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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to          

Commission file number: 001-33883

K12 Inc.

(Exact name of registrant as specified in its charter)

Delaware

95-4774688

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

2300 Corporate Park Drive

Herndon, VA 20171

(703483-7000

(Address of Principal Executive Offices)

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, $0.0001 par value

LRN

New York Stock Exchange (NYSE)

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   No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes   No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   No 

As of October 16, 2020, the Registrant had 41,536,151 shares of common stock, $0.0001 par value per share outstanding.

PART I — FINANCIAL INFORMATION

Item 1.    Financial Statements (Unaudited).

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, 

June 30,

    

2020

    

2020

(audited)

(In thousands except share and per share data)

ASSETS

Current assets

Cash and cash equivalents

$

308,784

$

212,299

Accounts receivable, net of allowance of $18,483 and $6,808

419,615

236,134

Inventories, net

24,009

28,300

Prepaid expenses

33,338

13,058

Other current assets

19,745

11,480

Total current assets

805,491

501,271

Operating lease right-of-use assets, net

107,747

111,768

Property and equipment, net

70,147

38,668

Capitalized software, net

49,263

48,493

Capitalized curriculum development costs, net

48,931

48,849

Intangible assets, net

75,360

77,451

Goodwill

174,523

174,939

Deposits and other assets

73,014

71,824

Total assets

$

1,404,476

$

1,073,263

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities

Accounts payable

$

91,957

$

40,428

Accrued liabilities

25,782

27,351

Accrued compensation and benefits

27,598

47,227

Deferred revenue

55,373

24,417

Credit facility

100,000

Current portion of finance lease liability

14,629

13,304

Current portion of operating lease liability

20,655

20,689

Total current liabilities

235,994

273,416

Long-term finance lease liability

18,156

4,634

Long-term operating lease liability

91,624

96,544

Long-term debt

287,811

Deferred tax liability

35,872

13,771

Other long-term liabilities

15,998

9,569

Total liabilities

685,455

397,934

Commitments and contingencies

Stockholders’ equity

Preferred stock, par value $0.0001; 10,000,000 shares authorized; zero shares issued or outstanding

Common stock, par value $0.0001; 100,000,000 shares authorized; 46,872,975 and 46,341,627 shares issued; and 41,538,232 and 41,006,884 shares outstanding

4

4

Additional paid-in capital

768,232

730,761

Accumulated other comprehensive income (loss)

(99)

93

Retained earnings

53,366

46,953

Treasury stock of 5,334,743 shares at cost

(102,482)

(102,482)

Total stockholders’ equity

719,021

675,329

Total liabilities and stockholders' equity

$

1,404,476

$

1,073,263

See accompanying notes to unaudited condensed consolidated financial statements.

3

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended September 30, 

    

2020

    

2019

    

    

(In thousands except share and per share data)

Revenues

$

370,960

$

257,121

Instructional costs and services

241,069

169,358

Gross margin

129,891

87,763

Selling, general, and administrative expenses

117,827

107,151

Income (loss) from operations

12,064

(19,388)

Interest income (expense), net

(2,107)

910

Other income (expense), net

429

(8)

Income (loss) before income taxes and loss from equity method investments

10,386

(18,486)

Income tax benefit

2,376

8,818

Loss from equity method investments

(96)

(62)

Net income (loss) attributable to common stockholders

$

12,666

$

(9,730)

Net income (loss) attributable to common stockholders per share:

Basic

$

0.32

$

(0.25)

Diluted

$

0.30

$

(0.25)

Weighted average shares used in computing per share amounts:

Basic

39,985,417

39,288,557

Diluted

42,189,673

39,288,557

See accompanying notes to unaudited condensed consolidated financial statements.

4

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three Months Ended September 30, 

    

2020

    

2019

    

(In thousands)

Net income (loss)

$

12,666

$

(9,730)

Other comprehensive income (loss), net of tax:

Foreign currency translation adjustment

(192)

139

Comprehensive income (loss) attributable to common stockholders

$

12,474

$

(9,591)

See accompanying notes to unaudited condensed consolidated financial statements.

5

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

K12 Inc. Stockholders' Equity

(In thousands except share data)

Common Stock

Additional
Paid-in

Accumulated Other
Comprehensive

Retained

Treasury Stock

    

Shares

    

Amount

    

Capital

    

Income (Loss)

    

Earnings

    

Shares

    

Amount

    

Total

Balance, June 30, 2020

46,341,627

$

4

$

730,761

$

93

$

46,953

(5,334,743)

$

(102,482)

$

675,329

Adjustment related to new credit losses guidance

(6,253)

(6,253)

Net income

12,666

12,666

Foreign currency translation adjustment

(192)

(192)

Stock-based compensation expense

9,009

9,009

Exercise of stock options

948,867

32

32

Withholding of stock options for tax withholding

(655,219)

(10,885)

(10,885)

Equity component of convertible senior notes, net of issuance costs and taxes

105,477

105,477

Purchases of capped calls in connection with convertible senior notes

(60,354)

