Stride Inc (LRN) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the first-quarter 2011 K12, Incorporated earnings conference call. My name is Modesta and I will be your operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions.) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Keith Hass, Senior Vice President of Finance and Investor Relations. Please proceed.

Thank you. Good morning and welcome to the K12 first-quarter 2011 earnings conference call.

Before we begin, the Company would like to remind you that statements made during this conference call and 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 Management's best analysis only as of the date of this live call. K12 does not undertake any obligations to publicly update or revise any forward-looking statements. For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to K12's Form 10-Q and 10-K filings with the SEC. These filings 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 being webcast on our website. The call will be available for replay there 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 will answer any questions you may have. I will now turn the call over to Ron.

Good morning and welcome to the K12 first-quarter 2010 earnings call. This year marks the ninth anniversary of our first school launch in September 2001. Our online public school business has grown over 80-fold since then.

This quarter is especially noteworthy as K12 has achieved record revenue and enrollments and has established itself firmly in several high growth channels that leverage our curriculum, technology and core competencies. Revenue for the quarter was $135 million, up 27% from the first quarter last year. If we exclude the recent acquisition of KCDL, the Company would have grown at 21.5%. EBITDA would have grown over 25% without this acquisition.

I'd also like to take a moment to welcome our new students to K12 and take this moment to congratulate all of our recent high school graduates, most of whom have now matriculated over 200 different institutions, including some of the nation's most selective universities and colleges.

Our core virtual school business remains strong. Enrollments on November 1st were up approximately 19% over November 1st the prior year. Existing state enrollments grew at 17.5%. Additionally, the cost structure and margins from this business continue to remain healthy and to improve versus last year.

We hired and trained over 500 new full and part-time teachers this summer and this year's school launch went very smoothly, as all of the materials were delivered on time.

We expect revenue per student to be slightly down for this year versus last year, as states continue to wrestle with their education budgets.

This year we opened virtual academies in two new states, Michigan and Massachusetts. These schools' enrollment are strong and will continue to grow over the coming years. We believe these place a great foundation for future growth of our virtual academy business. Demand for virtual academy education persists because of the great options it offers students, as well as its proven academic gains. We also completed the full roll-out of our K-8 Learning Management System and our new Math+ product, which has an adaptive curriculum and is also highly interactive.

The recent political elections were a positive development for K12. While the environment at the federal level has been favorable for education during the past two years, what happens at state government is more relevant for K12. We saw many state political offices and legislatures move in a direction that we believe will be far more supportive of education innovation and educational liberty than at any time in recent memory. This bodes well for our expansion into new states, as well as for the removal of enrollment caps in the existing states in the coming year. The pace at which K12 moves towards its manifest destiny of being able to serve every child in the United States should accelerate as states embrace technology-based education.

Not withstanding all the recent M&A activity, we have not lost our focus on creating innovative curriculum and technologies to enhance a child's ability to learn. This year we successfully launched a mix of seven new courses and eight second-generation core courses across grades K through 12. We introduced new exploratory educational games that test learning mechanisms via adapted algorithms and allow us to measure the instructional effectiveness of these games. We are optimistic about the impact that these educational games will have on a student's computational fluency.

Other innovations include a rollout of high school study aids such as content maps and an extensive battery of illustrative problem-solving videos called [mathcasts] into our math curriculum.

To further explore how technology can enable learning while reducing our carbon footprint, we now have virtual labs available in all our science courses, with full online lab offerings in biology and earth science. In addition, all of our proprietary high school content is available via ebooks and is optimized for mobile device use. Our new content management system is now fully in use, which enables us to more efficiently develop new courses as well as quickly develop customized courses.

Beyond the strong growth of our core business, I am quite pleased that we have been able to position the Company as a major participant in several other exciting channels. We believe these channels have a similar high growth profile and margins to our core business and leverage K12's assets and capabilities. These businesses are being built through a combination of internal initiatives and selective acquisitions. We have broadened our product line, our geography, and our age range.

We are in the process of acquiring approximately $150 million of revenue at an annualized rate for less than 1.5 times revenue, assuming a complete purchase of Web. These acquisitions have strengthened our position in virtual schools, positions us as a clear leader in online private schools, made us a leader in technologies education in school districts, and given us a physical platform from which we can leverage our digital assets in the world's fastest growing economy and education market.

Evaluating, purchasing and integrating these entities requires a significant amount of time and effort. We prefer to acquire companies in similar businesses that are significantly smaller than K12, as research has shown these types of acquisitions are the most likely to succeed. We are using outside consultants to help with integration, along with many of us in the management team who have significant experience with M&A execution and integration.

Over the past two years as we've executed our strategy we have backed away from many deals when the price was not right, the management team was not right, or it was not a good fit strategically. Recently there was one significant deal that we backed away from when the performance of the target was different than expected. We incurred significant legal and accounting expenses for that deal in this quarter. In that respect I should also add that the past few months were extremely unusual and we expect the deal pace to slow significantly moving forward as the major pieces in our strategy are now intact.

The institutional business -- we recently purchased two companies with product lines that are online and primarily sold to school districts. We talked about KC Distance Learning and Aventa acquisition on the prior call. Last week we announced the acquisition of American Education Corporation, or AEC. This company's line of software and education products that span grades K through 12, including assessment and credit recovery products. We are especially excited about their penetration in small and rural school districts. AEC also has products for native Spanish speakers in grades K -- grades one through eight, as well as college remediation courses.

After closing adjustments, the purchase price will likely be somewhere between $30 million and $35 million at approximately an effective multiple of six times EBITDA. We believe this is a good value for a company whose product line is complementary to ours and growing at a compound annual growth rate of almost 25% over the last two years. We believe there are significant synergies that K12 can bring to this entity. Even without any synergies, we believe this acquisition enhances shareholder value and will be a great deal.

