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K12 (NYSE:LRN)

Q1 2013 Earnings Call

November 09, 2012 8:00 am ET

Executives

Christi Parker - Vice President of Investor Relations

Ronald J. Packard - Founder, Chief Executive Officer and Director

Harry T. Hawks - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Timothy L. Murray - President and Chief Operating Officer

Analysts

Thomas Allen - Morgan Stanley, Research Division

Sara Gubins - BofA Merrill Lynch, Research Division

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Kelly A. Flynn - Crédit Suisse AG, Research Division

Jeffrey M. Silber - BMO Capital Markets U.S.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

Joseph D. Janssen - Barrington Research Associates, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2013 K12 Inc. Earnings Conference Call. My name is Grant, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Ms. Christi Parker, Vice President of Investor Relations. Please proceed.

Christi Parker

Thank you, and good morning. And welcome to K12 First Quarter Fiscal 2013 Earnings Conference Call.

Before we begin, the company would like to remind you that statements made during this conference call that are not historical facts may be considered forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the date of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements. For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to our filings with the SEC. These filings can be found on the Investor Relations section of our website at www.k12.com.

In addition to disclosing 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.

This call is open to the public and is being webcast. The call will be available for replay on our website for 60 days.

With me on today's call is Ron Packard, Founder and Chief Executive Officer; Harry Hawks, Chief Financial Officer; and Tim Murray, President and Chief Operating Officer. Following our prepared remarks, we will answer any questions you may have.

I would now like turn the call over to Ron.

Ronald J. Packard

Good morning. And welcome to K12's first year -- fiscal year 2013 earnings call. Our financial performance this quarter was in line with our expectations, with revenue of $221.1 million, an increase of $27.8 million over the first quarter of last year, driven primarily by solid growth in our core virtual Managed Public Schools business. This quarterly performance has increased our comfort with meeting our previously announced annual guidance.

I would like to start off this morning by again welcoming students and teachers in all 33 of our states, including the new schools we're very excited to have opened this year in Florida, Iowa, New Mexico and New Jersey. We are working hard and making substantial investments to recruit and train the workforce of the 21st century teachers and develop the products, processes and operational infrastructure to meet the needs of a growing and increasingly diverse student base. This year, we hired and trained over 750 new full- and part-time certified teachers, having received approximately 30 applications for every teaching job. With a total of over 4,500 full- and part-time teachers delivering K12 curriculum, we believe we have the finest group of teachers in the country, and we can't thank them enough for their significant contributions as K12 continues to lead the technology-driven transformation of education to individualized learning.

I would also like to welcome an important addition to our Board of Directors. The former Governor of Michigan, John Engler, joined us on October 22, and we are very excited about his involvement in the board and his business leadership experience, Mr. Engler brings to our company.

Now I would like to make some brief comments on the elections. First, I would like to congratulate President Obama in his reelection. Secretary Duncan has done a fantastic job over the past 4 years, advancing things like common core, school choice, innovation education, and we look forward to additional progress over the next 4 years. He has always been an innovator since he first became CEO of Chicago Schools and helped create, in partnership with K12, one of the nation's first hybrid schools. That school, which is managed by K12, was recently named one of Chicago's Best High Schools by Chicago Magazine. We are also quite excited by several other election results. It was especially encouraging to see that the voters of Georgia overwhelmingly supported an amendment to allow charter schools in the state. This is a significant milestone for educational liberty. There were several other initial positive developments, Tuesday, that we believe should help advance K12's mission of providing expanded learning options for students.

During the first quarter this year, enrollment in our Managed Public Schools grew by more than 14% over last year, with average student enrollments for the quarter of approximately 122,000 students, 15,000 students more than last year's first quarter. The largest source of new students continues to be referrals from other students and their parents, which is the best indication we are delivering value for students. High parent and student satisfaction drives recommendations and is one of the most important measures of success internally, and we are proud to serve an increasing number of children across our business lines.

For the 2013 school year, we released 41 new courses and 59 customized courses for various states. Our curriculum now includes 155 full-year K through 8 courses and 540 high school courses. We continue to innovate and to focus on learning efficiencies, academic outcomes and remediation so we can better serve the increasing number of students who come to K12 behind grade level, as well as the districts with whom we partner with to offer remediation, advanced courses and curriculum that would otherwise not be available to their student populations.

