EFTA02707575.pdf

Knowledge Universe Education L.P. and Subsidiaries Consolidated Financial Statements as of and for the Years Ended December 31, 2011 and 2010, and Independent Auditors' Report EFTA_R1_02106168 EFTA02707575 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES TABLE OF CONTENTS Page INDEPENDENT AUDITORS' REPORT 1 CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31,2011 AND 2010: Balance Sheets 2-3 Statements of Operations 4 Statements of Partners' Equity 5 Statements of Cash Flows 6-7 Notes to Consolidated Financial Statements 8-35 EFTA_R1_02106169 EFTA02707576  Deloitte 6 Touche LIP Suite 200 350 South Grand Avenue Los Angeles. CA 90071-3462 USA Tel +1 213 688 0800 Fax: +1 213 6800100 wwwdeloitte can INDEPENDENT AUDITORS' REPORT To the Board of Directors of KUE Management Inc., General Partner of Knowledge Universe Education L.P. and Subsidiaries Santa Monica, California We have audited the accompanying consolidated balance sheets of Knowledge Universe Education L.P. and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of operations, partners' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes 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 Company's 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. --bdotiO 53.7rueite----ZLP June 2.)C 21112 Membet ad Deloine -ouch. EFTA_R1_02106170 EFTA02707577 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2011 AND 2010 (Dollars in thousands) 2011 2010 ASSETS CURRENT ASSETS: Cash and cash equivalents S 277,436 S 148,452 Short-term marketable securities 40,986 198,953 Accounts receivable, net 72,429 83,446 Income tax receivable 4,184 5,739 Deferred income taxes 49,658 23,046 Assets held for sale 238 10,785 Prepaid expenses and other current assets 44,932 40,774 Assets related to discontinued operations 86 Total current assets 489,863 511,281 PROPERTY AND EQUIPMENT, Net 1,018,394 1,008,204 LONG-TERM INVESTMENTS 136,634 223,936 GOODWILL 391,676 388,887 OTHER INTANGIBLE ASSETS, Net 130,376 132,826 ASSETS HELD FOR SALE 18,814 OTHER ASSETS 46,953 59,379 TOTAL $2,213,896 $2,343,327 (Continued) -2- EFTA_R1_02106171 EFTA02707578 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2011 AND 2010 (Dollars in thousands) 2011 2010 LIABILITIES AND EQUITY CURRENT LIABILITIES: Accounts payable S 34,876 $ 25,920 Current portion of self-insurance 24,078 22,427 Income taxes payable 206 392 Accrued property and other taxes 12,135 12,763 Deferred revenue 59,561 50,547 Accrued interest 8,384 8,622 Accrued compensation and related expenses 42,094 45,428 Other accrued liabilities 59,495 52,830 Current portion of long-term debt 21,745 17,970 Current portion of capital lease obligations 3,105 3,073 Current portion of liabilities associated with assets held for sale 29,964 Total current liabilities 265,679 269,936 LONG-TERM DEBT 1,000,943 1,121,605 CAPITAL LEASE OBLIGATIONS 12,237 18,129 DEFERRED INCOME TAXES 68,699 85,336 LIABILITIES ASSOCIATED WITH ASSETS HELD FOR SALE 551 OTHER LONG-TERM LIABILITIES 90,031 95,281 Total liabilities 1,437,589 1,590,838 EQUITY: Partners' equity: Common partner units — 2,239,551 units issued and outstanding 757,383 757,383 Accumulated other comprehensive income 31,014 104,261 Accumulated deficit (22,380) (120,326) Total partners' equity attributable to Knowledge Universe Education L.P. Partners 766,017 741,318 Noncontrolling interests 10,290 11,171 Total equity 776,307 752,489 TOTAL $2,213,896 $2r343i327 ...--- See notes to consolidated financial statements. (Concluded) -3- EFTA_R1_02106172 EFTA02707579 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 (Dollars in thousands) 2011 2010 REVENUE $1,621,150 $1,654,502 COST OF REVENUE 1,179,475 1,241,369 GROSS MARGIN 441,675 413,133 OPERATING EXPENSES (INCOME): General and administrative 286,749 236,839 Depreciation 117,858 112,249 Amortization of intangibles 5,987 7,679 Other 3,426 (106) Total operating expenses, net 414,020 356,661 INCOME FROM OPERATIONS 27,655 56,472 NONOPERATING EXPENSE (INCOME): Losses (gains) on investments 8,570 (4,540) Interest expense 81,639 92,903 Interest income (11,060) (19,895) Other income, nct (1,542) (1,168) Nonoperating expense, net 77,607 67,300 LOSS BEFORE INCOME TAXES (49,952) (10,828) INCOME TAX BENEFIT 39,345 24,375 (LOSS) INCOME FROM CONTINUING OPERATIONS (10,607) 13,547 GAIN FROM DISCONTINUED OPERATIONS 110,455 18,159 NET INCOME 99,848 31,706 NET (INCOME) LOSS ATTRIBUTABLE