Magnolia Public Schools tell LAUSD it is financially in order

8/12/2019 Magnolia Public Schools tell LAUSD it is financially in order

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July 3, 2014

Charter Schools Division

Los Angeles Unified School District

333 South Beaudry Avenue, 20thFloor

Los Angeles, CA 90017

RE: MAGNOLIA SCIENCE ACADEMY #6 (CDS #19647330117648) & MAGNOLIA

SCIENCE ACADEMY #7 (CDS #19647330117655)

Dear Mr. Cole-Gutierrez,

We have received and thoroughly reviewed the Charter School Division (CSD) report/

correspondence dated Friday, June 27, 2014 regarding Magnolia Science Academy #6 (CDS

#19647330117648) and Magnolia Science Academy #7 (CDS #19647330117655). Based on our

review of the CSD June 27, 2014 correspondence we respectfully disagree with the findings and

analysis of the CSD staff in their interpretation of the forensic review performed by the

accounting firm of Vicenti, Lloyd and Stutzman (VLS).

We have demonstrated over the past three to six months that our organization is fiscally viable

and is in no danger of being disrupted by financial difficulties. Furthermore, we presented to

VLS substantial documentation and analysis which supported our compliance with Generally

Accepted Accounting Principles (GAAP) and demonstrated our significant financial strength.

Our auditors, Hill, Morgan and Associates, LLP, a very reputable Certified Public Accounting

firm who audits numerous California charter schools have issued clean (unqualified) opinions

every year of our operations and have never issued any comments regarding potential insolvency

of any of our operations.


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In direct conflict with the CSD June 27, 2014 correspondence, Hill, Morgan and Associates, LLP

unambiguously explained to VLS there were no going concern issues with any of ouroperations, including Magnolia Science Academy (MSA) #6 & MSA #71.

As the CSD June 27, 2014 correspondence identified in pages six and seven at MSA 6 and MSA

7, our organization has succeeded in attaining our educational goals and our student academic

achievement and test scores are superior. In order to fully address the CSD June 27, 2014

correspondence concerns, continue our excellent and cooperative partnership with the CSD, and

further demonstrate that the VLS findings are incomplete, we anticipated that the VLS report

would have been presented as an attachment to the CSD June 27, 2014 correspondence;

however, the VLS report was not available as an integral component of the CSD June 27, 2014

correspondence.

The omission of the VLS report as a material component of the CSD June 27, 2014

correspondence presents substantial questions as to the actual VLS report contents and how the

VLS report may have been interpreted by the CSD staff in preparing the CSD June 27, 2014

correspondence. We were not supplied a draft report of findings by VLS prior to its issuance as

is customary in such investigations. Furthermore, based on the errors we have identified in

the analysis by the Charter School Division staff, there is a strong likelihood that VLS drew

erroneous and uninformed conclusions from their work. These misstatements and errors most

likely would have been avoided if Magnolia staff had been consulted by VLS prior to issuance of

the reports by VLS and the CSD.

As explained in your July 27, 2014 correspondence at page 2, Education Code Section

47607(a)(3)(A) also provides that the authority that granted the charter shall consider increases in

pupil academic achievement for all groups of pupils served the charter school as the most important

factor in determining whether to grant a charter renewal.(sic) Please note that Magnolia Schools

have been wholly successful in fulfilling this requirement!

1Exhibit A, Letter from Hill Morgan and Associates dated July 3rd, 2014,


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As further explained at page two in your July 27, 2014 correspondence, State regulations further

provide: When considering a petition for renewal, the district governing board shall consider thepast performance of the school's academics, finances, and operation in evaluating the likelihood

of future success, along with future plans for improvement if any. (Title 5, California Code of

Regulations, section 11966.4, subdivision (b)(1).) Although page two of the CSD July 27, 2014

correspondence identifies that future plansare a component of considering a petition for

renewal, we are disappointed that after the many years of our successful partnership with the CSD

that no evaluation of our future plans were considered in the CSDs unilateral denial of our MSA

#6 and MSA #7 charter school renewals.

We are confident that our responses below to the CSD June 27, 2014 correspondence will

demonstrate that our good partnership and relationship with the CSD should continue and that

MSA 6 and MSA 7 are demonstrably likely to successfully implement the program as set forth

in the renewal petitions and met all the criteria for renewal.

The following is our response to the findings: (Note, the CSD June 27, 2014 correspondence

findings are restated in each section below and our response is written in bold, italicized

indented text)

1. Financial Solvency of the CMO and MSA 6 and MSA 7, or Lack Thereof

MERF:

Magnolia Science Academies are operated by the nonprofit corporation/charter management

organization (CMO) Magnolia Educational and Research Foundation (MERF). MERF operates

11 MSA charter schools, 8 of which are authorized by LAUSD. VLS performed some analysis of

the financial information of MERF and reviewed transactions that involved loans and/or

transfer of funds to MERF or to any of the MSA schools.


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As the CSD is aware, all 11 MSA Charter Schools are managed by one nonprofit organization,

MERF. MERF has a single board of directors and one taxpayer ID number. MERF files asingle consolidated tax return that includes all 11 schools. The MERF non-profit tax return

is based on a consolidated audit including all 11 MSA charter schools. There is no

prohibition in the Ed code that prohibits loans or transfers between charter schools that are all

under the umbrella of one organization.

Education Code Section 47633 states that [general-purpose entitlement funding may

be used for any public school purpose determined by the governing board of the charter

school. Education Code Section 47634.1(f) states that [categorical block grant

funding may be sued for any purposed determined by the governing body of the charter

school.

