K12's (LRN) CEO Nate Davis on Q4 2014 Results - Earnings Call Transcript

Aug.14.14 | About: K12 Inc. (LRN)

K12, Inc. (NYSE:LRN)

Q4 2014 Results Earnings Conference Call

August 14, 2014 8:30 AM ET


Mike Kraft - Vice President, Investor Relations

Nate Davis - Chairman and CEO

Tim Murray - President and COO

James Rhyu - Chief Financial Officer


Corey Greendale - First Analysis

Jeff Meuler - Robert W. Baird

Jerry Herman - Stifel

Jeff Lee - Wells Fargo

Henry Chien - BMO Capital Markets


Greetings. And welcome to the K12 2014 Fourth Quarter and Full Year Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Oper1ator Instructions)

As a reminder, this conference is being recorded. It is now pleasure to introduce your host, Mike Kraft, Vice President of Investor Relations. Thank you, sir. You may begin.

Mike Kraft

Thank you, and good morning. Welcome to K12’s fiscal 2014 earnings conference call. Before we begin, I would like to remind you that in addition to historical information certain comments made during this conference call maybe considered forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, and should be considered in conjunction with cautionary statements contained in our earnings release and the company’s periodic filings with the SEC.

Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied by such statements.

In addition, this conference call contains time-sensitive information that reflects management’s best analysis only as of the day of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements.

For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC, including without limitation, cautionary statements made in K12’s 2014 annual report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.k12.com.

In addition to disclosing financial results in accordance with Generally Accepted Accounting Principles in the U.S., or GAAP, we will discuss certain information that is considered non-GAAP financial information.

A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included in our earnings release and is also posted on our website. Today’s call is open to the public and is being webcast. The call will be available for replay on our website for 30 days.

With me on today’s call is Nate Davis, Chief Executive Officer and Chairman; Tim Murray, President and Chief Operating Officer; and James Rhyu, Chief Financial Officer. Following our prepared remarks, we will answer any questions you may have.

I would like to now turn the call over to Nate. Nate?

Nate Davis

Good morning, everyone. Thanks for joining us on the call today. I am pleased to say that we ended fiscal year 2014 with solid results, also the quarter and full year. Our results met the guidance we have provided.

Revenue for the year was $919.6 million, increasing 8.4% year-over-year, our operating income excluding the charges recorded for the second quarter was $55.1 million, increasing 20.6% year-over-year and our capital expenditures were $73.5 million, slightly below the $75 million we invested the prior year. As I said last quarter, our financial performance this year is a direct result of the disciplined we have instilled in the assignment of resources.

Regarding operational performance, the entire organization is very committed to our core focus on academic outcomes. Our investment philosophy over the next couple years is to drive operational excellence in academics, with well-placed expenditures in three key areas, as well as key investments in product to serve the growing market of online programs and public school districts.

So the three areas are, first, we will invest in the effectiveness of our school workforce. We are expanding our training and professional and development programs for our teachers and we recently established a new program to better develop our local school leaders what we call hit the school. We will seek to provide more teachers and more teacher coaches as well.

Second, we will continue the development of new instructional coaches that increase student and parental engagement, an example would be more hybrid or part-time face-to-face learning environment for those students who needed the most.

And third, we will enhance our curriculum in our systems architecture, we have talked this before. This includes improving core systems with an eye toward mobility, more information for teachers, about individual student progress, greater accessibility for students with disabilities and updating our content as state standard and state assessment change.

This is a multiyear effort that will support growth initiatives and performance for managed public schools in the short run, as well as our international, private pay and institutional group’s overtime.

I have been asked multiple times for the vision of where this company is headed. I want to be clear that our number one mission will always be improving the academic outcomes for all students we serve and supporting the independent boards and their request to build great schools.

But I do see a transition in education to more hybrid model and more traditional school districts offering online summer courses, online supplemental programs and full-time district run online programs.

This is why our institutional business that we branded Fuel Education. It’s so important to us. This is the way we will participate in the growth of technology in classroom in the United States.

I'm encouraged by the number of programs we see come online for which we are a competitive provider. Before I hand the call off to Tim to review some operational highlights, I wanted to provide you a status on our managed public schools enrollment season, which began in early April and will go through early October of this year.

From an operational standpoint, we have effectively executed on our commitment to improve prophecies, streamline operations and provide new reporting and tools for the enrollment season. I believe the majority of the issues that we face last enrollment season have been addressed.