K12 continues to push forward with innovation and technology-based education. With the acquisition of Insight Schools previously, K12 began to manage specialized schools for at-risk students, and we're working diligently to open more of these at-risk schools. These specialized schools will allow us to customize the entire offering, including curriculum, systems, teachers and social services, for these children so that we can deliver even more value to them. These specialized schools may also increase our growth rate as millions of students are at risk in seeking a quality educational solution.

Our mission remains to deliver an outstanding individualized education program for each of the more than 100,000 full-time students, enabling them to pursue their dreams and become whatever they would like to be in life. Without our highly skilled teachers and staff, this simply would not be possible.

Turning now to the outlook for fiscal year 2013. This quarter puts us on path to achieve the annual guidance we announced back on our call in mid-October. We anticipate that revenues will be between $840 million and $870 million, and EBITDA will be between $107 million and $115 million. For the second quarter of fiscal year 2013, we anticipate that revenues will be between $205 million and $215 million and EBITDA will be between $30 million and $33 million. EBITDA for the second quarter will be significantly be higher than the first quarter because of the normal seasonality of our business that results from the second quarter having 3 full months of school in all of our states, as well as significantly lower recruiting enrollment expenses than in the first quarter. It is important to point out that last year we did not see the normal seasonal increase in the second quarter, because of unanticipated funding issues that happened in the second quarter of last year. For example, without those unprecedented reductions of $8 million, EBITDA last year would have grown from $21.2 million to $29.2 million. If our EBITDA this year would have grown by $8 million, it would take us to $32 million for the second quarter this year, which is in the range of our guidance.

Now I will turn the call over to our CFO, Harry Hawks.

Harry T. Hawks

Thank you, Ron. Good morning to everyone participating in our call and webcast, and a special K12 shout-out to our Mid-Atlantic and Northeast friends still coping with the effects of last week's Hurricane Sandy and this week's nor'easter.

This morning, we're reporting first quarter results that are in line with our plans for fiscal 2013, revenue of $221.1 million, an increase of $27.8 million or 14.4%; EBITDA of $24.3 million, an increase of $3 million or 14.1%; operating income of $8.7 million, a $400,000 increase; net income of $4.4 million, a $200,000 decrease.

In addition, this morning, we are providing our second quarter outlook for revenue of $205 million to $215 million and for EBITDA of $30 million to $33 million. Both metrics are in line with consensus estimates for each post of the first call as of last night.

Based upon our reported results for Q1 and our outlook for Q2, we're also reaffirming our full-year guidance for fiscal 2013 previously given on October 17, reaffirmed by Ron just a few minutes ago and provided again in this morning's press release. In anticipation of some of your questions, let me address a few topics that frequently come up in our ongoing dialogue with many of you.

First, the slower growth rate in Managed Public School enrollment this quarter and this year. As we mentioned in our guidance call on October 17, enrollment growth in 2012 benefited from the effects of our acquisitions, a greater number of enrollments from new states and a larger contribution from increased caps. Once again, as we previously stated, if we isolate and then compare same school organic growth, we added 10,500 students this year versus 9,500 last year, growth rates of 14% and 15%, respectively. As we look forward, we're focused on quality of enrollment growth, where we have significantly fewer unfunded students.

Second, the negative comparative revenue performance in Institutional business. This innovative business has several different kinds of business relationships with school districts and institution. One aspect of those different kinds of business relationships is a perpetual license transaction, which we sometimes do. Perpetual license transactions occur in a very uneven pattern throughout the year, and that is distorting the period-over-period comparison this quarter. Normalizing, we would actually see 6% growth rather than 6% decline. We have great confidence in growth in that business segment -- that line of business this year.

Next, the seasonal buildup in accounts receivable. As is our normal seasonal pattern, our accounts receivable substantially increased this quarter. The increase of $98 million this quarter as compared to our June 30 year end is in line with our expectations although DSOs have -- or excuse me, days sales outstanding, or aging in other words, have increased slightly by a few days due to mix. A year ago, the accounts receivable increase in Q1 was $118 million, given effect of the acquisition of the Kaplan Insight Schools. As is also our normal seasonal pattern, this investment in growth-related working capital impacts the GAAP cash from operations as reported in our statement of cash flows.

