Stride, Inc. (LRN) Q1 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the K12 Fiscal 2016 Guidance 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 your host, Mr. Mike Kraft. Thank you, Mr. Kraft, you may now begin.

Thank you, and good morning. Welcome to K12's Fiscal Year 2016 Guidance Conference Call. 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 guidance 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 on the Investor Relations section of our Web site at www.k12.com. This call is open to the public and is being webcast. The call will be available for replay on our Web site for 30 days. With me on today's call is Nate Davis, Chairman and Chief Executive 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?

Good morning. I want to thank everyone for joining us on the call today. This morning we want to provide you with an update on our fiscal year 2016 count date enrollment as well as our financial guidance for the full year. For fiscal year 2016, we expect revenues in the range of $830 million to $865 million, and this is about 9% to 12% below our reported revenues for fiscal year '15. As we've discussed in the previous quarters, this year the Agora Cyber School in Pennsylvania has shifted from a managed to a non-managed program. And as such, the declines in our enrollment, revenue, and operating income guidance for the year are largely attributable to this change. Excluding the impact of the Agora transition, we actually see underlying revenue growth of up to 3% year-over-year. Some of that growth is coming from improved revenue per enrollment. Now, the revenue per enrollment growth is resulting from a combination of factors, including school mix, and improved funding environment in some states, and other variables. It's important to note that our guidance today is very much a reflection of our multiyear strategy to help our school boards find students who will persist or retain and stay longer, and succeed in an online environment. We've partnered with our boards to determine very specific enrollment targets for each school for the objectives of that school. Some school boards chose to grow enrollment, while others did not. Our enrollment season plan was to increase lifetime value for every student over time by focusing more heavily on student persistence or retention, and effective management of the marketing cost per enrollment. And there are very early indicators, internal indicators that our retention efforts are beginning to show promise. Over time, an increase in student persistence should have a positive impact on our financials. Let me give you some color on the results for this season so far. For the majority of our partner schools, enrollment remains relatively flat. 14 schools increased by more than 200 enrollments, including those schools in Indiana and Arkansas just to name a couple. Other states where schools that just launched this year, for example, North Carolina, Maine, Colorado, Minnesota, all performed well. However, the change in the Agora relationship coupled with events at three schools resulted in overall decline of nearly 12% in our managed public school enrollments year-over-year. Four schools alone resulted in an enrollment decline of over 4000 students year-over-year. So the takeaway here is that these declines were not across the board. Overall, enrollment at the majority of our partner schools were relatively flat to increasing. Now, going forward, we believe the demand for managed public programs will continue to grow, and we're already working with partners and authorizers in states like Alabama, Nebraska, Connecticut, Pennsylvania, and Missouri to open online charters. At the same time, we're working with independent school boards to open management for blended programs in states like Wisconsin, New Mexico, and Maryland. While these efforts may take some time, we believe the demand to provide new educational choices for students will continue to increase. Now, before moving on, I want to mention that our institutional business, FuelEd continues to see increases in demand from school districts or other educational services and software services that we provide. We believe this demand will translate into double-digit revenue gains year-over-year for our institutional software and services business. Now, turning to operating income, we expect operating income in the range of $23 million to $17 million. This is in line with consensus expectations that we've seen. Importantly, even with lower enrollment, we plan to achieve revenue growth, excluding the impact of Agora, and deliver operating income between $17 million and $23 million. Regarding capital expenditures, we expect to invest in the range of $70 million to $80 million, and this will include curriculum and software development, student computers, and infrastructure costs. This year, we will continue to update our learning management platform. We successfully implemented a new high school platform this year, and we will move to update the middle school platform next year. And lastly, our tax rate is expected to be approximately 39% to 41%, which is in line with our effective rate for fiscal year '15. In closing, I want to be clear that our number one mission will always be to improve the academic outcomes for all students we serve. At the same time, we are keenly focused on establishing an efficient business model, which produces consistent growth in earnings over the long-term. That strategy includes maximizing the lifetime value of each enrollment, while we manage the school through a focus on retention, revenue per enrollment, and cost of enrollment. And we also want to continue to focus, of course, on higher growth in our institutional business. Now, before we move into your questions, I wanted to mention something about our first quarter earnings date. It's going to be October 27, just 13 days from now. Beginning next year, we will combine our guidance release with our first quarter earnings release. In prior years, we'd been releasing our earnings in mid November. And with our counts date in early October, the entire investment community focuses on enrollment growth. In the past, the company didn't want to wait until November to share the status of those enrollments. Therefore, we released guidance in early October. However, we now release earnings in late October, which is much closer to the count date. Also our focus is more squarely on total revenue and operating income, not just enrollment growth. Therefore, going forward, we will combine the announcement of annual guidance with the first quarter earnings. Thanks everyone, and we can now move to Q&A. Operator, who's our first question from?

Thank you. [Operator Instructions] Our first question comes from the line of Corey Greendale with First Analysis. Please proceed with your question.

Hey, good morning everyone.

Good morning, Corey. How are you doing?