The new parent portal application process has been built and deployed. This portal was performing as expected and reduces the number of steps to enrollment. This provides families with better information and better control over the enrollment process. Families can upload compliance documents on their own, easily add multiple students to the family account, track their enrollment process and perform other functions.

In addition, the new K12-owned cloud-based telephony platform is now live. This improves our management of inbound calls. The new family support center in Knoxville, Tennessee opened on schedule in May.

We have hired, trained and onboarded 152 employees to date and trying to increase total employee capacity to approximately 330 by the end of the year as we prepare for next year’s enrollment season and we built and deployed a new suite of internal reports that provide greater end-to-end visibility from media acquisition, the student interest, the application all the way to enrollment.

Now at the same time, while it’s too early to predict with any certainty our total enrollments for the 2014/2015 school year. There have been a number of -- there have been a few developments which are creating some headwinds and challenges to enrollment growth, and I’d like to highlight some of those for you now.

First in Tennessee, the Education Commissioner reported that annual assessment course for the 2013/2014 school year at the Tennessee Virtual Academy, which we manage. In total scores were low.

At the same time, we concluded those students who persisted in the school for two or more years performed at a reasonable level, scoring at three out of five, which is significant improvement from previous years.

The Commissioner stated that the Tennessee Virtual Academy students have shown improvement in years two and three, and as the challenges rested primarily with first year students.

The net result was that the Commissioner asked Union County Public Schools, our partner not to take new enrollments after July 10th, because it was the new students who were bringing down school’s overall score and just you understand the potential impact in the first two years, last two years of the school, we had an average of approximately 3,000 students per year in enrollment in the Tennessee Virtual Academy.

When this cap our new student growth was enacted, K12 had to turn away approximately 2,000 students within the enrollment process who are already interested in attending the program this fall and potentially more as a season progressed.

The positive point here is that the Tennessee experienced again underscores, what we have said repeatedly about persistent, for those students who stayed with the K12 program, even for students who come into the program behind grade level, academic results improved each additional year there in the program.

Second, Colorado, in Colorado one of our partners took longer than expected to finalize the state authorized charter, renewal, and subsequently, the contract with K12 took longer.

While that renewal was eventually secured, the result was a delay in the beginning of the enrollment season for this fall, last year the school open enrollment in mid-June. This year enrollment began in late July and we believe the shorter enrollment timeframe will translate into lower Colorado enrollment for season compared to previous years.

And third, on a more micro level, well, I see the overall market adoption for online education growing, as families today have more choices in choosing full-time and part-time virtual programs for their child.

In the past, if you were family speaking of virtual education option for your son and daughter, the only choice you had was a full-time managed program like the ones K12 manages.

Today there are more public schools and districts that offer summer online courses, in-season electives online, supplementary skilled specific online programs and full-time programs run by the public school district itself. The number of online options is broader and we believe that the overall demand for virtual choice is increasing.

As I mentioned earlier, K12 through our institutional group, FuelEd, is participating in this market shift and we are seeing increase in the interest of our services we offer. However, in the short-term, these market dynamics create a challenge to enrolling school students in the public schools.

To bring that home for you in specifics, in the State of Pennsylvania, the overall growth rate for enrollment for online charter schools, according to the Pennsylvania Department of Education has slowed from 11.7% school year 2010/11 to 4.1% in ‘13/14.

In Ohio the growth rate in same period is slowed from 5.5% per year to 0.5% in 2014, according to the Ohio Department of Education and the National Education Policy Center.

And there are similar stats in Arizona, another state, where online schools have existing for sometime, but the growth in online programs is now slowed down. To give you balance point of view, Texas, Michigan and Georgia are relatively new markets compared to Ohio, Arizona and Pennsylvania.

The penetration in those markets is less for us, growth in Texas, Michigan and Georgia, online programs remain strong and at some point we do believe New Jersey, Illinois, Connecticut, Kentucky and New York will become state allowing online charter schools and will experience the same growth these other states experience.

In fact, legislation in North Carolina was enacted this past year allowing two online charters programs to be authorized and to convert to permanent programs in four years if successful. We certainly will attempt to be one of the educations management organizations for the charter board who received authorization.

All of the headwinds I just mentioned, are all on top of our school boards and K12 itself, pushing to keep business enrolled only if they're truly engaged and ready to learn. We help students in everyway we can, but if they are not engaged, we often to shift back into structure that traditional brick-and-mortar school and those withdrawals hurt enrollment as well.