Next, the seasonal drawdown on cash. Consistent with the foregoing comment about investment in working capital, we also routinely draw down on cash in Q1 to fund that investment and growth working capital. For example, the $37 million drawdown this quarter compares to about a $60 million drawdown in the comparative period last year, once again, last year impacted by the Kaplan transaction. With a cash balance of about $108 million, our liquidity remains excellent.

Next, the impact of depreciation and amortization on operating income growth in relation to EBITDA growth. From fiscal 2010 to fiscal 2012, depreciation and amortization more than doubled from around $26 million to about $58 million, largely as a result of purchase -- or acquisition-related purchase accounting. Our guidance for the year of $60 million to $65 million compares to $58 million last year, the trend clearly slowing down. However, the increase in Q1 of about $2.7 million is a higher variance than we expect in subsequent quarters. Furthermore, our stated goal of slowing the rate of growth of capital expenditures will also contribute to a slowing growth in depreciation and amortization as we go forward.

Next, the decrease in product development expenses in the quarter. As a reminder, at K12, this expense line is actually comprised of 2 very important functions, product, or in other words, curriculum development and software development, both staffed and led by very talented people here at K12. The $2 million decrease is a function of 2 things: capitalization rate, which is influenced by project-specific factors; and a decrease in system implementation expenses year-over-year. Total cash spend is actually up year-over-year, reflecting continued investment in strategically important assets.

Next, the tax provision is higher than statutory rates and higher than our annual guidance. Yes, that is correct this period. However, we have reaffirmed our annual guidance for tax provision. So it can be expected that some quarters throughout the rest of the year will be less than the full provision. If indeed Q1 had a tax provision at our annual expected rate, EPS would have been approximately $0.02 higher at about $0.13 per share.

Certainly, I've not preempted all of your questions. So now will be a good time for Ron, Tim and me to respond to your questions and comments. Operator, please open the call for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Suzi Stein.

Thomas Allen - Morgan Stanley, Research Division

It's Thomas Allen filling in for Suzi. Can you give us an update on your thoughts around the Web acquisition?

Ronald J. Packard

Sure, I'd be happy to. We're still -- we are actually extended to December 31, and we're currently still in due diligence on that. So we're ready to comment on whether we'll move forward. Just to remind you, we have several options. We can increase our interest up to 51% or we potentially could put it back to them at an 8% return to us. And we're evaluating that. We'll say that the Web continues to grow and perform well in this period.

Thomas Allen - Morgan Stanley, Research Division

Great. And then it's been about a year since Pearson bought Connections. Now there's been a little bit of time, can you give us an update on how they're offering and if they're doing anything differently than they were doing before?

Ronald J. Packard

Sure. We don't notice that much -- that many things different in the Virtual Academy business. I mean, they are now put into Pearson. So we don't see what they do so much, but we haven't seen significant changes in what they do in that business. I think they're potentially doing more sales to school districts, but we don't see a lot of changes other than we know they opened up 5 kind of hybrid schools this fall.

Thomas Allen - Morgan Stanley, Research Division

Again, if I may have one last one in, just on unfunded students and thinking about the comp a little more, it seems to me that there's a cut-off date that after that date you don't get funding for new students anymore. It would mean that the drag builds up over the course of the last year. So kind of back half comps will be easier. Is that the right way to think about it? Or is the window of funded versus nonfunded relatively small so that impact all begins in 1Q and is relatively even for the year?

Harry T. Hawks

It's different by state. It depends upon whether there's a single count date or multiple count dates. This year versus last year, a couple of our schools and states have actually gone to a multiple count date. So I think if I'm answering your question correctly, in terms of comps, we would expect the unfunded number later this year to be, if you will, better, meaning less, the second half for the year than the first than last year. If I understood...

Thomas Allen - Morgan Stanley, Research Division

So the impact of the -- of having more unfunded students was more -- was felt more in the second half of last year than the first half, right?

Harry T. Hawks

It does indeed occur throughout the year. But yes, this year, we'll do better in the back half of the year than we did last year on that specific question.

Operator

Our next question comes from the line of Sara Gubins.