TO NONCONTROLLING INTERESTS (1,902) 2,086 NET INCOME ATTRIBUTABLE TO KNOWLEDGE UNIVERSE EDUCATION L.P. PARTNERS S 97,946 $ 33,792 See notes to consolidated financial statements. -4- EFTA_R1_02106173 EFTA02707580  KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 (Dollars in thousands) Knowledge Universe Education L.P. Accumulated Other Total Common Accumulated Comprehermthe Fergus's' Nemo/tolling Total Comprehensive Partner Units Amount Deficit Income Equity Interests Equity Income BALANCE - - January 1, 2010 2,239.551 5757,383 5(154,118) S 52.160 5655,425 S 4,967 5660.392 Nei income (loss) 33,792 31,792 (2,086) 31,706 S 31.706 Other comprehensive income: Foreign currency translation adjustments 1,195 1,195 294 1,489 1,489 Nmicomrolling interest related to CIS acquisition 7,996 7.996 Unrealized gain on investments 50,906 50,906 50,906 50,906 Total comprehensive income S 84.101 BALANCE — December 31, 2010 2,239,551 757,383 (120,326) 104,261 741.318 11,171 752,489 Net income 97,946 97,946 1,902 99.848 S 99,848 Other comprehensive income (loss): Foreign currency translation adjustments (129) (129) (630) (759) (759) Noncontrolling interest related to sale of KUE Digital Inc. (2,153) (2,153) Unrealized loss on investments— K12 Inc. (82,143) (82,143) (82,143) (82,143) Reclassification of loss on investment to net income 9,025 9,025 9,025 9.025 Total comprehensive income S 25.971 BALANCE-- December 31, 2011 2239.551 5757,383 S (22.380) S 31,014 $766,017 510.290 5776.307 See notes to consolidated financial statements. -5- PLI.90LZO— L8—Vid3 EFTA02707581 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 (Dollars in thousands) 2011 2010 OPERATING ACTIVITIES: Net income S 99,848 $ 31,706 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 105,645 106,966 Impairment of fixed assets 19,254 11,966 Stock-based compensation (3,348) 212 Loss (gain) on sale of property and equipment and software rights 662 (3,196) Loss (gain) on sales of debt securities 1,603 (III) Losses on sale of investments 4,412 Gain on sale of discontinued operations (110,397) (40,258) Unrealized gain on marketable securities and derivatives (3,633) (5,183) Return on equity method investments (22) Amortization of deferred financing and other costs 4,746 3,922 Interest expense capitalized as long-term debt 210 767 Foreign currency exchange gain (559) (1,337) Changes in: Accounts receivable 10,844 6,088 Prepaid expenses and other current assets (6,506) (162) Income tax receivable (2,724) 6,157 Assets held for sale (101) 38 Deferred income taxes (39,789) (18,775) Other assets 1,311 (2,988) Accounts payable 19 18,497 Accrued expenses and other liabilities 26,994 14,740 Net cash used in discontinued operations (5,505) (15,512) Net cash provided by operating activities 102,964 113.537 INVESTING ACTIVITIES: Purchases of property and equipment and software costs (129,676) (80,908) Proceeds from sale of property and equipment 970 15,821 Proceeds from sale of investments 119,385 (Increase) decrease in restricted cash 9,935 (4,856) Receipts on long-term note receivable and tax refunds credited to goodwill 9 18 Investment in equity method investment (3,514) Purchases of short-term marketable securities (423,082) (1,150,123) Proceeds from sales of short-term marketable securities 579,062 1,242,122 Acquisitions of businesses (11,766) (6,561) Net cash provided by investing activities 144,837 11,999 (Continued) -6- EFTA_R1_02106175 EFTA02707582 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 (Dollars in thousands) 2011 2010 FINANCING ACTIVITIES: Payments on long-term debt and capital leases (196,102) S (158,869) Proceeds from long-term debt 77,285 64,867 Proceeds from related-party borrowing 2,146 Debt issuance costs (2,111) Net cash used in financing activities (118,817) (93,967) EFFECT OF EXCHANGE RATES ON CASH 23 NET INCREASE IN CASH 128,984 31,592 CASH AND CASH EQUIVALENTS — Beginning of year 148,452 116,860 CASH AND CASH EQUIVALENTS — End of year S 277,436 S 148,452 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 99,455 $ 87,239 Cash paid for income taxes, net of refunds S 2,608 $ 8,489 NONCASH INVESTING AND FINANCING ACTIVITIES: Purchases of property and equipment included in current liabilities 643 Assets acquired under capital leases $ 713 S 5,319 See notes to consolidated financial statements. (Concluded) -7- EFTA_R1_02106176 EFTA02707583 KNOWLEDGE UNIVERSE EDUCATION