Now with all these key factors, keep in mind, we just started in the busiest portion of enrollment season. Everyday we’re enrolling new students for the upcoming academic year and we will continue to do so through the end of September.

There will continue to be a lot of variability over the coming weeks, therefore we cannot take final enrollments and where they will land. In the meantime, we want to share with you these events and challenges we’re facing to help you understand the growth trend, risk taking for upcoming years.

Thanks very much and now let me hand it off to Tim. Tim?

Tim Murray

Thank you, Nate, and good morning, everyone. With a very busy quarter closing out the school year with students participating in year end state standardize exams before heading on to summer vacation. We move the number of initiatives forward and once again our education solutions and products won industry awards that acknowledge K12’s innovation and quality.

Operationally, student experience levels through the end of the year were consistent with expectations. System-wide performance exceeded 99% availability for learning management platform and for our peak solution for school districts.

We, of course, continued to build out K12 portfolio of courses. This quarter we release the number of new course options, including enhanced assessments for primary and middle school students and expansion of our use of gains as part of our mobile and desktop applications and customized curriculum to meet state specific requirements.

We are always proud to be recognized by our peers in this sector and once again, the K12 team garnered new accolades. K12’s embark online and universe applications on both the 2014 Parents' Choice and 2014 Mom's Choice Awards.

Turning now to our institutional business, we expanded the PEAK library to include more choices for schools and have the capability for schools to utilize additional third-party applications by K12 Education and the Khan Academy through the PEAK application.

The K12 platform now also allows teachers to upload their own content to create new courses or supplement information. We will continue to invest to expand the capabilities of this platform to provide schools for the choice of signal application for online course management, analytics and reporting.

K12’s technology team continues to excel, moving many projects forward this quarter. We enhance school analytics, improve the efficiency of school management solutions and address upgrades and improvements for the exciting learning management solutions, including the ability to publish new mobile compatible content for our middle school students.

In addition, we successfully migrates our software development and reporting hardware environment to increase performance, stability and future scalability needs. Going forward, we expect to be able to accelerator our software development capabilities through the use of new automated software building deploy capabilities developed by the team in this quarter.

I want to note here that we are especially excited to end this year with over 6,000 students graduating from K12 partner schools. This is a 50% increase over last year. Therefore we have to replace some 2,000 more students we did previous year. This K12 graduates are going on to schools and universities of all types, including names like Boston University, New York University, George Washington University, Texas A&M, Georgia Tech and the University of North Carolina just to name a few.

Graduates also going into the military for vocational training or directly into the workforce, we are very proud of each and everyone and excited about their accomplishments and wish them well in the next endeavor.

And finally, let me note that we lunched four new schools this quarter will be open for the school year starting in the fall. The Insight School of Oklahoma, the Insight School of California, one in Los Angeles and one in San Diego and the Hill House Passport Academy in Pittsburgh.

These schools will specifically support at risk students and those behind grade level for the comprehensive set of support programs in addition to academic courses, each school represent the best of what we do serve a student across the learning inspector and its specially gratifying to recognize K12’s very positive impact on students and families that need that extra support to achieve success. We’re excited about the challenges we have before us and we are keenly focus on our students and our schools.

Thanks very much. Let me now hand the call over to James.

James Rhyu

Thanks Tim and good morning everybody. As Nate already mentioned, we posted revenues of $919.6 million for the year and an operating income of $55.1 million, excluding the impact of $32 million of charges posted in the second quarter. The operating income is right in the middle of the range, we have been providing and revenues came in a bit above the range we last provided in Q3.

We achieved our financial goals this year while continuing to make investments in our business as Nate previously mentioned. Our primary investments this year have been to improve academic outcomes and that will continue into next year.

It’s worth noting that while we expand investments in our key academic initiatives, we will also able to more than double free cash flow to $50 million from $20 million we posted last year. We began the year indicating we want to be disciplined in our investment approach and I think we demonstrated our ability to do so.

Now let me take you through some details of our quarter and the full year. Revenue for the quarter was $232 million, an increase of 14% over the year-ago quarter. For the full year, revenue at $919.6 was 8.4% increase over the prior year.

The growth in the quarter was largely driven by 17% increase in our Managed Public Schools’ revenue. The combination of factors impacted revenue in the quarter including timing, revenue capture, and year end filing adjustments among other variables. We don’t see this revenue increase as a structural trend carrying into next year.