(60,354)

Issuance of restricted stock awards

383,223

Forfeiture of restricted stock awards

(9,329)

Repurchase of restricted stock for tax withholding

(136,194)

(5,808)

(5,808)

Balance, September 30, 2020

46,872,975

$

4

$

768,232

$

(99)

$

53,366

(5,334,743)

$

(102,482)

$

719,021

K12 Inc. Stockholders' Equity

(In thousands except share data)

Common Stock

Additional
Paid-in

Accumulated Other
Comprehensive

Retained Earnings (Accumulated

Treasury Stock

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit)

    

Shares

    

Amount

    

Total

Balance, June 30, 2019

45,575,236

$

4

$

713,436

$

(40)

$

22,447

(5,334,743)

$

(102,482)

$

633,365

Net loss

(9,730)

(9,730)

Foreign currency translation adjustment

139

139

Stock-based compensation expense

5,594

5,594

Exercise of stock options

2,500

42

42

Issuance of restricted stock awards

918,702

Forfeiture of restricted stock awards

(34,090)

Repurchase of restricted stock for tax withholding

(171,778)

(4,698)

(4,698)

Balance, September 30, 2019

46,290,570

$

4

$

714,374

$

99

$

12,717

(5,334,743)

$

(102,482)

$

624,712

See accompanying notes to unaudited condensed consolidated financial statements.

6

K12 INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended September 30, 

    

2020

    

2019

(In thousands)

Cash flows from operating activities

Net income (loss)

$

12,666

$

(9,730)

Adjustments to reconcile net income (loss) to net cash used in operating activities:

Depreciation and amortization expense

18,277

17,146

Stock-based compensation expense

8,893

5,522

Deferred income taxes

8,065

3,776

Provision for (recovery of) doubtful accounts

4,875

(280)

Amortization of discount and fees on debt

1,219

Other

10,792

4,141

Changes in assets and liabilities:

Accounts receivable

(196,953)

(75,765)

Inventories, prepaid expenses, deposits and other current and long-term assets

(23,975)

(8,942)

Accounts payable

30,893

(2,396)

Accrued liabilities

(1,883)

(266)

Accrued compensation and benefits

(19,629)

(23,038)

Operating lease liability

(5,165)

(2,073)

Deferred revenue and other liabilities

37,392

5,091

Net cash used in operating activities

(114,533)

(86,814)

Cash flows from investing activities

Purchase of property and equipment

(1,106)

(1,246)

Capitalized software development costs

(7,204)

(7,196)

Capitalized curriculum development costs

(4,488)

(8,528)

Sale of long-lived assets

223

Other acquisitions and investments, net of distributions

(3,113)

(1,277)

Net cash used in investing activities

(15,688)

(18,247)

Cash flows from financing activities

Repayments on finance lease obligations

(5,669)

(7,460)

Repayments on credit facility

(100,000)

Issuance of convertible senior notes

409,390

Purchases of capped calls in connection with convertible senior notes

(60,354)

Proceeds from exercise of stock options

32

42

Withholding of stock options for tax withholding

(10,885)

Repurchase of restricted stock for income tax withholding

(5,808)

(4,698)

Net cash provided by (used in) financing activities

226,706

(12,116)

Net change in cash, cash equivalents and restricted cash

96,485

(117,177)

Cash, cash equivalents and restricted cash, beginning of period

213,299

284,621

Cash, cash equivalents and restricted cash, end of period

$

309,784

$

167,444

Reconciliation of cash, cash equivalents and restricted cash to balance sheet as of September 30th:

Cash and cash equivalents

$

308,784

$

165,944

Other current assets (restricted cash)

500

500

Deposits and other assets (restricted cash)

500

1,000

Total cash, cash equivalents and restricted cash

$

309,784

$

167,444

See accompanying notes to unaudited condensed consolidated financial statements.

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Description of the Business

K12 Inc., together with its subsidiaries (“K12” or the “Company”) is an education services company providing online and blended learning. The Company’s technology-based products and services enable its clients to attract, enroll, educate, track progress, and support students on a scalable basis. These products and services, spanning curriculum, systems, instruction, and support services are designed to help learners reach their educational goals through inspired teaching and personalized learning.  The Company’s clients are primarily public and private schools, school districts, and charter boards. Additionally, it offers solutions to employers, government agencies and consumers, including through private schools which it operates. These products and services are provided through two lines of revenue:

General Education products and services are predominantly focused on kindergarten through twelfth grade students for core subjects including math, English, science and history, to help build a common foundation of knowledge. Programs utilizing General Education products and services are for students that are not specializing in any particular curriculum or course of study. These programs provide an alternative to traditional school options and serve a range of student needs including safety concerns, increased academic support, scheduling flexibility, physical/health restrictions or advanced learning among other reasons. Products and services are sold a-la carte or combined into customized customer offerings.

