Stride, Inc. (LRN) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q4 and Full Year 2012 K12 Inc. Earnings Conference Call. My name is Clinton, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Christi Parker, Vice President, Investor Relations.

Thank you. Good morning, and welcome to the K12 Fourth Quarter and Full Year 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 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 K12's Form 10-K and 10-Q 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 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; Harry Hawks, our Chief Financial Officer; and Tim Murray, President and Chief Operating Officer. Following our prepared remarks, we will answer any questions you may have. I will now turn the call over to Ron.

Thank you, Christi. Good morning, and welcome to the K12's Fiscal Year 2012 Earnings Call. I am pleased to be speaking with you today about our accomplishments over the past year and provide some insight about our goals and commitments for the new school year. I would like to start the morning by first welcoming all our students and teachers back to school. Our mission is to deliver an outstanding individualized education program for each of our students that enables them to pursue their dreams. We could not do that without the tremendous support of our talented teachers and staff. I want to recognize and thank all of them. Before we begin talking about our strong quarter and our review of the upcoming year, I would like to provide some additional information regarding the allegations in Florida. First, all teachers teaching Seminole County students were Florida certified, and in our internal review, we have only identified minor mistakes in matching the appropriate grade and course certifications with specific students and courses. Second, the emails at issue did not reflect our teacher-assignment policies, practices and controls. We believe the allegations resulted from both a mismatch of the timing of assignments with the reporting deadlines and more fundamentally, a misunderstanding by its author of the process used to generate the report in question in the Seminole materials. Third, we have shared and walked through all the internal supporting documentation for those teacher assignments with the IG's office and cooperated in every way. Beyond that, the results of our internal investigation concluded there's not evidence to support the conclusions drawn in the Seminole-submitted materials about teacher certification. It would be inappropriate for me to comment further, while the IG's office is still in the process of its investigation. Given the unbelievable amount of…

Thanks, Ron. Before I comment on the fourth quarter, let me say a few words about my focus and where I expect to add value to K12. I have been and will continue to be focused on 4 aspects of our business: first, the customer experience, as well as our employees' experience. Combined, this is what I think of as our product. Second is academic outcomes, the output of our product. While Ron touched on this topic, it's everyone's responsibility at K12, and we take delivering great student outcomes as our job 1. Number three, operating leverage, how we'll achieve it with scale; and last, cash, how we most effectively generate and utilize cash. The growth of the company has been nothing short of stellar. I'm very proud to be here to work with our team to continue to invest and develop the processes, systems and policies to manage this growth, including investing in our team. We will ensure that we have a platform and structure necessary to efficiently grow the company. We'll make the required investments with an appropriate balance of both near-term and long-term focus. Investments made in our ERP, CRM and data centers are a great start, and we'll build on them to ensure we derive the value that can be seen in increased operating leverage. We will strive to deliver a better experience to our customers and better processes for our employees. As for the fourth quarter, I think you can see in the financial results that we took actions to slow the growth in SG&A. I would characterize the results as a comprehensive reduction in discretionary expenditures resulting from a broad and deep focus on the scaling of costs. Regarding CapEx in Q4, we spent $15.8 million, excluding capital leases, taking our full year investment…

Thank you, Tim. 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 for your questions. First, thanks to the incredible efforts of the over 3,000 men and women who passionately support our mission, I am pleased to be able to report a strong fourth quarter as evidenced by revenue of $170.4 million versus $128.3 million, an increase of $42 million or nearly 33%; EBITDA of $17.7 million versus $6.3 million, an improvement of $11.4 million; operating income of $2 million versus operating loss of $6.2 million, an $8.2 million improvement; net income of $1.8 million versus a net loss of $2.8 million, an improvement of $4.6 million; diluted EPS of $0.05 versus a loss of $0.08, an improvement of over $0.13. Improved results, particularly on a comparative basis with a relatively higher expense Q4 last year, are attributable to several factors, including, revenue growth in all businesses, substantial slowing of growth in SG&A, partially a result of cost savings initiatives and the absence of certain transaction, merger integration and system implementation expenses in the prior year. Numerous other factors, such as reversal of a portion of the revenue adjustment we had in the second quarter, modest improvement in gross margin, slowing in the growth and product and software development expenses, all resulting in improvement in both EBITDA and operating income margin. Second, our solid finish to fiscal 2012 contributed to the full year results reported last night. Revenue increased 35.6% to $708 million. EBITDA increased nearly 30% to $87 million. Operating income increased nearly 20% to $29 million. EPS increased 22.3% to $0.45, and please note that our press release provides additional revenue detail by line of business. Third, I'd like to emphasize the importance…