The full year revenue increase in our Managed Public Schools at 10% was in line with our expectations, keeping in mind that we told you that our phasing of revenue through the year was going to more evenly spread than in the prior year.

Institutional sales revenue decreased $0.5 million or 3.1% from the prior year, rose sequentially almost 23%. As we previously discussed, we see this business in transition heading into next year.

In addition, for this fiscal year, we recorded approximately $4 million in institutional sales that were related to divested businesses in June of this year. So the year-over-year comparison next year, we’ll need to consider the divested amounts.

Our international and private pay schools’ revenue was flat on a year-over-year basis. The year-over-year comparison was also impacted by the business that we expressed towards the end of the year. For the full year, the divested businesses contributed almost $13 million of revenue.

On a full year basis, the international and private pay business grew almost 10%. Gross margins increased from 36.4% last year to 38.8% due to higher revenue in the quarter and came in line plus or minus where we expected to be for the year.

Selling, administrative and other expenses increased 13% to $74.8 million on a year-over-year basis. As we’ve previously indicated, we ramped up some of our promotional activities earlier in the season as compared to last year.

Product development expenses for the quarter were $2.3 million compared to $6.3 million in the prior year. This is consistent with the trend we’ve been seeing throughout the year. Operating income was $12.8 million for the quarter versus $1.4 million last year.

Now, let’s turn to some other items. We ended the quarter with cash and cash equivalents of $196.1 million, which represents increase of $14.6 million from the prior year. Net cash provided by operating activities was $123.5 million, which is an increase of $28 million from the year ago period, largely as a result of improvements in network and capital, somewhat offset by the lower starting operating income -- sorry, lower starting net income.

Accounts receivable rose 4.4% to $194.7 million largely in line with the enrollment group for the year. Our DSO was also marginally better this quarter compared to last year.

The company continued to repurchase shares in the quarter investing $21.9 million to purchase 953,000 shares of common stock. We had $26.5 million remaining available under authorization as of June 30th.

CapEx, as we’ve been historically defined it, which includes curriculum and software development, computers and infrastructure was $18.3 million for the quarter or basically flat on a year-over-year basis. On a full year basis, CapEx came in at $73.5 million, which on the same basis is marginally lower than either fiscal year 2013 or fiscal year 2012, which were in the $75 million to $76 million range.

We indicated earlier in the year we would be between $75 million and $85 million in CapEx but that we would also be disciplined in our spend. We are going to continue to keep investing in key areas whether that’s for platform or content, consistent with what we’ve been seeing all year.

Our tax rate for the quarter and for the year came in better than we previously indicated at approximately 38%. We drove some better discipline in our tax planning compliance which has helped our effective tax rate for the year.

As previously announced, we closed the sale of the select businesses during the first half of June. Those businesses had revenues of $16.9 million for this fiscal year of a close to breakeven on an operating income basis.

We also recorded the gain on sales of $6.4 million or about $0.11 per share. I’ve already provided you the split between our institutional sales and international and private pay businesses. So please be mindful of that as we discuss our results for those businesses next year.

With that, I’ll hand the call over back to Nate.

Nate Davis

Thank you, James. Before we move to Q&A, I want to remind everyone that we are in the midst of the enrollment season and therefore we’re unable to address questions regarding fiscal year 2014 enrollment and revenue guidance.

I know everyone is keenly interested in our progress but I ask you to refrain from asking questions that attempt to give us specific revenue or specific enrollment guidance that we’ll be giving in October.

And now, let’s move to Q&A. Operator, who’s our first question from?

Question-and-Answer Session


Thank you. (Operator Instructions) Thank you. Our first question comes from the line of Corey Greendale with First Analysis. Please proceed with your question.

Corey Greendale - First Analysis

Hi. Good morning.

Nate Davis

Good morning Corey.

Corey Greendale - First Analysis

Nate, so I will honor your request, but I do have a couple of more specific questions. Can you give us -- is there any update on the Agora and either the timing or in feedback you’ve heard on that?

Nate Davis

They had one board meeting. The board did have one board meeting where they made some decisions and indicated a clear interest to be self-managed organization beyond that we don’t really know because we are not going to hear until the next board meeting which is August 25th, I believe. After that board meeting, I’m sure we’ll hear more. So there really isn’t much update to on other than the next board meeting is August 25th and we’ll learn more there.

Corey Greendale - First Analysis

Okay. Did you expect that there will be some decision in that press release of the event?

Nate Davis

As of August 25th, are you asking about that date?

