Greetings. Welcome to K12 First Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the conference over to your host, Mike Kraft, Head of Investor Relations. Thank you. You may begin.

Thank you, and good afternoon. Welcome to K12's First Quarter's Earnings Call for Fiscal 2020. 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. These statements are made pursuant to the Safe Harbor's provisions of the Private Securities Litigation Reform Act of 1995. They 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. These reports include, without limitation, cautionary statements made in K12's 2019 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 on 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 of the Board; and James Rhyu, Chief Financial Officer and President, Product and Technology. 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. Good afternoon, and thanks for joining us on the call. Today I want to provide you with some details on our fiscal year 2020 [ account date ] enrollment as well as our guidance for the full year. I'd like to start by thanking the entire K12 team for such a great year. Outside of having a large school in Georgia decide to go to self-management which, as we've previously announced, dampened our enrollment growth, this team is driving excellent progress on so many fronts. Specifically, on enrollment, our Managed Public School business grew to 122,300 students. This is an increase of 3,500 students or 2.9% year-over-year. Importantly, this marks the fourth year in a row that we've seen enrollment growth in our Managed Public Schools business. Without the impact of the GCA board decision, our enrollment growth would have been even stronger. In fact, enrollments would have increased 14,700 students instead of 3,500. And this would be up from 11,100 students in the prior year. This is an increase of more than 32% year-over-year. It's also the highest absolute enrollment growth we have posted in the last 7 years. Importantly, enrollment growth was not concentrated in one school nor in one state. We saw growth in more than 80% of the states in which we operate in fiscal '20. It's also worth noting that nearly 50% of the schools posted enrollment growth of more than 10%. And our new program in Alabama, Florida, Texas, Missouri and Ohio also helped as they comprised a little more than 1/3 of our enrollment growth. These results underscore the enrollment growth, we posted over the last few years, were not a temporary phenomenon, rather they are a clear indication that the market demand for online and blended learning options continues…

Thank you, Nate, and good afternoon. First, a recap of our reported results. Revenue for the quarter was $257.1 million, an increase of $5.8 million or 2.3% from the prior year. Our loss from operations was $19.4 million compared to $13.8 million in the prior year. And our adjusted operating loss was $13.9 million compared to $9.7 million. Capital expenditures for the quarter were $16.9 million versus $17.7 million last year. Revenues for Managed Public School Programs increased to $227.5 million or 3.2% higher than a year ago. The increase was largely a result of the 2.9% increase in student enrollments. As Nate mentioned, we're encouraged with the enrollment growth and broad-based demand we saw across the schools and states. Over 80% of the states in which we operate saw enrollment growth, and we believe that this growth reflects the ongoing macro trends of greater acceptance of online education as well as demand for our Career Readiness educational offerings. Revenue per enrollment for the quarter was largely flat. We continue to see a positive overall funding environment in fiscal '20, however, for the full year, our revenue per enrollment will be somewhat pressured by school mix. As we previously highlighted, when states open, we see revenue per enrollment that is often below average. Over time, we work with the schools we support and the states to increase per-pupil funding. This year, we are indexing a little bit more in newer states such as Texas, Florida, Missouri and Alabama where funding is below average. And given our mix and the current climate, we believe per-pupil funding levels will be flat plus or minus a couple of hundred basis points for the full year. In our institutional business, revenue declined 7% on a year-over-year basis. Non-managed Public School program revenues declined 16.1%…

[Operator Instructions] And your first question comes from the line of Alex Paris with Barrington Research.

This is Chris Howe filling in for Alex Paris. Congrats on the quarter. I have many questions here for you, but I'll just start off with a few then I'll hop back in the queue. Can you talk about the cost structure in the quarter more specifically, the early investments in schools, that you mentioned, to assist them with onboarding? Is that just more of a timing for expenses? Or how should we look at those investments and the return that you're seeing thus far?

Yes. I think -- so we test various things every year. This year, we invested a little bit more in the first quarter on a -- sort of, a one-off basis and not really a shift in timing but it's more on a one-off basis. On onboarding students, we find that the better students onboard on to our programs, the better they retain, and obviously, there's a long-term financial benefit to them retaining, there's also a long-term academic benefit and outcomes benefit to them to retaining longer. So we invested in some programs to essentially help kids get onboarded, better, easier, help them with their set up, et cetera. So really, incremental in some respects, not a shift, we would not expect to see that shift out of other quarters.