The integration of AEC should be less complex than that of KCDL, as we do not have to separate it from a parent entity. But we are seeking to prioritize and execute all of these integrations in the most effective way possible.

When we combine AEC's revenue with K12's, and then add KCDL Aventa existing sales to schools and school districts, we anticipate that revenue on an annualized basis will exceed $60 million between K12, Aventa, and AEC. We will also then have relationships with over 6,500 schools and school districts.

Online learning has taken off with school districts at a very fast rate and K12's robust offerings can meet their needs at a wide range of price points and needs. We believe this institutional line of business can expand to more than 30% going forward and should have margins similar or better than that of the virtual academy business. While virtual academy business will remain the largest component of K12 for the foreseeable future because of its relative size and high growth rate, we expect school district sales to become a significant part of K12 in the near future.

We started our international and private school business organically several years ago and revenue increased 60% last year before any acquisitions. This business includes an international virtual academy and a physical location in Dubai. We now have students enrolled in 59 countries, including the United States. This business fits well with the Keystone School which we acquired as part of the KCDL transaction. Keystone has been in existence since 1974 and served over 250,000 students from 84 countries. K12 now has two different private school offerings at two different price points. This will increase marketing efficiency and consumer choice.

While unlikely to become as large as the other two KCDL businesses, we expect it will grow double-digit rates for many years. This business has the extra benefit of having negative working capital and not being relying on government funding. Moreover, it leverages the content, school management and teaching skills that K12 has developed for the virtual academy business. This business will be profitable this year before marketing expenses, but investment in next year's growth results in a small loss. We anticipate forming several other private schools with partnership with entities in the coming year.

Yesterday we announced an investment in Web International English, which should be completed at the end of the calendar year. We will infuse $10 million into the company for a 20% stake. This investment should accelerate the growth of an already fast growing company in the world's most exciting economy. In China currently there are five times more people learning English than there are in the UK. We believe the potential for this business is extraordinary. Additionally, Web's networked English learning centers will provide us with distribution for K12's digital products and services throughout China. We believe there is potential to expand the range of student ages that are currently being served by Web. Web has an excellent management team who we believe are capable of further growing this business at a rapid rate.

The large size of the Chinese market, the economy's growth rate, and the population's willingness to spend money on education make this opportunity uniquely attractive. For the current year revenue for Web will be approximately $44 million US. Additionally, K12 has the option to purchase the remainder of Web at predetermined revenue and income multiples.

Earlier this year K12 formed a subsidiary called Capital Education, which purchased the assets of Cardean Learning for approximately $1 million cash, plus a small royalty. Over $100 million had been vested in these assets, which included a complete learning management system for post-secondary courses, along with 720 online courses, which we believe are the highest quality online courses we have seen for post-secondary education. Thus, this was an opportunity to purchase a sophisticated LMS and a vast content library for a fraction of the cost to build. In fact, this asset took over 10 years to build. Capital Education will [be providing] these courses to high school students and also to colleges that wish to offer online programs.

The K12 Middlebury joint venture is proceeding quite well as our respective specialists continue to work together to build effective online foreign language courses that include the latest pedagogical and cognitive research on foreign language instruction. The first two course prototypes should be ready for testing shortly. Meanwhile, the summer language camps and sales of Powerspeak courses continue to attract more students. Both of these business lines in this joint venture are growing at double-digit rates, but we expect this business to level off for the year as we continue to invest in the growth.

K12 has also completed a series of other deals in the past quarter that we expect will eventually generate significant new revenue. The most prominent is our partnership with Blackboard to sell content to colleges. Blackboard is physically located not far from K12, has an extensive installed base and relationship coverage into higher education institutions. We believe K12 has the highest quality content for this market. Combining these two competencies and assets allows us to immediately begin selling courses to colleges with minimal investment by either company. We believe this partnership could yield significant revenue for both companies.

Additionally, K12 announced an exclusive new partnership with the National Society of High School Students, or NSHSS. This partnership gives member scholars special access to more than 130 high quality online high school courses through our online private school, the K12 International Academy. NSHSS is an example of an organization that was seeking superior online courses and they came to K12 to find them. We anticipate doing many more partnerships like this in the coming year.

We are also piloting the integration of our curriculum into the early childhood centers at KinderCare. KinderCare nationally has over 1,000 centers and we believe if these pilots are successful this is a great opportunity to allow younger children to access K12's content. If these pilots are successful they could lead to introduction into hundreds of centers in the coming years. This deal came about as a result of our purchase of KCDL and an enhanced relationship with Knowledge Universe.

Investing in infrastructure is also critical to support our rapidly growing operations. While our learning systems are scalable and could easily handle many more students, our accounting and IT systems are being upgraded to support future growth. Fortunately our CIO, Rob Moon, and CFO, Harry Hawks, both have extensive experience scaling business systems at multi-billion dollar companies. We are also improving our system reliability and disaster preparedness by adding a second data center.

We are making expenditures to increase the size of our school district sales force. We plan to hire more sales reps, add sales support positions this year, although these new additions will not generate revenue until the following year. We believe these hires will be very productive with the world-class portfolio of products that K12 has either built or acquired.

K12 has now positioned itself in several high-growth, high-margin segments that leverage our core assets and competencies. We now have an online institutional sales business, a private school business, hybrid schools, a world languages joint venture and a small brick-and-mortar pilot business. These noncore business lines on an annual basis are expected to exceed $120 million. This is almost the size that K12 was itself the cal- -- the fiscal year prior to the IPO. These businesses have similar growth and profitability characteristics to K12's core business.

I could not be more excited about their potential or the potential of K12 going forward. We have purposely entered the strategic markets management decided to pursue well over a year ago when we developed our strategic plan. The potential change in tax rates have caused there to be a flurry of activity during towards the end of this calendar year and made some of these assets come up quicker than we expected. Looking ahead, we will slow down the pace of acquisitions, as all the pieces are now in place to drive K12 at high growth rates for the next decade.