Corey Greendale - First Analysis


Nate Davis

I think they will make a decision. I don’t think they will issue a press release. We probably won’t until they talk to us and explain the decisions they make. Of course, we’ll be at the meeting. We’ll be talking to them but there will be conversations right after that. So I think you should not expect on August 25th, August 26th, there’ll be a press release but you should expect in the coming weeks as soon as we understand whatever decisions they make, we will then issue press release.

Corey Greendale - First Analysis

Okay. And then you were nice enough to give us some sense of the impact of Tennessee. Could you help us, kind of, get our heads around the potential Colorado impact by just what the number was last year?

Nate Davis

Well, we don’t give by school enrollment numbers. I gave you Tennessee because it’s actually in the public domain. I would tell you that Colorado, I think is, not in the same side as Tennessee, it’s smaller than that impact. But other than that, I try not to give state-by-state enrollment projections for obvious reasons.

Corey Greendale - First Analysis

Okay. And Tim somewhat gave part of this but could you help just -- I understand, you are trying to set reasonable expectations. Just tick up a few of the offset like what are some of the positives that could help drive growth offsetting some of things you pointed out?

Nate Davis

I will take a little bit of that. Tim, you do some as well. We talked about the operational improvements that we put in place. And I think those operational improvements are allowing us to get greater conversion from leads into ERs. Easy to prepare us to get -- to get into the parent portal, to get the documents uploaded to get -- to become a completed application.

We are also seeing because we put more money into the promotional activities earlier in the year. We saw greater lead volumes earlier in the year. However, I want to jump over that by saying I think big issue today I gave you is trends. A big states like Ohio and Pennsylvania, where we traditionally got a lot of growth, those states are slowing down. So we have them offset wholly but less conversion is taken by Pennsylvania and Ohio. So they are offsetting each other. Do you want to add anything, Tim?

Tim Murray

Yeah, I’m just saying we’re a couple of weeks earlier this year having established as we were last year. So we still have more of the enrollment season in front of us. So all of the operational improvements that Nate just alluded to, we’ve got good six weeks ahead to see the impact of those.

The other thing I would add is in terms of the new schools that I noted that were open this coming season, each of those will get started in a small way but they are targeting 100 to 200 students per school range till house passed the academy and the Insight School of Oklahoma et cetera. So we do expect some positive benefit there and more in the future.

Corey Greendale - First Analysis

Okay. That helps. And then James, you characterized the marketing spend has been pulled forward. Does that suggest that we would expect a lesser growth in Q1 because that was pulled forward into 2Q ‘14 or is it more likely to be up at a similar rate year-over-year in Q1 as it was in the Q4?

James Rhyu

Yeah. Corey, I apologize, I said pull forward -- actually I didn’t think I said pull forward. I think we started a little bit earlier this year in this season. We are monitoring our promotional spend very closely. I’m not going to give guidance on what we’re going to end the year with but we’re going to continue to invest in promotional activities throughout the course of this season that’s going to end in early October.

Corey Greendale - First Analysis

Okay. You’re correct. I interpreted the earlier start as pull forward but thanks for the clarification. And then just one more on the cost side, the things that you talked about providing more teachers, more hybrid learning environment, that all sounds all like a growth in market opportunity and improves outcome. It also continues to be margin profile. So could you just comment on kind of the impact on the cost side from those things?

Nate Davis

I do believe that it will increase cost in the coming fiscal year. It’s right investment we think to make. It’s primarily focused on student outcome more than it is market opportunity. It’s really the student outcomes we’re focused on. So yeah, I think that teachers cost money and to the extent that we add teachers, we will incur some of that cost.

The Board’s and their own funding sources from the state, we will incur some of that. So it’s not like 100% of that hits our P&L. Some will actually come out of their surpluses or come out of funding sources they will get from the state. But certainly, it will change our cost structure a bit and we’ll have a little hard cost on the structure side.

Tim Murray

Just a little more context. I think we discussed just a couple of quarters ago, we indicated that we probably would have some gross margin traction. During the course of this year, we experienced about 80 basis points traction during the course of this year relative to last year. As Nate indicated, we’re going to continue to invest.

So I think you’d expect some continued contraction and we’ll give you a little more color as we get into next year and give them cost and guidance for the year. But I think that we are going to continue to invest. So from that -- just from that pure metric yield, we’ll expect a little bit more contraction, I think.

