K12's (LRN) CEO Nathaniel Davis on Q2 2016 Results - Earnings Call Transcript

| About: K12 Inc. (LRN)
This article is now exclusive for PRO subscribers.

K12 Inc. (NYSE:LRN) Q2 2016 Earnings Conference Call January 28, 2016 8:30 AM ET

Executives

Mike Kraft - Vice President of Investor Relations

Nathaniel Davis - Chairman and Chief Executive Officer

James Rhyu - Executive Vice President and Chief Financial Officer

Analysts

Corey Greendale - First Analysis

Henry Chien - BMO Capital Markets

Operator

Greetings, and welcome to the K12 Fiscal 2016 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now turn the conference over to Mike Kraft, Vice President of Finance for K12. Thank you, Mr. Kraft. You may now begin.

Mike Kraft

Thank you, and good morning. Welcome to K12's second quarter earnings call for fiscal 2016. Before we begin, I would like to remind you, that in addition to historical information, certain comments made during the conference call may be 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 operating performance and results, please refer to our reports filed with the SEC, including without limitation, cautionary statements made in K12's 2015 Annual Report on Form 10-K. These filings can be found in 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. This call is open to the public and is being webcast. The call will be available for replay for 30 days.

With me on today's call is Nate Davis, Executive Chairman of the Board and James Rhyu, Chief Financial Officer. Following our prepared remarks, we will answer any questions you may have.

I'd like to now turn the call over to Nate. Nate?

Nathaniel Davis

Thank you, Mike and good morning, and thanks to everyone for joining us on the call today. Before reviewing the results for the quarter, I wanted to first touch on the announcement we made yesterday naming Stuart Udell as K12’s Chief Executive Officer. Stuart comes to K12 with over two decades of experience in the education sector with a specific background in virtual learning.

Most recently, he was first CEO and then Executive Chairman of Catapult Learning, a privately held provider of instructional services, professional development, and an operator of schools. Stuart’s depth of experience will provide a seamless transition to K12 and allow us to continue executing on the programs and initiatives that we have launched in the last two years. His experience spans curriculum and program development, school operations, educational services, and technology innovation.

Stuart has been a proponent of providing education solutions for students regardless of their geographic location or socioeconomic background. His principles and his passion clearly aligning with K12’s mission and our vision for the future of education. Personally, I will continue to be actively involved in K12 and maintain my role as Executive Chairman of the Board of Directors.

In addition to supporting Stuart, I will be focused on public policy and the issues that surround our public policy, we’ll continue to work closely with our schools and their boards and additionally I will work with Stuart on strategic direction and acquisition opportunities as they arise.

As you’ve seen over the past few years since I stepped in from the Board of Management to Management and with the support of the Board, we have worked to strengthen K12’s culture by always putting student achievement above everything else. We’ve also built the cadre of great teachers and school leaders while simultaneously strengthening new technology and content we provide.

During this time, we’ve also improved our relationship with our Board, changed our marketing to lower cost and to be more focused on students who stay with our program longer and achieve better results.

And finally, we’ve begun growing our institutional business as a key way to position this company for future growth. Perhaps most importantly, we have built a depth in our management team to broaden the skills across many functional areas. This transition to Stuart’s leadership is at the next step in that long-term plan initiated in 2013 that will ensure K12 as the right mix of talent to support its growth and maintain a great culture for many years to come.

Being able to attract Stuart to our company, caps the effort to bring great talent to K12. I am really looking forward to working with students to support – Stuart to support students and families and our schools and deliver the best academic outcomes faster.

We’ll work together and look for opportunities to introduce Stuart to the investment community in the coming months.

And now turning to results. Revenue for the quarter was $208.8 million, a decline of 9.7% year-over-year. On a pro forma basis, excluding the impact of the Agora transition, revenue grew 2% from the second quarter of last year.

Operating income for the quarter was $14.7 million versus $20.5 million in the prior year. James will be providing more details on the financials in just a few minutes. Importantly, our revenue, operating income and capital expenditures were within the guidance we provided last quarter.

Now this underlines the predictability and reliability of our results for the past twelve quarters, we have consistently delivered results that we are inline with the guidance we provided on an annual and a quarterly basis.

I also want to highlight our enrollment results for the quarter. Average enrollments for managed programs for the second quarter was 103751. Now keep in mind, this was the second quarter figure that was the average. As you would expect, I also look at weekly operational performance and a report on enrollment level every week. Those reports show that we ended the quarter on December 2001 from December 31 with enrollments of 105,015.

