THE VARNETT SCHOOLS INC. dba THE VARNETT PUBLIC SCHOOL

dba THE VARNETT PUBLIC SCHOOL ANNUAL FINANCIAL AND COMPLIANCE REPORT FOR THE YEAR ENDED AUGUST 31, 2015

dba THE VARNETT PUBLIC SCHOOL ANNUAL FINANCIAL AND COMPLIANCE REPORT FOR THE YEAR ENDED AUGUST 31, 2015 TABLE OF CONTENTS PAGE Certificate of Board... ii FINANCIAL SECTION Independent Auditors Report... 1 A-1 Statement of Financial Position... 3 A-2 Statement of Activities... 4 A-3 Statement of Cash Flows... 5 Notes to the Financial Statements... 6 SUPPLEMENTARY INFORMATION C-1 Schedule of Expenses... 14 D-1 Schedule of Capital Assets... 15 E-1 Budgetary Comparison Schedule... 16 OVERALL COMPLIANCE, INTERNAL CONTROL SECTION AND FEDERAL AWARDS Independent Auditors Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards... 18 Independent Auditors Report on Compliance for Each Major Program and on Internal Control Over Compliance Required By OMB Circular A-133... 20 Schedule of Findings and Questioned Costs... 22 Summary Schedule of Prior Audit Findings... 25 Corrective Action Plan... 29 Schedule of Expenditures of Federal Awards... 30 Notes to Schedule of Expenditures of Federal Awards... 31 i

HLSK Hereford, Lynch, Sellars & Kirkham Certified Public Accountants A Professional Corporation Conroe Members of the Cleveland 1406 Wilson Rd., Suite 100 American Institute of Certified Public Accountants 111 East Boothe Conroe, Texas 77304 Texas Society of Certified Public Accounts Cleveland, Texas 77327 Tel 936-756-8127 Private Companies Practice Section Tel 281-592-6443 Metro 936-441-1338 of the AICPA Division for Firms Fax 281-592-7706 Fax 936-756-8132 INDEPENDENT AUDITORS REPORT To the Board of Directors of The Varnett Schools Inc. dba The Varnett Public School 5025 South Willow Drive Houston, Texas 77035 Report on the Financial Statements We have audited the accompanying financial statements of The Varnett Schools Inc. dba The Varnett Public School ( the Charter Holder ), which comprise the statement of financial position as of August 31, 2015, and the related statements of activities and cash flows for the year then ended, and the related notes to the financial statements. Management s 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. Auditor s 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 and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. 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 auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s 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 entity s 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 audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Charter Holder as of August 31, 2015, and the changes in its net assets and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. 1

Other Matters Supplementary Information Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The Supplementary Information, as listed in the table of contents, is presented for purposes of additional analysis and is not a required part of the financial statements. The accompanying schedule of expenditures of federal awards, as required by U.S. Office of Management and Budget Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations, is presented for purposes of additional analysis and is also not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the financial statements as a whole. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated January 13, 2016, on our consideration of the Charter Holder s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the Charter Holder s internal control over financial reporting and compliance. Respectfully, Hereford, Lynch, Sellars & Kirkham, P.C. HEREFORD, LYNCH, SELLARS & KIRKHAM, P.C. Certified Public Accountants Conroe, Texas January 13, 2016 2

EXHIBIT A-1 dba THE VARNETT PUBLIC SCHOOL STATEMENT OF FINANCIAL POSITION AUGUST 31, 2015 Data Control Codes ASSETS: Current Assets: 1110 Cash and Cash Equivalents $ 11,783,097 1240 Due from Governments 1,861,210 1290 Other Receivables 1,068,467 Total Current Assets 14,712,774 Property and Equipment: 1510 Land and Improvements 653,287 1520 Buildings and Improvements 6,821,586 1530 Furniture and Equipment 2,514,866 1570 Accumulated Depreciation (3,438,905) Total Non-Current Assets 6,550,834 1000 Total Assets 21,263,608 LIABILITIES AND NET ASSETS: Current Liabilities: 2110 Accounts Payable 376,177 2160 Accrued Wages Payable 230,592 2180 Due to Governments 2,046,976 2300 Unearned Revenue 15,079 Total Current Liabilities 2,668,824 2000 Total Liabilities 2,668,824 NET ASSETS: 3500 Temporarily Restricted 12,547,310 3600 Unrestricted 6,047,474 3000 Total Net Position $ 18,594,784 The accompanying notes are an integral part of this statement. 3

