renewals of present policies)
shall include a clause or endorsement to the effect that any such release shall not adversely
affect or impair said policies or prejudice the right of the releasor to recover thereunder.
14.
PARKING
Subtenant shall be entitled to use parking spaces in accordance with the terms of the Master Lease,
including but not limited to Section 13 of the First Amendment concerning reserved parking spaces
of which Subtenant shall be entitled to its proportionate share based on the ratio of Subleased
Premises to Master Premises.
15.
SIGNAGE
Subtenant shall have the rights to suite entry signage and building directory signage pursuant to
the terms contained in the Master Lease.
16.
CONDEMNATION
In the event of damage or destruction of the Subleased Premises or the taking of all or any part
thereof under the power of eminent domain, this Sublease shall terminate only if the Master Lease
is terminated as a result thereof.
17.
EMERGENCY POWER SYSTEM
Subject to the terms and conditions of the Master Lease, Subtenant shall have the right, with
Master Landlords consent pursuant to the Master Lease, to connect certain equipment into the
Master Landlords emergency power generator and uninterrupted power supply systems (Emergency
Power System). Subtenant shall pay directly to the Master Landlord all costs and expenses related
to the Subtenants actual usage of the Emergency Power System. In the event that Subtenant is not
permitted to pay such costs directly, then Tenant shall pay the costs and expenses of the Emergency
Power System and the Subtenant shall promptly reimburse the Tenant for Tenants actual costs
incurred with respect to the Subleased Premises; provided that Tenant submits reasonable supporting
documentation regarding such costs.
18.
DEFAULT
Subtenant shall be in material default of its obligations under this Sublease if any of the
following events occur:
A. Subtenant fails to pay any Rent within five (5) business days after receipt of written
notice from Tenant that such item of Rent is due and unpaid; or
B. Subtenant fails to perform any term, covenant or condition of this Sublease (except those
requiring payment of Rent) and fails to cure such breach within
8
thirty (30) days after delivery of
a written notice to Subtenant specifying the nature of the breach; provided, however, that if more
than thirty (30) days are reasonably required to remedy the failure, then Subtenant shall not be in
default if Subtenant commences the cure within the thirty (30) day period and thereafter diligently
completes the cure; or
C. Subtenant makes a general assignment of its assets for the benefit of its creditors,
including attachment of, execution on, or the appointment of a custodian or receiver with respect
to a substantial part of Subtenants property or any property essential to the conduct of its
business; or
D. Subtenant abandons (without payment of Rent) the Subleased Premises in violation of the
Master Lease; or
E. Subtenant commits any other act or omission which constitutes a default under the Master
Lease, which has not been cured after delivery of any written notice required and passage of
three-quarters (
3
/
4
) of any applicable grace period provided in the Master Lease as modified, if at
all, by the provisions of this Sublease.
19.
SECURITY DEPOSIT
Subtenant shall provide Tenant prior to the execution of this Sublease a security deposit in the
amount of $14,964.00. Tenant may use the security deposit, or any part of the deposit, to satisfy
any default of Subtenant and any expenses arising from such default. If any portion of the
security deposit is so used or applied, Subtenant shall, within five (5) business days after
written demand therefore, deposit cash with Tenant in an amount sufficient to restore the security
deposit to its original amount. Tenant may commingle
the security deposit with its own funds and Subtenant shall not be entitled to interest on the
security deposit. Any remaining balance of the Security Deposit shall be returned to Subtenant at
such time after the Termination Date that all of Subtenants obligations under this Sublease have
been fulfilled, but in no event later than thirty (30) days following the Termination Date.
20.
ASSIGNMENT AND SUBLETTING
Subtenants rights to assign, transfer or hypothecate the leasehold estate under this Sublease, or
any interest therein shall be governed by the Master Landlord pursuant to Article 13 of the Master
Lease and by the Tenant pursuant to such Article 13 as incorporated into this Sublease.
21.
ENTIRE AGREEMENT; AMENDMENTS
This Sublease contains all agreements between the parties with respect to any matter mentioned
herein, and no other prior or contemporaneous agreement or understanding shall be effective. This
Sublease may not be amended except by the written agreement of all parties hereto.
9
22.
WAIVER
If either Tenant or Subtenant waives the performance of any term, covenant or condition contained
in this Sublease, such waiver shall not be deemed to be a waiver of any subsequent breach of the
same or any other term, covenant or condition contained herein, or constitute a course of dealing
contrary to the expressed terms of this Sublease. The acceptance of Rent by Tenant shall not
constitute a waiver of any preceding breach by Subtenant of any term, covenant or condition of this
Sublease regardless of Tenants knowledge of such preceding breach at the time Tenant accepted such
Rent. Failure by Tenant to enforce any of the terms, covenants or conditions of the Sublease for
any length of time shall not be deemed to waive or decrease the right of Tenant to insist
thereafter upon strict performance by Subtenant. Waiver by Tenant of any term, covenant or
condition contained in this Sublease may only be made by a written document signed by Tenant, based
upon full knowledge of the circumstances.
23.
RELATIONSHIP OF PARTIES
This Sublease does not and shall not create the relationship of principal and agent, or of
partnership, or of joint venture, or of any other association between Tenant and Subtenant, except
that of sublandlord and subtenant.
24.
NO DRAFTING PRESUMPTION
The parties acknowledge that this Sublease has been agreed to by both the parties, that both Tenant
and Subtenant have consulted with attorneys with respect to the terms of this Sublease and that no
presumption shall be created against Tenant because Tenant drafted this Sublease.
25.
COUNTERPARTS
This Sublease may be executed in one or more counterparts, each of which shall be deemed an
original, and all of which together shall constitute one and the same instrument.
26.
MASTER LANDLORDS CONSENT
After its execution by Tenant and Subtenant, this Sublease shall be effective only upon
obtaining the written consent of Master Landlord, or its duly authorized agent. Promptly after the
execution of this Sublease by the Tenant and Subtenant, Tenant shall use its commercially
reasonable efforts to secure the Master Landlords consent to this Sublease and shall keep
Subtenant reasonably apprised of the status of such efforts.
10
[SIGNATURE PAGE FOLLOWS]
THIS SUBLEASE SHALL BE OF NO FORCE OR EFFECT UNLESS CONSENTED TO BY MASTER LANDLORD WITHIN 30 DAYS
AFTER EXECUTION HEREOF, IF SUCH CONSENT IS REQUIRED UNDER THE TERMS OF THE MASTER LEASE.
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Date:
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6/25/08
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Date:
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6/26/08
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Tenant: Dieca Communications, Inc.
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Subtenant: K12, Inc.
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By:
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/s/ Jeff Bailey
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By:
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/s/ John Baule
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Title:
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CFO
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Title:
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Exec VP of Operations & CFO
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11
Exhibit A
Master Lease
12
Exhibit B
Subleased Premises
Note:
1) Subleased Premises totals 6,192 rentable square feet and is illustrated as the Covad space in
this illustration.
13
Exhibit C
Sublease Furniture
14
FINAL
EXECUTED LEASE
DEED OF LEASE
TST WOODLAND FUNDING I, L.L.C.,
a Delaware limited liability company,
Landlord
and
DIECA COMMUNICATIONS, INC.,
a Virginia corporation,
Tenant
South Pointe II
2300 Corporate Park Drive
Woodland Park
Herndon, Virginia 20171
July 8, 2002
TABLE OF CONTENTS
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Page
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ARTICLE 1. BASIC LEASE PROVISIONS
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1
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ARTICLE 2. PREMISES, TERM, RENT
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5
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2.1 Lease of Premises
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5
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2.2 Commencement Date
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5
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2.3 Payment of Rent
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2.4 First Months Rent
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6
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ARTICLE 3. USE AND OCCUPANCY
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3.1 Permitted Uses
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3.2 Parking Facilities
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ARTICLE 4. CONDITION OF THE PREMISES
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4.1 Condition
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4.2 Landlords Contribution
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4.3 Existing Furnishings
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ARTICLE 5. ALTERATIONS
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5.1 Tenants Alterations
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5.2 Manner and Quality of Alterations
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5.3 Removal of Tenants Property
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5.4 Mechanics Liens
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5.5 Labor Relations
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5.6 Tenants Costs
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5.7 Tenants Equipment
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5.8 Legal Compliance
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5.9 Floor Load
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|
|
11
|
|
ARTICLE 6. REPAIRS
|
|
|
11
|
|
6.1 Landlords Repair and Maintenance
|
|
|
11
|
|
6.2 Tenants Repair and Maintenance
|
|
|
11
|
|
6.3 Restorative Work
|
|
|
11
|
|
6.4 Supplemental HVAC Units
|
|
|
12
|
|
6.5 Emergency Power System
|
|
|
13
|
|
ARTICLE 7. INCREASES IN TAXES AND OPERATING EXPENSES
|
|
|
14
|
|
7.1 Definitions
|
|
|
14
|
|
7.2 Tenants Tax Payment
|
|
|
16
|
|
7.3 Tenants Operating Payment
|
|
|
17
|
|
7.4 Non-Waiver; Disputes
|
|
|
18
|
|
7.5 Final Year of Term
|
|
|
19
|
|
7.6 No Reduction in Rent
|
|
|
19
|
|
ARTICLE 8. REQUIREMENTS OF LAW
|
|
|
20
|
|
8.1 Compliance with Requirements
|
|
|
20
|
|
8.2 Fire and Life Safety
|
|
|
21
|
|
ARTICLE 9. SUBORDINATION
|
|
|
21
|
|
9.1 Subordination and Attornment
|
|
|
21
|
|
-i-
|
|
|
|
|
|
|
Page
|
|
9.2 Mortgage or Superior Lease Defaults
|
|
|
22
|
|
9.3 Tenants Termination Right
|
|
|
22
|
|
9.4 Provisions
|
|
|
23
|
|
ARTICLE 10. SERVICES
|
|
|
23
|
|
10.1 Electricity
|
|
|
23
|
|
10.2 Excess Electricity
|
|
|
24
|
|
10.3 Elevators
|
|
|
24
|
|
10.4 Heating, Ventilation and Air Conditioning
|
|
|
24
|
|
10.5 Overtime HVAC
|
|
|
25
|
|
10.6 Cleaning
|
|
|
25
|
|
10.7 Water
|
|
|
25
|
|
10.8 Refuse Removal
|
|
|
25
|
|
10.9 Directory
|
|
|
25
|
|
10.10 Tenant Access to Premises
|
|
|
26
|
|
10.11 Service Interruptions
|
|
|
26
|
|
ARTICLE 11. INSURANCE; PROPERTY LOSS OR DAMAGE
|
|
|
26
|
|
11.1 Tenants Insurance
|
|
|
26
|
|
11.2 Waiver of Subrogation
|
|
|
28
|
|
11.3 Restoration
|
|
|
28
|
|
11.4 Landlords Termination Right
|
|
|
29
|
|
11.5 Tenants Termination Right
|
|
|
29
|
|
11.6 Final 18 Months
|
|
|
29
|
|
11.7 Landlords Liability
|
|
|
30
|
|
ARTICLE 12. EMINENT DOMAIN
|
|
|
30
|
|
12.1 Taking
|
|
|
30
|
|
12.2 Awards
|
|
|
31
|
|
12.3 Temporary Taking
|
|
|
31
|
|
ARTICLE 13. ASSIGNMENT AND SUBLETTING
|
|
|
31
|
|
13.1 Consent Requirements
|
|
|
31
|
|
13.2 Tenants Notice
|
|
|
|
|
13.3 Conditions to Assignment/Subletting
|
|
|
33
|
|
13.4 Binding on Tenant; Indemnification of Landlord
|
|
|
34
|
|
13.5 Tenants Failure to Complete
|
|
|
34
|
|
13.6 Profits
|
|
|
35
|
|
13.7 Transfers
|
|
|
35
|
|
13.8 Assumption of Obligations
|
|
|
36
|
|
13.9 Tenants Liability
|
|
|
36
|
|
13.10 Listings in Building Directory
|
|
|
36
|
|
13.11 Lease Disaffirmance or Rejection
|
|
|
36
|
|
ARTICLE 14. ACCESS TO PREMISES
|
|
|
37
|
|
14.1 Landlords Access
|
|
|
37
|
|
14.2 Building Name
|
|
|
38
|
|
ARTICLE 15. DEFAULT
|
|
|
38
|
|
15.1 Tenants Defaults
|
|
|
38
|
|
15.2 Landlords Remedies
|
|
|
39
|
|
-ii-
|
|
|
|
|
|
|
Page
|
|
15.3 Landlords Damages
|
|
|
40
|
|
15.4 Interest
|
|
|
41
|
|
15.5 Other Rights of Landlord
|
|
|
41
|
|
ARTICLE 16. LANDLORDS RIGHT TO CURE; FEES AND EXPENSES
|
|
|
41
|
|
ARTICLE 17. NO REPRESENTATIONS BY LANDLORD; LANDLORDS APPROVAL
|
|
|
42
|
|
17.1 No Representations
|
|
|
42
|
|
17.2 No Money Damages
|
|
|
42
|
|
17.3 Reasonable Efforts
|
|
|
42
|
|
ARTICLE 18. END OF TERM
|
|
|
42
|
|
18.1 Expiration
|
|
|
42
|
|
18.2 Holdover Rent
|
|
|
42
|
|
ARTICLE 19. QUIET ENJOYMENT
|
|
|
43
|
|
ARTICLE 20. NO SURRENDER; NO WAIVER
|
|
|
43
|
|
20.1 No Surrender or Release
|
|
|
43
|
|
20.2 No Waiver
|
|
|
43
|
|
ARTICLE 21. WAIVER OF TRIAL BY JURY; COUNTERCLAIM
|
|
|
44
|
|
21.1 Jury Trial Waiver
|
|
|
44
|
|
21.2 Waiver of Counterclaim
|
|
|
44
|
|
ARTICLE 22. NOTICES
|
|
|
44
|
|
ARTICLE 23. RULES AND REGULATIONS
|
|
|
44
|
|
ARTICLE 24. BROKER
|
|
|
45
|
|
ARTICLE 25. INDEMNITY
|
|
|
45
|
|
25.1 Tenants Indemnity
|
|
|
45
|
|
25.2 Landlords Indemnity
|
|
|
45
|
|
25.3 Defense and Settlement
|
|
|
46
|
|
ARTICLE 26. MISCELLANEOUS
|
|
|
46
|
|
26.1 Delivery
|
|
|
46
|
|
26.2 Transfer of Real Property
|
|
|
46
|
|
26.3 Limitation on Liability
|
|
|
46
|
|
26.4 Rent
|
|
|
47
|
|
26.5 Entire Document
|
|
|
47
|
|
26.6 Governing Law
|
|
|
47
|
|
26.7 Unenforceability
|
|
|
47
|
|
26.8 Lease Disputes
|
|
|
47
|
|
26.9 Landlords Agent
|
|
|
47
|
|
26.10 Estoppel
|
|
|
48
|
|
26.11 Certain Interpretational Rules
|
|
|
48
|
|
26.12 Parties Bound
|
|
|
48
|
|
26.13 Memorandum of Lease
|
|
|
48
|
|
26.14 Counterparts
|
|
|
49
|
|
26.15
Survival
|
|
|
49
|
|
26.16 Inability to Perform
|
|
|
49
|
|
26.17 Substitute Premises
|
|
|
49
|
|
26.18 Deed of Lease/Landlords Agent for Service of Process
|
|
|
49
|
|
26.19 Lien for Payment of Rent
|
|
|
49
|
|
-iii-
|
|
|
|
|
|
|
Page
|
|
26.20 Financial Statements
|
|
|
49
|
|
ARTICLE 27. SECURITY DEPOSIT
|
|
|
49
|
|
27.1 Letter of Credit
|
|
|
49
|
|
27.2 Application of Security
|
|
|
50
|
|
27.3 Transfer
|
|
|
51
|
|
|
|
|
|
|
|
EXHIBITS
|
Exhibit A
|
|
Floor Plan
|
Exhibit B
|
|
Definitions
|
Exhibit C
|
|
Work Letter
|
Exhibit D
|
|
Cleaning Specifications
|
Exhibit E
|
|
Rules and Regulations
|
Exhibit F
|
|
Commencement Notice
|
Exhibit G
|
|
Existing Furnishings
|
|
|
|
RIDERS
|
Rider No. 1
|
|
Extension Option
|
Rider No. 2
|
|
Antenna
|
Rider No. 3
|
|
Exterior Signage
|
-iv-
DEED OF LEASE
This
Deed of Lease (the
Lease
) is made as of the 8
th
day of July, 2002
(
Effective Date
), between TST WOODLAND FUNDING I, L.L.C (
Landlord
), a Delaware limited
liability company, and DIECA COMMUNICATIONS, INC., (
Tenant
), a Virginia corporation.
Landlord and Tenant hereby agree as follows:
ARTICLE 1
BASIC LEASE PROVISIONS
|
|
|
|
|
|
PREMISES
|
|
The rentable area of the portion of the first (1st) floor of
the Building, the entire rentable area of the third (3rd)
floor of the Building and the rentable area of the portion
of the fourth (4th) floor of the Building, as more
particularly shown on
Exhibit A
.
|
|
|
|
BUILDING
|
|
The building, fixtures, equipment and other improvements and
appurtenances now located or hereafter erected, located or
placed upon the land known as 2300 Corporate Park Drive,
Woodland Park, Herndon, Virginia 20171 (commonly known as
South Pointe II).
|
|
|
|
REAL PROPERTY
|
|
The Building, the Common Area, the parking facilities and
the real property upon which the Building and the parking
facilities stand.
|
|
|
|
COMMENCEMENT DATE
|
|
The date which is earlier to occur of (a) the date Tenant
(or any person claiming by, through or under Tenant)
occupies any part of the Premises for the conduct of its
business, or (b) the later of (i) the date upon which the
Tenant Improvements (as described in
Exhibit C
attached
hereto) are Substantially Completed in accordance with the
terms of this Lease, or (ii) July 15, 2002.
|
|
|
|
RENT COMMENCEMENT
DATE
|
|
The day following the third (3
rd
) monthly
anniversary of the Commencement Date.
|
|
|
|
EXPIRATION DATE
|
|
The last day of the month in which the third
(3
rd
) yearly anniversary of the Commencement Date
occurs, or the last day of any extension term, if the Term
of this Lease is extended in accordance with any express
provision hereof.
|
|
|
|
TERM
|
|
The period commencing on the Commencement Date and ending
|
- 1 -
|
|
|
|
|
on the Expiration Date.
|
|
|
|
PERMITTED USES
|
|
Executive and general offices.
|
|
|
|
BASE YEAR
|
|
Calendar year 2002.
|
|
|
|
TENANTS
PROPORTIONATE SHARE
|
|
23.51%
|
|
|
|
AGREED AREA OF
BUILDING
|
|
159,633 rentable square feet, as measured in accordance with the
BOMA standard of building measurement and mutually agreed to
by Landlord and Tenant.
|
|
|
|
AGREED AREA OF
PREMISES
|
|
37,517 rentable square feet, as measured in accordance with the
BOMA standard of building measurement and mutually agreed to by
Landlord and Tenant, consisting of 3,573 square feet of rentable
area on the first (1
st
) floor, 27,752 square feet of
rentable area on the third (3
rd
) floor and 6,192
square feet of rentable area on the fourth (4th) floor (the
Fourth Floor Space
), being comprised of 3,044 square foot area
designated as
Suite 4A
on
Exhibit A
and
3,148 square foot area designated as
Suite 4B
on
Exhibit A
.
|
|
|
|
FIXED RENT
|
|
|
|
|
|
|
|
|
|
Fixed Rent per annum
|
|
|
per square foot of rentable area
|
Lease Year
|
|
of Premises
|
1
|
|
$
|
24.00
|
|
2
|
|
$
|
24.60
|
|
3 through original Expiration Date
|
|
$
|
25.22
|
|
|
|
|
|
|
|
LEASE YEAR
|
|
Each period of twelve (12) successive months commencing on the
Commencement Date or any anniversary thereof, except that the
last Lease Year of the Term might contain fewer than twelve
(12) months if the period between the expiration of the then
preceding Lease Year and the Expiration Date contains fewer
than twelve (12) months.
|
- 2 -
|
|
|
ADDITIONAL RENT
|
|
All sums other than Fixed Rent payable by Tenant to Landlord
under this Lease, including Tenants Tax Payment, Tenants
Operating Payment, late charges, overtime or excess service
charges, damages, and interest and other costs related to
Tenants failure to perform any of its obligations under this
Lease.
|
|
|
|
RENT
|
|
Fixed Rent and Additional Rent, collectively.
|
|
|
|
INTEREST RATE
|
|
The lesser of (i) 4% per annum above the then-current Base
Rate, and (ii) the maximum rate permitted by applicable law.
|
|
|
|
SECURITY DEPOSIT
|
|
$375,170.00, in the form of the Letter of Credit.
|
|
|
|
TENANTS ADDRESS FOR
NOTICES
|
|
Until Tenant commences business operations from the Premises:
|
|
|
|
|
|
Dieca Communications, Inc.
|
|
|
3420 Central Expressway
|
|
|
Santa Clara, CA 95051
|
|
|
Attn: Director of Real Estate
|
|
|
|
|
|
Copy to:
|
|
|
|
|
|
Dieca Communications, Inc.
|
|
|
3420 Central Expressway
|
|
|
Santa Clara, CA 95051
|
|
|
Attn: Legal Department
|
|
|
|
|
|
Thereafter:
|
|
|
|
|
|
Dieca Communications, Inc.
|
|
|
3420 Central Expressway
|
|
|
Santa Clara, CA 95051
|
|
|
Attn: Director of Real Estate
|
|
|
|
|
|
Copy to:
|
|
|
|
|
|
Dieca Communications, Inc.
|
|
|
3420 Central Expressway
|
|
|
Santa Clara, CA 95051
|
|
|
Attn: Legal Department
|
- 3 -
|
|
|
|
|
and
|
|
|
|
|
|
Dieca Communications, Inc.
|
|
|
2300 Corporate Park Drive
|
|
|
Woodland Park
|
|
|
Herndon, Virginia 20171
|
|
|
|
LANDLORDS ADDRESS FOR
NOTICES
|
|
TST Woodland Funding I, L.L.C.
|
|
|
c/o Tishman Speyer Properties, L.P.
|
|
|
520 Madison Avenue, Sixth Floor
|
|
|
New York, New York 10022
|
|
|
Attn: Chief Financial Officer
|
|
|
|
|
|
Copies to:
|
|
|
|
|
|
TST Woodland Funding I, L.L.C.
|
|
|
c/o Tishman Speyer Properties, L.P.
|
|
|
8270 Greensboro Drive, Suite 810
|
|
|
McLean, Virginia 22102
|
|
|
Attn: James A. Evans
|
|
|
|
|
|
and:
|
|
|
|
|
|
Tishman Speyer Properties, L.P.
|
|
|
520 Madison Avenue, Sixth Floor
|
|
|
New York, New York 10022
|
|
|
Attn: General Counsel
|
|
|
|
TENANTS BROKER
|
|
Scheer Partners and Liberty Greenfield.
|
|
|
|
LANDLORDS AGENT
|
|
Tishman Speyer Properties, L.P. or any other
person designated at any time and from time to
time by Landlord as Landlords Agent and their
successors and assigns.
|
|
|
|
LANDLORDS CONTRIBUTION
|
|
$-0-.
|
|
|
|
GUARANTOR
|
|
None.
|
All capitalized terms used in this Lease without definition are defined in
Exhibit
B
-Definitions or in
Exhibit C
-Work Letter to this Lease.
- 4 -
ARTICLE 2
PREMISES, TERM, RENT
Section 2.1 Lease of Premises.
Subject to the terms of this Lease, Landlord leases to Tenant
and Tenant leases from Landlord the Premises for the Term. In addition, Landlord grants to Tenant
the right to use, on a non-exclusive basis and in common with other tenants, the Common Areas.
Section 2.2 Commencement Date.
Upon the Effective Date, the terms and provisions hereof shall
be fully binding on Landlord and Tenant, including prior to the occurrence of the Commencement
Date. The Term of this Lease shall commence on the Commencement Date and, unless sooner terminated
or extended as hereinafter provided, shall end on the Expiration Date. If Landlord does not tender
possession of the Premises to Tenant on or before any specified date, for any reason whatsoever,
Landlord shall not be liable for any damage thereby, this Lease shall not be void or voidable
thereby, and the Term shall not commence until Landlord tenders possession of the Premises to
Tenant. No failure to tender possession of the Premises to Tenant on or before any specified date
shall affect any other obligations of Tenant hereunder. Once the Commencement Date is determined,
Landlord and Tenant shall execute an agreement in the form of Exhibit F hereto stating the
Commencement Date and the Expiration Date, but the failure to do so will not affect the
determination of such dates. For purposes of determining whether Tenant has accepted possession of
the Premises, Tenant shall be deemed to have done so when Tenant first moves Tenants Property
and/or any of its personnel into the Premises and/or commences construction, except to the extent
that Tenant is authorized in this Lease or by Landlords agreement to do any of the foregoing
without being deemed to have accepted possession of the Premises.
Notwithstanding the foregoing, if the Commencement Date has not occurred by August 1, 2002
(as such date may be extended by any Tenant Delay and/or Unavoidable Delay), Tenant shall have the
right, as Tenants sole remedy, to terminate this Lease by delivering written notice of such
termination (the
Termination Notice
) to Landlord at any time on or after such date but prior to
the Commencement Date with such termination being effective 30 days after Landlords receipt of
the Termination Notice; provided however, if the Commencement Date occurs within such 30 day
period, the Termination Notice shall be deemed null and void. If Landlord incurs an Unavoidable
Delay in connection with Landlords Substantial Completion of the Tenant Improvements due to any
delay in the issuance of any permits or in connection with any governmental inspections of the
Tenant Improvements, Landlord will send Tenant written notice of such Unavoidable Delay within 2
business days after Landlord obtains actual knowledge of such Unavoidable Delay. If Landlord fails
to send such notice to Tenant within such 2 business day period, then the delay will not be
treated as an Unavoidable Delay until the day on which Landlord sends such notice to Tenant.