As of June 30, 2013, MERF meets the IRS definition of being insolvent. At the end of FY 2013,

MERF had deficit net assets of ($1,661,985). This level of deficit spending raises substantial

doubt about the financial solvency of MERF. The forensic review revealed that MERF met its

cash flow by borrowing monies from the Magnolia charter schools. At the end of FY 2013,

MERF reported owing a net amount of $2.8 million to the various schools it oversees. This is a

very significant and material finding. MERF is a CMO established to provide support and

services to the schools it operates. The insolvency of the CMO not only raises significant

questions about the governance of the schools and overall health of the organization but also its

capacity to implement the educational program and its future likelihood of success.

MERF, in its Consolidated Audit2 of June 30, 2013 that was provided to CSD on

December 23, 2013 presents Net Assets of $4.8 million. The individual audits of MSA

6 and 7 were provided to CSD prior to the audit submission deadline of December 15,

2013. The MERF June 30, 2013 consolidated audit clearly demonstrated that there is

2Exhibit B, Consolidated Audit, Magnolia Educational Research Foundation, June 30, 2013


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no danger of insolvency when the organization as a whole presented net asset of $4.8

million. MERFs $4.8 million of net assets represents a reserve of approximately 7.3%which is above the minimum reserve requirement of the State of 5%. At June 30, 2014

we anticipate that MERFs net assets will be in excess of $7 million. This indicates an

extremely well capitalized and financially viable organization.3

The $2.8 million referred to above are intra-company transfers within a single

organization (MERF). Currently, this number is $0.

Based on the information we have provided, MSA 6 and MSA 7 are demonstrably

likely to successfully implement the program as set forth in the renewal petitions and

should be renewed.

The March 4, 2014 board report recommending the conditional renewal of MSA 6 and MSA 7

reported that the 2012-2013 consolidated audit showed that the organization had positive net

assets in the amount of $4.8 million which was reported in the board report. CSD was provided

the 2012-2013 consolidated audit of all the MSA schools and based its fiscal analysis on that

audit. VLS performed an evaluation on the individual audits provided of MSA 6, MSA 7, and

MERF which revealed a different and concerning fiscal picture of the schools as noted below

given the insolvent position of the CMO.

The individual audits that VLS examined do not properly represent the solvency of

the organization which was explained to VLS. Examining the entity as a whole

presents the complete financial picture of the organization. This is the reason the

organization reports are consolidated. This is required for the tax return filing. As

discussed above, this is one consolidated financial organization. Taking individual

departments and breaking them out can give misleading results, as evidenced by the

VLS and CSD analysis.

3Exhibit C, Letter from Onisko & Scholz, Certified Public Accountants


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MSA 6:

The forensic review revealed that MSA 6 meets the IRS definition of being insolvent withliabilities exceeding assets by $351,461 as of June 30, 2013.' This level of deficit spending raises

substantial doubt about the financial solvency and management of the fiscal affairs of the

schoolparticularly when considering that MERF, the CMO for the school, met the definition of

insolvency in its 2012-2013 audit. Although audited financial information regarding fiscal year

2013-2014 revenues was not yet available, based on the second interim report filed by MSA 6, it

is projected that the schools will still have negative net assets of ($238,029) for fiscal year 2013-

14

As described above, the entity as a whole is solvent and has been established to protect

each individual school from financial setback. By June 30, 2014 MSA 6s deficit will

be reduced to approximately $95,000. ( This is due to improvements after the second

interim report was submitted.) As of June 30th, 2015, MSA-6 is projected to have

positive net asset of approximately $50,000.


likely to successfully implement the program as set forth in the renewal petitions and

should be renewed.

MSA 7:

As of June 30, 2013, MSA 7 had negative net assets of ($218,978). In two of the last three

completed fiscal years, MSA 7 operated in a deficit mode with expenditures exceeding revenues.

The report noted that fiscal year ending June 30, 2013, resulted in increase to net assets of

$281,537 which is a positive trend for the school and helps alleviate concern about the entities

ability to meet its financial obligations; however, the school was still in a deficit financial

position at the end of June 30, 2013. Again, this is particularly concerning when considering that

MERF met the definition of insolvency in its 2012-2013 audit.


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The entity as a whole is solvent. At 2nd interim report, provided to LAUSD, there is aprojected positive net assets of approximately $300,000 for MSA 7. The deficit has been

cured; however, the CSD June 27, 2014 correspondence omitted the projected $300,000

positive net assets in the findings.

Based on the information we have provided, MSA 6 and MSA 7 are demonstrably likely to

successfully implement the program as set forth in the renewal petitions and should be

renewed.

2. Fiscal Mismanagement

The forensic review revealed issues, which rise to a level of fiscal mismanagement. The

following are material areas of concern:

a. Lack of Disclosures for Audited Financial Statements

Generally Accepted Accounting Standards (GAAP) provide that an external auditor

performing a financial statement audit evaluate whether there is substantial doubt about

the entity's ability to continue as a "going concern" for a reasonable period of time. VLS

discovered that there were certain footnote disclosures that were not made by MSA 6,

MSA 7, and/or MERF. One of the critical disclosures that were not made was the

negative net assets of both schools. Also, there was no disclosure in the related party

notes identifying CMO fees paid by the schools to MERF. Specific to MERF, there was

no disclosure about the $2.8 million that MERF owed to the various MSA schools or

payment terms or interest rates.


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The auditor, Hill, Morgan and Associates, CPAs clearly indicated to VLS why there was not a

going concern audit report note.4Also, there is no requirement for disclosures of CMO fees,

loans or highlighting of negative net assets. The organization is a single entity and is

solvent to the tune of $4.8 million at June 30, 2013. There are no loans between

departments of a single entity, except as memo items in the books.

