Stride, Inc. (LRN) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2012 K12 Inc. Earnings Conference Call. My name is Katine, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Christi Parker, Vice President of Investor Relations. Please proceed.

Thank you. Good morning, and welcome to the K12 Third Quarter 2012 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 day 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 K12's Form 10-Q and 10-K filings with the SEC. These filings can be found on the Investor Relations section of our website at the www.k12.com. In addition to disclosing results in accordance with generally accepted accounting principles in the U.S., or GAAP, we'll 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 posted on our website. This call is open to the public and is being webcast simultaneously on our website. The call will be available for replay there for 60 days. With me on today's call is Ron Packard, Founder and Chief Executive Officer; and Harry Hawks, Chief Financial Officer. Following our prepared remarks, we'll answer any questions you may have. I will now turn the call over to Ron.

Good morning, and welcome to K12's Fiscal Year 2012 Third Quarter Earnings Call. I'm pleased to report strong revenue growth and significant progress in building out the infrastructure to support our long-term expansion. Revenue was $178.2 million, up 36.8% as compared to the third quarter last year and EBITDA was $26.2 million, a quarter-over-quarter increase of 24.8%. Online education continues to become more mainstream as restrictive entry barriers remove for virtual public schools, school districts recognize the value of K12 online courses, and student demand for our curriculum rises. I would like to begin the call today introducing you to some important new additions to the K12 leadership team. Most notably, Tim Murray, recently joined us as President and Chief Operating Officer, a newly created position at the company. Tim was formerly the CEO of Pulse Point and a Senior Executive at AT&T, where he worked for over 20 years, leading up to the position of Executive Vice President, Business Service Operations. Tim brings significant operating and management experience to K12 and is already involved in efforts to improve the efficiency of the organization and deliver greater profitability to our shareholders. Additionally, please welcome Christi Parker, our new Vice President of Investor Relations. She is joining us from Cooley LLP, where legal practice focused on corporate and securities law. Christi has extensive public company experience, and she is looking forward to speaking with many of you over the coming weeks. I'm especially pleased to report that 2012 is shaping up to be one of our best development years ever. Last quarter, we announced the expansion of the open enrollment and period window in Wisconsin. Since then, the cap in Michigan was raised from 1,000 students to 10,000 students for fiscal year 2014. We are optimistic that caps in other states may be increased or eliminated before the next school year begins. Equally exciting, more new states are embracing virtual public schools starting this fall. Beyond the new virtual academy in Iowa that we recently announced, new virtual schools will be opening in New Jersey and New Mexico this coming school year. A second virtual charter school in Oregon will also commence this fall. In addition, approval was received for a new Florida virtual academy in Osceola County, and there are several additional applications in various stages of the appeal process in Florida. We also had success this past quarter renewing our existing agreements with fully managed schools. We recently renewed our agreement with the California virtual academy at Kern for another 5 years, with 2 new charters for K8 and high school. And we renewed our agreement with the California Virtual Academy at San Joaquin for 5 years based on a new K-12 charter. We renewed virtual academy agreements in Arkansas and Oregon, as well as agreements with inside Los Angeles and inside Washington. This makes a total of 7 renewals this quarter alone. While we decided to end our relationship with the Steilacoom Historical School District in the state of Washington, students attending that school will have several other K12 managed virtual programs to choose from in Washington next year, including Washington Virtual Academy in Omak and Washington Virtual Academy at Monroe, both of which are more favorable for K12. Our innovative new flex schools continues to receive significant attention from the education community, and the experience with the pilot schools is encouraging. We are excited to have received approvals to open 2 of these schools in New Jersey and 2 in Ohio, which will bring our domestic total to 6 Flex schools and our total number of blended public school sites to over 30. We are also proud of our new Pre-K curriculum that will be launched this fall. We see opportunities to sell this Pre-K curriculum to public schools, childcare centers and to consumers directly. We expect to pilot this curriculum in several locations this fall. Our National Math Lab continues to deliver promising results. As you may recall from our Investor Day