Section 2.3 Payment of Rent.
Tenant shall pay to Landlord, without notice or demand, and
without any set-off, counterclaim, abatement or deduction whatsoever, except as may be expressly
set forth in this Lease, in lawful money of the United States by wire transfer of funds or by
check, (i) Fixed Rent in equal monthly installments, in advance, on the first day of
- 5 -
each month during the Term, commencing on the Commencement Date, and (ii) Additional Rent, at the
times and in the manner set forth in this Lease. The foregoing and any other provision of this
Lease to the contrary notwithstanding, Landlord hereby waives Tenants obligation to pay (a) Fixed
Rent for the entire Premises for the 3 month period that begins on the Commencement Date; and (b)
Fixed Rent for Suite 4A for the 6 month period that begins on the Commencement Date. Nothing
herein contained shall be deemed to diminish or relieve Tenant of its obligation to pay in
accordance with the terms of this Lease all other sums owed by Tenant to Landlord under the Lease
(other than Base Rent for the aforementioned periods).
Section 2.4 First Months Rent.
Tenant shall pay one months Fixed Rent upon the execution of
this Lease.
ARTICLE 3
USE AND OCCUPANCY
Section 3.1 Permitted Uses.
Tenant shall use and occupy the Premises for the Permitted Uses
and for no other purpose. Tenant shall not use or occupy or permit the use or occupancy of any
part of the Premises in a manner constituting a Prohibited Use. If Tenant uses the Premises for a
purpose constituting a Prohibited Use, violating any Requirement, or causing the Building to be in
violation of any Requirement, then Tenant shall promptly discontinue such use upon notice of such
violation. Tenant, at its expense, shall procure and at all times maintain and comply with the
terms and conditions of all licenses and permits required for the lawful conduct of the Permitted
Uses in the Premises, other than with respect to those licenses and permits that Landlord is
responsible for obtaining and maintaining.
Section 3.2 Parking Facilities.
Tenant shall have the right to use 3.98 parking spaces per
1,000 rentable square feet in the Premises for no additional Rent (except for Additional Rent
payable in accordance with Article 7 below) during the Term and any extension thereof (except as
set forth in Section 4 of Rider No. 1Extension Option to the contrary). Parking spaces shall be
provided on an unreserved basis in common with other Building tenants. Notwithstanding the
foregoing, Tenant acknowledges that Landlord may temporarily relocate, or specifically designate
the location of, Tenants parking spaces from time to time as a result of emergencies or repair and
maintenance work. Tenant agrees that it and its employees shall observe reasonable safety
precautions in the use of the parking structure and surface lots, and shall at all times abide by
all reasonable rules and regulations promulgated by Landlord, (or any parking operator selected by
Landlord) governing the use of the parking structure and surface lots. It is understood and agreed
that Landlord does not assume any responsibility for any damage or loss to any automobiles parked
in the parking structure or surface lots or to any personal property located therein, or for any
injury sustained by any person in or about the parking structure or surface lots. Any provision of
this Lease to the contrary notwithstanding, Landlord and Tenant acknowledges that the Building
parking facilities were designed to accommodate approximately 3.98 parking spaces per 1,000
rentable square feet in the Building and that Tenant might have a need for more than 3.98 parking
spaces per 1,000 rentable square feet in the Premises. If Tenant notifies Landlord that Tenant
desires more than 3.98 parking spaces per 1,000 rentable square feet in the Premises or if Landlord
determines on its own that Tenant is consistently using more
- 6 -
than 3.98 parking spaces per 1,000 rentable square feet in the Premises, Landlord have the right
to attempt to accommodate Tenants parking needs, at Tenants expense, by implementing such
parking policies and procedures as Landlord determines from time to time to be reasonably
necessary to accommodate the parking needs of Tenant and of the other tenants at the Building
including, for example, restriping all or some of the parking areas; specifically designating the
location of Tenants parking spaces (provided, however, if Landlord specifically designates the
location of Tenants parking spaces, the percentage of Tenants total parking spaces that are
located in the parking garage shall equal or exceed the percentage of all parking spaces at the
Building that are in the parking garage. Thus, if 70% of the Buildings parking spaces are located
in the parking garage, then at least 70% of Tenants designated spaces must be in the parking
garage).
ARTICLE 4
CONDITION OF THE PREMISES
Section 4.1 Condition.
Tenant agrees (a) to accept possession of the Premises upon
Substantial Completion of the Premises in accordance with the terms of the Work Letter attached
hereto as Exhibit C, and (b) except for the Tenant Improvements described in the Work Letter, that
Landlord has no obligation to perform any work, supply any materials, incur any expense or make
any alterations or improvements to prepare the Premises for Tenants occupancy. Tenants occupancy
of any part of the Premises shall be conclusive evidence, as against Tenant, that (i) Landlord has
Substantially Completed any work to be performed by Landlord under this Lease, (ii) Tenant has
accepted possession of the Premises in its then current condition and (iii) at the time such
possession was taken, the Premises and the Building were in a good and satisfactory condition as
required by this Lease.
Section 4.2 Landlords Contribution.
[Intentionally omitted]
Section 4.3 Existing Furnishings.
Tenant acknowledges that as of the Commencement Date, the
Premises contains or will contain certain furniture, fixtures and equipment, including, without
limitation, the furniture described on
Exhibit G
-
Existing Furnishings
to this
Lease (the
Existing Furnishings
). Tenant shall have the right to use the Existing Furnishings
throughout the Term and any extension thereof, provided that (i) Tenant shall maintain he Existing
Furnishings in good condition and repair at Tenants expense, (ii) the Existing Furnishing shall
at all times remain Landlords property and shall be during the Term, (iii) at no time shall
Tenant remove any of the Existing Furnishings from the Premises, and (iv) Tenant shall be
surrender the Existing Furnishings to Landlord upon the expiration or sooner termination of this
Lease in good order and repair, reasonable wear and tear excepted. Within thirty (30) days after
written demand therefor, Tenant shall pay or reimburse Landlord for all personal property, use and
other taxes payable in connection with the Existing Furnishings.
Section 4.3 Tenant Access.
Subject to the provisions of this paragraph, Tenant will be allowed
to enter into the Premises prior to the Commencement Date so that Tenant can complete through
Tenants contractor or vendor the cabling of telephone, computer, security systems and specialized
office equipment, at the same time that Landlords contractors are working in the the
- 7 -
Premises. Any person granted access on behalf of Tenant pursuant to this paragraph shall comply
with all reasonable requirements that Landlord and Contractor may impose and shall strictly observe
all rules and regulations promulgated by Contractor and/or Landlord relating to the job site,
including without limitation those relating to safety. If required by Landlord, each person granted
access shall sign a release and waiver of liability form as reasonably required by Landlord. Tenant
shall have the insurance required pursuant to the Lease in full force and effect (and naming
Landlord and any construction supervisor as additional insureds thereunder) prior to entering the
Building and/or the Premises, and all relevant terms and conditions of this Lease (excluding the
payment of Fixed Rent) shall be fully applicable to Tenants early access of the Building and/or
the Premises. Tenant shall indemnify and hold Landlord and Contractor harmless from and against any
cost, damage, claim, liability or expense (including reasonable attorneys fees) arising out of or
in connection with the entry into, or activities at, the Building and/or the Premises by Tenant
and all of Tenants employees, agents, contractors, subcontractors and invitees. Any delay in the
construction of the Tenant Improvements which results from the entry into the Building and/or the
Premises by Tenant or Tenants employees, agents, contractors, subcontractors or invitees or their
activities in the Building and/or the Premises, shall constitute a Tenant Delay. The foregoing
license to enter is conditioned upon Tenants workmen and mechanics working in harmony and not
interfering with the Contractor or with any other tenants or their contractors. Contractor shall
use commercially reasonable efforts to facilitate and coordinate with Tenants vendors and
contractors. If, at any time, such entry shall cause disharmony or interference therewith, the
license granted by the terms of this paragraph may be withdrawn by Landlord on twenty-four hours
notice to Tenants Representative. Landlord shall not be liable in any way for any injury, loss or
damage which may occur to any of the Tenants installation so made, the same being solely at
Tenants risk.
ARTICLE 5
ALTERATIONS
Section 5.1 Tenants Alterations.
(a) Tenant shall not make any alterations, additions or other physical changes
in or about the Premises (collectively,
Alterations
), other than (A) decorative Alterations
such as painting, wall coverings and floor coverings and (B) Alterations that cost less than
$25,000 in the aggregate for a single project and that do not require the issuance of any building or
other permit (collectively,
Decorative Alterations
), without Landlords prior consent,
which consent shall not be unreasonably withheld if such Alterations (i) are non-structural and do
not affect any Building Systems, (ii) affect only the Premises and are not visible from outside of
the Premises, (iii) do not affect the non-residential use permit issued for the Building or the
Premises, and (iv) do not violate any Requirement.
(b)
Plans and Specifications.
Prior to making any Alterations, Tenant, at its
expense, shall (i) submit to Landlord for its approval, detailed plans and specifications
(
Plans
) of each proposed Alteration (other than Decorative Alterations), and with respect to any
Alteration affecting any Building System, evidence that the Alteration has been designed by,
or
- 8 -
reviewed and approved by, Landlords designated engineer for the affected Building System, (ii)
obtain all permits, approvals and certificates required by any Governmental Authorities, (iii)
furnish to Landlord duplicate original policies or certificates of workers compensation (covering
all persons to be employed by Tenant, and Tenants contractors and subcontractors in connection
with such Alteration) and commercial general liability (including property damage coverage)
insurance and Builders Risk coverage (as described in Article 11) all in such form, with such
companies, for such periods and in such amounts as Landlord may reasonably require, naming
Landlord, Landlords Agent, any Lessor and any Mortgagee as additional insureds, and (iv) furnish
to Landlord reasonably satisfactory evidence of Tenants ability to complete and to fully pay for
such Alterations (other than Decorative Alterations). Tenant shall give Landlord a reasonably
detailed description of any Decorative Alteration made at the Premises within seven (7) days after
Landlords request therefor.
(c)
Governmental Approvals.
Tenant, at its expense, shall, as and when required, promptly
obtain certificates of partial and final approval of such Alterations required by any Governmental
Authority and shall furnish Landlord with copies thereof, together with as-built Plans for such
Alterations and, if Tenant engages the services of an architect (other than Tenants in-house
architect(s)) in connection with the Alterations, prepared on an AutoCAD Computer Assisted
Drafting and Design System (or such other system or medium as Landlord may accept), using naming
conventions issued by the American Institute of Architects in June, 1990 (or such other naming
conventions as Landlord may accept) and magnetic computer media of such record drawings and
specifications translated in DFX format or another format acceptable to Landlord.
Section 5.2 Manner and Quality of Alterations.
All Alterations shall be performed (a) in a
good and workmanlike manner and free from defects, (b) substantially in accordance with the Plans,
and by contractors approved by Landlord, and (c) in compliance with all Requirements, the terms of
this Lease and all construction procedures and regulations then prescribed by Landlord. All
materials and equipment shall be of first quality and at least equal to the applicable standards
for the Building then established by Landlord, and no such materials or equipment (other than
Tenants Property) shall be subject to any lien or other encumbrance.
Section 5.3 Removal of Tenants Property.
Tenants Property shall remain the property of
Tenant and Tenant may remove the same at any time on or before the Expiration Date. If, at the time
that Landlord approves any Specialty Alterations, Landlord informs Tenant that Tenant must remove
such Specialty Alterations on or prior to the Expiration Date, then Tenant shall, at Tenants
expense, remove such Specialty Alterations and close up any slab penetrations in the Premises on or
prior to the Expiration Date. Landlord will not require Tenant to remove any Specialty Alterations
and slab penetrations constructed or installed by Landlord as part of the initial Tenant
Improvements at the Premises. Tenant shall repair and restore, in a good and workmanlike manner,
any damage to the Premises or the Building caused by Tenants removal of any Specialty Alterations
or Tenants Property or by the closing of any slab penetrations, and upon default thereof, Tenant
shall reimburse Landlord for Landlords cost of repairing and restoring such damage. Any Specialty
Alterations or Tenants Property not so removed shall be deemed abandoned and Landlord may remove
and dispose of same, and repair and restore any damage caused thereby, at Tenants cost and without
accountability to Tenant.
- 9 -
All other Alterations shall become Landlords property upon termination of this Lease. Landlord
and Tenant agree that none of the initial Tenant Improvements (as defined in Exhibit C) are
Specialty Alterations nor shall Tenant be required to remove any of the initial Tenant
Improvements upon the expiration or earlier termination of this Lease.
Section 5.4 Mechanics Liens.
Tenant, at its expense, shall discharge any lien or charge
recorded or filed against the Real Property in connection with any work done or claimed to have
been done by or on behalf of, or materials furnished or claimed to have been furnished to,
Tenant, within 10 days after Tenants receipt of notice thereof by payment, filing the bond
required by law or otherwise in accordance with law.
Section 5.5 Labor Relations.
Tenant shall not employ, or permit the employment of, any
contractor, mechanic or laborer, or permit any materials to be delivered to or used in the
Building, if, in Landlords sole judgment, such employment, delivery or use will interfere or cause
any conflict with other contractors, mechanics or laborers engaged in the construction, maintenance
or operation of the Building by Landlord, Tenant or others. If such interference or conflict
occurs, upon Landlords request, Tenant shall cause all contractors, mechanics or laborers causing
such interference or conflict to leave the Building immediately.
Section 5.6 Tenants Costs.
Tenant shall pay promptly to Landlord, upon demand, all
out-of-pocket costs actually incurred by Landlord in connection with Tenants Alterations,
including costs incurred in connection with (a) Landlords review of the Alterations (including
review of requests for approval thereof) and (b) the provision of Building personnel during the
performance of any Alteration, to operate elevators or otherwise to facilitate Tenants
Alterations. In addition, if Tenants Alterations cost more than $25,000 and (i) Landlord and
Tenant agree that Landlord will supervise the construction of such Alterations, Tenant shall pay
to Landlord, upon demand, an administrative fee in an amount equal to 5% of the total cost of such
Alterations; and (ii) Landlord does not supervise the construction of such Alterations, Tenant
shall pay to Landlord, upon demand, an administrative fee in an amount equal to 2 1/2% of the
total cost of such Alterations.
Section 5.7 Tenants Equipment.
Tenant shall provide notice to Landlord prior to moving any
heavy machinery, heavy equipment, freight, bulky matter or fixtures
(collectively,
Equipment
)
into or out of the Building and shall pay to Landlord any costs actually incurred by Landlord in
connection therewith. If such Equipment requires special handling, Tenant agrees (a) to employ
only persons holding all necessary licenses to perform such work, (b) all work performed in
connection therewith shall comply with all applicable Requirements and (c) such work shall be done
only during hours designated by Landlord.
Section 5.8 Legal Compliance.
The approval of Plans, or consent by Landlord to the making of
any Alterations, does not constitute Landlords representation that such Plans or Alterations
comply with any Requirements. Landlord shall not be liable to Tenant or any other party in
connection with Landlords approval of any Plans, or Landlords consent to Tenants performing any
Alterations. If any Alterations made by or on behalf of Tenant, require Landlord to make any
alterations or improvements to any part of the Building in order to comply with any
- 10 -
Requirements, Tenant shall pay all costs and expenses incurred by Landlord in connection with such
alterations or improvements.
Section 5.9 Floor Load.
Tenant shall not place a load upon any floor of the Premises that
exceeds 80 pounds per square foot live load. Landlord reserves the right to reasonably designate
the position of all Equipment which Tenant wishes to place within the Premises, and to place
limitations on the weight thereof.
ARTICLE 6
REPAIRS
Section 6.1 Landlords Repair and Maintenance.
Landlord shall operate, maintain and, except
as provided in Section 6.2 hereof, make all necessary repairs (both structural and nonstructural)
to (i) the Building Systems, and (ii) the Common Areas, in conformance with standards applicable
to Comparable Buildings.
Section 6.2 Tenants Repair and Maintenance.
Tenant shall promptly, at its expense and in
compliance with Article 5, make all nonstructural repairs to the Premises and the fixtures,
equipment and appurtenances therein (including any supplemental HVAC (other than as set forth in
Section 6.4(b) to the contrary with respect to the Supplemental HVAC Units), specialty lighting or
Specialty Alteration) (collectively
Tenant Fixtures
) as and when needed to preserve the Premises
in good working order and condition, except for reasonable wear and tear and damage for which
Tenant is not responsible. All damage to the Building or to any portion thereof, or to any Tenant
Fixtures requiring structural or nonstructural repair caused by or resulting from any act,
omission, negligence or willful misconduct on the part of a Tenant Party or during the moving of
Tenants Property or Equipment into, within or out of the Premises by a Tenant Party, shall be
repaired at Tenants expense by (i) Tenant, if the required repairs are nonstructural in nature
and do not affect any Building System, or (ii) Landlord, if the required repairs are structural in
nature, involve replacement of exterior window glass or affect any Building System. All Tenant
repairs shall be of good quality utilizing new construction materials.
Section 6.3 Restorative Work.
Landlord reserves the right to make all changes, alterations,
additions, improvements, repairs or replacements to the Building and Building Systems, including
changing the arrangement or location of entrances or passageways, doors and doorways, corridors,
elevators, stairs, toilets or other Common Areas (collectively,
Restorative Work
), as Landlord
deems necessary or desirable, and to take all material into the Premises required for the
performance of such Restorative Work provided that (a) the level of any Building service shall not
decrease in any material respect from the level required of Landlord in this Lease as a result
thereof (other than temporary changes in the level of such services during the performance of any
such Restorative Work) and (b) Tenant is not deprived of reasonable access to the Premises.
Landlord shall use reasonable efforts to minimize interference with Tenants use and occupancy of
the Premises during the performance of such Restorative Work. There shall be no Rent abatement or
allowance to Tenant for a diminution of rental value, no actual or constructive eviction of Tenant,
in whole or in part, no relief from any of Tenants other
- 11 -
obligations under this Lease, and no liability on the part of Landlord by reason of inconvenience,
annoyance or injury to business arising from Landlord, Tenant or others performing, or failing to
perform, any Restorative Work, unless Landlord has not used reasonable efforts to minimize
interference with Tenants use and occupancy of the Premises during the performance of such
Restorative Work and such failure results in Tenants use and enjoyment of the Premises being
substantially interfered with.
Section 6.4 Supplemental HVAC System.
(a) (i) At any time during the Term, Tenant shall have the right to elect to
use the supplemental HVAC units and the equipment related thereto located at the Premises on
the date of this Lease (collectively, the
Supplemental HVAC Units
). The foregoing
notwithstanding, prior to using any Supplemental HVAC Units, Tenant shall provide Landlord
with all equipment plans and specifications relating to the loads that would be imposed upon
the Supplemental HVAC System (hereinafter defined), and Landlord shall have the right to deny
Tenant use of the Supplemental HVAC Units if Landlord determines the Supplemental HVAC
System will not or might not be adequate to meet Tenants demand. If Landlord approves of
Tenants use of the Supplemental HVAC Units, Landlords engineer or contractor will activate
Tenants use of the Supplemental HVAC Units. The minimum period for which Tenant can elect
to use a Supplemental HVAC Unit is thirty (30) days and Tenant shall provide Landlord with at
least thirty (30) days prior written notice if Tenant elects at any time to discontinue using
any Supplemental HVAC Unit.
(ii) If Tenant does not use the Supplemental HVAC System, Landlord shall have the right to
lock-off the Supplemental HVAC Units and/or to remove the Supplemental HVAC Units from the
Premises at Landlords expense.
(b) (i) Except with respect to emergency repairs, Landlord will maintain,
repair and make any capital repairs or replacements of the Supplemental HVAC Units.
(ii) If any Supplemental HVAC Units require emergency repairs, Tenant shall send Landlord
prompt written notice of such emergency and Tenant shall make arrangements for such repairs
directly with Landlords Supplemental HVAC Unit contractor. Landlord will provide Tenant with
written notice from time to time of the name and telephone number of Landlords Supplemental HVAC
Unit contractor.
(iii) Landlord will maintain, repair and make any capital repairs or replacements to any
equipment relating to the operation of the Supplemental HVAC Units that is not located at the
Premises, which shall include the cooling tower(s) located on the roof of the Building that
generally serve(s) the supplemental HVAC units presently located in the Building (collectively,
the
Supplemental Common Equipment
). The Supplemental HVAC Units and the Supplemental Common
Equipment are together called the
Supplemental HVAC System
.
(c) Beginning on the date on which Tenant commences to use the
Supplemental HVAC System and continuing thereafter during the Term for so long as Tenant has
elected to use any Supplemental HVAC Unit:
- 12 -
(i) Tenant shall pay all costs incurred by Landlord and/or Tenant during the Term in
connection with the ordinary maintenance and emergency and non-emergency repairs and replacements
to the Supplemental HVAC Units (whether for parts, labor, warranty coverage or otherwise) (the
Supplemental Maintenance Costs
). If Tenant directly incurs any Supplemental Maintenance Costs,
Tenant shall pay such Supplemental Maintenance Costs as and when due and owing to the applicable
Supplemental HVAC Unit service provider.
(ii) Tenant shall pay Tenants Supplemental Share of all costs incurred by Landlord in
connection with the ordinary maintenance and emergency and non-emergency repairs and replacements
of the Supplemental Common Equipment (whether for parts, labor, warranty coverage or otherwise)
(the
Supplemental Common Costs
).
Tenants Supplemental Share
means a fraction, the numerator of
which shall be the tonnage rating of the Supplemental HVAC Units in the Premises and the
denominator of which shall be the tonnage rating of all supplemental HVAC units in the Building
(exclusive of any such units that are owned by a tenant of the Building) that any tenant of the
Building from time to time elects to use.
(iii) In addition to the Supplemental Maintenance Costs and Tenants Supplemental Share,
Tenant shall pay to Landlord the monthly electricity charge for the Supplemental HVAC System as
reasonably established from time to time by Landlord (the
Supplemental Charge
). The current
Supplemental Charge is $70 per ton per month.
(iv) All sums payable by Tenant to Landlord under this Section shall constitute Additional
Rent and shall be due and payable to Landlord within thirty (30) days after Landlord sends Tenant
an invoice therefor. Landlord will be entitled to an administrative charge of ten percent (10%) of
all costs payable by Tenant under this Section, other than the Supplemental Charge (the
Supplemental Administrative Fee
).
(d) Landlord shall have no liability arising from any failure of the
Supplemental HVAC System or any component thereof to operate properly or at all at any time
including, without limitation, no liability if any such failure results in the Premises not
being reasonably comfortable or useable at all, any of Tenants equipment not functioning or not
functioning fully or properly, Tenant missing or being delayed in meeting any business or
other deadlines, or Tenant incurring any other costs or damages.
(e) Tenant shall cooperate with Landlord and shall abide by the rules and
regulations which Landlord may reasonably prescribe for the proper functioning and protection
of the Supplemental HVAC System.
Section 6.5 Emergency Power System.
(a) The Building is equipped with an emergency power generator and an uninterrupted power
supply system (collectively, the
Emergency Power System
). At any time during the Term, Tenant
shall have the right to elect to connect certain equipment at the Premises to the Emergency Power
System. The foregoing notwithstanding, prior to connecting any equipment to the Emergency Power
System, Tenant shall provide Landlord with all equipment plans and specifications relating to the
loads that would be imposed upon the Emergency Power
- 13 -
System, and Landlord shall have the right to deny Tenant use of the Emergency Power System to the
extent that Landlord determines that Tenants usage might or would exceed the usage allotment
that Landlord has determined for the Premises. If Landlord approves of Tenants use of the
Emergency Power System, at Landlords election, either Landlords contractor will connect
Tenants approved equipment to the Emergency Power System or Tenants contractor will connect
Tenants approved equipment to the Emergency Power System.
(b) Landlord will operate, maintain, repair and make any capital repairs or
replacements to the Emergency Power System.
(c) (i) If Tenant elects to connect any equipment to the Emergency Power
System, Tenant shall pay to Landlord Tenants EPS Share of all costs and expenses incurred by
Landlord on or after the date on which such equipment is connected to the Emergency Power
System in connection with the operation, maintenance, repair and replacement of the Emergency
Power System (
EPS Costs
).
Tenants EPS Share
means a fraction, the numerator of which
shall be the potential load (as reasonably determined by Landlord) of Tenants equipment that
is connected to the Emergency Power System and the denominator of which shall be the potential
load (as reasonably determined by Landlord) of all equipment that tenants of the Building from
time to time elect to have connected to the Emergency Power System.
(ii) All sums payable by Tenant to Landlord under this Section shall constitute Additional
Rent and shall be due and payable to Landlord within thirty (30) days after Landlord sends Tenant
an invoice therefor. Landlord will be entitled to an administrative
charge of ten percent (10%) of
all costs payable by Tenant under this Section (the
EPS Fee
).
(d) Landlord shall have no liability arising from any failure of the Emergency
Power System or any component thereof to operate properly or at all at any time including,
without limitation, no liability if any such failure results in any of Tenants equipment not
functioning or not functioning fully or properly, Tenant losing any data, Tenant missing or
being delayed in meeting any business or other deadlines, or Tenant incurring any other costs or
damages.
