Stride Inc (LRN) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 K12 Incorporated earnings call. My name is Katie and I'll be your coordinator for today. At this time all participants will be in a listen only mode. We will be conducting a question and answer session towards the end of today's call. (Operator Instructions). I would like to now hand the call over to Keith Haas, Senior Vice President, Finance and Investor Relations. Please proceed.

Thank you. Good morning. Welcome to the K12 fourth quarter and year-end 2010 earnings conference call.

Before we begin, the Company would like to remind you that statements made during this conference call that are not historical facts may be considered forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. In addition, this conference call contains time sensitive information that reflects Managements best analysis only as of the date of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements.

For further information concerning issues that could materially affect financial performance relating to forward-looking statements, please refer to K12's form 10-K filing with the SEC. This filing can be found on the Investor Relations section of our website www.K12.com. In addition to disclosing results in accordance with Generally Accepted Accounting Principles in the US, 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 also being Webcast. A call will be available for replay on our website for 60 days.

With me on today's call is Ron Packard, Founder and Chief Executive Officer and Harry Hawks, Chief Financial Officer. Following our prepared remarks, we'll answer any questions you may have. I'll now turn the call over to Ron.

Good morning, and welcome to K12's fiscal year 2010 earnings call. As we complete our tenth year and a new school season begins, I am pleased to report that K12 continues to drive value for our shareholders, and most importantly, to satisfy the educational needs of our students.

Starting with our financial results, we ended the year with revenue of $384.5 million, an increase of 21.8% over last year. EBITDA increased by 41.8% to $61.2 million, up from $43.2 million last year. Operating income rose by 58.8% from $22.3 million to $35.5 million this year. These increases were the result of higher enrollment, further scaling of the business, and greater productivity. These results do not include our acquisition of KC Distance Learning, which closed after the end of our fiscal year.

The significant growth we achieved in fiscal year 2010 occurred despite the difficult economic climate. This is primarily attributable to the dedication, passion, and talent of our employees, who went above and beyond their job description to deliver on the commitments we make to our school customers and the students they educate. On behalf of our investors, I want to take this opportunity to express the gratitude for their efforts. Their passion for the K12 mission is the reason for our success.

Our business is scaling quite nicely. We continue to pursue improvements on both the cost and revenue side, and this combination has lead to increased operating margins. State funding this past year experienced overall declines on a per student basis, which makes our margin improvement even more noteworthy. We still anticipate reduced funding levels in fiscal year 2011, but are cautiously optimistic that the $10 billion education stimulus recently approved the US Congress will help to mitigate against deeper funding cuts.

Last year, we opened new schools in Oklahoma, Wyoming, Virginia, and Alaska. We are thrilled this year to be opening new virtual public schools in Massachusetts and Michigan. The Massachusetts Virtual Academy at Greenfield is the first virtual school in the State. We hope that this is the beginning of many more statewide programs in the Northeast. We are excited about the opportunity to help educate the next generation of Michigan students through the Michigan Virtual Charter Academy.

Other expansion accomplishments this year included the addition of ninth grade in Georgia and high school in Oklahoma. We are now in a total of 27 states plus the District of Columbia, which brings us closer to our manifest destiny of having K12 managed virtual schools in all 50 states. The mix of educational products and services we offer to states and school districts is also evolving and expanding. For example, the Delaware Department of Education recently asked us to assume responsibility for all aspects of the operation of the Moyer Academy Charter School.

We earned that opportunity as a result of our success in providing management services for the past three years to Sarah T. Reed High School in New Orleans. The students of that school experienced a significant performance increase on Louisiana High Stakes Test. Over the past two years, the percentage of students who passed the State math test increased by 32%, and the percentage of students who passed the State English language arts test increased by 20%.

The launch of a new school year is always challenging from an operations perspective. This year, it went very smoothly thanks to our terrific operations team, with over 98% of all materials being shipped within one day of an improved enrollment. In total, we shipped over four million items weighing over 2000 tons across 99 million miles. As our fourth grade science students can tell you, that is six million miles farther than the distance from the earth to the sun. These materials included six tons of rocks and 60 tons of dirt.

