Stride Inc (LRN) 2017 Q2 法說會逐字稿

Greetings, and welcome to the K12 fiscal 2017 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Mike Kraft. Thank you, Mr. Kraft you may begin.

Thank you, and good afternoon. Welcome to K12's second-quarter earnings call for fiscal year 2017. Before we begin, I would like to remind you that in addition to historical information, certain comments made during this conference call may be considered forward-looking statements, made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, and should be considered in conjunction with cautionary statements contained in our earnings release, and the Company's periodic filings with the SEC.

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

For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC, including without limitation, cautionary statements made in K12's 2016 Annual Report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.k12.com.

In addition, to disclosing financial results in accordance with Generally Accepted Accounting Principles in the 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 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.

Thanks Mike. Good afternoon, and thanks for joining us on the call today. With my one-year anniversary with K12 just around the corner, I've been taking some time to reflect on our business strategy, priorities, and opportunities. Today I want to review with you where I think this business is going, and therefore, how we are prioritizing our resources to support future growth. Across all of our lines of business I see tremendous opportunity, and after a number of years in which we faced stiff environmental headwinds, we believe that the recent election at both the federal and state level may contribute to a generally more positive environment for growth going forward.

In our managed schools business, demand in the first half of fiscal 2017 has been stronger than we've seen in several years, certainly in new enrollments, but just as importantly in the application level, which is a good proxy for market demand. Established states like Texas, Michigan, and South Carolina, continue to show strong demand for applications, and newer states like Alabama, North Carolina, and Virginia, have posted solid enrollment growth.

At the same time, in some of our more mature states where we've had programs for ten or more years, we saw flatter in some cases slight declines in enrollment. On balance, however, we believe that our uptick in managed school enrollments in fiscal year 2017, combined with the renewed attention on school choice and online education, portends a favorable environment for long term growth in our managed public school business.

We also see opportunities to increase the number of partner schools that we serve across our existing state footprint, and increase the number of states that we serve with full time online programs. In the last few years, we opened up partner schools in North Carolina, Virginia, Alabama, and Maine. Over the next few years, we are looking at opportunities to launch schools in several new key states. Remember, opening new states is often a multi year process, but we remain optimistic about continuing our successful track record of bringing virtual school options to new states, and more families.

While we were excited about the long-term growth prospects for managed public school programs, in the current period we did see some pressure on enrollment levels, due to a decline in retention rates. To address this issue, we've aggressively evaluated the entire student experience, reviewed operations on a school by school basis, and rolled out new initiatives to compliment existing retention programs. Everyone on the K12 team is keenly focused on what student retention means to the long run economics of our business, and more importantly, what persistence means to student level academic outcome. We believe that these programs and initiatives will have a positive impact on retention levels, but we probably won't see that affect until fiscal 2018.

Now turning to other key initiatives, we are excited by the potential we see in our online career technical education programs. As a reminder, these career tech ed, or CTE programs, are attractive for many different types of students. From college bound students, CTE programs allow for a head start on specific career paths. However, for the many students interested in a more direct and immediate career pathway, CTE offers the opportunity to earn a high school diploma, along with specific career skills that can lead to a job, which they otherwise may never have been able to achieve.

We launched five new CTE schools this year and established more than a dozen CTE partnerships with school districts, and these programs are still in the early stages of development. We believe that over the next five years, the demand for online and career education will accelerate. Should this happen, K12 will be uniquely positioned with established CTE programs, and thus well equipped to garner significant growth.

Next, we remain enthused about future growth potential of blended programs, in which K12 works closely with school districts that are looking for innovative ways to meet the individualized needs of their students. Blended models allow districts to offer students more flexible alternatives to the standard classroom instructional model. We've recently worked with some large city districts like Omaha, Nebraska, and Richmond, Virginia, to develop blended offerings designed to meet their specific goals. In these innovative partnerships K12 provides curriculum, technology, and a menu of service options, such as instructors, program management, and professional development. We see this model as an increasingly attractive alternative for school districts around the country, to really innovate and better serve the individualized needs of students.

In total, we believe the market demand and growth trend for online public schools over the next few years is promising, moreover from a funding perspective, the average revenue per enrollment has been generally favorable, and we believe will continue to be so, with flat to marginally higher levels over time.