L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 1. GENERAL Knowledge Universe Education L.P. was formed in April 2006 as a Cayman Islands exempted limited partnership. Knowledge Universe Education L.P. is a holding company, whose subsidiaries specialize in education in the preschool to 12th grade segment, mainly in the United States, Asia, and the United Kingdom (collectively, KUE L.P. or the "Company"). The major subsidiaries are as follows: Knowledge Universe Education Holdings Inc. — Knowledge Universe Education Holdings Inc. (KUEH) was formed in May 2011 as a holding company for the early childhood education operations of its wholly owned subsidiary, Knowledge Universe Education LLC (KUE LLC) formerly, Knowledge Learning Corporation (KLC) and related subsidiaries and offers early childhood education programs to children aged six weeks through 12 years. These include toddler care, preschool and kindergarten classes, and before- and after-school programs. KUE LLC provides education and care programs within the following three categories: Early Childhood Care and Education — KUEH provides early childhood care and education services, generally marketed under the names of KindcrCarc Learning Centers, Knowledge Bcginnings, Cambridge Schools, and The Grove School. These services are provided through 1,618 community centers with a licensed capacity of 215,535 in 38 states. Children's Creative Learning Centers — Children's Creative Learning Centers provides employer- sponsored early childhood care and education services, as well as back-up care, through 96 centers, eight before- and after-school sites, and four game-day sites for professional sport teams. These centers and sites have a licensed capacity of 12,055 in 22 states and the District of Columbia. CCLC operates in partnership with employer sponsors under a variety of arrangements, such as discounted rent, enrollment guarantees, or an arrangement whereby the center is managed by CCLC in return for a management fee. Champions — KUEH provides customized before- and after-school educational enrichment and recreational programs for school-age and preschool children in partnership with elementary schools under the Champions brand. Champions offers approximately 405 education and enrichment programs for school-age children in 17 states and the District of Columbia. These programs primarily operate at preschool and elementary school facilities. KC Distance Learning, Inc. — KC Distance Learning, Inc. (KCDL) sells middle and high school level courses via online and correspondence formats and provides related instructional services directly to private students, as well as to cyber and traditional schools and school districts. In July 2010, the Company sold its ownership in KCDL in exchange for shares of preferred stock in K12 Inc. KCDL's operating results have been classified as discontinued operations (see Note 4). Knowledge Universe PTE Ltd. — Knowledge Universe PTE Ltd. is a Singapore holding company for the early childhood education operations of its wholly owned subsidiaries in Asia. Its primary operations include: Pat's Schoolhouse, Learning Vision, Asian International College, Learning Horizon, Global Educare, The Odyssey Creative Leaming Centre, Canadian International Schools, and Brighton Montessori Centres. -8- EFTA_R1_02106177 EFTA02707584  Busy Bees Group Limited — The Company owns approximately 85% of Busy Bees Group Limited ("Busy Bees"). Busy Bees is the UK's largest provider of care and education for children up to school age (five years age). It operates more than 122 child care centers across the UK with a capacity of more than 11,000 children. The nurseries provide complete child care services with child development programs and curricula designed to develop creativity, individuality, and self-confidence in the children. Global Educare Sdn Bhd — The Company acquired Global Educare Sdn Bhd ("Global") on May 14, 2010. The principal activity of Global is providing child care and educational services in Malaysia. Canadian International School Pre Ltd — The Company acquired a 60% joint venture interest in Canadian International School Pte Ltd. (CIS) on June 5, 2010. The principal activity of CIS is providing primary and secondary education services. CIS has constructed a new 463,000 square foot "Lakeside campus" at Jurong West in Singapore. KUE DigitalInternational LLC — KUE Digital International