I'd like to take this moment to thank the employees of K12 for their hard work and commitment to children. It's not easy to grow at the rate K12 has been growing, and it would be impossible without our dedicated employees. For this I am grateful to every one of them. I believe K12 is a premier employer for people who care about educating children and want to make a difference. We strive to keep this culture and with this culture we can achieve anything. It is why we've been able to enter new businesses while maintaining year-over-year growth in both revenue and profitability in our core business.

Turning to the outlook for fiscal year 2011, we believe revenue will exceed $500 million and EBITDA will exceed $70 million. Operating income will be over $28 million. These figures include the KCDL acquisition from July 23rd on, but not the acquisition of AEC or any subsequent acquisitions. Including the acquisition of AEC our revenue will likely exceed $500 million by a significant amount.

Our profitability estimate would have been significantly higher if not for the acquisition costs, integration costs, and other one-time costs that will be incurred this year. These costs alone are expected to total $10 million for this year, so without these one-time costs and integration costs, EBITDA would have been $80 million for the year.

Additionally, startup losses in International, Middlebury Interactive, FLEX schools and Capital Education will total between $5 million and $6 million. These businesses are expected to grow rapidly and turn profitable in the near future. For example, international is currently growing at a 60% rate. We are investing in these businesses because we believe in their potential to expand, be profitable in the near future and, most importantly, in their ability to educate children.

K12 is now embarking on another great year during which we will help tens of thousands of students receive a better education. I am as excited about K12 and its prospects as I was when I founded the Company 10 years ago.

Now I will turn the call over to our CFO, Harry Hawks, who will go through the financial results.

Thank you, Ron, and good morning.

Given the extent of Ron's comments and the detail that we've provided in the press release and the 10-Q which was filed last night, I'll keep my comments brief so we can get to your questions.

But I would like to make four observations. One, as it relates to revenue, I will second Ron in recognizing yet another quarter of record revenue growth, marking the 25th consecutive quarter that we've posted record revenues. And as Ron said, our core business continues to grow substantially and the additional transactions that we've done are complementary to that. If you back out the KCDL revenues in the period it is still record revenue for the period.

Regarding expenses, perhaps you've observed it from the press release or from Ron's comments, there is, indeed, an explanation and a rationale, a compelling rationale, for the spike or surge in expenses in the first quarter. The transaction and integration costs, which those of you that have been observers of accounting for a number of years would recognize that only a couple of years ago these are expenses that would have been capitalized. But in the current environment they are recognized as current-period expenses and, therefore, as deal activity for us slows down, those will not be recurring.

Also during the period, as Ron referenced, we've launched several new initiatives that are incurring some launch costs that are putting pressure on the expenses and operating income for the period. However, we believe those expenditures are essentially an investment in the future with an ROI. And even though they're recognized as a current-period expense, we believe that they will be contributing to revenue and profitability in subsequent periods.

In addition, we do not expect the level of spending you observed in the first quarter to be any indication of a run rate for the rest of the year. We would expect subsequent quarters in fiscal 2011 to show a deceleration in spending. You will note from the past several years of publicly announced results of K12 typically we have a much higher first quarter sort of seasonal level of expenditure anyway, with subsequent quarters tapering off. This particular first quarter of course impacted by the transaction costs, one-time-only costs and the like.

As it relates to liquidity and financial flexibility, we are delighted that the Company remains very, very healthy from a financial position point of view. Cash in the period was well above this time last year, at about a 63% increase over the comparable quarter last year. We have excellent liquidity in the Company. Our line of credit is completely available to us and undrawn at this time. There are a number of corporate finance options available to the Company as we go forward and we're considering those as we start to evaluate the long-term strategy -- excuse me, the long-term corporate finance strategy.

Last comment as it relates to guidance, as Ron mentioned we've given guidance that gives effect to the incurrence of these various expenses, on the order of $10 million during the year, in addition supporting some very promising, very exciting new initiatives where we'll incur startup costs on the order of $5 million to $6 million. So backing those expenses out, you get the guidance that we've provided.

Now, I will make one comment, though. We will not be providing adjustments -- adjusted EBITDA or pro forma EBITDA; however, we will, as we've done in this earnings release and call, provide you with the items which we believe offer the explanation and items which we believe are one time only. Do want to point out that, in our definition of EBITDA, we have subtracted noncash stock compensation expense, which in this quarter was $3.4 million, which is about a $1.5 million increase over the comparable quarter last year. It is our intention that we would update this guidance on the next call to give effect to the acquisition of American Education, which we expect to close in the second quarter and provide additional comments on Web International, which we also expect to close during the second fiscal quarter as well.

With that, we will be delighted to take your questions. Operator, we're ready for Q&A.

(Operator instructions.) Sara Gubins; Bank of America Merrill Lynch.

Could you talk a bit, within the core business, about the impact of state caps, kind of any negative impact that that may be having to growth right now, and the possibility of getting those caps raised over the next year?

Yes, I'd be happy to. The state caps -- obviously when we say we grow by 19%, that includes a significant number of states, if not almost half of them where our growth where our growth is limited by some kind of artificial restriction. And that includes some of the biggest states in the country where we have that limitation. So without those caps obviously we would have grown it much higher.

And I think I said in my call, what happened in the elections was quite significant. The political landscape for educational choice changed more rapidly in favor of what we do than I'd ever seen in my ten years. So we would expect that many of these states with caps, due to some changes in the legislative bodies or in certain key positions that have been limiting us, have now improved. And we're gearing up for a significantly larger effort than we've probably ever had before in terms of the number of states that will be trying to [either] lift those caps -- but also new states. There are states that we don't think politically we could have done a week and a half ago that are now on the table as possible new states.