Turning to our institutional business, we see online learning and digital solutions grabbing an increasing share of the instructional curriculum and content market. Our product portfolio is one of the largest and most comprehensive of any digital publisher, we have the product school districts wants, including career tech ed, core digital curriculum courses, world languages, credit recovery, and Stride, our newly added practice and test preparation solution.

We have also created innovative new programs to meet very customized 21st century needs of students. For instance, in Colorado, Pikes Peak Early College team with FuelEd, to help students earn college credit and professional certifications at the same time as taking their core course work in high school. Students can work towards an Associate's degree while in high school and earn up to 60 credits to transfer to a four-year college. Students can also earn actual professional certifications at no cost to the student or family, and at a fraction of the cost of a typical college education. This type of innovative approach is just one example of how K12 is working with school districts, to mitigate the cost of college for the average American.

It has been estimated that the aggregate market size for career technical education, world languages, credit recovery, and supplemental courses is over $5 billion, in our FuelEd business, we have taken steps to ensure that we have the right team on the field to address these markets, and drive us towards sustained and predictable double-digit growth over the long-term. This includes shifting the sales team's focus to large accounts and larger contract sizes. We believe districts are increasingly ready to adopt the strategic macro view of how to meet diverse student needs and pursue scalable system-wide solutions.

Next, in a move that benefits our FuelEd managed public schools and private pay businesses, we are pleased to announce that Middlebury Interactive Languages is now fully owned by K12, as we have recently acquired Middlebury College's ownership interest in the joint venture. As the academic leader in digital language learning for K12 students, Middlebury Interactive Languages has long been a key part of K12's value proposition to schools, districts, and families. With this transaction, we have become better positioned in the world language marketplace, gained more flexibility and operating control, and a more nimble governance structure, to help schools, districts, and families, to prepare students for college and careers. The agreement to purchase the remaining 40% ownership share closed in December for $9.1 million.

I also want to take just a minute the potential impact the recent election on our business. Though nothing is certain, we are encouraged that several key elected and prospective members of the new administration, have historically held views that are supportive of school reform and parent choice. We have a shared belief that an equitable and high quality education, ought to be readily available to all students, whether in public, private, or charter schools. We anticipate that this will contribute to an improved environment across the nation for school choice, and more options for families and students.

While support at the federal level is important, of course most of the decision-making about education reform happens at the state level. This election cycle saw movement in some key states, which should help advance education reform, parent choice, charter schools, and innovation. Practically speaking, we believe over the next few years, we have an opportunity to develop new partnerships to open schools in new states, open new specialized schools like CTE within states, and see equitable funding levels for all students.

As an organization, we will continue to work across both sides of the aisle to advance school choice, options and alternatives for students. We are very pleased announce a couple of weeks ago that Kevin Chavous joined our Board of Directors. Kevin has been an tireless advocate for education reform, having advanced charter school and parent choice programs in Washington DC, and around the nation.

Under the Every Student Succeeds Act, or ESSA, states are empowered with greater autonomy to determine how to measure schools. Traditional accountability systems create real challenges for alternative schools, including many of the schools that K12 manages, as they do not fully take into account the notable differences in student mobility, at risk populations, students who come to K12 high schools with significant credit deficiencies, or even students who dropped out of school all together before arriving to our schools.

We believe that it's a truly unique opportunity in time for policy makers to rethink how to best define and measure success per school, and potentially make a course correction from static one size fits all proficiency measures, to a true student centered accountability. Rather than relying on systems that assign a grade to a school based primarily on annual high stakes tests and graduation rates, states can adopt dashboard approaches, that give a more complete picture of a school to parents, that factor in the demographics of the student body, and allow regulators to determine how a school is fulfilling its unique mission. For instance, a report released just last week on Michigan schools by the Mackinac Center for Public Policy, stated that some schools ranked poorly when only test scores are considered, but when the socioeconomic status of students is factored in, they are beating difficult odds and performing beyond expectations. One of our partner schools, Michigan Virtual Charter Academy, or MVCA, could be erroneously viewed as failing, when looking solely at test scores, but in fact, was determined by the Mackinac center to be average across the state when adjusted for poverty.

Improvements in accountability standards would allow us to spend more time serving families and teaching students, within a framework that more accurately reflects the progress that students are making, and the milestones important to parents. More transparency across these multiple measures of interest to parents, could directly impacts overall interest in an online option, and help drive growth in the category. When all these policy and market developments are considered in their entirety, we believe the future is bright for an education technology company like K12. We will therefore continue investing in our people, programs and products, to ensure that we have an engaging and enriching environment to support student learning.