This compares to our accounted enrollments of 104,429 in the first quarter and that’s an increase of 586 enrollments or 0.6%. Now just to put this in perspective, if I look at the same period from last year, from our October count date to December 31, enrollments declined 2740 or 2.5% which is a normal seasonal pattern. But as I said this year, we increased 586 or 0.6%. That’s a great turnaround.

Looking historically, I believe this is the first time we’ve seen this trend in eight years. This means we are retaining more students and having to spend less for marketing expense. We believe this significant improvement is the result of our comprehensive company-wide approach to address student retention of what we call persistence.

This target was providing a streamlined student enrollment experience for families a process that is much smoother today than several years ago. Once students have enrolled, our teachers and our school leaders implement a set of programs designed to improve student persistency.

For example, we expanded our strong start initiatives in 18 schools this year. These initiatives are focused on starting students are strong and keep them on track through various actions. Those actions include programs such as Walk The Class and our interventions to family academic support team.

Through the second quarter of this current fiscal year, K12 has improved student retention by a 140 basis points compared to the performance for the same period last year. I got to tell you, I couldn’t be more proud of the organization and its response to the challenge to improve in this area. This data gives us confidence that our investments and programs and processes that we’ve been putting in place are now providing great solid results.

Now everyone understands that improved student persistence is obviously important to enrollment and revenue. But more important, it’s how it directly correlates to academic outcomes.

As we outlined previously, students enroll with three or more years in K12’s management program achieve much higher proficiency compared to students who enroll less than a year. 22% higher in English language are 17% higher in mathematics, according to the testing data from school year 2014, 2015.

And we certainly have a lot more work to do. But I am encouraged by the progress we are seeing. Moving on, I want to highlight another announcement that we made earlier this month. That is, K12’s sponsorship in the launch of the foundation for blended and online learning.

The mission of this new foundation is to advance the availability and quality of blended and online opportunities across all types of schools, not only this is a great way to K12 to give back to the community to students and the educators, but it will also advance the field of digital and blended learning beyond what K12 is doing itself through its scholarship to students from blended and online programs, they will support students co-secondary education.

It will also support innovation in teaching in a digital and blended learning environment. The foundation will bring key stakeholders together to reinforce by digital learning and digital technology in our school and even school choice, it’s critical in delivering a great education to students across the United States.

To give you an idea of the importance of this effort, take a look at that foundation board in our announcement. It includes prominent industry leaders and experts. Each have chosen to participate because of the importance of the foundation’s mission.

In particular they all believe in empowering students and parents by giving them choice and availability of digital learning opportunities. I am excited about this effort and the potential impact it will have on digital learning in our country.

And before I hand the call up to James, I wanted to leave you some thoughts on how K12 is valued in the market today. With where K12’s stock has been trading, our market capitalization is about $300 million. Now this is well below our book value of $535 million.

To think about that valuation in light of where we are today. The results in our managed public schools programs are improving. Student persistence, revenue per enrollment and importantly academic outcomes have all shown improvement and are increasing the life time value per customer.

From a school development point of view, we are working with various school boards to open both new schools, in existing states, as well as open up new states that don’t yet offer a virtual school progress. Our institutional business continues to hold great potential for future growth.

All districts are always reevaluating how they deliver academic programming to meet their ever-growing digital evolution needs. Districts are using digital content as supplemental classroom instruction, address their home bound population and even there is replacements for traditional textbook and we are well positioned to benefit in this digital education exposure.

We are also expanding our business in new areas. Last year, we launched English language learning programs which met with great interest. This year, we are bringing Career Technical Education or CTE offering to the market.

These programs allow new students to pursue distinct career path based on the national career cluster model. We believe CTE has enormous potential to provide quality education for students who might not otherwise be able to obtain one and can significantly add to the skill trade work within the country.

Our technical and our product teams are on schedule to deliver significant upgrades that curriculum and structure on top of what we delivered last year in our new high school experience. I believe our next-generation curriculum will enhance our speed to market and flexibility in providing solutions to schools, to districts, families and students.

So overall, I hope you can see why I am excited about K12’s future growth prospects. I am particularly excited about the improvement in enrollments at our managed programs business. All of this, and a new leader in Stuart Udell who can help take care of K12 even further, tells me that we are beginning to hit on all cylinders.