LLC (KUED) is a holding company for early-stage ventures that provide technology products and services in the education industry. The Company owned approximately 88% of KUED at December 31, 2010. KUED provides comprehensive online educational resources for students at all levels, teachers in grades K-12 and college, companies, schools, and school districts requiring administrative support for education and training programs. In January 2011, KUED sold its subsidiaries. The related assets and liabilities are reflected in assets held for sale as of December 31, 2010, and the operations arc reflected in discontinued operations for the years ended December 31, 2011 and 2010 (see Note 4). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation — The consolidated financial statements include the accounts ofKUE L.P. and its wholly owned subsidiaries, KUEH, Knowledge Universe Education Inc. (KUE Inc.), KCDL, Knowledge Universe Holdings Cooperatief U.A. (KUHC), Learning Group LLC, Knowledge Universe Online Services Inc., and its majority owned subsidiaries KUED and Busy Bees. All intercompany balances and transactions arc eliminated in consolidation. The information presented herein is for the calendar years ended December 31, 2011 and 2010, with the exception of KUEH and KUHC. The information included herein reflects activity for the 52 weeks ended December 31, 2011, and January 1, 2011. For simplicity, all information herein is referred to as relating to the years ended December 31, 2011 and 2010. The noncontrolling interests represent the 12% noncontrolling ownership in KUED as of December 31, 2010, and the 15% noncontrolling ownership in Busy Bees and the 40% noncontrolling interest in CIS as of December 31, 2011 and 2010. Use of Estimates — The consolidated financial statements are presented in conformity with accounting principles generally accepted in the United States of America. The preparation thereof requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared based on the most current and best available information and actual results could differ from those estimates. The most significant estimates underlying the consolidated financial statements include the allowance for doubtful accounts; long-lived assets, other intangible assets, and goodwill valuations and any resulting impairment; self-insurance obligations; valuation of stock appreciation rights; and recognition and measurement of uncertain tax positions and valuation allowances against deferred tax assets. -9- EFTA_R1_02106178 EFTA02707585 Revenue Recognition — The recognition of revenues meets the following criteria: the existence of an arrangement through an enrollment agreement, the rendering of child care and tutoring services, an age- specific tuition rate and/or fees, and probable collection. Tuition, fees, and other income are recognized as the related services arc provided. Payments for these types of services may be received in advance of services being rendered, in which case the revenue is deferred and recognized over the appropriate service period. Deferred revenue for nonrefundable registration fees is recognized over the average enrollment period, not to exceed 12 months. The Company's primary source of revenue is tuition paid by parents and supplemented, in some cases, by employer sponsors and government agencies. Revenues also include management fees paid by employer sponsors. In addition to tuition revenue and management fees, the Company receives fees for registration and other ancillary services. Cash and Cash Equivalents — Cash and cash equivalents include interest-earning securities that mature within three months or less from the date purchased. Restricted Cash — At December 31, 2011 and 2010, restricted cash of $16.0 million and $25.9 million, respectively, is included within other assets in the Company's consolidated balance sheets. Restricted cash of S7.7 million and $17.4 million at December 31, 2011 and 2010, respectively, is related to debt service requirements for properties sold that are held as collateral under the collateralized mortgaged- backed security (CMBS) facility; consisting of a $650.0 million mortgage loan and $50.0 million senior mezzanine loan (see Note 12). Restricted cash of $8.3 million at December 31, 2011 and 2010, is held as collateral on the Company's foreign currency hedge (see Note 14). Concentration of Credit Risk — Financial