EXHIBIT A-2 dba THE VARNETT PUBLIC SCHOOL STATEMENT OF ACTIVITIES FOR THE YEAR ENDED AUGUST 31, 2015 Data Control Codes REVENUE: Local Revenue: 5740 Other Revenues from Local Sources $ 542,494 $ - $ 542,494 5750 Food Service, Cocurricular, & Enterprising 23,789-23,789 Total Local Revenue 566,283-566,283 State Program Revenue: 5810 Foundation School Program - 12,452,168 12,452,168 5820 Other State Revenue (TEA) - 266,286 266,286 Total State Program Revenue - 12,718,454 12,718,454 Federal Program Revenue: Pass Through TEA: 5920 Child Nutrition - 950,729 950,729 5921 ESEA Title I Part A - 700,503 700,503 5922 IDEA Part B Formula and Preschool - 188,577 188,577 5923 ESEA Title II Part A - 53,314 53,314 5924 ESEA Title III, Part A - 62,326 62,326 5925 Summer School LEP - 7,746 7,746 Pass Through Other Agencies: 5939 Child Nutrition - 136,194 136,194 5949 Miscellaneous Federal Revenue - 581,199 581,199 Total Federal Program Revenue - 2,680,588 2,680,588 Net Assets Released from Restrictions: Restrictions Satisfied by Payments 13,944,051 (13,944,051) - Total Net Assets Released from Restrictions 13,944,051 (13,944,051) - Total Revenues 14,510,334 1,454,991 15,965,325 EXPENSES: 0011 Instruction 6,310,944-6,310,944 0012 Instructional Resources and Media Services 327,684-327,684 0013 Curriculum and Instructional Staff Development 423,603-423,603 0021 Instructional Leadership 140,958-140,958 0023 School Leadership 806,928-806,928 0031 Guidance, Counseling, and Evaluation Services 11,000-11,000 0033 Health Services 160,026-160,026 0034 Transportation 863,692-863,692 0035 Food Service 1,137,622-1,137,622 0041 General Administration 1,091,143-1,091,143 0051 Plant Maintenance 1,856,902-1,856,902 0052 Security and Monitoring Services 251,235-251,235 0053 Data Processing Services 363,715-363,715 0061 Community Services 198,599-198,599 0081 Fundraising 1,734-1,734 6030 Total Expenses 13,945,785-13,945,785 8949 Refund to TEA (2,046,976) - (2,046,976) Increase (Decrease) in Net Assets (1,482,427) 1,454,991 (27,436) Net Assets at Beginning of Year 7,945,342 11,092,319 19,037,661 3700 Prior Period Adjustment - Grant Receivable (415,441) - (415,441) Net Assets at End of Year $ 6,047,474 $ 12,547,310 $ 18,594,784 The accompanying notes are an integral part of this statement. 4 Unrestricted Temporarily Restricted Total

EXHIBIT A-3 dba THE VARNETT PUBLIC SCHOOL STATEMENT OF CASH FLOWS FOR THE YEAR ENDED AUGUST 31, 2015 CASH FLOWS FROM OPERATING ACTIVITIES: State and Federal Programs Received $ 13,299,116 Contributions Received 542,494 Charges for Services Received 23,789 Payments to Employees (8,200,168) Payments to Vendors for Goods and Services (5,332,411) Net Cash Provided by (Used for) Operating Activities 332,820 CASH FLOWS FROM INVESTING ACTIVITIES: Net Cash Provided by (Used For) Investing Activities - CASH FLOWS FROM FINANCING ACTIVITIES: Net Cash Provided by (Used For) Financing Activities - Net Increase (Decrease) in Cash 332,820 Cash at Beginning of Year 11,450,277 Cash at End of Year $ 11,783,097 RECONCILIATION OF CHANGE IN NET ASSETS TO NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES: Change in Net Assets $ (27,436) Prior Period Adjustment - Grant Receivable (415,441) Adjustments to Reconcile Change in Net Assets to Net Cash Provided by Operating Activities: Depreciation 485,471 (Increase) Decrease in Assets: Due From Other Governments (614,677) Other Receivables (1,068,467) Increase (Decrease) in Liabilities: Accounts Payable (176,295) Accrued Wages Payable 104,030 Due To Other Governments 2,030,556 Unearned Revenue 15,079 Net Cash Provided by (Used For) by Operating Activities $ 332,820 The accompanying notes are an integral part of this statement. 5