Good. So, Nate, I was hoping you can elaborate on what you were saying about things going well broadly, issues at some specific schools, I think you said 4000 student impacted four schools. If I'm getting those numbers wrong, correct me, but can you just talk a little bit about what those issues were?

Sure, and you have it right. The four schools amounted to the entire decline from last year to this year. Four schools amounted to that entire decline. And while our schools don't like us to talk about their specific names on earnings calls, because it just draws attention to that individual school and they've got their own set of things they like to deal with, I can tell you some things that are public. For example, you know that Tennessee -- in Tennessee, the Department of Education has asked that the school not take on new enrollment, and we resolved the fact that the school needs to stay open. But even while staying open, the school cannot increase enrollments. As a matter of fact, it declined enrollment year-over-year. So, we have that situation. We had another school that had an academic situation where it decided that it wanted not to grow enrollment to make sure that they were focused on their academic achievement. So they actually shrunk a little bit in enrollments as well. So, those are the kind of situations we face that I mentioned.

And maybe can you just elaborate on -- you sort of called those out as specific issues. Why -- if you look at the whole basket, why would similar things not happen in the future? In other words, why are those sort of outliers that we would expect not to see those kinds of things again in 2017, or maybe we would?

Well, I think we will always have some set of schools that were new and opened up. And if we didn't get it right, then they may go through some troubles. But I think the number one thing I will say to you is there is a lot more focus in the last two years at our company on making sure that we do a better job when we open schools, have the proper staffing, proper focus on academics results. So I think number one -- that's the number one reason why you won't see this. These schools that I just talked about, for example, Tennessee, that was -- it was opened in a timeframe when we were candidly more aggressive about growth. And unfortunately, the school -- the leader of the school just didn't do the greatest job. I think we are doing a better job of that today; better job of supporting the students that come in and opening up these schools in a great way. I am very pleased, for example, with North Carolina. The leader in North Carolina, and the approach we are taking, and the cooperation with the board, I believe we are going to run a great school there; same thing in Maine. So I think we are going to see less of this problem going forward. The issue that could bite us is that the standards in every state are changing. They are going to new assessments. And so, we could in fact open a school, and the assessments change. And when the assessments change, we run into that problem. But in general, I think we have better programs to support our academics. We have been more focused on great outcomes of students. We have better teacher programs and teacher support tools. But I think we are going to experience less of this problem in the future.

Okay. Then, next question, I know you don't want to talk about individual schools, but I was hoping you might help us understand what the impact of the Agora switch was, like what -- specifically how much that impacted the managed, and helped the non-managed?

Yes, James has gone through these numbers before, but I think he'll just go through them again, James. And if everybody asks the question we should always help them understand economically what happened, so …

So, Corey the -- I think when we've talked previously to you, we have sort of outlined a sort of a generic case where if Agora has a little more than 10,000 enrollments, and that translates into about $127 million, and clearly half of that is going away just through the teachers, not just [indiscernible]. We've also lost a number of the other components of the revenue. So, to put it a little more specifically, and some of this information is in our release. The revenues for this full year will actually net out to be about $110 million less this year than last year. Last year was -- the actual last year 2015 was about 130 million. And so, the full year impact is about 110 million. We don't break out the operating income impact of Agora just because we have sort of a network effect of how we run our schools. And therefore, getting a direct operating income from Agora is not really an exact science anyway, so -- but on the revenue side of it, I think one thing that did impact us was we were anticipating -- and when we had talked to you previously about the Agora impact for coming this year, all the numbers that we described were sort of on an apples-to-apples, assuming enrollments stay flat. In fact, the actual net enrollments that we actually delivered to Agora this year were lower than last year, so that also had a negative impact to us.

And actually, that is all helpful. I was trying to get it more specifically, that last point, if you can help us understand the enrollment impact. Like in other words, just –- essentially, I was asking how many students are in Agora, so we can understand the underlying impact of Agora shifting from it [ph].

Yes, so let me answer the question in a couple of different ways, and I think hopefully this will give you enough information. So, in Agora, specifically in the 10,000 enrollments we had last year, we have -- and because we don't manage their enrollments anymore, so the way that the enrollments will, I will say sort of pan out through the year will be in fact a little bit different, just because we haven't managed through all the -- I'll say the returns and everything like that, but relative to last year's 10,000 and change, the enrollments that we service this year will be down a little over 30% year-over-year.

Okay, all right, that helps. And then, just one last quick one for me; what are you assuming for revenue per managed and non-managed enrollments in the guidance?

So we have revenue per enrollment that's going to be up basically a few percent year-over-year.

In fact, that's in the managed program?

That's right.

And what about non-managed?

In non-managed, it's essentially flattish.

Okay, great. Thank you.

You're welcome.

Thanks, Corey.

Thank you. Our next question is from the line of Jeff Silber with BMO Capital Markets. Please go ahead with your question.