Before we take questions, I would like just to recap some important upcoming dates. Later this morning, we will be presenting at the BMO Back to School Conference here in New York. Next week, on September 20, we will return to New York for the Credit Suisse Annual Small and Mid Cap Conference. The week of October 8, we will issue our guidance in a separate call dedicated entirely to this topic. Later in the fall, we will issue an academic performance report to explain how we measure the academic performance of our students. In early or mid-December, we will host an academics and products day where we encourage you to join us to experience firsthand the power of our products, the rich curriculum and innovative learning applications and learn more about our academics. Operator, we will be pleased to take questions at this time.

[Operator Instructions] Your first question comes from the line of Sara Gubins.

This is Kelly Metzler for Sara Gubins. Revenue per student for Managed Public Schools declined 7% for the year after being flat in 2011. Could you talk about what drove the decline? How much was due to state funding versus a mix shift?

I'll start with that. I mean, there's a lot -- the revenue per student is a lot more complex than that. It's not just the funding in the state, and it's not just the mix shift. There are about 12 factors that actually affect that number. One of those, as we mentioned at the Investor Day, is we have a lot of students enrolled, but because of either changes in counties [ph] or other reasons, we get paid 0 for them. So a combination will be this year, in particular, we had a large number of kids that are enrolled that we are not receiving funding for, for a variety of reasons, so that also lowers it. But the general -- I think, the core the question was trying to get at is with the general -- the general level of pricing reduction was not 7%. It was less than that, and it was more due to other factors than it was pricing reductions. Harry, you want to add to that?

Yes, I think the part that's related to price reductions is probably 2% or 3%, and the remainder is mix shift. But once again, just to reaffirm what Ron said, there's at least 12 factors that go into this, and so it's a little bit more complicated. But I think that's the short hand.

That's helpful. And how much of the $8 million revenue adjustment from the second quarter was reversed?

Between $1 million and $2 million.

The next question comes from the line of Suzi Stein.

Just going back to the last question, you said that the pricing should be down about 1% this year. It was down 2% last year, and you mentioned the 7% decline for managed schools. How should we think about the decline given that you said there are 12 factors? What are you expecting for this year just in terms of that revenue per student decline?

We do not expect it to be nearly as large as it was last year. And this past year had a bunch of factors, particularly the number of students we ended up serving where we get nothing for will be smaller, certainly, a smaller percentage of our students going forward. So we expect that number to be -- that decline to be much less then this coming year. Harry, you want to add to that?

I think that really says it Ron. I mean, I don't have much to add to that.

Can you maybe just discuss how significant Florida is to the business just from an enrollment and maybe a revenue perspective and maybe specifically, Seminole County? And any idea of timing of when that could be resolved?

We don't want to speculate on the timing of an IG investigation. I mean, like as we mentioned in our press release and today, we've had not only internal investigation, but also hired an independent investigator. But we're hoping it's resolved relatively quickly. And Florida, as of today, is a relatively small part of our business, but we're optimistic it will become a large part over the coming years.

Okay. And then maybe just a final one. On the restatement of the enrollment numbers, you gave an annual number, but can you give us some quarterly color and maybe how much was -- were the managed students down year-over-year in fourth quarter -- I mean, sorry, up for the quarter, year-over-year on the managed student side?

Yes, let me grab on to one word you said, which was restatement. We're just changing the presentation format for the 3 lines of business. We'll continue to use student enrollment on a -- if you will, an average basis for the managed schools. And we're changing to be more reflective of what's appropriate for the other businesses. We're evolving to other reporting other metrics, particularly for International and Private Pay. So there's no restatement per se. As it relates to the full year number, which is in the 10-K, that is an accurate number and a healthy growth of approximately 40% over the prior year, and it's -- we'll be providing a lot more enrollment data on our call on -- at the week of October 8.