So what happened in the elections on a federal level doesn't matter that much to us. But it turned out the movement toward school choice was significantly greater at the local statehouse level than it even was at the federal level. So we couldn't be more bullish on the prospects of opening up new states and also removing those caps. Because when you're growing at 19% and you have half the places off the table to you for growth, it means you're growing a lot more in other places. So we're -- I've never been more optimistic about our prospects for new states and lifting caps than I am at this moment in time.

And what percentage, or how many states, have caps currently?

We can go through the list. We have states right now like Arkansas and Texas where they're completely capped. And then there's some other type -- and we have caps in Michigan. We have caps in Massachusetts. We have caps in Oregon. We have limitations in Wisconsin. We are capped in Chicago right now by the size of the charter. We are capped in Indiana right now. So that's just a quick list. And there's a couple other -- Washington, DC. So -- and Florida has things that are significantly limiting our growth. In fact, Florida hasn't grown hardly at all over the last several years. So Florida and Texas are the second and third largest states in the country for us.

So you look at all those states where you're not allowed to grow. Once we can free that up, it bodes well for our future growth. And we think all of those ones I listed, the probability is now higher -- significantly higher today, maybe by orders of magnitude in some cases than it was a week ago.

Okay. The new initiatives that are generating the $5 million in losses in fiscal year '11, is the expectation that those would turn positive next year in terms of positive operating profit?

I think the way I'd answer that, Sara, is they could. What determines that is how fast we choose to grow them. You look at the international and private school business, it just grew by 60%. So -- and it's not losing very much. It's close and if we toned down the growth at all it wouldn't lose money this year, but when you have something that you can grow at 60%, we'll continue to invest in that. But it's not losing that much.

The Middlebury Language venture very easily could turn positive next year. What we'd expect, actually, on a P&L basis it would, potentially, next year. Because both the camps business is growing rapidly and already close to turning a profit and the language sales are similar in that case. So that one probably will, we would think.

The FLEX schools is just a pilot. That was intentional. We knew that would lose money this year but as we do more of those, it just depends how many more we do. And we don't know the answer to that yet.

So they're not losing that much and I'd certainly imagine some of them will turn a profit. And KCDL is going to continue to increase its profitability rapidly. Not only will we not have the M&A integration costs or any of those costs, there are some purchase accounting adjustments that are going to go away. And also, there's a lot more costs we can take out of that system as we have the time to integrate the curricular and the systems processes. So there's a lot of these things that are going to be -- when we say one-time, there's probably even more than we described that will not be there next year. And we easily, I think, could turn all of those businesses profitable next year if we chose to do so.

With KCDL -- I'll just tag team with Ron for a moment. KCDL was actually a drag on our results for the quarter, but will contribute very nicely for the full year as we come out of -- the current quarter that we just released reflects only two months worth of activity there. And a lot of the transitional work is being done and subsequent quarters should look very good there.

Okay, thank you. And then, just last question, in the description of the first quarter you talk about $6 million related to losses from new launches and marketing and the international expansion. And then in the guidance for 2011 you talk about $5 million related to the launch of new initiatives. So I'm just wondering if you can explain the differences between those two. Clearly, strategic marketing isn't in the $5 million, but I'm wondering what the other differences may be.

Really, the one -- in the guidance we were more conservative in the way we handled the, if you will, some of the strategic marketing expenditures. For example, one of the things that we have pointed out in a number of our investor presentations is the number of K to 12 children in America at 58 million, 50 million in public schools, 6 million in private, 2 million home schooled. And two issues for us -- one is very low penetration, but perhaps more significant is very low awareness. So we've actually ramped up the spending on awareness, which is kind of at the national level and building brand awareness and just awareness of online education, which is different than local advertising to drive enrollment at a local school.

In other words, there's no -- I guess, to come at it a different way, there's no inconsistency between the numbers.

Okay.

Kelly Flynn; Credit Suisse.

Couple of questions. Actually, following up on Sara's questions about the transaction costs, et cetera, in fiscal '11, your -- it was helpful what you said, it's about $10 million in kind of transaction-related costs assumed there. Can you just explain does that include the incremental amortization related to the acquisitions? And kind of what else is included in that $10 million number?

Kelly, it does not include that. This was all on an EBITDA basis, so we excluded the --

Oh, that's right. Okay. All right. And what -- so what is included in that number, the $10 million? I mean, are we talking --

Well, we gave a general listing in the press release as to the kinds of things there. We didn't go to the individual line items, but we can give you some color on that, though. M&A expense and integration costs on the order of 5 -- in terms of for the full year -- $5 million to $7 million. Some of the one-time costs, we had some stock -- one-time stock comp expense -- and that was about $1.5 million. We had some purchase accounting expenses of about $2 million. So that's more or less how you get to the $10 million.

And then the investments in operating losses or, if you will, the startup of some new initiatives which we're very excited about. I think Ron already went through those, making reference to our brick-and-mortar pilot project, the launch of Capital Ed, the launch of Middlebury and our significant expansion of international. Those were the kinds of things that are behind the number that's related to the investment in new initiatives for revenues and profitability in subsequent periods.

Okay. And then for KCDL, can you go over the assumptions for fiscal '11. I think you said $60 million for KCDL and AEC. So what's the revenue assumption for KCDL alone? And also, can you just go back to accretion dilution targets you set out when you announced the deal. I think you said slightly dilutive in fiscal '11, slightly accretive in fiscal '12. Is that still what you're expecting?

The first part of your question was revenue, as I recall. And that would be correct, on the order of $60 million annualized revenue for the fiscal year 2011. And that's approximately $40 million for KCDL, and actually it's a little bit more than $20 million for AEC. But the two combined on the order of $60 million. And the prior comments that we've made in the past about accretion in dilution for KCDL, we reaffirm those prior comments.

Okay, great. And then, just a couple more. Since you said that the guidance does not include AEC, I was just wondering, is it possible that you could end up below $70 million on EBITDA when you add in the transaction costs for that one?

No, we do not -- that will not happen.

