Stride, Inc. (LRN) Q3 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the K12 Fiscal 2015 Third 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 like to turn the conference over to Mr. Mike Kraft, Vice President of Finance for K12. Thank you, Mr. Kraft you may now begin.

Thank you and good morning. Welcome to K12’s third quarter earnings conference call for fiscal year 2015. Before we begin, I would like to remind you, that in addition to historical information, certain comments made during this 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 2014 annual report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.k12.com. In addition to disclosing financial results in accordance with generally accepted accounting principles in the U.S. or GAAP, we will discuss certain information that is considered non-GAAP financial information. A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included in our earnings release and is also posted on our website. 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, Chief Executive Officer and Chairman; Tim Murray, President and Chief Operating Officer; and James Rhyu, Chief Financial Officer. Following our prepared remarks we will answer any questions you may have. I’d like to now turn the call over to Nate. Nate?

Thank you Mike and good morning everyone. Thanks for joining us on the call today. Let me start by highlighting a few results for the quarter. Revenue was $244.6 million, up 4% year-over-year. Excluding the businesses we sold last year revenue rose 6.4% year-over-year. This quarter we delivered growth across the board. We reported gains in both Managed and Non-managed Public School Programs, as well as in our international and private pay schools. We also continued strong growth in institutional business. Operating income for the quarter was $27.4 million, which was flat compared to prior year. Excluding the businesses we sold last year operating income rose 1.9%. Both revenue and operating income came in ahead of guidance we provided last quarter and our business trends going into the fourth quarter remain solid. We are therefore tightening and slightly improving our full year guidance. For fiscal year 2015 we are forecasting revenues of $938 million to $948 million, operating income of $39 million to $42 million, and capital expenditures of $75 million to $78 million. While FY'15 business trends were better than we expected, only actual results from the upcoming enrollment season will allow us to accurately issue FY'16 guidance. We will provide FY'16 guidance once the new enrollment season is completed in October. Now let me turn to some commentary on the current quarter. First on business development, I talked last quarter about new schools in both North Carolina and Colorado. In North Carolina we’re on track to open a new virtual academy in partnership with the North Carolina Learns Group. We project a first year enrollment of up to 1,500 students and over the next four years expect that to double to 3,000 students. In Colorado we opened a new school in partnership with Colorado Digital. The new school name will be Pikes Peak Online School and it’s specifically designed for athlete students in grades 9 through 12. While this is our sixth partnered school in the State of Colorado we think there is considerable room for growth in this market. Second, let me turn to two businesses we don’t talk enough about. Let’s start with our private pay business. This business contributes over $30 million in annual revenues and on a year-to-date basis, revenues were up 12%. K12 private schools, a parent pay tuition [ph] and they include Keystone, K12 International Academy and the George Washington University High School. These schools have partnerships with such prestigious institutions as the Joffrey Ballet Academy, Edward Tennis Academy, the Nusle [ph] Conservatory of the Arts, The Rock School and the Oxford School of Performing Visual Arts. In sum we serve over 35,000 full and part time private school students across 50 states in 80 countries around the world. Each private school serves a different student population according to their need and their specific objectives. Overall K12 private school students have strong academic records with solid GPAs as well as strong AP and SAT scores. Approximately 90% go on to college and that’s well above the national average. K12 private school graduates have gone on to Harvard, MIT, The University of Virginia and a host of other prestigious schools. Notably K12’s greater flexibility uniquely accommodates the learning and schedule needs of a non-typical student such as athletes and performers. And let me cite just a few examples of the types of unique students that this business serves. We serve a number of the school of the American Ballet who recently performed at Lincoln Center of New York City. We serve a student in Venture [ph] that took his invention that he Defined Model [ph] on short take and generated $1 million in revenue. We serve an Eye Academy Freshman who is working with the United Nations to bring peace, food and water to other countries through the GEN [ph] UN program. And he has been invited to speak at the UN. This is just to name a few but there are so many unique stories that inspire us. We’re very proud of what we built in our private pay business and we’re targeting continued double-digit gains consistent with our year-to-date results for this business going forward. In addition, we’re pursuing new partnerships to establish additional private schools that we hope we can announce next year. Now let me switch to a discussion on our sales in institutions like our Public School district partners. Last quarter we said that FuelEd’s growth will continue all year and again this business delivered another strong quarter. Non-managed program revenues increased 37.8% year-over-year and institutional software services revenue rose 34.8% year-over-year, adjusted for the sale of the businesses last year. Enrollments in our peak platform were up 25% year-to-date. Peak enrollment growth was a result of higher usage of programs and courses per student with our existing district partners. And also this quarter FuelEd begin selling a new solution to support the growing population of English language learners or ELL students. The demand for ELL solutions is growing. Today the market for ELL products in Grades K12 is approximately $900 million and growing at a double-digit pace. By 2025 it’s forecasted that 25% of the students in K12 will require some sort of ELL remediation. And the solution we rolled out this quarter supports academic success at the late elementary and middle school students. It’s designed to align with Common Core and many other state standards. Early interest is very promising. In only a few months of pre-selling we have a sales pipeline of over $2 million. Beginning next month we will continue our controlled rollout and provide more customers with access to ELL through peak time. But we see a number of positive trends that are driving in the FuelEd business. Going forward we expect to see modest double-digit gains as districts and schools continue to adopt digital learning. Switching to managed schools we made progress this quarter, particularly in two key areas, streamlining the enrollment process and a new high school experience that is based on the installation of a new learning management system, we licensed from our partner, Desire2Learn. This quarter we kicked off the enrollment season for the new school year and we brought a number of changes online. We changed our marketing program to be more targeted than in previous years. We believe our strategy will be more effective in attracting students who will be successful within the K12 model. We are promoting schools through a very few specific channels that are more directly going to speak to students and their families who want to be in this program. For example we are employing more local execution, meaning more local events and more digital acquisition including borrow [ph] and social campaigns. We also refined our messaging based on specific needs and integrated that down to the state level. In fact we have eliminated most national media which would also allow us to lower the marketing cost per enrollment overtime and all of these programs are intended to attract students who are best fit for the K12 program. And as I said on numerous occasions if students are a good fit they will stay longer in the program and succeed academically more often. In addition to further streamline the enrollment process we have enhanced our parent portal. This portal is very user friendly and clearly guides students and parents through all the steps necessary to enroll in a K12 partner school. Importantly, this redesign removes unnecessary steps and documents that may have frustrated families in previous years. The key to all of these changes is customer satisfaction. We want to ensure that families have a positive experience from the beginning with K12 and then student starts school year with enrollment requirements all completed and behind them. We’ve also made progress this year on the integration of new learning management system, and our high school students are based on a new partnership with Desire2Learn, I mentioned that a few minutes ago. We have been talking about this in our discussions for some time and we are finally near completion. As you may recall we launched a pilot with four of our schools in January. These pilots have been successful and we will launch the full system for all of our schools in July. This new high school learning experience provides a more robust platform. It unifies the student experience by aggregating key resources for their experience all in one place, and it allows greater personalization of the student learning experience which bolsters academic success. The platform also provides a new dashboard which makes it easier to gauge performance, so a student, a parent and the teachers can all easily see and evaluate the student’s progress all in one place and identify where additional work maybe needed. And importantly the new learning management platform is a major step toward providing K12 mobile solutions that can be anytime anywhere. And finally this new platform will be the basis for the next generation of content and a new engaging user experience. Some of this work will take some time to complete but we’ve started the process when we turned the system up in July. You can expect to see progress in these areas in coming quarters and the coming years. In summary our business is in great shape, our institutional business grew 35% in revenue, this quarter on an adjusted basis. We introduced a major new product, ELL, that will help growth in the future. And I didn’t even talk about a new math product called Learn Box [ph] that kicks off this next school year. Our Private Schools grew 8% this quarter on a year-over-year basis, and 12% for the nine months year-to-date. New schools continue to open in the managed Public School area. Our academic results, which will be published next week show our education programs are making a positive difference in students’ lives and our cash position is very strong in a $143 million which will allow us to look for strategic opportunities to drive even a stronger business. We are very proud of what we built out, and I believe this will be move positive in the next year. And finally, let me remind everyone that our Investor Meeting will be on August 6th at the New York Stock Exchange. I look forward to seeing everyone at the meeting. Please reach out to Mike Kraft to learn more about this event. Thank you very much for your time this morning and now I hand the call over to James Rhyu. James?