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Note 1. Summary of Significant Accounting Policies The financial statements of The Varnett Schools Inc. dba The Varnett Public School the Charter Holder were prepared in conformity with accounting principles generally accepted in the United States of America. The Financial Accounting Standards Board is the accepted standard setting body for establishing not-for-profit accounting and financial reporting principles. Reporting Entity The Charter Holder is a not-for-profit organization incorporated in the State of Texas in 1990 and exempt from federal income taxes pursuant to Section 501(c)(3) of the Internal Revenue Code. The Charter Holder is governed by a Board of Directors comprised of three members. The Board of Directors is selected pursuant to the bylaws of the Charter Holder and has the authority to make decisions, appoint the chief executive officer of the Charter Holder, and significantly influence operations. The Board of Directors has the primary accountability for the fiscal affairs of the Charter Holder. Since the Charter Holder received funding from local, state, and federal government sources, it must comply with the requirements of the entities providing those funds. Corporate Operations The Charter Holder is a Texas State Open Enrollment Charter School. The Texas Education Agency approved a name change from Varnett Charter School to The Varnett Public School effective the 2008-09 school year. The Charter Holder primarily serves children preschool to 5 th grade. The Charter Holder s vision is to create an environment in which every student receives a quality education in a safe environment, and assure every student access to a learning environment that encourages them to be in school with other students learning to the best of their ability. The first year of operation was for the period ended August 31, 1999. The Charter Holder operates three campuses and does not conduct any non-charter activities. Basis of Accounting and Presentation The accompanying financial statements have been prepared using the accrual basis of accounting in accordance with generally accepted accounting principles. Net assets and revenues, expenses, gains, and losses are classified based on the existence and nature or absence of donor-imposed restrictions. Accordingly, net assets of the Charter Holder and changes therein are classified and reported as follows: Unrestricted net assets that are not subject to donor-imposed stipulations. Temporarily restricted net assets subject to donor-imposed stipulations that may or will be met, either by actions of the Charter Holder and/or the passage of time. When a restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the statement of activities as net assets released from restrictions. Permanently restricted net assets required to be maintained in perpetuity with only the income to be used for The Charter Holder s activities due to donor-imposed restrictions. The Charter Holder has not received any funds that require a permanent restriction. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Contributions The Charter Holder accounts for contributions as unrestricted, temporarily restricted, or permanently restricted support, depending on the existence and/or nature of any donor restrictions. 6

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Support that is restricted by the donor is reported as an increase in temporarily restricted or permanently restricted net assets in the reporting period in which the support is recognized. When a restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the statement of activities as net assets released from restrictions. Cash and Cash Equivalents For financial statement purposes, the Charter Holder considers all highly liquid investment instruments with an original maturity of three months or less to be cash equivalents. Capital Assets Capital assets, which include land and improvements, buildings and improvements, and furniture and equipment, are reported in the financial statements. Capital assets are defined by the Charter Holder as assets with an individual cost of more than $5,000. Such assets are recorded at historical cost and are depreciated over the estimated useful lives of the assets, which range from five to thirty-nine years, using the straight-line method of depreciation. Payment for additions, major renewals and betterments are capitalized, and maintenance and repairs are charged to expense as incurred. Donations of assets are recorded as direct additions to net assets at fair value at the date of donation, which is then treated as cost. Donated Services No amounts have been reflected in the financial statements for donated services since no objective basis is available to measure the value of such donations. Nevertheless, a substantial number of volunteers have donated their time in connection with the program service and administration of the Charter Holder. Federal Income Tax The Internal Revenue Service has determined that the Charter Holder is exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code. Form 990 is filed annually. Generally accepted accounting principles require the recognition, measurement, classification, and disclosure in the financial statements of uncertain tax positions taken or expected to be taken in the Charter Holder s tax returns. Management has determined that the Charter Holder does not have any uncertain tax positions and associated unrecognized benefits that materially impact the financial statements or related disclosures. Since tax matters are subject to some degree of uncertainty, there can be no assurance that the Charter Holder s tax returns will not be challenged by the taxing authorities and that the Charter Holder will not be subject to additional tax, penalties, and interest as a result of such challenge. Generally, the Charter Holder s tax returns remain open for federal income tax examination for three years from the date of filing. Note 2. Cash on Deposit The Charter Holder maintains cash balances in banks. These balances are partially insured by the Federal Deposit Insurance Corporation. As of August 31, 2015, the uninsured portion of this balance was $1,635,568 and such balance was collateralized with a letter of credit from the Federal Home Loan Bank of Dallas. The Charter Holder s funds are required to be deposited and invested under the terms of a depository contract pursuant to the Texas School District Depository Act. The letter of credit shall be in an amount sufficient to protect the Charter Holder funds on a day-to-day basis during the period of the contract. The letter of credit is waived only to the extent of the depository bank s dollar amount of Federal Deposit Insurance Corporation (FDIC) insurance. Note 3. Due from Governments Due from governments as of August 31, 2015 are as follows: 2015 Reimbursement of 2013-2014 Federal Grants from TEA* $ 803,231 Foundation Allotment for 2014-2015 763,439 Reimbursement of 2014-2015 Federal Grants from TEA 294,540 Total $ 1,861,210 *TEA has advised the Charter Holder that it will be reimbursed. Such denial of reimbursement of funds would have a material effect on the Charter Holder's financial position. 7