(e) Tenant shall cooperate with Landlord and shall abide by the rules and
regulations which Landlord may reasonably prescribe for the proper functioning and protection
of the Emergency Power System.
ARTICLE 7
INCREASES IN TAXES AND OPERATING EXPENSES
Section 7.1 Definitions.
For the purposes of this Article 7, the following terms shall
have the meanings set forth below:
(a)
Assessed Valuation
shall mean the amount for which the Real Property is assessed
by the County Assessor of Fairfax County for the purpose of imposition of Taxes.
- 14 -
(b)
Base Operating Expenses
shall mean the Operating Expenses for the
Base Year.
(c)
Base Taxes
shall mean the Taxes payable on account of the Base Year.
(d)
Comparison Year
shall mean any calendar year commencing
subsequent to the Base Year.
(e)
Operating Expenses
shall mean the aggregate of all costs and expenses
paid or incurred by or on behalf of Landlord in connection with the ownership, operation,
repair and maintenance of the Real Property, including (i) capital improvements only if such capital
improvement either (A) is reasonably intended to result in a reduction in Operating Expenses
(as for example, a labor-saving improvement) provided, the amount included in Operating Expenses
in any Comparison Year shall not exceed an amount equal to the savings reasonably anticipated
to result from the installation and operation of such improvement, and/or (B) is made during
any Comparison Year in compliance with Requirements, (ii) reasonable rent for the management
office, if any, in the Building, and (iii) all costs relating to the ownership, operation,
repair and maintenance of the Building and any parking facilities serving the Building. Such capital
improvements shall be amortized (with interest at the Base Rate) on a straight-line basis over
its useful life as Landlord shall reasonably determine, and the amount included in Operating
Expenses in any Comparison Year shall be equal to the annual amortized amount. Operating
Expenses shall not include any Excluded Expenses. If during all or part of the Base Year or
any Comparison Year, Landlord shall not furnish any particular item(s) of work or service (which
would otherwise constitute an Operating Expense) to any leasable portions of the Building for
any reason, then, for purposes of computing Operating Expenses for such period, the amount
included in Operating Expenses for such period shall be increased by an amount equal to the
costs and expenses that would have been reasonably incurred by Landlord during such period if
Landlord had furnished such item(s) of work or service to such portion of the Building. In
determining the amount of Operating Expenses for the Base Year or any Comparison Year, if
less than 95% of the Building rentable area is occupied by tenants at any time during any such
Base Year or Comparison Year, Operating Expenses that vary with the Building occupancy level
shall be determined for such Base Year or Comparison Year to be an amount equal to the like
expenses which would normally be expected to be incurred had such occupancy been 95%
throughout such Base Year or Comparison Year.
(f)
Statement
shall mean a reasonably detailed statement containing a
comparison of (i) the Taxes payable for the Base Year and for any Comparison Year, or (ii) the
Base Operating Expenses and the Operating Expenses payable for any Comparison Year.
(g)
Taxes
shall mean (i) all real estate taxes, assessments, sewer and water
rents, rates and charges and other governmental levies, impositions or charges, whether
general,
special, ordinary, extraordinary, foreseen or unforeseen, which may be assessed, levied or
imposed upon all or any part of the Real Property, and (ii) all expenses (including reasonable
attorneys fees and disbursements and experts and other witnesses fees) incurred in
contesting any of the foregoing or the Assessed Valuation of the Real Property. Taxes shall not include
(x) interest or penalties incurred by Landlord as a result of Landlords late payment of Taxes, or
(y)
- 15 -
franchise, transfer, gift, inheritance, estate or net income taxes imposed upon Landlord. For
purposes hereof, Taxes for any calendar year shall be deemed to be the Taxes which are assessed,
levied or imposed for such calendar year regardless of when due or paid. If Landlord elects to pay
any assessment in annual installments, then (i) such assessment shall be deemed to have been so
divided and to be payable in the maximum number of installments permitted by law, and (ii) there
shall be deemed included in Taxes for each Comparison Year the installments of such assessment
becoming payable during such Comparison Year, together with interest payable during such
Comparison Year on such installments and on all installments thereafter becoming due as provided
by law, all as if such assessment had been so divided. If at any time the methods of taxation
prevailing on the Effective Date shall be altered so that in lieu of or as an addition to the
whole or any part of Taxes, there shall be assessed, levied or imposed (1) a tax, assessment,
levy, imposition or charge based on the income or rents received from the Real Property whether or
not wholly or partially as a capital levy or otherwise, (2) a tax, assessment, levy, imposition or
charge measured by or based in whole or in part upon all or any part of the Real Property and
imposed upon Landlord, (3) a license fee measured by the rents, or (4) any other tax, assessment,
levy, imposition, charge or license fee however described or imposed, including business
improvement district impositions then all such taxes, assessments, levies, impositions, charges or
license fees or the part thereof so measured or based shall be deemed to be Taxes.
Section 7.2 Tenants Tax Payment.
(a) If the Taxes payable for any Comparison Year exceed the Base Taxes, Tenant shall pay to
Landlord Tenants Proportionate Share of such excess (Tenants Tax Payment). For each Comparison
Year, Landlord shall furnish to Tenant a statement setting forth Landlords reasonable estimate of
Tenants Tax Payment for such Comparison Year (the Tax Estimate). Tenant shall pay to Landlord on
the 1st day of each month during such Comparison Year an amount equal to 1/12 of the Tax Estimate
for such Comparison Year. If Landlord furnishes a Tax Estimate for a Comparison Year subsequent to
the commencement thereof, then (i) until the 1
st
day of the month following the month in
which the Tax Estimate is furnished to Tenant, Tenant shall pay to Landlord on the 1
st
day of each month an amount equal to the monthly sum payable by Tenant to Landlord under this
Section 7.2 during the last month of the preceding Comparison Year, (ii) promptly after the Tax
Estimate is furnished to Tenant or together therewith, Landlord shall give notice to Tenant stating
whether the installments of Tenants Tax Estimate previously made for such Comparison Year were
greater or less than the installments of Tenants Tax Estimate to be made for such Comparison Year
in accordance with the Tax Estimate, and (x) if there shall be a deficiency, Tenant shall pay the
amount thereof within 30 days after demand therefor, or (y) if there shall have been an
overpayment, Landlord shall credit the amount thereof against subsequent payments of Rent due
hereunder, and (iii) on the 1
st
day of the month following the month in which the Tax
Estimate is furnished to Tenant, and on the 1
st
day of each month thereafter throughout
the remainder of such Comparison Year, Tenant shall pay to Landlord an amount equal to 1/12 of the
Tax Estimate. Notwithstanding the foregoing, Tenant shall have no obligation to pay Tenants Tax
Payment for the first 12 months after the Commencement Date.
- 16 -
(b) As soon as reasonably practicable after Landlord has determined the Taxes
for a Comparison Year, Landlord shall furnish to Tenant a Statement for such Comparison Year.
If the Statement shall show that the sums paid by Tenant under Section 7.2(a) exceeded the
actual amount of Tenants Tax Payment for such Comparison Year, Landlord shall credit the
amount of such excess against subsequent payments of Rent due hereunder, or if the Term has
expired, Landlord shall refund the overpayment to Tenant within 30 days after the year-end Tax
reconciliation.. If the Statement for such Comparison Year shall show that the sums so paid
by Tenant were less than Tenants Tax Payment for such Comparison Year, Tenant shall pay the
amount of such deficiency within 30 days after delivery of the Statement to Tenant.
(c) Only Landlord may institute proceedings to reduce the Assessed Valuation
of the Real Property and the filings of any such proceeding by Tenant without Landlords
consent shall constitute an Event of Default. If the Taxes payable for the Base Year are reduced, the
Base Taxes shall be correspondingly revised, the Additional Rent previously paid or payable on
account of Tenants Tax Payment hereunder for all Comparison Years shall be recomputed on
the basis of such reduction, and Tenant shall pay to Landlord within 30 days after being
billed therefor, any deficiency between the amount of such Additional Rent previously computed and
paid by Tenant to Landlord, and the amount due as a result of such recomputations. If
Landlord receives a refund of Taxes for any Comparison Year, Landlord shall credit against subsequent
payments of Rent due hereunder, an amount equal to Tenants Proportionate Share of the refund,
net of any expenses incurred by Landlord in achieving such refund, which amount shall not
exceed Tenants Tax Payment paid for such Comparison Year. Landlord shall not be obligated
to file any application or institute any proceeding seeking a reduction in Taxes or the
Assessed Valuation. The benefit of any exemption relating to all or any part of the Real Property
shall accrue solely to the benefit of Landlord and Taxes shall be
computed without taking into
account any such exemption or abatement.
(d) Tenant shall be responsible for any applicable occupancy or rent tax now
in effect or hereafter enacted and, if payable by Landlord, Tenant shall promptly pay such
amounts to Landlord, upon Landlords demand.
Section 7.3 Tenants Operating Payment.
(a) If the Operating Expenses payable for any Comparison Year exceed the Base Operating
Expenses, Tenant shall pay to Landlord Tenants Proportionate Share of such excess (
Tenants
Operating Payment
). For each Comparison Year, Landlord shall furnish to Tenant a written statement
setting forth Landlords reasonable estimate of Tenants Operating Payment for such Comparison
Year, based upon such years budget (the
Estimate
). Tenant shall pay to Landlord on the 1st day
of each month during such Comparison Year an amount equal to 1/12 of Landlords estimate of
Tenants Operating Payment for such Comparison Year. If Landlord furnishes an Estimate for a
Comparison Year subsequent to the commencement thereof, then (a) until the 1st day of the month
following the month in which the Estimate is furnished to Tenant, Tenant shall pay to Landlord on
the 1st day of each month an amount equal to the monthly sum payable by Tenant to Landlord under
this Section 7.3 during the last month of the preceding Comparison Year, (b) promptly after the
Estimate is furnished to Tenant or together therewith, Landlord shall give notice to Tenant stating
whether the installments of
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Tenants Operating Payment previously made for such Comparison Year were greater or less than the
installments of Tenants Operating Payment to be made for such Comparison Year in accordance with
the Estimate, and (i) if there shall be a deficiency, Tenant shall pay the amount thereof within
30 days after demand therefor, or (ii) if there shall have been an overpayment, Landlord shall
credit the amount thereof against subsequent payments of Rent due hereunder, and (c) on the 1st
day of the month following the month in which the Estimate is furnished to Tenant, and on the 1st
day of each month thereafter throughout the remainder of such Comparison Year, Tenant shall pay to
Landlord an amount equal to 1/12 of Tenants Operating Payment shown on the Estimate.
Notwithstanding the foregoing, Tenant shall have no obligation to pay Tenants Operating Payment
for the first 12 months after the Commencement Date.
(b) On or before May 1st of each Comparison Year, Landlord shall furnish to Tenant a
Statement for the immediately preceding Comparison Year. If the Statement shows that the sums paid
by Tenant under Section 7.3(a) exceeded the actual amount of Tenants Operating Payment for such
Comparison Year, Landlord shall credit the amount of such excess against subsequent payments of
Rent due hereunder, or if the Term has expired, Landlord shall refund the overpayment to Tenant
within 30 days after the year-end Operating Expense reconciliation. If the Statement shows that
the sums so paid by Tenant were less than Tenants Operating Payment for such Comparison Year,
Tenant shall pay the amount of such deficiency within 30 days after Tenants receipt of the
Statement.
Section 7.4 Non-Waiver; Disputes.
(a) Landlords failure to render any Statement on a timely basis with respect
to any Comparison Year shall not prejudice Landlords right to thereafter render a Statement
with respect to such Comparison Year or any subsequent Comparison Year, nor shall the rendering of
a Statement prejudice Landlords right to thereafter render a corrected Statement for that
Comparison Year.
(b) Each Statement sent to Tenant shall be conclusively binding upon Tenant
unless Tenant (i) pays to Landlord when due the amount set forth in such Statement, without
prejudice to Tenants right to dispute such Statement, and (ii) within 60 days after such
Statement is sent, sends a notice to Landlord objecting to such Statement and specifying the
reasons therefor. Tenant agrees that Tenant will not employ, in connection with any dispute
under this Section, any person who is to be compensated in whole or in part, on a contingency
fee basis. If the parties are unable to resolve any dispute as to the correctness of such
Statement within 30 days following such notice of objection, either party may refer the issues raised to
a national firm reasonably acceptable to the other with at least 200 certified public
accountants, provided that the selected firm does not provide accounting or consulting services to either
party and does not otherwise have an affiliation or business relationship with either party and the
individual auditors area of expertise includes lease expense analysis. Notwithstanding the
immediately preceding sentence, the parties hereby agree that any of the Big Five public
accounting firms shall be acceptable, provided such firm has not served as an accountant for
Landlord or Tenant within the preceding 12 month period. The decision of the agreed upon
accountants shall be conclusively binding upon Landlord and Tenant. In connection therewith,
Tenant and such accountants shall execute and deliver to Landlord a confidentiality agreement, in
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form and substance reasonably satisfactory to Landlord, whereby such parties agree not to disclose
to any third party any of the information obtained in connection with such review. Tenant shall
pay the fees and expenses relating to such procedure, unless such accountants determine that
Landlord overstated Operating Expenses by more than 5% for such Comparison Year, in which case
Landlord shall pay such fees and expenses.
Section 7.5 Final Year of Term.
If the Expiration Date occurs on a date other than December
31st, any Additional Rent under this Article 7 for the Comparison Year in which such Expiration
Date occurs shall be apportioned on the basis of the number of days in the period from January 1st
to the Expiration Date. Upon the expiration or earlier termination of this Lease, any Additional
Rent under this Article 7 shall be paid or adjusted within 30 days after submission of the
Statement.
Section 7.6 No Reduction in Rent.
In no event shall any decrease in Operating Expenses or
Taxes in any Comparison Year below the Base Operating Expenses or Base Taxes, as the case may be,
result in a reduction in the Fixed Rent or any other component of Additional Rent payable
hereunder.
Section 7.7 Cap on Controllables.
Any provision of this Lease to the contrary
notwithstanding, Landlord and Tenant agree as follows:
(a) For purposes of calculating Tenants liability for payment of Tenants
Share of Controllable Operating Expenses, Controllable Operating Expenses for any calendar
year after the Base Year shall be deemed not to have exceeded the
Cap. The
Cap
means the
product of the Controllable Operating Expenses incurred during the Base Year multiplied by
105% (compounded annually for each calendar year (or partial calendar year) after the Base
Year for which the Cap is being determined). For example, if the Controllable Operating Expenses
incurred during the Base Year were $10,000, then the Cap would be $10,500 (
i.e., $
10,000 x
105%) for the first calendar year after the Base Year; $11,025 (
i.e., $
10,500 x 105%) for the
second calendar year after the Base Year; $11,576.25
(i.e.,
$11,025 X 105%) for the third
calendar year after the Base Year; and so on.
(b)
Controllable Operating Expenses
means all Operating Expenses other
than those incurred for: (i) property management fees; (ii) costs incurred to comply with
laws; (iii) [Intentionally Omitted]; (iv) property owner association dues and charges, (v) insurance
premiums, (vi) utility costs, (vii) [Intentionally Omitted], and (viii) costs incurred for ice
and snow removal.
(c) All payment calculations under this Article shall be prorated for any partial
calendar years during the Term and all calculations shall be based upon Operating Expenses as
grossed-up in accordance with the terms of this Lease.
(d) Taxes are not included in Operating Expenses and, therefore, Tenants Tax
Payments shall not be affected by the provisions of this Section.
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ARTICLE 8
REQUIREMENTS OF LAW
Section 8.1 Compliance with Requirements.
(a)
Tenants Compliance.
Tenant, at its expense, shall comply with all
Requirements applicable to Tenants use and occupancy of the Premises; provided, however, that
Tenant shall not be obligated to comply with any Requirements requiring any structural
alterations to the Building unless the application of such Requirements arises from (i) the
specific manner and nature of Tenants use or occupancy of the Premises, as distinct from general
office use, (ii) Alterations made by Tenant, or (iii) a breach by Tenant of any provisions of this
Lease. Any such repairs or alterations shall be made at Tenants expense by Tenant (1) in compliance
with Article 5 if such repairs or alterations are nonstructural and do not affect any Building
System, or (2) by Landlord if such repairs or alterations are structural or affect any
Building System. If Tenant obtains knowledge of any failure to comply with any Requirements applicable
to the Premises, Tenant shall give Landlord prompt notice thereof.
(b)
Hazardous Materials.
Tenant shall not cause or permit (i) any Hazardous
Materials to be brought into the Building, (ii) the storage or use of Hazardous Materials in
any manner other than in full compliance with any Requirements, or (iii) the escape, disposal or
release of any Hazardous Materials within or in the vicinity of the Building. Nothing herein
shall be deemed to prevent Tenants use of any Hazardous Materials customarily used in the ordinary
course of office work, provided such use is in accordance with all Requirements. Tenant shall
be responsible, at its expense, for all matters directly or indirectly based on, or arising or
resulting from the presence of Hazardous Materials in the Building which is caused or permitted by a
Tenant Party. Tenant shall provide to Landlord copies of all communications received by Tenant
with respect to any Requirements relating to Hazardous Materials, and/or any claims made in
connection therewith. Landlord or its agents may perform environmental inspections of the
Premises at any time.
(c)
Landlords Compliance.
Landlord shall comply with (or cause to be
complied with) all Requirements applicable to the Real Property which are not the obligation
of Tenant, to the extent that non-compliance would materially impair Tenants use and occupancy
of the Premises for the Permitted Uses.
(d)
Landlords Insurance.
Tenant shall not cause or permit any action or
condition that would (i) invalidate or conflict with Landlords insurance policies, (ii)
violate applicable rules, regulations and guidelines of the Fire Department, Fire Insurance Rating
Organization or any other authority having jurisdiction over the Building, (iii) cause an
increase in the premiums of fire insurance for the Building over that payable with respect to
Comparable Buildings, or (iv) result in Landlords insurance companies refusing to insure the Building
or any property therein in amounts and against risks as reasonably determined by Landlord. If
fire insurance premiums increase as a result of Tenants failure to comply with the provisions of
this
- 20 -
Section 8.1, Tenant shall promptly cure such failure and shall reimburse Landlord for the
increased fire insurance premiums paid by Landlord as a result of such failure by Tenant.
Section 8.2 Fire and Life Safety.
Landlord has installed a fire alarm and life safety system
in the Premises as part of its completion of the Building shell work. Any modifications to the fire
alarm and life safety systems installed as part of the Building shell work required by Tenant or
completed as part of the Tenant Improvements shall be at Tenants sole cost and expense, except
with respect to any such modifications that are part of the Tenant Improvements. If the Fire
Insurance Rating Organization or any Governmental Authority or any of Landlords insurers requires
or recommends any modifications and/or alterations be made or any additional equipment be supplied
in connection with the sprinkler system or fire alarm and life-safety system serving the Building
by reason of Tenants business, any Alterations performed by
Tenant or the location of the
partitions, Tenants Property, or other contents of the Premises, Landlord (to the extent outside
of the Premises) or Tenant (to the extent within the Premises) shall make such modifications and/or
Alterations, and supply such additional equipment, in either case at Tenants expense.
ARTICLE 9
SUBORDINATION
Section 9.1 Subordination and Attornment.
(a) This Lease is subject and subordinate to all Mortgages and Superior
Leases, and, at the request of any Mortgagee or Lessor, Tenant shall attorn to such Mortgagee
or Lessor, its successors in interest or any purchaser in a foreclosure sale.
(b) If a Lessor or Mortgagee or any other person or entity shall succeed to the
rights of Landlord under this Lease, whether through possession or foreclosure action or the
delivery of a new lease or deed, then at the request of the successor landlord and upon such
successor landlords written agreement to accept Tenants attornment and to recognize Tenants
interest under this Lease, Tenant shall be deemed to have attorned to and recognized such
successor landlord as Landlord under this Lease. The provisions of this Section 9.1 are
self-operative and require no further instruments to give effect hereto; provided, however, that
Tenant shall promptly execute and deliver any instrument that such successor landlord may reasonably
request (i) evidencing such attornment, (ii) setting forth the terms and conditions of
Tenants tenancy, and (iii) containing such other terms and conditions as may be required by such
Mortgagee or Lessor, provided such terms and conditions do not increase the Rent, materially
increase Tenants obligations or materially and adversely affect Tenants rights under this
Lease. Upon such attornment this Lease shall continue in full force and effect as a direct lease
between such successor landlord and Tenant upon all of the terms, conditions and covenants set forth
in this Lease except that such successor landlord shall not be
(i) liable for any act or omission of Landlord (except to the extent such act or omission
continues beyond the date when such successor landlord succeeds to Landlords interest and Tenant
gives notice of such act or omission);
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(ii) subject to any defense, claim, counterclaim, set-off or offsets which Tenant may have
against Landlord;
(iii) bound by any prepayment of more than one months Rent to any prior landlord;
(iv) bound by any obligation to make any payment to Tenant which was required to be made
prior to the time such successor landlord succeeded to Landlords interest;
(v) bound by any obligation to perform any work or to make improvements to the Premises except
for (x) repairs and maintenance required to be made by Landlord under this Lease, and (y) repairs
to the Premises as a result of damage by fire or other casualty or a partial condemnation pursuant
to the provisions of this Lease, but only to the extent that such repairs can reasonably be made
from the net proceeds of any insurance or condemnation awards, respectively, actually made
available to such successor landlord;
(vi) bound by any modification, amendment, or renewal of this Lease made without successor
landlords consent after Tenant has notice of the identity of the successor landlord;
(vii) liable for the repayment of any security deposit or surrender of any letter of credit,
unless and until such security deposit actually is paid or such letter of credit is actually
delivered to such successor landlord;
(viii) liable for the payment of any unfunded tenant improvement allowance, refurbishment
allowance or similar obligation; or
(ix) bound by any provisions of the Lease with respect to the Existing Furnishings.
(c) Tenant shall from time to time within 10 days of request from Landlord execute and
deliver any documents or instruments that may be reasonably required by any Mortgagee or Lessor to
confirm any subordination.
Section 9.2 Mortgage or Superior Lease Defaults.
Any Mortgagee may elect that this Lease
shall have priority over the Mortgage and, upon notification to Tenant by such Mortgagee, this
Lease shall be deemed to have priority over such Mortgage, regardless of the date of this Lease.
In connection with any financing of the Real Property, Tenant shall consent to any reasonable
modifications of this Lease requested by any lending institution, provided such modifications do
not increase the Rent, materially increase the obligations, or materially and adversely affect the
rights, of Tenant under this Lease.
Section 9.3 Tenants Termination Right.
As long as any Superior Lease or Mortgage exists,
Tenant shall not seek to terminate this Lease by reason of any act or omission of Landlord until
(a) Tenant shall have given notice of such act or omission to all Lessors and/or Mortgagees, and
(b) a reasonable period of time shall have elapsed following the giving of notice of such default
and the expiration of any applicable notice or grace periods (unless such act or
- 22 -
omission is not capable of being remedied within a reasonable period of time), during which period
such Lessors and/or Mortgagees shall have the right, but not the obligation, to remedy such act or
omission and thereafter diligently proceed to so remedy such act or omission. If any Lessor or
Mortgagee elects to remedy such act or omission of Landlord, Tenant shall not seek to terminate
this Lease so long as such Lessor or Mortgagee is proceeding with reasonable diligence to effect
such remedy.
Section 9.4 Provisions.
The provisions of this Article 9 shall (a) inure to the benefit of
Landlord, any future owner of the Building or the Real Property, Lessor or Mortgagee and any
sublessor thereof and (b) apply notwithstanding that, as a matter of law, this Lease may terminate
upon the termination of any such Superior Lease or Mortgage.
Section 9.5 Nondisturbance Agreement.
Any provision of this Section to the contrary
notwithstanding, Landlord shall use reasonable efforts (but without being obligated to commence
any legal or arbitration proceeding and without the expenditure of unreimbursed sums (other than
reasonable expenses that a landlord normally incurs in attempting to obtain a subordination,
non-disturbance and attornment agreement for its tenant, such as Landlords attorneys fees)) to
obtain for Tenant a subordination, non-disturbance and attornment agreement from all existing and
all future Mortgagees and Lessors, in the standard form customarily employed by such Mortgagee
and/or Lessor, provided that Tenant shall have no claim against Landlord, and Landlord shall have
no liability to Tenant and the subordination provided for in this Lease shall not be affected in
the event that Landlord is unable to obtain any such agreements.
Section 9.6 Right to Terminate.
Any provision of this Lease to the contrary notwithstanding,
if Landlord does not obtain for Tenant, within 30 days after the Effective Date (the
Delivery
Period
), a subordination, non-disturbance and attornment agreement from Landlords existing
Mortgagee, in the standard form customarily employed by such Mortgagee, Tenant shall have the
right, as Tenants sole remedy, to terminate this Lease by delivering to Landlord written notice
of such termination within the 7 day period following the Delivery Period. If Tenant so elects to
terminate this Lease, the termination shall be effective upon Landlords receipt of the aforesaid
notice. If Tenant fails to so terminate this Lease, Tenant shall be deemed to have waived its
right to such subordination, non-disturbance and attornment agreement.
ARTICLE 10
SERVICES
Section 10.1 Electricity.