Okay. And then, the last one, I think, Ron, you touched on some accounting and IT system upgrades. I was wondering if you could give us a little more detail there. A, is that basically why the CapEx is higher and, B, just kind of exactly what are you doing and what execution risks, if any, do you see associated with that? Thanks.

Sure. The answer is that is why there's a significant portion of capital expenditures that deals with that. And the two primary things that are going on are we are putting in the -- an ERP system and installing basically also a second datacenter for disaster recovery and for better load balancing and reliability. So those are in the capital expenditures for this year.

And you've got to remember when we went public we were a $140 million of revenue in 2007, with primarily operations only in the United States in virtual academies. We've gone in a period of less than three years to over a $500 million run rate with operations overseas and diverse business lines. So in order to be able to scale -- our learning systems are incredibly scalable. But in order to scale the business systems you needed to move off the old accounting systems and onto a financial system that can handle that. So we're going through that process. And what really gives me a lot of comfort in this is our CIO has done this multiple times in his career, has tremendous relationships with Oracle. And our CFO also is incredibly familiar, having done this in his career several times. So we have the right people doing it. We've brought in the right outside help. And we're quite optimistic that this will go smoothly. Our CIO will tell us he's never had one that didn't meet its deadlines and work correctly. I'll let Harry comment any more if he'd like.

I'll just add additional emphasis to your question about execution risk. And as Ron was pointing out, the folks involved actually have experience in doing this and an incredible amount of effort was expended in planning risk mitigation, seeing issues before they come up, involving a large number of people so that the implementation is thorough, well planned, well managed, and the oversight is -- every single day there's, if you will, progress assessment, problem identification, resolution. And so we're moving forward. We're on track, on budget and so far, so good.

Okay, perfect. Thanks a lot.

Suzi Stein; Morgan Stanley.

Ron, you made some general comments about the state budgets still being under pressure. Can you just be more specific in some of your key states where you think that stands?

We think overall -- and you have to look at the portfolio, because if you do any one individual state you're likely to be wrong. But we look at down 1 to 2% again. And we just don't know how the federal money that was infused is going to distribute down to the states and may mitigate some of that. But we're anticipating across the average of our states down 1 to 2%.

Okay. And then I just had a separate question on the sales force, I guess. Given that you've changed your product line up over the years through acquisition and development and other things, can you just talk about how your sales force has changed and how aggressively -- I know you talked a little bit about adding to the sales force. So can you give us some sense of how much you're planning to add and what the plans are just structurally going forward?

Yes, I'd be happy to do that. So if you went back even as recently as two or three years ago, we did not have a sales force really selling to districts. What we had was a business development team that helped open virtual academies, but no one -- not selling products to school districts. So we started building that sales force really two years ago. And today we have approximately 25 people selling to school districts. And we'll expanding it this year -- how much, we're still working on that number. But that's a brand new thing. In addition, the American Education has a vast network of resellers that sells to the small schools and to small districts. So we'll -- in addition to having our sales force, we're going to be working with a large group of resellers. So we've expanded our distribution from literally nothing a few years ago to now 25 dedicated people plus an entire reseller network that we will acquire through the -- American Education.

And what we're really truly excited about is now we now have, we believe, the best products significantly in the marketplace with regard to courses, credit recovery, at every single price point. In addition, we've picked up some great assessments, things from [Aplus]. We've also picked up another complete library of courses in Spanish from K-8 and a series of college remediation courses. So we've expanded our product portfolio dramatically. And now you have the sales force to push that through. And one of the reasons you've seen these acquisitions, is in order to really justify sales force you have to have scale in your product line. And these acquisitions gave us that scale in order to justify building a sales force where the returns on that are quite high.

Okay, great. Thank you.

Karen Legotte; Gilder.

If possible, could you just break out in this quarter exactly what was one-time in nature and which line items were they in so that we can get a better understanding going forward in modeling how to think about the business?

This is Keith. The one-time items that we incurred in the quarter were primarily in selling, general and administrative expenses. So it's primarily reflected in that line. And the categories, as we mentioned, were M&A related expenses and integration expenses in that line, as well as the one-time stock compensation charge of approximately $1.5 million. That's in the SG&A line as well.

So there's about an $18 million swing, so besides that $1.5 million stock-based compensation, what other charges should we pull out?

(Inaudible - multiple speakers) --

Because I thought that you talked about them for the year.

Right. So for the quarter we had basically investments in strategic marketing in the quarter. Again, that's in the SG&A line. We also had the integration costs. And most of those start-up costs also for some of these launches happened in the first quarter. So for International, we had losses in the quarter as well, as well as our Capital Education launch.

Okay, so again my question is how much of the $18 million increase quarter to quarter should be pulled out as one time and then what is a sort of run rate without those charges?

Well, we believe we're answering your question.

No, but you're not giving any numbers out. All you're saying is $1.5 million of stock-based compensation. That's the only quantitative number that you gave. You said $10 million for the quarter, but there's an 18 -- $10 million for the year, but there's $18 million in sequential increase in expenses. So I'm just trying to figure out what part of the $10 million has already been recognized and what part of it is normal operating increases so I can have a better understanding of the margin profile.

All right. Let's try again. In the SG&A line, in the quarter $2.4 million of transaction expenses in the quarter.

Thank you. Okay.

In the C&A line, $1.5 million of stock comp expense in the quarter. Startup costs for the different initiatives that we've just talked about on the order of, oh, call it $4 million to $5 million. There is a comment that was made earlier that a goodly portion of those dollars that we're talking about were indeed incurred early in the period. So we've already said that. And in addition there was a substantial increase in marketing for the new launches, international, the brick-and-mortar pilot project, et cetera. If that's not satisfactory, we'll be happy to take your call off line.

No, that's fine and I guess -- okay, thank you.

Jeff Silber; BMO Capital.

Thanks. Just one more question on the guidance. Does the seasonality of the business change dramatically with these acquisitions?