Sara Gubins - BofA Merrill Lynch, Research Division

First question, the revenue per student in the managed segment was up nicely this quarter. Could you talk about what was driving that?

Harry T. Hawks

Certainly. I think the previous question is probably the appropriate introductory comment there, and that being the -- we have, if you will, an improvement in the -- what we call the capture -- revenue capture, in other words, less unfunded students. And then once you go past that into some of the other nuances, it just becomes mix by state and things such as that. Also, within that business segment, we have an expanding business in our Flex school and hybrid school areas. And so there is areas indeed -- some revenue mix going on. But as we commented on the October 17 call, there are a number of factors such as that, that allow us to have revenue growth greater than the enrollment growth this year, which is different than last year.

Sara Gubins - BofA Merrill Lynch, Research Division

Okay. Second question, could you provide an update on your margin initiatives and how they're progressing so far?

Timothy L. Murray

Sara, it's Tim. Let me comment on that. As we think about operating leverage, our approach is two-pronged: what can we do now, and what can we do to focus on those areas of the business where we have high transaction volumes, where we can see an opportunity to reduce unit costs. So a unit cost approach. On the what can we do now, the most obvious place for us to focus is on procurement and purchasing. If we look back at 2012, we spent over $300 million in procurement and by the way did that in lots of small increments, some 27,000-plus purchases. And so what have we done there? The first step was to look at our many to one relationships with some of those vendors and consolidate them so that we can leverage our purchasing power and bring rates down. Second is just brute force price negotiation with our vendors. Third, we've been enforcing SLAs, quite frankly. We seem to be bringing some of our vendors along into performance levels in a 7 by 24 operation and they haven't been performing. And so where they haven't, we've looked for some relief and have achieved that. And then last, of course, is we've talked on previous calls about our implementation of an ERP system. We have implemented much of the process reengineering but not all in the so-called procured and pay business process, and we're seeing some benefits there. In the areas of unit cost, there are 4 areas that we're focused on. We're looking at all aspects of the value chain from cost per enrollment perspective. Secondly, as we've previously said, we added over 1,000 employees last year. And so we're looking at all of the costs associated with employee-related transactions using Oracle, HRIS, et cetera, to reduce the unit cost there. Third, we're looking at the materials and logistics part of our business. And I think many of you probably know, we shipped over 6 million items in this past couple of months. We shipped over 80 tons of materials to our students, over 400,000 deliveries. And so there is lots of opportunity over the longer term through supply chain automation and other ways of looking at that business process to be able to achieve efficiencies. And then the fourth area that where we, again, have very high volume and so see an opportunity to reduce unit costs is in our call centers, where we're currently processing over half a million calls per year. So we're looking at process technology, training of the team, et cetera, to reduce unit costs. So in sum, what we can do today is focus on procurement purchasing. What we see unfolding over future quarters, as volume increases and our initiatives take hold, is a unit cost base approach to reducing cost in those processes I just mentioned.

Sara Gubins - BofA Merrill Lynch, Research Division

And then last question, Ron, any comments on the new state pipeline, particularly now after the elections. You sounded relatively optimistic. I'm wondering if anything is looking more likely over the next 6 to 12 months.

Ronald J. Packard

Well, yes, as you know, I tried -- tend not to talk about prospective states but I will say just the following of the results of the elections in several of the states were very favorable for K12 with regard to potentially opening a new school and in other cases, increasing the enrollment cap. So we were actually quite pleased with the results in several of the states on Tuesday night.

Operator

Our next question comes from the line of Jeff Meuler.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Could you talk a little bit more about the more project -- or more development projects qualifying for capitalization -- capitalizing the cost. Was that something specific to this quarter because of the projects you were working on? Or should we expect a fairly sizable decline on a full year basis in project development expense, at least as it runs through the P&L?

Harry T. Hawks

Well, just to be clear and as it relates to when and if and how a project is capitalized, capitalization is a -- if you will, an output, not an input. And it's based on a number of different factors, a whole lot of rigor goes into it. And so there is no standard capitalization rate that applies all periods, all years. It's a function of timing of a specific project. Some projects carry over multiple periods. Some are shorter in duration, et cetera, et cetera. So having provided that context, I would say that we would expect there to be a slower growth rate in that expense line for this year.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

But you would still expect the absolute dollars of project development expense on your income statement to be up in year-over-year in 2013, just for growth rate?