As you are aware, we were investing capital at a very high level for many years to get to this stage in our development, and now we are well-positioned in the market, and can begin to taper our spending. As you can see in our updated guidance, this year we expect to spend between $55 million and $60 million, which is about $5 million below last year. Over the next few years as many of the major capital programs near completion, we would look for capital outlays to fall below $50 million, and ultimately stabilize in the $40 million to $50 million range, with a corresponding increase in free cash flow. I want to also emphasize that while we are bullish on the long-term future prospects for K12 for the reasons I've discussed, none of these directional changes will have an immediate impact on our financials for fiscal 2017. We will look for the results of these changes to start to materialize in future periods, as we work with policy makers on both sides of the aisle, to provide more options and alternatives for students. Thanks very much for your support, I will now hand the call over to James, to review second quarter results, as well as our third quarter guidance, James.

Thank you Stuart, and good afternoon everybody. First to recap our reported results. Revenue for the quarter increased 5.9% to $221.1 million. Operating income for the quarter was $18.3 million, an increase of $3.6 million, or 24% from the prior year. Adjusted operating income was $22.9 million, an increase of $3.2 million, or 16% from the prior year. As a reminder, adjusted operating income and adjusted EBITDA excludes stock based compensation. Capital expenditures were $9.8 million, a decline of $1.8 million from the prior year, in each case, these results exceeded the expectations we provided in our guidance last quarter. Some additional details for the quarter.

Revenue was $221.1 million, an increase of $12.3 million, or 5.9% from the year ago. Revenue growth was largely driven by increases in our managed public school programs, and some modest gains in our institutional business. Somewhat offset by declines in our private pay business. As I mentioned on last quarter's call, the private pay business declined as a result of closing down our UK operations, that we announced in fiscal 2016. Revenues for managed public school programs increased 7.1% compared to the prior year to $182.4 million, the increase was a result of a 2.3% increase in student enrollments, combined with revenue per enrollment increasing 4.6%. From an enrollment standpoint, demand continues to be strong.

For the first half of fiscal 2017 more students applied to K12 managed schools than in the same time last year, also as Stuart already mentioned, in Q2 we saw a reduction in student retention rates compared to the year ago quarter. We continue to roll out programs to improve our retention efforts, and we believe that those programs will take some time to take hold, and we will have an effective fiscal year 2018, but it will not have an impact on fiscal 2017. So while we will look for improving retention levels in fiscal 2018, we may see continued retention pressure for the remainder of this year.

Revenue per enrollment increased 4.6% this quarter, we reiterate that the full year revenue per enrollment is likely to be flat to moderately up on an year-over-year basis. That means likely lower revenue per enrollment year-over-year growth in the second half of the year. In our institutional business, which includes both non-managed public school programs as well as our institutional software and services, revenue grew 9.4% on a year-over-year basis, non-managed public school programs increased 13.1%, versus the prior year helped by continued increases in our Agora program, as well as a new school partnership in California. Institutional software and services revenues were up 4.7%, this is largely the result of sales of curriculum credit recovery, and our acquisition last year of LTS.

As our new product continues to roll out and gain traction, we expect institutional to be a growth driver for K12 over the long term. You should also note as we previously mentioned, we expect revenue growth to be an uneven pace, particularly for the remainder of this year. We had an unusually strong Q4 for last year, which will be a tough comparison for us in this Q4.

Turning to our private pay business, revenues declined 22.3% to $8.3 million, excluding the impact of the UK operations, revenue was largely flat year-over-year. As we have said in previous quarters, we are seeing interesting opportunities in the private pay space, and believe we have potential for growth in this business over the long term. Gross margins were 37.8% in the quarter, and were largely flat compared to 37.9% a year ago. On a full year basis, we expect gross margins to contract by approximately 100 basis points, compared to the prior year, as a result of the increased amortization related to the curriculum we've recently put in service, and some ongoing investments in driving stronger student outcomes, and student mix.

Selling administrative and other expenses increased by 1.5% in the quarter, to $62.4 million. The sequential decline from the first quarter is in line with our normal seasonal patterns. Our spending as a percent of revenue has declined about 120 points from last year. On a full year basis, we would expect Selling Administrative and Other expenses to be approximately 1% lower, excluding the impact of the California AG settlement last year in Q4.

