Magnolia Public Schools Tell LAUSD It Is Financially in Order

Magnolia Public Schools
13930 MllLon Ave. 2008 WesLmlnsLer, CA 92683

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July 3, 2014

Charter Schools Division
Los Angeles Unified School District
333 South Beaudry Avenue, 20
th
Floor
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 our
operations, including Magnolia Science Academy (MSA) #6 & MSA #7
1
.

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!

1
Exhibit A, Letter from Hill Morgan and Associates dated July 3
rd
, 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 the
past 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 a
single 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 Audit
2
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

2
Exhibit 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.

3
Exhibit 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 with
liabilities 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 30
th
, 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 a
projected 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.
4
Also, 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 known
as (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:

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

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No documentation of loans between the schools and MERF showing the terms and
conditions related to the loans. There was no documentation provided that showed that
the 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 from
MERF. 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 to
MERF.

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 was
violated and an analysis of the interpretation, this accusation has no merit.

d. Weak Fiscal Controls
Principal 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 up
regarding 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 two
individuals 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 for
day 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 the
payroll 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 million
5
. The Accord payments identified above were less 3%
of total revenue. These funds were spent for:

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5
Exhibit D, Calculation of Revenues from Consolidated Audits

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As a further example of Accords work for MERF, Accord is the coordinator in charge
of the Santa Ana School building project. This project was funded with $18.5 million
and consists of the construction of a complete campus that will serve approximately
1000 students. In addition, a $500,000 grant was also applied for by Accord and
received by MERF.

The charter petitions for MSA 6 and MSA 7 state that:

Magnolia Public Schools (MPS) has developed this proven model over the years with
services and support from Accord. As explained in Element 4, "Governance," MPS Central
Office (MPSCO) provides supervision, support, and services to all its schools to ensure its
education model is implemented efficiently and successfully. Central Office responsibilities
include curriculum development, professional development, data management, and other
services outlined in section 4.3, "MPSCO." MPSCO outsources some of those services to
Accord. Specifically, MSA 7 will receive services and support from Accord in areas
including, but not limited to, the following major categories:

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Program accountability and evaluation reports (student achievement and growth analysis
including data triangulation, surveys, etc.)
Curriculum development (A+ Advanced STEM program, Technology Integrated
Education (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 as
MathMatters, 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
Payr ol 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 the
question 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 services
of 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 AUDITED
FINANCIAL STATEMENTS
FOR THE YEAR ENDED
JUNE 30, 2013

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

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 J une 30, 2013,
and the related statements of activities and cash flow for the year then ended, and the related
notes to the financial statements. The prior year summarized comparative information has been
derived 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 statements
in accordance with accounting principles generally accepted in the United States of America;
this includes the design, implementation, and maintenance of internal control relevant to the
preparation and fair presentation of financial statements that are free from material misstatement,
whether due to fraud or error.
3

Auditors Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We
conducted our audit 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 from material misstatement. An audit
involves performing procedures to obtain audit evidence about the amounts and disclosures in the
financial statements. The procedures selected depend on the auditors judgment, including the
assessment 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 entitys
preparation and fair presentation of the financial statements in order to design audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the entitys internal control. Accordingly, we express no such opinion. An audit
also includes evaluating the appropriateness of accounting policies used and the reasonableness of
significant accounting estimates made by management, as well as evaluating the overall
presentation 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 J une 30, 2013, and
the changes in their net assets and their cash flows for the year then ended in accordance with
accounting principles generally accepted in the United States of America.

Carson, California
October 21, 2013
4
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
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 $ 1,510,543
State 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 3,289,081
Books 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
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

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 BUSINESS
Magnolia Educational and Research Foundation (a California not-for-profit organization)
during fiscal year ended J une 30, 2013, operated twelve charter schools with grades K
through twelve serving 3,647 students. The charter schools operate under the approval of
the California State Board of Education and the local school districts. Each school
receives public per-pupil funding to help support operations.

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

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

CASH AND CASH EQUIVALENTS
For the purpose of the Statement of Cash Flows, Magnolia Educational and Research
Foundation considers all highly liquid investments available for current use with an
initial maturity of three months or less to be cash equivalents.

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

Magnolia Educational and Research Foundations Forms 990, Return of Organization
Exempt from Income Tax for the years ending J une 30, 2010, 2011, 2012 and 2013 are
subject to examination by the Internal Revenue Service, generally for three years after
they were filed.

9

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continud)

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

COMPARATIVE FINANCIAL INFORMATION
The financial statements include certain prior-year summarized comparative information
in total but not by net asset class. Such information does not include sufficient detail to
constitute a presentation in conformity with accounting principles generally accepted in
the United States of America. Accordingly, such information should be read in
conjunction with the Schools financial statements for the year ended J une 30, 2012 from
which the summarized information was derived.

FINANCIAL STATEMENT PRESENTATION
The accompanying financial statements include the consolidated activities of Magnolia
Educational and Research Foundation. Magnolia Educational and Research Foundation
operates the following public charter schools during fiscal year ended J une 30, 2013:

Magnolia Science Academy
Magnolia Science Academy 2
Magnolia Science Academy Santa Clara
Magnolia Science Academy San Diego
Pacific Technology School Orange vale
Pacific Technology School Santa Ana


10

NOTE 2 - PROPERTY AND EQUIPMENT

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

Est. Accumulated Net
Description Life Cost Depreciation Book Value
Construction in progress $ 3,151,626 $ 3,151,626
Equipment 5 1,235,447 $ (920,191) 315,256
Leasehold 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 J une 30, 2013 the schools received cash advances on per-pupil revenue projections
from subsequent years from an entity independent of the California State Board of
Education and local school districts. These advances were secured by, and to be repaid
with, the expected receipts of these projected per-pupil revenues from State and Local
sources in the subsequent year.