Thank you, Nate and good morning everybody. First a few words on our reported results. We ended the quarter with revenue of $244.6 million, up 4% from the year-ago quarter. Operating income was $27.4 million, which was flat with the third quarter of last year and total managed and non-managed enrollment were also largely flat with the year ago quarter. Growth in non-managed programs rose 38.1%, offset by the 4.6% decline in managed programs. I am going to focus the remainder of my remarks this morning on the pro forma results excluding the business we sold in 2014 to ensure we look at the results on a comparable basis. For the quarter we reported revenues of $244.6 million, which represents an increase of 6.4% over the pro forma Q2 results last year, $229.9 million. We saw growth in all lines of our business. Revenues for Public School Programs rose 4.6% year-over-year, while enrollments were flat and managed program revenue rose 3.5% year-over-year. This was in contrast to an enrollment decline of 4.6% on a year-over-year basis. As we have seen for the past year or so the positive revenue per enrollment trends relate to a combination of factors including school mix and accrued overall funding environment in some states and other variables. We expect the positive rate environment to continue through Q4 and sequentially to be about flat in Q3. Non-managed program revenue rose 37.8%, to $9.3 million. Non-managed enrollment rose 38.1% with revenue per enrollment largely flat year-over-year. While revenue per enrollment trends may fluctuate on a quarterly basis due to school mix and seasonality we would expect that Q3 trends will largely continue through Q4 of this year. Institutional Software and Services, which includes our core software technology professional and other education services sold by our FuelEd team posted revenues of $11 million for the quarter. This is an increase of $2.8 million or 34.8% on a year-over-year basis. We are beginning to see product investments we have made in our institutional business, that Nate mentioned starting to pay-off. The year-over-year growth also benefitted from a lower comp in Q3 of last year, however the sequential trend from Q2 remains strong on a historically low seasonal quarter. We believe we will continue to see this business grow into next year with the addition of additional products and deeper penetration into existing clients. Our International and Private Pay Schools revenue rose $2 million or 22.4% on a year-over-year basis. This increase was due to the continued strong performance at our Keystone and I Academy Private Schools, which posted year-over-year gains of 14% and 13% respectively as well as gains internationally in our schools in the UK. Gross margins declined from 39.8% last year to 39.1% in the current period. Margin pressure directly relates to our investments in teachers that I previously highlighted. Selling, administrative and other expenses increased $2.9 million or 4.7% year-over-year to $64.9 million. SG&A expense actually fell as a percentage of revenue from 27% to 26.5%. For the fourth quarter we would expect to see some seasonal increase in expenses as we start to spend on marketing related to our enrollments here. However, we expect a certainly more moderate increase sequentially this year versus last year. Product development expenses for the quarter were $3.3 million, an increase of approximately $500,000 over the last year. Sequential trend of product enrollment expenses has been consistent with the past couple of quarters and we are likely to see fairly flat sequential spend in Q4. Operating income for the quarter was $27.4 million which is 1.9% higher than last year and $3.4 million higher than the upper range of our guidance for the quarter. Now let's turn to some other items. We ended the quarter with cash and cash equivalents of $142.9 million, an $18.7 million increase from the prior quarter. We ended the quarter with a higher DSO of approximately 12 days, largely due to the timing of collection of some large accounts. This also increased our AR balance sequentially from the prior quarter. We believe we'll have those schools caught up by the end of the year and brings the accounts receivable down to more inline with historical trends. CapEx, as we've historically provided which includes curriculum and software development, computers and infrastructure was $19.4 million for the quarter and $57.4 million year-to-date versus $14.3 million and $55.2 million respectively last year. So year-to-date we're a couple of million up and we're trending right within our guidance range. Our tax rate for the quarter was 39% versus 43% in the year ago quarter and our guidance for the full year remains in the range of 38% to 40%. So turning to our expectations for the fourth quarter, we expect revenue of $225 million to $235 million, operating income of between $4 million and $7 million. I think the press release this morning said $4 million to $6 million but it will be $4 million to $7 million and capital expenditures of $18 million to $21 million. That translates into full year guidance of revenues of $938 million to $948 million which is at the upper end of our previous guidance, operating income in the range of $39 million to $42 million which is above the previous guidance and CapEx of $75 million to $78 million which is at the lower end of our previous guidance. Thank you for your time today and now I'll turn the call back over to Nate.