Nate Davis

So, James giving you the numbers, let me give you the one quick statement about why? We believe it’s really important to make sure that we give every effort to making sure that students have right teacher support and getting the right academic support, because that keeps school open, that keeps boards happy and that’s what keeps us in business. So this is the critical investment we have to make.

Corey Greendale - First Analysis

That is all I have. Thank you.

Nate Davis

Okay. There is number of question from Corey.Operator, who is next?


Our next question comes from Jeff Meuler with Robert W. Baird. Please proceed with your question.

Jeff Meuler - Robert W. Baird

Hey, good morning. Let me ask you about your choice of words. Nate, you’re using the phrase growth trends directionally. Are you trying to indicate that you would still expect this for next year to be an enrollment growth year?

Nate Davis

Over a multiple years, I would say, yes, we expect them to grow. The volume of growth is something that is very difficult for us to project. As, we go through the season, we’re learning more. We learned that in the bigger, older, more higher penetrated states, we’re going to get less growth. In the newer states, we get more growth. The offset for those I really can’t -- I really can’t tell you at this point but -- do I expect some positive growth? I do expect it, but I just can’t say how much?

Jeff Meuler - Robert W. Baird

Okay. That’s helpful. And then could you just maybe talk about how the competitive landscape trends to evolve over the first 10 years that after states open up to online schools? And I’m asking from the standpoint like is it more that you and your large four profit competitor tend to kind of be the main players in the states for the first five years. And then once there is certain level of market demand, you’re trying to see the state -- the hosted offerings coming into the market?

So just trying to, kind of figure out if you are largely funding the investment for the first however, many years and then once there’s critical maths in the market, that’s when you see the states-sponsored entities come into the market?

Nate Davis

This has changed overtime. So the answer to your question is today yes. What generally happen is that we and we have a largest competitor, tend to be the first to in. And we tend to spend the most be on the process of getting approvals and getting authorization in getting the state to adapt the law. Nationalized and Charter schools also helps. So there is number of parties that participate in that process.

But once the first set of application come along in this current environment, we tend to be two large players that come in at first. However, in previous year, in the early years of this industry, there were other players who were significant player, especially when you look at Ohio and Pennsylvania, they had schools that were sponsored by other parties. Some of those parties have gotten themselves in some trouble legally and have gone away, others are still there

So if you look at the large schools at Ohio and large schools at Pennsylvania, it’s not just us and Pearson, it’s -- there are other couple of large players. We think going forward there will be even more competition for the big school in big states. We think we will always be the leader, but there’s no doubt about it. More people have looked at this market and said this is attractive market and I want to be in it.

Jeff Meuler - Robert W. Baird

Okay. And then just finally, on the -- how they think about kind of the expense year end and kudos to you for coming into your guidance? I’ll call myself out that I was skeptical entering the year. So kudos on hitting the EBIT guidance. How should I think about the kind of expense management?

And I’m asking that from the standpoint that during the call I think that you referenced being more disciplined around how you think about what investment you should fund and things along those lines? But my recollection was that in the past, James, that you’ve also caution that in the year ago period that you’re comping against, you had some investments in anticipation of a big enrollment year. So just trying to think about how expenses will trend going forward? How we should maybe think about incremental margins?

James Rhyu

Yeah. So Jeff, thanks for the call. I do remember your skepticism earlier in the year. And I think that as we think about the business, Nate, Tim and I are really focused on academic outcomes primarily. So when we think about investments, whether CapEx, whether using the instructional cost, we mentioned earlier, whether -- even when we think about our promotional activities.

We are considering investment that will improve academic outcomes. And so, I mentioned that there’s probably a little bit of contraction in the gross margins side, because of some of educational investments that we’re going to make, that Nate referenced.

I think that if you look at trajectory of the product expenses, we have tightened up on those from an OpEx perspective. However, we are going to continue investing in product and curriculum. And so if you just look year-over-year this year and the last year, the P&L got, I think some benefit from it but you should expect some continued investment in curriculum and product.

Similarly on things like software investments and things like that of our platform investments and Nate, mentioned in his remarks, investments in the peak platform for institutional side of the business, those will continue. And I can't give you -- some of that there is a mix of CapEx versus OpEx in that year. I’m not going to give you exact guidance. But in the long term, we do think that there is margin growth in this business over the long term. It might be a little bit choppy over the shorter term.

Jeff Meuler - Robert W. Baird

Okay. Thanks, guys.

Mike Kraft

Operator, next question.


Our next question comes from the line of Jerry Herman with Stifel. Please proceed with your question.