Heading into the new school year, we have over 2600 teachers in the schools we manage and we recently trained over 500 new teachers. Our online school and other systems have never performed better, with almost no unscheduled down time. Hawaii was our first school to open this year on August 2, and now all of our schools are open. Last year's graduates for the virtual public schools we serve are beginning college this Fall. Those students have been accepted in almost 400 different institutions, including some of the nations top ranked colleges such as Cornell, Princeton, Stanford, Duke, Middlebury and Juilliard. It is extremely reward to know students in K12-managed schools are accepted at so many fine institutions.

On today's call, I also wanted to review with you the progress we made over the past year in achieving our strategic objectives. First, we renewed eight of the agreements we have with fully managed virtual academies. One deserving special mention is our five year agreement with the newly constituted Agora Cyber Charter School. I am pleased the issues surrounding the school will resolve successfully and that K12 is able to continue to serve its returning students as well as new students.

Second, we are developing a significant presence in selling curriculum and other support services to school districts. In the past year, K12 signed over 95 contracts with school districts and KC Distance Learning signed over 110 school district contracts. We expect this business to continue to grow rapidly. On a combined unaudited basis, K12 and KCDL generated nearly $30 million in revenue from sales to school districts in the past school year.

Third, we formed a joint venture with Middlebury College in April to develop a premium line of online foreign language courses, and operate the nation's premier language camps. This past Summer, those camps served over 600 students. The joint venture is going well and the first two courses are now being beta tested and will be formally introduced this school year. We believe both of these business lines have significant growth potential.

As discussed on our last call, we are actively seeking acquisition opportunities. On July 23rd, we closed our acquisition of KC Distance Learning, a nationally recognized provider of distance learning programs for middle and high school students. The integration is proceeding smoothly. This acquisition was an excellent strategic fit and gives us better scale in our private school offerings and sales to school districts. KCDL has a successful track record of selling to school districts and we expect the economics of the transaction to flow to the bottom line as we fully realized synergies of this transaction.

In that regard, we expect this acquisition to be accretive in our next fiscal year. Finally, if we had owned KCDL last fiscal year, our unaudited combined revenue would have been approximately $420 million. We are pursuing other M & A transactions and have deals in our pipeline for which we have signed letters of intent, but I will not be commenting on those today.

Fourth, the K12 international Academy continues to draw more students with 59 different countries now represented. Our acquisition of KC Distance Learning also includes the Keystone School, a tuition based private school that served over 250,000 students over the past 36 years. The addition of Keystone is of strategic importance as it allows us to create differentiated offerings in the private school business; however, while our online private school business is growing, it is not yet profitable as the market cost for the next school year are incurred in the current school year.

Finally, our Product Development team remains a leader in online curriculum development. We launched 33 new courses for this school year, from history to science to high school credit recovery courses. We also introduced new Mark 12 Remedial reading courses, and our proprietary K through 5 Math Plus curriculum. Those courses were built with adaptive features that allows more individualized learning and could help struggling students master concepts and skills before moving forward.

We also now offer five applications on Apple's iTunes marketplace and we are increasing the engagement level of our curriculum through the introduction of innovative labs for science courses, E-books, and Math Cat videos illustrating solutions to math problems. Finally, we have transitioned to a new state-of-the-art content management system which enhances productivity and enables more course development flexibility. In short, we believe our fiscal year 2010 performance has met or exceeded the expectations of our customers and investors and that K12 is very well positioned to meet the ever increasing demands for effective public and private technology-based education.

We look forward to our November call, when we will provide our guidance for the upcoming fiscal year. With that, I will now turn the call over to Harry Hawks to walk you through the year-end financial results.

Thank you, Ron. First off, I joined Ron in recognizing our leadership team, our employees and our teachers for the very strong financial performance for the year just ended. As the newest member of Management at K12, its been an exciting few months for me here.