The finding also states Generally Accepted Accounting Standards (GAAP) (sic); however,

Generally Accepted Accounting Standards are the standards by which auditors perform their

audits and is known as (GAAS) where Generally Accepted Accounting Principles are knownas (GAAP). Whether the CSD June 27, 2014 correspondence is meant to address GAAS or

GAAP, under either definition, the VLS discovery cited by the CSD June 27, 2014

correspondence has no basis for reliance by VLS or the CSD because Hill, Morgan and

Associates, CPAs explained to VLS the reasons why there was no need for a going concern

disclosure which is corroborated by MERF and MSA #6 and MSA #7s materially improved

financial position.

Based on the information we have provided, MSA 6 and MSA 7 are demonstrably likely to

successfully implement the program as set forth in the renewal petitions and should be

renewed.

b. Inter-Schools Borrowing

The forensic review of MERF identifies monies that it receives from the MSA schools as

"intercompany borrowing." Each MSA school is not its own company or nonprofit.

Accordingly, it is more accurate to refer to the transactions as "inter-schools borrowing."

The following significant issues rise to a level of fiscal mismanagement:

4Exhibit A, Letter from Hill Morgan and Associates dated July 3rd, 2014,


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No documentation of loans between the schools and MERF showing the terms andconditions related to the loans. There was no documentation provided that showed thatthe inter-schools borrowing were approved by the MERF governing board. CSD had

previously placed MERF on notice of this issue through oversight.

The MSA schools lend MERF money. MSA 6 and MSA 7 also received loans fromMERF. There was no documentation that the transfers were approved by the board.

More importantly, it raises the question regarding the appropriateness of lending

money to a CMO that is established to provide support to the schools. The District is

not aware of any other CMO that borrows substantial money as is the case for MERF

from its schools, if any at all.

MSA 6 and MSA 7 did not keep detailed records of administration/CMO fees paid toMERF.

There is no legal requirement for documentation of advances from one department to

another in a single organization. As a legal matter, one cannot contract withones self. In

a legal sense, these are not loans. Documentation is not required from a legal perspective.

The advances are placed in the books as memo items to keep track of the advances.

However, MERF has created internal procedures, in its accounting manual that call for

documentation, payment schedules and interest. Note that this is not a legal requirement,

but simply an internal control mechanism.

c. Failure to Follow GAAP Standards

Education Code section 47607(c)(1)(C) provides that a charter school may be revoked for

failure to meet generally accepted accounting principles, or engaged in fiscal

mismanagement. The forensic review noted instances in which MERF and the schools'

failed to abide by GAAP standards.


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Because the CSD did not provide us with the VLS report which may identify the

details of the CSD staffs summarized findings, and because the CSD June 27, 2014

correspondence fails to cite which GAAP standards MERF and the schools are

alleged to not abide by, we have no idea what GAAP requirements were alleged as

not followed. It appears that the CSD may have inferred that we did not follow

GAAP, but presented no evidence of the GAAP violations. For the non-

accountant reader, GAAP is a codification of principles that requires interpretation

by the entity and auditor. Therefore, without disclosing the principle that wasviolated and an analysis of the interpretation, this accusation has no merit.

d. Weak Fiscal ControlsPrincipal Debit Cards: a sampling performed of the expenses showed that principals spent

more than $500 per transaction which exceeds the amount established by MERF in its

fiscal control policies. The samplings showed that there were no documented approvals

for purchases greater than $500 and some transactions did not appear in the ledger.

Although the purchases are reconciled with receipts, there is no documented approval

process for the expenses over $500.


details of the CSD staffs summarized findings, and because the CDS June 27, 2014

correspondence does not provide the alleged sampled debit card transactions, the

debit card assertion is a flawed analysis. If VLS had inquired, VLS would have

discovered that school Principals are allowed to spend more than $500 in a

transaction only if approvals are granted by the CEO or CFO. VLS failed to

request debit card approval data from MERF management. Had VLS discussed

with us the debit card transactions sampled, we could have easily presented the

proper authorization procedure and explanation of the authorization process. We


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believe that VLS did not understand the control procedures and may have been

under such time constraints to complete their report that proper follow upregarding our internal control procedures may not have been possible. Approvals

are granted through the Coolsis internal control system. Coolsis is a specialized

electronic purchasing internal control submission and authorization system used by

MERF and all MSA schools. The authorizations for the debit card transactions are

available upon the CSDs request.


likely to successfully implement the program as set forth in the renewal petitions

and should be renewed.

e. Questionable/Unexplained Transactions MERF's payments for immigration fees and immigration lawyers in the past 4

years totaled $206,489, including fees paid to a contracted agency Accord for

Accord's immigration needs. In addition, MSA 6 and MSA 7 also made payments

for immigration fees and immigration lawyers. When expenditures were tested, 6

out of 9 individuals that MSA 6 paid for immigration related expenses were not

employees.

Because the CSD did not provide us with the VLS report which may identify the details of

the CSD staffs summarized findings, and because the CDS June 27, 2014 correspondence

does not provide the alleged immigration fee transactions, we do not know what comprises

$206,489. We have record of $43,248 paid by MERF presented in a schedule prepared by

VLS titled immigration services and fees of which a significant portion were

fingerprinting services for existing teachers. There were never any payments made for

Accords immigration needs. We have however, made payments to Accord to secure

human resource consulting services regarding immigration issues; nevertheless, VLS


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failed to follow up with us and request additional information that may have assisted their

forensic examination. To be clear, regarding immigration type fees and costs, only twoindividuals did not work for the school because those individuals did not receive proper

visas to allow them employment. Any payments made were on behalf of potential

employees of the schools. To state or imply that immigration related expenses were paid

with school funds for non-school related activities or costs is factually incorrect. MERF

schools are Science, Technology, Engineering, and Math focused and one of the strengths

of our programs is the strength of qualifications and experience of our teaching staff. In

the past, we have incurred immigration related expenses only as a means to hire the most

qualified applicants. Considering the serious nature of such a finding, we are disappointed

that VLS or the CSD staff who prepared the CSD June 27, 2014 correspondence failed to

follow up with us prior to the correspondence.

