Greetings and welcome to the K12 Fiscal 2016 Fourth Quarter Earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Mike Kraft, Vice President of Finance. Thank you, sir, you may begin.

Thank you and good morning. Welcome to K12’s fourth quarter earnings call for fiscal year 2016. 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 2016 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 Stuart Udell, 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 Stuart. Stuart?

Thanks Mike. Good morning everyone and thanks for joining us on the call today. As noted in our release issued this morning, we ended fiscal 2016 with revenue for the year declining 8% year-over-year to $872.7 million. Operating income for the year was $13.9 million, declining $4.5 million from the prior year. Excluding the net impact of the settlement with the California Attorney General, operating income would have been $21 million. Capital expenditures were $71.2 million for the year. The majority of capex went towards upgrading our technology platform and curriculum to dramatically improve the student online learning experience. Notably, we produced $50.6 million in free cash flow and ended the year with nearly $214 million in cash. We achieved this while investing $20 million for the acquisition of LTS last quarter. These results, adjusted for the impact of the settlement, are in line with the guidance we gave you last fall. Performance for each quarter and for the full year consistently met or beat guidance we provided. Now let me turn to some commentary on business operations for the year. First, in our managed public school programs we continued to execute on our objectives to improve student retention. We ended the fourth quarter with student enrollment almost equal with the year ago quarter. The improvement equates to more than a 150 basis point increase in our in-year student retention rate. This reduction was not the result of a single event but part of a multi-year effort to attract and retain students who are most likely to succeed in an online environment. As part of this effort, we continued to invest in our Students First portfolio of programs. This year, we rolled out these programs to 19 schools, representing about 50% of all students attending our partner schools. The programs…

Thank you, Stuart, and good morning everybody. Let me start with our reported results. Revenue for the quarter declined 6.1% from the year ago quarter to $221.3 million. For the year, revenue was $872.7 million, down 8% from fiscal 2015. For the quarter, operating income was $510,000 compared to an operating loss of $16.3 million in the year ago quarter. For the year, operating income was $13.9 million compared to $18.4 million for the fiscal 2015. As you saw in our press release, our operating income for the quarter and the year included a settlement with the State of California, resolving all claims related to the Attorney General inquiry. The company took a net charge during the fourth quarter related to this settlement of $7.1 million. This is comprised of $2.6 million of settlement payments, $6 million to defray the cost to taxpayers for the Attorney General’s expenses, and $1.5 million of insurance reimbursements. Excluding this cost, we would have reported operating income of $7.6 million for the quarter and $21 million for the year. This is in line with our guidance for the quarter and for the year. For comparison purposes, if we looked at 2015 excluding the $28.4 million in charges reported in the fourth quarter of that year, our fiscal 2015 operating income would have been $8.9 million for the fourth quarter and $43.7 million for the year. I’m going to exclude the impact of the settlement and investigation costs for this year and the charges booked for 2015 when talking about expense and profitability numbers. This should provide you with a clearer picture of the underlying trends in our business. Revenue for the quarter was $221.3 million, a decrease of 6.1% versus the year ago quarter. For the full year, revenue was $872.7 million, which represents…

Thanks James. Donna, we’d be pleased to answer any questions.

[Operator instructions] Our first question is coming from Corey Greendale of First Analysis. Please proceed with your question.

Hi, good morning everyone.

Morning.

Congratulations on a nice end to the year. I mostly had a few numbers questions. So first of all, is LTS, I assume that’s in the institutional software [indiscernible], is that right?

Yes, that’s correct, Corey. Since we closed it late in the year, it was really immaterial. As you know, the way the accounting works, the deferred revenue gets written off in things like that, so it was really immaterial in both revenue and profit for the year.

Okay, so you kind of pre-empted my next question, which is the improvement in growth in institutional software, so it was not driven by LTS. Can you just comment on the change in the trend there, and whether you think the better growth is sustainable?

Yes, so it is—correct, it is not really attributable to LTS. We think the growth in our institutional software and services business will continue to be a little bit lumpy, but as I think Stuart mentioned, we are investing behind it both organically and inorganically. I think we’re going to continue to see growth into next year and beyond, but we’re not really, I think, ready to put a precise range of that growth right now.

We’ve also worked to build and structure our sales organization to support better growth moving forward.

You may not know this off the top of your head, but what percent of that business is now annual subscriptions versus more site licenses?

Within institutional software and services, we’ll do almost half of annual license business now.

Okay, all right. Great. Then there were a couple things that James you talked about relatively briefly. I just wanted to follow up on the point about funding levels in newer states in 2017 being below average. Should our expectation be that revenue per enrollment in managed will actually be down next year, or are you saying lower growth?