Harry T. Hawks

Yes, that is correct.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then could you just talk a little bit more about the Institutional license sales that was impacting this quarter and if it's just lumpiness and you're still doing license sales but maybe they came through a little bit light this quarter or heavy in the year ago period? And then also just generally on the Institutional business, even if you adjust for that factor, 6% growth is quite a bit below what you've historically been doing there even on an organic basis, so if you could just address that, please.

Timothy L. Murray

Jeff, it's Tim. Let me comment on both those points. First, on the lumpiness issue, we will continue to sell perpetual licenses, where that is what the customer wants to buy. It's not our lead offering. And so we would expect to continue to see lumpiness going forward. On a quarter-over-quarter basis, we've not have any perpetual license sales in this first quarter. We do see some in our pipeline going forward. So the year-over-year comparison, it was a factor. The other thing I would say that will make GAAP-based comparisons challenging this year is there are other factors going on as we compare the Institutional business on a year-over-year basis. One of the acquisitions we made was on a billing arrangement, where we billed those customers 3 times a year. And as you could imagine, we have to work customer by customer to move that to a monthly billing basis. And so that's going to make comparisons challenging. As an operating person, I don't operate the business on a GAAP basis. We think about it on a cash basis. And so we judge the momentum of the business on a non-GAAP cash basis, if you will. And to the point of opportunity, perhaps, I could just step back for a moment and talk about what this business really is. This is the business where we are targeting, bringing a continuum of solutions or strategies to be a full service solution provider to the students who will likely never choose to come into a permanent virtual academy. And so the law of large number says this is where the opportunity in the long-term is. And unlike many of our competitors who are coming to market with very narrow point solutions, our strategy is to be a full service provider. In the last quarter, we announced that -- I think we spoke about it on one of the earlier calls, the introduction of a new product platform called PEAK, which allows us to look at a customer and address what is becoming an increasingly complex set of challenges. Customers out in the districts today are buying curriculum from many fragmented players. And the challenge is the more of those vendors and point solutions they have, they have to measure performance and judge performance at the student level, if not at the vendor level. And so they're increasingly looking for a vendor who will integrate together the various solutions that are being provided to us so that the district can report compliance, measure progress of the districts at the student level or at the school level. That's the opportunity we're chasing. And some of the challenges that we're seeing right now is just customers are adopting that value proposition, as you would expect, at a different rate. We've got some customers who are already intrigued by the value proposition and talking about a full outsourcing solution. We have others who are interested in just buying curriculum, curriculum plus hosting plus instruction, integrated curriculum plus hosting plus instruction, et cetera, et cetera. And so again, our approach is to have a -- given the cost structure of a national sales force, we have to have a solution set that is broad enough and that will drive a high enough revenue per sale to cost justify that sales force. And so we'll take a long-term approach to building up that business. Now let me conclude by just talking to the question of momentum. When I look at the size of our sales force this year versus last year, we're up about 1.5x. When I look at the funnel, the pipeline generation, we're up 3.5x over what we were last year. And the average value of those opportunities is getting bigger. And so we look at those kinds of metrics, and they indicate to us building momentum. The 6% growth that Harry mentioned on a normalized basis, if I subsegment that business, there are several that are growing in the high-double-digit growth rates. And so we're comfortable that this is the right long-term opportunity, but we also understand there will be some lumpiness quarter by quarter.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Okay, that's helpful. And then just finally, for me, could you talk about what the, I guess, the beginning of your churn and intake has been like a month or 2 into the school year and how the initial turnover is compared to prior years?

Ronald J. Packard

We don't give a lot of details on that, but I'll say a couple of things on it. We measure intensely. From October 1 on, it's been relatively stable to what it was in past years. In the initial -- from the call center, improvement enrolled to -- actually, October 1, it was actually slightly higher, higher than it was the year earlier. So we saw a slight increase in that. I'd also add long term, we expect -- this year, the high school mix grew relatively similar to the K through 8 mix. In the past year, high school grew dramatically faster than the K through 8 mix. So high school tends to have a higher churn rate or lower retention than K through 8 does. so as that mix naturally goes up over time, that high school continues to grow faster, we will see -- even with K through 8 and high school both stable, we will see slight upticks in that kind of a withdrawal rate because the high school for graduation, as well as the fact it has slightly higher return rates.