Subject to any Requirements or any public utility rules or
regulations governing energy consumption, Landlord shall make or cause to be made, customary
arrangements with utility companies and/or public service companies to furnish electric current to
the Premises for Tenants use in accordance with Annex 1 to the Work Letter attached hereto. If
Landlord reasonably determines by the use of an electrical consumption survey or by other
reasonable means that Tenant is using electric current (including overhead fluorescent fixtures) in
excess of .60 kilowatt hours per square foot of usable area in the Premises per month, as
- 23 -
determined on an annualized basis (
Excess Electrical Usage
), then Landlord shall have the right
to charge Tenant an amount equal to Landlords reasonable estimate of Tenants Excess Electrical
Usage, and shall have the further right to install an electric current meter, sub-meter or check
meter in the Premises (a
Meter
) to measure the amount of electric current consumed in the
Premises. The cost of such Meter special conduits, wiring and panels needed in connection
therewith and the installation, maintenance and repair thereof shall be paid by Tenant. Tenant
shall pay to Landlord, from time to time, but no more frequently than monthly, for its Excess
Electrical Usage at the Premises. The rate to be paid by Tenant for submetered electricity shall
include any taxes or other charges in connection therewith.
Section 10.2 Excess Electricity.
Tenant shall at all times comply with the rules and
regulations of the utility company supplying electricity to the Building. Tenant shall not use any
electrical equipment which, in Landlords reasonable judgment, would exceed the capacity of the
electrical equipment serving the Premises. If Landlord determines that Tenants electrical
requirements necessitate installation of any additional risers, feeders or other electrical
distribution equipment (collectively,
Electrical Equipment
), or if Tenant provides Landlord with
evidence reasonably satisfactory to Landlord of Tenants need for excess electricity and requests
that additional Electrical Equipment be installed, Landlord shall, at Tenants expense, install
such additional Electrical Equipment, provided that Landlord, in its sole judgment, determines that
(a) such installation is practicable and necessary, (b) such additional Electrical Equipment is
permissible under applicable Requirements, and (c) the installation of such Electrical Equipment
will not cause permanent damage to the Building or the Premises, cause or create a hazardous
condition, entail excessive or unreasonable alterations, interfere with or limit electrical usage
by other tenants or occupants of the Building or exceed the limits of the switchgear or other
facilities serving the Building, or require power in excess of that available from the utility
company serving the Building.
Section 10.3 Elevators.
Landlord shall provide elevator service to the Premises 24 hours per
day, 7 days per week, subject to the Rules and Regulations attached hereto as
Exhibit F.
Section 10.4 Heating, Ventilation and Air Conditioning.
Landlord shall furnish to the
Premises heating, ventilation and air-conditioning (
HVAC
) in accordance with Annex 1 to the Work
Letter during Ordinary Business Hours. Landlord shall have access to all air-cooling, fan,
ventilating and machine rooms and electrical closets and all other mechanical installations of
Landlord (collectively,
Mechanical Installations
), and Tenant shall not construct partitions or
other obstructions which may interfere with Landlords access thereto or the moving of Landlords
equipment to and from the Mechanical Installations. No Tenant Party shall at any time enter the
Mechanical Installations or tamper with, adjust, or otherwise affect such Mechanical
Installations. Landlord shall not be responsible if the HVAC System fails to provide cooled or
heated air, as the case may be, to the Premises by reason of (i) any equipment installed by, for
or on behalf of Tenant, which has an electrical load in excess of the average electrical load and
human occupancy factors for the HVAC System as designed, or (ii) any rearrangement of partitioning
or other Alterations made or performed by, for or on behalf of Tenant. Tenant shall cooperate with
Landlord and shall abide by the rules and regulations which Landlord may reasonably prescribe for
the proper functioning and protection of the HVAC System. Landlord
- 24 -
shall not be responsible if the HVAC System fails to provide cooled or heated air, as the case may
be, to the Premises by reason of (i) any equipment installed by, for or on behalf of Tenant, which
has an electrical load in excess of the average electrical load and human occupancy factors for
the HVAC System as designed, or (ii) any rearrangement of partitioning or other Alterations made
or performed by, for or on behalf of Tenant. Tenant shall cooperate with Landlord and shall abide
by the rules and regulations which Landlord may reasonably prescribe for the proper functioning
and protection of the HVAC System.
Section 10.5 Overtime HVAC.
The Fixed Rent does not include any charge to Tenant for the
furnishing of HVAC to the Premises during any periods other than Ordinary Business Hours (
Overtime
Periods
). If Tenant desires HVAC services during Overtime Periods, Tenant shall deliver notice to
the Building office requesting such services by 2:00 p.m. of the Business Day on which or preceding
the date such services are requested; provided, however, that Landlord shall use reasonable efforts
to arrange such service on such shorter notice as Tenant shall provide. If Landlord furnishes HVAC
service during Overtime Periods, Tenant shall pay to Landlord the cost thereof at the then
established rates for such services in the Building. The current rate charged for HVAC during
Overtime Periods is $45.00 per hour per floor, which rate is subject to change during the Term.
Section 10.6 Cleaning.
Landlord shall cause the Premises (excluding any portions thereof used
for the storage, preparation, service or consumption of food or beverages) to be cleaned,
substantially in accordance with the standards set forth in
Exhibit D.
Any areas of the
Premises requiring additional cleaning such as areas used for preparation or consumption of food,
private bathrooms, computer rooms, mail rooms and trading floors shall be cleaned, at Tenants
expense, by Landlords cleaning contractor, at rates which shall be competitive with rates of
other cleaning contractors providing comparable services to Comparable Buildings. Landlords
cleaning contractor and its employees shall have access to the Premises at all times except
between 8:00 a.m. and 5:30 p.m. on weekdays which are not Observed Holidays.
Section 10.7 Water.
Landlord, at Landlords expense, shall provide water in the core
lavatories, drinking fountains and janitors closets on each floor of the Building. If Tenant
requires water in excess of that used by an average office building tenant of similar size using
its premises for ordinary office use, Tenant shall pay for the cost of bringing water to the
Premises and Landlord may install a meter to measure the water. Tenant shall pay the cost of such
installation, and for all maintenance, repairs and replacements thereto, and for the reasonable
charges of Landlord for the water consumed.
Section 10.8 Refuse Removal.
Landlord shall provide refuse removal services at the Building.
Tenant shall pay to Landlord, Landlords reasonable charge for such removal to the extent that the
refuse generated by Tenant exceeds the refuse customarily generated by general office tenants.
Tenant shall not dispose of any refuse in the Common Areas, and if Tenant does so, Tenant shall be
liable for Landlords reasonable charge for such removal.
Section 10.9 Directory.
Landlord shall list Tenant on the Building directory located in the
first floor lobby. The Building directory will be shared with other Building tenants.
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Section 10.10 Tenant Access to Premises.
Tenant shall have access to the Premises 24 hours a
day, 7 days a week. Outside of Ordinary Business Hours, Building and floor access will be
monitored by an electronic key security and access system installed and maintained by Landlord.
Landlord shall be responsible for access control to the Building, which access control shall be
at least to the access control standard found at typical Comparable Buildings. Tenant shall be
responsible for access control to the Premises at Tenants sole cost and expense. Landlord will
deliver (or cause to be delivered) to Tenant, at Landlords expense, 250 Building access cards.
Any additional or replacement cards will be issued at Tenants expense.
Section 10.11 Service Interruptions.
Landlord reserves the right to suspend any service when
necessary, by reason of Unavoidable Delays, accidents or emergencies, or for Restorative Work
which, in Landlords reasonable judgment, are necessary or appropriate until such Unavoidable
Delay, accident or emergency shall cease or such Restorative Work is completed and Landlord shall
not be liable for any interruption, curtailment or failure to supply services. Landlord shall use
reasonable efforts to minimize interference with Tenants use and occupancy of the Premises as a
result of any such failure, defect or interruption of any such service, or change in the supply,
character and/or quantity of, electrical service, and to restore any such services, remedy such
situation and minimize any interference with Tenants business. The exercise of any such right or
the occurrence of any such failure by Landlord shall not constitute an actual or constructive
eviction, in whole or in part, entitle Tenant to any compensation, abatement or diminution of Rent,
relieve Tenant from any of its obligations under this Lease, or impose any liability upon Landlord
or any Indemnified Party by reason of inconvenience to Tenant, or interruption of Tenants
business, or otherwise. Landlord shall not be liable in any way to Tenant for any failure, defect
or interruption of, or change in the supply, character and/or quantity of electrical service
furnished to the Premises for any reason except if attributable to the gross negligence or willful
misconduct of Landlord.
ARTICLE 11
INSURANCE; PROPERTY LOSS OR DAMAGE
Section 11.1 Tenants Insurance.
(a) Tenant, at its expense, shall obtain and keep in full force and effect during the
Term:
(i) a policy of commercial general liability insurance on an occurrence basis against claims
for personal injury, bodily injury, death and/or property damage occurring in or about the
Building, under which Tenant is named as the insured and Landlord, Landlords Agent and any
Lessors and any Mortgagees whose names have been furnished to Tenant are named as additional
insureds (the
Insured Parties
). Such insurance shall provide primary coverage without
contribution from any other insurance carried by or for the benefit of the Insured Parties, and
Tenant shall obtain blanket broad-form contractual liability coverage to insure its indemnity
obligations set forth in Article 25. The minimum limits of liability shall be (a) a combined
single limit with respect to each occurrence in an amount of not less than $1,000,000; and (b)
Umbrella/Excess Liability with limits of not less than $10,000,000 combined
- 26 -
single limit in excess of the above-referenced commercial general liability. The deductible or
self insured retention for such policy shall not exceed $25,000;
(ii) insurance against loss or damage by fire, and such other risks and hazards as are
insurable under then available standard forms of Special Form Causes of Loss or All Risk
property insurance policies, insuring Tenants Property and all Alterations and improvements to the
Premises (including the initial installations) to the extent such Alterations and improvements
exceed the cost of the improvements typically performed in connection with the initial occupancy of
tenants in the Building (
Building Standard Installations
), for the full insurable value thereof
or replacement cost thereof, having a deductible amount, if any, not in excess of $25,000; and
insurance against loss or damage by fire, and such other risks and hazards as are insurable under
then available standard forms of Special Form Causes of Loss or All Risk property insurance
policies, insuring the Existing Furnishings for the full insurable value thereof or replacement
cost thereof, having a deductible amount, if any, not in excess of $25,000;
(iii) during the performance of any Alteration, until completion thereof, Builders Risk
insurance on an all risk basis and on a completed value form including a Permission to Complete
and Occupy endorsement, for full replacement value covering the interest of Landlord and Tenant
(and their respective contractors and subcontractors) in all work incorporated in the Building and
all materials and equipment in or about the Premises;
(iv) Workers Compensation Insurance, as required by law;
(v) [Intentionally Omitted]; and
(vi) during the Extension Term, such other insurance in such amounts as the Insured Parties
may reasonably require from time to time, but only if Landlord has informed Tenant of such other
insurance requirements prior to the date on which Tenant gives Landlord notice that Tenant elects
to lease the Premises for the Extension Term pursuant to Rider No. 1 Extension Option.
(b) All insurance required to be carried by Tenant (i) shall contain a provision
that (x) no act or omission of Tenant shall affect or limit the obligation of the insurance
company to pay the amount of any loss sustained, and (y) shall be noncancellable and/or no material
change in coverage shall be made thereto unless the Insured Parties receive 30 days prior
notice of the same, by certified mail, return receipt requested, and (ii) shall be effected under
valid and enforceable policies issued by reputable insurers permitted to do business in the Commonwealth
of Virginia and rated in Bests Insurance Guide, or any successor thereto as having a Bests
Rating of A- or better and a Financial Size Category of at least X or better or, if
such ratings are not then in effect, the equivalent thereof or such other financial rating as
Landlord may at any time consider appropriate.
(c) On or prior to the Commencement Date, Tenant shall deliver to Landlord
appropriate policies of insurance, including evidence of waivers of subrogation required to be
carried pursuant to this Article 11 and that the Insured Parties are named as additional
insureds (the
Policies
). Tenant shall provide evidence of each renewal or replacement of the Policies
and shall use commercially reasonable efforts to deliver such evidence to Landlord at least 10
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days prior to the expiration of the Policies. Tenant shall also advise all Insured Parties in
writing by certified mail, return receipt requested, at least 30 days in advance of any
termination or change to the Policies that would affect the interest of any of the Insured
Parties. In lieu of the Policies, Tenant may deliver to Landlord a certification from Tenants
insurance company (on the form currently designated Acord 27 (Evidence of Property Insurance)
and Acord 25-S (Certificate of Liability Insurance), or the equivalent, provided that attached
thereto is an endorsement to Tenants commercial general liability policy naming the Insured
Parties as additional insureds) which shall be binding on Tenants insurance company, and which
shall expressly provide that such certification conveys to the Insured Parties all the rights and
privileges afforded under the Policies as primary insurance.
Section 11.2 Waiver of Subrogation.
Landlord and Tenant shall each procure an appropriate
clause in or endorsement to any property insurance covering the Real Property and personal
property, fixtures and equipment located therein, wherein the insurer waives subrogation or
consents to a waiver of right of recovery, and Landlord and Tenant agree not to make any claim
against, or seek to recover from, the other for any loss or damage to its property or the property
of others resulting from fire or other hazards to the extent covered by such property insurance;
provided, however, that the release, discharge, exoneration and covenant not to sue contained
herein shall be limited by and be coextensive with the terms and provisions of the waiver of
subrogation or waiver of right of recovery. Tenant acknowledges that Landlord shall not carry
insurance on, and shall not be responsible for, (i) damage to any Above Building Standard
Installations, (ii) Tenants Property, and (iii) any loss suffered by Tenant due to interruption of
Tenants business.
Section 11.3 Restoration.
(a) If the Premises are damaged by fire or other casualty, or if the Building is damaged such
that Tenant is deprived of reasonable access to the Premises, the damage shall be repaired by
Landlord, to substantially the condition of the Premises prior to the damage, subject to the
provisions of any Mortgage or Superior Lease, but Landlord shall have no obligation to repair or
restore (i) Tenants Property or (ii) except as provided in Section 11.3(b), any
Alterations or improvements to the Premises, to the extent such Alterations or improvements exceed
Building Standard Installations (
Above Building Standard Installations).
So long as Tenant is
not in default beyond applicable grace or notice provisions in the payment or performance of its
obligations under this Section 11.3, and provided Tenant timely delivers to Landlord either
Tenants Restoration Payment (as hereinafter defined) or the Restoration Security (as hereinafter
defined) or Tenant expressly waives any obligation of Landlord to repair or restore any of Tenants
Above Building Standard Installations, then until the restoration of the Premises is Substantially
Completed or would have been Substantially Completed but for Tenant delay, Fixed Rent, Tenants Tax
Payment and Tenants Operating Payment shall be reduced in the proportion by which the area of the
part of the Premises which is not usable (or accessible ) and is not used by Tenant bears to the
total area of the Premises.
(b) As a condition precedent to Landlords obligation to repair or restore any Above Building
Standard Installations, Tenant shall pay to Landlord upon demand a sum
(Tenants Restoration
Payment)
equal to the amount, if any, by which (A) the cost, as
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estimated by a reputable independent contractor designated by Landlord, of repairing and restoring
all Alterations and Tenant Improvements in the Premises to their condition prior to the damage,
exceeds (B) the cost of restoring the Premises with Building Standard Installations. If Tenant
shall fail to deliver to Landlord either (1) Tenants Restoration Payment, or (2) a waiver by
Tenant, in form satisfactory to Landlord, of all of Landlords obligations to repair or restore
any of the Above Building Standard Installations, in either case within 15 days after Landlords
demand therefor, Landlord shall have no obligation to restore any Above Building Standard
Installations and Tenants abatement of Fixed Rent, Tenants Tax Payment and Tenants Operating
Payment shall cease when the restoration of the Premises (other than any Above Building Standard
Installations) is Substantially Complete.
Section 11.4 Landlords Termination Right.
Notwithstanding anything to the. contrary
contained in Section 11.3, if the Premises are totally damaged or are rendered wholly
untenantable, or if the Building shall be so damaged that, in Landlords reasonable opinion,
substantial alteration, demolition, or reconstruction of the Building shall be required (whether
or not the Premises are so damaged or rendered untenantable), then in either of such events,
Landlord may, not later than 60 days following the date of the damage, terminate this Lease by
notice to Tenant, provided that if the Premises are not damaged, Landlord may not terminate this
Lease unless Landlord similarly terminates the leases of other tenants in the Building aggregating
at least 50% of the portion of the Building occupied for office purposes immediately prior to such
damage. If this Lease is so terminated, (a) the Term shall expire upon the 30th day after such
notice is given, (b) Tenant shall vacate the Premises and surrender the same to Landlord, (c)
Tenants liability for Rent shall cease as of the date of the damage, and (d) any prepaid Rent for
any period after the date of the damage shall be refunded by Landlord to Tenant.
Section 11.5 Tenants Termination Right.
If the Premises are totally damaged and are thereby
rendered wholly untenantable, or if the Building shall be so damaged that Tenant is deprived of
reasonable access to the Premises, and if Landlord elects to restore the Premises, Landlord shall,
within 60 days following the date of the damage, cause a contractor or architect selected by
Landlord to give notice (the
Restoration Notice
) to Tenant of the date by which such contractor
or architect estimates the restoration of the Premises (excluding any Above Building Standard
Installations) shall be Substantially Completed. If such date, as set forth in the Restoration
Notice, is more than 12 months from the date of such damage, then Tenant shall have the right to
terminate this Lease by giving notice (the
Termination Notice
) to Landlord not later than 30 days
following delivery of the Restoration Notice to Tenant. If Tenant delivers a Termination Notice,
this Lease shall be deemed to have terminated as of the date of the giving of the Termination
Notice, in the manner set forth in the second sentence of Section 11.4.
Section 11.6 Final 18 Months.
Notwithstanding anything to the contrary in this Article 11, if
any damage during the final 18 months of the Term renders the Premises wholly untenantable, either
Landlord or Tenant may terminate this Lease by notice to the other party within 30 days after the
occurrence of such damage and this Lease shall expire on the 30th day after the date of such
notice. For purposes of this Article, the Premises shall be deemed wholly untenantable if Tenant
shall be precluded from using more than 50% of the Premises for the conduct of its business and
Tenants inability to so use the Premises is reasonably expected to continue for more than 90
days.
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Section 11.7 Landlords Liability.
Any Building employee to whom any property shall be
entrusted by or on behalf of Tenant shall be deemed to be acting as Tenants agent with respect to
such property and neither Landlord nor its agents shall be liable for any damage to such property,
or for the loss of or damage to any property of Tenant by theft or otherwise. For example, if a
Tenant employee leaves an envelope with a Building lobby guard for pick-up by a messenger service,
Landlord will not be responsible if such package is misplaced, stolen, damaged or picked up by the
wrong messenger service. None of the Insured Parties shall be liable for any injury or damage to
persons or property or interruption of Tenants business resulting from fire or other casualty, any
damage caused by other tenants or persons in the Building or the parking facilities or by
construction of any private, public or quasi-public work, or any latent defect in the Premises or
in the Building or the parking facilities (except that Landlord shall be required to repair the
same to the extent provided in Article 6). No penalty shall accrue for delays which may arise by
reason of adjustment of fire insurance on the part of Landlord or Tenant, or for any Unavoidable
Delays arising from any repair or restoration of any portion of the Building, provided that
Landlord shall use reasonable efforts to minimize interference with Tenants use and occupancy of
the Premises during the performance of any such repair or restoration.
Section 11.8 Landlords Insurance.
During the Term, Landlord shall maintain in effect such
policies of insurance as are at least in such amounts (and are subject to no larger deductibles)
as are customarily carried by landlords of Comparable Buildings, including, without limitation,
insurance against loss or damage by fire, and such other risks and hazards as are insurable under
then available forms of all risk property insurance policies with extended coverage, insuring
the Building for the full insurable value thereof or replacement cost thereof (exclusive of
footing and foundation costs).
ARTICLE 12
EMINENT DOMAIN
Section 12.1 Taking.
(a)
Total Taking.
If all or substantially all of the Real Property, the Building or the
Premises shall be acquired or condemned for any public or quasi-public purpose (a
Taking
), this
Lease shall terminate and the Term shall end as of the date of the vesting of title and Rent shall
be prorated and adjusted as of such date.
(b)
Partial Taking.
Upon a Taking of only a part of the Real Property, the Building or the
Premises then, except as hereinafter provided in this Article 12, this Lease shall continue in full
force and effect, provided that from and after the date of the vesting of title, Fixed Rent and
Tenants Proportionate Share shall be modified to reflect the reduction of the Premises and/or the
Building and/or Tenants loss of any parking rights as a result of such Taking.
(c)
Landlords Termination Right.
Whether or not the Premises are affected, Landlord
may, by notice to Tenant, within 60 days following the date upon which Landlord receives notice of
the Taking of all or a portion of the Real Property, the Building or the
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Premises, terminate this Lease, provided that Landlord elects to terminate leases (including this
Lease) affecting at least 50% of the rentable area of the Building.
(d)
Tenants Termination Right.
If the part of the Real Property so Taken contains more than
20% of the total area of the Premises occupied by Tenant immediately prior to such Taking, or if,
by reason of such Taking, Tenant no longer has reasonable means of access to the Premises or if
Tenants parking rights are totally or substantially curtailed, Tenant may terminate this Lease by
notice to Landlord given within 30 days following the date upon which Tenant is given notice of
such Taking. If Tenant so notifies Landlord, this Lease shall end and expire upon the 30th day
following the giving of such notice. If a part of the Premises shall be so Taken and this Lease is
not terminated in accordance with this Section 12.1 Landlord, without being required to spend more
than it collects as an award, shall, subject to the provisions of any Mortgage or Superior Lease,
restore that part of the Premises not so Taken to a self-contained rental unit substantially
equivalent (with respect to character, quality, appearance and services) to that which existed
immediately prior to such Taking, excluding Tenants Property and Above Building Standard
Installations.
(e)
Apportionment of Rent
. Upon any termination of this Lease pursuant to the provisions of
this Article 12, Rent shall be apportioned as of, and shall be paid or refunded up to and
including, the date of such termination.
Section 12.2 Awards.
Upon any Taking, Landlord shall receive the entire award for any such
Taking, and Tenant shall have no claim against Landlord or the condemning authority for the value
of any unexpired portion of the Term or Tenants Alterations; and Tenant hereby assigns to
Landlord all of its right in and to such award. Nothing contained in this Article 12 shall be
deemed to prevent Tenant from making a separate claim in any condemnation proceedings for the then
value of any Tenants Property or Above Building Standard Installations included in such Taking
and for any moving expenses, provided any such award is in addition to, and does not result in a
reduction of, the award made to Landlord.
Section 12.3 Temporary Taking.
If all or any part of the Premises is Taken temporarily during
the Term for any public or quasi-public use or purpose, Tenant shall give prompt notice to
Landlord and the Term shall not be reduced or affected in any way and Tenant shall continue to pay
all Rent payable by Tenant without reduction or abatement and to perform all of its other
obligations under this Lease, except to the extent prevented from doing so by the condemning
authority, and Tenant shall be entitled to receive any award or payment from the condemning
authority for such use.
ARTICLE 13
ASSIGNMENT AND SUBLETTING
Section 13.1 Consent Requirements.
(a)
No Assignment or Subletting.
Except as expressly set forth herein, Tenant shall not
assign, mortgage, pledge, encumber, or otherwise transfer this Lease, whether by operation of law
or otherwise, and shall not sublet, or permit, or suffer the Premises or any part
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thereof to be used or occupied by others (whether for desk space, mailing privileges or
otherwise), without Landlords prior consent in each instance. Any assignment, sublease,
mortgage, pledge, encumbrance or transfer in contravention of the provisions of this Article 13
shall be void and shall constitute an Event of Default.
(b)
Collection of Rent.
If, without Landlords consent, this Lease is assigned, or any part of
the Premises is sublet or occupied by anyone other than Tenant or this Lease is encumbered (by
operation of law or otherwise), Landlord may collect rent from the assignee, subtenant or occupant,
and apply the net amount collected to the Rent herein reserved. No such collection shall be deemed
a waiver of the provisions of this Article 13, an acceptance of the assignee, subtenant or occupant
as tenant, or a release of Tenant from the performance of Tenants covenants hereunder, and in all
cases Tenant shall remain fully liable for its obligations under this Lease.
(c)
Further Assignment/Subletting.
Landlords consent to any assignment or subletting shall
not relieve Tenant from the obligation to obtain Landlords consent to any further assignment or
subletting. In no event shall any permitted subtenant assign or encumber its sublease or further
sublet any portion of its sublet space, or otherwise suffer or permit any portion of the sublet
space to be used or occupied by others.
Section 13.2 Tenants Notice.
If Tenant desires to assign this Lease or sublet all or any
portion of the Premises, Tenant shall give notice thereof to Landlord, which shall be accompanied
by (a) with respect to an assignment of this Lease, the date Tenant desires the assignment to be
effective; (b) with respect to a sublet of all or a part of the Premises, a description of the
portion of the Premises to be sublet and the commencement and expiration dates (together with all
extension options) of such sublet; and (c) a copy of a
bona fide
term sheet or letter of intent
pertaining to such proposed assignment or sublease and executed by Tenant and the proposed
assignee or subtenant. If Tenant desires to assign this Lease or if Tenant desires to sublet as
aforesaid and the term (including, if exercised, any extension option(s)) of the sublease that
will expire during the last 12 months of the then Term, such notice shall, except with respect to
a Permitted Transfer, be deemed an irrevocable offer from Tenant to Landlord of the right, at
Landlords option, (1) to terminate this Lease with respect
to such space as Tenant proposes to
sublease (the
Partial Space
), upon the terms and conditions hereinafter set forth, or (2) if the
proposed transaction is an assignment of this Lease, to terminate this Lease with respect to the
entire Premises. Such option may be exercised by notice from Landlord to Tenant within 30 days
after delivery of Tenants notice. If Landlord exercises its option to terminate all or a portion
of this Lease, (a) this Lease shall end and expire with respect to all or a portion of the
Premises, as the case may be, on the date that such assignment or sublease was to commence, (b)
Rent shall be apportioned, paid or refunded as of such date, (c) Tenant, upon Landlords request,
shall enter into an amendment of this Lease ratifying and confirming such total or partial
termination, and setting forth any appropriate modifications to the terms and provisions hereof,
and (d) Landlord shall be free to lease the Premises (or any part thereof) to Tenants prospective
assignee or subtenant. Tenant shall pay all costs to make the Partial Space a self-contained
rental unit and to install any required Building corridors.