Conference, our experience indicates that students who enrolled in this optimal program are staying in our schools at a significantly higher rate than non-participating students. The full academic results are not yet available, but the early indicators are promising. As a result, the K12 high growth rate over the past several years, in fact, a 5-fold increase in revenues since fiscal year 2007, it has become essential to invest in infrastructure improvements to enable us to manage and sustain our growth. To this end, we recently completed our implementation of a leading CRM system on time and on budget. The system will enable us to attract, engage, acquire, support and retain customers more effectively on proving operational efficiencies across the customer life cycle. In addition, our second data center has now gone live. And we are moving business applications to the status center as we speak. This second data center provides us with improved business continuity and disaster recovery capabilities. The increased size of this center and its state-of-the-art technology will provide us with improved scalability as the company grows and our business needs evolve. Lastly, we improved and expanded our internal call center in Herndon, Virginia in order to increase our capacity and efficiency during what we expect to be a busy enrollment season. At the same time, as we are making these infrastructure improvements, we are focused intently on increasing our profitability in fiscal year 2013. Our initiative to accomplish this goal without any adverse effects on student performance, employee retention, customer satisfaction or our growth rate has already found over $10 million of such cost savings that we have begun implementing. We have also identified another $10 million of potential savings, which we are developing plans to capture. These cost-saving opportunities include reducing our reliance on third-party curriculum providers, as well as exploring ways to use technology to remediate students who are behind grade level more effectively and economically. We are also expecting to realize cost savings by reducing our use of ERP consultants, improving our vendor pricing and reducing losses at nascent businesses. We are in the middle of extensive due diligence review of the Chinese English language learning center company web, which has grown significantly since we made our 20% investment in early 2011. Doing business in China is enticing but also challenging, so we are proceeding prudently. We have until June 30 to decide whether to acquire the remainder of web and therefore, we are not yet ready to commit at this time. On the private school side, the K12 International Academy continues to expand and now draws students from 3 additional countries, bringing the total to 85 countries. For those of you who are curious, the 3 new countries are Afghanistan, Madagascar and Burkina Faso, which some of you may remember from your geography classes as upper Volta. Also, our International School of Berne has been selected as 1 of 4 schools to participate in the pilot of the International Baccalaureate Open World School. As part of the pilot, this school will operate an online program that delivers International Baccalaureate diploma-level high school courses over the Internet to students anywhere in the world. Visibility into state funding for fiscal year 2013 is still not precise. While tax collections have increased in many states, this initial revenue has not yet been reflected in school budgets for this year and is certainly not consistent across all states. For example, one of our larger states has notified public schools that it will delay payments this year. In this state, K12 will, therefore, be reducing delayed payments, resulting in a larger-than-anticipated accounts receivable buildup. It is still too early to predict what the state funding levels for education will be next year, but we are hopeful that improved state tax revenues will put less pressure on public school funding than we have experienced over the past 4 years. By our next earnings call, we should have much better visibility into next year's school funding levels. We should also note that our funding expectations for this current year have not changed since our last call. It was nice to see many of you at our Investor Day in Chicago last month. We enjoyed spending time with our owners, who share our passion for improving educational opportunities for children around the world. Hopefully, the value of the K12 educational program is now clearer than ever and more compelling to all of you. Also, in case you missed it, we published a report last month about the academic performance trends of students in the virtual academies we manage. This report is available to the Investor Relations section of our website. It provides detailed analysis on the complex topic of the academic performance of our students and the associated challenges and accuracies of applying traditional static performance evaluation methods to virtual public schools with their high student growth and dynamic student population. We hope to see you at the Baird Growth Stock Conference in Chicago on Thursday. And with that, I will turn the call over to Harry.