Career Learning products and services are focused on developing skills for students, in middle school through high school and adult learners, to enter careers in high-growth, in-demand industries—including information technology, business, and health services. The Company provides middle and high school students with Career Learning programs that complement their core general education coursework in math, English, science and history.  K12 currently offers a catalog of over 160 Career Learning courses in 23 Career Pathways™ in five of the sixteen National Career Clusters™. The middle school program spans career exploration, exposes students to a variety of career options, and introduces career skill development. In high school, students may engage in industry content pathway courses, project-based learning in virtual teams, and career development services. High school students also have the opportunity to progress toward certifications, connect with industry professionals, earn college credits while in high school, and participate in job shadowing and/or work based learning experiences that are required to succeed in today’s digital, tech-enabled economy. A student enrolled in a school offering our General Education program may take Career Learning courses but that student and associated revenue is not reported as Career Learning enrollment and revenue. A student and the associated revenue, whether in middle or high school is counted as Career Learning if enrolled in a school offering our Career Learning program and must commit to a career pathway and its associated services, including the Exploratory Pathways. Like General Education, products and services for the Career Learning market are sold a-la carte or combined into a Career Learning program or customized customer offering. The Company also offers post-secondary Career Learning programs to adult learners, through its Galvanize, Inc. (“Galvanize”) subsidiary. These programs include skills training in data science and software engineering, technology staffing and talent development, and are offered directly to consumers, employers and government agencies.

During the first quarter of fiscal year 2021, the Company revised its lines of revenue. Previously, the lines of revenue were (i) Managed Public School Programs, (ii) Institutional, and (iii) Private Pay Schools and Other. The Company believes that the change in the lines of revenue will facilitate a better understanding of the markets in which the Company competes.

2.   Basis of Presentation

The accompanying condensed consolidated balance sheet as of September 30, 2020, the condensed consolidated statements of operations and comprehensive income for the three months ended September 30, 2020 and 2019, the condensed consolidated statements of cash flows for the three months ended September 30, 2020 and 2019, and the condensed consolidated statements of stockholders’ equity for the three months ended September 30, 2020 and 2019 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements, and in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s financial position and results of operations for the periods presented. The results for the three months ended September 30, 2020 are not necessarily indicative of the results to be expected for the year

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

ending June 30, 2021, for any other interim period or for any other future fiscal year. The condensed consolidated balance sheet as of June 30, 2020 has been derived from the audited consolidated financial statements at that date.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, the Company does not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of the Company’s condensed consolidated results of operations, financial position and cash flows. Preparation of the Company’s financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This quarterly report on Form 10-Q should be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on August 12, 2020, which contains the Company’s audited financial statements for the fiscal year ended June 30, 2020.

The Company operates in one operating and reportable business segment as a technology-based education company providing proprietary and third party curriculum, software systems and educational services designed to facilitate individualized learning for students primarily in kindergarten through 12th grade. The Chief Operating Decision Maker evaluates profitability based on consolidated results.

3.   Summary of Significant Accounting Policies

Recent Accounting Pronouncements

Accounting Standards Adopted

On July 1, 2020, the Company adopted Accounting Standards Codification (“ASC”) Topic 326, Financial Instruments – Credit Losses (“ASC 326”), related to the methodology for recognizing credit losses. The new standard revises the accounting requirements related to the measurement of credit losses. Assets must be presented in the financial statements as the net amount expected to be collected. The allowance is based upon historical losses, customer-specific information, current economic conditions, and reasonable and supportable forecasts of future economic conditions. The Company adopted this standard using the modified retrospective approach. The adoption of ASC 326 resulted in the recognition of an additional allowance for credit losses of $8.5 million, as well as decreases of $6.2 million and $2.3 million to retained earnings and deferred tax liabilities, respectively, as of July 1, 2020.

On July 1, 2020, the Company adopted Accounting Standards Update (“ASU”) 2017-04, Intangibles – Goodwill and Other (Topic 350) (“ASU 2017-04”). This amendment simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company adopted this standard prospectively without a material impact to its condensed consolidated financial statements.

Accounting Standards Not Yet Adopted

In March 2020, the Financial Accounting Standards Board (“FASB”) issued ASU 2020-04, Reference Rate Reform (Topic 848) (“ASU 2020-04”) which provides relief to companies that will be impacted by the cessation of reference rate reform, e.g. LIBOR that is tentatively planned for the end of calendar year 2022. The ASU permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement. This ASU will be effective for the Company as of March 12, 2020 through December 31, 2022 and adoption is permitted at any time during the period on a prospective basis. The Company is currently evaluating the impact of this ASU on its condensed consolidated financial statements.

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40) which, among other things, simplifies the accounting for  convertible instruments by eliminating the requirement to separate conversion features from the host contract. Consequently, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost. Early adoption is permitted for fiscal years beginning after December 15, 2020, including interim periods. The Company is currently evaluating the impact of this ASU on its condensed consolidated financial statements.