Operator

Our next question comes from the line of Kelly Flynn.

Kelly A. Flynn - Crédit Suisse AG, Research Division

A couple of questions. Thanks for all the color on kind of the organic growth rates. I just want to clarify a couple of things on that front. For last year, can you just tell us what the enrollment growth rate was, just excluding the acquisitions, not exclude anything else?

Harry T. Hawks

Hang on a minute. I don't -- we don't have that at our fingertips. I'll get it for you. Let's see. Last year, we -- in Q1, we -- let me clarify and make sure I'm answering the right question. This Q1 this year versus Q1 last year. I've got Q1 information in front of me.

Kelly A. Flynn - Crédit Suisse AG, Research Division

That's fine, yes.

Harry T. Hawks

Q1 last year, we reported 35% growth in enrollment but we also acquired some enrollment. And so the total enrollment growth with the acquired growth was 42%. Of that 35% growth, however, if you will, organic, quite a bit of it -- boy, this is one I'll have to segment and perhaps supplementally get back to you on. That included growth from new states and that also included growth from capped increases. So if you try to normalize, if you will, the same state growth, so to speak, which is the comment we're making on October 17, was that the 14% growth this year compares to 15% growth last year. But the absolute or total growth was 35%, with another 6% acquired. Am I answering your question?

Kelly A. Flynn - Crédit Suisse AG, Research Division

Yes -- not really. I think I'll have to talk about it in more detail online -- offline. Let me just ask it a few other ways. The number of students from new states added in fiscal '13, the number you guys just reported on October versus last year from new states, I had 800 this year versus 3,300 last year. Is that right?

Ronald J. Packard

That sounds about right, yes.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Okay. And then for, same thing about cap increases, I had 6,200 from cap increases this year versus 8,200 last year. Is that right?

Ronald J. Packard

That sounds about right. We'll verify with you offline, but that sounds about right.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Okay. And then just switching gears, I know you talked about the Georgia victory, so to speak. Can you just kind of translate that to some extent into the numbers, like is that a material event for this year and just sort of how should we think about that order of magnitude as far as the benefits that yields to K12?

Ronald J. Packard

Kelly, I'm not prepared to comment on the specific order of magnitude, but I would say that, that was a very significant event for K12, not only the future but potentially this year, but certainly in the future it was a very significant event for K12.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Okay. And then lastly, wasn't there something on the ballot in North Carolina? Can you address that? Maybe I missed it.

Ronald J. Packard

Well, there was nothing on the ballot in North Carolina. I think the new governor-elect in North Carolina is very much in favor of educational freedom. So I think in that way, North Carolina was a positive development.

Operator

Our next question comes from the line of Jeff Silber.

Jeffrey M. Silber - BMO Capital Markets U.S.

When you give guidance for the second quarter, it implies a sequential decline in revenues from what you just reported in the first quarter. Can you just remind us about the seasonality, now that you have these different segments. Which of those 3 segments will we see the seasonal decline?

Harry T. Hawks

Well. First off, let me clarify that the pattern you see is normal. It's not a negative. So your takeaway should not be that, that's negative. That is our normal pattern, that Q2 is less than Q1. And that's a pattern that's played out over many years. So it is indeed normal in our -- that the seasonality of our business. In terms of individual lines of business, we've not broken out guidance by line of business. Yes, and by the way, just as a reminder, we talked about this before that in Q1, one of the reasons Q1 is higher than Q2 is there are certain elements of the business that we're in that occurs in Q1, such as materials and student computers and things like that, that distort, so to speak, the first quarter. And second quarter, often than not, normally would come down. In terms of -- once again, we've not given guidance by line of business -- or excuse me, by the 3 pillars. But I would just say it this way that what we're looking at in Q2 2013 versus Q2 2014, we're expecting growth in all 3 lines of business.

Jeffrey M. Silber - BMO Capital Markets U.S.