It does change dramatically. As you know, with our virtual academy business, the seasonality was pretty clear that you'd -- and I think now you look at the new businesses, a lot of things changed. The private school runs a negative working capital -- I think you'll still see the revenue and enrollment surge in the fall with that business. But that revenue pattern will be similar. It's just some of the ways it pays will be different. I think the China business doesn't have that seasonality. It'll continue to grow quarter to quarter once we get that where we consolidate it. It'll just be continuous growth and much less seasonality than we have in our current business. And the institutional business, I mean, I think it just depends on what you're selling. But that'll be a little different selling pattern also. So it will change.

Should we still expect the fourth quarter to be the seasonally weakest quarter? Historically you've had a small operating loss. Is that something we should expect going forward?

I don't know if I would necessarily say we expect a small operating loss, but I think the fourth quarter generally should be the weaker quarter, barring something like this where we had all the one-time expenses, most of them coming up in the first quarter.

Great. And in terms of the format for the disclosure, the way that you've disclosed enrollments this quarter, is that the type of disclosure or format we should expect going forward as well?

Yes. We wanted to give a little more visibility, particularly into the private school and international programs. Because we've talked a lot about international enrollments in the past and we're also seeing a lot more sales to traditional brick-and-mortar -- private brick-and-mortar schools, so we wanted to give that kind of granularity. And what we've also done is converted a lot of those -- we've converted those enrollments to what we call FTEs to account for the fact that there's a lot of students there taking individual courses.

And will you be disclosing historical, I guess, pro forma numbers? I know you broke out your core business between public and private schools. Is that something we can get at least for last year on a quarterly basis?

We can look into that, certainly, Jeff. For the private schools, that was not international, that was basically immaterial last year so that's new business. But for the International Academy we'll look into breaking that out.

That would be helpful. And I just wanted to circle back to, Ron, your comments about the election being somewhat transformative, at least at a state level. And let me play devil's advocate here a little bit. In just reading a lot of analysis we've had somewhat of a seismic change towards Republican administrations, both at the governor level and in a lot of the state houses as well. Along with that there's a lot of talk about more budget cuts. How do you think that might impact your business going forward?

I think there's -- you point -- the other side of it, I'm not sure necessarily that you'll see education budget cuts being cut that much other than in some of the places where they're just way above national averages, which isn't -- doesn't tend to be where we operate. And I also, what I believe the bigger force is, when you look at what we get reimbursed per child from taxpayers, 60% of what the typical brick and mortar schools gets. And if you read the Cato Report we get even less than that. I think it portrays well for a huge shift to the most efficient form of education. So I believe whatever effects you see in the budget will be dwarfed by the number of new students and states we're able to serve. And I just don't think the core education budgets are going to be cut that much more because of the [land] shift. I don't hear a lot of Republicans out there saying, "We're going to cut per-pupil funding in education because we think they get too much." You'll hear them -- they'll cut it because there are real budget problems but it's not a philosophy thing that they want to pay schools less. I haven't seen that and if they want a more efficient way of educating, they'll come to us.

All right, great, that's helpful. Thanks so much.

Peter Heise; RedChip.

Just getting back to the effects of the recent turnover in Congress, when do you expect that to happen? When do you see some of that take place? Is that something we have to wait until next year or could it be possibly later in the year?

There's possible some small things would happen this year, but I believe most of what it's doing is setting up potential for large growth in the coming year.

Okay. And are you able to give us the legal and accounting expenses related to the acquisitions backed away from?

That was approximately $1 million.

Okay. And when you talk about the slowdown in acquisitions, is that for this year or is that the next few years, or -- ?

That's for the next year. We didn't anticipate that we'd be doing as many things in as short a period as we have. It's just -- we set out looking for -- we believe China's is the world's most exciting education market outside of the US. We set out to build our institutional business and get scale. And we would love the chance to augment -- give us curriculums at various price points. All those things came available. We've been looking at this 18 months, 2 years. Even since the IPO we've been looking. And so that they all happened to come in at the same time, there's a digestion issue. We've just -- we're absorbing a lot of cost and man hours to digest these things. So I think from a point of view that over the next, certainly next 12 months, 18 months, there's going to be a slowdown in what we do. Because we just literally, we have to integrate these things and make them work.

And the KCDL integration is going well and that was a very complicated one because we had to pull the company outside of its parent. And it was -- had all kinds of tentacles with regards to systems and finance that you have to replace and bring into your own. AEC is easier because it's a standalone entity running by itself. But we still have to integrate things and make sure we deliver on the cost savings, deliver on the revenue opportunities. And then as things become available that fit into this -- the strategy, which is broadening our age range, our product range, our geography, we'll look at them. But there's a digestion issue that's got to happen.

We're going through -- once we get our financial systems upgraded and it's going to be much easier to bring these things in. So we anticipate April we have that ERP system up and running and the second datacenter, it's going to be much easier. So there's literally a year kind of slowdown. There might be one or two small things that come up, but generally we're not look- -- we're trying not to do much as we integrate these.

Okay. Thanks, guys.

Gordon Lasic; Robert W. Baird.

I had a question actually about the same-state enrollment growth. And, Ron, I think you said it was 17.5% in the year. I'm wondering if you'd talk about that a little bit more. We were under the impression that you could potentially see some acceleration there, given that you were holding back enrollment in a couple of large states last year. Did that, in fact, provide a boost? And what do you see as kind of the dynamics in that number? And then, with some of the political gains you talked about, could we see that potentially accelerate next year with some capping (inaudible - multiple speakers.)

Yes. Well, you know, I think we had -- I had talked and consistently saying we would see the enrollments grow in the virtual academy business 18 to 20%, which our total we're in that range. New states came in probably a little lower number than we normally would expect. And I absolutely believe there will be an acceleration in that number potentially as a result of the addition of new states and removing caps. Remember, a lot of it is we have big states that we can't grow in. It makes it very difficult. That 18 to 20% is a large number when you take the fact that two of your biggest states, your biggest potential markets, you're not allowed to grow in. So that -- obviously 18 to 20% I think is pretty strong, given that. Now if we can succeed in removing those caps, which I believe that probability went up dramatically, like I said, in the last week or so, then that number should accelerate. And I also think you'll see new states potentially accelerate as a result of some of the changes and the personnel that have changed out.

