Stride Inc (LRN) 2016 Q3 法說會逐字稿

Welcome to the K12 fiscal 2016 third-quarter earnings results conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mike Kraft, Vice President of Finance. Please go ahead, sir.

Thank you, and good morning. Welcome to K12's third-quarter earnings call for fiscal year 2016. Before we begin, I would like to remind you that, in addition to historical information, certain comments made during this conference call may be considered forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. And should be considered in conjunction with cautionary statements contained in our earnings release and the Company's periodic filings with the SEC.

Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied by such statements. In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the date of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statement.

For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC including, without limitation, cautionary statements made in K12's 2015 annual report on Form 10-K. These filings can be found on the investor relations section of our website at www.k12.com.

In addition to disclosing financial 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. The call will be available for replay for 30 days.

With me on today's call is Nate Davis, Executive Chairman; Stuart Udell, Chief Executive Officer; and James Rhyu, Chief Financial Officer. Following our prepared remarks, we will answer any questions you may have. I would like to now turn the call over to Stuart Udell. Stuart?

Thank you, Mike. Good morning, and thanks for joining us on the call today. Before reviewing the results for the quarter, I just want to share how delighted I am that I came to K12. My entire career is focused on providing instructional services to kids who need the most help. I've always been a champion of school choice and educational options for students. Now, after almost three months on the job, I'm even further convinced that there is no better platform to do this at scale and to make a difference with kids than at K12.

I've spent the last 75 days visiting schools, attending school board meetings, listening to customers and talking with employees to quickly gain a deep understanding of the Company's operations, curriculum and talent. My takeaway is that the K12 team is more than just a leader in building great curriculum and technology. It's a team of an incredibly passionate and committed individuals -- including teachers, school administrators and support personnel -- who are on a mission. It's those individuals that truly differentiate this organization and make us a true pioneer and leader in online and blended education.

Now turning to the results.

Revenue for the quarter was $221.3 million, a decline of 9.5% year over year. On a pro forma basis, excluding the impact of the Agora transition, revenue grew 3.1% from the third quarter of last year. Operating income for the quarter was $19.1 million versus $27.4 million in the prior year. Once again, our revenue, operating income and capital expenditures were within the guidance we provided last quarter.

Our forecast for the fourth quarter places our full-year expectations at or above our original guidance for the year. This underscores the strength of the K12 management team and our commitment to deliver on our financial objectives while remaining focused on our core mission to help deliver an outstanding education to students.

Now, today, I want to cover four important topics: enrollment, academic results for our managed public schools, international operations, and our institutional business. First, enrollment results for the quarter.

Average enrollments for managed programs in the third quarter were 104,640, an increase of about 1% versus our average enrollment in the second quarter of this year. This is the first time in the last three years where average enrollment actually increased from the second to third quarter. Most importantly, this means that student retention is continuing to improve.

To put this in perspective, let's look at the figures for the last two years. From count date in fiscal year 2015, excluding the impact of Agora, to count date in fiscal year 2016, enrollments declined by over 4,000. However, by the end of the third quarter in fiscal year 2016, enrollments were the same at the end of the third quarter in 2015. In other words, in-year in fiscal year 2016, we gained over 4,000 enrollments over fiscal year 2015's in-year performance. Primarily, we believe this is due to the effectiveness of the programs we introduced to keep students engaged and to reduce withdrawal.

On a year-over-year basis, our retention has improved about 200 basis points. Over the last two years, our retention has improved by 280 basis points. This is certainly not something that we are able to accomplish overnight. We believe this improvement in retention is a result of a fundamental shift in how we manage the entire student lifecycle. These programmatic changes began about two years ago and have now been rolled out to enough schools to make a measurable impact. Despite these positive indicators, I believe we have a lot more work to do in this area.

Second, I want to share some results from newly available annual standardized test data from the 2014, 2015 school year. This year, the majority of states changed the test they use to evaluate student progress. Of the states which administer the test, and where K12 manages the school, 65% of the states switched to a different test, making it extremely challenging to compare results year over year. Test scores for students taking the same test in consecutive years demonstrate that students in K-12 manage schools improved by 2 points in reading and English language arts and 1 point in math. These results reflect 12 schools across eight states.

Among our schools, we had some very nice successes. For example, students at the Virginia Virtual Academy exceeded the average percent proficient statewide in both math and ELA in grades four, five and six on the state-developed assessment, scoring above the 80th percentile.