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Section 13.3 Conditions to Assignment/Subletting.
(a) If
Landlord does not exercise its termination option provided under
Section 13.2,
and provided no Event of Default then exists, Landlords consent to the proposed assignment or
subletting shall not be unreasonably withheld or delayed. Such consent shall be granted or denied
within 15 days after delivery to Landlord of (i) a true and complete statement reasonably detailing
the identity of the proposed assignee or subtenant (
Transferee
), the nature of its business and
its proposed use of the Premises, (ii) current financial information with respect to the
Transferee, including its most recent financial statements, and (iii) any other information
Landlord may reasonably request, provided that:
(i) in Landlords reasonable judgment, the Transferee is engaged in a business or
activity, and the Premises will be used in a manner, which (1) is in keeping with the then
standards of the Building, (2) is for the Permitted Uses, and (3) does not violate any restrictions
set forth in this Lease, any Mortgage or Superior Lease or any negative covenant as to use of the
Premises required by any other lease in the Building;
(ii) the Transferee is reputable with sufficient financial means to perform all of its
obligations under this Lease or the sublease, as the case may be;
(iii) [Intentionally Omitted];
(iv) [Intentionally Omitted];
(v) [Intentionally Omitted];
(vi) Tenant shall, upon demand, reimburse Landlord for all reasonable expenses incurred by
Landlord in connection with such assignment or sublease, including any investigations as to the
acceptability of the Transferee and all legal costs (not to exceed $1,500) reasonably incurred in
connection with the granting of any requested consent; and
(vii) the Transferee shall not be entitled, directly or indirectly, to diplomatic or
sovereign immunity, regardless of whether the Transferee agrees to waive such diplomatic or
sovereign immunity, and shall be subject to the service of process in, and the jurisdiction of the
courts of, the District of Columbia.
(b) with respect to each and every subletting and/or assignment approved by Landlord under the
provisions of this Lease:
(i) the form of the proposed assignment or sublease shall be reasonably satisfactory to
Landlord;
(ii) [Intentionally Omitted];
(iii) no Transferee shall take possession of any part of the Premises, until an executed
counterpart of such sublease or assignment has been delivered to Landlord and approved by Landlord
as provided in Section 13.3;
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(iv) if an Event of Default occurs prior to the effective date of such assignment or
subletting, then Landlords consent thereto, if previously granted, shall be immediately deemed
revoked without further notice to Tenant, and if such assignment or subletting would have been
permitted without Landlords consent pursuant to Section 13.7, such permission shall be void and
without force and effect, and in either such case, any such assignment or subletting shall
constitute a further Event of Default hereunder; and
(v) each sublease shall be subject and subordinate to this Lease and to the matters to which
this Lease is or shall be subordinate; and Tenant and each Transferee shall be deemed to have
agreed that upon the occurrence and during the continuation of an Event of Default hereunder,
Tenant has hereby assigned to Landlord, and Landlord may, at its option, accept such assignment of,
all right, title and interest of Tenant as sublandlord under such sublease, together with all
modifications, extensions and renewals thereof then in effect and such Transferee shall, at
Landlords option, attorn to Landlord pursuant to the then executory provisions of such sublease,
except that Landlord shall not be (A) liable for any previous act or omission of Tenant under such
sublease, (B) subject to any counterclaim, offset or defense not expressly provided in such
sublease, which theretofore accrued to such Transferee against Tenant, (C) bound by any previous
modification of such sublease not consented to by Landlord or by any prepayment of more than one
months rent, (D) bound to return such Transferees security deposit, if any, except to the extent
Landlord shall receive actual possession of such deposit and such Transferee shall be entitled to
the return of all or any portion of such deposit under the terms of its sublease, or (E) obligated
to make any payment to or on behalf of such Transferee, or to perform any work in the subleased
space or the Building, or in any way to prepare the subleased space for occupancy, beyond
Landlords obligations under this Lease. The provisions of this Section 13.3(b)(v) shall be
self-operative, and no further instrument shall be required to give effect to this provision,
provided that the Transferee shall execute and deliver to Landlord any instruments Landlord may
reasonably request to evidence and confirm such subordination and
attornment.
Section 13.4 Binding on Tenant; Indemnification of Landlord.
Notwithstanding any assignment
or subletting or any acceptance of rent by Landlord from any Transferee, Tenant shall remain fully
liable for the payment of all Rent due and for the performance of all the covenants, terms and
conditions contained in this Lease on Tenants part to be observed and performed, and any default
under any term, covenant or condition of this Lease by any Transferee or anyone claiming under or
through any Transferee shall be deemed to be a default under this Lease by Tenant. Tenant shall
indemnify, defend, protect and hold harmless Landlord from and against any and all Losses
resulting from any claims that may be made against Landlord by the Transferee or anyone claiming
under or through any Transferee or by any brokers or other persons claiming a commission or
similar compensation in connection with the proposed assignment or sublease, irrespective of
whether Landlord shall give or decline to give its consent to any proposed assignment or sublease,
or if Landlord shall exercise any of its options under this Article 13.
Section 13.5 Tenants Failure to Complete.
If Landlord consents to a proposed assignment or
sublease and Tenant fails to execute and deliver to Landlord such assignment or sublease within 90
days after the giving of such consent, then Tenant shall again comply with all
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of the provisions and conditions of Section 13.2 before assigning this Lease or subletting all or
part of the Premises.
Section 13.6 Profits.
If Tenant enters into any assignment or sublease permitted hereunder or
consented to by Landlord, Tenant shall, within 60 days of Landlords consent to such assignment or
sublease, deliver to Landlord a list of Tenants reasonable third-party brokerage fees, legal fees,
architectural fees and tenant improvement costs paid or to be paid in connection with such
transaction and any actual costs incurred by Tenant in separately demising the subleased space
(collectively,
Transaction Costs
), together with a list of all of Tenants Property to be
transferred to such Transferee. The Transaction Costs shall be amortized, on a straight-line basis,
over the term of any sublease. Tenant shall deliver to Landlord evidence of the payment of such
Transaction Costs promptly after the same are paid. In consideration of such assignment or
subletting, Tenant shall pay to Landlord:
(a) In
the case of an assignment, on the effective date of the assignment, 50% of all sums
and other consideration paid to Tenant by the Transferee for or by reason of such assignment
(including sums paid for the sale or rental of Tenants Property, less, the then fair market or
rental value thereof) after first deducting the Transaction Costs; or
(b) In the case of a sublease, 50% of any consideration payable under the sublease to Tenant
by the Transferee which exceeds on a per square foot basis the Fixed Rent and Additional Rent
accruing during the term of the sublease in respect of the subleased space (together with any sums
paid for the sale or rental of Tenants Property, less, the then fair market or rental value
thereof) after first deducting the monthly amortized amount of Transaction Costs. The sums payable
under this clause shall be paid by Tenant to Landlord monthly as and when paid by the subtenant to
Tenant.
Section 13.7 Transfers.
(a)
Related Entities.
If Tenant is a legal entity, the transfer (by one or more transfers) of
a majority of the stock or other beneficial ownership interest in Tenant (collectively
Ownership
Interests
) shall be deemed a voluntary assignment of this Lease; provided, however, that the
provisions of this Article 13 shall not apply to the transfer of Ownership Interests in Tenant if
and so long as Tenant is publicly traded on a nationally recognized stock exchange. For purposes
of this Section 13.7 the term transfers shall be deemed to include the issuance of new Ownership
Interests which results in a majority of the Ownership Interests in Tenant being held by a person
or entity which does not hold a majority of the Ownership Interests in Tenant on the Effective
Date.
Any provision of this Article to the contrary notwithstanding, Tenant shall have the right to
assign this Lease or to sublease the Premises or a portion thereof to a business entity into or
with which Tenant is merged or consolidated or to which substantially all of Tenants assets are
transferred so long as (i) such transfer was made for a legitimate independent business purpose
and not for the purpose of transferring this Lease, (ii) the successor to Tenant has a net worth
computed in accordance with generally accepted accounting principles at least equal to the net
worth of Tenant immediately prior to such merger, consolidation or transfer, and (iii) proof
satisfactory to Landlord of such net worth is delivered to Landlord at least 10 days prior to the
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effective date of any such transaction. Tenant may also, upon prior notice to Landlord, permit any
business entity which controls, is controlled by, or is under common control with the original
Tenant (a
Related Entity
) to sublet all or part of the Premises for any Permitted Use, provided
the Related Entity is in Landlords reasonable judgment of a character and engaged in a business
which is in keeping with the standards for the Building and for so long as such entity remains a
Related Entity. Such sublease shall not be deemed to vest in any such Related Entity any right or
interest in this Lease nor shall it relieve, release, impair or discharge any of Tenants
obligations hereunder. For the purposes hereof, control shall be deemed to mean ownership of not
less than 50% of all of the Ownership Interests of such corporation or other business entity.
Notwithstanding the foregoing, Tenant shall have no right to assign this Lease or sublease all or
any portion of the Premises without Landlords consent pursuant to this Section 13.7 if Tenant is
not the initial Tenant herein named or a person or entity who acquired Tenants interest in this
Lease in a transaction approved by Landlord.
(b)
Applicability.
The limitations set forth in this Section 13.7 shall apply to Transferee(s)
and guarantor(s) of this Lease, if any, and any transfer by any such entity in violation of this
Section 13.7 shall be a transfer in violation of Section 13.1.
(c)
Modifications, Takeover Agreements.
Any modification, amendment or extension of a sublease
and/or any other agreement by which a landlord of a building other than the Building agrees to
assume the obligations of Tenant under this Lease shall be deemed a sublease for the purposes of
Section 13.1 hereof.
Section 13.8 Assumption of Obligations.
No assignment or transfer shall be effective unless
and until the Transferee executes, acknowledges and delivers to Landlord an agreement in form and
substance reasonably satisfactory to Landlord whereby the assignee (a) assumes Tenants
obligations under this Lease and (b) agrees that, notwithstanding such assignment or transfer, the
provisions of Section 13.1 hereof shall be binding upon it in respect of all future assignments
and transfers.
Section 13.9 Tenants Liability.
The joint and several liability of Tenant and any
successors-in-interest of Tenant and the due performance of Tenants obligations under this Lease
shall not be discharged, released or impaired by any agreement or stipulation made by Landlord, or
any grantee or assignee of Landlord, extending the time, or modifying any of the terms and
provisions of this Lease, or by any waiver or failure of Landlord, or any grantee or assignee of
Landlord, to enforce any of the terms and provisions of this Lease.
Section 13.10 Listings in Building Directory.
The listing of any name other than that of
Tenant on the doors of the Premises, the Building directory or elsewhere shall not vest any right
or interest in this Lease or in the Premises, nor be deemed to constitute Landlords consent to
any assignment or transfer of this Lease or to any sublease of the Premises or to the use or
occupancy thereof by others. Any such listing shall constitute a privilege revocable in Landlords
discretion by notice to Tenant.
Section 13.11 Lease Disaffirmance or Rejection.
If at any time after an assignment by Tenant
named herein, this Lease is not affirmed or is rejected in any bankruptcy proceeding or
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any similar proceeding, or upon a termination of this Lease due to any such proceeding, Tenant
named herein, upon request of Landlord given after such disaffirmance, rejection or termination
(and actual notice thereof to Landlord in the event of a disaffirmance or rejection or in the event
of termination other than by act of Landlord), shall (a) pay to Landlord all Rent and other charges
due and owing by the assignee to Landlord under this Lease to and including the date of such
disaffirmance, rejection or termination, and (b) as tenant, enter into a new lease of the
Premises with Landlord for a term commencing on the effective date of such disaffirmance, rejection
or termination and ending on the Expiration Date, at the same Rent and upon the then executory
terms, covenants and conditions contained in this Lease, except that (i) the rights of Tenant named
herein under the new lease shall be subject to the possessory rights of the assignee under this
Lease and the possessory rights of any persons claiming through or under such assignee or by virtue
of any statute or of any order of any court, (ii) such new lease shall require all defaults
existing under this Lease to be cured by Tenant named herein with due diligence, and (iii) such new
lease shall require Tenant named herein to pay all Rent which, had this Lease not been so
disaffirmed, rejected or terminated, would have become due under the provisions of this Lease after
the date of such disaffirmance, rejection or termination with respect to any period prior thereto.
If Tenant named herein defaults in its obligations to enter into such new lease for a period of 10
days after Landlords request, then, in addition to all other rights and remedies by reason of
default, either at law or in equity, Landlord shall have the same rights and remedies against
Tenant named herein as if it had entered into such new lease and such new lease had thereafter been
terminated as of the commencement date thereof by reason of Tenants default thereunder.
ARTICLE 14
ACCESS TO PREMISES
Section 14.1 Landlords Access.
(a) Landlord, Landlords agents and utility service providers servicing the Building may
erect, use and maintain concealed ducts, pipes and conduits in and through the Premises provided
such use does not cause the usable area of the Premises to be reduced beyond a
de minimis
amount.
Landlord shall promptly repair any damage to the Premises caused by any work performed pursuant to
this Article 14.
(b) Landlord, any Lessor or Mortgagee and any other party designated by Landlord and their
respective agents shall have the right to enter the Premises at all reasonable times, upon 24-hours
prior notice (which notice may be oral) except in the case of emergency (for which no notice shall
be required), to examine the Premises, to show the Premises to prospective purchasers,
Mortgagees, Lessors or tenants and their respective agents and representatives or
others and to perform Restorative Work to the Premises or the Building.
(c) All parts (except surfaces facing the interior of the Premises) of all walls, windows and
doors bounding the Premises, all balconies, terraces and roofs adjacent to the Premises, all space
in or adjacent to the Premises used for shafts, stacks, stairways, mail chutes, conduits and other
mechanical facilities, Building Systems; Building facilities and Common
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Areas are not part of the Premises, and Landlord shall have the use thereof and access thereto
through the Premises for the purposes of Building operation, maintenance, alteration and repair.
Section 14.2 Building Name.
Landlord has the right at any time to change the name, number or
designation by which the Building is commonly known. If Landlord elects to change the name, number
or designation by which the Building is commonly known, Landlord will endeavor to provide Tenant
with at least 15 days prior written notice of such election.
ARTICLE 15
DEFAULT
Section 15.1 Tenants Defaults.
Each of the following events shall be an
Event of Default
hereunder:
(a) Tenant fails to pay when due any installment of Rent and such default shall continue for
five (5) days after notice of such default is given to Tenant except that if Landlord shall have
given 3 such notices of default in the payment of any Rent in any 12-month period, Tenant shall not
be entitled to any further notice of its delinquency in the payment of any Rent or an extended
period in which to make payment until such time as 12 consecutive months shall have elapsed without
Tenant having failed to make any such payment when due, and the occurrence of any default in the
payment of any Rent within such 12-month period after the giving of 3 such notices shall constitute
an Event of Default; or
(b) Tenant fails to observe or perform any other term, covenant or condition of this Lease and
such failure continues for more than 30 days (10 days with respect to a default under Article 3)
after notice by Landlord to Tenant of such default, or if such default (other than a default under
Article 3) is of a nature that it cannot be completely remedied within 30 days, failure by Tenant
to commence to remedy such failure within said 30 days, and thereafter diligently prosecute to
completion all steps necessary to remedy such default, provided in all events the same is completed
within 90 days; or
(c) if Landlord applies or retains any part of the Security Deposit, and Tenant fails to
deposit with Landlord the amount so applied or retained by Landlord, or to provide Landlord with a
replacement Letter of Credit (as hereinafter defined), if applicable, within 5 days after notice by
Landlord to Tenant stating the amount applied or retained; or
(d) there shall occur or exist any default under any guaranty of this Lease, which default is
not cured within any applicable notice and/or cure period set forth in such guaranty.
Upon the occurrence of any one or more of such Events of Default, Landlord may, at its sole
option, give to Tenant notice of cancellation of this Lease (or of Tenants possession of the
Premises), in which event this Lease and the Term (or Tenants possession of the Premises) shall
terminate (whether or not the Term shall have commenced) with the same force and effect as if the
date set forth in the notice was the Expiration Date stated herein; and Tenant shall then quit and
surrender the Premises to Landlord, but Tenant shall remain liable for damages as provided
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in this Article 15. Any notice of cancellation of the Term (or Tenants possession of the
Premises) may be given simultaneously with any notice of default given to Tenant.
Section 15.2 Landlords Remedies.
(a)
Possession/Reletting.
If this Lease and the Term, or Tenants right to possession of the
Premises, terminate as provided in Section 15.1:
(i)
Surrender of Possession.
Tenant shall quit and surrender the Premises to Landlord, and
Landlord and its agents may immediately, or at any time after such termination, re-enter the
Premises or any part thereof, without notice, either by summary proceedings, or by any other
applicable action or proceeding, or by force (to the extent permitted by law) or otherwise in
accordance with applicable legal proceedings (without being liable to indictment, prosecution or
damages therefor), and may repossess the Premises and dispossess Tenant and any other persons from
the Premises and remove any and all of their property and effects from the Premises.
(ii)
Landlords Reletting.
Landlord, at Landlords option, may relet all or any part of the
Premises from time to time, either in the name of Landlord or otherwise, to such tenant or
tenants, for any term ending before, on or after the Expiration Date, at such rental and upon such
other conditions (which may include concessions and free rent periods) as Landlord, in its sole
discretion, may determine. Landlord shall have no obligation to accept any tenant offered by
Tenant and shall not be liable for failure to relet or, in the event of any such reletting, for
failure to collect any rent due upon any such reletting; and no such failure shall relieve Tenant
of, or otherwise affect, any liability under this Lease. However, to the extent required by law,
Landlord shall use reasonable efforts to mitigate its damages but shall not be required to divert
prospective tenants from any other portions of the Building. Landlord, at Landlords option, may
make such alterations, decorations and other physical changes in and to the Premises as Landlord,
in its sole discretion, considers advisable or necessary in connection with such reletting or
proposed reletting, without relieving Tenant of any liability under this Lease or otherwise
affecting any such liability.
(b)
Tenants Waiver.
Tenant, on its own behalf and on behalf of all persons claiming through
or under Tenant, including all creditors, hereby waives all rights which Tenant and all such
persons might otherwise have under any Requirement (i) to the service of any notice of intention to
re-enter or to institute legal proceedings, (ii) to redeem, or to re-enter or repossess the
Premises, or (iii) to restore the operation of this Lease, after (A) Tenant shall have been
dispossessed by judgment or by warrant of any court or judge, (B) [Intentionally Omitted], or (C)
any expiration or early termination of the term of this Lease, whether such dispossess, re-entry,
expiration or termination shall be by operation of law or pursuant to the provisions of this Lease.
The words re-enter, re-entry and re-entered as used in this Lease shall not be deemed to be
restricted to their technical legal meanings.
(c)
Tenants Breach.
Upon the breach or threatened breach by Tenant, or any persons claiming
through or under Tenant, of any term, covenant or condition of this Lease, Landlord shall have the
right to enjoin such breach and to invoke any other remedy allowed by law or in equity as if
re-entry, summary proceedings and other special remedies were not
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provided in this Lease for such breach. The rights to invoke the remedies set forth above are
cumulative and shall not preclude Landlord from invoking any other remedy allowed at law or in
equity.
Section 15.3 Landlords Damages.
(a)
Amount of Damages.
If this Lease and the Term, or Tenants right to possession of the
Premises, terminate as provided in Section 15.1, then:
(i) Tenant shall pay to Landlord all items of Rent payable under this Lease by Tenant to
Landlord prior to the date of termination;
(ii) Landlord may retain all monies, if any, paid by Tenant to Landlord,
whether as prepaid Rent, a Security Deposit or otherwise, which monies, to the extent not
otherwise applied to amounts due and owing to Landlord, shall be credited by Landlord against any
damages payable by Tenant to Landlord;
(iii) Tenant shall pay to Landlord, in monthly installments, on the days specified in this
Lease for payment of installments of Fixed Rent, any Deficiency; it being understood that Landlord
shall be entitled to recover the Deficiency from Tenant each month as the same shall arise, and no
suit to collect the amount of the Deficiency for any month, shall prejudice Landlords right to
collect the Deficiency for any subsequent month by a similar proceeding; and
(iv) whether or not Landlord shall have collected any monthly Deficiency, Tenant shall pay to
Landlord, on demand, in lieu of any further Deficiency and as liquidated and agreed final damages,
a sum equal to the amount by which the Rent for the period which otherwise would have constituted
the unexpired portion of the Term (assuming the Additional Rent during such period to be the same
as was payable for the year immediately preceding such termination or re-entry, increased in each
succeeding year by 4% (on a compounded basis)) exceeds the then fair and reasonable rental value
of the Premises, for the same period (with both amounts being discounted to present value at a
rate of interest equal to 2% below the then Base Rate) less the aggregate amount of Deficiencies
theretofore collected by Landlord pursuant to the provisions of Section 15.3(a)(iii) for the same
period. If, before presentation of proof of such liquidated damages to any court, commission or
tribunal, the Premises, or any part thereof, shall have been relet by Landlord for the period
which otherwise would have constituted the unexpired portion of the Term, or any part thereof, the
amount of rent reserved upon such reletting shall be deemed
prima facie,
to be the fair and
reasonable rental value for the part or the whole of the Premises so relet during the term of the
reletting.
(b)
Reletting.
If the Premises, or any part thereof, shall be relet together with other space
in the Building, the rents collected or reserved under any such reletting and the expenses of any
such reletting shall be equitably apportioned for the purposes of this Section 15.3. Tenant shall
not be entitled to any rents collected or payable under any reletting, whether or not such rents
exceeds the Fixed Rent reserved in this Lease. Nothing contained in Article 15 shall be deemed to
limit or preclude the recovery by Landlord from Tenant of the maximum
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amount allowed to be obtained as damages by any Requirement, or of any sums or damages to which
Landlord may be entitled in addition to the damages set forth in this Section 15.3.
Section 15.4 Interest.
If any payment of Rent is not paid when due, interest shall accrue on
such payment, from the date such payment became due until paid at the Interest Rate. Tenant
acknowledges that late payment by Tenant of Rent will cause Landlord to incur costs not
contemplated by this Lease, the exact amount of such costs being extremely difficult and
impracticable to fix. Such costs include, without limitation, processing and accounting charges,
and late charges that may be imposed on Landlord by the terms of any note secured by a Mortgage
covering the Premises. Therefore, in addition to interest, if any amount is not paid when due, a
late charge equal to 5% of such amount shall be assessed; provided, however, that on 2 occasions
during any calendar year of the Term, Landlord shall give Tenant notice of such late payment and
Tenant shall have a period of 5 days thereafter in which to make such payment before any late
charge is assessed. Such interest and late charges are separate and cumulative and are in addition
to and shall not diminish or represent a substitute for any of Landlords rights or remedies under
any other provision of this Lease.
Section 15.5 Other Rights of Landlord.
If Tenant fails to pay any Additional Rent when due,
Landlord, in addition to any other right or remedy, shall have the same rights and remedies as in
the case of a default by Tenant in the payment of Fixed Rent. If Tenant is in arrears in the
payment of Rent, Tenant waives Tenants right, if any, to designate the items against which any
payments made by Tenant are to be credited, and Landlord may apply any payments made by Tenant to
any items Landlord sees fit, regardless of any request by Tenant. Landlord reserves the right,
without liability to Tenant and without constituting any claim of constructive eviction, to
suspend furnishing or rendering to Tenant any property, material, labor, utility or other service,
whenever Landlord is obligated to furnish or render the same at the expense of Tenant, in the
event that (but only for so long as) Tenant is in arrears in paying Landlord for such items for
more than 5 days after notice from Landlord to Tenant demanding the payment of such arrears.
ARTICLE 16
LANDLORDS RIGHT TO CURE; FEES AND EXPENSES
If Tenant defaults in the performance of its obligations under this Lease, Landlord, without
waiving such default, may perform such obligations at Tenants expense: (a) immediately, and
without notice, in the case of emergency or if the default (i) materially interferes with the use
by any other tenant of the Building, (ii) materially interferes with the efficient operation of
the Building, (iii) results in a violation of any Requirement, or (iv) results or will result in a
cancellation of any insurance policy maintained by Landlord, and (b) in any other case if such
default continues after 10 days from the date Landlord gives notice of Landlords intention to
perform the defaulted obligation. All costs and expenses reasonably incurred by Landlord in
connection with any such performance by it and all costs and expenses, including reasonable
counsel fees and disbursements, incurred by Landlord in any action or proceeding (including any
unlawful detainer proceeding) brought by Landlord to enforce any obligation of Tenant under this
Lease and/or right of Landlord in or to the Premises, shall be paid
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by Tenant to Landlord on demand, with interest thereon at the Interest Rate from the date incurred
by Landlord. Except as expressly provided to the contrary in this Lease, all costs and expenses
which, pursuant to this Lease are incurred by Landlord and payable to Landlord by Tenant, and all
charges, amounts and sums payable to Landlord by Tenant for any property, material, labor, utility
or other services which, pursuant to this Lease or at the request and for the account of Tenant,
are provided, furnished or rendered by Landlord, shall become due and payable by Tenant to
Landlord within 10 Business Days after receipt of Landlords invoice for such amount.