Thanks James. Mike?

Manny, we're ready to take the first call.

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions]. Our first question is from Jeff Silber of BMO Capital Markets. Please go ahead.

Thank you so much. And looking back on the quarter that just ended, I'm just curious if you could pinpoint where you thought the upside was versus your guidance, both from a revenue and operating income perspective.

So Jeff this is James. Yeah we had a little bit more rate favorability than I think we had anticipated and we also, I think we managed our costs a little bit tighter than we had previously thought. That's where the main difference is.

Okay, great. Now, I know you're not going to give specific color on upcoming enrollment trends for next year, but I'm just curious versus at this time last year how you think things are tracking for the upcoming school year.

Well I'm optimistic because the changes we put in place, I talked about some of them in the enrollment process that made it easier to make it through the process for students. I also think there is a marketing segmentation work that we’ve done that looks more specifically at what message speaks to each type of student and how do we reach them in a more, more vital and more social networking and more local event way. So I think that that I'm optimistic that we'll see better results. And right now I'm seeing some results that indicate that maybe we're right, but this is very, very early in the season. And so it's hard to predict, but early in the season and we're pretty pleased with where we are.

Okay fair enough. And if I can just ask one more question about your cash position, which you highlighted. What minimum cash do you need to run the business, and you mentioned maybe some strategic acquisitions. I'm just curious what holes you think are you in your current portfolio.