In at least two instances, principals sought reimbursement for cash payment forday laborers. This is not a recommended practice since the laborers would not be

covered under liability insurance. It also raises improper reporting payments or

lack thereof to the IRS.

These two instances over the five plus years that were sampled were isolated

incidents. Because of our internal control system we discovered these minor

transactions and the principals were notified that they violated policy and were

instructed not to continue this practice. We have not had any repeat of such

transactions since.

Payroll accounting irregularities including payments made outside of thepayroll system, overstatement of payroll expenses, and payroll expenses recorded

outside of payroll object codes.


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details of the CSD staffs summarized findings, and because the CDS June 27,2014 correspondence does not provide the alleged payroll accounting

irregularities, we have no idea what items were at issue or the amounts of these

items. In order to address this finding, our best guess is that this may be an

immaterial $300 payment made to an administrator as a reward for excellent

work. If the specifics of the alleged finding had been provided, we would have

been able to address the issue more precisely.

3. Governance and Administration of Services

The District has concerns regarding MERF's contract with Accord and the accountability and

governance of MERF. Accord is a nonprofit corporation providing services to MSA schools in

the areas of curriculum development, professional training, assessments, human resources,

business and financial support, teacher evaluation, and academic support services. The amount

paid to Accord from FY 2010 through February 28, 2104, amounted to $3 million. Payments to

Accord amount to 29.7% of MERF's total expenditures in FY 2012 and 25.7% in FY 2013.

The numbers cited above are very misleading and no supporting information was

provided to establish how the CSD June 27, 2014 correspondence findings were

determined. Over the period described above, the consolidated revenue of the

organization was $110 million5. The Accord payments identified above were less 3%

of total revenue. These funds were spent for:

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5Exhibit D, Calculation of Revenues from Consolidated Audits


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Program accountability and evaluation reports (student achievement and growth analysisincluding data triangulation, surveys, etc.)

Curriculum development (A+ Advanced STEM program, Technology IntegratedEducation (TIE), Computer Science curriculum, Get Ready For Life (GRFL) curriculum,

etc.)

Professional development (workshops for teachers, deans of academics/assistant principals,and principals, STEM conference, data analysis workshops, teacher observation and

support)

Supplemental program development (STEM focused after-school clubs/contests such asMathMatters, etc.)

Aside from the affordability of the contract with Accord especially in light of MERF's negative

fiscal condition, it raises the question of MERF's responsibilities and accountability in the

operations of the school. The organizational chart in the charter petition states that

MERF/Magnolia Public Schools delegates operations to the MPSCO which comprises of a Chief

Academic Officer, Chief Operations Officer, Chief Financial Officer, Chief Accountability

Officer, Project Manager and a Credential Officer. The responsibilities of MPSCO include, but

are not limited to:

Overseeing operations of the schools to ensure compliance with the charter agreements Making hiring recommendations regarding school principals to the CEO Curriculum development Professional development Payrol l Purchasing Budgeting


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Financial and other reporting Annual audit Community outreach Public relations Information Technology (IT) support Data management Facility management Human resources

The overlap of services MERF provides as a CMO and the services Accord provides raises thequestion of the purpose of the CMO and the management fees it receives from the schools when

it appears that Accord is providing wholesale operations to the school.

Based on the above findings, MSA 6 and MSA 7 are demonstrably unlikely to successfully

implement the program set forth in the renewal petitions. The review of both schools' fiscal

processes and operations revealed material findings and therefore the schools have not met the

conditions of its renewal.

This finding states in light of MERF's negative fiscal condition As described

earlier in our explanations, MERF is not in any negative fiscal condition and

reported $4.8 million in net assets as of June 30, 2013 and will report in excess of $7

million in net assets as of June 30, 2014.

MERF subcontracts certain service to Accord such that MERF does not have to hire

additional staff. Accord has economies of scale because it provides services to schools

in five states. The Accord contract is currently about 4% of the consolidated revenue

total. There is no question in our minds that the value added by Accord far exceeds the

costs to MERF. Accord is a solvent, secure educational organization with June 30,

2014 net assets of approximately $7 million.


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Because of the cost savings MERF and MSA schools enjoy resulting from the servicesof Accord, the services and cost saving benefits further support why MSA 6 and MSA 7

are demonstrably likely to successfully implement the program as set forth in the

renewal petitions and should be renewed.

Academic Achievement of the School:

The District considered increases in pupil academic achievement for all groups of pupils served

by MSA 6 and MSA 7 in renewing the charter.

MSA 6: As noted in the March 4, 2014 board report for the conditional renewal of MSA 6, MSA

6 has met the minimum academic performance criteria for renewal required under Education

Code section 47607(b). In 2013, the school achieved a school-wide Growth API of 828, a 17-

point decrease from its Base API of 845. Since its opening in 2009, MSA 6 has maintained its

API score above 800. The school earned a 2013 Statewide Rank of 7 and a Similar Schools

Rank of 8. The school has outperformed the resident District schools with comparable

demographics in each year of its charter in API and in the percentage of students scoring

proficient and advanced on CST ELA and Mathematics. Further, all subgroups met their API

growth targets with the exception of the Socioeconomically Disadvantaged subgroup. Their API

growth target fell 39 points from the 2012 base of 817 down to 778 for 2013.