Jerry Herman - Stifel

Thanks. Good morning, everybody. Nate, I wanted to start with sort of a high level question. You are helpful in terms of explaining some of the changes in transitions and shifts in the business. There has been couple of examples where your partner have talked about taking some of the services that you provided house, i.e. Kansas City, Pennsylvania. Do you see that as a developing trend in someway? And if so, how do you think it sort of impacts the business model over time.

Nate Davis

Very interesting, I think some positive and some negatives from that. I don’t know if I can say it’s a trend but I will just give you some facts. Over May of 2006, I believe in PAVCS decided that they will going to be self managed and go in-house. At the same time, we established another school that we’re working with called Agora. And Agora is from dramatically in PAVCS which has been a good school staying at the same size.

Since that time, yes, Colorado and we’ve disclosed Colorado and Hawaii have done a same thing. But we’ve got other schools in Colorado. So I think you will see that we continue to pursue second, third schools in the state, both for academic risk and for other reasons including CTE. So when you look at that, there is some balance.

In terms of the business model and how it changes the business model, remember that there’s a lot of expense associated with managing a school. So if the board decides to take that work on themselves, that expense comes out of our P&L. We were the curriculum provider for PAVCS. We hope to be the curriculum provider for Colorado and we hope to be the curriculum provider for anybody who decides to go self managed.

The strength of our program is in our curriculum and we think that’s the one of the great assets we have. So I think there will be some change where cost come out of the P&L, revenue comes out P&L but we still continue, but I would consider it a very good margin curriculum business, and I think it changes.

Jerry Herman - Stifel

Great. Thanks. And I guess, one for James and well for all of you for that matter. Your cash balance is obviously very healthy. You have -- you’ve taken action to buys some shares. Again, given sort of the some of the transitions in the market, how do you look at the portfolio right now? And what role might acquisition in M&A take in terms of business positioning and news of cash going forward?

James Rhyu

We’ve been asked that question many times. If you look at the cash we have, why don’t you give dividend to shareholders, why don’t you use the buy back more shares. We did it to the tune of an authorization program of $75 million, but we didn’t do bigger with higher numbers because the board believes and I believe that this is a growth market and an opportunity.

So we do look that as we got the core business more, better managed. We do look at opportunities to do acquisition. We looked at a couple in the last six months, one that actually came about but we’re looking at more out in the marketplace. As you know the multiples are very high in many of the business that are in the marketplace. So we try to be very smart about it. Some people have been frustrated because we’re sitting on the money, but its not that we’re not looking at opportunities.

It simple, we are trying to make sure that we make the right investment. I think you will see more acquisitive activity going forward not in the core business but in those adjacent businesses and especially in maybe the institutional area that give us an opportunity to keep growing and participating in that market growth.

Jerry Herman - Stifel

Great. Thanks very much guys. I’ll turn it over.

Nate Davis



Our next question comes from the line of Jeff Lee with Wells Fargo. Please proceed with your question.

Jeff Lee - Wells Fargo

Thank you. Good morning. I just want to get a little more background of Agora. I think if you can give us some color on parent and teacher satisfaction scores of Agora policies and national average and then also maybe some color on state test cores of Agora and what sort of either improvement or decline we’ve shown recently?

Nate Davis

Well, let me comment on state test scores and then Tim can comment on satisfaction score. On state test scores, they’re not yet been released for this year, so I don’t know where they stand at this point in time. This data is a little slow in getting its data out. I don’t think it is slower than their normal average but slower than some others.

So I don’t really know where it stands. We don’t expect the dramatic improvement of our decline. We expect Agora to get slightly better and that sort of our expectation but I haven’t seen that yet.

Tim Murray

Jeff, we cannot refer you back to the K-12 annual academic report that was published earlier in this year, where you could see the historical Agora results against all your schools that we supported well. In terms of parent satisfaction results, we don’t typically disclose how they compare between school and other. But as Nate said, we see trends there that are consist with past years. In Agora, we’re just out collecting and processing those results across all of our school. So it’s a little early to draw any firm conclusions to that.

Nate Davis

Okay. You asked also about teacher satisfaction. I remind you that teachers work for Agora they don’t work for K12 and Agora did go through a significant discussion about unionization, they’ve multiple times, multiple years and so the Board has been working with us to make sure that we satisfy teachers as best we can, because we don’t think that unions can do better job than us.

So, there are some concerns among the set of teachers. There is also some very strong support for teachers who don’t believe the union should be in between them and their Board. So there is some, I would say, mix results on teacher satisfaction at the Agora school.