Product development expenses for the quarter were basically flat to the prior year at $2.9 million. For the full year we would expect these costs to continue to be flattish compared to last year.

EBITDA for the quarter was $30.7 million, increasing 18.6% from the same quarter last year, this increase was largely a result of our revenue gains, solid cost controls in the quarter, adjusted EBITDA for the quarter was $41.6 million, an increase of 14.9% from the prior year, year-over-year stock based comp declined approximately $400,000, operating income was $18.3 million, an increase of $3.6 million, or $24.4 million. Adjusted operating income was $22.9 million, an increase of $3.2 million, or 16.2% from the prior year.

Now let's turn to some other items, we entered the quarter with cash and cash equivalents of $182.1 million. An increase of $10.8 million from the second quarter of fiscal 2016. This is significant considering some of the incremental outlays in the first half of this year, including the payment for the settlement with the California Attorney General, and the acquisition of the Middlebury interest, which combined for a little more than $16 million. CapEx which includes capitalized curriculum and software development, and property and equipment purchases was $9.8 million, a decrease of $1.8 million compared to last year. This decrease was a result of lower capitalized software and property and equipment expenditures, somewhat offset by larger investments in curriculum. Our tax rate for the quarter was 41.4%.

Before I move to our expectations for the rest of the year, I want to address two topics. First, as we continually review our operations and portfolio of assets, we look for ways to improve long term profitability, and as a result, we will be taking some actions during Q3, which include reducing our real estate exposure, and lowering our Human Resource costs. From a real estate perspective, we are looking to consolidate our corporate headquarters footprint, and look to exit some underutilized school facilities. From a resources standpoint, we have proactively reviewed our organization, since Stuart joined last year, and we will refine our headcount in !3, which will result in some severance costs. Neither of these charges are included in the guidance we provided in our release today. We will provide more details on these charges in our next quarterly earnings call.

Second, as we have previously discussed, we introduced some performance based stock compensation last year, which has the potential to vest this year, depending on whether certain performance metrics are met. So we may see some variability in stock based compensation in the third or fourth quarter of this year, we've introduced adjusted operating income and adjusted EBITDA in this year, so those metrics exclude the impact of stock based compensation, but our normal operating and income EBITDA will include these potential charges, this vesting could result in charges of up to $4 million to $5 million this year, that was not part of our original full year operating income guidance.

Before turning to guidance for the third quarter, as you may have already seen in our release, we have improved our CapEx spend guidance for the full year, specifically as we continue to focus on improving free cash flow, along with other operating results. We are reducing our full year range for CapEx to $55 million to $60 million, from our previous $60 million to $65 million. For our upcoming third quarter, we're looking for revenue in the range of $210 million to $220 million. Adjusted operating income in the range of $18 million to $21 million, operating income in the range of $14 million to $17 million, and capital expenditures of $14 million to $16 million.

As you will note our guidance for the third quarter operating income is somewhat below consensus, however, we would look for fourth quarter operating income that is above consensus. As a reminder the third quarter guidance excludes any charges we may take for the actions regarding facility and severance that I previously mentioned, also our full year guidance for operating income and adjusted income imply stock based compensation costs of approximately $17 million. I believe the consensus is closer to $19 million. This $17 million we have implied again excludes any performance based stock that may vest this year. Thank you for your support, and I will hand the call back over to Stuart. Stuart.

Thank you very much, James. Tim, if you would queue up some questions, we would be happy to take them now.

Absolutely. (Operator Instructions). Our first question comes from the line of Cory Greendale of First Analysis. Please proceed with your question.

Thank you, this is Ken Wang on for Corey. So just looking at Q3 guidance, it looks like it implies revenue would be down year-on-year, just wondering if there's any additional color you can provide there?

Yes, I mean, so it does imply slight deterioration of revenue year-on-year, and I think as Stuart mentioned, we are seeing some softer retention rates, and we'll see how this actually forms up throughout the course of the quarter, into what it actually means. But there is some softness that we probably expect largely driven by some softness in the retention.

All right. Thank you. And looking at the institutional software revenue growth, which looked like it slowed sequentially in the December quarter, what was the organic growth in the segment, and why did it slow? What do you expect for the rest of the year?