instruments that subject the Company to credit risk consist primarily of cash and cash equivalents and trade receivables. Cash and cash equivalents are placed with high-credit-quality financial institutions. Concentration of credit risk with respect to trade receivables is generally diversified due to the large customer base and its geographic dispersion. The Company performs ongoing credit evaluations of its customers and maintains an allowance for doubtful accounts. Accounts Receivable — Accounts receivable are composed primarily of tuition and reimbursable expenses due from government agencies, parents, and employers. Accounts receivable arc presented at estimated net realizable value. The Company uses estimates in determining the ability to collect accounts receivable and must rely on its evaluation of historical experience, specific customer issues, governmental funding ►evels, and current economic trends to arrive at appropriate reserves. Investments — The Company classifies investments in debt and equity securities as trading, held to maturity, or available for sale in accordance with Accounting Standards Codification (ASC) 320-10, Investments — Debt andEquity. Available-for-sale securities include debt and equity securities, which the Company records at fair value, with unrealized gains and losses reported as part of accumulated other comprehensive income in the consolidated balance sheets. Trading securities include investments in short-term corporate debt securities. Unrealized gains and losses on these short-term marketable securities are included in nonoperating income in the consolidated statements of operations. - 10 - EFTA_R1_02106179 EFTA02707586 Our investments at December 31, 2011 and 2010, consisted of the following (in thousands): 2011 2010 Available-for-sale equity securities — K-12 Inc. S 133,098 $ 212,516 Trading — short-term marketable securities 40,986 198,953 Equity method investments 3,536 11,420 Total investments 177,620 422,889 Less short-term marketable securities 40,986 198,953 Total long-term investments $ 136 634 5 223,936 Our investments in available-for-sale equity securities and trading short-term marketable securities at December 31, 2011 and 2010, consisted of the following (in thousands): 2011 2010 Gross Estimated Gross Estimated Unrealized Fair Unrealized Fair Cost Gain (Loss) Value Cost Gain (Loss) Value Available for sale: Equity securities — K-12 Inc. $101,465 531,633 5133,098 S 98,866 5113,650 $212,516 Trading — short-term marketable securities 41,879 (893) 40,986 200,092 (1,139) 198,953 Property and Equipment — Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed on a straight-line basis over the useful lives of the assets or, in the case of leasehold improvements, the lesser of the term of the related lease or the useful lives of the improvements. A summary of estimated useful lives is as follows: Buildings and leaseholds 5-50 years Land improvements 2-15 years Furniture, fixtures, and equipment 2-10 years Building and leasehold improvements 2-60 years Maintenance, repairs, and minor refurbishments arc expensed as incurred. Assets Held for Sale — Assets held for sale include centers that are being actively marketed and are considered probable of being sold within one year. Such assets are recorded at the lower of their carrying amount or fair value less cost to sell. Long-lived assets are not depreciated while classified as held for sale. Also included in assets held for sale as of December 31, 2010, are the assets of KUED (see Note 4). There were no assets held for sale as of December 31, 201 I . Goodwill — Goodwill represents the excess of the cost over the fair value of the identifiable net assets of businesses acquired. The Company tests its goodwill for impairment on an annual basis, or more frequently, if circumstances indicate reporting unit carrying values exceed their fair values. Fair value is estimated by projecting future discounted cash flows from the reporting unit in addition to other quantitative and qualitative analyses. If the carrying amount of goodwill exceeds the implied estimated fair value (based on discounted cash flows), an impairment charge to current operations is recorded to reduce the carrying value to the implied estimated fair value. There was no impairment of goodwill in fiscal years 2011 or 2010. EFTA_R1_02106180 EFTA02707587 Other Intangible Assets — Other intangible