Given the detail in the press release and the comprehensive comments Ron just shared with you, we'll quickly go through the financial results to focus on a few key takeaways, and therefore get quickly to your questions. As Ron mentioned, our revenues for fiscal year 2010 were $384.5 million, an increase of 21.8% over last year. The primary driver was a 21.6% increase in enrollments in our virtual public schools and hybrid schools. As Ron also mentioned, we experienced strong growth in our K12 international academy.

Operating income for the year at $35.5 million, an increase of 58.8% over last year, helped improve operating margins to 9.2%, representing a gross increase of 2.1 percentage points over the prior year. The increases in both operating income and operating margin, as compared to the year prior, reflects several factors. First, our instructional cost in services expenses benefited from efficiencies and materials fulfillment, including increased volume of materials returned. This not only had a significant impact on our operating results, but also on our cash flow, as we're able to manage lower inventory levels from improved resource planning. We believe these improvements are sustainable going forward.

Second, we benefited from cost control and productivity initiatives in our school operations implemented last year resulting in operating leverage. For selling, general and other operating expenses, we continued to make significant investments to grow the business, particularly Marketing, including brand awareness, student recruiting and enrollment. We also expanded our institutional sales force and call center operations, and are seeing benefits from this investment this selling season. Our SG&A also includes growth in a number of other items including incentive compensation, some significant M & A related transaction expenses and legal costs, et cetera.

As a result of these very strong financial performance metrics, our financial position has improved significantly. We finished the year with excellent liquidity and financial flexibility. Our cash balance at June 30 was $81.8 million, up from $49.5 million at the beginning of the year. In addition, we have no debt outstanding under our $35 million line of credit.

This strong balance sheet enhances our ability to invest in new initiatives, new curriculum, new technologies, brand extension, new markets, international and additional M & A activity that can both support our core business as well as drive incremental growth. As Ron mentioned, and as we have previously discussed, we will not be providing fiscal 2011 guidance on this call, but will wait until our first quarter earnings call in November. Regarding the subsequent event that Ron mentioned, that being the acquisition of KCDL, the integration is moving along as we had planned.

We want to remind you that we have some upcoming filings that you will notice. We have an 8-K filing in the coming weeks which will include the audited results for KCDL, and then subsequent to that, we'll have a shareholder vote regarding the conversion of the special shares issued in that transaction.

One other note, while you probably have not had a chance to read the 10-K yet, which was filed just this morning, I will mention that we do disclose a fairly narrow and technical material weakness associated with accounting for complex non-routine and non-recurring transactions. Management believes this matter is already remediated as part of a much larger comprehensive plan to improve financial resources, processes, systems, and materially improve our technical and analytical capabilities.

Today, as we look forward, we have numerous opportunities to put your capital to work and we look forward to that in 2011 and the years beyond. With that, we will now take your questions.

(Operator Instructions). And your first question comes from the line of Amy Junker from Robert W Baird.

Hi, good morning. Thank you. Ron, I just wanted to clarify one thing you said in your prepared comments. You said you expect the acquisition to be accretive in the next fiscal year, and I just wanted to clarify, did you mean fiscal 2011 or did you mean fiscal 2012?

Fiscal year 2012.

Okay, great. And then, if we can just touch on, given it is mid-September, is it safe to assume that we probably won't get any new state announcements in addition to the Michigan and Massachusetts? And as a follow-up to that, can you just comment, two states is obviously very strong, you continue to win new states, but were you at all disappointed that you didn't get more, that both of those were capped?

I think the answer is, it's unlikely we would get new states but not impossible, to answer your first question. Michigan and Massachusetts have been states we'd like to have been in for a long time, so we're pretty excited about those. Obviously we're always disappointed when we have to limit the number of students who could access these schools because the demand is far stronger than the number of slots we have, but we're optimistic. We've been in this situation before, and that we can continually expand that cap going forward, and hopefully remove it.

Given how proven the academic performance of our schools are, there's really not a great reason to have these, but still people in the first years, some states want to do them. So we're just excited to be in those two states, and I'm hoping as we demonstrate results in those states that those will be removed.