Yes, so the organic growth year-over-year was sort of in the low single-digit range. And for the rest of the year, the institutional software and services I mentioned earlier, is going to have some variability throughout the rest of the year, particularly if you look at Q4 of last year, we had a pretty significant Q4. I would expect that to be actually down year-over-year, but we probably won't post such a strong Q4. If you looked at fiscal year 2016, sequentially Q3 is normally lower than Q2. We would expect some sequential decline again in Q3. So that is sort of the directional range of what you should expect.

And I will add, we continue to see obviously positive trends in the marketplace. I think as we've grown in institutional over time, one of the things we felt we needed to do was to top grade our talent a little bit, and over the last quarter brought in new leadership, for both our sales organization and our customer service organization, which of course impacts retention and the institutional business. So we are very pleased to have a team that we think can execute against kind of our longer term vision and growth prospects.

All right. That is very helpful. Thank you.

(Operator Instructions). Our next question comes from the line of Jeff Silber of BMO Capital Markets. Please proceed with your question.

Thanks so much. Just wanted to circle back to your outlook. If I'm looking for the full year fiscal 2017 revenues and adjusted operating income, I know there is going to be noise in stock based comp, but I want to leave that out. Are you still comfortable with the guidance that you gave on the last quarter for the entire year?

We're not changing our full year guidance at this time, except for the CapEx which we previously mentioned is coming down. The full year guidance we are not changing.

Okay. Fantastic, I just wanted to double check on that. And you mentioned a few times the decline in the retention. Can you give us a little bit more color on that? Is this something that just happened this quarter? What do you think happened, and how do you think you can fix it?

Well, look, you may have mentioned we alluded in our last quarterly call to a little bit of a challenge with launching our new technology for back to school, which created a little bit of early year problem, but as you know, there is sensitivity in the model. So if we have students that had a little rougher on boarding experience, that can kind of play out through the year, in terms of slightly higher attrition.

So while we are certainly not pleased with that and that little bit of care carryover effect, it is something that we are very confident will not happen again, and when we look at all of the programs we've introduced over the last year, including some new processes we've put in place to deal with ongoing retention, we have every reason to believe in the future, that we'll be kind of back to where we were with those efforts. So we do not believe that it is a systematic issue.

Great. And finally, can you just give us an update on what progress you've been makingin Ohio? Thanks.

Sure. In Ohio, the conversations are ongoing, and I would say we are in a very normal and standard renewal process. So we're we would like and expect to be at this point.

And is there a time frame when we would expect an announcement? How close to the beginning of the next school year does that normally come?

Well it certainly varies by individual contract negotiations, so I can't speculate exactly when that might come to fruition, but we feel good about the pace at which it's moving along.

Okay. Great. Thanks so much.

You're very welcome. Thank you for the question.

Our next question comes from the Alex Paris of Barrington Research. Please proceed with your question.

Hi, good afternoon. This is Chris Howe sitting in for Alex Paris. A few of my questions have been taken. But I was wondering if you could provide maybe some more color than you already have, in regards to the changes in Washington, and how this might affect your approach to the market? And I guess more specifically, how it might affect the progress you're making with states in regard to caps?

Sure. Well, look, as we talked a little bit, certainly having a more favorable pro school choice environment in Washington is always helpful. We're in a very different place than we have ever really been historically, in terms of that perspective. As I also mentioned, it really is a state to state business, there are obviously some changes in government in several key states. We believe there are a few key states that we have an opportunity to potentially open up over the next couple, few years, if things continue to go well.

In terms of structural caps in individual states, there are a handful that our partner schools are working with, but there are also individual kind of Board imposed caps that we have an ability, that our school boards with the ability to raise over time, and we expect some of that to happen along the way. But again we have a very favorable national environment, the state environment I think eased up in some places, and we'll continue to work with advocates on both sides of the aisle, to deal with issues like the ones you questioned.

Thank you for taking my question.

Thank you.

There are no further questions over the audio portion of the conference. I would like now to turn the conference back over to management for closing remarks.

Well, thank you very much for joining us this quarter. We appreciate everyone's time and questions. And we of course look forward to rejoining you in three months. Have a great night everybody.

This concludes today's conference. Thank you for your participation, you may disconnect your lines at this time, and have a wonderful rest of your evening.