Contracts with Customers

Revenue is recognized when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration it expects to be entitled to in exchange for those goods or services using the following steps:

identify the contract, or contracts, with a customer;
identify the performance obligations in the contract;
determine the transaction price;
allocate the transaction price to the performance obligations in the contract; and
recognize revenue when, or as, the Company satisfies a performance obligation.

Revenue Recognition

Revenues related to the products and services that the Company provides to students in kindergarten through twelfth grade or adult learners are considered to be General Education or Career Learning based on the school in which the student is enrolled. General Education products and services are focused on core subjects, including math, English, science and history, for kindergarten through twelfth grade students to help build a common foundation of knowledge. Career Learning products and services are focused on developing skills to enter and succeed in careers in high-growth, in-demand industries—including information technology, business, and health services, for students in middle school through high school and adult learners.

The majority of the Company’s contracts are with the following types of customers:

an online or blended school whereby the amount of revenue is primarily determined by funding the school receives;
a school or individual who licenses certain curriculum on a subscription or course-by-course basis; or
an enterprise who contracts with the Company to provide job training.

Funding-based Contracts

The Company provides an integrated package of systems, services, products, and professional expertise that is administered together to support an online or blended public school. Contractual agreements generally span multiple years with performance obligations being isolated to annual periods which generally coincide with the Company’s fiscal year. Customers of these programs can obtain administrative support, information technology, academic support services, online curriculum, learning systems platforms and instructional services under the terms of a negotiated service agreement. The schools receive funding on a per student basis from the state in which the public school or school district is located. Shipments of materials for schools that occur in the fourth fiscal quarter and for the upcoming school year are recorded in deferred revenue.

The Company generates revenues under contracts with online and blended public schools and include the following components, where required:

providing each of a school’s students with access to the Company’s online school and lessons;
offline learning kits, which include books and materials to supplement the online lessons;

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

the use of a personal computer and associated reclamation services;
internet access and technology support services;
instruction by a state-certified teacher; and
management and technology services necessary to support an online or blended school. In certain contracts, revenues are determined directly by per enrollment funding.

To determine the pro rata amount of revenue to recognize in a fiscal quarter, the Company estimates the total expected funds each school will receive in a particular school year. Total funds for a school are primarily a function of the number of students enrolled in the school and established per enrollment funding levels, which are generally published on an annual basis by the state or school district. The Company reviews its estimates of funding periodically, and updates as necessary, by adjusting its year-to-date earned revenues to be proportional to the total expected revenues to be earned during the fiscal year. Actual school funding may vary from these estimates and the impact of these differences could impact the Company’s results of operations. Since the end of the school year coincides with the end of the Company’s fiscal year, annual revenues are generally based on actual school funding and actual costs incurred (including costs for the Company’s services to the schools plus other costs the schools may incur). The Company’s schools’ reported results are subject to annual school district financial audits, which incorporate enrollment counts, funding and other routine financial audit considerations. The results of these audits are incorporated into the Company’s monthly funding estimates for the three months ended September 30, 2020 and 2019.

Each state and/or school district has variations in the school funding formulas and methodologies that it uses to estimate funding for revenue recognition at its respective schools. As the Company estimates funding for each school, it takes into account the state definition for count dates on which reported enrollment numbers will be used for per pupil funding. The parameters the Company considers in estimating funding for revenue recognition purposes include school district count definitions, withdrawal rates, average daily attendance, special needs enrollment, academic progress and historical completion, student location, funding caps and other state specified categorical program funding.

Under the contracts where the Company provides products and services to schools, the Company is responsible for substantially all of the expenses incurred by the school and has generally agreed to absorb any operating losses of the schools in a given school year. These school operating losses represent the excess of costs incurred over revenues earned by the online or blended public school (the school’s expected funding), as reflected in its respective financial statements, including Company charges to the schools. To the extent a school does not receive sufficient funding for each student enrolled in the school, the school would still incur costs associated with serving the unfunded enrollment. If losses due to unfunded enrollments result in a net operating loss for the year that loss is reflected as a reduction in the revenues and net receivables that the Company collects from the school. A school net operating loss in one year does not necessarily mean the Company anticipates losing money on the entire contract with the school. However, a school’s net operating loss may reduce the Company’s ability to collect its management fees in full and recognized revenues are constrained to reflect the expected cash collections from such schools. The Company records the school’s estimated net operating loss against revenues based upon the percentage of actual revenues in the period to total estimated revenues for the fiscal year. Actual school net operating losses may vary from these estimates or revisions, and the impact of these differences could have a material impact on results of operations. For the three months ended September 30, 2020 and 2019, the Company’s revenues included a reduction for net school operating losses at the schools of $19.9 million and $16.3 million, respectively. Because the Company has agreed to absorb any operating losses of the schools, the Company records the expenses incurred by the school as both revenue and expenses in the condensed consolidated statements of operations. Amounts recorded as revenues and expenses for the three months ended September 30, 2020 and 2019 were $109.8 million and $85.5 million, respectively.