Thank you so much for your time this morning. I’ll now hand the call over to James. James?

James Rhyu

Thank you, Nate. Good morning everybody. First a few words about our reported results. Revenue for the quarter declined 9.7% from the year ago quarter to $208.8 million. This quarter we posted an operating income of $14.7 million, this compares to $20.5 million in the second quarter of last year.

In order to looking – in order to look at the underlying trends in our business, I am going to spend some time discussing the revenue and enrollment on a pro forma basis, excluding the impact of Agora which we transitioned last year. We believe this approach will provide you with a clear picture of the underlying trends in our business.

This is the fact that the infrastructure shared across all of our schools and businesses, we won't extend that approach for operating income or other components of our results.

So excluding the impact of Agora, total company pro forma revenue increased 2%. Revenues for managed school programs would have risen approximately 3.2% year-over-year, while average enrollments would have declined by 2%. However, as Nate mentioned, our ending quarter enrollments were actually higher than our account enrollment.

We normally have some drop-off after account dates slightly average is lower but ending at a higher account despite as some of our investments are beginning to pay-off for us as Nate indicated.

Average revenue per enrollment increased more than 5% year-over-year for managed programs. The revenue per enrollment trends relate to a combination of factors including school mix, improved funding environment in some states.

For our non-managed public school program, excluding the impact of Agora revenues would have been $15.6 million. Non-managed program enrollments grew 2%, and we benefited from new programs launched this year offsetting the rise in enrollments, revenue per enrollment declined 7%, largely due to mix.

Our institutional software and services business, which includes core software, technology, professional and other educational services sold by our FuelEd team, posted revenues of $12.2 million for the quarter.

This is a year-over-year increase of 3.1%. We continue to believe the opportunities in the institutional market and as we have previously discussed the continued investment in targeted products and distribution in that market as these products are allowed to gain traction we continue to expect institutional to be growth driver for K12 over the long-term.

Revenue for our private pay and other businesses was up $10.7 million, a reduction of 5.5% from the prior year period. This area is comprised of a number of consumer-related products involve other remaining international operations.

We continue to evaluate these businesses and look to maximize growth opportunities and profitability here, so we will invest prudent as we go. Therefore results in this area will likely be somewhat variable in the coming years that will refine our strategy here.

Gross margins improved slightly from 37.3% last year to 37.9% in the current period. On a full year basis, we anticipate gross margins to continue to be flattish plus or minus. Selling, administrative, and other expenses was $61.4 million, declined 1.9% on a year-over-year basis.

We continue to look to manage these costs tightly and have been marginally flat for three consecutive years.

Product development expenses for the quarter were largely flat at $3 million. Operating income for the quarter was $14.7 million, compared to $20.5 million in the prior year. The reduction in operating income was predominantly due to the transition of the Agora contract.

Now turning to some other items. We ended the quarter with cash and cash equivalents of $171.3 million, a $20.4 million increase from the prior quarter. Our cash balance increased approximately $47 million versus the year ago period.

That’s important to note even with the impact of Agora, cash balance have risen even if you discount stock purchases we made last fiscal year our cash balances are higher by approximately $20 million in the current period.

DSOs have improved by seven days on a year-over-year basis, which is partly be improving in this management capital world. There is also some timing issues in there, so I would not extrapolate this trend, but clearly we are seeing more discipline.

CapEx as we historically define it, which includes curriculum and software development, computers and infrastructure were $27.9 million year-to-date versus $30 million in the previous year. We also had approximately $2 million in computer-related equipment that falls under our capital lease program, but we expense these as not part of our CapEx number I just mentioned.

The $10.1 million decline in this quarter versus last year was a result of lower spending on property and equipment, as well as due to computers.

Our tax rate for the quarter was 45.8% versus 42% in the year ago quarter. Our guidance for the full year still remains in the range of 39% to 41%. We continue it now that we are a cash tax payer, we continue to work on tax strategies to further improve our rates and keep you inform with the range changes in our guidance for the year.

Now turning to our expectations for the third quarter, we expect revenue of $215 to $225 million, operating income of between $16 and $20 million, and capital expenditures of between $20 and $25 million.

Looking ahead, I believe we are on track to deliver revenues in the upper half of the guidance range for the full fiscal year at the same time we remain confident in the operating guidance provided for the full year of $17 million to $22 million.

Thank you for your time today and now I'll hand the call back over to Nate. Nate?