Got it, got it. Okay. And then Nate mentioned, the lead volume that was strong in the quarter reaching a high point. How should we think about these leads coming in, as you look at growth in 2020, about the current capacity and your ability to handle inflection?

Chris, this is Nate. Yes, I did mention that the leads have made it up to 385,000 leads this year and that's up from previous years. We have not seen a deterioration in our conversion rates on leads to applications, that's when a student applies or into a student actually entering a school. So the way to think about it is obviously is the top of the funnel, the more leads we have and keeping the conversion rates the same, the more enrollments we have. So from a capacity point of view, it does cost us a little bit more in enrollments in order to process these students if we get more leads. But on a profitability basis, the return on that investment is strong. And not only the return on investment but the incremental cost is not nearly as much as incremental students. Now some of that happens because you open up new schools and some of that happens because of the Destinations Career Academy. But we are seeing greater leads as we market these academies and market these schools.

Okay. That's helpful. And my last question is on Career Readiness. You mentioned your expectations of $90 million in revenues in 2020. And then $200 million over the next 2 to 3 years. As we look at this outlook and consider your part-time programs versus your full-time programs, how should we consider the mix as we move 2 to 3 years out in regard -- and in regard to revenue and margins for part-time versus full-time?

Well, I think for now the best thing to do is to treat all of the growth that we're talking about is coming from the full-time programs. The part-time programs are brand-new. They're nascent. They are small at this point in time. In 2 to 5 states, and it's only a few hundred students. We started it in Wisconsin and we'll be going on to few other states. I think from a volume point of view, you should think that all of the enrollment is coming from the full-time, we will report out next year this time, and say, how well the part-time programs are doing, that's the way to think about it.

Okay. And maybe, just a bookkeeping. You mentioned the adjacent could be adult learning, corporate training and international. That's additional upside, none of that's factored into the next 2 to 3 years for Career Readiness. Is that correct?

Yes, that's correct. All of those are upside and opportunities we see in the market.

Our next question comes from the line of Corey Greendale with First Analysis.

Congratulations on the strong fall intake. I have a few questions. Do you -- is your sense that the good results are -- how much of that is because of just the market getting more sort of comfortable with online programs, so how much of it is market growth versus how much is you taking share from other providers?

Yes, actually, I think that there's a couple of ways I look at that. Number 1, I think, it's really more to do with our growth in Career Readiness, that was sort of the top factor, the more we talk about it the more people are interested in online program. Even if they first have an initial interest in Career Readiness schools, they may find that a general education school is good for them. But I think it's more market growth because of the talk about Career Readiness than it is taking share from others. And I actually can't see yet what others are reporting. So taking share from others, I really can't see that at this point. But if I look over the last couple of years, it's not been share from others that's driving our growth, it's really been increase in the market.

Yes. I was thinking since you shared the data on leads, which is helpful, looking at like conversion rates or anything like that if you're seeing -- I guess you can't necessarily disaggregate whether that is due to market growth or taking share. But anyway, I think you answered my question, so I appreciate that. Second question I had is, on the non-managed, I just want to make sure with some of the things, it sounds like it was entirely due to the folks operating those schools. But is there any -- so is that done and no issue? Or could there be some -- like is there any contentiousness around termination of those contracts? Or is there any possibility someone could come back and say, "Hey, it was the FuelEd that was part of the problem."

I can't see that or the -- without going into the detail because we don't comment on open litigation, but I can tell you that at least 1 or 2 of those parties are under investigation by the state authorities. So it doesn't appear to have anything to do with us. We were just a curriculum provider. But all of the other things they did, how they ran their finances, how they marketed to students, how they accounted for things was all on them. So I don't -- it has nothing to do with us. We just provide a curriculum. So I -- we don't see in any way that this has any impact on us or any -- coming back at us in any way. So no, I don't see that.

And should we assume that Q1 year-over-year trend in that segment continues for the entire year?

Yes. I mean pretty much, you're going to have -- see that flow through the rest of the year because the enrollments that we don't get essentially from them in the beginning of the year, we're not going to bank up through the rest of the year.