Well, I’ll just take the first half of the question and maybe Nate will take the second half. So you may know that we need cash predominantly for the first quarter, first quarter’s sort of our largest cash usage quarter. Well so we know we'll have some sequential decline in Q1 fiscal year '16 in our cash balance. We don't really provide guidance of exactly how much cash we need but if you look historically, I think last year we had cash that's now excluding the share repurchase of in the range of $50 million or so. So that that’s a good [ph] proxy of at least the minimum net amount of cash we need for Q1. We also think that our cash balance will grow a little bit Q4 as well as the historical trends is proving.

Relative to the scale that we need in the institutional business I think that's the place where I look for strategic opportunities. The managed public school business I think is actually, has all the content it needs. There is always more that we can do but we think we will do some of that through internal development, through strategic partnerships and acquisition opportunities and other joint marketing relationships, I think that we want more reach to school districts. We need greater distribution. Our sales force is just not large enough to reach all the schools. We’ve got such great products in ELL and in PEAK and in Matchbox but the problem is you got to get to all the school districts. So I want to get the greater distribution. I also think there is opportunity in the area of career readiness, career readiness is as I talk to Governors and legislatures around the state, every state struggles with the issue that many students are going on to college and the degrees they are getting in college are not really helping them fulfill the jobs that are open. And they want more career readiness, whether it’s in networking or it’s in some of the professional fields, so places like nursing and they want to see more high schools deal with that problem. So we believe that there is an opportunity to have more career readiness content as well and those are the areas that I think, there is one or two others but that’s the top priorities for us.

All right, great. Thank you so much.

Operator, next call.

Thank you. [Operator Instructions]. The next question is from Jerry Herman of Stifel. Please go ahead.

Thanks, good morning everybody. Nate, I was wondering if you give a little color on the pipeline, inclusive of some of the other states you have mentioned last quarter such as Texas, Michigan, Georgia, Minnesota and likewise maybe just an update or a progress report on Agora if anything is new or different there?

The pipeline for new states has not changed dramatically from last quarter. These things take a while to build up although there is one new development and that is in the state of Alabama. There is a new law which we think will open up opportunities. I don’t think it will open an opportunity for this coming school year but the school year afterwards we think that there maybe an opportunity to open a school in Alabama. There is a lot still work to be done there but the states that we mentioned before, are all still the states that we believe are opportunities. We do think that second schools and third schools within the state is likely, the higher growth pattern than brand new state although there is one or two brand new states, the larger pattern is going to be second and third schools within a state and building out counties in the State of Florida, that’s another one that we still think is an opportunity to grow. We know that Florida we won’t be opening schools this year but we will, we’ll have at least two and maybe three schools that we think we will open in Florida in the following school year, schools year ‘16-‘17. So I think second schools in a state as well as schools that are dedicated to this career readiness concept that I talked about as well as schools that are dedicated to athlete students are all going to be opportunities for us which will allow each schools to be more focused on what its particular niche is. So that’s what we see coming in the areas of new business development. Tim is going to address the Agora question for you.

Hey Tim.

Hey, Jerry how are you? On Agora we continue to work very closely with the team there to ensure continuity for the coming school year. The systems integrations work that was necessary for our systems to be able to hand off data to theirs has been completed. We are working to transition the enrollment process, so that when our contract comes to the end on June 30th that there is a seamless process to continue enrollments. We continue to perform marketing for Agora up to June 30th as well. So we are committed to their success going forward and to being a customer of ours in terms of their consumption of our curriculum and other support services.

Okay, and the financial metrics, in the transition look similar to previously described in terms of the impact, the negative impact on ‘16?

Yes I think as we previously talked about the only real unknown is the level of enrollment that the Agora School will ultimately have but yes the overall economics are as we have previously described yes.

And then just one quick follow-up if I may, the institutional software and services business as per the release shows a 16% increase, I guess sort of a two part question. I know that you guys have transitioned the revenue model in that business and that’s been, let’s call it dilutive to growth, can you talk about what, if that is now normalized and what is sort of the run rate on that business?

Hey Jerry let me take the first part of that and James may jump in as well. Historically as we reported the institutional business it was a combination of what we are now reporting in software and services. It also included our full time student programs. Those full time student programs as you have suggested have been now -- are being reported under this category called non-managed schools. So the results, as normalized both me and James commented on the 34.8% growth is looking purely at the software and services growth this year versus last year. The FTS business obviously is growing at a slightly less rate but still, I am sorry FTS being our full time students program, is still growing in a double-digits range.

Yes, so I think Jerry the only thing I would add to what Tim said is I do think that we are now -- we sort of lapped some of the transitions that we previously talked about in, I think last year and the year before and so I think that the run rate you see in that line item is pretty indicative of sort of a normalized run rate.

Great, thanks guys. I turn it over.

Operator, are there any other questions?

We have no further questions at this time.

Okay, well I appreciate everybody’s time this morning and hope you guys all the information you needed to understand our results. And again we are very pleased with our results and I thank you everybody for your time. Operator I think we are finished.

Thank you ladies and gentlemen this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.