No, I actually don’t think it will be down, Corey. You know, we had some pretty heady growth and revenue per enrollment over the past few years. I just want to be careful that I think the overall environment continues to be positive, but given just that mix, we will sort of mix a little bit into some of these—you know, Stu mentioned a number of states, like Alabama and things like that, where those states just do have slightly lower than average revenue per enrollment. So I still think we’ll get some gains, I just think it’ll be much more muted as compared to the past few years.

And of course, we’ve had success historically entering new states and improving the per-pupil funding over time, so that’s of course something we’ll be working hard to try to accomplish.

Understood. I think you also said something briefly about doing some things to increase profitability versus enrollment. Hopefully you know what I’m referring to, but could you just elaborate on that?

Yes, as you know, in our non-managed side of our business, we have an enrollment side of that business as well. We’re increasingly looking at our portfolio, just as we have consistently over the past couple of years – you know, we closed down the U.K. this year. We’ve done it more at sort of a structural level at the U.K. business. I think we’re going to continue to dive deeper down at the contract level and things like that, and just make sure that we’re not adding enrollments for enrollment sake. So I think we have some contracts that probably are unprofitable for us, and I think the top line enrollment number is not what we should be shooting for. We should be shooting to improve profitability overall, so in the non-managed enrollment business if that is somewhat going to compromise the enrollment numbers, we’d rather take that. We want to improve retention, we want to talk about ensuring that our marketing for those programs is efficient, so I think there’s a number of things involved in that, but just like the managed business, it’s not enrollment for enrollment sake. In the non-managed business, it’s not enrollment for enrollment sake, it’s also to look at profitability, retention, efficiency, those kinds of things as well.

Okay, and on the non-managed, can you give – and I apologize if you gave this already – some sense of what the increase in what you’re doing for Agora, what the impact of that financially will be in fiscal ’17 versus ’16?

Yes, so sorry – we haven’t given that. We’re still working through it, because with Agora, it is obviously a fluid situation and somewhat unique. It will be a positive. It’s hard to cite at this point because we actually don’t know what the enrollments are going to look like, and because we haven’t managed those enrollments for a while, everything from re-enrollments or re-registration through the next year and the arc of enrollments through the summer and the fall is still uncertain. So I think there’s a fairly big range on what that Agora improvement could be, so I think at this point it’s a little early to give any guidance on that.

Okay. One last one from me, and I at least have to try to ask this. As we’re going into the next school year, any sort of preliminary indications of how the enrollment season is going?

No, it’s still very early. We’re not even halfway into the season. It’s very early still in our trajectory.

We’ll certainly talk about it enrollments on the first quarter call.

I get it. I’m just contractually obligated to ask. All right, great. Talk to you soon. Thanks.

Thanks Corey.

Thank you. Our next question is coming from Jeff Silber of BMO Capital Markets. Please proceed with your question.

Thank you. My contract makes me follow up from Corey’s questions. In terms of the new schools that you cited coming up next fall, are there any caps that we need to be aware of, or are they going to be typical new schools in terms of first year of enrollments?

There are no caps on many of those schools. I believe that three have caps in place—four, so four of the 13 have caps in place.

Can you just remind me what the typical enrollment is per school in the first year?

Yes, I think Jeff, you’ve got to remember, a number of those schools are in states where we already operate, so normally in a state like North Carolina, which was just virgin territory for us this past year, we have a three or four-year trajectory of growth that will go into the thousands, right. Also remember, North Carolina is also capped, but that cap does allow us to go over a three to five-year period, upwards of 5,000 enrollments. So that would be a typical trajectory in a state like North Carolina. Maine – different, right? It’s a much smaller state, much smaller enrollments, so we only had a few hundred there, but in many of the schools, as Stuart mentioned, where we already have an existing school, the growth trajectories are much smaller than, say, like North Carolina, so there’s no quote-unquote typical, as you know, but there would be more in the hundreds range than the thousands range, certainly.

Okay. From an upcoming elections impact, I know it really depends on each state and sometimes each local district. Anything at a high level that we need to look out for in some of the states you’re operating in, or some of the states you might be entering?

Well, I certainly think that this is a state-level business, so we’re not particularly concerned about the federal election. The ESSA framework reinforces that this is a state business effectively, so we don’t really—we’re business as usual.

So nothing on the agenda in terms of new caps coming on board, or caps being taken off?

Not that we’re aware.

No, not that we’re—the only thing, Jeff, which is—you know, the caps I’d say are the caps, meaning that the state sets them. That’s all publicly available information. But you know, you also have to remember we work with our boards, and we really—the boards often run schools where they impose caps as well, because they want to ensure growth doesn’t get out of hand, we run very strong academic programs, et cetera. We can sort of build into our growth the infrastructure and the teachers, et cetera. So for us at least, I think the structural caps by the state are one component. The boards and working with boards—you know, they have often not hard and fast caps. They give us some guidance ranges, sometimes they say let’s look at it during the course of the year as well. There’s economics behind in-years as well, so it is very, very fluid but I think that there is in general across the board, I don’t think we’re currently worried about the election year having a big cap issue for us, so I don’t know that that’s really the issue.