Okay. James, I had a question for you. The -- I know that there is seasonality in the cash flow, and this is consistent with that, but it looked like the cash flow was down pretty meaningfully year-over-year, and some of that looks like it's deferred revenue. So could you just -- is something going on with that? Was there some timing issue with getting paid by any states or anything?

No. There was a little bit of timing just in Q4, actually, Q4 bleeding into Q1, but nothing structurally unusual, it was just a little bit of unfortunate timing, that's all.

Would you expect that free cash flow -- or let's just say, cash flow from op for the full year should grow in line with adjusted operating income?

Yes. That's right.

Okay. All right. And then, Nate, strategic question. It sounds like [indiscernible] things are going on at Tallo. You -- I don't think you control that -- I think you are working closely with them. Is there any -- [ do you have them ] locked up at all? Or like theoretically, do they -- others are sort of tackling this market, could they sell to someone else? Or what's the protection against someone else taking advantage or leveraging what they're accomplishing?

Two things. Number one, we have a Board seat and a very tight relationship with them. Number two, we have a path that deals with what happens if they need further investment, and it obviously involves us first. So given our sort of right of first refusals and path to control, we're not worried at all about somebody else investing because we have first look.

And, Corey, the other thing I would say is that we are, I would say, in many respects, encouraging as many people to get on the platform as possible. So we don't really view [ clinical ] competitors. We want their kids on as well. We think it's good for everybody.

Yes. I'm sorry if I misinterpreted that. Tallo is very much -- obviously, the number of students is 500-and-some-thousand students. We're not the majority of their customers. It's really an open market for Tallo. So we want more people to leverage them. I thought you were talking about our financial leverage.

No. That is what I meant. So those are both helpful. And then the last question I had is -- and then I'll follow up is some of the other things you're talking about, Nate, with the Career Readiness, it sounds like some of that is potentially other -- well, corporate training, obviously, is a different source of revenue. But I just want to verify, is some of this -- is it only enrolling students that are of an age that they are eligible for all the revenue sources coming from the state? Or are you getting to other revenue sources today? And secondly -- meaning like workforce revenue or something like that? And secondly, how are you thinking about deployment of capital as some of those other things are clearly adjacent, but I would think they would take a different go-to-market than what you're doing today? And how are you thinking about kind of the gating of that deployment to capital?

Yes. So first of all, all of the funding today is coming from the traditional state funding sources that come to all our MPS schools. We're not tapping on funds from -- let's say, from consumer directly. We're not tapping any of those funding sources. Those are all opportunities for us. As a matter of fact, the part-time schools, we -- as I mentioned before, it's a very small market for us. It started in a couple of states. We want to go to the 5 states, but it's still very small. So you should think right now 100% of that revenue is coming from the traditional state sources that we use for our MPS schools. Now in terms of the opportunity and how would we deploy capital around that, the first step in doing that is in these part-time programs. We are developing a different go-to-market because that's not the same team that develops a new MPS school. We have to go out and work with school districts and work with the funding sources that the school districts have. For example, some of them have innovation funding. Some of them may have career readiness funding. There might even be Perkins funding that goes to their school. We could be a provider of the content. And by the way, that is the institutional business that will be making that sale. So we plan to go-to-market with a whole new approach because it's not your traditional MPS schools. We see -- if we see that working, I intend to just take a look at what we can provide at a college level and what we can provide at an adult learning level. But those are not businesses I'm in today. But what we want to do is build these pathways and build the content and then be able to go to corporation, pick a name of a corporation that has a number of workers that are not college educated and say, "You need those workers to have a better education. We can provide that content." So expertise in programming, expertise in manufacturing, expertise in agriculture or business courses, those are all courses that we can provide to their general employee base. Not the ones that are college degrees and not the ones that are generally advanced degrees, it'd more the ones that are not advanced educated.

Good. And if I could just one more comment, which is it's not easy to identify kind of a new market opportunity and grow that to $90 million in revenue. And the idea made sense on paper, but the fact that it's playing out, as you said, is very impressive. So just congratulations to you and the whole team on kind of laying that out and executing on it.

Thank you. It's -- interesting story. We had some consultants in one time and they told us, "I don't know how you're going to get this done. We really don't see the path." It's obviously working a lot better than they thought it would. So sometimes it just requires vision and focus, and I'm really proud of the team to do that. Thank you.