Great. And then on the flip side of that, given all four of your new states from last year uncapped, how big do you think those opportunities are? I know that Alaska is probably pretty small, but I would think Virginia, in particular, presents a huge opportunity. Any reason that that would not be the case, or anything we should be thinking about with Virginia, Oklahoma and Wyoming?

Well, Wyoming is also very small. I think actually even smaller than Alaska on some metrics, but Virginia and Oklahoma, Oklahoma is growing a great deal this year. Virginia, there's some structural reasons why that growth will be slower, but we hopefully can get those resolved over the next year. So Virginia won't reach its full potential by any stretch this year, but going forward we're hoping to be able to remedy that situation.

Great, and then last question for me, and I'll pass it over. I think we usually hear from Texas, it feels like earlier than this, and we haven't come across anything. Was the cap raised there again? Has that been decided on yet, or was that endeavor unsuccessful?

I think it's still in progress. I'd rather not comment on it right now.

Okay, thank you so much.

You're welcome, Amy. Thank you.

Your next question comes from the line of Jeff Silber from BMO Capital Markets. Please proceed.

Thanks so much. I'm sorry to go back to this material weakness issue. Could you just provide a little bit more color on exactly what this is, and are there going to be any restrictions or anything along those lines going forward?

It probably would be best to refer you to the 10-K, but really the matter is narrow, and as technical as I suggested in my remarks. It is specifically a matter that deals with complex accounting, non-routine, non-recurring transactions. But just to be clear, there is a clean, unqualified opinion on the financial statements. This is a technical matter, which we believe is already remediated. So I'm not sure I would read more into it than that.

Okay. I know you're not giving guidance for the current year, but at least in terms of capital spending, can you give us some indication what you're budgeting for that?

Well, all of that is going to be part of our guidance that we give on the next call. We're actually not giving any guidance, including CapEx, on this call. However, obviously with the liquidity in the Company, and the amount of opportunities that we have, you can assume that we'll be doing everything we can to put capital to work, because we do have a lot of opportunities. But it's a bit premature for us to cite a number, other than excellent liquidity, lots of opportunities, and we intend to put that money to work.

Ron, in your comments, you talk about potential new M&A opportunities. I'm not going to ask you the types or names of the company, but going forward, are there any holes in your product or service portfolio you'd like to fill?

No, thanks for not asking for the names, but no, I don't think it's that. I think on our call you can see that we're building a significant business selling technology-based learning products to school districts, so we're looking to continually augment that part of our business. And the core business of virtual academy is there's no gaps in our product line.

Our curriculum and systems are significantly better than anything else that's out there, so there's no gaps there. It's more as we build that business on the school systems we're looking to augment that product line particularly, and basically putting more things in the bag.

All right, thanks, I'll jump back in the queue.

Your next question comes from the line of Kelly Flynn from Credit Suisse. Please proceed.

Thanks. I understand you're not giving guidance, but Ron, you did mention some expectations for state budgets in fiscal 2011 decreasing again. Can you give us any sense of what you are seeing there? Do you think it's looking worse since fiscal 2010, or -- ?

Well, I think on a year-over-year basis, I don't think it's looking worse than fiscal 2010. I think state budgets are stabilizing, in regard to decline, but we do expect to see slight overall declines when you average out all of the states we have combined, and we always prepare for that. And the reason I think we've been able to deliver constantly increasing numbers in this environment is because we always prepare for that case.

Okay, great. And then just a similar question about enrollments. I guess building on what Amy said about the four states you added last year uncapping, how should we think of that as an offset to the fact that you're only adding two states? I mean, does adding two states kind of imply you grow at a slower rate, or is it really just (inaudible) I don't know if even that's the case?

I don't think it implies we grow at a slower rate, Kelly. Remember, our goal has always been to add two to three states per year. We've been fortunate enough to be above that the last couple of years. I think both Michigan and Massachusetts are significant opportunities, and even though they are capped, we're optimistic that doesn't stay on too long.