assets consist of customer lists, contract rights, accreditations, proprietary curricula, covenants not to compete, trade names, and trademarks. Other intangible assets subject to amortization are amortized on a straight-line basis over their estimated useful lives. The Company reviews and evaluates the remaining useful lives of such assets if events or changes in circumstances require impairment testing and/or a revision to the remaining period of amortization. Any such impairment analysis is based on a comparison of the carrying values to expected future cash flows. Other intangible assets with indefinite useful lives are tested for impairment on an annual basis, or more frequently, if circumstances indicate the carrying values exceed their fair values. If the carrying amount exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to the implied estimated fair value. There was no impairment of other intangible assets in fiscal years 2011 or 2010. Long-Lived Assets — The Company reviews and evaluates its long-lived assets, other than goodwill and other intangible assets, for impairment when events or changes in circumstances indicate that the carrying value of assets may not be recoverable through future undiscounted cash flows. Any impairment is measured as the amount by which the carrying values of such assets exceed their fair value (based on discounted cash flows). Impairment losses related to child care center property and equipment totaled $19.3 million for 2011 and $10.2 million for 2010. The impairment charges are included as a component of depreciation expense in the consolidated statements of operations. Financial Instruments — In accordance with reporting and disclosure requirements of ASC 825-10, Financial Instruments, the Company calculates the fair value of financial instruments and includes this information in the Company's notes to consolidated financial statements when the fair value is different than the book value of those financial instruments. When fair value is equal to book value, no disclosure is made. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, accrued compensation, and related expenses and other accrued liabilities, excluding derivatives, approximate fair value due to the short-term nature of these assets and liabilities. The Company's derivatives include an interest rate swap agreement, an interest rate cap agreement, and a four-year forward currency hedge based on the British pound. These instruments are recognized in the consolidated balance sheets at fair value. None of these instruments have been designated as a hedge of specific underlying interest rate exposure and marked to market with the resulting gains or losses recognized as a component of interest expense in the consolidated statement of operations. Changes in the foreign currency hedge are included as a component of gains and losses on investments. Deferred Financing Costs — Included in other assets are deferred financing costs incurred in connection with the issuance of debt. Deferred financing costs are amortized over the lives of the related debt facilities using a method that approximates the effective interest method. Deferred financing costs are recorded in other assets (see Note 11). Income Taxes — The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax liabilities and assets are recognized for the expected future consequences of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is established to reduce the amount of that deferred tax asset to the amount, more likely than not, to be recognized. Uncertain tax positions and the related interest and penalties are recognized in other liabilities and income tax expense (see Note 20). - 12 - EFTA_R1_02106181 EFTA02707588 Other Comprehensive Income— ASC 320-10 requires that investment securities with readily determinable market values be marked to market at each reporting period. Accumulated other comprehensive income includes unrealized gains and losses on marketable securities classified as available for sale, net of the related tax effects, and adjustments to reclassify losses to the consolidated statements of operations for securities that have been determined to have other-than-temporary impairment — net of the related tax effects. ASC 323-10, Investments-Equity Method andJoint Ventures, requires that a transaction of an investee of a capital nature should be recorded based on the investor's proportionate share of stockholder's equity of the investee. Therefore, the Company has recorded its proportionate share of the investee's adjustments to other comprehensive income. 