MSA 7: The March 4, 2014 board report for the conditional renewal of MSA 7 states that MSA 7

has met the minimum academic performance criteria for renewal required under Education Code

section 47607(b). In 2013, the school achieved a school-wide Growth API of 904. In the last

three years, MSA 7 has consistently maintained its API score above 800. The school earned a

2013 Statewide Rank of 9. The school has outperformed the resident District schools with

comparable demographics in each year of its charter in Growth API and in the percentage of

students scoring proficient and advanced on CST ELA and Mathematics. MSA 7 was also

classified as an "excelling" school on LAUSD's School Performance Framework. Though not


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considered numerically significant, all subgroups met their API growth targets for 2013 and two

of the last three years.

The District acknowledges MSA 6 and MSA 7's academic achievement and considers increases

in academic achievement for all groups of pupils as the most important factor in making renewal

decisions. The conditions for the renewal focused on the schools' fiscal processes and

operations. As the state renewal regulations indicate, authorizers must consider the past

performance of the school's academics, finances and operation in evaluating the likelihood of

future success along with future plans for improvement. In closely considering the totality of the

findings outlined herein, the foregoing deficiencies and concerns rise to a level of severity that

seriously questions the CMO's ability to operate the school let alone support itself. These types

of operational and financial issue permeate the overall health of the organization and its ability to

provide educational support to its students.

As stated above, since The District acknowledges MSA 6 and MSA 7's academic

achievement and considers increases in academic achievement for all groups of pupils

as THE MOST IMPORTANT FACTOR in making renewal decisions (emphasis

added, the superior academic achievement of MSA 6 and MSA 7 alone should be

reason enough that the charters should be continued and the renewal petitions deemed

granted. Please remember: Education Code section 47607(a)(3)(A) provides that the

authority that granted the charter shall consider increases in pupil academic

achievement for all groups of pupils served the charter school as the most important

factor in determining whether to grant a charter renewal.

Based on the information we have provided, MERF, MSA 6 and MSA 7 are financially

viable and continually improving financially, present a well managed operation with

sound internal controls, correct errors in a timely manner, have audited financial

statements from a reputable independent certified public accounting firm, and are

demonstrably likely to successfully implement the program as set forth in the renewal

petitions and thus met all the criteria for renewal.


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SUMMARY AND CONCLUSION

Magnolia Educational and Research Foundation and its Charter Schools, MSA 6 and MSA 7 are

solvent with net assets of $4.8 million as of June 30, 2013 and estimated net assets $7 million as

of June 30, 2014.

Financial solvency, superior internal controls, a good partnership and working relationship with

the CSD, coupled with superior academic achievement for all groups of pupils (per ED Code

47607(a)(3)(A), demonstrates that the MSA #6 and MSA #7 renewal charter petitions should be

approved.

Sincerely,

Mehmet Argin, M.A., Ph.D.

Chief Executive Officer


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MAGNOLIA EDUCATIONAL AND RESEARCH

FOUNDATION

CONSOLIDATED AUDITEDFINANCIAL STATEMENTS

FOR THE YEAR ENDED

JUNE 30, 2013


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MAGNOLIA EDUCATIONAL AND RESEARCH FOUNDATION

TABLE OF CONTENTS

Page

Independent auditors report 3

Consolidated statement of financial position 4

Consolidated statement of activities 5

Consolidated statement of cash flows 6

Notes to consolidated financial statements 8

2


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To the Board of Directors of the

Magnolia Educational and Research Foundation

Westminster, California

INDEPENDENT AUDITOR'S REPORT

We have audited the accompanying financial statements of Magnolia Educational and

Research Foundation, which comprise the statement of financial position as of June 30, 2013,and the related statements of activities and cash flow for the year then ended, and the relatednotes to the financial statements. The prior year summarized comparative information has beenderived from the organizations 2012 financial statements and in our report dated December 23,2012 an unqualified opinion was expressed on those financial statements.

Managements Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statementsin accordance with accounting principles generally accepted in the United States of America;this includes the design, implementation, and maintenance of internal control relevant to thepreparation and fair presentation of financial statements that are free from material misstatement,whether due to fraud or error.

3


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Auditors Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. Weconducted our audit in accordance with auditing standards generally accepted in the United Statesof America. Those standards require that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free from material misstatement. An auditinvolves performing procedures to obtain audit evidence about the amounts and disclosures in thefinancial statements. The procedures selected depend on the auditors judgment, including theassessment of the risks of material misstatement of the financial statements due to fraud or error.In making those risk assessments, the auditor considers internal control relevant to the entityspreparation and fair presentation of the financial statements in order to design audit proceduresthat are appropriate in the circumstances, but not for the purpose of expressing an opinion on theeffectiveness of the entitys internal control. Accordingly, we express no such opinion. An auditalso includes evaluating the appropriateness of accounting policies used and the reasonableness of

significant accounting estimates made by management, as well as evaluating the overallpresentation of the financial statements. We believe that the audit evidence we have obtained is

sufficient and appropriate to provide a basis for our opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the

financial position of Magnolia Educational and Research Foundation as of June 30, 2013, andthe changes in their net assets and their cash flows for the year then ended in accordance withaccounting principles generally accepted in the United States of America.

Carson, CaliforniaOctober 21, 2013

4


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CONSOLIDATED STATEMENT OF FINANCIAL POSITION

At June 30, 2013

(With comparative totals at June 30, 2012)

The accompanying notes are an integral part of these financial statements.