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Note 4. Other Receivables Other receivables as of August 31, 2015 are as follows: 2015 Funds recovered from prior Superintendent due to fraud $ 467,343 Refund of unused retainers for legal matters 448,694 Insurance proceeds from theft claims 100,000 Overpayment to Teacher Retirement System 52,430 Total $ 1,068,467 Note 5. Capital Assets Capital assets at August 31, 2015 were as follows: 2015 Land and Improvements $ 653,287 Buildings and Improvements 6,821,586 Furniture and Equipment 2,514,866 Total Property and Equipment 9,989,739 Less: Accumulated Deprecation (3,438,905) Property and Equipment - Net $ 6,550,834 Depreciation expense was $485,471 for the year ended August 31, 2015. Capital assets acquired with public funds received by the Charter Holder for the operation of the school constitute public property pursuant to Chapter 12 of the Texas Education Code. These assets are specifically identified on the Schedule of Capital Assets for the Charter Holder. Note 6. Due to Governments Due to governments as of August 31, 2015 was $2,046,976, which consists of a refund to TEA for disallowed expenses on federal grants for prior fiscal years. Such refund to TEA is expected to be completed in January 2016. Note 7. Defined Benefit Pension Plan Plan Description The Charter Holder participates in a cost-sharing multiple-employer defined benefit pension that has a special funding situation. The plan is administered by the Teacher Retirement System of Texas (TRS). TRS s defined benefit pension plan is established and administered in accordance with the Texas Constitution, Article XVI, Section 67 and Texas Government Code, Title 8, Subtitle C. The pension trust fund is a qualified pension trust under Section 401(a) of the Internal Revenue Code. The Texas Legislature establishes benefits and contribution rates within the guidelines of the Texas Constitution. The pension s Board of Trustees does not have the authority to establish or amend benefit terms. As a governmental plan, TRS is not a plan subject to the Employees Retirement Income Security Act of 1974. The risk of participating in a multiemployer defined benefit pension plan is different from single-employer plans because: (a) assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers, (b) the required member, employer, and state contribution rates are set by the Texas Legislature as noted above, and (c) if the Charter Holder chooses to stop participating in the multiemployer plan, it may be required to pay a withdrawal liability to the plan. The Charter Holder has no plans to withdraw from this multiemployer plan. All employees of public, state-supported educational institutions in Texas who are employed for one-half or more of the standard work load and who are not exempted from membership under Texas Government Code, Title 8, Section 822.002 are covered by the system. 8

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Pension Plan Fiduciary Net Position Detailed information about the TRS s fiduciary net position is available in a separately-issued Comprehensive Annual Financial Report (CAFR) that includes financial statements and required supplementary information. That report may be obtained on the Internet at http://www.trs.state.tx.us/about/documents/cafr.pdf#cafr; by writing to TRS at 1000 Red River Street, Austin, TX, 78701-2698; or by calling (512) 542-6592. According to the most recently available Comprehensive Annual Financial Report and Actuarial Valuation Report for the year ended August 31, 2014, total plan assets is $157 billion, net position is $133 billion, the total actuarial present value of (accumulated plan benefits) (total pension liability) is $159 billion, contributions from all employers, members and non-employer contributing entity (state) totaled $4.9 billion, and the plan is 83% funded. The Charter is not aware of a collective-bargaining agreement. Benefits Provided TRS provides service and disability retirement, as well as death and survivor benefits, to eligible employees (and their beneficiaries) of public and higher education in Texas. The pension formula is calculated using 2.3 percent (multiplier) times the average of the five highest annual creditable salaries times years of credited service to arrive at the annual standard annuity except for members who are grandfathered, the three highest annual salaries are used. The normal service retirement is at age 65 with 5 years of credited service or when the sum of the member s age and years of credited service equals 80 or more years. Early retirement is at age 55 with 5 years of service credit or earlier than 55 with 30 years of service credit. There are additional provisions for early retirement if the sum of the member s age and years of services credit total at least 80, but the member is less than age 60 or 62 depending on date of employment, or if the member was grandfathered in under a previous rule. There are no automatic post-employment benefit changes; including automatic COLAs. Ad hoc post-employment benefit changes, including ad hoc COLAs can be granted by the Texas Legislature as noted in the Plan Description above. Contributions Contribution requirements are established or amended pursuant to Article 16, section 67 of the Texas Constitution which requires the Texas legislature to establish a member contribution rate of not less than 6% of the member s annual compensation and a state contribution rate of not less than 6% and not more than 10% of the aggregate annual compensation paid to members of the system during the fiscal year. Texas Government Code section 821.006 prohibits benefit improvements, if as a result of the particular action, the time required to amortize TRS unfunded actuarial liabilities would be increased to a period that exceeds 31 years, or, if the amortization period already exceeds 31 years, the period would be increased by such action. Employee contribution rates are set in state statute, Texas Government Code 825.402. Senate Bill 1458 of the 83 rd Texas Legislature amended Texas Government Code 825.402 for member contributions and established employee contribution rates for fiscal years 2014 thru 2017. It also added a 1.5% contribution for employers not paying Old Age Survivor and Disability Insurance (OASDI) on certain employees effective for fiscal year 2015 as discussed in Note 1 of the TRS 2014 CAFR. The 83 rd Texas Legislature, General Appropriations Act (GAA) established the employer contribution rates for Plan fiscal years 2014 and 2015. 2015 2014 Member $ 6.7% $ 6.4% Non-Employer Contributing Entity (State) 6.8% 6.8% Employers/Charter Holder 6.8% 6.8% The required contribution amounts for the Plan s fiscal year are as follows: 2015 Charter Holder Contributions $ 30,416 Member Contributions 436,268 NECE On-behalf Contributions (State) 427,172 The Charter Holder did not contribute more than 5% of the total contributions to the plan. There have been no changes that would affect the comparison of employer contributions from year to year. 9