And remember, most of our growth is driven by same-state growth. It's not driven by new states. The percentage of our enrollment from new states the past couple of years has been pretty low, so I don't think it implies that at all. In fact, I think the size of these states implies significant growth opportunities when and if we can get those caps removed.

And also, our institutional business is growing quite rapidly, not only through acquisitions but organically faster than the core business, so I don't think it implies slower growth at all. In fact, I think with the institutional business, our growth will continue to be strong.

Okay, well I'm talking about fiscal 2011, not over time.

That's what I'm talking about, too.

Oh, okay, great. Thank you.

And then just one other question about, I actually have two more, about the Product Development expense in the quarter. I mean it was down year-over-year, and also sequentially, and there was a comment in the release about why that was. Can you just give a little more context there? Is that kind of a good run rate level, or is there some one-off timing issue that played a role?

Kelly, this is Keith. Basically for the quarter it was down, just because of the start and stop of various projects that we had in the quarter, so it was low versus last year. But we really think about that business on a full year basis, so in terms of trends, we look at what we did for the year, which was relatively flat again for Product Development expenses.

But also I would say that the pipeline is rather robust, so there's plenty of stuff in the queue. It's just, as Keith mentioned, just the timing of the individual projects.

Yes, on an annual basis we manage that to a relatively tight range, and that increases just a little bit year to year, or it may even decrease in some years.

Okay, great. And then finally, I think you mentioned, Ron, in talking about all of the strategic developments, you were talking about marketing for next year, and how, I can't remember exactly which initiative you were referring to, but you were saying it's not going to be without incremental marketing. Can you talk a bit more about that? What new initiatives are most likely to result in significant incremental marketing, and any other kind of qualitative color you could give around new marketing would be helpful.

Well, I think the comment you're referring to had to do with the international private school business, and it's also true of our virtual academy business in that, a significant portion of the acquisition expense of students for this current year was done last year, as the fourth quarter has very heavy marketing expenses that provides no revenue for the fourth quarter at all, but for the next fiscal year. And so until the businesses get to scale like our private school business, that marketing expense is enough to take the business from profitable to a losing business because of that offset in timing.

We continue to spend more and more marketing because we're growing, and adding more and more kids, and that's going to continue. It's tough to predict the cost per acquisition, it has been creeping up slightly over the past year, and we're reaching broader in, and we're doing more awareness marketing. So, we're doing a lot of it now, and it's still proven to be very successful in the economics of a customer, so it works quite nicely.

Okay, perfect. Thanks a lot. I appreciate it.

Thank you, Kelly.

(Operator Instructions). Your next question comes from the line of David Ridley-Lane from Banc of America.

Yes, hi. For revenue per student in fiscal year 2010, there was an amount of non-margin or zero margin instructional-only funding. Can you quantify the amount of revenue from that source for fiscal year 2010? And then secondly, would you expect those types of revenues to repeat in about the same rate in fiscal year 2011?

Yes, this is Keith again. We're not talking about 2011 yet, but for 2010 those funds that we had that were primarily for direct costs in the various schools were roughly, contributed about 2.5% to our growth in revenue for the year, if you look on a full year basis.

Okay, and you don't know if those will repeat again next year or not?

Well, again, it depends on what's going to happen with, because a lot of those grants were federal, so it depends on what happens with the federal grants coming into the next year.

Okay, and then in the first quarter of fiscal year 2011, you're going to have a couple of months of revenue and cost from KC Distance Learning, and I think the information provided previously gives us a good idea of the ongoing cost and revenue, but are there any one-time integration costs that we should be aware of, or do you want to give us any sort of sense about those costs?

Well, as we made reference a moment ago to some of the items which increased 2010, and particularly Q4 SG&A expenses, we incurred in fiscal 2010 probably $2.1 million worth of transaction-related cost, a material portion of that related to KCDL but not all of it. And then in the 2011 period, we'll try to speak to that in our next call, but I think we've done a very good job of making sure that the merger integration is cost effective. We have very little exposure on our side to severance expense, for example. We will incur some capital cost over the next 18 to 24 months with some systems investments, but I think the merger and integration one-time only costs will be a modest number. And we'll try to break that out for you when we give guidance.