Thank you, Ron. Good morning to everyone participating in our call and webcast. I'd like to touch on a few key topics before we open the call to your questions. First, I'm pleased to be able to report a strong third quarter as evidenced by revenue of $178 million versus $130.3 million same quarter last year, an increase of 36.8%; EBITDA of $26.2 million as compared to $21 million, an increase of 24.8%; operating income of $11.6 million versus $10.8 million, an increase of 7.4%; and net income of $7 million versus $5.6 million, an increase of 25%. Our diluted EPS of $0.18 compares to $0.16 last year. Second, I'm especially pleased to also introduce Christi Parker. As Ron mentioned, she has just joined K12 after a distinguished career as a public company securities and corporate finance lawyer from a major international law firm. Her expertise in capital markets, SEC compliance and corporate governance will be of significant value to us as we continue to grow, while seeking to continually improve our communication with you, the owners of K12. Third, I'd like to emphasize the importance of our significant ongoing investments in K12's future. To date, we have invested over $275 million in curriculum, technology and learning platforms. These capital investments made during the quarter and planned for the fiscal year were almost all related to curriculum development, software development and systems enhancements. These investments are critical to our education mission and contribute to a scalable infrastructure necessary to support our future growth. Our investment in scalable infrastructure will decelerate in coming quarters, as Ron mentioned, and our investment in content and technology will continue to be opportunistic, strategic and in support of future growth. Fourth, our financial position remains strong. We have a substantial -- we have substantial liquidity and financial flexibility. In March 31, our cash balance was over $123 million, we had no bank debt and approximately $36 million of computer-related capital leases. I would like to take this opportunity to respond to a frequently asked question that I get from many of you regarding working capital and its effect on the GAAP statement of cash flows. This fiscal year, our cash flow statements has been a little harder to understand for many, particularly given the significant changes in accounts receivable. The provision of working capital to the schools acquired in the Kaplan Insight acquisition, where we did not acquire working capital, the launch of new schools, significant growth in Institutional sales and other new initiatives resulted in a significant increase in accounts receivable this year. Indeed, more than $109 million increase just in the 9 months since June 30, 2011. As Ron mentioned briefly, we have also seen an impact from the seasonal pattern of collections, as some states are paying more slowly than in the past, resulting in a increase in accounts receivable aging on average. In the past, we have seen our fourth fiscal quarter as a period of high cash receipts with the expected impact on cash flow from operations in the cash flow statement. We estimate some of those collections will carry over into Q1. Therefore, on a comparative basis, we believe fiscal 2012 will not be representative of the typical cash flow patterns for K12. With that, fiscal 2013 may swing the other direction, as we expect a disproportionate amount of 2012 collections will be received then. These observations are primarily directed at those of you that calculate free cash flow as GAAP cash flow from operations less capital expenditures. Happy to take questions on that offline, if you like. Finally, a comment regarding our outlook for fiscal 2012. We currently expect fiscal 2012 revenue of approximately $700 million and EBITDA at the lower end of our previous guidance. Operator, we'd be pleased to take questions at this time.

[Operator Instructions] Your first question comes from the line of Sara Gubins, representing Bank of America Merrill Lynch.

Thanks for providing in the release the details about revenue by segment. We used it to try to calculate revenue per student for managed schools, and it looks like that was down 9% year-over-year in the quarter. I'm wondering if you can comment on that? It's more than I would have expected to have seen. And is that the kind of declines you have been seeing recently? Would you expect that to continue?

Sara, no, we are not seeing in the public schools revenue declines of that -- to that extent. We are seeing probably on the -- at the low-single digits range, but not 9%. Probably, just some mix changes and the like, but that's not representative of our actual experience.

Okay. Is there any chance that you could provide us with revenue for the managed school for the first 2 quarters of this fiscal year, so that we can do the same calculation?

Well, Sara, I think that's a calculation that I'm not sure you're going to get the right answer from because the mix changes that affect that number are so complex. That's why we try to give you that we saw was approximately a couple of percent reduction in the price per student on average across the portfolio, but as you see mix shifts between, not only among the different states but also between the different grade level, some states fund high school more, some states fund high school less. You'll end up getting misleading conclusions if you look at the numbers that way. It's just not the right way to look at it.

Okay. And then separately, just a question on the updated outlook for the year. One, on the below-the-line-type items, is there any change in your expectations, so D&A, CapEx, tax rate, that sort of thing?

No material change. The tax rate's probably at the low end of what we previously said. The D&A probably right in the middle. Capital expenditures, pretty much in line, so everything else not much in a way have changed.

Your next question comes from the line of Kelly Flynn, representing Credit Suisse.