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Contributors to the plan include members, employers and the State of Texas as the only non-employer contributing entity. The State is the employer for senior colleges, medical schools and state agencies including TRS. In each respective role, the State contributes to the plan in accordance with state statutes and the General Appropriations Act (GAA). As the non-employer contributing entity for public education and junior colleges, the State of Texas contributes to the retirement system an amount equal to the current employer contribution rate times the aggregate annual compensation of all participating members of the pension trust fund during that fiscal year reduced by the amounts described below which are paid by the employers. Employers (public school, junior college, other entities or the State of Texas as the employer for senior universities and medical schools) are required to pay the employer contribution rate in the following instances: On the portion of the member s salary that exceeds the statutory minimum for members entitled to the statutory minimum under Section 21.402 of the Texas Education Code. During a new member s first 90 days of employment. When any part or all of an employee s salary is paid by federal funding sources, a privately sponsored source, from non-educational and general, or local funds. When the employing district is a public junior college or junior college district, the employer shall contribute to the retirement system an amount equal to 50% of the state contribution rate for certain instructional or administrative employees; and 100% of the state contribution rate for all other employees. In addition to the employer contributions listed above, when employing a retiree of the Teacher Retirement System, the employer shall pay both the member contribution and the state contribution as an employment after retirement surcharge. Pension Liabilities, Pension Expense, and Deferred Outflows of Resources and Deferred Inflows of Resources Related to Pensions At August 31, 2015, the Charter Holder disclosed a liability of $320,457 for its proportionate share of the TRS s net pension liability. This liability reflects a reduction for State pension support provided to the Charter Holder. The amount not recognized by the Charter Holder as its proportionate share of the net pension liability, the related State support, and the total portion of the net pension liability that was associated with the Charter Holder are as follows: Charter Holder's Proportionate Share of the Net Pension Liability Not Included in Financial Statements $ 320,457 State's Proportionate Share of the Net Pension Liability Associated with the Charter Holder 4,620,667 Total $ 4,941,124 The net pension liability was measured as of August 31, 2014 and the total pension liability used to calculate the net pension liability was determined by an actuarial valuation as of that date. The Charter Holder s proportion of the net pension liability was based on the Charter Holder s contributions to the pension plan relative to the contributions of all employers to the plan for the period September 1, 2013 through August 31, 2014. At August 31, 2014, the employer s proportion of net pension liability was.0011997%. The change in the employer s proportion of the net pension liability was immaterial and therefore disregarded this year. There were no changes of assumptions or other inputs that affected measurement of the total pension liability during the measurement period. There were no changes of benefit terms that affected measurement of the total pension liability during the measurement period. 10