The next question comes from the line of Jeff Meuler.

This is Nick Nikitas for Jeff. You mentioned the $1 million, $2 million reversal of revenue recognition. Was there any impact to Q4 by other funding adjustments? And if so, to what magnitude?

Really not material. So what we have -- what we said at the time we did the -- we disclosed the $8 million adjustment in Q2 was -- we have plus and minus sort of adjustments every month, every quarter, all year long. It's just that at that one point in time, we had a negative number that was material, so we disclosed it. But minor adjustments throughout the rest of the year and some of that $8 million adjustment in Q2 actually came back of $1 million or $2 million but nothing material else to report on that.

Okay. And then with the cost-savings initiatives, you mentioned the SG&A expense savings throughout 4Q. Is there any additional traction or going into fiscal '13, incremental to the $10 million that you mentioned previously?

Well, I think it's important -- this is a continual process where K12 is continually trying to improve what we do, whether it's get purchasing scale, whether it's improve the efficiency of our operating model. Tim is working on a whole series of initiatives. So we expect to just be continually getting more efficient, and we're quite pleased with what we were able to achieve already in the fourth quarter. And we view this as an ongoing process, and a lot of that momentum that we had in the fourth quarter, we believe, continues into the next year and years to come.

Your next question comes from the line of Trace Urdan.

Ron, I wanted to start by -- just by asking about the internal investigation and whether it included counties besides Seminole and whether it -- you -- as a result of that investigation, you've made any adjustments to any procedures around this issue.

I think -- I'm not sure it's adjustments to procedures, but making sure instead that we make sure that we're complying with all of our existing procedures everywhere. But we'll -- obviously, we looked at this in a much larger basis than Seminole. And again, the -- we're quite convinced that our processes for making sure all our teachers are certified, which they were in this case -- I can't say that enough times -- are there. And you got to ask yourself a question. Why would we ever hire teachers who are not certified? We have tens of applicants for every single job opening. So it's almost ridiculous. So we have -- we are looking at all our procedures to make sure that everything is done right, particularly how we assign teachers and students to classes, and we're going -- we're doing a complete review of that. We always do though. This is nothing new. We are constantly receiving questions about things as we break new ground. Virtual education didn't exist in most places before K12 started it. The fact that we've gone through 12 years, over 30 states and have had so few incidents, and almost all of them minor, is remarkable, given the ground we're breaking. But the answer is, of course, we did. We looked at make sure the policies are enforced, and we'll continue to always do so.

Great. And then in your prepared remarks, you talked about your efforts to develop products to help remediate kids that are coming from behind grade level. And I'm wondering are you currently supplying any products like that to districts on a supplemental basis at the moment.

We do have some products like that, that the districts are starting to use. I mean, a couple of things, specifically, we have a marketable reading program that will take kids who are 3 years behind grade levelly and bring them up to grade level in 18 months, and that's a remarkable program. It's a combination -- and half the time, I think, it's actually autodidactic and the rest with an instructor. So that's one example. We're, hopefully, piloting the National Math Labs program with at least one district this coming year, and that's where you can put children for an hour a day in a computer lab, and we're seeing in eighth, ninth, 10th grade this year. It looks like almost twice the national norm learning gains. So we are beginning that process, but I think it's a continual process, and I can't emphasize enough, where we've seen such a change in the children who are coming to us and we always got a lot of advanced learners, but now the number of kids who are way behind grade level is going up, and we're now looking at tens of thousands of these kids. So we view it as our challenge to figure out how to remove -- get kids up to grade level. And remember, we're not just talking about taking a child and moving them to a year per year. If you're 2 years behind grade level, all of sudden we you get you learning at 1 year for every year, you stay 2 years behind grade level. We have to accelerate learning to 1.5 years or 2 years per year in order to get kids to grade level. Remember, these are kids that might come to us having learned half a year per year. So this is an extraordinary challenge, one we face. It's one school districts face. But I believe our combination, because we build such -- we build learning software, we build curriculum, we also manage schools, the combination of those core competencies, I believe, put us in a tremendous position to begin to solve this problem, which is really the essence of getting the U.S. school system to where it needs to be.