ARTICLE 17
NO REPRESENTATIONS BY LANDLORD; LANDLORDS APPROVAL
Section 17.1 No Representations.
Except as expressly set forth herein, Landlord and
Landlords agents have made no warranties, representations, statements or promises with respect to
the Building, the Real Property or the Premises and no rights, easements or licenses are acquired
by Tenant by implication or otherwise. Tenant is entering into this Lease after full investigation
and is not relying upon any statement or representation made by Landlord not embodied in this
Lease.
Section 17.2 No Money Damages.
In no event shall Landlord be liable for, and Tenant, on
behalf of itself and all other Tenant Parties, hereby waives any claim for, any indirect,
consequential or punitive damages, including loss or profits or business opportunity, arising
under or in connection with this Lease.
Section 17.3 Reasonable Efforts.
For purposes of this Lease, reasonable efforts by Landlord
shall not include an obligation to employ contractors or labor at overtime or other premium pay
rates or to incur any other overtime costs or additional expenses whatsoever.
ARTICLE 18
END OF TERM
Section 18.1 Expiration.
Upon the expiration or other termination of this Lease, Tenant shall
quit and surrender the Premises to Landlord vacant, broom clean and in good order and condition,
ordinary wear and tear and damage for which Tenant is not responsible under the terms of this
Lease excepted, and Tenant shall remove all of Tenants Property and Tenants Specialty
Alterations.
Section 18.2 Holdover Rent.
Landlord and Tenant recognize that Landlords damages resulting
from Tenants failure to timely surrender possession of the Premises may be substantial, may exceed
the amount of the Rent payable hereunder, and will be impossible to accurately measure.
Accordingly, if possession of the Premises is not surrendered to Landlord on the Expiration Date or
sooner termination of this Lease, in addition to any other rights or remedies Landlord may have
hereunder or at law, Tenant shall (a) pay to Landlord for each month (or any portion thereof)
during which Tenant holds over in the Premises after the Expiration Date or sooner termination of
this Lease, a sum equal to 1.5 times the Rent payable under this Lease for
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the last full calendar month of the Term, (b) be liable to Landlord for (i) any payment or rent
concession which Landlord may be required to make to any tenant obtained by Landlord for all or
any part of the Premises (a
New Tenant
) in order to induce such New Tenant not to terminate its
lease by reason of the holding-over by Tenant, and (ii) the loss of the benefit of the bargain if
any New Tenant shall terminate its lease by reason of the holding-over by Tenant, and (c)
indemnify Landlord against all claims for damages by any New Tenant. No holding-over by Tenant,
nor the payment to Landlord of the amounts specified above, shall operate to extend the Term
hereof. Nothing herein contained shall be deemed to permit Tenant to retain possession of the
Premises after the Expiration Date or sooner termination of this Lease, and no acceptance by
Landlord of payments from Tenant after the Expiration Date or sooner termination of this Lease
shall be deemed to be other than on account of the amount to be paid by Tenant in accordance with
the provisions of this Section 18.2.
ARTICLE 19
QUIET ENJOYMENT
Provided this Lease is in full force and effect and no Event of Default then exists, Tenant
may peaceably and quietly enjoy the Premises without hindrance by Landlord or any person lawfully
claiming through or under Landlord, subject to the terms and conditions of this Lease and to all
Superior Leases and Mortgages.
ARTICLE 20
NO SURRENDER; NO WAIVER
Section 20.1 No Surrender or Release.
No act or thing done by Landlord or Landlords agents
or employees during the Term shall be deemed an acceptance of a surrender of the Premises, and no
provision of this Lease shall be deemed to have been waived by Landlord, unless such waiver is in
writing and is signed by Landlord.
Section 20.2 No Waiver.
The failure of either party to seek redress for violation of, or to
insist upon the strict performance of, any covenant or condition of this Lease, or any of the Rules
and Regulations, shall not be construed as a waiver or relinquishment for the future performance of
such obligations of this Lease or the Rules and Regulations, or of the right to exercise such
election but the same shall continue and remain in full force and effect with respect to any
subsequent breach, act or omission. The receipt by Landlord of any Rent payable pursuant to this
Lease or any other sums with knowledge of the breach of any covenant of this Lease shall not be
deemed a waiver of such breach. No payment by Tenant or receipt by Landlord of a lesser amount than
the monthly Rent herein stipulated shall be deemed to be other than a payment on account of the
earliest stipulated Rent, or as Landlord may elect to apply such payment, nor shall any endorsement
or statement on any check or any letter accompanying any check or payment as Rent be deemed an
accord and satisfaction, and Landlord may accept such check or payment without prejudice to
Landlords right to recover the balance of such Rent or pursue any other remedy provided in this
Lease.
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ARTICLE 21
WAIVER OF TRIAL BY JURY; COUNTERCLAIM
Section 21.1 Jury Trial Waiver.
Landlord and Tenant hereby waive trial by jury in any action,
proceeding or counterclaim brought by either party against the other on any matters in any way
arising out of or connected with this Lease, the relationship of Landlord and Tenant, Tenants use
or occupancy of the Premises, or the enforcement of any remedy under any statute, emergency or
otherwise.
Section 21.2 Waiver of Counterclaim.
If Landlord commences any summary proceeding against
Tenant, Tenant will not interpose any counterclaim of any nature or description in any such
proceeding (unless failure to interpose such counterclaim would preclude Tenant from asserting in
a separate action the claim which is the subject of such counterclaim), and will not seek to
consolidate such proceeding with any other action which may have been or will be brought in any
other court by Tenant.
ARTICLE
22
NOTICES
Except as otherwise expressly provided in this Lease, all consents, notices, demands,
requests, approvals or other communications given under this Lease shall be in writing and shall
be deemed sufficiently given or rendered if delivered by hand (provided a signed receipt is
obtained) or if sent by registered or certified mail (return receipt requested) or by a nationally
recognized overnight delivery service making receipted deliveries, addressed to Landlord and
Tenant as set forth in Article 1, and to any Mortgagee or Lessee who shall require copies of
notices and whose address is provided to Tenant, or to such other address(es) as Landlord, Tenant
or any Mortgagee or Lessor may designate as its new address(es) for such purpose by notice given
to the other in accordance with the provisions of this Article 22. Any such approval, consent,
notice, demand, request or other communication shall be deemed to have been given on the date of
receipted delivery, refusal to accept delivery or when delivery is first attempted but cannot be
made due to a change of address for which no notice is given of 3 Business Days after it shall
have been mailed as provided in this Article 22, whichever is earlier.
ARTICLE 23
RULES AND REGULATIONS
All Tenant Parties shall observe and comply with the Rules and Regulations, as supplemented or
amended from time to time. Landlord reserves the right, from time to time, to adopt additional
Rules and Regulations and to amend the Rules and Regulations then in effect. Nothing contained in
this Lease shall impose upon Landlord any obligation to enforce the Rules and Regulations or terms,
covenants or conditions in any other lease against any other Building tenant, and Landlord shall
not be liable to Tenant for violation of the same by any other tenant, its employees, agents,
visitors or licensees, provided that Landlord shall enforce the Rules or Regulations against Tenant
in a non-discriminatory fashion.
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ARTICLE 24
BROKER
Landlord has retained Landlords Agent as leasing agent in connection with this Lease and
Landlord will be solely responsible for any fee that may be payable to Landlords Agent. Landlord
agrees to pay a commission to Scheer Partners pursuant to a separate agreement. Each of Landlord
and Tenant represents and warrants to the other that neither it nor its agents have dealt with any
broker in connection with this Lease other than Landlords Agent and Tenants Broker and that no
other broker, finder or like entity procured or negotiated this Lease or is entitled to any fee or
commission in connection herewith. Each of Landlord and Tenant shall indemnify, defend, protect and
hold the other party harmless from and against any and all Losses which the indemnified party may
incur by reason of any claim of or liability to any broker, finder or like agent (other than
Landlords Agent and Scheer Partners) arising out of any dealings claimed to have occurred between
the indemnifying party and the claimant in connection with this Lease, and/or the above
representation being false. Landlord will have no liability to Tenant arising from any commission,
fee or other sum that is or might become due and payable to Liberty Greenfield in connection with
this Lease. Landlord and Tenant acknowledge that any commission, fee or other sum that is or might
become due and payable to Liberty Greenfield in connection with this Lease is to be paid by Scheer
Partners pursuant to the terms of a separate agreement between Scheer Partners and Liberty
Greenfield.
ARTICLE 25
INDEMNITY
Section 25.1 Tenants Indemnity.
Tenant shall not do or permit to be done any act or thing
upon the Premises or the Building which may subject Landlord to any liability or responsibility
for injury, damages to persons or property or to any liability by reason of any violation of any
Requirement, and shall exercise such control over the Premises as to fully protect Landlord
against any such liability. Tenant shall indemnify, defend, protect and hold harmless each of the
Indemnitees from and against any and all Losses, resulting from any claims (i) against the
Indemnitees arising from any negligence or willful misconduct of (A) all Tenant Parties or (B)
both Landlord and Tenant, provided, however, that Tenants liability hereunder with respect to
matters judicially determined to have arisen out of the negligence of Landlord, which
determination shall not be subject to appeal, shall be limited to the amount of insurance coverage
carried by Tenant pursuant to Article 11, (ii) against the Indemnitees arising from any accident,
injury or damage whatsoever caused to any person or to the property of any person and occurring in
or about the Premises, and (iii) against the Indemnitees resulting from any breach, violation or
nonperformance of any covenant, condition or agreement of this Lease on the part of Tenant to be
fulfilled, kept, observed or performed.
Section 25.2 Landlords Indemnity.
Landlord shall indemnify, defend and hold harmless Tenant
from and against all Losses incurred by Tenant arising from (i) any accident, injury or damage
whatsoever caused to any person or the property of any person in or about the
Real Property (exclusive of the Premises) to the extent attributable to the negligence or
willful misconduct of Landlord or its employees or agents, and/or (iii) any breach, violation or
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nonperformance of any covenant, condition or agreement of this Lease on the part of Landlord to
be fulfilled, kept, observed or performed.
Section 25.3 Defense and Settlement.
If any claim, action or proceeding is made or brought
against any Indemnitee for which Tenant is obligated to indemnify such Indemnitee under Section
25.1, then upon demand by an Indemnitee, Tenant, at its sole cost and expense, shall resist or
defend such claim, action or proceeding in the Indemnitees name (if necessary), by attorneys
approved by the Indemnitee, which approval shall not be unreasonably withheld (attorneys for
Tenants insurer shall be deemed approved for purposes of this Section 25.3). Notwithstanding the
foregoing, an Indemnitee may retain its own attorneys to participate or assist in defending any
claim, action or proceeding involving potential liability in excess of the amount available under
Tenants liability insurance carried under Section 11.1 for such claim and Tenant shall pay the
reasonable fees and disbursements of such attorneys. If Tenant fails to diligently defend or if
there is a legal conflict or other conflict of interest, then Landlord may retain separate counsel
at Tenants expense. Notwithstanding anything herein contained to the contrary, Tenant may direct
the Indemnitee to settle any claim, suit or other proceeding provided that (a) such settlement
shall involve no obligation on the part of the Indemnitee other than the payment of money, (b) any
payments to be made pursuant to such settlement shall be paid in full exclusively by Tenant at the
time such settlement is reached, (c) such settlement shall not require the Indemnitee to admit any
liability, and (d) the Indemnitee shall have received an unconditional release from the other
parties to such claim, suit or other proceeding.
ARTICLE 26
MISCELLANEOUS
Section 26.1 Delivery.
This Lease shall not be binding upon Landlord or Tenant unless and
until Landlord shall have executed and delivered a fully executed copy of this Lease to Tenant.
Section 26.2 Transfer of Real Property.
Landlords obligations under this Lease shall not be
binding upon the Landlord named herein after the sale, conveyance, assignment or transfer
(collectively, a
Transfer
) by such Landlord (or upon any subsequent landlord after the Transfer
by such subsequent landlord) of its interest in the Building or the Real Property, as the case
may be, and in the event of any such Transfer, Landlord (and any such subsequent Landlord) shall
be entirely freed and relieved of all covenants and obligations of Landlord hereunder arising
from and after the date of Transfer and the transferee of Landlords interest (or that of such
subsequent Landlord) in the Building or the Real Property, as the case may be, shall be deemed to
have assumed all obligations under this Lease arising from and after the date of Transfer.
Section 26.3 Limitation on Liability.
The liability of Landlord for Landlords obligations
under this Lease shall be limited to Landlords interest in the Real Property and Tenant shall not
look to any other property or assets of Landlord or the property or assets of any direct or
indirect partner, member, manager, shareholder, director, officer, principal, employee or agent of
Landlord (collectively, the
Parties
) in seeking either to enforce Landlords obligations under
this Lease or to satisfy a judgment for Landlords failure to perform such obligations; and
- 46 -
none of the Parties shall be personally liable for the performance of Landlords obligations under
this Lease.
Section 26.4 Rent.
All amounts payable by Tenant to or on behalf of Landlord under this
Lease, whether or not expressly denominated Fixed Rent, Tenants Tax Payment, Tenants Operating
Payment, Additional Rent or Rent, shall constitute rent for the purposes of Section 502(b)(6) of
the United States Bankruptcy Code.
Section 26.5 Entire Document.
This Lease (including any Schedules and Exhibits referred to
herein and all supplementary agreements provided for herein) contains the entire agreement between
the parties and all prior negotiations and agreements are merged into this Lease. All of the
Schedules and Exhibits attached hereto are incorporated in and made a part of this Lease, provided
that in the event of any inconsistency between the terms and provisions of this Lease and the terms
and provisions of the Schedules and Exhibits hereto, the terms and provisions of this Lease shall
control.
Section 26.6 Governing Law.
This Lease shall be governed in all respects by the laws of the
Commonwealth of Virginia (but not including the choice of law rules thereof).
Section 26.7 Unenforceability.
If any provision of this Lease, or its application to any
person or circumstance, shall ever be held to be invalid or unenforceable, then in each such event
the remainder of this Lease or the application of such provision to any other person or any other
circumstance (other than those as to which it shall be invalid or unenforceable) shall not be
thereby affected, and each provision hereof shall remain valid and enforceable to the fullest
extent permitted by law.
Section 26.8 Lease Disputes.
(a) Landlord and Tenant agree that (i) all disputes arising, directly or indirectly,
out of or relating to this Lease, and all actions to enforce this Lease, shall be dealt with and
adjudicated in the state courts of the Commonwealth of Virginia or the United States District Court
for the Eastern District of Virginia and for that purpose hereby expressly and irrevocably submits
itself to the jurisdiction of such courts; and (ii) to the extent permitted under applicable law,
this consent to personal jurisdiction shall be self-operative and no further instrument or action,
other than service of process in one of the manners specified in this Lease, or as otherwise
permitted by law, shall be necessary in order to confer jurisdiction upon it in any such court.
(b) To the extent that Tenant has or hereafter may acquire any immunity from jurisdiction of
any court or from any legal process (whether through service or notice, attachment prior to
judgment, attachment in aid of execution, execution or otherwise) with respect to itself or its
property, Tenant irrevocably waives such immunity in respect of its obligations under this Lease.
Section 26.9 Landlords Agent.
Unless Landlord delivers written notice to Tenant to the
contrary, Landlords Agent is authorized to act as Landlords agent in connection with the
performance of this Lease, and Tenant shall be entitled to rely upon correspondence received from
Landlords Agent. Tenant acknowledges that Landlords Agent is acting solely as agent for
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Landlord in connection with the foregoing; and neither Landlords Agent nor any of its direct or
indirect partners, members, managers, officers, shareholders, directors, employees, principals,
agents or representatives shall have any liability to Tenant in connection with the performance of
this Lease, and Tenant waives any and all claims against any and all of such parties arising out
of, or in any way connected with, this Lease, the Building or the Real Property.
Section 26.10 Estoppel.
Within 10 Business Days following request from Landlord, any
Mortgagee or any Lessor, Tenant shall deliver to Landlord a statement executed and acknowledged by
Tenant, in form reasonably satisfactory to Landlord, (a) stating the Commencement Date, the Rent
Commencement Date and the Expiration Date, and that this Lease is then in full force and effect
and has not been modified (or if modified, setting forth all modifications), (b) setting forth
the date to which the Fixed Rent and any Additional Rent have been paid, together with the amount
of monthly Fixed Rent and Additional, Rent then payable, (c) stating whether or not, to the best of Tenants knowledge, Landlord is in default under this
Lease, and, if Landlord is in default, setting forth the specific nature of all such defaults,
(d) stating the amount of the Security Deposit, if any, under this Lease, (e) stating whether there
are any subleases or assignments affecting the Premises, (f) stating the address of Tenant to
which all notices and communications under the Lease shall be sent, and (g) responding to any
other matters reasonably requested by Landlord, such Mortgagee or such Lessor. Tenant
acknowledges that any statement delivered pursuant to this Section 26.10 may be relied upon by
any purchaser or owner of the Real Property or the Building or all or any portion of Landlords
interest in the Real Property or the Building or any Superior Lease, or by any Mortgagee, or
assignee thereof or by any Lessor, or assignee thereof.
Section 26.11 Certain Interpretational Rules.
For purposes of this Lease, whenever the words
include, includes, or including are used, they shall be deemed to be followed by the words
without limitation and, whenever the circumstances or the context requires, the singular shall
be construed as the plural, the masculine shall be construed as the feminine and/or the neuter and
vice versa. This Lease shall be interpreted and enforced without the aid of any canon, custom or
rule of law requiring or suggesting construction against the party drafting or causing the
drafting of the provision in question.
The captions in this Lease are inserted only as a matter of convenience and for reference and
in no way define, limit or describe the scope of this Lease or the intent of any provision hereof.
Section 26.12 Parties Bound.
The terms, covenants, conditions and agreements contained in
this Lease shall bind and inure to the benefit of Landlord and Tenant and, except as otherwise
provided in this Lease, to their respective legal representatives, successors, and assigns.
Section 26.13 Memorandum of Lease.
This Lease shall not be recorded; however, at Landlords
request, Landlord and Tenant shall promptly execute, acknowledge and deliver a memorandum with
respect to this Lease sufficient for recording and Landlord may record the memorandum. Within 10
days following the end of the Term. Tenant shall enter into such documentation as is reasonably
required by Landlord to remove the memorandum of record.
- 48 -
Section 26.14 Counterparts.
This Lease may be executed in 2 or more counterparts, each of
which shall constitute an original, but all of which, when taken together, shall constitute but
one instrument.
Section 26.15 Survival.
All obligations and liabilities of Landlord or Tenant to the other
which accrued before the expiration or other termination of this Lease, and all such obligations
and liabilities which by their nature or under the circumstances can only be, or by the provisions
of this Lease may be, performed after such expiration or other termination, shall survive the
expiration or other termination of this Lease. Without limiting the generality of the foregoing,
the rights and obligations of the parties with respect to any indemnity under this Lease, and with
respect to any Rent and any other amounts payable under this Lease, shall survive the expiration
or other termination of this Lease.
Section 26.16 Inability to Perform.
This Lease and the obligation of Tenant to pay Rent and
to perform all of the other covenants and agreements of Tenant hereunder shall not be affected,
impaired or excused by any Unavoidable Delays. Landlord shall use reasonable efforts to promptly
notify Tenant of any Unavoidable Delay which prevents Landlord from fulfilling any of its
obligations under this Lease.
Section 26.17 Substitute Premises.
[Intentionally Omitted]
Section 26.18 Deed of Lease/Landlords Agent for Service of Process.
For purposes of Section
55-2, Code of Virginia (1950), as amended, this Lease is and shall be deemed to be a deed of
lease. For purposes of Section 55-218.1, Code of Virginia (1950), as amended, Landlords resident
agent for service of process is: James C. Brincefield, Jr., Attorney at Law, 526 King Street,
Alexandria, Virginia 22314.
Section 26.19 Lien for Payment of Rent.
[Intentionally Omitted]
Section 26.20 Financial Statements.
Tenant agrees to deliver to Landlord by April 30 of each
year a balance sheet of Tenant as of the end of the preceding calendar year and an income and loss
statement of Tenant for the 12 month period ending on such date.
ARTICLE 27
SECURITY DEPOSIT
Section 27.1 Letter of Credit.
Tenant shall deliver to Landlord, upon Tenants execution of
this Lease, a Letter of Credit (as hereinafter defined) in the amount specified in the Basic Lease
Information, as security for the faithful performance and observance by Tenant of the terms,
covenants and conditions of this Lease. The Letter of Credit shall be in the form of a clean,
irrevocable, non-documentary and unconditional letter of credit (the
Letter of Credit)
issued by
and drawable upon any commercial bank which is a member of the New York Clearing House Association
or other bank satisfactory to Landlord, trust company, national banking association or savings and
loan association with offices for banking purposes in the Washington, D.C. metropolitan area (or,
if the issuing bank is Wells Fargo, an office in New York City, Washington, D.C. or San Francisco,
California) (the
Issuing Bank),
which has outstanding
- 49 -
unsecured, uninsured and unguaranteed indebtedness, or shall have issued a letter of credit or
other credit facility that constitutes the primary security for any outstanding indebtedness (which
is otherwise uninsured and unguaranteed), that is then rated, without regard to qualification of
such rating by symbols such as + or - or numerical notation, Aa or better by Moodys
Investors Service and AA or better by Standard & Poors Rating Service, and has combined capital,
surplus and undivided profits of not less than $2,000,000,000. The Letter of Credit shall (a) name
Landlord as beneficiary, (b) have a term of not less than one year, (c) permit multiple drawings,
(d) be fully transferable by Landlord without the payment of any fees or charges by Landlord, and
(e) otherwise be in form and content satisfactory to Landlord. If upon any transfer of the Letter
of Credit, any fees or charges shall be so imposed, then Landlord shall pay the first $250 of such
fees and charges and Tenant shall pay any additional fees or charges imposed in connection with
such transfer. The Letter of Credit shall provide that it shall be deemed automatically renewed,
without amendment, for consecutive periods of one year each thereafter during the Term (and in no
event shall the Letter of Credit expire prior to the 45th day following the Expiration Date) unless
the Issuing Bank sends duplicate notices (the
Non-Renewal Notices
) to Landlord by certified mail,
return receipt requested (one of which shall be addressed Attention, Chief Legal Officer and the
other of which shall be addressed Attention, Chief Financial Officer), not less than 45 days next
preceding the then expiration date of the Letter of Credit stating that the Issuing Bank has
elected not to renew the Letter of Credit. The Issuing Bank shall agree with all drawers, endorsers
and bona fide holders that drafts drawn under and in compliance with the terms of the Letter of
Credit will be duly honored upon presentation to the Issuing Bank at an office location in the
Washington, D.C. metropolitan area. The Letter of Credit shall be subject in all respects to the
International Standby Practices 1998, International Chamber of Commerce Publication No. 500.
Section 27.2 Application of Security.
If (a) an Event of Default by Tenant occurs in the
payment or performance of any of the terms, covenants or conditions of this Lease, including the
payment of Rent, or (b) Tenant fails to make any installment of Rent as and when due, or (c)
Landlord receives a Non-Renewal Notice, Landlord shall have the right by sight draft to draw, at
its election, all or a portion of the proceeds of the Letter of Credit and thereafter hold, use,
apply, or retain the whole or any part of such proceeds, as the case may be, (x) to the extent
required for the payment of any Fixed Rent or any other sum as to which Tenant is in default
including (i) any sum which Landlord may expend or may be required to expend by reason of Tenants
default, and/or (ii) any damages to which Landlord is entitled pursuant to this Lease, whether
such damages accrue before or after summary proceedings or other reentry by Landlord, and/or (y)
as a cash security deposit, unless and until, in the case of clause (c) above, Tenant delivers to
Landlord a substitute Letter of Credit which meets the requirements of this Article 27. If
Landlord applies or retains any part of the proceeds of the Letter of Credit, or cash security,
Tenant, upon demand, shall deposit with Landlord the amount so applied or retained so that
Landlord shall have the full amount thereof on hand at all times during the Term. If Tenant shall
comply with all of the terms, covenants and conditions of this Lease, the Letter of Credit or cash
security, as the case may be, shall be returned to Tenant after the Expiration Date and after
delivery of possession of the Premises to Landlord in the manner required by this Lease.
- 50 -
Section 27.3 Transfer.
Upon a sale or other transfer of the Real Property or the Building, or
any financing of Landlords interest therein, Landlord shall have the right to transfer the Letter
of Credit and any cash security to its transferee or lender. With respect to the Letter of Credit,
within 5 days after notice of such transfer or financing, Tenant, at its sole cost, shall arrange
for the transfer of the Letter of Credit to the new landlord or the lender, as designated by
Landlord in the foregoing notice or have the Letter of Credit reissued in the name of the new
landlord or the lender. Upon such transfer, Tenant shall look solely to the new landlord or lender
for the return of the Letter of Credit or such cash security and the provisions hereof shall apply
to every transfer or assignment made of the Letter of Credit or such cash security to a new
landlord. Tenant shall not assign or encumber or attempt to assign or encumber the Letter of Credit
or such cash security and neither Landlord nor its successors or assigns shall be bound by any such
action or attempted assignment, or encumbrance.
[SIGNATURES FOLLOW]
- 51 -
IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the day and year first
above written.
LANDLORD:
TST WOODLAND FUNDING I, L.L.C.,
a Delaware limited liability company
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By:
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/s/ Gary W. Roth
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Gary W. Roth
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Its:
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Vice President
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TENANT:
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DIECA COMMUNICATIONS, INC.,
a Virginia corporation
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By:
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/s/ Charles E. Hoffman
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Its:
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President & CEO
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- 52 -
Exhibit A
Floor Plan
The floor plan which follows is intended solely to identify the general location of the Premises,
and should not be used for any other purpose. All areas, dimensions and locations are approximate,
and any physical conditions indicated may not exist as shown.