NOTE 4 - LOANS PAYABLE

Magnolia Educational and Research Foundation and the schools that they operate have
the following loans outstanding as of J une 30, 2013:
Description Amount

Magnolia Science Academy 2 has an unsecured revolving loan payable to
the California School Finance Authority totaling $100,000. The loan has
an annual interest rate of 0.24%. The loan repayment terms require four
annual payments of $25,000 over the next four years. The outstanding
balance was $100,000 on J une 30, 2013. The maturity date is J une 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 J une 30, 2013 was $40,103. The
loan 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 on August 20, 2010. The State Controllers Office
deducts the loan payments from the Schools State School Fund
Apportionments.

$

40,103

11

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

Description Amount

Magnolia Science Academy 5 received an unsecured revolving loan payable to
the California Department of Education totaling $100,000 on May 25, 2010.
The loan balance as of J une 30, 2013 was $36,688. The loan 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 on August 20,
2010. The State Controllers Office deducts the loan payments from the
Schools State School Fund Apportionments.

$

36,688

Magnolia Science Academy 6 received an unsecured revolving loan payable to
the California Department of Education totaling $100,000 on May 25, 2010.
The loan balance as of J une 30, 2013 was $43,438. The loan 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 on August 20,
2010. The State Controllers Office deducts the loan payments from the
Schools State School Fund Apportionments.

$ 43,438

Facilitated by the California School Finance Authority, Magnolia Science
Academy 8 received loan amounts from a local financing company for an
accumulated total of $826,500 during the fiscal year. The loan balance as of
J une 30, 2013 was $336,282. The loan has an annual interest rate of 5%. The
loan 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 local
financing company when the funds are disbursed from the State. The full
balance was paid off on August 28, 2013 (Note 6.)

$ 336,282


12


Description Amount

Facilitated by the California School Finance Authority, Magnolia Science
Academy Santa Clara received loan amounts from a local financing company
for an accumulated total of $444,200 during the fiscal year. The loan balance
as of J une 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 the
State budget crisis, and it will be repaid by State revenue directly to the local
balance 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 J une
23, 2010. The loan balance as of J une 30, 2013 was $40,000. The loan has an
interest rate of 0.54% and it matures in five years. The repayment terms
require six monthly payments each year in five fiscal years beginning on
August 20, 2010. The State Controllers Office deducts the loan payments
from the Schools State School Fund Apportionments.

$

40,000

Facilitated by the California School Finance Authority, Pacific Technology
School Orangevale received loan amounts from a local financing company for
an accumulated total of $223,600 during the fiscal year. The loan balance as
of J une 30, 2013 was $223,600. The loan has an annual interest rate of 5%.
State budget crisis, and it will be repaid by State revenue directly to the
balance was paid off in October, 2013 (Note 6.)

$ 223,600

Pacific Technology School Orangevale received an unsecured revolving loan
payable to the California Department of Education totaling $250,000 on March
23, 2010. The loan balance as of J une 30, 2013 was $108,334. The loan has
an interest rate of 0.53% and it matures in five years. The repayment terms

$ 108,334

13


Description Amount

Facilitated by the California School Finance Authority, Pacific Technology
School Santa Ana received loan amounts from a local financing company for
an accumulated total of $261,400 during the fiscal year. The loan balance as
of J une 30, 2013 was $261,400. The loan has an annual interest rate of 5%.
State budget crisis, and it will be repaid by State revenue directly to the local
balance was paid off on October 16, 2013 (Note 6.)

$ 261,400

Pacific Technology School Santa Ana received an unsecured revolving loan
payable to the California Department of Education totaling $100,000 on May
25, 2010. The loan balance as of J une 30, 2013 was $36,669. The loan has an
interest rate of 0.53% and it matures in five years. The repayment terms

$ 36,669

Pacific Technology School Santa Ana received another unsecured revolving
loan payable to the California Department of Education totaling $150,000 on
November 30, 2012. The loan balance as of J une 30, 2013 was $150,000. The
loan 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 on
October 30, 2013. The State Controllers Office deducts the loan payments

$ 150,000


14


Description Amount

Pacific Technology School Santa Ana was approved for a loan of $8,706,978
from California School Finance Authority for the land acquisition and
construction of a new school facility. The School received $2,040,698 in the
year ended J une 30, 2012. The outstanding loan balance as of J une 30, 2013
was $2,040,698. The loan has an annual interest rate of 3% and it matures in
30 years after the completion of the project, which is estimated to be in the
middle of calendar year 2014. The repayment schedule will be determined
after 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 3,861,412
Less 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 J une 30, Amount

2014 $ 1,475,714
2015 205,000
2016 55,000
2017 55,000
2018 30,000
Thereafter 2,040,698

Total $ 3,861,412


15

NOTE 5 - TEMPORARILY RESTRICTED NET ASSETS

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

NOTE 6 - SUBSEQUENT EVENT

The Schools Management has evaluated subsequent events for the period from J une 30,
2013 through October 21, 2013, the date the financial statements were available to be
issued. Management identified the following transactions that require disclosure or that
would 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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For the year ended J une 30, 2012
REVENUES:
Federal support $ 1,510,543
State support 20,788,192
Local support 1,926,163
Contributions 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
(With comparative totals for the year June 30, 2012)
6
2013 2012
REVENUES:
Federal support $ 2,047,144 $ 1,510,543
State 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 3,289,081
Books 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

Magnolia Public Schools Tell LAUSD It Is Financially in Order

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