Okay. And you mentioned in your prepared remarks as well that you completed the first phase of Oracle implementation. That set off alarm bells in my head. Can you describe what is still to come in terms of the Oracle ERP opportunity and how we should think about what that might cost?

When the word Oracle is mentioned, the bells are ringing in my head continually. But what I'd say is we've done the heavy lifting and we're -- but when you put these systems in, right, they're so powerful and there are so many things you can do, you're never ever complete -- never ever completely there. And I'm going to let Tim comment a little bit on where we're going with the Oracle implementation. Though, I want to just add that it is -- the bulk of it -- lifting has been done.

Yes, thanks, Ron. There's a reason why Oracle does so well as a company, right? Once you start, you never stop. The functionality that we have implemented to date is largely around improving some of our accounting and financial functions. The opportunity in front of us is to look at our other business processes and either integrate legacy systems into Oracle, in some cases, replace or upgrade legacy systems. And so the proper way to think about our ERP is the foundation is in place, and as we implement further integration with other business applications, that's where we can automate workflows, streamline workflows and achieve the type of productivity gains that are available to us.

Okay, great. And then last question, I'll let you move on. Can you just describe where -- how the board -- what the board's thinking at the moment about potential share repurchase and how that's evolved?

Yes, I'll just comment briefly. We continually will look at that. I mean, there's a -- it's something we look at as we -- when you believe your shares are significantly undervalued. But also, when you're a growth company like K12, I mean, the growth opportunities and the high IRR investments in front of us is unbelievable. I mean, our challenge is not finding high IRR investments. Our challenge is prioritizing them. So you always want to make sure you have the capital to be able to do what you do, but it's something we, obviously, have looked at and we'll continue to look at going forward.

The next question comes from the line of Giri Krishnan.

I guess, I had a couple of questions. One, I understand you'll give a preliminary -- your outlook on the week of October 8, but is there qualitatively any way for us to think about enrollment growth for the next school year relative to the last, given all the cap removals and new state additions and so forth?

Sure. I think it's a little early, and we always want to be careful since we tend to have measured enrollment year over -- October 1 to October 1. But I'd say a couple of things. I think Harry's general statement that we're comfortable where the first call numbers are and he -- I think he said what those first call numbers are. To give you an idea that we're at least comfortable with the enrollment growth level that's similar to the revenue growth number in there or close to it that we'll provide those numbers. I'd also say that it's a continual process, and looking forward, when you look at the cap expansions that are already in place for the year after this one, then you have a pretty good growth prospects for the next couple of years between those things. But I wouldn't want to comment any more on enrollment growth or revenue growth than other to say we're comfortable where the consensus numbers are, and we'll give you much more detail on that in the October call.

Okay. And then in your prepared -- in the press release, there were some -- you made some comments about initiatives to improve student outcomes. Can you expand on what those are? And is there -- should we expect any material impact on costs? Or is it just normal initiatives that you've always had in mind or implemented?

Yes. I'm not sure you're going to see a material impact on costs this year, but some of the things we talk about are expanding, for example, the National Math Labs to all students that are significantly behind grade level. We did a pilot to make sure they worked in the past year. It's also looking at the number of online sessions and interventions our teachers do with students, so there's a whole series of things we're doing. We're looking at actually building specific math courses to actually get you ready for algebra and pre-algebra. So these things are already built into our numbers, so I don't think you'll look at a material change in the coming year. But we're going to continue to get at this. And also, a big part of what we need to do is make sure that policymakers -- and I think we've done this effectively at least at the policy level -- understand how you need to measure schools like this, schools with such a high mobility of population, kids with -- schools with so many kids coming in so far behind grade level. I mean, ironically, this isn't what K12 originally was founded to do, but I believe one of the great long-term impacts of online education is just going to help dramatically reduce the dropout rate. Our school in Chicago, which only takes high school dropouts, is actually taking these kids back in and through a flexible hybrid model, graduating over 90% of them. So we have -- our virtual schools are showing that these kids who come way behind grade level, given an extra year, we can graduate these kids. So in a nation where we now have -- almost 30% of our kids don't graduate from high school, the flexibility and individualization of online education, I believe, can greatly reduce that number. And we are committed to doing that. I mean, we're here to help solve national problems. So -- and we're very excited about it, but it's a lot of work. And we're going to, in the academic annual report, give you a lot of, not only data but also just logical information on how these schools should be measured and why they should be measured that way. So we're quite excited about it. We want to be incredibly transparent with the kids that come in to us, how -- what we do with them. And we're very excited about it.