Subscription-based Contracts

The Company provides certain online curriculum and services to schools and school districts under subscription agreements. Revenues from the licensing of curriculum under subscription arrangements are recognized on a ratable basis over the subscription period. Revenues from professional consulting, training and support services are deferred and recognized ratably over the service period.

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In addition, the Company contracts with individual customers who have access for one to two years to company-provided online curriculum and generally prepay for services to be received. Adult learners enroll in courses that provide specialized training in a specific industry. Each of these contracts are considered to be one performance obligation. The Company recognizes these revenues pro rata over the maximum term of the customer contract based on the defined contract price.

Enterprise Contracts

The Company provides job training over a specified contract period to enterprises. Each of these contracts are considered to be one performance obligation. The Company recognizes these revenues based on the number of students trained during the term of the contract based on the defined contract price.

Disaggregated Revenues

The revenue recognition related to the types of contracts discussed above can span both of the Company’s lines of revenue as shown below. For example, a funding-based contract may include both General Education and Career Learning students. In total, there is one performance obligation and revenue is recognized over the Company’s fiscal year. The revenue is then disaggregated between General Education and Career Learning based on the Company’s estimated full-year enrollment totals of each category. During the three months ended September 30, 2020 and 2019, approximately 89% and 87%, respectively, of the Company’s General Education revenues; and 98% and 99%, respectively, of the Company’s Middle – High School Career Learning revenues, were from funding-based contracts.

The following table presents the Company’s revenues disaggregated based on its two lines of revenue for the three months ended September 30, 2020 and 2019:

Three Months Ended

September 30, 

2020

  

2019

(In thousands)

General Education

$

313,848

$

233,566

Career Learning

Middle - High School

48,771

23,555

Adult

8,341

Total Career Learning

57,112

23,555

Total Revenues

$

370,960

$

257,121

Concentration of Customers

During the three months ended September 30, 2020 and 2019, the Company had zero and one contract, respectively, that represented greater than 10% of total revenues.

Contract Balances

The timing of revenue recognition, invoicing, and cash collection results in accounts receivable, unbilled receivables (a contract asset) and deferred revenue (a contract liability) in the condensed consolidated balance sheets. Accounts receivable are recorded when there is an executed customer contract and the customer is billed. The collectability of outstanding receivables is evaluated regularly by the Company and an allowance is recorded to reflect probable losses. Unbilled receivables are created when revenue is earned prior to the customer being billed. Deferred revenue is recorded when customers are billed or cash is collected in advance of services being provided.

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The opening and closing balance of the Company’s accounts receivable, unbilled receivables and deferred revenue are as follows:

September 30, 

June 30,

2020

    

2020

(In thousands)

Accounts receivable

$

419,615

$

236,134

Unbilled receivables (included in accounts receivable)

35,284

15,688

Deferred revenue

55,373

24,417

Deferred revenue, long-term (included in other long-term liabilities)

2,197

2,236

The difference between the opening and closing balance of the accounts receivable and unbilled receivables relates to the timing of the Company’s billing in relation to month end and contractual agreements. The difference between the opening and closing balance of the deferred revenue relates to the timing difference between billings to customers and the service periods under the contract. Typically, each of these balances are at their highest during the first quarter of the fiscal year and lowest at the end of the fiscal year. The amount of revenue recognized during the three months ended September 30, 2020 and 2019 that was included in the previous July 1st deferred revenue balance was $14.8 million and $11.2 million, respectively. During the three months ended September 30, 2020 and 2019, the Company recorded revenues of ($0.1) million and $0.4 million, respectively, related to performance obligations satisfied in prior periods.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. For the majority of its contracts, the Company’s performance obligations are satisfied over time, as the Company delivers, and the customer receives the services, over the service period of the contract. The Company’s payment terms are generally net 30 or net 45, but can vary depending on the customer or when the school receives its funding from the state.

The Company has elected, as a practical expedient, not to report the value of unsatisfied performance obligations for contracts with customers that have an expected duration of one year or less. The amount of unsatisfied performance obligations for contracts with customers which extend beyond one year as of September 30, 2020 was $2.2 million.

Significant Judgments

The Company determined that the majority of its contracts with customers contain one performance obligation. The Company markets the products and services as an integrated package building off its curriculum offerings. It does not market distinct products or services to be sold independently from the curriculum offering. The Company provides the significant service of integrating the goods and services into the operation of the school and education of its students, for which the customer has contracted.

The Company has determined that the time elapsed method is the most appropriate measure of progress towards the satisfaction of the performance obligation. Generally, the Company delivers the integrated products and services package over the course of the Company’s fiscal year. This package includes enrollment, marketing, teacher training, etc. in addition to the core curriculum and instruction. All of these activities are necessary and contribute to the overall education of its students, which occurs evenly throughout the year. Accordingly, the Company recognizes revenue on a straight-line basis.