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Note 8. Retiree Health Care Plan Description The Charter contributes to the Texas Public School Retired Employees Group Insurance Program ( TRS-Care ), a cost-sharing, multiple-employer defined benefit postemployment health care plan administered by TRS. TRS-Care provides health care coverage for certain persons (and their dependents) who retired under TRS. The statutory authority for the program is Texas Insurance Code, Chapter 1575. Section 1575.052 grants the TRS Board of Trustees the authority to establish and amend basic and optional group insurance coverage for participants. TRS issues a publicly available financial report that includes financial statements and Required Supplementary Information for TRS-Care. That report may be obtained by visiting the TRS website at www.trs.state.tx.us; by writing to the Communications Department of the Teacher Retirement System of Texas at 1000 Red River Street, Austin, Texas 78701; or by calling 1-800-223-8778. Funding Policy Contribution requirements are not actuarially determined but are legally established each biennium by the Texas Legislature. Texas Insurance Code, Sections 1575.202, 203, and 204 establish state, active employee, and public school contributions, respectively. The State of Texas contribution rate was 1.0% for fiscal year 2015, with the Charter Holder contributing a percentage of payroll set at 0.55%. The active public school employee contribution rate was 0.65% for 2015. Per Texas Insurance Code, Chapter 1575, the school contribution may not be less than 0.25% or greater than 0.75% of the salary of each active employee of the public school. For the year ended August 31, 2015, the active member contributions were $48,543, and the Charter Holder s contributions were $41,075, which equaled the required contributions. Note 9. Health Care Coverage During the year ended August 31, 2015, employees of the Charter Holder were covered by a TRS-Active Care (the Plan). The Charter Holder contributed $225 per month per employee to the Plan. Employees, at their option, authorized payroll withholdings to pay contributions or premiums for dependents. All premiums were paid to TRS. Note 10. Temporarily Restricted Net Assets Temporarily restricted net assets for the year ended August 31, 2015 consisted of the following: 2015 Restricted for Unexpended State Revenue $ 12,547,310 Total Restricted Funds $ 12,547,310 Note 11. Legal Matters and Contingencies Legal Matters Former employees, who held management positions, are under federal investigation as described in Note 15. On October 13, 2015, TEA re-initiated a portion of issues from the prior reports through a Corrective Action and Refund Notice against the Charter Holder, whereby TEA has sought the return of $2,046,976. The Charter Holder plans to settle with TEA and refund $2,046,976 in January 2016. See Note 6 for reporting of liability. Contingencies The Charter Holder receives funds through state and federal programs that are governed by various statutes and regulations. State program funding is based primarily on student attendance data submitted to the Texas Education Agency and is subject to audit and adjustment. Expenses charged to federal programs are subject to audit and adjustments by the grantor agency. The programs administered by the Charter Holder have complex compliance requirements, and should state or federal auditors discover areas of noncompliance, charter school funds may be subject to refund if so determined by the Texas Education Agency or the grantor agency. During the fiscal year ending August 31, 2015, the Charter Holder was not in compliance with eligibility and reporting related to the Child Nutrition Grant. Documentation for free and reduced applications could not be provided. The Charter Holder requested and recognized as revenue $950,729 from TEA for free and reduced lunches. The uncertainty of TEA s response to such finding is not known. 11

dba THE VARNETT PUBLIC SCHOOL NOTES TO THE FINANCIAL STATEMENTS AUGUST 31, 2015 Note 12. Evaluation of Subsequent Events The Charter Holder had evaluated subsequent events through January 13, 2016, the date which the financial statements were available to be issued. Note 13. Nonmonetary Transactions During 2015, the Charter Holder received textbooks purchased by the State of Texas for the benefit of the Charter Holder for a purchase price of $131,282. The Charter Holder receives the textbooks as part of state funding for textbook allotment. The textbook allotment has been recorded in the amount of $131,282 as both state revenues and expenses, which represents the amount of consideration given by the State of Texas. Note 14. Economic Dependency During the year ended August 31, 2015, the Charter Holder earned revenue of $15,399,042, from the Texas Education Agency (TEA), including grants passed through the TEA. This amount constitutes approximately 96.5% of total revenues earned for the year ended August 31, 2015. Any unforeseen loss of the charter agreement with TEA or changes in legislative funding could have a material effect on the ability of the charter school to continue to provide the current level of services to its students. TEA has designated the Charter Holder as high-risk. The designation does not prevent the Charter Holder from receiving federal funds. The designation requires the Charter Holder to provide appropriate documentation before its expense will be reimbursed. Such condition may be removed if the issues leading to the impositions are resolved and TEA determines no subsequent additional concerns have arisen that justify the high-risk designation. If such conditions are not rectified or cleared, the Charter Holder s ability to continue as a going concern may be affected. Note 15. Federal Investigation Dr. Cluff, former superintendent, who was a former member of the charter holder board and a former non-voting member of the school board, and spouse, Mr. Cluff, who was the former facilities and operations director and a former member of the school board, resigned in August 2014, from The Varnett Schools Inc., dba The Varnett Public School (auditee). The United States Attorney s Office for the Southern District of Texas along with agents of the Internal Revenue Service and the Federal Bureau of Investigation investigated the Dr. & Mr. Cluff to determine if such individuals wrongfully converted funds to their personal use. Dr. & Mr. Cluff were indicted on charges including misappropriation of funds. As of January 13, 2016, approximately $1.5 million has been recovered from Dr. & Mr. Cluff. The Charter Holder has received $467,343 subsequent to year end (See Note 4) and the remainder is in a trust account per an agreement with the Department of Justice. The recovery of funds held in trust is not included in the financial statements of The Varnett Schools Inc., dba The Varnett Public School (auditee). The outcome of this indictment cannot be predicted. Current management of The Varnett Schools Inc., dba The Varnett Public School (auditee) is not aware of any pending or contemplated charges against The Varnett Schools Inc., dba The Varnett Public School (auditee). Note 16. Prior Period Adjustment In January 2016, TEA determined that the Charter Holder will be reimbursed $803,231 from reimbursement request totaling $1,218,672 for the 2013-2014 federal grants. The disallowed amount of $415,441 was reported as an adjustment to beginning net assets. 12