5

Temporarily 2013 2012

Unrestricted restricted Total Total

ASSETS

CURRENT ASSETS:

Cash and cash equivalents (Note 5) $ 1,974,524 $ 959,362 $ 2,933,886 $ 4,944,348

Accounts receivable 5,010,875 5,010,875 5,433,404

Total current assest 6,985,399 959,362 7,944,761 10,377,752

PROPERTY AND EQUIPMENT:

Construction in progress (Note 2 and 5) 29,592 3,122,034 3,151,626 133,261

Furniture and equipment (Note 2) 1,438,094 1,438,094 1,235,447

Leasehold improvements (Note 2) 401,712 401,712 401,712

Less: accumulated depreciation (Note 2) (1,296,954) (1,296,954) (1,063,920)

Net property and equipment 572,444 3,122,034 3,694,478 706,500

OTHER ASSETS:

Security deposits 127,733 127,733 49,035

Total other assets 127,733 127,733 49,035

Total assets $ 7,685,576 4,081,396 11,766,972 $ 11,133,287

LIABILITIES AND NET ASSETS

CURRENT LIABILITIES:

Accounts payable $ 2,305,800 2,305,800 $ 2,579,298

Accrued payroll and related liabilities 302,753 302,753 173,153

Advances on program revenue 505,300 505,300

Loans payable-current portion (Note 4 and 6) 1,475,714 1,475,714 5,021,785

Total current liabilities 4,589,567 4,589,567 7,774,236

LONG-TERM LIABILITIES:

Loans payable-net of current portion (Note 4) 345,000 2,040,698 2,385,698 2,340,698

Total long-term liabilities 345,000 2,040,698 2,385,698 2,340,698

Total liabilities 4,934,567 2,040,698 6,975,265 10,114,934

NET ASSETS:

Unrestricted 2,751,009 2,751,009 (1,022,345)

Temporarily restricted (Note 5) 2,040,698 2,040,698 2,040,698

Total net assets 2,751,009 2,040,698 4,791,707 1,018,353

Total liabilities and net assets $ 7,685,576 $ 4,081,396 $ 11,766,972 $ 11,133,287


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CONSOLIDATED STATEMENT OF ACTIVITIES

For the year ended June 30, 2013

(With comparative totals for the year June 30, 2012)


6

2013 2012

REVENUES:

Federal support $ 2,047,144 $ 1,510,543State support 24,224,272 20,788,192

Local support 3,351,437 1,926,163

Contributions 1,024,633 406,491

Total revenues 30,647,486 24,631,389

EXPENSES:

Certificated salaries 11,348,116 10,509,588

Classified salaries 2,029,752 1,964,667

Benefits 3,679,493 3,289,081Books and supplies 1,758,884 2,065,982

Services and other operating expenses 7,520,778 7,533,792

Interest 276,579 95,743

Depreciation 233,034 178,343

Capital outlay 27,496

Special education 65,363

Total expenses 26,874,132 25,702,559

Increase (decrease) in net assets 3,773,354 (1,071,170)

Net assets, beginning of the year 1,018,353 2,089,523

Net assets, end of the year $ 4,791,707 $ 1,018,353


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CONSOLIDATED STATEMENT OF CASH FLOWS


(With comparative totals for the year ended June 30, 2012)


7

2013 2012

Cash flows from operating activities:

Increase (decrease) in net assets $ 3,773,354 $ (1,071,170)

Adjustments to reconcile change in net assets

to net cash provided by operating activities:


Changes in operating assets and liabilities:

(Increase) decrease in assets:

Accounts receivable 422,529 (1,370,371)

Security deposit (78,698) (10,000)

Increase (decrease) in liabilities:

Accounts payable (273,498) 1,186,918 Accrued payroll and related liabilities 129,600 150,899

Net cash provided by (used in) operating activities 4,206,321 (935,381)

Cash flows from investing activities:

Cash paid for the construction of building

and purchase of fixed assets (3,221,012) (228,353)

Net cash used in investing activities (3,221,012) (228,353)

Cash flows from financing activities:

Advances on program revenue 505,300

Net payment on lease liabilities (11,824)

Net proceeds from loans and lines of credit (3,501,071) 5,732,676

Net cash (used in) provided by financing activities (2,995,771) 5,720,852

Net (decrease) increase in cash (2,010,462) 4,557,118

Cash and cash equivalents, beginning of the year 4,944,348 387,230

Cash and cash equivalents, end of the year $ 2,933,886 $ 4,944,348

SUPPLEMENTAL INFORMATION:

Cash paid for interest expense $ 276,579 $ 95,743


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

These notes are an integral part of the preceding financial statements.

8

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESSMagnolia Educational and Research Foundation (a California not-for-profit organization)during fiscal year ended June 30, 2013, operated twelve charter schools with grades Kthrough twelve serving 3,647 students. The charter schools operate under the approval ofthe California State Board of Education and the local school districts. Each schoolreceives public per-pupil funding to help support operations.

BASIS OF ACCOUNTINGThe accompanying financial statements were prepared on the accrual basis in accordancewith the AICPA's audit and accounting guide, "Not-For-Profit Organizations."

ESTIMATESThe preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires the use of managementestimates and assumptions that could affect certain reported amounts and disclosures.Accordingly, actual results could differ from those estimates.

CASH AND CASH EQUIVALENTSFor the purpose of the Statement of Cash Flows, Magnolia Educational and ResearchFoundation considers all highly liquid investments available for current use with aninitial maturity of three months or less to be cash equivalents.

INCOME TAXES

Magnolia Educational and Research Foundation is a not-for-profit organization that isexempt from Federal and state income taxes under the Internal Revenue Code Section501(c) (3) and the California State Revenue and Taxation Code 23701 (d) except on netincome derived from unrelated business activities. The Organizations managementbelieves that it has support for any tax position taken, and as such, does not have anyuncertain tax positions that are material to the financial statements.

Magnolia Educational and Research Foundations Forms 990, Return of OrganizationExempt from Income Tax for the years ending June 30, 2010, 2011, 2012 and 2013 aresubject to examination by the Internal Revenue Service, generally for three years afterthey were filed.