The Company determined that the expected value method is the most appropriate method to account for variable consideration and the Company’s forecasting method is an estimation process that uses probability to determine expected funding. On a monthly basis, the Company estimates the total funds each school will receive in a particular school year and the amount of full-year school revenues and operating expenses to determine the amount of revenue the Company will recognize. Enrollment and state funding rates are key inputs to this estimate. The estimates are adjusted monthly, and a

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

cumulative catch-up adjustment is recorded to revenue as necessary to reflect the total revenues earned to date to be proportional to the total revenues to be earned in the fiscal year. The Company builds in known constraints (i.e. enrollment, funding, net operating losses, etc.) into the estimate of the variable consideration to record the most probable amount.

Sales Taxes

Sales tax collected from customers is excluded from revenues. Collected but unremitted sales tax is included as part of accrued liabilities in the condensed consolidated balance sheets. Revenues do not include sales tax as the Company considers itself a pass-through conduit for collecting and remitting sales tax.

Consolidation

The condensed consolidated financial statements include the accounts of the Company, the wholly-owned and affiliated companies that the Company owns, directly or indirectly, and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Allowance for Doubtful Accounts

The Company maintains an allowance for uncollectible accounts primarily for estimated losses resulting from the inability or failure of individual customers to make required payments. 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. The Company maintains an allowance under ASC 326 based on historical losses, customer-specific information, current economic conditions, and reasonable and supportable forecasts of future economic conditions. The allowance under ASC 326 is updated as additional losses are incurred or information becomes available related to the customer or economic condition.

The Company writes-off accounts receivable based on the age of the receivable and the facts and circumstances surrounding the customer and reasons for non-payment. Actual write-offs might differ from the recorded allowance.

Inventories

Inventories consist primarily of textbooks and curriculum materials, a majority of which are supplied to online and blended public schools, and utilized directly by students. Inventories represent items that are purchased and held for sale and are recorded at the lower of cost (first-in, first-out method) or net realizable value. The Company classifies its inventory as current or long-term based on the holding period. As of September 30, 2020 and June 30, 2020, $6.1 million and $5.2 million, respectively, of inventory, net of reserves, was deemed long-term and included in deposits and other assets on the condensed consolidated balance sheets. The provision for excess and obsolete inventory is established based upon the evaluation of the quantity on hand relative to demand. The excess and obsolete inventory reserve was $5.0 million and $4.8 million at September 30, 2020 and June 30, 2020, respectively.

Other Current Assets

Other current assets consist primarily of textbooks, curriculum materials and other supplies which are expected to be returned upon the completion of the school year. Materials not returned are expensed as part of instructional costs and services.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization 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 under the finance lease). Amortization of assets capitalized under finance lease arrangements is included in depreciation expense. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful life of the asset. The determination of the lease term is discussed below under “Leases.”

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property and equipment are depreciated over the following useful lives:

    

Useful Life

Student and state testing computers

3 - 5 years

Computer hardware

3 - 7 years

Computer software

3 - 5 years

Web site development

3 years

Office equipment

5 years

Furniture and fixtures

7 years

Leasehold improvements

Shorter of useful life or term of the lease

The Company makes an estimate of unreturned student computers based on an analysis of recent trends of returns.  The Company recorded accelerated depreciation of $0.8 million and $0.6 million for the three months ended September 30, 2020 and 2019, respectively, related to unreturned student computers. Depreciation expense, including accelerated depreciation, of $5.5 million and $4.0 million, related to computers provided to students is reflected in instructional costs and services during the three months ended September 30, 2020 and 2019, respectively.

Depreciation expense of $1.0 million and $1.1 million, related to property and equipment is reflected in selling, general, and administrative expenses during the three months ended September 30, 2020 and 2019, respectively.

The Company fully expenses computer peripheral equipment (e.g. keyboards, mouses) upon purchase as recovery has been determined to be uneconomical. These expenses totaled $4.4 million and $2.5 million for the three months ended September 30, 2020 and 2019, respectively, and are recorded as instructional costs and services.

Capitalized Software Costs

The Company develops software for internal use. Software development costs incurred during the application development stage are capitalized. The Company amortizes these costs over the estimated useful life of the software, which is generally three years. Capitalized software development costs are stated at cost less accumulated amortization.

Capitalized software additions totaled $7.2 million and $7.2 million for the three months ended September 30, 2020 and 2019, respectively. The Company recorded amortization expense of $4.7 million and $5.4 million related to capitalized software reflected in instructional costs and services and $1.1 million and $1.5 million reflected in selling, general, and administrative expenses during the three months ended September 30, 2020 and 2019, respectively.

Capitalized Curriculum Development Costs

The Company internally develops curriculum, which is primarily provided as online content and accessed via the Internet. The Company also creates textbooks and other materials that are complementary to online content.

The Company capitalizes curriculum development costs incurred during the application development stage, as well as the design and deployment phases of the project. As a result, a significant portion of the Company’s courseware development costs qualify for capitalization due to the concentration of its development efforts on the content of the courseware. Capitalization ends when a course is available for general release to its customers, at which time amortization of the capitalized costs begins. The period of time over which these development costs are amortized is generally five years.