Let me ask the question another way, I'm sorry, Harry. Just in looking last year, it looks like you had a big drop in the Institutional business between Q1 and Q2 in terms of GAAP revenues relative to the other segments. Should we just expect something similar this year?

Harry T. Hawks

For Institutional, yes, Q2 versus Q1 last year was a decline, but this year, not so much.

Ronald J. Packard

So, you would -- we don't expect to see the same significant decline in Institutional business quarter, Q1 to Q2 to Q1, that we saw last year.

Jeffrey M. Silber - BMO Capital Markets U.S.

All right, great. That's all I needed on that. Let me just shift gears a little bit. You alluded to Hurricane Sandy and the nor'easter. We've seen you up here on the Northeast. Can you tell us, one, was there any impact in your business because of that? And two, let's say a school had to close for a week or so and you don't make up those days, do you lose funding? Are you paid on a daily basis?

Ronald J. Packard

It depends a lot, Jeff, on the state, the way states fund. There are states that pay on a daily basis. There are states who fund you by count dates. So our schools and systems, despite the fact that we're located in an area that was affected by Sandy, we didn't have issues. So our schools were always up. They don't go to sleep. And any student in an affected state -- and as you know, we -- other than Newark Flex, we weren't -- we do not have virtual schools in the heart of where Sandy really did the most damage. But as long as you have access to a phone line, our schools would be up all through the disaster.

Jeffrey M. Silber - BMO Capital Markets U.S.

Yes, that was my question. A lot of people lost power and couldn't get access to the Internet, so...

Ronald J. Packard

You can -- there is something -- there's still dial-up. But if you have a phone line, you can do it, but -- so we've been through a lot of these things and our schools stay up. And in most cases, a lot of our attendance is done not where you have to be there on Monday but you might have to do 5 days a week or so many days in a month, right? So it's very easy for kids if they were out Monday and Tuesday to go to school Saturday and Sunday. That's the beautiful part about our businesses. When there are disasters like this, our schools don't stop.

Operator

Our next question comes from the line of Trace Urdan.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

My question is about California. I think when you guys gave guidance for the full year, you could not have necessarily been planning for Prop 30 to go through. I have to figure that's got to be a reasonably big deal for funding purposes. Is that just sort of money that you'll put in the bank against other contingencies? Or how should we think about that?

Ronald J. Packard

Well, I would think it this way. This Prop 30 greatly reduces the probability that we'll see funding reductions that we'll see in California. So we have not updated any of our guidance reflecting Prop 30. But generally, obviously, that's favorable if California doesn't see funding decreases.

Operator

You have no further questions at this time. [Operator Instructions] We do have another question that has just come through and it comes from the line of Joe Janssen.

Joseph D. Janssen - Barrington Research Associates, Inc., Research Division

It's Joe Janssen filling in for Alex Paris. Trace actually just stole my question, but maybe just -- I know I'm the last one in the queue here. Maybe you can just comment real quick. I know you gave a lot of information on the guidance call regarding your certified teachers and the percentages in the system. Maybe just a quick comment on Seminole County. Was that enough data? Is that internal review closed? Or is that still outstanding?

Ronald J. Packard

Well, we've done the internal review and had our own external investigator in -- with regard to Seminole. And nothing has changed, right? I mean, the reports came out that we used all certified teachers. The Florida IG report has not come out and there has really been no information, new information to report on that. We're also still in the process of auditing our, we call, centralized teaching bank that we -- which is a bank of teachers -- a group of teachers that we teach individual courses with, with thousands of districts across the country, and we're still undergoing that internal review.

Operator

Thank you for your question. You have no further questions at this time. I would now like to turn the call over to Ron Packard for closing remarks.

Ronald J. Packard

Great. I'd like to just highlight some upcoming dates. On November 14, we'll be presenting at the JPMorgan Ultimate Services Investor Conference, and December 4, we'll be presenting at the UBS Annual Global Media & Communications Conference. We also anticipate in the -- at the end of November or early December, we will be releasing our annual academic report to talk about how we measure the academic performance of our students and give a lot of information on the academic performance of our individual schools. So I look forward to seeing all of you at the upcoming conferences. Thank you.

Operator

Thank you for your participation in today's conference. Ladies and gentlemen, this concludes the presentation. You may now disconnect. Have a good day.

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