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9

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continud)

PROPERTY AND EQUIPMENTProperty and equipment purchased with a value of $5,000 or more and a life expectancygreater than two years are capitalized in the year of purchase. Property and equipmentare included on the financial statements at cost less the related accumulated depreciation.The depreciation method used by Magnolia Educational and Research Foundation isstraight-line over the estimated useful life of the fixed assets.

COMPARATIVE FINANCIAL INFORMATIONThe financial statements include certain prior-year summarized comparative informationin total but not by net asset class. Such information does not include sufficient detail toconstitute a presentation in conformity with accounting principles generally accepted inthe United States of America. Accordingly, such information should be read inconjunction with the Schools financial statements for the year ended June 30, 2012 fromwhich the summarized information was derived.

FINANCIAL STATEMENT PRESENTATIONThe accompanying financial statements include the consolidated activities of MagnoliaEducational and Research Foundation. Magnolia Educational and Research Foundationoperates the following public charter schools during fiscal year ended June 30, 2013:

Magnolia Science AcademyMagnolia Science Academy 2Magnolia Science Academy 3

Magnolia Science Academy 4Magnolia Science Academy 5Magnolia Science Academy 6Magnolia Science Academy 7Magnolia Science Academy 8Magnolia Science Academy Santa ClaraMagnolia Science Academy San DiegoPacific Technology School Orange valePacific Technology School Santa Ana


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10

NOTE 2 - PROPERTY AND EQUIPMENT

Below is a summary of the fixed assets owned by Magnolia Educational and ResearchFoundation and the schools that they operate:

Est. Accumulated NetDescription Life Cost Depreciation Book Value

Construction in progress $ 3,151,626 $ 3,151,626Equipment 5 1,235,447 $ (920,191) 315,256Leasehold improvements 10 401,712 (376,763) 24,949

Total $ 4,788,785 $ (1,296,954) $ 3,491,831

NOTE 3 - ADVANCES ON PROGRAM REVENUE

As of June 30, 2013 the schools received cash advances on per-pupil revenue projectionsfrom subsequent years from an entity independent of the California State Board ofEducation and local school districts. These advances were secured by, and to be repaidwith, the expected receipts of these projected per-pupil revenues from State and Localsources in the subsequent year.

NOTE 4 - LOANS PAYABLEMagnolia Educational and Research Foundation and the schools that they operate havethe following loans outstanding as of June 30, 2013:

Description Amount

Magnolia Science Academy 2 has an unsecured revolving loan payable tothe California School Finance Authority totaling $100,000. The loan hasan annual interest rate of 0.24%. The loan repayment terms require fourannual payments of $25,000 over the next four years. The outstandingbalance was $100,000 on June 30, 2013. The maturity date is June 30,2017.

$ 100,000

Magnolia Science Academy 4 received an unsecured revolving loan

payable to the California Department of Education totaling $100,000 on

May 25, 2010. The loan balance as of June 30, 2013 was $40,103. Theloan has an interest rate of 0.53% and it matures in five years. Therepayment terms require six monthly payments each year in five fiscalyears beginning on August 20, 2010. The State Controllers Officededucts the loan payments from the Schools State School FundApportionments.

$ 40,103


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11

NOTE 4 - LOANS AND LINES OF CREDIT PAYABLE (continued)

Description Amount

Magnolia Science Academy 5 received an unsecured revolving loan payable tothe California Department of Education totaling $100,000 on May 25, 2010.The loan balance as of June 30, 2013 was $36,688. The loan has an interestrate of 0.53% and it matures in five years. The repayment terms require sixmonthly payments each year in five fiscal years beginning on August 20,2010. The State Controllers Office deducts the loan payments from theSchools State School Fund Apportionments. $ 36,688

Magnolia Science Academy 6 received an unsecured revolving loan payable tothe California Department of Education totaling $100,000 on May 25, 2010.

The loan balance as of June 30, 2013 was $43,438. The loan has an interestrate of 0.53% and it matures in five years. The repayment terms require sixmonthly payments each year in five fiscal years beginning on August 20,2010. The State Controllers Office deducts the loan payments from theSchools State School Fund Apportionments. $ 43,438Facilitated by the California School Finance Authority, Magnolia ScienceAcademy 8 received loan amounts from a local financing company for anaccumulated total of $826,500 during the fiscal year. The loan balance as ofJune 30, 2013 was $336,282. The loan has an annual interest rate of 5%. Theloan is secured by anticipated State funding that was deferred due to the State

budget crisis, and it will be repaid by State revenue directly to the localfinancing company when the funds are disbursed from the State. The fullbalance was paid off on August 28, 2013 (Note 6.) $ 336,282


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12


Description Amount

Facilitated by the California School Finance Authority, Magnolia ScienceAcademy Santa Clara received loan amounts from a local financing companyfor an accumulated total of $444,200 during the fiscal year. The loan balanceas of June 30, 2013 was $444,200. The loan has an annual interest rate of 5%.The loan is secured by anticipated State funding that was deferred due to theState budget crisis, and it will be repaid by State revenue directly to the localfinancing company when the funds are disbursed from the State. The fullbalance was paid off on September 20, 2013 (Note 6.) $ 444,200

Magnolia Science Academy San Diego received an unsecured revolving loan

payable to the California Department of Education totaling $100,000 on June23, 2010. The loan balance as of June 30, 2013 was $40,000. The loan has aninterest rate of 0.54% and it matures in five years. The repayment termsrequire six monthly payments each year in five fiscal years beginning onAugust 20, 2010. The State Controllers Office deducts the loan paymentsfrom the Schools State School Fund Apportionments. $ 40,000Facilitated by the California School Finance Authority, Pacific TechnologySchool Orangevale received loan amounts from a local financing company foran accumulated total of $223,600 during the fiscal year. The loan balance asof June 30, 2013 was $223,600. The loan has an annual interest rate of 5%.