SUPPLEMENTARY INFORMATION 13

EXHIBIT C-1 dba THE VARNETT PUBLIC SCHOOL SCHEDULE OF EXPENSES FOR THE YEAR ENDED AUGUST 31, 2015 Data Control Codes 2015 EXPENSES: 6100 Payroll Costs $ 8,304,198 6200 Professional and Contracted Services 3,202,414 6300 Supplies and Materials 1,660,096 6400 Other Operating Costs 779,077 Total Expenses $ 13,945,785 14

EXHIBIT D-1 dba THE VARNETT PUBLIC SCHOOL SCHEDULE OF CAPITAL ASSETS FOR THE YEAR ENDED AUGUST 31, 2015 Data Control Codes Local Ownership Interest State Federal 1510 Land and Improvements $ - $ 653,287 $ - 1520 Buildings and Improvements - 6,821,586-1530 Furniture and Equipment - 2,514,866 - Total Property and Equipment $ - $ 9,989,739 $ - 15

EXHIBIT E-1 dba THE VARNETT PUBLIC SCHOOL BUDGETARY COMPARISON SCHEDULE FOR THE YEAR ENDED AUGUST 31, 2015 Data Budgeted Amounts Variance Control Actual from Final Codes Original Final Amounts Budget REVENUES: Local Revenue: 5740 Other Revenues from Local Sources $ 199,857 $ 252,295 $ 542,494 $ 290,199 5750 Food Service, Cocurricular, & Enterprising 34,573 23,789 23,789 - Total Local Revenue 234,430 276,084 566,283 290,199 State Program Revenue: 5810 Foundation School Program 11,747,122 11,685,775 12,452,168 766,393 5820 Other State Revenue (TEA) 110,559 143,228 266,286 123,058 Total State Program Revenue 11,857,681 11,829,003 12,718,454 889,451 Federal Program Revenue: Pass Through TEA: 5920 Child Nutrition 1,036,900 985,444 950,729 (34,715) 5921 ESEA Title I Part A 817,312 817,312 700,503 (116,809) 5922 IDEA Part B Formula and Preschool 258,120 258,120 188,577 (69,543) 5923 ESEA Title II Part A 87,212 87,212 53,314 (33,898) 5924 ESEA Title III, Part A 78,547 78,547 62,326 (16,221) 5925 Summer School LEP 7,746 7,746 7,746 - Pass Through Other Agencies: 5939 Child Nutrition - 71,986 136,194 64,208 5949 Miscellaneous Federal Revenue - - 581,199 581,199 Total Federal Program Revenue 2,285,837 2,306,367 2,680,588 374,221 Total Revenues 14,377,948 14,411,454 15,965,325 1,553,871 EXPENSES: 0011 Instruction 5,989,799 6,360,398 6,310,944 49,454 0012 Instructional Resources and Media Services 357,081 344,081 327,684 16,397 0013 Curriculum and Instructional Staff Development 491,150 491,149 423,603 67,546 0021 Instructional Leadership 209,110 164,110 140,958 23,152 0023 School Leadership 685,439 819,539 806,928 12,611 0031 Guidance, Counseling, and Evaluation Services 34,090 54,090 11,000 43,090 0033 Health Services 169,806 169,806 160,026 9,780 0034 Transportation 798,459 758,459 863,692 (105,233) 0035 Food Service 1,071,473 1,081,219 1,137,622 (56,403) 0041 General Administration 1,532,112 1,330,112 1,091,143 238,969 0051 Plant Maintenance 2,113,927 1,818,827 1,856,902 (38,075) 0052 Security and Monitoring Services 220,777 246,777 251,235 (4,458) 0053 Data Processing Services 270,639 335,801 363,715 (27,914) 0061 Community Services 174,606 177,606 198,599 (20,993) 0081 Fundraising 1,734 1,734 1,734-6030 Total Expenses 14,120,202 14,153,708 13,945,785 207,923 8949 Refund to TEA - - (2,046,976) (2,046,976) Increase (Decrease) in Net Assets 257,746 257,746 (27,436) (285,182) Net Assets at Beginning of Year 19,037,661 19,037,661 19,037,661-3700 Prior Period Adjustment - Grant Receivable - - (415,441) (415,441) Net Assets at End of Year $ 19,295,407 $ 19,295,407 $ 18,594,784 $ (700,623) 16