Okay, thank you very much.

You bet.

Your next question comes from the line of Peter Heise from RedChip.

Hi, guys.

Hello.

Just to follow-up on that, we shouldn't see any litigation expenses relating to the deal between KCDL and Aventa, is that correct? Did I read that in the 10-K correctly?

You read that correctly. That is a matter which we are fully protected against by the seller. We're indemnified, that indemnification is guaranteed, so we expect to have zero litigation expense, as the original parties to that matter resolve that issue.

Great, perfect. And do you know if the Missouri virtual instruction program reviewed any of K12's online courses last May? I saw it chose events as online programs, and I was just wondering if K12 was in that mix as well.

We'll have to get back to you on that.

Okay, thanks guys.

Thank you.

Your next question comes from the line of James Maher from ThinkEquity. Please proceed.

Good morning, guys.

Good morning, James.

A couple of questions for you. Ron, I think you had stated that the situation with the Agora school has been fully resolved, and that you have now a longer term contract in place. Should we assume therefore that this year, you'll have full marketing activities fully ramped up, unlike last year when you really kind of throttled back while there was some uncertainty there?

Yes, this year, Pennsylvania is going forward with complete marketing activities.

Okay, excellent, thank you.

Secondly, in terms of expenses, at least relative to my estimates, you seem to be beating for the quarter on most every line item. I remember last year that we had talked about how, with the cost certainty that you promise in some of your contracts, there's a lot of truing up in the fourth quarter. Would you characterize some of what we saw in terms of the improved, even relative to your guidance, I think improved expenses in the quarter, as part of that kind of just catching up in the fourth quarter that happens, or was this more of a kind of a sustainable rate?

Well, I think a couple of things, James. One is, we came in right at the top of our range in terms of operating income for the year, so we did, we basically came in-line there. In terms of expenses at the fourth quarter, we're always trying to manage expenses, and control costs all the way through the tape, so we think we did a very good job of that in the fourth quarter, while still being able to invest in growth. So, there's no real surprises there in terms of the year-end reconciliation. It was just managing all the way through the end.

I'd say James, as I said, we manage costs very closely here. I think for a Company, a growth Company like ours, probably it's extreme how much we manage costs here, and try to leverage our human capital, and a lot of it is driven by the environment we've been under with regard to the state budgets. So we've had to just continually drive efficiency. And it's part of our culture now, is to try to deliver the best education as efficiently as possible, period.

Okay, thank you very much.

Thank you, James.

Your next question comes from the line of David Ridley-Lane from Banc of America.

Sure, just a quick follow-up. Do you have the ending enrollment for IQ Academies?

Could you repeat the question, please?

Sure. Do you have the ending enrollment for IQ Academies?

Oh, at this point in time we're not breaking out or disclosing those enrollments separately, other than what we had in that prior press release.

Okay. So I mean, the problem with that is the prior press release adds all of the different channels. Can you just give us a ballpark sense of the enrollment? This is the current enrollment, I guess, the ending enrollment?

Yes, I mean they are basically right in the middle of their recruiting season as well, so we don't want to go into that disclosure at this time, David.

We'll talk more about IQ Academies, and their various enrollments on the next call.

Okay, thank you.

At this time, I'm showing you have no further questions. I'd like to now hand the call back over to management for closing remarks.

All right, thank you very much. We have, just as a note for everybody. We have a group of investor conferences coming up. We'll be at the Credit Suisse first annual small cap conference in Boston on Tuesday, the ThinkEquity G7 conference on Wednesday, September 15, BMO Back-to-School conference on Thursday, September 16, and the Morgan Stanley business services conference in New York on Wednesday, September 22. We appreciate all of your interest, and look forward to this coming year. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect. Have a wonderful day.