Nathaniel Davis

Okay, we are completed with our prepared remarks. Operator, we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question is from Corey Greendale from First Analysis. Please go ahead.

Corey Greendale

Hi, good morning.

Nathaniel Davis

Good morning, Corey. How are you doing?

Corey Greendale

I am doing well. How are you Nate?

Nathaniel Davis

Good.

Corey Greendale

So, few questions. First of all, congratulations on the persistence improvement. I realize it may be a little hard to parse, but, how much the improvement do you think is due to the things you’ve been doing to try to make sure the people that are coming to your schools or more likely to succeed in the first place versus things you are doing once their in school to improve their retention?

Nathaniel Davis

It is hard to parse that. I would say, little more weighted towards the efforts to retail students after they join the program. Call out to those students and to the families to make sure any problems they run into or resolve quickly, we make sure we provide lot more support to them to help them understand what we work they have to go through, what process should be, it really changes their life.

We spend a lot more time trying to make sure that teachers are in touch with them more frequently. So, I think this has a little more impact, and the reason I say that is because the efforts to new promotional programs is really new this year. So it has not yet had its full impact, because it’s a brand new program.

We expect it to have more impact in the coming years. But the actions that be more in touch with our students and be more touch with the parents, those actions I think have a little bit more impact than the new market program.

Corey Greendale

Okay and in terms of the fact that the end of the quarter enrollment was higher. I know, there was a time when you would take students to – we are not funded and the fact that they came in after the account date and that – and maybe went back. Can you just update us on where you are on that? And are you enrolling students or you are not get funded for this year?

Nathaniel Davis

Yes, we still take students who were not going to get funded for the year. The student comes to us and, there is two reasons why we do that by the way. First of all, we want to make sure we provide access to the program to all students.

But secondly, if we can provide great services to those students, they will stay in the program and then that becomes a reimbursable student in the next year. So we want to retain them. So, yes, we still take students who come in after the account date and state that we may not get funded to us.

James Rhyu

I think Corey, again to think that – another thing I just – we previously talked about how we are changing our external acquisition approach to optimizing against students who we think will come in. We won’t get funded for them and lead.

That doesn’t – as Nate was mentioning, that doesn’t mean that we are not going to take those students, but our acquisition activities are more focused where we are going to generate greater revenue and profits for students. So, sort of just new one – but we never really gone away from taking those students. We are just trying to focus more on those students where we will make sure that we do get funding for us.

Nathaniel Davis

In other words, we don’t promote to them, but if they come to us, we still take them

Corey Greendale

Okay, that helps and actually, James on a related point, could you give us some help on how to model revenue per enrollment for both managed and non-managed for the rest of the year?

James Rhyu

Yes, I mean, I think for managed revenue per enrollment, for the rest of the year, you are going to see year-over-year, you’ll continue to see similar declines as you’ve seen in sort of first half of the year to the first half of the year we saw between sort of 2% and 2.5%, currently something similar for the full year. So, your back half of the year is going to be something similar. That’s for the managed. And remember, that includes the impact of Agora.

Corey Greendale

Yes.

James Rhyu

And then for the non-managed, which also again includes the impact of Agora, we’ll likely see something – again in a similar range of the first half of the year. We’ve got some lumpiness quarter-over-quarter, but I think that full year, you are going to see similar kind of year-over-year improvement.

Corey Greendale

Okay. And then, one more, then I’ll turn it over. On the institutional, can you just talk about kind of price versus volume trend? And the – I think the growth there is little less than, maybe you had talked about earlier, actually getting this year, it’s kind of what’s happening in that business and what you expect for the rest of the year there?

Nathaniel Davis

Yes, I’ll talk about that. This is Nate speaking. So, number one, the first part of your question, rate versus volume. We see most of the growth coming from volume and not in the tutorial. Competitive pricing issue, we have not seen the competitive pricing issues we saw maybe a year, year and a half ago.

The market is settling just a little, but it’s not like RFP is still competitive there, certainly competitive and there is certainly some pressure. But it’s not nearly the pressure we saw year and a half ago where we saw prices just across the board was dropping. The volumes increase, we are seeing more in RFPs from school districts, we are seeing more school districts look for various solutions – not just solutions traditional solutions of supplemental content but designed with learning content, particularly math specific need.