My question relates to state funding also. Can you talk in more detail about the $8 million revenue hit you referenced last quarter and sort of where that stands? Have you gotten any of that back, if you will, from the states it related to? And have you seen any similar issues popping up in other states?

Kelly, the $8 million from last quarter, remember was adjustment revenue made based on expectations of payments in certain states. And the answer is we have gotten some of that back, but there are some other potential offsets to that, so we made no such adjustments to it this quarter. But we did get some of it back, but we didn't take that because there's some potential other things that could happen adversely. So there was no revenue adjustment made, positive or negative, this quarter.

Okay. And then I mean as far as the offsets you referenced that offset what you got back, were those related to new states? And I guess I'm just looking for more color on how we can be comfortable that you may not see additional negative adjustments next year?

Well, I think this and a couple of things. When you normally and historically as well, with the exception of the last quarter, generally, what ends up happening is you do have positive effects to negative effects generally worked out relatively close to 0 be immaterial. Last quarter, what made it a little different was they all seemed to work in one direction, which created a material change we had a talk about. As you move towards this part of the year, every month we move forward, the visibility gets greater and greater. So the odds of something happening go down every single month we operate. So I think the probability of it happening isn't 0, but it's certainly a lot less than it would have been a quarter ago.

Okay, great.

And I might just -- perhaps, stating the obvious, but as you're thinking about that, I encourage you to also note that we just said we expected revenue to come in at around $700 million. That is an increase over our previous guidance.

Your next question comes from the line of Jeff Silber, representing BMO Capital Markets.

Harry, actually, just a follow-up on that. You did raise your revenue guidance, but if you're looking to come in at the lower end of the EBITDA guidance, are there any specific line items that you expect to be worse than before?

Jeff, one of the things about our business is the more successful we become with regard to business development, the more costs we incur in the fourth quarter. So every time we open a new state, every time we expand the cap, every time we open a Flex School, all of a sudden, we have additional call center people we need to bring in for recruiting; we have additional marketing spend; we have to hire school staff, including sometimes almost always a principal; sometimes, teachers in advance of this. So the weird thing about our business is the more successful we are in terms of growing the business and the opportunities, the fourth quarter has start-up expenses that go with that business without any revenue increase at all in the fourth quarter.

Okay. I got it, it's understandable. You mentioned in your prepared remarks about ending the relationship with the school district in Washington. I'm assuming it's relatively small in the scheme of things, but if you can give us a little bit more color exactly why that happened?

Sure. I mean we decided to do that because we have several schools in the state of Washington, and Washington is one of the states where economics are difficult and so the relationship that we could have -- we have with the other partners was better in terms of the working relationship but also with the economics of those schools. So what matters to us is that we have great schools for the students, because the students -- we believe the students come because they want what K12 is offering and the relationship with the other 2 districts is just -- is better, easier and more economically favorable.

Your next question comes from the line of Joe Janssen, representing Barrington Research.

That's Joe Janssen, filling in for Alex Paris. Ron, in your -- in the press release, you mentioned acquisition costs have been declining and conversion rates increased. Just was curious, is that -- the acquisition cost, is that a function of just the overall brands starting to resonate more or maybe is that a mix shift in the ad space?

We think it's a bunch of things. We think, one is it is as our brand gets stronger every year, we operate and continue to deliver. Referrals from existing customers has been very high. But also, we went through a pretty extensive reworking of our call center process, which really touched all things. There's a list of 60 different improvements made to the call center. We've brought a lot more of the call center internally to K12, and what we think that does is we -- creates a culture in the call center that seems to have a higher conversion rate. We also look how we hire in the call center, how we train people. And the fact is our scripts are actually more almost less inviting in a sense that we're much clearer about and we're very clear about how many hours it takes to do this. But I think we've noticed a significant change in conversion. I think part of this because what we've done and part of this is just online education is becoming more mainstream.

Okay, great. Jumping around here a bit. Can you just talk about maybe the enrollment trends and what you're seeing on a state level? Maybe just are you seeing any weaknesses in any states? Or are they still kind of trending ahead of expectations?