Okay, that’s helpful. I know you’re not giving official guidance for next year, but can you tell us what we should be expecting for our capital expenditures budget, and how will the new disclosure on capex compare to fiscal year ’16? So for example, if you were disclosing capex the way you are going forward in the year that just ended, what was the number on fiscal ’16? Thanks.

Good question, Jeff. So what it will do is going forward, the capex number—well sorry, yes, we’re not giving guidance for next year, but I would tell you if you looked at the trajectory over the past few years, we’ve sort of been in that $70 million to $75 million range. This year, the $71 million would have actually been sort of down to $61 million, $62 million range. On that basis, I don’t think that we’re looking to dramatically increase capex levels in next year or years beyond.

Okay, fantastic. Thanks so much.

You’re welcome.

Once again, that is star, one to register any questions at this time. Our next question is coming from Alex Paris of Barrington Research. Please proceed with your question.

Good morning, this is Chris Howe sitting in for Alex Paris.

Morning.

Good morning. Can you comment on how the integration of LTS and the core Stride Academy is going so far compared to your internal expectations, and when would we be able to see a meaningful impact from this? In other words, when do you see it being a driver within the software and services?

Sure. So far, the integration has gone very well. We have done a fair bit of work around marketing and sales integration. The teams are working well. We’ve done a fair bit of cross-training. Of course, we’re really entering a new sales year or sales cycle, so we haven’t seen huge returns yet, although we’ve had certainly some nice deals happen along the way, so that’s been good. From an operational perspective, we’ve maintained our little operation down in Arkansas and are communicating very closely with the team. We also have engaged in a collaborative product road map, so some of the work around adaptation and gamification that’s been done at LTS over the years has already been shared and integrated with our core business. We’ve also done some fun little projects, so for instance we launched in very short order a gaming and coding academy in Ohio on a pilot basis over the summer and had about 45 kids engaged in that program, so we’re starting to really share the tools across the business in a lot of ways. But generally going, the integration has gone very, very well. In terms of driving meaningful impact, we’ll be—we’ve kind of trained up our inside sales team. We think this is a great product, a great point purchase product at the price levels it’s at, and we certainly expect to see significant increases in adoptions over time.

I think one thing just to keep in mind is for fiscal year ’17 specifically, again just because of the way the accounting works on the deferred revenue when we acquired the business, we really won’t see any meaningful contribution to profitability certainly in ’17, and even the revenue impact gets muted, again all sort of through the accounting of it, not through the underlying business trends. So I think starting in fiscal year ’18, though, assuming the business grows as Stuart indicated, you will see some more meaningful growth in ’18 out of that, but it’s fairly muted in ’17 because of the accounting impact.

The other thing I’ll just say is we like LTS as a product entrée, not only because of its price point but it covers all grade levels, all subjects, and that’s going to help us expand the conversation for our sales team in the Fuel Education organization.

Thank you for the additional color, that’s very helpful. My next question is in regard to LearnBop for families, if you’d be able to provide some general overview on this product and what it exactly could mean for expanding your portfolio within the math skills arena.

Yes, I think I mentioned a little bit earlier that we see some interesting things in the private pay side of the business, and LearnBop for families, which is the consumer product, it really falls within our private pay business. We think that we have some really interesting assets that translate really well into the consumer market, and with very minimal investment we think we can pivot some of those into the consumer market. LearnBop is one of those that we’ve done an early pivot on. It’s being used internally throughout some of our managed schools as well, and so we see both internal use as well as that consumer product. But this literally was launched within the past few months, it’s early days of traction, and again very little investment, so I think that consumer piece of the business, some of these digital assets we will continue to see as we test the market on whether those consumer assets can gain some traction.

The other benefit of launching a consumer version of LearnBop is particularly in the math areas, it helps avoid some summer slide, and it’s a way to, you know, we hope over time as we experiment, improve retention on a year-over-year basis.

Thank you. One last one from me. It may be too early to provide, but what kind of cash flow impact are you anticipating from the investments in Summit?

I think on a cash flow basis, for fiscal ’16 at least, we invested a lot of money in Summit in ’16, getting ready for the ’17 launch. It was sort of just built into the overall capex numbers, and I think our capex, as I said, we don’t anticipate any dramatic increases in capex. So I don’t think that there is a—I don’t think that the trajectory of capex is going to change much, and therefore the trajectory of our cash flow shouldn’t be impacted dramatically from Summit either.

Thank you.

Thank you. At this time, I’d like to turn the floor back over to management for any additional or closing comments.

Thank you for spending time with us today. We look forward to talking to you on the first quarter call about enrollments and guidance, and until then enjoy the summer.

Ladies and gentlemen, thank you for your participation. This concludes today’s teleconference. You may disconnect your lines at this time, and have a wonderful day.