I wanted to focus on the seasonality of the business. Historically, the revenue number that you've reported for the first quarter, if you analyze it, you get roughly what you end up reporting for the entire year. In looking at your guidance, if I just take the midpoint of the guidance for the first quarter revenues and annualize that, it's actually short of where you are guiding for the fiscal year. Is there something going on from a seasonal perspective that's different this year than prior years?

Not really, not dramatically, and I don't think it's that far off. But we had in -- probably the biggest difference would be -- and this is somewhat Agora-related as well, because we recognized -- we shipped a fair bit of material, so there's some seasonal shift. There is a lower mix of Agora materials that we shipped this year. So that will sort of bring down the Q1 a little bit. There's probably a lot of other puts and takes, but there is not a dramatic shift, I don't think.

Yes. And My guess is it's probably the puts and takes, because if you are bringing down Q1 a little bit, that would actually justify my point. But we can talk about this off-line.

Yes, why don't you give me a call, and we can go through that detail.

Okay, [indiscernible].

The second question deals with your operating income guidance, just sort of a follow-up from the first question. So you're looking for revenues down. I think we are understand that on a year-over-year basis, but operating income relatively flat. Which line items on the income statement do you expect to see the leverage, so to speak?

Yes, most of the leverage is going to come from the general and administrative expenses.

Okay, great. And then one other -- I'm sorry, one other revenue-related question. The international private pay business, what's incorporated in your revenue guidance for the year?

The international private pay will grow year-over-year.

It's modest growth though.

Yes, it's sort of in the still single, upper single digits growth.

Okay, great. All right, thanks so much.

Welcome.

Our next question is from the line of Timothy Holly with Red Alert Group. Please go ahead with your question.

Good morning. This is for Nate Davis I guess. Will the shareholders benefit from a new strategic plan? And if a new strategy exists that would maximize shareholder value and maybe allow the Company to go public, would exploring that option be in the best interest of its shareholders?

Hi, Tim. The answer is we are on a new strategic plan. And new strategic plans unfortunately take multiple years to implement, and not one quarter. So if an investor is looking for a quarterly difference in plan, they are not going to see it, because we're in an annual business. The education businesses fortunately or unfortunately is a business that you go through an annual cycle of enrollment of students, and then evaluation of those students, and helping them with their academics throughout the year. The new strategic plan I'm talking about is that the company has changed over the last couple of years from a company that drove a lot of enrollment growth in the managed public schools business, and had this nascent business called instructional -- I'm sorry, called institutional. And what we've done is we've had more focus on growing the institutional business, and even some growth in the private pay business while we focus more rapidly on making sure the schools are getting great academic outcome. We think the long-term reputation of the company and the support we'll get from policymakers will all come from making sure that we do a great job of educating our students. When you do that, you get a better reputation, you get a better support from the students, you get better referrals, you get better retention, and all those things would change the economics of our business. So that's what we're in the middle of doing today. And as I said in the script earlier, we've seen some early signs that that's working. We are getting a lot of positive feedback from our boards. We're getting a lot of -- a little bit better retention, and those things will allow us to have a better long-term business. And that's the change in strategy we've embarked on in the last couple of years. And I think shareholders will benefit from that. But this is going to require some patience, because it won't happen in one quarter.

(Technical difficulty) K12's founder Ron Packard (technical difficulty) private company had any impact or influence on the company, particularly like for example in the national area?

No, as long as we are not working with or have any arrangements with Ron Packard other than we do license curriculum to them, but other than that his business is his business, and he is not involved in the K12 business.

And specifically, internationally our businesses don't overlap, and we have a very small international footprint. So there is really no -- there is no issue internationally either.

Thank you very much.

Thanks.

Thanks, Tim.

Our next question is from the line of Corey Greendale, First Analysis. Please go with your questions.

Hey, thanks for taking this, two quick follow-ups. I realize after I hung up that, on my last question I asked you -- you said that you are assuming revs per enrollment up modestly in the Managed Programs, but I thought there was a somewhat meaningful negative impact there from Agora coming out of that mix. Can you just clarify that?

I'm sorry. Excluding Agora, it's up modestly. Including -- all entities down, yes. I apologize, I should have been clear. My comments were pro forma, but we try and look at it on a pro forma basis. So, we apologize.

Okay, no, I should have clarified. And as far as how much down, like, is mid single digits on a reported basis reasonable?

On a reported basis it will be down I think upper single digits.

And the other follow-up is in fiscal -- in the last fiscal year, you did a good job of keeping cash flow from ops relatively constant, even though results were -- the GAAP income statement results were down. Can you give us a sense of what you think on cash flow from ops, their free cash flow will be in?

I think we're going to – we're trying to trend towards here as having a similar profile of free cash flow -- the pass-through of operating income to free cash flow as in previous years on an as adjusted basis.

Okay, all right. Good, thank you.

You are welcome.

Thank you. And Mr. Davis, there are no additional questions at this time.

Okay. Well, thank you everybody for your time this morning. This was a short call, because it was only focused on guidance. We do have our earnings call coming up in a couple of weeks, and we look forward to talking to everybody about first quarter results at that time. Thanks everyone.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.