Overall, I am very proud of the work that our teachers, school administrators and the entire K12 team puts into driving student outcomes. While we are excited about how far we've come, we appreciate that even more work still needs to be done to maximize student outcomes. We will be publishing our annual academic report in the next few months, which will provide a rigorous review of all assessment results on a school-by-school basis. Typically, we would hope to issue this report earlier. But with so many states changing their assessments, it's taken more time to normalize and understand the results.

Third, an update on our international operation. As we previously mentioned, from a financial point of view we are focused equally on growth and long-term profitability. With that in mind, last year we took a hard look at our existing assets, specifically in the United Kingdom, and decided that the current framework for operating schools in the UK did not fit our business plan. Virtual schools and online curriculum are just not moving at the pace we would like, and operating brick-and-mortar schools is not our long-term goal.

As such, we have begun transitioning our schools in the UK to other trust consortia with the support of the Department for Education. At the end of the third fiscal quarter, three of our four schools in the UK have been transitioned or closed. The remaining school will be transitioned by the end of the fiscal year. Our future international efforts will focus on less of a physical footprint and more flexibility. We will keep you apprised of other developments as our international strategy moves forward.

And lastly, our institutional business. As you know, we believe Fuel Education is a growth business for us over the long run. Unfortunately, revenues can be somewhat lumpy, and this quarter's results are no exception. Since arriving at K12, a lot of my time has been spent with the institutional team and I've already enacted some changes including adding incremental sales resources and accelerating and refining the focus the Company places on large account sales.

While it is still early in the process, I believe we can begin to see some improvement in the near term. Obviously, we are far from satisfied, and we will continue to work with the team to drive growth in this business for the next year and beyond.

From a strategic standpoint, we continue to look for multiple strategic acquisitions and partnerships to expand our distribution, to enhance our product set and to improve our technology platform. In that regard, I am very pleased to announced today that last Thursday, we closed our first acquisition that fits all of these criteria: LTS Education Systems. The value of the transaction was approximately $20 million in cash.

LTS Education Systems is a proven educational technology company that provides flexible learning solutions to 1,500 school and after-school sites. They serve more than 350,000 pre-K to 11th-grade students in 37 states across the country. Their core product is Stride Academy, which is a SaaS offering that blends instruction, assessments and games into a mobile skilled practice and test readiness solution. It is adaptive, it is gamified, it is engaging and it is mobile, all of which we know works. And it's where we are heading as an organization.

Importantly, the solution has delivered positive efficacy results. In a 2014 independent study by the Public Affairs Research Council of Alabama, student test results in grades three through eight were 10% to 14% higher in reading proficiency and 13% higher in math proficiency as a result of using Stride Academy to support learning. And the results were strong across subgroups, indicating that the product helps close the achievement gap.

From a strategic standpoint, this acquisition fits nicely with our institutional assets in many ways. First, the product fills the gap we have in skilled practice assessment and test readiness across all core subjects: in reading, English language arts, math, science, and social studies.

Second, the LPS customer base has been very minimal state or client overlap with our current fuel ed customer base. Therefore, we will be able to take advantage of cross-sell opportunities with fuel ed solution sets.

And lastly, this acquisition gives us an entree into game-based products. Gamification of learning engages today's students, translating into engagement and persistence. And as we know, engagement and persistence are key to improving academic outcome. We believe that gamification and game-based learning will be important to both our future student success and our Company growth.

Our team is excited about the prospects for this acquisition. While LPS is an already profitable company with $8 million in revenue at the onset, we believe the growth prospects for Stride Academy and the cross-sell potential for fuel ed product sets will make this acquisition a strong growth driver for K12 in the future.

I want to again reiterate that I'm very excited to be here, and I look forward to supporting K12's growth going forward.

Thank you for your time this morning. I will now have the call over to James. James?

Thank you, Stuart, and good morning, everybody. First, a few words about our reported results. Revenue for the quarter declined 9.5% from the year-ago quarter -- [$221.3 million]. This quarter, we posted an operating income of $19.1 million. This compares to $27.4 million in the third quarter of last year.

As in previous quarters, I will spend some time discussing revenue and enrollment on a pro forma basis excluding the impact of Agora. We believe this approach will provide you with a clearer picture of the underlying trends in our business.

Total Company pro forma revenues increased 3.1%. Revenues from managed programs would have risen about 3.9% year over year. This is largely a result of a 4.3% increase in revenue per enrollment. The revenue per enrollment trends related to a combination of factors including school mix and improved funding environment in some states.

