LRN

Business Context and Reporting Period

This Form 10-Q covers K12 Inc. (not Stride, Inc.) for the quarterly and six-month periods ended December 31, 2009. K12 is a technology-based education company providing proprietary online curriculum, educational materials, and management services to virtual public schools and individual consumers. As of the reporting date, the company served schools in 25 states and the District of Columbia, having expanded into four new states (Wyoming, Oklahoma, Alaska, and Virginia) during the fiscal year.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 20.1% year-over-year for the quarter and 20.0% for the six-month period, driven by a 22.3% increase in average enrollments (67,354 vs. 55,076).
• Profitability Expansion: Operating income more than doubled for the quarter ($14.3M vs. $6.0M) and increased 77.5% for the six-month period ($27.0M vs. $15.2M). Net income attributable to K12 Inc. increased 173.8% for the quarter and 77.2% for the six-month period.
• Cost Efficiency: Instructional costs as a percentage of revenue decreased significantly to 55.4% (quarter) and 55.0% (six months) from 64.8% and 63.0% in the prior year, respectively. This was due to lower fulfillment costs and increased productivity, partially offset by higher high school enrollment costs.
• Expense Increases: Selling, administrative, and other operating expenses rose 31.8% for the quarter and 39.6% for the six-month period, primarily due to increased personnel costs, student recruiting, and stock-based compensation.
• Cash Flow Improvement: Net cash provided by operating activities turned positive at $9.8 million for the six months ended Dec 31, 2009, compared to a net cash use of $20.9 million in the prior year period.

Guidance, Outlook, and Risks

• Seasonality: The company notes significant seasonality, with higher revenues and margins typically in the first fiscal quarter due to the shipment of materials at the start of the school year. The second and third quarters generally have higher online curriculum and computer revenues.
• Funding Risks: Management highlighted risks related to state and district per-enrollment funding levels. While federal funds (ARRA) may help sustain levels, mid-year funding cuts for the 2009-10 school year remain a possibility that could impact results.
• Liquidity: The company maintains a $35 million line of credit with no outstanding balance as of December 31, 2009. Management believes existing cash and operating cash flows are sufficient to fund operations and capital expenditures for the foreseeable future.
• Legal Proceedings: A significant legal matter regarding the Agora Cyber Charter School was settled in October 2009. The settlement resulted in the release of withheld fees from a state escrow account and the dismissal of related lawsuits.

Investor Verification Checklist

• Enrollment Quality: Verify the sustainability of the 22.3% enrollment growth and the mix of high school vs. K-8 students, as high school enrollments carry higher costs.
• Funding Stability: Monitor state budget announcements for the 2009-10 school year to assess the risk of funding cuts impacting revenue recognition.
• Debt Obligations: Review the $25.7 million in total minimum payments for capital leases and notes payable to ensure cash flow coverage remains adequate.
• Stock Compensation: Assess the impact of increasing stock-based compensation expenses ($3.5M for six months) on future net income.
• Legal Settlement Impact: Confirm the full collection of fees released from the Agora Cyber Charter School escrow account.