A-1
FIRST AMENDMENT TO DEED OF LEASE
THIS FIRST AMENDMENT TO DEED OF LEASE
(this First Amendment) is made this
31
st
day of March, 2005 (the Effective Date), by and between
ACP/2300
CORPORATE PARK
DRIVE,
LLC, a Delaware limited liability company (Landlord), and
DIECA COMMUNICATIONS,
INC., a Virginia corporation (Tenant).
W I T N E S S E T H :
WHEREAS,
pursuant to that certain Deed of Lease dated July 8, 2002 (the Original Lease),
TST Woodland Funding I, L.L.C. (Original Landlord) leased to Tenant, and Tenant leased from
Original Landlord, approximately 37,517 rentable square feet of space (the Premises) on the
first (1
st
), third (3
rd
) and fourth (4
th
) floors of the building located
at 2300 Corporate Park Drive, Herndon, Virginia (the Building);
WHEREAS,
Landlord purchased the Building from Original Landlord and succeeded to the
interest of Original Landlord under the Original Lease; and
WHEREAS,
Tenant desires to extend the Term for a period of five (5) years, commencing on
August 1, 2005 and expiring on July 31, 2010, and Landlord is willing to do so, subject to the
terms and conditions set forth in this First Amendment.
NOW, THEREFORE,
in consideration of the foregoing and for other good and valuable
consideration and of the mutual agreements hereinafter set forth, it is hereby mutually agreed as
follows:
1. Incorporation of Recitals.
The foregoing recitals are hereby incorporated in this First Amendment and made a part hereof by this reference.
2. Definitions.
All capitalized terms used in this First Amendment shall have the meanings
ascribed thereto in the Original Lease, unless otherwise defined herein. As used herein and
in the Original Lease, the term Lease shall mean the Original Lease, as amended by this First
Amendment.
3. Extension Term.
The Term is hereby extended for a period of five (5) years (the
Extension Term), commencing on August 1, 2005 (the Extension Term Commencement Date) and
ending on July 31, 2010 (the Extension Term Expiration Date).
4. Improvements to the Premises.
A. Tenant shall retain possession of the Premises on the Extension Term Commencement Date in
its then as-is condition, and, except as expressly set forth in this Paragraph 4, Landlord shall
have no obligation to perform or pay for any work, improvements or alterations in or to the
Premises in connection with this First Amendment or otherwise. Notwithstanding the foregoing and
provided that Tenant is not then in default of its obligations under the Lease, Landlord shall
install in the Premises, at Tenants sole cost and expense, subject to application of the
Refurbishment Allowance (hereinafter defined), the improvements and alterations (the Tenant
Improvements) described in the plans and specifications prepared by Tenants architect and
approved by Landlord (the Tenants Plans). Landlord shall provide Tenant with an allowance of up
to Seven Hundred Thirty-One Thousand Five Hundred Eighty-One and 50/100 Dollars ($731,581.50) (or
Nineteen and 50/100 Dollars ($19.50) per rentable square foot of the Premises) (the Refurbishment
Allowance) to pay for costs and expenses incurred by Tenant in connection with the design and
construction of the Tenant Improvements. Once Landlord has approved the Tenants Plans, Landlord
shall bid the Tenant Improvements work to three (3) general contractors selected by Landlord who
are licensed in Virginia (the Approved Bidders). Upon
HOLLAND & KNIGHT
llp
Landlords receipt of fixed price bids from those of the Approved Bidders which intend to submit
bids for the construction of the Tenant Improvements, Tenant shall select the contractor which
shall undertake construction of the Tenant Improvements (the Contractor) from among the Approved
Bidders which Landlord determines have submitted conforming bids. Subject to Landlords approval of
the Tenants Plans, construction of the Tenant Improvements work may commence at any time after the
Effective Date. Landlord shall disburse portions of the Refurbishment Allowance from time-to-time
as Landlord incurs costs in connection with the construction of the Tenant Improvements. The
Tenants Plans prepared by Tenants architect shall be subject to Landlords approval in accordance
with the terms and conditions of the Original Lease, including without limitation those set forth
in Article 5 thereof (captioned, Alterations); provided that Landlord shall approve or reject in
its sole discretion all Tenant Improvements proposed by Tenant which affect the base Building or
the mechanical, electrical, plumbing or other any base Building system therein. The Refurbishment
Allowance shall be used by Tenant solely to pay for the cost of constructing the Tenant
Improvements in the Premises, except as otherwise expressly permitted pursuant to the terms and
conditions of Paragraph 4.C, below.
B. All costs and expenses incurred in connection with the design and construction of
the Tenant Improvements (the Construction Costs) in excess of the Improvement Allowance
shall be paid solely by Tenant on or before the date such costs are due and payable (or if previously
paid by Landlord, shall be reimbursed to Landlord by Tenant within ten (10) days of receipt by Tenant
of invoices therefor from Landlord), and Tenant agrees to indemnify Landlord from and against any
such costs. All amounts payable by Tenant pursuant to this Paragraph 4.B shall be deemed to be Additional Rent
for purposes of the Lease.
C. At any time after Tenant has completed the Tenant Improvements and obtained
lien waivers from all contractors who performed construction-related services, Tenant may;
upon ten (10) business days notice to Landlord, cause Landlord to apply any then-undisbursed portion of the
Refurbishment Allowance toward the next installment of Extension Term Monthly Fixed Rent
(hereinafter defined) and/or Additional Rent coming due under the Lease. In the event that
Landlord has not disbursed all of the Refurbishment Allowance by January 1, 2007 (the Outside Allowance
Date) in payment of, or reimbursement for, Tenant Improvements permitted hereunder and/or to defray
Extension Term Monthly Fixed Rent and/or Additional Rent under the Lease, Landlord shall credit such
undisbursed portion of the Refurbishment Allowance against Tenants obligation to pay Rent
(including without limitation Extension Term Monthly Fixed Rent and/or Additional Rent) first owing under
the Lease after the Outside Allowance Date.
D. Landlords designated representative, ACP Mid-Atlantic LLC (the Construction
Supervisor), shall supervise the construction of the Tenant Improvements, and Tenant shall
pay the Construction Supervisor a construction supervisor fee (the Construction Supervision Fee)
equal to five percent (5%) of the cost of the Tenant Improvements to cover the Landlords cost of
supervision of construction of the Tenant Improvements. In supervising the construction of the Tenant
Improvements, the Construction Supervisor shall perform the following tasks: (1) prepare the bid package for
the construction of the Tenant Improvements; (2) discuss the bid package with Tenant; (3) submit a
bid package to each of the Approved Bidders; (4) discuss the bid package with the Approved
Bidders; (5) show the Premises to each Approved Bidder; (6) collect from the Approved Bidders fixed price
bids for the construction of the Tenant Improvements; (7) discuss each bid with Tenant, Landlord and
each Approved Bidder which submitted same; (8) approve the form of construction contract to be
executed by Landlord and the Contractor; (9) oversee the Contractors obtaining of permits
for, and the commencement of construction with respect to, the Tenant Improvements work; (10) supervise
construction of the Tenant Improvements; (11) determine when the Tenant Improvements have been
substantially completed by the Contractor; (12) hold a walk through inspection of the
Premises with Tenant and the Contractor; and (13) oversee the completion by the Contractor of all punch
list items noted by Tenant and confirmed by Landlords architect. The Construction Supervision Fee
shall be
HOLLAND & KNIGHT
llp
2
deducted by the Landlord from the Refurbishment Allowance. Notwithstanding the foregoing,
Tenant shall be required to reimburse Landlord for any reasonable third-party costs incurred
by Landlord in connection with Landlords review of any plans or specifications depicting the
Tenant Improvements, within thirty (30) days after invoice by Landlord; provided however
that, before incurring any such third-party costs, Landlord shall contact Tenant and inform
it of the nature and scope of the third-party services that Landlord intends to retain.
Landlord shall deduct such third-party costs from the Refurbishment Allowance.
E. Tenant expressly acknowledges and agrees that (1) Landlord shall undertake the Tenant
Improvements in the Premises while Tenant is in. occupancy thereof; (2) Landlord shall
perform construction activities in the Premises during regular business hours (Monday-Friday,
9:00 a.m. to 5:00 p.m.), unless Landlord elects in its sole discretion to perform some or all
of such work in the evening and on weekends; (3) Landlord shall not be liable to Tenant for
constructive eviction or for any interference to Tenants business operations in the Premises
arising out of Landlords construction of the Tenant Improvements; and (4) no delay by
Landlord in substantially completing the Tenant Improvements shall delay or otherwise affect
any of Tenants obligations hereunder, including without limitation its obligation to pay
full Extension Term Monthly Fixed Rent and Additional Rent from and after the Extension Term
Commencement Date. Notwithstanding the provisions of subsection (2), above, at Tenants
written request, received by Landlord prior to the execution by Landlord and the Contractor
of a construction contract for the construction of the Tenant Improvements, Landlord shall
cause the Contractor to undertake the construction of the Tenant Improvements during days and
hours other than regular business hours; provided however that Tenant shall bear all
additional and/or increased costs which arise out of such election by Tenant, including
without limitation an increase in the Contractors price to construct the Tenant Improvements
and all engineering, security and other costs incurred by Landlord as a result thereof. All
such additional and/or increased costs shall be paid by Landlord out of the Refurbishment
Allowance. Landlord agrees that, if Tenant elects to have Landlord undertake the construction
of the Tenant Improvements during regular business hours, Landlord shall use commercially
reasonable efforts to coordinate the scheduling of the Tenant Improvements with Tenant in
order to attempt to minimize the interference to Tenants business operations in the Premises
caused by such construction work.
5. Fixed Rent During Extension Term.
Commencing on the Extension Term Commencement Date,
and thereafter on the first day of each and every calendar month during the Extension Term,
Tenant shall pay to Landlord Fixed Rent for the Premises (Extension Term Annual Fixed Rent)
in the following amounts, in equal monthly installments (Extension Term Monthly Fixed
Rent), in advance, as follows:
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Extension Term Annual
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Fixed Rent Per Square
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Extension Term
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Extension Term
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Period
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Foot
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Annual Fixed Rent
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Monthly Fixed Rent
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8/1/05-7/31/06
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$
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25.50
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$
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956,683.56
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$
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79,723.63
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8/1/06-7/31/07
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$
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26.14
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$
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980,600.64
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$
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81,716.72
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8/1/07-7/31/08
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$
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26.79
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$
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1,005,115.68
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$
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83,759.64
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8/1/08-7/31/09
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$
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27.46
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$
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1,030,243.56
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$
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85,853.63
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8/1/09-7/31/10
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$
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28.15
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$
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1,055,999.64
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$
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87,999.97
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Tenant shall pay Landlord Extension Term Annual Fixed Rent without deduction, diminution,
setoff, counterclaims or prior notice or demand, in accordance with the terms and provisions
of Article 2 of the Original Lease (captioned, Premises, Term, Rent).
HOLLAND & KNIGHT
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3
6. Additional Rent During Extension Term.
A. Commencing on January 1, 2007 and continuing thereafter throughout the Extension Term,
Tenant shall pay to Landlord: (i) Tenants Proportionate Share (as such term is defined in Article 1 of the Original Lease) of the amount of Operating Expenses incurred by Landlord during
any calendar year in the Extension Term which is in excess of the amount of Operating Expenses
incurred by Landlord in the E.T. Base Year (hereinafter defined) in accordance with the terms and
conditions of Section 7.3 of the Original Lease (captioned, Tenants Operating Payment); and (ii)
Tenants Proportionate Share of the amount of Taxes incurred by Landlord during any calendar year
in the Extension Term which is in excess of the amount of Taxes incurred by Landlord in the E.T.
Base Year in accordance with the terms and conditions of Section 7.2 of the Original Lease
(captioned, Tenants Tax Payment). As used herein, the term E.T. Base Year shall mean calendar
year 2006.
B. Effective as of January 1, 2007, Section 7.7(a) of the Original Lease is amended by (1)
deleting 105% in each instance in which such percentage is used therein and by inserting in
lieu thereof 106%; (2) deleting the example set forth therein; and (3) inserting the following
language regarding the cumulative nature of the Cap immediately after the word determined) in
line 6 thereof: Notwithstanding the foregoing, for each calendar year in which Controllable
Operating Expenses are less than 106% of Controllable Operating Expenses for the
immediately-preceding calendar year, the percentage by which actual Controllable Operating
Expenses for such year are below 106% of the prior years Controllable Operating Expenses shall
be added to the Cap for the next calendar year (and each succeeding calendar year until
actual Controllable Operating Expenses for such year exceed by more than 106% (plus any unused
carryover percentage from prior calendar years) of the prior years Controllable Operating
Expenses.
7. Tenants Continuing Obligations.
Between the Effective Date and the Extension Term
Commencement Date, Tenant shall continue to pay to Landlord: (a) all Fixed Rent for the Premises in
accordance with the terms and conditions of Article 2 of the Original Lease; (b) Tenants
Proportionate Share of increases in Operating Expenses in accordance with the terms and conditions
of Section 7.3 of the Original Lease; (c) Tenants Proportionate Share of increases in Real Estate
Taxes in accordance with the terms and conditions of Section 7.2 of the Original Lease; and (d) any
and all other Additional Rent payable to Landlord under the Original Lease.
8. Option To Extend Term.
A. Tenant shall have and is hereby granted the option to further extend the Term hereof for
one (1) additional period of five (5) years commencing on the date immediately following the
Extension Term Expiration Date (the Second Extension Term), provided that: (i) Tenant
delivers written notice (the Second Extension Notice) to Landlord, on the date which is
twelve (12) months prior to the Extension Term Expiration Date, time being of the essence, of
Tenants irrevocable election to exercise such extension option, time being of the essence;
(ii) no Event of Default has occurred during the Extension Term and no event exists at the time
of the exercise of such option or arises subsequent thereto, which event by notice and/or the
passage of time would constitute an Event of Default if not cured within the applicable cure
period; and (iii) Tenant has not assigned its interest in the Lease (except to a Related
Entity) or sublet more than thirty percent (30%) of the Premises (except to a Related Entity).
B. All terms and conditions of the Lease, including without limitation all provisions
governing the payment of Additional Rent and annual increases in Annual Fixed Rent, shall
remain in full force and effect during the Second Extension Term, except that (i) Annual Fixed
Rent (on a per rentable square foot basis) payable during the Second Extension Period shall
equal the then-current Fair Market Rental Rate (hereinafter defined) at the time of the
commencement of the Second Extension Period; (ii) Landlord shall provide a market improvement
allowance, rental abatement and other tenant concessions
HOLLAND & KNIGHT
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4
in connection with the Second Extension Term; and (iii) the Base Year for Tenants Proportionate
Share of increases in Operating Expenses and Tenants Proportionate Share of increases in Real
Estate Taxes shall be calendar year 2011. As used in this Lease, the term Fair Market Rental Rate
shall mean the fair market rental rate that would be agreed upon between a landlord and a tenant
entering into a lease renewal for comparable space as to location, configuration, size and use, in
a comparable building as to quality, reputation and age which is located in the Dulles Toll Road
Corridor submarket, with a comparable build-out and a comparable term assuming the following: (A)
the landlord and tenant are informed and well-advised and each is acting in what it considers its
own best interests; (B) the landlord shall provide a market tenant improvement allowance, free
rent period and other tenant concessions (including, for example, an allowance for architectural
and engineering fees) typically provided to tenants of comparable space in comparable buildings for
leases having terms comparable to the Second Extension Period; and (C) the tenant will continue to
pay its share of increases in Operating Expenses and Real Estate Taxes as described above.
C. Landlord and Tenant shall negotiate in good faith to determine the Annual Fixed
Rent for the first year of the Second Extension Term, for a period of thirty (30) days after
the date on which Landlord receives Tenants written notice of Tenants irrevocable election to exercise
the extension option provided for under this Paragraph 8. In the event Landlord and Tenant are unable to
agree upon the Annual Fixed Rent for the first year of the Second Extension Term within said thirty
(30)-day period, the Fair Market Rental Rate for the Premises shall be determined by a board of three (3)
licensed real estate brokers, one of whom shall be named by the Landlord, one of whom shall be named by
Tenant, and the two so appointed shall select a third. Each real estate broker so selected shall be
licensed in the Commonwealth of Virginia as a real estate broker specializing in the field of office leasing
in Fairfax County, having no fewer than ten (10) years experience in such field, and recognized as
ethical and reputable within the field. Landlord and Tenant agree to make their appointments promptly
within ten (10) days after the expiration of the thirty (30)-day period, or sooner if mutually agreed
upon. The two (2) brokers selected by Landlord and Tenant shall promptly select a third broker (the Third
Broker) within ten (10) days after they both have been appointed, and each broker, within fifteen (15)
days after the third broker is selected, shall submit his or her determination of the Fair Market Rental
Rate. The Third Broker shall determine which determination of Fair Market Rental Rate made by Landlords
broker or Tenants broker is closest to the determination of Fair Market Rental Rate made by the
Third Broker (the Closest Determination). The Fair Market Rental Rate hereunder shall be the mean of the
Closest Determination and the determination of Fair Market Rental Value made by the Third Broker.
Landlord and Tenant shall each pay the fee of the broker selected by it, and they shall equally share
the payment of the fee of the Third Broker.
D. Should the Term of the Lease be extended hereunder, Tenant shall, if required by
Landlord, execute an amendment modifying the Lease within thirty (30) days after Landlord
presents same to Tenant, which agreement shall set forth the Annual Fixed Rent for the first year of
the Second Extension Term and the other economic terms and provisions in effect during the Second
Extension Term. Should Tenant fail to execute the amendment (which amendment accurately sets forth
the economic terms and provisions in effect during the Second Extension Term) within thirty (30)
days after presentation of same by Landlord, time being of the essence, Tenants right to further extend
the Term of the Lease shall, at Landlords sole option, terminate, and Landlord shall be permitted to
lease such space to any other person or entity upon whatever terms and conditions are acceptable to Landlord in
its sole discretion.
9. Right of First Offer.
A. Subject to (i) any renewal rights granted by Landlord, before or after the Effective
Date, to any tenant of all or any portion of the Right of First Offer Space, and (ii) the right of
any tenant of the Right of First Offer Space (or any portion thereof) to negotiate an extension of
the term
HOLLAND & KNIGHT
llp
5
of its lease of such space or a new lease demising such space, Tenant shall be granted during the
Extension Term only the following rights with respect to the Right of First Offer Space. As used
herein, the term Right of First Offer Space shall mean the portion, if any, of the First Floor
Space (hereinafter defined) and/or the Fourth Floor Space (hereinafter defined) which Landlord
determines is available for lease by Tenant during the Extension Term and with respect to which
Landlord receives an Offer (hereinafter defined) to lease all or any portion of such space. As
used herein (1) the term First Floor Space means the space located on the first
(1
st
) floor of the Building which is designated as First Floor Space on
Exhibit
A
attached hereto, and (2) the term Fourth Floor Space means the space located on the
fourth (4
th
) floor of the Building which is designated as Fourth Floor Space on
Exhibit A-1
attached hereto. Notwithstanding any provision of the Lease to the contrary,
Tenant shall have no rights with respect to the Right of First Offer Space or any other rights of
first offer or refusal, or first right to negotiate, or any other expansion rights whatsoever,
except as expressly provided in this Paragraph 9.
B. If, during the Extension Term, Landlord determines that any portion of the Right of First
Offer Space is, or will be, available for lease by Tenant and thereafter Landlord receives a bona
fide offer from a prospective tenant which is not related to Landlord (a Prospective Tenant) to
lease all or any portion of the Right of First Offer Space (an Offer), the financial terms of
which Landlord is prepared to accept, Landlord shall notify Tenant in writing of such Offer (the
ROFO Notice), and Landlord shall set forth in the ROFO Notice: (i) a description of the portion
of the Right of First Offer Space that is subject to the Offer (the Available Space), (ii) the
base rent, tenant concessions and other terms and conditions pursuant to which Landlord would
agree to lease the Available Space to Tenant (which terms need not be those contained in the
Offer), and (iii) the date on which Landlord anticipates that the Available Space would become
available for lease by Tenant (the ROFO Availability Date). Provided that (A) no Event of
Default then exists under the Lease; (B) Tenant has not assigned the Lease (except to a Related
Entity), or sublet twenty-five percent (25%) or more of the Premises (except to a Related Entity);
(C) not less than thirty-six (36) months remain in the Extension Term as of the ROFO Availability
Date; and (D) Tenant notifies Landlord, in writing, within five (5) business days after Tenant
receives the ROFO Notice, time being of the essence, of Tenants irrevocable election to lease all
(but not less than all) of the Available Space described in the ROFO Notice on the terms and
conditions set forth in the ROFO Notice (the ROFO Tenant Election Notice), Tenant shall have the
right to lease all, but not less than all, of the Available Space described in the ROFO Notice on
the terms and conditions set forth in the ROFO Notice.
C. In the event that Tenant timely delivers a ROFO Tenant Election Notice to
Landlord, Landlord shall prepare an amendment modifying the Lease to incorporate the
Available Space (the ROFO Amendment), which amendment shall set forth, among other things: (i) the amount
of Annual Fixed Rent payable by Tenant for the Available Space (based on the per rentable square
foot rental rate set forth in the ROFO Notice) during each year of the Right of First Offer Space
Term (hereinafter defined); and (ii) the adjustments to Tenants obligation to pay Additional Rent
caused by the addition of the Available Space. The term of the demise of the Available Space (the Right of
First Offer Space Term) shall commence on the date on which Landlord delivers such Available Space to
Tenant (the ROFO Space Commencement Date), at which time all of Tenants obligations with respect
to the Available Space shall commence, including the obligation to pay Annual Fixed Rent. The Right
of First Offer Space Term shall be coterminous with the Extension Term, as such term may be further
extended.
D. In the event that Landlord and Tenant enter in a ROFO Amendment, and
Landlord is unable to deliver to Tenant possession of the Available Space demised thereunder
on the ROFO Availability Date for any reason whatsoever, including without limitation the failure of
an existing tenant to vacate such space, Landlord shall not be liable or responsible for any claims,
damages or liabilities in connection therewith or by reason thereof, provided that (i) Landlord shall
use reasonable efforts to obtain possession of such space and deliver same to Tenant as soon as reasonably
practicable thereafter; and (ii) rent shall abate until Landlord delivers the Available Space to Tenant.
HOLLAND & KNIGHT
llp
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E. In the event Tenant fails timely to deliver a ROFO Tenant Election Notice to Landlord or,
having done so, Tenant fails to execute the ROFO Amendment tendered by Landlord within ten (10)
days after Landlord tenders such amendment to Tenant: (i) Landlord may lease the Available Space
(or any portion thereof) described in the ROFO Notice to any person or entity of Landlords
choice, on whatever terms and conditions are selected by Landlord in its sole discretion; and
(ii) this Paragraph 9 shall terminate automatically, and Tenant shall have no further right to
lease any Right of First Offer Space.
10. Monument Sign.
In the event that, at any time during the Term, Landlord elects in
its sole discretion to erect a monument sign (the Monument) adjacent to the main entrance of the
Building, Tenant, at Tenants sole cost and expense, shall be permitted to install on a
non-exclusive basis a plaque or other means of entity identification selected by Landlord in its
sole discretion and bearing Tenants name (the Monument Signage) on such Monument, in a location
selected by Landlord. All attributes of the Monument, if constructed by Landlord, shall be
determined by Landlord in its sole discretion. All attributes of the Monument Signage, including
without limitation size, materials, and color and position on Landlords Monument, shall be subject
to Landlords approval in its sole discretion. The location of other tenants signage on the
Monument (if built) shall be determined by Landlord in its sole discretion. In the event that the
Monument is constructed by Landlord, Tenants right to install the Monument Signage shall be
subject to Tenants receipt of all necessary permits and governmental approvals for such
installation; provided that the failure to obtain such permits or approvals shall not affect the
Lease (or Tenants obligations thereunder) in any way. Tenant shall be responsible for repairing
and maintaining the Monument Signage in a first-class condition throughout the Term. The Monument
Signage shall be installed by Landlord at Tenants sole cost and expense. The right to install the
Monument Signage shall be personal to Dieca Communications, Inc. and shall not apply to any
sublessee, assignee or other transferee of Tenant; provided that (a) if an affiliate of Tenant
occupies the Premises pursuant to this Lease or a sublease, such affiliates name may be on the
Monument Signage in lieu of Tenants name; and (b) Tenant may insert its Covad trade name on the
Monument Signage in lieu of its corporate name. Tenant agrees to indemnify Landlord and hold it
harmless from and against all claims, damage or liability (including reasonable attorneys fees)
sustained or suffered by Landlord arising out of or related to the installation, maintenance or
removal of the Monument Signage. Tenant shall remove the Monument Signage at the end of the Term,
and shall restore the portion of Landlords Monument affected by such removal to its condition
immediately prior to the installation of such Monument Signage, reasonable wear and tear excepted.
If Tenant fails to remove the Monument Signage from the Monument at the expiration of the Term or
fails to restore the portions of the Monument affected by such removal, Landlord may, but shall not
be obligated to remove the Monument Signage and/or restore the portion of the Monument affected
thereby, and Tenant shall reimburse Landlord for all costs and expenses incurred by Landlord with
respect to such removal and/or restoration immediately upon demand therefor.