And I want to add, we've had a very supportive federal government. I mean, the President and Secretary Duncan have been phenomenal with regard to supporting educational choice and educational innovation. And now to have a more widespread movement at the states where the people we see in various key positions are much more favorable towards that position, I'd be surprised if we didn't get an acceleration. All it takes is one of those states that has multiple thousands on the waiting list to not be capped and by itself will provide an acceleration.

Sure. And then, again, you certainly talked about a lot of acquisitions, a lot of changes in the business. So I'm just wondering, how should investors think about your organic growth for this business over the next three to five years, given kind of all the moving parts?

For the whole business or for the core business?

For -- well, both, ideally.

Well, I think for the core business I think we've been saying pretty consistently 18 to 20% growth over the next three-plus years. And that was before any of the seats -- the landscape that changed a week ago. And I think that's fine and we said that we'd increase margins and EBITDA faster than that. And without the absence of one-time things, that would be happening. So the business is moving exactly like we said and I expect it to continue at that and hopefully have that acceleration we just talked about.

I think you look at the various pieces, we expect the institutional business to grow over 30%. We expect China to be growing at that 25 to 30%, maybe faster if we can actually successfully introduce some of the online things and some of the [kid-range] products that we do. Private school business -- the international grew at 60% just the private school last year. We don't expect it to continue to grow at that high a rate, but certainly above 20%. So these other businesses should just accelerate and add to that 20%. And we really believe we've positioned ourselves with these businesses which we're very -- we went through a long process to figure out where we wanted to be. That positioned us for growth for the next decade. Right?

I mean, these -- you look at the potential for education in China, soon to be the largest English-speaking nation in the world, if you look at the potential for school districts as they rapidly adapt online courses, online summer schools -- and just combine that with a core business that's still doing fantastic and I believe will accelerate. I mean, we're only in 27 states and a huge portion of those, including two of the three largest, are capped. So you just look at that over the next decade, you've really -- I think we've really positioned the company to grow at these higher rates for a decade, at least one decade. So we're pretty bullish. I mean these things -- this was no accident that we decided to do something in China. It was no accident that we chose the institutional business. We've seen school districts adopting virtual education, technology education much faster than I thought it would happen.

Thanks a lot for all that color. And then just one quick one. Kind of shifting gears to Race to the Top a little bit, we've seen 12 winners announced. Can you provide any update on traction you're seeing in those states and the kind of the -- just aggregate some of the opportunity for incremental revenue there?

Yes. We've -- there's definitely opportunity. We think the big opportunity for us is there's school improvement grants, which are billions of dollars for turnaround schools. We didn't even talk on this call, because we have so much going on, but K12 has now been involved with literally improving a high school in New Orleans that's had dramatic results, changes, since we helped take over the management of it on a management contract. We've seen proficiency scores go up 30, 35% in math and language arts over a two-year period at this school in New Orleans. Our solution in the classrooms -- we actually can go into a K-8 school, keep the existing staff, the existing principal, the existing teachers, put in our technology-based curriculum and deliver it. And we've seen results that go from 10 to 15 points proficiency improvements to almost 50 in certain cases.

There's a school in Mississippi that's seen 50 points of math improvement. And it was a school that the Washington Post had called the worst in the country. Now you're getting this huge proficiency in this rural Mississippi school. So we've done seven of these and have had dramatic results everywhere. So if school districts and states, if they want to turn around a school in K through 8 and want to do it without firing everybody on the staff, there's nobody that has a better solution to do that than K12.

So we think the Race to the Top and the school improvement money can be used for that. And we have the most -- the least intrusive solution to fixing low performing schools that we know of.

Frank McEvoy; Craig-Hallum.

I have a couple of quick questions. In terms of the guidance for fiscal '11, you talked about $10 million in transaction costs, integration costs, et cetera, $5 million in operating expenses related to launching new initiatives. How much of each of those categories -- this was sort of asked before, but in a different way -- but how much of those, of that $10 million in transaction costs would have been in Q1? How much of that $5 million in the launched initiatives would have been in Q1?

Well, in terms of the -- I'd say in both of those categories, a lot of it was indeed in Q1. So we would see, oh, call it 60% or so of each category incurred in the first quarter and tapering off. Now, the full-year guidance that we gave is, indeed, our preferred approach to guidance and that is the full year. So we haven't given quarterly guidance. However, as you can kind of back into the total expense for the year and you'll see what kind of expenses are embedded in the full-year guidance, and you see what was incurred in the first quarter, you can easily, I think, ascertain that there is a deceleration in subsequent quarters.

By the way, as I made reference earlier, it's indeed our historical pattern that there's a deceleration of expenses after the first quarter, sometimes into the second and third quarters, with sometimes a little uptick in the fourth quarter. But there is some historical pattern there with a spike in the first quarter for the surge in -- so the brand building, the transaction and one-time-only stuff, and then more heavily front-end loaded some of the losses, startup costs, if you will, in the new initiatives. And so the remaining dollars associated with that in subsequent quarters, there's still some but to a lesser extent than incurred in the first quarter.

Okay, that helps. And then institutional business, my understanding and I think I heard Ron say that the revenue run rate once you get AEC completed would add about $60 million. Was that right?

That's about right.

K12 plus KCDL plus AEC?

Correct.

And then also, if you just looked at KCDL in total plus AEC those add also, coincidentally, to about $60 million run rate?

Right, because in the KCDL you have the private school business and you have the iQ Academies, which add up roughly to $20 million. So just by pure coincidence they swap out.