Total capitalized curriculum development additions were $4.5 million and $8.5 million for the three months ended September 30, 2020 and 2019, respectively. These amounts are recorded on the condensed consolidated balance sheets net of amortization charges. Amortization expense for the three months ended September 30, 2020 and 2019 was $4.0 million and $4.4 million, respectively, and is recorded in instructional costs and services.

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Leases

The Company’s principal leasing activities include student computers and peripherals, classified as finance leases, and facilities, classified as operating leases.

Leases are classified as operating leases unless they meet any of the criteria below to be classified as a finance lease:

the lease transfers ownership of the asset at the end of the lease;
the lease grants an option to purchase the asset which the lessee is expected to exercise;
the lease term reflects a major part of the asset’s economic life;
the present value of the lease payments equals or exceeds the fair value of the asset; or
the asset is specialized with no alternative use to the lessor at the end of the term.

Finance Leases

The Company enters into agreements to finance the purchase of student computers and peripherals provided to students of its schools. Individual leases typically include 1 to 3 year payment terms, at varying rates, with a $1 purchase option at the end of each lease term. The Company pledges the assets financed to secure the outstanding leases.

Operating Leases

The Company enters into agreements for facilities that serve as offices for its headquarters, sales and enrollment teams, and school operations. Initial lease terms vary between 1 and 17 years. Certain leases include renewal options, usually based upon current market rates, as well as termination rights. The Company performs an evaluation of each lease to determine if the lease payments included in the renewal option should be included in the initial measurement of the lease liability.

Discount Rate

The present value of the lease payments is calculated using either the rate implicit in the lease, or the lessee’s incremental borrowing rate, over the lease term. For the Company’s finance leases, the stated rate is defined within the lease terms; while for the Company’s operating leases, the rate is not implicit. For operating leases, the Company uses its incremental borrowing rate as the discount rate; determined as the Company’s borrowing rate on a collateralized basis for a similar term and amount to the term and amount of the lease.

For its adoption of ASC Topic 842, Leases (“ASC 842”), the Company utilized its agreements used for its finance leases as the basis for calculating its incremental borrowing rate. The rate was collateralized and its term reflected a similar term of the remaining lease payments of the Company’s largest operating lease. As of the adoption date, the incremental borrowing rate was 3.86%.  Upon the execution of its senior secured revolving credit facility (see Note 7, “Credit Facility”), the Company has reassessed its incremental borrowing rate as 2.55%. The incremental borrowing rate is subsequently reassessed upon modification of its leasing arrangements or with the execution of a new lease agreement.

Policy Elections

Short-term Leases

The Company has elected as an on-going accounting policy election not to apply ASC 842 to short-term facility leases of 12 months or less. By making this election, the Company will not record a right-of-use asset or lease liability at the commencement of the lease, and will continue to expense its lease payments on a straight-line basis over the lease term.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The accounting policy election is made by class of underlying asset to which the right of use relates. The Company has elected to apply the accounting policy election only to operating leases.

Income Taxes

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. The net deferred tax asset is 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.

Goodwill and Intangible Assets

The Company records as goodwill the excess of the purchase price over the fair value of the identifiable net assets acquired. Finite-lived intangible assets acquired in business combinations subject to amortization are recorded at their fair value. Finite-lived intangible assets include trade names, acquired customers and distributors, developed technology and non-compete agreements. Such intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortization expense for the three months ended September 30, 2020 and 2019 was $2.1 million and $0.7 million, respectively, and is included within selling, general, and administrative expenses in the condensed consolidated statements of operations. Future amortization of intangible assets is expected to be $6.0 million, $7.9 million, $7.7 million, $6.7 million, and $5.5 million in the fiscal years ending June 30, 2021 through June 30, 2025, respectively and $41.4 million thereafter. At September 30, 2020 and June 30, 2020, the goodwill balance was $174.5 million and $174.9 million, respectively.

The Company reviews its finite-lived intangible 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.

The process for testing goodwill and intangible assets with indefinite lives for impairment is a two-step process that is performed annually, as well as when an event triggering impairment may have occurred. Companies are also allowed to  qualitatively assess goodwill impairment through a screening process which would permit companies to forgo Step 1 of their annual goodwill impairment process. This qualitative screening process will hereinafter be referred to as “Step 0”. The Company performs its annual assessment on May 31st based on the Company’s one reporting unit. During the year ended June 30, 2020, the Company performed “Step 0” of the impairment test and determined that there were no facts and circumstances that indicated that the fair value of the reporting unit may be less than its carrying amount, and as a result, the Company determined that no impairment was required.

The Company performed a qualitative assessment of Coronavirus disease (“COVID-19”) as a triggering event related to the value of its goodwill and intangible assets and concluded that there were no indicators of impairment during the three months ended September 30, 2020.