The loan is secured by anticipated State funding that was deferred due to theState budget crisis, and it will be repaid by State revenue directly to thefinancing company when the funds are disbursed from the State. The fullbalance was paid off in October, 2013 (Note 6.) $ 223,600Pacific Technology School Orangevale received an unsecured revolving loanpayable to the California Department of Education totaling $250,000 on March23, 2010. The loan balance as of June 30, 2013 was $108,334. The loan hasan interest rate of 0.53% and it matures in five years. The repayment termsrequire six monthly payments each year in five fiscal years beginning onAugust 20, 2010. The State Controllers Office deducts the loan payments

from the Schools State School Fund Apportionments. $ 108,334


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13


Description Amount

Facilitated by the California School Finance Authority, Pacific TechnologySchool Santa Ana received loan amounts from a local financing company foran accumulated total of $261,400 during the fiscal year. The loan balance as

of June 30, 2013 was $261,400. The loan has an annual interest rate of 5%.The loan is secured by anticipated State funding that was deferred due to theState budget crisis, and it will be repaid by State revenue directly to the localfinancing company when the funds are disbursed from the State. The fullbalance was paid off on October 16, 2013 (Note 6.) $ 261,400Pacific Technology School Santa Ana received an unsecured revolving loan

payable to the California Department of Education totaling $100,000 on May25, 2010. The loan balance as of June 30, 2013 was $36,669. The loan has aninterest rate of 0.53% and it matures in five years. The repayment termsrequire six monthly payments each year in five fiscal years beginning onAugust 20, 2010. The State Controllers Office deducts the loan paymentsfrom the Schools State School Fund Apportionments. $ 36,669Pacific Technology School Santa Ana received another unsecured revolvingloan payable to the California Department of Education totaling $150,000 onNovember 30, 2012. The loan balance as of June 30, 2013 was $150,000. Theloan has an interest rate of 0.53% and it matures in five years. The repayment

terms require six monthly payments each year in five fiscal years beginning onOctober 30, 2013. The State Controllers Office deducts the loan paymentsfrom the Schools State School Fund Apportionments. $ 150,000


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14


Description Amount

Pacific Technology School Santa Ana was approved for a loan of $8,706,978from California School Finance Authority for the land acquisition andconstruction of a new school facility. The School received $2,040,698 in theyear ended June 30, 2012. The outstanding loan balance as of June 30, 2013was $2,040,698. The loan has an annual interest rate of 3% and it matures in30 years after the completion of the project, which is estimated to be in themiddle of calendar year 2014. The repayment schedule will be determinedafter completion of the project. The State Controllers Office will deduct the

loan payments from the Schools State School Fund Apportionments (Note 5.) $ 2,040,698

Total 3,861,412Less current portion 1,475,714

Long-term portion $ 2,385,698

Principal maturities for the outstanding loans are listed as follows:

For the year ended June 30, Amount

2014 $ 1,475,7142015 205,000

2016 55,0002017 55,000

2018 30,000Thereafter 2,040,698

Total $ 3,861,412


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15

NOTE 5 - TEMPORARILY RESTRICTED NET ASSETS

Pacific Technology School Santa Ana has been approved from the State of CaliforniasCharter School Facilities Program for $17,413,956 for constructing a new facility whichwill cost the same amount. The State will fund 50% of the total amount of $17,413,956through a grant in the amount of $8,706,978; the State will fund another 50% of the totalproject cost through a loan in the amount of $8,706,978. As of June 30, 2013, the Schoolhas received total amount of $4,081,396, of which $2,040,698 was loan, and $2,040,698was grant. The grant portion of the amount is classified as temporarily restricted netassets until the fund is used for the purchase of the land and the construction of thefacility.

NOTE 6 - SUBSEQUENT EVENT

The Schools Management has evaluated subsequent events for the period from June 30,2013 through October 21, 2013, the date the financial statements were available to beissued. Management identified the following transactions that require disclosure or thatwould have an impact on the financial statements.

Loans mentioned in note 4 with the amount of $1,265,485 were paid off by October 21,2013.


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REVENUES:

Federal support $ 1,510,543

State support 20,788,192

Local support 1,926,163Contributions 406,491

Total revenues 24,631,389

EXPENSES:

Certificated salaries 10,509,588

Classified salaries 1,964,667

Benefits 3,289,081

Books and supplies 2,065,982

Services and other operating expenses 7,533,792

Interest 95,743

Depreciation 178,343


Total expenses 25,702,559

Increase in net assets (1,071,170)

Net assets, beginning of the year 2,089,523

Net assets, end of the year $ 1,018,353


5


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(With comparative totals for the year June 30, 2012)

2013 2012

REVENUES:

Federal support $ 2,047,144 $ 1,510,543State support 24,224,272 20,788,192

Local support 3,351,437 1,926,163

Contributions 1,024,633 406,491

Total revenues 30,647,486 24,631,389

EXPENSES:

Certificated salaries 11,348,116 10,509,588

Classified salaries 2,029,752 1,964,667

Benefits 3,679,493 3,289,081Books and supplies 1,758,884 2,065,982

Services and other operating expenses 7,520,778 7,533,792

Interest 276,579 95,743


Capital outlay 27,496


Total expenses 26,874,132 25,702,559

Increase (decrease) in net assets 3,773,354 (1,071,170)

Net assets, beginning of the year 1,018,353 2,089,523

Net assets, end of the year $ 4,791,707 $ 1,018,353

Documents

Magnolia Public Schools tell LAUSD it is financially in order