2011 2010 Unrealized (losses) gains on available-for-sale securities: Unrealized (losses) gains on investment in K12 Inc. S (82,143) 551,130 Unrealized gain (loss) on equity method investments: Reclassification of loss on investment in Blesbok LLC to net income 9,025 (224) Adjustments for unrealized (loss) gain on investments — net of tax (73,118) 50,906 Foreign currency translation adjustments — net (129) 1,195 Other comprehensive (loss) income 5 (73,247) S 52,101 Advertising Costs — Costs incurred to produce media advertising for seasonal campaigns arc expensed when the advertising first takes place. All other advertising costs are expensed as incurred. Total advertising expense was $16.2 million and $18.0 million for the years ended December 31, 2011 and 2010, respectively, and are included in general and administrative expenses. Self-Insurance — KUEH is self-insured for certain levels of general liability, workers' compensation, auto, property, and employee medical insurance coverage. Estimated costs of these self-insurance programs are accrued at the undiscounted value of projected settlements for known and anticipated claims incurred. The self-insurance reserves established and claims paid at December 31, 2011 and 2010, arc as follows (in thousands): 2011 2010 Balance — beginning of year S 41,648 S 41,505 Expense 107,574 100,338 Claims paid (106,015) (100,195) Balance — end of year $ 43,207 S 41,648 Recent Accounting Pronouncements — In June 2011, the FASB modified the presentation of comprehensive income in the financial statements. The revised standard requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and must be applied retrospectively. This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in - 13 - EFTA_R1_02106182 EFTA02707589  equity. The revised standard does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. For nonpublic entities, the amendments are effective fiscal years ending after December 15, 2012, which will be our fiscal year ended December 31, 2012. We do not believe the amendment will have a significant impact on the consolidated financial statements. 3. RESTRUCTURE OF CERTAIN SUBSIDIARIES In May 2011, a wholly owned subsidiary of KUE Inc., Knowledge Schools, Inc., the parent company of KLC, converted from a corporation into a limited liability company and changed its name to Knowledge Schools LLC (KS). In conjunction with this, the membership interest in KC Propco II LLC ("KC Propco") was distributed to KUE Inc. KUE Inc. then contributed all of its membership interest in KS to a newly formed wholly owned subsidiary, KUEH. KUE Inc. then distributed KUEH to its parent company, KUE LP. KUEH provides early childhood education programs. The real estate held by KC Propco is utilized by KUEH. This restructuring activity did not have an impact on the consolidated financial statements. 4. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE KCDL — On July 23, 2010, the Company sold its wholly owned subsidiary, KCAL to K12 Inc. in exchange for 2,750,000 shares of Series A Special Preferred Stock in K12 Inc., which had a fair value of $66.8 million on the date of sale and a fair value of $49.3 million and $78.8 million at December 31, 2011 and 2010, respectively. The carrying value of KCDL was $26.5 million on the date of the sale. As a result, in 2010 the Company recognized a gain on the transaction of approximately $40.3 million, which is included under discontinued operations in the consolidated statements of operations. These Series A Special Preferred Stock shares are eligible for conversion into K12 Inc. common stock on a one-for-one basis upon the approval of the conversion rights by K12 Inc. shareholders. On January 27, 2011, the right to convert the Series A Special Preferred Stock to common stock was approved by the shareholders of K12 Inc. As a result, these shares are now convertible. These securities have been treated at available-for-sale securities and are included within long-term investments in the consolidated balance sheet at December 31, 2011 and 2010. - 14 - EFTA_R1_02106183 EFTA02707590 The table below discloses certain information regarding KCDL included in discontinued operations for 2010 as follows (in thousands):