Average enrollments was declined slightly from the year-ago quarter. As Stuart mentioned, our ending quarter enrollment actually was about the same as third quarter of fiscal 2015. That means that while we started fiscal 2016 approximately [$4,000] below the start of fiscal 2015, we have now closed that gap. The investments we have been making for the last two years are beginning to pay off in improved student retention and average student enrollment.

Our non-managed programs, excluding the impact of Agora, revenues would have been $13.1 million. Non-managed programs enrollments grew just under 1%. That was more than offset by a 4.7% decline in revenue per enrollment. Revenue per enrollment declines were largely due to mix.

Institutional software and services -- which includes software technology, professional and other educational services -- sold by our fuel ed teams posted revenues of $10.6 million in the quarter. This is a year-over-year decline of 2.8%.

While we did see modest decline in these revenues this quarter, we continue to believe in the opportunities in the institutional market. The LPS acquisition is the first step in a set of targeted investments to expand our product set and distribution capability. As we have previously mentioned, our investments in areas like our peak product ELL and other products should gain traction over a number of sale cycles.

Revenue for our private pay and other businesses was about $11.7 million, an increase of 5.4% over the prior year. As Stuart already reviewed, we are pivoting away from our UK operations. On a year-to-date basis, we have recorded approximately $9 million of revenue for the UK. While we will see a decline in private pay and other revenues for the fourth quarter as a result of this shift, the impact to operating income will not be material. You should also note that we have already accounted for this change in our fourth-quarter guidance.

Third-quarter gross margins remain flat at 39.1% compared to prior year. On a full-year basis, we anticipate gross margins to be roughly flat.

Selling, administrative and other expenses were [$64.9 million] in the quarter. That is flat from a year-ago period and consistent with our focus to manage costs tightly.

Product development expenses were $2.6 million, which is largely flat from a year-ago quarter. Operating income for the quarter was $19.1 million, compared to $27.4 million in the prior year. The reduction in operating income is largely due to the transition from the Agora contract. Now let's turn to some other items.

We ended the quarter with cash and cash equivalents of $199.5 million, a $28.2 million increase from the prior quarter. Our cash balances increased approximately $57 million versus the year-ago period, and it's higher than our beginning-of-the-year cash balance. Cash on hand now represents approximately $5 a share of value.

DSOs have improved by 12 days on a year-over-year basis, with improvements across all business units. These improvements continue to be the result of a strong emphasis we are placing on accounts receivable management. While there may be some exceptions in general, we are clearly seeing more discipline in this area.

CapEx as we have historically defined it, which includes curriculum in software development, computers, and infrastructure, was $45.3 million year to date versus $57.4 million in the previous year. We also had approximately $2.5 million in computer-related equipment that falls on our capital lease program. But we expense, so it's not part of our CapEx number I just mentioned.

The $12.1 million year-to-date decline versus last year was a result of lower spending on operating equipment as well as student computers.

Our tax rate for the quarter was 28% versus 39% in the year-ago quarter. We get the benefit of certain losses in some subsidiaries as well as our international operation, which lowered our tax rate this quarter. We'll be able to take that benefit for the full year and are therefore updating guidance for the full-year tax rate to a range of 34% to 36%.

Now turning to our expectations for the fourth quarter, we expect revenue of $205 million to $215 million, operating income of between $5 million and $9 million, capital expenditures of $22 million to $27 million. On a full-year basis, this outlook equates to the following full-year guidance. In all cases, we anticipate full-year results that meet or beat our original full-year guidance expectation: revenue in the range of $856 million to $866 million; operating income of between $18 million and $22 million; capital expenditures of $70 million to $75 million; and, as I just said, a tax rate in the range of 34% to 36%.

Thank you for your time, and now I will hand the call back over to Stuart.

Thank you, James. Kevin, we are ready for any questions.

(Operator Instructions) Jeff Silber, BMO Capital Markets.

Thank you so much, and congratulations on the quarter. I'm just curious, compared to your initial guidance, where the areas of upside were both in the third quarter and in the current quarter based on your guidance.

Predominantly, Jeff, we've been seeing a good environment for mix and rate on our managed school side. And that, by the way, has a lot to do with the way our retention programs have actually worked as well. Because our retention programs obviously feed into, as you know, the way that the funding often works is pro rata throughout the year. So that retention lift, if you will, does feed into improved revenue in many schools. Not all schools, because there are some that have a different type of funding environment where it gets funded on the county. But as states have over the years shifted to more pro rata during the course of the year, that retention does provide an annual lift. That's probably the primary driver of the lift.