Okay. Then last -- a question on enrollments. I think someone had asked a question on your Managed Public School enrollments, and I'm not sure if I understood the answer. Just looking at the average enrollment number for the Managed Public Schools, in doing with some rough math, it implies that the Q4 Managed School -- Public School enrollment number was around 87,000 or 88,000. Can you guys confirm if we're in the ballpark, correct on this?

Well, I think we'll just, more or less, repeat what we said a moment ago, which was that the number that's in the 10-K is indeed correct, and it looks like it's a very substantial growth year-over-year of 41%. And we'll be providing more enrollment information the week of October 8. So I think we'll just leave it at that.

The next question comes from the line of Jarrel Price.

So as you said, the midyear revisions that you experienced in 2012 seemed pretty unique. So based on what you see for the upcoming year, do you think this trend is going to continue? Or should we expect that you return to a year of more balanced adjustments?

Well, it's always hard to predict the future. I'd say a couple of things. We -- if you look at the relative size of those kind of adjustments prior to this past year, they were always much, much smaller than anything we experienced this year. And the way we look at our year going forward, is everything we know that's going to happen or even if we think it's a shot that would happen, we model in. So when Harry gives those numbers, we've looked at states that have told us it's going to be flat, for example, and we've actually modeled in reductions, just looking at their fiscal situation. So we, obviously, begin the year and we model in everything that we know will happen or we think might happen with any reasonable probability. So the answer is we expect it to be 0 going -- when we start the year, but we know that hasn't happened. But prior to this year, we had never seen adjustments that went more than $4 million one way or the other. And this year, the $8 million, which were 2 quarters, so the annualized number is actually almost twice that. So we don't expect it to happen, and if we did, we already have it modeled in.

And I think you've been pretty clear about only employing certified teachers, but just a quick clarification about your policies in other states than Florida. For example, in Pennsylvania, up to 25% of a charter's teachers can be noncertified. In Ohio, we understand that part-time teachers can be noncertified. So given these state standards, do you employ noncertified teachers in Ohio and Pennsylvania? Or should it be clear that you only employ teachers who are certified in the states?

Let me say it this way, and I'll -- we'll give you -- we'll give a more detailed answer. I want to make sure I have all the data in front of me. But we comply with all laws and regulations. So in the cases you've described, we would comply with all laws and regulations. But generally, we push the bar much higher than that and look to hire certified teachers. I can't sit here without the data and tell you it's 100% everywhere. But I can guarantee you that it complies with all laws and regulations. And we will get back to you on that question. I just don't have the certification status in every state with all the schools we have in front of me, but I believe, generally -- I think, we only hire certified teachers, but I don't want to say that and commit until I have the exact facts in front of me.

The final question comes from the line of Justin Harrison [ph].

You mentioned Chicago earlier. I noticed in following the teacher strike there that the charter schools opened without any issue. I guess the question is, do you have any or really how do high-profile events like this tend to impact your business development activities in kind of entering into new states or growing caps?

I -- it's hard to say, but we're thankful that our schools in Chicago are open, and we wish we could take more kids. That being said, it's always sad when you have events like this where students and their families aren't going to school, which for a lot of these families, provides enormous childcare issues. But I think it's one of the -- when you look at the overall situation, it's one of the reasons why you need school choices. When you have a situation like Chicago and also -- and you're going to shut down the education for 100,000 kids, that's a bad situation for everybody involved. So in general, I would like to think these things kind of help us and really accentuate the need for more choices for students and also for districts to have the online capability to serve kids when events like this happens. But we're here to help school districts and states however we can.

And now I'd like to turn the call over to Ron Packard for closing remarks.

All right. Well, we thank you for your attention. We look forward to seeing a lot of you at conferences coming up, and also, we look forward to our guidance call in early October. Thanks, everybody.

Thank you for joining today's conference. This concludes your presentation. You may now disconnect. Good day.