Jeff Lee - Wells Fargo

Okay. And one more from me, I know may disclosed about Agora revenue in your 10-K? I was wondering if you give us some color on EBITDA contribution from Agora?

Nate Davis

Well, we don’t report on a segment or school basis, as you know, so we can't. But I can -- it's pretty obvious to everybody that Agora has a higher reimbursement rate because the State of Pennsylvania does. So I think it’s a good margin business and I don’t think we can disclose any more than that.

James Rhyu

You also have to remember that most of our cost or many of cost except for those direct costs like teachers are structural cost across our network. So same is like our platform and things like that are not school specific often. Sometimes we do school specific things and we make school specific adjustments, but a lot of our curriculum is network as across our network, et cetera. So you don’t really get to kind of a contribution margin type of line for any school. You never get to an EBITDA anyway.

Nate Davis

And remember in Pennsylvania, I’ll go back to one other thing, it’s very, very important to remember and that is, the teachers are on the payroll of the school. So if the cost associated with that is sort of a direct cost that the school incurs on teachers. So, while there is a high reimbursement rate, there is also like teacher cost that the school really deals with.

Jeff Lee - Wells Fargo

Okay. Thank you.

Mike Kraft



Our next question comes from the line of Jeff Silber with BMO Capital Markets. Please proceed with your question.

Henry Chien - BMO Capital Markets

Hi. Good morning. It’s Henry Chien calling in for Jeff. I wanted to ask a little bit about the increases in revenue per student. I know you mentioned some of that was due to shift in the calendar, is there anything else driving that in the quarter?

James Rhyu

Yeah. Hey, Henry. It’s James. There is always every quarter there is a number of puts and takes. We kind of the year-over-year comp is a little bit just sort of that we mentioned earlier in the year that just kind of the way that the timing of the revenue is going to come in this year would be a little bit different. So, some of the quarterly year-over-year comp is driven just by that.

Based in term, of course, of the year, this year that’s different than year, we have everything from captures, I mentioned, which you’re continuing try to improve. There is some timing issues, we do get some adjustments in some quarters either from state audits or things like that.

So lots of puts and takes, we are not going to go into detail, but as I said, the quarterly year-over-year trend -- the quarterly year-over-year results not really going to be attract going-forward.

Nate Davis

The year-over-year total, this is Nate speaking, Henry. The year-over-year total revenue per student is affected by some rate increases. They were these two states last year that had rate increases. And I think I’ve mentioned in previous calls that as the economy gets better, the educational community fights for each portion of the state budget. We want a good portion of the money, the tax money that get collected to go back into education in local schools.

We are a public school and so for that reason we end up with some positive rate variances in good economic times. I don’t think that’s going to be 5% to 10%, its going to be in the very low single digits, but we did get some of that benefit this year.

Henry Chien - BMO Capital Markets

Got it. In terms of the low single-digit, just if you just clarify, is that trending upward or it’s just sort of flat just in terms of the year-over-year for ’15. I know you’re not giving guidance which is …

Tim Murray

Yeah. I think we want to be careful. What Nate’s referencing is the funding environmental overall…

Henry Chien - BMO Capital Markets


Tim Murray

… looks to be trending favorably. How that translates to K12 revenue, even always direct one for one. It depends on our student mix which again, we are very early in the enrollment season. So funding rates can vary pretty widely. Our capture rates vary widely. The way that enroll -- that we capture revenue through enrollments in every state is different. We have single count days, double count days, et cetera.

So we get through our enrollment season and we know the mix of state and how we are going to count them et cetera. Our revenue picture growth across rate specifically we won’t now on talk to but general funding environment you see overall is improving.

Nate Davis

And I know, let say, this funding environment, I don’t see a change in it from year-to-year. I think it will be positive, but I don’t think it’s going to be more positive in FY ’15 than it was in FY ’14. So I’m not sure, Henry, exactly your question. If you’re asking do I see even more rate increases coming on a funding level, then I saw last, no. I think we’ll see some, but I don’t think it will be any bigger than we’ve got last year.

Henry Chien - BMO Capital Markets

Got it. Yeah. That’s very helpful. Thank you.

Mike Kraft

So, Operator, I think that was a last question on the board. So we don’t have any more questions. Nate, I don’t know if you want to say some closing remarks.

Nate Davis

I don’t have any closing remarks. I appreciate everybody’s time this morning and thank you for signing on.


Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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