Okay. And then switching gears to the LPS acquisition, obviously there's a number of companies out there that do this. I'm just curious why LPS. Why not some of the other companies? And what do you think the impact going forward will be on your business from a revenue and margin perspective?

Well, LPS, as I mentioned, fits a number of the things that we thought were really important for us moving forward. It helps us with skills practice, assessment and test readiness across all subject areas. Not just reading, English language arts and math, which is common in many products but also science and social studies. And it also covers grades pre-K through 11. So it helps fill in some gaps for us at the lower level.

We think it is a product that is extensible across all of our areas. We, of course, will distribute the product through Fuel Education, but we think there is a private-pay optionality around it. And it's a tool that we can use in our managed public schools to improve performance. So we love the fact that it is extensible throughout the business.

We also see gamification as something that is really well done in this product. As an example, we see usage in some districts up to 35% to 40% at home. So it's a product that is so engaging that kids are using it in free time, not just in school, in some cases.

So there's a lot that we love about it. As we mentioned earlier, it is not particularly material at this time, but we think it's something that will tie to a lot of our future efforts around SaaS-based products, around gamified products and around adaptivity.

Jeff, this is Nate. I don't -- Stuart gave you all the operational reasons and strategic reasons. I would add one thing and that's some financial reasons. Anytime you want to do these transactions, you're right: there are many companies out there, but not all of them are executable. Meaning, somebody you can buy at a reasonable price and be current-period accretive. Meaning, as soon as we buy it, we are not taking an in-period loss. So -- ongoing losses from operations.

So that's the other reason why this is attractive: because it gave us all of those things Stuart mentioned at a very reasonable price. And it was executable in a short period of time, and we don't have to start taking immediate losses from an operation that is losing money.

Okay. I appreciate that color. And just one more question. I know it's still a bit early to talk about next year, but can you highlight some of the states from a managed school perspective where you may be seeing either expansions or new programs?

Yes, this is Nate speaking. First of all, I think there's probably only two or three states where we see some risk. And you guys already know about Tennessee and a few like that. But we are expanding into new schools, particularly in areas of career readiness. We have four schools that have agreed to do a school within a school where a career-readiness academy gets started.

In addition to that, as we have mentioned before, Alabama is a state where they opened up the law last year. But we really didn't understand what the funding would be -- what the rates and the procedures would be. So this year, we understand that. We know what the rates are going to be, and we are going to start expanding in Alabama. So we think that that's an opportunity to expand as well.

Let's see, academy -- Career Academy in Wisconsin, in fact, has already taken enrollment. We also see a new opportunity in Michigan. There's a new school that we will be starting there that focuses on dual-accredited. And they are a college, so it's really a high-end school there. And then we have an opportunity in Indiana as well. Those schools were all what I would call relatively small, but will offer expansion opportunities.

And then our normal schools will all be focusing on growing enrollment because their retention is so much better. We have a better opportunity to grow. So that's where we see opportunity.

All right. Appreciate the color. Thanks so much.

(Operator Instructions) Corey Greendale, First Analysis.

First question, Stuart, in doing some quick Googling here, I see that you worked with LPS any rate at Catapult. So maybe that's a good springboard to asking just how you see the landscape. Is it -- presumably you thought it was a good product from your work there. And given your background in the industry, are there several other things that you have worked with or are familiar with that you think could make interesting acquisition targets? Do you think this is a one-off, or what is your perspective?

Well, yes, certainly one of the things that was attractive is that I have some personal track record with LPS. I saw it used successfully in schools. And we've been able to -- it's certainly always more attractive when we know what product works well. And not just from a usability perspective but from an implementation perspective with schools.

So it truly is SaaS-based. There is not a huge service component around it. And it's easily deployable, which is -- are things that we certainly like.

Regarding other opportunities, this is certainly the type of deal we like. We are looking at opportunities, frankly, of all sizes. But the key isn't size; it's really strategic fit. And the key is also -- we are also looking -- we will make sure that anything we close on is right within our environment, whether it's next month or a year or two from now. Timing and size are really not important; it's strategic fit.

So this again is something we love because it was such an easy snap-in to Fuel Education. But we could also use it across other aspects of our business. And those are the types of deals I think we will continue to love most. As Nate also indicated, it is immediately accretive and we like that, too.

Thanks. And then I had a few kind of scattered questions. First of all, the data that you shared on the schools where they used the same test this year from last year, was the improvement -- are you comparing last year's fifth grade to this year's fifth grade, or is it the same group of students last year to this year?