So we are seeing school district products to expand a little bit more. Now the second part of your question you talked about our growth and what does growth look like. Remember that, we look at growth for the full year. Even last year if you look at last year’s quarters, you would see one quarter was 4% growth, other quarters with 30% growth and in other quarters with 16% growth.

So it’s not consistent across the year because the selling season really varies across the year. And so you are going to see the same thing this year. You are going to see some quarters that are not high growth, so others that are high growth. We also are going to be very much impacted and I hope you know that, I think you know this by whatever we do in the managed public school business when we enroll students in managed public school, we also get more students enrolling in full time programs at the districts we are running.

Because when we promote in a state, we promote on a broad basis and it’s not just for managed schools, we will promote for all of the schools. So, generally, when we are up in enrollments for managed schools, we are also going to up in enrollment for intuitional and we reverse this is also true.

So this year, you may see less of these enrollments in these school districts. We think that comes back next year. So, overall, it’s a quarterly variance that you are probably seeing. We still believe that there is strong growth for the full year.

Corey Greendale

That’s very helpful. Thank you.

Operator

Thank you. The next question is from Jeff Silber of BMO. Please go ahead.

Henry Chien

Hey, good morning its Henry Chien calling in for Jeff.

Nathaniel Davis

How are you doing?

Henry Chien

Just wanted to ask about total enrollment, you mentioned it’s growing a little bit this quarter. Could you talk a little bit or add some more color on that growth? Is it just a broad retention improvement or are there any schools that you tied new schools or any trends you are seeing?

Nathaniel Davis

It’s primarily in broad, it’s across the board. Retention efforts that have really driven the growth. It’s not like there is some new trend in brand new enrollment. As a matter of fact, we’ve sort of gone off the promotional areas. We haven’t – much money on promotional efforts in the second quarter as we do in the first quarter, but as we will do in the fourth quarter of this year.

So we are active in a relatively low period of promotion after October. So really improving comps. I’m trying around the previous year’s decline to this year’s increase of just maintaining more students. So it’s really has been at now, relative to which school, it’s sort of been all of the schools that we’ve rolled these new programs to students.

We have seen a difference between the retention in schools we rolled out program to students versus the schools that don’t have it yet. So which is why we are optimistic about next year because we end up rolling it out all the other schools next year. That help you, Henry?

Henry Chien

Got it, yes, that’s helpful. And just sort of related question. Could you remind us the difference between your non-managed program revenues and institutional revenues, just trying to understand how to understand the growth of either those and whether they are related? Thanks.

James Rhyu

Yes, sorry Henry, if I understand your question correctly, the non-managed revenue versus institutional, the non-managed program revenue is really – those are essentially like the full-time equivalent programs that we manage for district partners, where in the institutional software and services, that’s in essence, sort of everything else meaning, that would include everything from platform solutions, one-off solutions that provide professional development, as well as course enrollment that have not likely sort of full-time program – district programs that we manage for them. So, it’s sort of everything else in that institutional software and services.

Henry Chien

Got it. And are these usually in the same course, are you seeing – I am just trying to understand the new add business is growing …

Nathaniel Davis

Generically I think, if you are asking the non-managed enrollments are generally distinct from the programs in the institutional software and services. But the customer relationship changes, right. The distinct programs and actually a different marketing where we market to them.

But the customers tend to be related. What I mean by that is, that we develop a good relationship with the school districts and once you develop a good relationship, not only you are running new programs for them, but you are also delivering the software in a content to that same customer. So, there is a relationship there, relation building. So the more we build the relationship with the big customer, the better off we are not only running new programs, but also providing software to them.

Henry Chien

Got it, okay, that’s helpful. Thank you.

Nathaniel Davis

Anything other?

Operator

[Operator Instructions] Okay, gentlemen, we have no further questions at this time. Would you like to make any additional or closing comments?

Nathaniel Davis

No additional closing comments other than one point I guess we didn’t talk about, people didn’t ask about was what’s our new business development activity. We announced at Alabama last year. We expect to see more students in Alabama.

We’ve got programs that we are working on in places like West Virginia, Nebraska, Missouri, Connecticut, none of these are program based – current programs approved yet. But these are all places where there are conversations going on and with expansions going on places like New Mexico, Texas, Wisconsin, Nevada, Virginia.

So there is a lot in the business development activity that we think over the next couple of years, we should see some benefit from as well.

So, I appreciate everybody’s time today and thank you for the time and I guess we are done operator. Thank you, Manny.

Operator

We welcome. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!