We're not seeing weaknesses. I mean enrollment continues to be strong, and we, again, we expect that to hopefully continue. I think the big thing going on here is online education, I think, is becoming much more mainstream, and people are viewing it and students and families are viewing it as a more mainstream option for their children. It's certainly different than when I started K12 12 years ago, where you -- it was very avant-garde and out on the edge to be going to a virtual school. Now it sounds the same, it sounds much more mainstream. So I think it's like any idea curve or new product curve. It becomes more mainstream that you just continue to see growth. I think that's what we're seeing.

And maybe you can just talk about the political side of it. I hate to bring it up, but given the article back in December, kind of given how 3 ways it could affect your business, 2 of which you talked about the third being the political fallout, which you really couldn't comment at that time, you wouldn't see until, I think, early spring, summer that still stands or are you starting to have...

Well, I mean I -- what I'd like to tell you, I can tell you, I think, I don't need to even comment on it in the sense that we're literally just to finish -- is finishing one of the best, if not the best, business developing in years in our history. And this included significant legislative votes in places like Michigan, in Wisconsin. We were seeing 7 charters renewed. We're seeing -- we have several cap removals in the Q. So the business development success, I think, speaks for itself, and we haven't seen the slightest slowdown in our ability to deliver educational liberty to more families. And we haven't seen the slightest slowdown in student demand. So how ever I was expecting an effect, we certainly haven't seen it as of this time, and I think one of the good things that come out about this is we have probably been a little too shy about talking about our academics and the student growth and the Scantron data. And I think sharing that data now so openly, both our retention data at the Investor Day but also the academic data from our Scantron value-added gains test, sharing the Arkansas study which happened to come out and the continued work we're doing in research, I think we're in a much stronger position politically than we would have been a year ago. And they say the truth will set you free, and I think in this case, the truth and what actually happens for kids and the value we're delivering, whether it be for kids who are dropouts trying to get a diploma in Chicago, whether it be for virtual school families who were struggling in their public school option previously and are now is having success. I mean the -- what we do for children is fantastic, and I think that's getting out there and the article actually helped us in communicating what that value proposition is.

[Operator Instructions] Your next question comes from the line of Jeff Meuler, representing Baird.

This is Nick Nakitis [ph] for Jeff. Your probably still in kind the fiscal 2013 budgeting process, but given that fiscal '12 was such a large infrastructure investment year, and it sounds like fiscal '13 revenue growth will likely remain strong, how are you guys thinking about the fiscal '13 margins going forward?

Well, we're looking to improve margins. I mentioned in my comments was we set in place a major efficiency initiative here to try to drive some cost out of the system without, like I said, affecting growth rates, student experience, employee satisfaction, so. And we've already identified over 10 that are already begun in either been captured or in the process of being implemented with another 10 to come. And one of the reasons we've moved to hire a President and Chief Operating Officer is to help us drive those efficiencies. So given that you -- hopefully, that we see a little better funding outlook where I'm not fighting this headwind, combined with these initiatives and the drop off of ERP expenses, which were quite substantial this year, we would look to see margin improvement for 2013. And that's our goal, and everyone here is working toward it and we are focused intently on it.

Okay, great. And then I guess given the new hiring with the COO, do you see your kind of organizational roles changing or have you guys kind of -- the hierarchy talked about that?

Well, I think the organizational role, my role here has changed every year for 12 straight years. As it's -- when you're in the first year, as the CEO entrepreneur, you do every business role there is because we put every dollar we had into the product and the systems. And so I view my role, hopefully, this allows me to be more external, do more business development work than I've been able to do the last year or 2. And I think we can concentrate more on some of the infrastructure with the -- whether it be the ERP that I haven't had all the time to be able to put my personal attention on, and I'd like to spend some more time on the next generation of products, which I haven't been able to spend enough time on. So hopefully, this allows me to do more of the things with regard to business development and product innovation and have a lot of the P&L and the efficiencies driven by a President and COO who's, I think, perfectly suited and his background is fantastic for dong that.

With no further questions at this time, I would now like to turn the call back to Mr. Ron Packard for closing remarks.

Well, I'd just like to thank everybody for joining us, and I look forward to seeing many of you at the -- this Thursday in Chicago.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.