Our next question comes from the line of Stephen Sheldon from William Blair.

I guess can you talk some about the enrollments that you have now in Career Readiness? And specifically, are a lot of the -- I think you said 13,500 enrollments in these programs, students that have previously been on your platform in some way or the vast majority of these students essentially new to you. And I guess I'm wondering, are you attracting a much different student profile to Career Readiness than you are in most of your existing other online schools?

I'll give -- James, you may have a different point of view, but I'll give you my point of view. First of all, Stephen, I believe that the majority of the students that are coming into the program right now look very much like the students that come into the MPS program. And we're still -- there's still room for us to get what I call a market expansion, right? So students that would never have considered an online school, we still think there's a lot of room to get more of those -- many, many, many more of those students, multiple [ factors ]. Right now, the students that are coming in -- are, for the most part, students that are sort of, hey, I was interested in online in the first place, but now with this career-ready thing, they really get over the hump, allows me to take courses I wanted in -- for my -- what I'm passionate about in life, gives me some confidence. It adds to my initial interest. The students who said I was never going to consider an online school, I would never have considered that, now career ready causes me to consider it. I still think there's a lot of room to get a lot more of those students. So that -- we're early in that phase.

Yes. And I just would add that, we do see a fair number of sort of the internal transfers, meaning kids who are signing up for the normal programs and are transferring over into the career programs. We see that as a good thing because we think that the career programs are more applicable for them, they're better suited to them. So -- but I just want to reiterate what Nate said, like I think the one thing that we didn't do great this year was expand the market for new incremental students. We did a better job of getting the Career Readiness folks into the career schools, but I think that our go-to-market for Career Readiness has -- we're in the first batter of the first inning. We've got a lot of upside opportunity on that. And we'll continue to push that to drive greater growth in the future.

And I'll add one thing to this, Stephen, because it's a pet peeve of mine inside this company, we're going to be looking at our marketing approach and making sure that we're reaching out to new sources and new channels to be able to reach students that would never have considered online before. Now it's not that we didn't get any of them issue, we did get some and we can tell the ones that are brand-new to the market. But we also -- there's some channels that we haven't tapped yet, and we use some outside resources to come up with some of those channels. We think that we can get better at it next year.

Got it. That's helpful. I guess in Georgia, can you maybe talk about any progress you've potentially made on getting another school open there? I think you talked last quarter about how we're going to have one open by the fall. So I guess where are you now? And what's the outlook there?

It's unlikely we'll see a school open up this coming fall. It's more likely the fall after. The board -- we've been working with 1 board. We may be working with another soon. So we may actually be the supporter of more than 1 school. We've got some positive signals that the things we're talking about doing, especially in the Career Readiness area and especially in the blended school area, when I say blended school, I mean having more face-to-face contact with students, some innovative models that we've been looking at, all of those things are reasons why the commission would approve a new school. And we're working with a couple of boards on that. So I don't think you'll see a new school in Georgia in school year 2021. You'll more likely see it the next year. But we are working with boards and the boards -- more than 1 board has been excited about working with us.

Okay. Got it. And then just lastly on the 2020 guidance, it assumes roughly 13% growth at the midpoint for adjusted operating income, but as you noted, you're going to be down in the first half. And you gave some helpful expense commentary, but just wanted to ask what factors we should think about that's going to drive strong year-over-year growth in the second half. I know you have an easy comparison in the fiscal fourth quarter, but just, I guess, any color there.

Yes. As I mentioned in my comments, I think we'll continue to drive leverage in the SG&A. But we also -- we were -- our gross margins were a little bit down year-over-year. I think they'll normalize closer to flat year-over-year throughout the year. We continue to look for opportunities to drive automation and efficiencies throughout our program. That's going to affect both line items. So I think you get some benefit across the board throughout the rest of the year.

Our next question comes from the line of Greg Pendy with Sidoti.

Just real quick on the non-managed public schools. Just kind of understanding now, I guess, with the contracts you've walked away from. You had a bump, I guess, in this quarter specifically on the revenue per enrollment. Is that something that's going to be sustainable throughout the year, I guess, with the mix maybe being more favorable from the contracts you've walked away from? Or is that just a onetime thing?