The following table represents the balance of the Company’s intangible assets as of September 30, 2020 and June 30, 2020:

September 30, 2020

June 30, 2020

($ in millions)

    

Gross
Carrying
Amount

    

Accumulated
Amortization

    

Net
Carrying
Value

    

Gross
Carrying
Amount

    

Accumulated
Amortization

    

Net
Carrying
Value

Trade names

    

$

77.9

    

$

(13.2)

    

$

64.7

$

77.9

$

(12.0)

$

65.9

Customer and distributor relationships

25.3

(17.8)

7.5

25.3

(17.2)

8.1

Developed technology

6.6

(3.8)

2.8

6.6

(3.5)

3.1

Other

1.4

(1.0)

0.4

1.4

(1.0)

0.4

Total

$

111.2

$

(35.8)

$

75.4

$

111.2

  

$

(33.7)

$

77.5

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K12 INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Impairment of Long-Lived Assets

Long-lived assets include property, equipment, right-of-use assets, capitalized curriculum and software developed or obtained for internal use. Management reviews the Company’s 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. The Company determines the extent to which an asset may be impaired based upon its expectation of the asset’s future usability as well as on a reasonable assurance that the future cash flows associated with the asset will be in excess of its carrying amount. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between fair value and the carrying value of the asset. The Company performed a qualitative assessment of COVID-19 as a triggering event related to the value of its long-lived assets and concluded that there were no indicators of impairment during the three months ended September 30, 2020.

Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. Measurements are described in a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The three levels of inputs used to measure fair value are:

Level 1:   Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2:   Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3:   Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

The carrying values reflected in the condensed consolidated balance sheets for cash and cash equivalents, receivables, and short term debt approximate their fair values, as they are largely short-term in nature. As of September 30, 2020, the estimated fair value of our long-term debt was $352.0 million. The Company estimated the fair value based on the quoted market prices in an inactive market on the last day of the reporting period (Level 2). The long-term debt is recorded at face value less the unamortized discount and debt issuance costs on our condensed consolidated balance sheet, and is discussed in more detail in Note 6, “Debt.” The Tallo, Inc. convertible note is discussed in more detail in Note 11, “Acquisitions and Investments.”

The following table summarizes certain fair value information at September 30, 2020 for assets or liabilities measured at fair value on a recurring basis:

 

Fair Value Measurements Using:

 

 

Quoted Prices

 

 

in Active

Significant

 

 

 

Markets for

Other

Significant

 

 

Identical

Observable

Unobservable

 

 

Assets

Input

Inputs

Description

    

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

(In thousands)

Convertible note received in acquisition

$

5,006

5,006

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table summarizes certain fair value information at June 30, 2020 for assets or liabilities measured at fair value on a recurring basis:

 

Fair Value Measurements Using:

 

 

Quoted Prices

 

 

in Active

Significant

 

 

 

Markets for

Other

Significant

 

 

Identical

Observable

Unobservable

 

 

Assets

Input

Inputs

Description

    

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

(In thousands)

Convertible note received in acquisition

$

5,006

$

$

$

5,006

The following table presents activity related to the Company’s fair value measurements categorized as Level 3 of the valuation hierarchy, valued on a recurring basis, for the three months ended September 30, 2020 and 2019:

 

Three Months Ended September 30, 2020

 

 

Purchases,

 

 

Fair Value

Issuances,

Unrealized

Fair Value

Description

    

June 30, 2020

    

and Settlements

    

Gains/(Losses)

    

September 30, 2020

 

 

(In thousands)

Convertible note received in acquisition

$

5,006

5,006

Three Months Ended September 30, 2019

 

 

Purchases,

 

 

Fair Value

Issuances,

Unrealized

Fair Value

Description

    

June 30, 2019

    

and Settlements

    

Gains/(Losses)

    

September 30, 2019

 

 

(In thousands)

Convertible note received in acquisition

$

5,006

5,006

Net Income (Loss) Per Common Share

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. The weighted average number of shares of common stock outstanding includes vested restricted stock awards. Diluted net income (loss) per share (“EPS”) reflects the potential dilution that could occur assuming conversion or exercise of all dilutive unexercised stock options and vesting of all dilutive unvested restricted stock awards. The dilutive effect of stock options and restricted stock awards was determined using the treasury stock method. Under the treasury stock method, the proceeds received from the exercise of stock options and restricted stock awards, the amount of compensation cost for future service not yet recognized by the Company and the amount of tax benefits that would be recorded as income tax expense when the stock options become deductible for income tax purposes are all assumed to be used to repurchase shares of the Company’s common stock. Stock options and restricted stock awards are not included in the computation of diluted net income (loss) per share when they are antidilutive. Common stock outstanding reflected in the Company’s condensed consolidated balance sheets includes restricted stock awards outstanding.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following schedule presents the calculation of basic and diluted net income per share:

Three Months Ended September 30,

  

2020

  

2019

  

(In thousands except share and per share data)

Basic net income (loss) per share computation:

Net income (loss) attributable to common stockholders

$

12,666

$

(