11. Security Deposit.
Within ten (10) days after the Effective Date, time being of the essence,
Tenant shall cause the Issuing Bank to extend until October 31, 2010 the expiration date under the
Letter of Credit, and to issue to Landlord an amendment to the Letter of Credit, in form and
substance acceptable to Landlord in its sole discretion, by which the Issuing Bank has effected
such extension. Notwithstanding any contrary provision contained in Article 27 of the Original
Lease (captioned, Security Deposit), provided that (a) no Event of Default then exists; (b) no
event has occurred which, but for the passage of time or the giving of notice, would constitute an
Event of Default under the Lease; and (c) Tenant has not assigned the Lease or subleased all or
any portion of the Premises (collectively, the Reduction Conditions), then, upon the earlier to
occur of (i) the date which is ten (10) days after that on which Tenant evidences to Landlords
reasonable satisfaction that, for four (4) successive three (3) calendar month periods during the
Extension Term, Guarantor (hereinafter defined) has been Profitable (hereinafter defined); or (ii)
August 31, 2008, the Letter of Credit shall be reduced by an amount (the First Reduction Amount)
sufficient to cause the Letter of Credit to be in an amount equal to three (3) times the
then-current Extension Term Monthly Fixed Rent. As used herein, the term Profitable means that,
at the end of each three (3) calendar month period described above, Tenant demonstrates to
HOLLAND & KNIGHT
llp
7
Landlords reasonable satisfaction that (A) Guarantor has achieved an after-tax profit
(i.e.,
net
income after taxes) for such period, (B) Guarantor has an owners equity net of unamortized
intangibles and. goodwill
(i.e.,
total assets less total liabilities and less any unamortized
intangible assets and any good will) equal to or greater than such owners equity as of the
Effective Date, and (C) the ratio of Guarantors total debt (long-term and short term) to
owners equity (net of unamortized intangibles and goodwill) is
less than 1:2 (i.e. total debt
¸
owners equity and less any unamortized intangible assets and any good will is less than .50).
The foregoing ratios and amounts for each three (3) calendar month period in question shall be
determined based upon Guarantors quarterly financial statements delivered to Landlord which have
been prepared in accordance with generally accepted accounting principles consistently applied
and certified to as such by Guarantors chief financial officer. Notwithstanding the foregoing,
the Issuing Bank (as such term is defined in Section 27.1 of the Original Lease) shall not reduce
the Letter of Credit as aforesaid unless and until Landlord delivers to such bank a written notice
confirming that all conditions precedent to such reduction have been satisfied. In addition,
provided that the Letter of Credit is reduced by the First Reduction Amount prior to August 31,
2008 in accordance with the provisions of Subparagraph (i), above, and provided that Guarantors
Net Worth (hereinafter defined) and Profitability have not declined between the date of such
initial reduction in the Letter of Credit and August 31, 2008, then within thirty (30) days after
August 31, 2008, provided that the Reduction Conditions are satisfied by Tenant as of this date,
the Letter of Credit shall be further reduced by an amount (the Second Reduction Amount)
sufficient to cause the Letter of Credit to be in an amount equal to two (2) times the then-current
Extension Term Monthly Fixed Rent. In no event shall the Letter of Credit be further reduced by
the Issuing Bank unless and until the Issuing Bank receives from Landlord written confirmation that
Tenant has timely satisfied the conditions set forth above, and that Tenant is then entitled to a
reduction in the Letter of Credit in me amount of the Second Reduction Amount. As used herein,
the term Net Worth means total assets (exclusive of intangible assets, including goodwill) minus
total liabilities.
12. Second Floor Storage Systems Furniture.
Subject to the terms and conditions set
forth below, Tenant shall have and is hereby granted a one-time right of first offer to use, during
the Extension Term,at no additional cost to Tenant, the systems furniture currently being stored
by Landlord on the second (2
nd
) floor of the Building, which furniture consists of
approximately twenty-four (24) work station cubicles (the Second Floor Storage Systems
Furniture). In the event that Landlord notifies Tenant in writing that Landlord intends to
utilize the Second Floor Storage Systems Furniture during the Extension Term, Tenant shall have
five (5) business days within which to notify Landlord in writing (the Furniture Election Notice)
of Tenants election to use the Second Floor Storage Systems Furniture during the Extension Term.
In the event that Tenant timely delivers the Furniture Election Notice to Landlord, Landlord, at
Tenants sole cost and expense, shall deliver the Second Floor Storage Systems Furniture to the
Premises on the Furniture Delivery Date in its then as-is condition. As used herein, the term
Furniture Delivery Date means the later to occur of: (i) the Extension Term Commencement Date;
or (ii) thirty (30) days after Landlords receipt of the Furniture Election Notice. Tenant hereby
expressly acknowledges and that Landlord shall have no obligation to provide or purchase any
supplemental components that may be necessary to assemble or otherwise use the Second Floor
Storage Systems Furniture. Throughout the Extension Term, Tenant shall be solely responsible for
the installation, maintenance, repair and/or replacement of the Second Floor Storage Systems
Furniture. At the expiration or other termination of the Extension Term, Tenant shall surrender
and deliver the Second Floor Storage Systems Furniture, to Landlord in the same condition and
repair as it existed on the Extension Term Commencement Date (except as repaired, rebuilt, or
replaced), ordinary wear and tear excepted. If Tenant fails to properly maintain, repair or
replace any of the Second Floor Storage Systems Furniture, Landlord may (but shall not be obligated
to) undertake such maintenance, repair or replacement, and Tenant shall reimburse Landlord for all
costs incurred by Landlord in connection therewith within five (5) days after demand by Landlord.
Notwithstanding any contrary provisions contained in the last sentence of Section 4.3 of the
Original Lease, provided (a) no Event of Default then exists, and (b) no event has occurred which,
but for the passage of time or the giving of notice, would constitute an Event of Default
HOLLAND & KNIGHT
llp
8
under the Lease, Tenant shall have the right, upon delivery of written notice to Landlord on or
before the date which is thirty (30) days prior to the Extension Term Expiration Date, time being
of the essence, to purchase the Existing Furnishings (as such term is defined in Section 4.3 of
the Original Lease) and the Second Floor Storage Systems Furniture from Landlord for One Dollar
($1.00), whereupon Landlord and Tenant shall enter into a bill of sale evidencing such purchase.
13. Parking.
A. Notwithstanding any contrary provision contained in Section 3.2 of the Original
Lease (captioned, Parking Facilities) , throughout the Extension Term, Landlord shall
provide Tenant with the right to use, without additional charge, an additional five (5) reserved parking
spaces (the Reserved Parking Spaces) in a location selected by Landlord in its sole discretion on the
surface lot adjacent to the Building and/or in the parking facility serving the Building. Landlord shall
have no obligation to police the Reserved Parking Spaces in order to assure that automobiles parked
in such Reserved Parking Spaces belong to Tenants employees or guests only.
B. Tenant agrees that it and its employees shall observe reasonable safety
precautions in the use of the parking garage, and shall at all times abide by all reasonable
rules and regulations promulgated by Landlord or the parking garage operator governing the use of the
parking garage. It is understood and agreed that Landlord does not assume any responsibility for any
damage or loss to any automobiles parked in the parking garage or to any personal property located
therein, or for any injury sustained by any person in or about the parking garage.
14. Exterior Signage.
A. Paragraph 1 of Rider No. 3 attached to the Original Lease is amended by
deleting the third (3
rd
) sentence thereof (which begins The Exterior Sign shall
not exceed...) and inserting in lieu thereof the following: The Exterior Sign shall not exceed its size as of
March 1, 2005.
B. Exhibit R-3-A attached to the Original Lease is deleted in its entirety, and
Exhibit
R-3-A
attached hereto is substituted therefor as though initially attached to the
Original Lease.
15. Landlords and Tenants Notice Addresses.
A. Article 1 of the Original Lease is amended by deleting the names and addresses set
forth opposite Tenants Address for Notices, and inserting in lieu thereof the following:
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TENANTS ADDRESS
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FOR NOTICES:
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Covad Communications
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Attn: Legal Department
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110 Rio Robles
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San Jose, California 95134
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B. Article 1 of the Original Lease is amended by deleting the names and addresses set
forth opposite Landlords Address for Notices, and inserting in lieu thereof the following:
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LANDLORDS ADDRESS
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FOR NOTICES:
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ACP/2350 Corporate Park Drive, LLC
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Attn: Chief Operating Officer
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444 Brickell Avenue
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Suite 900
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Miami, Florida 33131
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HOLLAND
& KNIGHT
Llp
9
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With copies to:
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ACP/2350 Corporate Park Drive, LLC
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c/o ACP Mid-Atlantic LLC, as Agent
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Attn: Asset Manager
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2350 Corporate Park Drive
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Suite 110
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Herndon, Virginia 20171
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and to:
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Holland & Knight LLP
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2099 Pennsylvania Avenue, NW
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Suite 100
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Washington, DC 20006
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Attn: David S. Kahn, Esq.
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16. USA Patriot Act and Anti-Terrorism Laws.
As of the Effective Date, the Original
Lease is hereby amended by adding the following language as new Article 28 thereof:
ARTICLE 28
USA PATRIOT ACT AND ANTI-TERRORISM LAWS
(a) Tenant represents and warrants to, and covenants with, Landlord that neither
Tenant nor any of its respective constituent owners or affiliates currently are, or
shall be at any time during the Term hereof, in violation of any laws relating to terrorism or
money laundering (collectively, the Anti-Terrorism Laws), including without
limitation Executive Order No. 13224 on Terrorist Financing, effective September 24, 2001 and
relating to Blocking Property and Prohibiting Transactions With Persons Who Commit,
Threaten to Commit, or Support Terrorism (the Executive Order) and/or the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (Public Law 107-56) (the USA Patriot Act).
(b) Tenant covenants with Landlord that neither Tenant nor any of its respective
constituent owners or affiliates is or shall be during the Term hereof a Prohibited
Person, which is defined as follows: (i) a person or entity that is listed in the
Annex to, or is otherwise subject to, the provisions of the Executive Order; (ii) a person or
entity owned or controlled by, or acting for or on behalf of, any person or entity that is
listed in the Annex to, or is otherwise subject to the provisions of, the Executive Order; (iii)
a person or entity with whom Landlord is prohibited from dealing with or otherwise
engaging in any transaction by any Anti-Terrorism Law, including without limitation the
Executive Order and the USA Patriot Act; (iv) a person or entity who commits, threatens
or conspires to commit or support terrorism as defined in Section 3(d) of the
Executive Order; (v) a person or entity that is named as aspecially designated national and blocked
person on the then-most current list published by the U.S. Treasury Department Office of Foreign Assets Control at its official website,
http://www.treas.gov/offices/eotffc/ofac/sdn/tllsdn.pdf,
or at any replacement website or other replacement official publication of such list; and (vi) a person or entity who is
affiliated with a person or entity listed in items (i) through (v); above.
HOLLAND
& KNIGHT
llp
10
(c) At any time and from time-to-time during the Term, Tenant shall deliver to
Landlord, within ten (10) days after receipt of a written request therefor, a
written certification reasonably acceptable to Landlord evidencing and confirming
Tenants compliance with this Article 28.
17. Deletion of Tenants Termination Right.
As of the Effective Date, Paragraph 9.6 of
the Original Lease (captioned Right to Terminate) is deleted in its entirety, and it shall
be of no further force or effect.
18. Guaranty.
Simultaneously with Tenants execution and delivery to Landlord of this First Amendment, Covad Communications Group, Inc. (Guarantor) shall execute and deliver to
Landlord the Guaranty of Deed of Lease attached hereto as
Exhibit C
(the Guaranty).
19. Low Voltage Cabling.
All voice, data, video, audio, and other low-voltage control
transport system cabling and/or cable bundles installed in the Building shall be (a) plenum
rated and/or have a composition makeup suited for its environmental use in accordance with NFPA 70/National
Electrical Code; (b) labeled every 3 meters with the Tenants name and origination and
destination points; (c) installed in accordance with all EIA/TIA standards and the National Electric Code; (d)
installed and routed in accordance with a routing plan showing as built or as installed configurations
of cable pathways, outlet identification numbers, locations of all wall, ceiling and floor
penetrations, riser cable routing and conduit routing if applicable, and such other information as Landlord may request.
The routing plan shall be available to Landlord and its agents at the Building upon request.
20. Brokers.
Landlord and Tenant recognize ACP Mid-Atlantic LLC, as Landlords agent,
and Liberty-Greenfield, LLP and Scheer Partners, as Tenants agent, as the sole brokers (the
Brokers) with respect to this First Amendment. Landlord shall be responsible for the payment of any
leasing commission owed to the Brokers in accordance with the terms of separate commission agreements
entered into between Landlord and the Brokers. Landlord and Tenant each represent and warrant
to the other that no other broker has been employed in carrying on any negotiations relating to this
First Amendment and shall each indemnify and hold harmless the other from any claim for brokerage or
other commission arising from or out of any breach of the foregoing representation and warranty.
21. Counterpart Copies.
This First Amendment may be executed in two (2) or more
counterpart copies, all of which counterparts shall have the same force and effect as if all
parties hereto had executed a single copy of this First Amendment.
22. Miscellaneous.
This First Amendment (a) shall be binding upon and inure to the benefit
of the parties hereto and their respective representatives, transferees, successors and
assigns and (b) shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia.
23. Ratification.
Except as expressly amended by this First Amendment, all other terms,
conditions and provisions of the Lease are hereby ratified and confirmed and shall continue in
full force and effect.
[signatures on next page]
HOLLAND
& KNIGHT
llp
11
IN WITNESS WHEREOF, the parties hereto have executed this First Amendment to Deed of Lease
under seal as of the day and year first hereinabove written.
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LANDLORD:
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ACP/2300 CORPORATE PARK DRIVE, LLC,
a
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Delaware limited
liability company
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By:
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ACP/Woodland Park, LLC, a Delaware limited
liability company, its sole member
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WITNESS:
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By:
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ACP/Woodland Park Manager, LLC, a
Delaware limited liability company, its
manager
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/s/
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By:
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/s/ Doug Fleit
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Name : Doug Fleit
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Title: Managing Member
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TENANT:
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ATTEST:
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DIECA COMMUNICATIONS, INC
., a Virginia
corporation
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/s/
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By:
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/s/ Charles E. Hoffman
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Name : CHARLES E. HOFFMAN
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Title:
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PRESIDENT & CEO
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HOLLAND
& KNIGHT
LLP
12
EXHIBIT A
FLOOR PLAN OF FIRST FLOOR SPACE
[Attach]
HOLLAND
& KNIGHT
llp
EXHIBIT A-l
FLOOR PLAN OF FOURTH FLOOR SPACE
[Attach]
HOLLAND
& KNIGHT
llp
EXHIBIT B
INTENTIONALLY OMITTED
HOLLAND
& KNIGHT
llp
EXHIBIT R-3-A
LOCATION OF EXTERIOR SIGNAGE
[Attach]
HOLLAND & KNIGHT
llp
EXHIBIT
R-3-A
LOCATION OF EXTERIOR SIGNAGE
EXHIBIT C
GUARANTY OF DEED OF LEASE
THIS
GUARANTY OF DEED OF LEASE
(this Guaranty) is made and given as of the ___ day of March,
2005, by
COVAD COMMUNICATIONS GROUP, INC.,
a Delaware corporation (Guarantor), to and for the
benefit of
ACP/2300 CORPORATE PARK DRIVE, LLC,
a Delaware limited liability company, and its
successors and assigns (Landlord).
W I T N E S S E T H:
WHEREAS,
concurrently with the execution of this Guaranty, Landlord and Dieca Communications,
Inc. (Tenant) have entered into that certain First Amendment to Deed of Lease, of even date
herewith (the First Amendment), pursuant to which Landlord and Tenant have amended the terms of
that certain Deed of Lease, dated July 8, 2002 (the Original Lease) demising certain premises
(the Premises) in the building known as South Pointe II located at 2300 Corporate Park Drive,
Herndon, Virginia (the Building) (the Original Lease, as amended by the First Amendment, is
hereinafter referred to as the Lease); and
WHEREAS,
the Guarantor has a direct and/or indirect financial interest in Tenant; and
WHEREAS,
the parties recognize that the terms and conditions contained in the First Amendment
were agreed to by Landlord solely because the Guarantor has agreed to guarantee the performance of
the obligations of Tenant and its respective successors and assigns under the Lease, and such
guarantee was and is a material inducement to the execution and delivery of the First Amendment by
Landlord; and
WHEREAS,
the Guarantor warrants and acknowledges that because of its financial interest,
direct and/or indirect, in Tenant and in the benefits and advantages which will result from the
First Amendment, the Guarantor will be significantly benefited by the First Amendment.
NOW, THEREFORE,
in consideration of the foregoing and as an inducement for the granting,
execution and delivery of the Lease, the sum of Ten Dollars ($10.00), and other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged, the Guarantor hereby
unconditionally and irrevocably guarantees, promises and agrees as follows:
1. The above recitals are by this reference incorporated herein as if fully restated herein.
2. The Guarantor hereby guarantees to Landlord, absolutely, unconditionally
and irrevocably: (a) the full and prompt payment of all sums which may at any time become due
under the Lease, including, but not limited to, monthly rent, additional rent, and all other sums
and charges (including without limitation Landlords attorneys fees and disbursements)
(hereinafter sometimes collectively referred to as the Monetary Obligations) which Tenant is
obligated to pay to or on behalf of Landlord or to pay to third parties under the provisions of the
Lease, and (b) the full and timely performance and observance of all of the covenants, terms,
conditions and agreements provided in the Lease to be performed and observed by Tenant (hereinafter
sometimes collectively referred to as the Non-Monetary
Obligations). The Guarantor hereby
covenants and agrees to and with Landlord that if at any time Tenant shall fail to make payment
when due of any of the Monetary Obligations, or if at any time Tenant shall fail to perform and
observe when and as required any of the Non-Monetary Obligations, the Guarantor shall forthwith pay
the Monetary Obligations to Landlord and any arrears thereof, and shall
HOLLAND & KNIGHT
llp
forthwith faithfully and punctually perform and fulfill all of the Non-Monetary Obligations and,
in addition thereto, shall forthwith pay to Landlord all reasonable attorneys fees and
disbursements incurred by Landlord or caused by any such default or the enforcement of this
Guaranty.
3. This Guaranty is an absolute and unconditional guaranty of payment (and not merely of
collection) and of performance. The liabilities of the Guarantor are primary, irrevocable and
co-extensive with that of Tenant and also joint and several, and this Guaranty shall be
enforceable against the Guarantor without the necessity of any suit or proceeding on Landlords
part of any kind or nature whatsoever against Tenant and without the necessity of any notice of
non-payment, non-performance or non-observance or of any notice of acceptance of this Guaranty or
of any other notice or demand to which the Guarantor might otherwise be entitled, all of which the
Guarantor hereby expressly waives. The Guarantor hereby expressly agrees that the validity of this
Guaranty and the obligations of the Guarantor hereunder shall in no way be terminated, affected,
diminished or impaired by reason of (a) the assertion of, or the failure to assert by Landlord,
against Tenant any of the rights or remedies reserved to Landlord pursuant to the terms, covenants
and conditions of the Lease, or (b) any non-liability of Tenant under the Lease, whether by
insolvency, discharge in bankruptcy, or any other defect or defense which may now or hereafter
exist in favor of Tenant.
4. This Guaranty guarantees the performance of all of the obligations of Tenant, its
successors and assigns, under the Lease.
5. This Guaranty shall be a continuing guaranty, and it is expressly agreed that the liability
of the Guarantor hereunder shall in no way be affected, modified or diminished by reason of (a)
any sublease of all or any portion of the Premises or assignment, renewal, modification, amendment,
extension or waiver of the Lease or any of the terms, covenants and conditions thereof, even if the
effect of such sublease, assignment, renewal, modification, amendment, extension or waiver shall be
to increase the obligations of the Guarantor hereunder, or (b) any extension of time that may be
granted by Landlord to Tenant, or (c) any consent, release, indulgence or other action, inaction or
omission under or in respect of the Lease, or (d) any dealings or transactions or matter or thing
occurring between Landlord and Tenant relating to the Building or the Lease, or (e) any bankruptcy,
insolvency, reorganization, liquidation, arrangement, assignment for the benefit of creditors,
receivership, trusteeship or similar proceeding affecting Tenant, or (f) any obligation of
Tenant under the Lease having become unenforceable as against Tenant, whether or not notice of any
of the aforesaid (a) through (f) is given to the Guarantor.
6. Should Landlord be obligated by any bankruptcy or other law to repay to Tenant or to the
Guarantor or to any trustee, receiver or other representative of any of them, any amounts
previously paid, this Guaranty shall be reinstated in the amount of such repayments. Landlord
shall not be required to litigate or otherwise dispute its obligations to make such repayments if
it in good faith believes that such obligation exists.
7. No delay on the part of Landlord in exercising any right, power or privilege under this
Guaranty or failure to exercise the same shall operate as a waiver of or otherwise affect any such
right, power or privilege, nor shall any single or partial exercise thereof preclude any other or
further exercise thereof or the exercise of any other right, power or
privilege.
8. No waiver or modification of any provision of this Guaranty nor any termination of this
Guaranty shall be effective unless in writing and signed by Landlord; nor shall any such waiver be
applicable except in the specific instance for which it is given.
HOLLAND
& KNIGHT
llp
Exhibit C, Page 2
9. All of Landlords rights and remedies under the Lease and under this Guaranty, now or
hereafter existing at law or in equity or by statute or otherwise, are intended to be distinct,
separate and cumulative and no exercise or partial exercise of any such right or remedy therein or
herein mentioned is intended to be in exclusion of or a waiver of any of the others.
10. The Guarantor agrees that whenever at any time or from time to time the Guarantor shall
make any payment to Landlord or perform or fulfill any term, covenant or condition hereunder on
account of the liability of the Guarantor, hereunder, the Guarantor will notify Landlord in writing
that such payment or performance, as the case may be, is for such purpose. No such payment or
performance by the Guarantor pursuant to any provision hereof or otherwise shall entitle the
Guarantor, by subrogation or otherwise, to the rights of Landlord to any payment by Tenant, or out
of the property of Tenant, except after payment of all sums and fulfillment of all covenants,
terms, conditions or agreements to be paid or performed by Tenant and its successors or assigns
under the Lease.
11. The Guarantor agrees that it will, at any time and from time to time, within ten (10) days
following written request by Landlord, execute, acknowledge and deliver to Landlord a statement
certifying that this Guaranty is unmodified and in full force and effect (or if there have been
modifications, that the same is in full force and effect as modified and stating such
modification). The Guarantor agrees that such certificate may be relied on by anyone holding or
proposing to acquire any interest in the Premises or the Building of which the Premises is a part
from or through Landlord or by the holder of any mortgage or prospective holder of any mortgage or
of any interest therein.
12. As a further inducement to Landlord to make and enter into the Lease and in
consideration thereof, Landlord and the Guarantor covenant and agree that in any action or
proceeding brought on, under or by virtue of this Guaranty., Landlord and the Guarantor shall and
do hereby waive trial by jury.
13. This Guaranty may be enforced by Landlord without the necessity of its signature appearing
hereon.
14. All notices and other communications permitted or required by the provisions of this
Guaranty shall be in writing and shall be deemed given either (a) three (3) business days after
being mailed through the United States Postal Service, designated as registered or certified mail,
return receipt requested, bearing adequate postage and addressed as hereinafter provided, or (b)
when delivered by hand or by means of a nationally-recognized commercial delivery service (such as
FedEx) which obtains a signed receipt to confirm delivery. Rejection or refusal to accept or
inability to deliver because of change of address of which no notice was given as provided herein
shall be deemed to be receipt of the notice or other communication sent. By giving to the other
party hereto at least ten (10) days notice thereof, any party hereto shall have the right from
time to time to change its address for purposes of this Guaranty to any other address. Each notice
or other communication to Guarantor or Landlord shall be addressed, until such notice of change of
address, as follows:
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If to Guarantor:
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Covad Communications Group, Inc.
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110 Rio Robles
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San Jose, California 95134
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Attention: Legal Department
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If
to Landlord:
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ACP/2350 Corporate Park Drive, LLC
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444 Brickell Avenue, Suite 900
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Miami, Florida 33131
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Attention: Chief Operating Officer
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HOLLAND & KNIGHT
llp
Exhibit C, Page 3
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and to:
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ACP/2350 Corporate Park Drive, LLC
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c/o ACP Mid-Atlantic LLC, as Agent
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2350 Corporate Park Drive, Suite 110
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Herndon, Virginia 20171
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Attention: Asset Manager
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with a copy to:
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Holland & Knight LLP
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2099 Pennsylvania Avenue, NW
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Suite 100
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Washington, DC 20006
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Attention: David S. Kahn, Esquire
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16. If
any provision of this Guaranty shall be declared to be unenforceable in whole or
in part by a court of competent jurisdiction, that part of the Guaranty found to be
unenforceable shall be deemed stricken and severed and the remaining provisions and portions
shall continue in fall force and effect.
17. The Guarantor agrees that this Guaranty shall inure to the benefit of, and may be
enforced by, Landlord and its successors and assigns, and shall be binding upon and
enforceable against the Guarantor, and its heirs, successors and assigns.
18. This Guaranty, the rights and obligations of the parties hereto, and any claims or
disputes relating thereto, shall be governed by and construed in accordance with the laws of
Commonwealth of Virginia.
IN WITNESS WHEREOF,
Guarantor has executed this Guaranty of Deed of Lease under seal
on the
day of March, 2005.
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Guarantor:
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WITNESS:
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COVAD COMMUNICATIONS GROUP, INC.,
a Delaware corporation
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/s/
|
|
|
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By
|
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/s/ Charles E. Hoffman
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|
|
|
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Name: CHARLES E. HOFFMAN
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Title: PRESIDENT & CEO
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HOLLAND
& KNIGHT
llp
Exhibit C
,
Page 4