Right. And then the guidance for fiscal '11, that did not include any AEC EBITDA contribution?

Correct.

Okay, very good. And then, in terms of the final question, I guess this is more looking ahead to 2012 fiscal year. But any color on the partnership with Blackboard and for the college remedial training and how big that could be and what role AEC's products might play in that?

Yes, sure. The Blackboard deal is kind of one of those joint ventures that's almost -- seems strategically, too good to be true in the sense that they have this distribution and relationships with, I think, something like 85% of higher ed institutions. And if you look at the higher institutions and you take out the most selective, we're looking at 70%-plus of the kids need remedial education in either language arts and/or math. And K12 has the product line for that currently. With the AEC portfolio we augment that even further. So we have the content basically already done. They have the distribution. If you just take -- and we can do it significantly cheaper -- I mean, we went through an exercise with Blackboard --than colleges can do it themselves.

So you have this incredible value being delivered to them through the existing distribution system and content that exists for this. So we're optimistic. It doesn't take even a small fraction of that 70% to actually take these for it to be a large opportunity, in the tens of millions of dollars, at a minimum. So they're out talking to customers right now and we'll probably have a lot more color on that in the next couple quarters.

Very good. Thank you very much.

Final question; Claus [von Stutter]; Deutsche Bank.

Hi. It's actually Claus von Stutterheim. I have two questions. Did I hear right that you bought a -- was it post-secondary company that took $100 million to build for $1 million? Did I hear that right?

Correct. Plus some royalties, but, yes.

Can you explain why something that cost $100 million would sell for $1 million and exactly what it is those guys do or did?

Yes, I'm happy to do that. What they had done was build a very extensive post-secondary curriculum and systems and really very high quality courses. I mean, 100 of these are as good as we've seen in anything. And what they failed to do was successfully build the right distribution system for it, either through an accredited institution that they had or through partnerships with others. And it just was a series of strategic mistakes. And the investor group of this just looked at what K12 has done and believed that we were the people that could take this asset and actually deliver serious revenue from it. So for $1 million cash, plus a small backend royalty, we were able to acquire this and immediately have a complete college library of 720 courses plus the learning management system.

So, yes, it was one of those things that just became available. And it costs us $1 million basically a grade almost to build a math course for elementary school. So to be able to get 720 for that same price, it's almost too good to be true, but it actually did occur. And it's closed and we have it and we have some institutions that have come to us asking us if we could provide the content for some existing brick-and-mortar schools that are going to colleges that are going to expand their offering from brick and mortar to online. So we think it's an attractive opportunity where we already now have the curriculum and the systems to do so.

And that sort of brings me to my second question. I don't know that there's a good answer for it. But you've gone, as you explained, on an -- over an explosion of acquisition and additional ventures. And I think everybody on this call has probably seen companies that have had a wonderful business and then went, you know, on a spree and there are, as you alluded to earlier, execution risks and they got bogged down. So I don't know whether there's an answer to this question, but do you have any comments as to why that's not likely to happen in your case?

I do, actually. Because we -- well, obviously we took this -- well, a lot of time with this. And I spent a lot of years at McKinsey doing M&A integrations and doing a lot of M&A work. And my belief is that if you acquire companies that are related to your business, where we're actually the natural owners of the business -- so if you look at these businesses, certainly the institutional business, the private school business, the private school business is just a simple extension of our virtual academy, the school management, the curriculum. So it's a natural extension that you almost have to do and it requires no different skill sets.

The content and products for the institutional business are what K12 already builds and has. And really what we've done through acquisitions and hiring a sales force is really just created a distribution system for a business we already had. And so it's just a repurposing of it. So -- and remember both -- all of these acquisitions were -- are very small relative to the K12. We're looking at acquiring things that have $20 million of revenue, $40 million, relative to our now $500 million.

The research, at least that I had seen in my years ago with McKinsey, was that 75%-plus of acquisitions, when a larger company buys a smaller company in the same industry, succeed. And that's what we're doing here. We're not taking the big risk and going out and trying to buy something that's near our size in an unrelated business, or even in a diverse educational business.

So the only thing -- so everything that we've talked about are just extensions of what K12's already doing and are small add-ons that broaden our product portfolio. The one exception, that would be the investment in China. We've done that investment in the 20% stage so that we can get a good feel for that and get a really understanding of how to build a business in China, how to push our products and things into China. But that one's the only one that isn't maybe the obvious extension.

But when you look at a company that currently is the world's leading online education company for K through 12 and has an opportunity to take -- to leverage our digitized expertise and what we do into the fastest growing and one of the largest education markets in the world, it's a natural extension. And, again, we're putting $10 million of capital in, so we're not betting the farm on any of these things. These are small things for K12. Every one of them, with the exception -- including China -- we believe there's synergies. But I don't believe there's any one of these deals that you wouldn't do if you were a private equity firm without any synergies, based on the growth and the valuation characteristics of these businesses.

You look at some of the valuations for some of the things that are trading publicly and what we've been able to acquire, the multiples in the private sector, these would be great deals without any synergies. But the fact is, K12 has cost synergies and revenue synergies in every one of these deals. So I think we've taken a low risk approach, which as a portfolio of acquisitions has significantly enhanced the value of our business, has enhanced the growth rate at which we'll grow for the next decade, without a lot of risk.

So we're pretty excited about it, to be able to acquire $115 million of revenue in strategic businesses for less than 1.5 times revenue, I mean that's a fantastic opportunity. And that's not counting any synergies that K12 is bringing to the table. So that's a long answer to your question, but I hope it answers it.

No, it's a very good answer. Okay, thanks.

I would now like to turn the call back over to Ron Packard for closing remarks. Please proceed.

Okay. Well, I want to thank all of you for your support and just mention that we'll be at the JPMorgan Ultimate Servicex Conferences in New York today and at the Signal Hill Education Conference tomorrow. We look forward to seeing some of you there. Thanks a lot.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.