Yes. I think what you'll see is last year, in fiscal '19 in Q1, the non-managed revenue per enrollment was actually unusually low, which helped the comp year-over-year. But -- so you're going to see the comp year-over-year decline dramatically. So you're going to be closer to, I'll say, flattish for the rest of the year year-over-year. But it's going to be more dramatic in Q1, but it's because of the low first quarter of last year.

Okay. So that was more of an anomaly this quarter where you had the unusually [ high ]?

Yes.

Our next question comes from the line of Henry Chien with BMO Capital Markets.

Just sort of follow-on question related to the positive enrollment growth. Maybe it's related to career -- the career technical stuff. But I was wondering like what is sort of like the sticking point of going to online versus, say, like -- I don't know if there's like ground or community kind of resources. Where have you kind of seen like the most traffic?

Where we -- Henry, you're asking a question, what causes a student to come to our program versus going to a ground-based program? Is that what...

Exactly, yes, yes. I'm just trying to get sort of an update as you think about sort of new growth right now.

Well, the first thing is reach. If you're in a traditional high school, you only have so many students, so you can only justify so many courses and so many teachers to teach a Career Readiness course. We can look across the state and just 5 students here, 10 students there, 3 students there, next thing you know, we rolled up a large number across the state, which justifies us providing more courses. So it's geographic reach and, therefore, a higher number of career pathways than an individual school might offer. I think many of the brick-and-mortar schools offer great programs. But with only a couple of thousand students in their school or sometimes even less, they can only offer so many programs. They can't offer IT and health care and automotive and [indiscernible]. Because we have such reach across the state and we're looking at larger numbers of students across the entire geography, we have the advantage of offering more program. That's really the advantage of this program that most people didn't see when we first came out with it, that we have a scale advantage most people can't reach.

Got it. Okay. And it sounds like it's -- like a decent chunk of that would be like hybrid partnering with more brick-and-mortar schools as well?

Well, not today. That's the future market opportunity that we were talking about. That's the future. But today, it's all about full-time students in one of our destinations academy schools. That's where all of the revenues coming from today. What I was mentioning was we're going to start that process. We've actually done it a little bit in Wisconsin, but it's really tiny. And we want to do more of it across the state. Wisconsin was pretty excited about it. One other state was pretty excited. So we're beginning to see people we want to work with. Because if you walk into a school district that offers -- let's say they offer 5 IT courses, but they don't offer data analytics, they don't offer Python programming, we could offer that where they can't. So we could augment what they're providing. That's the new market opportunity for us that we've got to work on.

Got it. Okay. Great. And switching gears on the political front. Warren's been sort of out campaigning against charter schools. Just wondering your thoughts on, I guess, maybe not Elizabeth Warren but the potential impact of the upcoming election and whether those kind of changes are feasible or not.

Yes. I have some expertise in a number of areas, politics is not one of them. So I won't comment on Elizabeth Warren. But I will say this, we have -- number one thing that everybody has to remember is most of the educational funding in this country comes from local and state funds, not from federal funds. Federal funds contribute for special education disability, but they don't really contribute to the general education fund. As a matter of fact, most -- the federal level also contributes in Perkins funding and things like that but most of it's state level. So it's not really up to the federal government, it's up to the local government. Now the federal government could try to ban, for example, for-profit charter schools. We don't serve for-profit charter schools, we serve not-for-profit charter schools. All of our boards are 501(c)(3) boards that are all not for profit. We are providers to them, but they're all not for profit. The other schools that we provide -- this is another thing that's not a well-known fact. A little over 30% of our schools are district programs. I don't think the federal government is going to ban districts from providing online programs. Districts are your traditional school in your neighborhood, but they want to have an online program. We run this for them. So we're not a for-profit charter operator, we are a service provider to not for profit. There's a big distinction. So not to say that the federal government couldn't do something to harm our business, but it is to say we're not the immediate target of for-profit charters because we're not a charter ourself. We're an operator.

[Operator Instructions] There seems to be no further questions at this time. I would like to turn the floor back over to management for any closing remarks.

Thank you, Devon. I noticed today, we had a more engaging set of questions, and I really appreciate everybody being involved, Chris, Cory, Stephen, Henry, everybody. It was nice to have an engagement with you. We are very proud of the results for this year. I thank you, guys, for spending time and, ladies, spending time on the call today. So I have no other comments, and thank you.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.