It will be last year's fifth grade to this year's fifth grade.

Okay.

The student cohort itself obviously has some changes that some students come into the cohort, some go out. So you can't compare exactly students to students; it's really grade to grade.

I will add, Corey, that we do have other data sets that compare same student to same student. So, for instance, we have some date in Texas that shows exceptional gains on the same-student basis from school year 2013/2014 to 2014/2015. So we try to look at both when possible.

Okay. And then on the managed program, I think -- James, I think you said that revenue for enrollment was down due to mix. Is that a phenomenon you expect to persist in Q4 and into 2017?

No. The mix for us is always sort of a little bit of a balancing act because, as you know, we work with the boards, and they really determine if there is enrollment cap levels or where the state determines there is enrollment cap levels and things like that. So I don't think that that is a trend that you are going to see going forward. It is sort of the way the mix panned out this year. And, again, there's a piece of that retention component that we talked about earlier that influences that (technical difficulty) as well.

I'll keep rotating my questions around. So maybe for Nate or Stuart, whoever wants to take this, is there an essay you can provide on the Ohio renewal?

The chairman of the Ohio board and myself have met a number of times already. They are very interested in starting the negotiation. As you know, the contract expires June 17. I think all indications are that we have a very good relationship. They love our head of schools, as I do. She does a fantastic job. The school's academics are strong.

The one thing that I think they would like us to do is they would like us to be more aggressive on the PR front. They certainly believe the school is doing a great job, and they would like to see more people know more about that.

So I think overall we have a great relationship, and the conversations are all about renewal. There are no real problems here that we can see.

Okay. And then just a couple more quick ones. On the -- what is going on with your UK schools. Is there a meaningful revenue impact to that, or can you quantify that?

The revenue year to date was about $9 million. That's sort of a good annualized number to use. So, next year we won't have that -- as long as the Q4 trajectory continues on migrating the school over to a different trust, that would all go away next year.

Just like $12 million annualized?

Well, what will happen is, depending on the timing of Q4, we will -- what will happen is probably we will pick up a little bit in Q4. And we will give you some indication when we get into Q4 because we are not sure that is the exact timing. But assuming it didn't happen until the end of Q4, yes, it would be 12. But depending on the timing of it happening during Q4, it might be a little bit less than that, actually.

Okay. And what's the margin on that?

So that was -- part of the reason I think Stuart in his comments was mentioning it, really, it's breakeven to slightly loss-making right now. So really, it won't impact bottom-line results for next year at all.

Okay. And any material impact on CapEx?

No.

Okay (inaudible). And then last quick one I had was on the institutional -- I guess it was listed in the segment breakout as institutional software and services. That had been modest growth. It was down a little bit this quarter. Anything you would highlight is the reason for that -- whether then turns around?

It's been a little bit lumpy. If you look back a few years -- each of the past few years, we've had a little bit of lumpiness. Actually, last fiscal year was probably our least lumpy year. But historically, it's always been a little bit lumpy.

I think we will continue to see some lumpiness going forward in that I think next quarter and going into next year, it will also be a little bit lumpy. But we --I think, as Stuart mentioned, the prospects we think given some of the products we've invested in, LPS, some of the synergies we'll gain from those things -- we do think the prospects are good, but there is some lumpiness that we will continue to see.

Okay. And, sorry, just one last one. On LPS, should we think of that as more products that will go through your existing sales force, or does the LPS bring meaningful sales force as well?

Yes, really both, Corey. So they bring some really exceptional sales resources to us. Some folks have been quite successful in terms of their track records, who know how to execute and close large account sales.

That said, we are very excited about the opportunity to distribute that product through our existing channel as well. And we are starting that cross-pollination fertilization immediately.

Corey, this is Nate. I want to add one thing to the question on institutional software and services. And that is that we've had an effort to try to get the sales force to sell on a little larger sales side -- average sales side. When you do that, you are selling to larger accounts. The sales cycle is a little longer. And, as James mentioned, it's more lumpy.

As you look at last year, you would've seen quarters where we were down, and then you would see big increases in a quarter. You'll see some of that same thing happen this year where we've got big sales that happen, but when they do happen they come through. So overall for the year, we are pretty comfortable we're going to see good growth. But it comes because as we try to go to a larger account, this sales cycle takes a little while and it takes a while for that one sale to pop through. That happened to us last year; we think it might happen some this year.

Okay. Very helpful. Thank you.

(Operator Instructions) We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

Thank you very much for joining us today. We do look for to joining you again in the coming quarter. Have a good day.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.