OVERALL COMPLIANCE, INTERNAL CONTROL SECTION AND FEDERAL AWARDS 17

HLSK Hereford, Lynch, Sellars & Kirkham Certified Public Accountants A Professional Corporation Conroe Members of the Cleveland 1406 Wilson Rd., Suite 100 American Institute of Certified Public Accountants 111 East Boothe Conroe, Texas 77304 Texas Society of Certified Public Accounts Cleveland, Texas 77327 Tel 936-756-8127 Private Companies Practice Section Tel 281-592-6443 Metro 936-441-1338 of the AICPA Division for Firms Fax 281-592-7706 Fax 936-756-8132 INDEPENDENT AUDITORS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS To the Board of Directors of The Varnett Schools Inc. dba The Varnett Public School 5025 South Willow Drive Houston, Texas 77035 We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the financial statements of The Varnett Schools Inc. dba The Varnett Public School (the Charter Holder), which comprise the statement of financial position as of August 31, 20X1, and the related statements of activities and cash flows for the year then ended, and the related notes to the financial statements, and have issued our report thereon dated January 13, 2016. Internal Control Over Financial Reporting In planning and performing our audit of the financial statements, we considered the Charter Holder s internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the Charter Holder s internal control. Accordingly, we do not express an opinion on the effectiveness of the Charter Holder s internal control. Our consideration of internal control was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies and therefore, material weaknesses or significant deficiencies may exist that were not identified. However, as described in the accompanying schedule of findings and questioned costs, we identified certain deficiencies in internal control that we consider to be material weaknesses and significant deficiencies. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity s financial statements will not be prevented, or detected and corrected on a timely basis. We consider the deficiency described in the accompanying schedule of findings and questioned costs as item 2015-001 to be a material weakness. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. We consider the deficiency described in the accompany schedule of findings and questioned costs as item 2015-001 to be a significant deficiency. Compliance and Other Matters As part of obtaining reasonable assurance about whether the Charter Holder s financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed instances of noncompliance or other matters that are required to be reported under Government Auditing Standards and which are described in the accompanying schedule of findings and questioned costs as item 2015-001. 18

The Charter Holder s Response to Findings The Charter Holder s response to the findings identified in our audit is described in the accompanying schedule of findings and questioned costs. The Charter Holder s response was not subjected to the auditing procedures applied in the audit of the financial statements and, accordingly, we express no opinion on it. Purpose of this Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of that testing, and not to provide an opinion on the effectiveness of the organization s internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the organization s internal control and compliance. Accordingly, this communication is not suitable for any other purpose. Respectfully, Hereford, Lynch, Sellars & Kirkham, P.C. HEREFORD, LYNCH, SELLARS & KIRKHAM, P.C. Certified Public Accountants Conroe, Texas January 13, 2016 19

HLSK Hereford, Lynch, Sellars & Kirkham Certified Public Accountants A Professional Corporation Conroe Members of the Cleveland 1406 Wilson Rd., Suite 100 American Institute of Certified Public Accountants 111 East Boothe Conroe, Texas 77304 Texas Society of Certified Public Accounts Cleveland, Texas 77327 Tel 936-756-8127 Private Companies Practice Section Tel 281-592-6443 Metro 936-441-1338 of the AICPA Division for Firms Fax 281-592-7706 Fax 936-756-8132 INDEPENDENT AUDITORS REPORT ON COMPLIANCE FOR EACH MAJOR PROGRAM AND ON INTERNAL CONTROL OVER COMPLIANCE REQUIRED BY OMB CIRCULAR A-133 To the Board of Directors of The Varnett Schools Inc. dba The Varnett Public School 5025 South Willow Drive Houston, Texas 77035 Report on Compliance for Each Major Federal Program We have audited The Varnett Schools Inc. dba The Varnett Public School (the Charter Holder) compliance with the types of compliance requirements described in the OMB Circular A-133 Compliance Supplement that could have a direct and material effect on each of the Charter Holder s major federal programs for the year ended August 31, 2015. The Charter Holder s major federal programs are identified in the summary of auditor s results section of the accompanying schedule of findings and questioned costs. Management s Responsibility Management is responsible for compliance with the requirements of laws, regulations, contracts, and grants applicable to its federal programs. Auditor s Responsibility Our responsibility is to express an opinion on compliance for each of the Charter Holder s major federal programs based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and OMB Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations. Those standards and OMB Circular A-133 require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred. An audit includes examining, on a test basis, evidence about the Charter Holder s compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion on compliance for each major federal program. However, our audit does not provide a legal determination of the Charter Holder s compliance. Basis for Modified Opinion on Child Nutrition Cluster As described in the accompanying schedule of findings and questioned costs, the Charter Holder did not comply with requirements regarding Child Nutrition Cluster as described in finding number 2015-001 for Eligibility and for Reporting. Compliance with such requirements is necessary, in our opinion, for the Charter Holder to comply with the requirements applicable to that program. Modified Opinion on Child Nutrition Cluster In our opinion, except for the noncompliance described in the Basis for Modified Opinion paragraph, the Charter Holder complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on the Child Nutrition Cluster for the year ended August 31, 2015. 20