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Edited Transcript of LRN earnings conference call or presentation 6-Aug-19 9:00pm GMT

Q4 2019 K12 Inc Earnings Call

HERNDON Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of K12 Inc earnings conference call or presentation Tuesday, August 6, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James J. Rhyu

K12 Inc. - CFO and President of Product & Technology

* Mike Kraft

K12 Inc. - SVP of Corporate Communications

* Nathaniel Alonzo Davis

K12 Inc. - CEO & Executive Chairman

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Conference Call Participants

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* Logan James Bender

First Analysis Securities Corporation, Research Division - Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the K12 Fourth Quarter Fiscal 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mike Kraft, Senior Vice President, Corporate Communications. Thank you. Mr. Kraft, you may begin.

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Mike Kraft, K12 Inc. - SVP of Corporate Communications [2]

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Thank you, and good afternoon. Welcome to K12's Fourth Quarter and Year-End Conference Call for Fiscal Year 2019. Before we begin, I would like to remind you that in addition to historical information, certain comments made during this conference call may be considered forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. They should be considered in conjunction with cautionary statements contained in our earnings release and the company's periodic filings with the SEC. Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied by such statements.

In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the day of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements. For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC. These reports include, without limitation, cautionary statements made in K12's 2019 annual report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.k12.com.

In addition to disclosing financial results in accordance with generally accepted accounting principles in the U.S., or GAAP, we will discuss certain information that is considered non-GAAP financial information. A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included 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, Chief Executive Officer and Chairman of the Board; and James Rhyu, Chief Financial Officer and President, Product and Technology. Following our prepared remarks, we will answer any questions you may have.

I'd like to now turn the call over to Nate. Nate?

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Nathaniel Alonzo Davis, K12 Inc. - CEO & Executive Chairman [3]

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Thank you, Mike. Good afternoon, everyone, and thanks for joining us on the call. I'm pleased to report that K12 ended fiscal year 2019 with solid financial results that exceeded our expectations, both for the quarter and the full year. We surpassed the $1 billion revenue mark for the first time, increasing 10.7% year-over-year. The strength of our revenue growth was based on the Managed Public Schools Program. This, again, demonstrates the strength of our core public schools business and the underlying demand for blended and online school options.

Adjusted operating income for the year was $62.2 million, an increase of 34.1% year-over-year. Capital expenditures were $48.4 million for the year, and note that our capital spend was focused on providing interactive virtual labs and more adaptive and personalized lessons for each student's learning level.

In addition to teacher and learning coach tools, we have been working to introduce 20 new project-based learning courses for the upcoming school year. These courses are all part of our important career readiness initiatives.

As a result of the revenue growth and expense management, we produced more than $93 million in free cash flow. This was an increase of 49% year-over-year. In fact, this is the second year in a row in which we grew free cash flow at that pace. Overall, our results this year met or beat the guidance we gave you each quarter as well as for the full year.

Now let me turn some commentary to our business operations. First, we remain dedicated to helping students grow in every way, especially in their academic endeavors. For instance, this year, we doubled down on our focus of student in-year growth. We established an internal goal that every student enrolled in a K12-powered partner school achieves at least a year's growth or more for every year that they attend school. It shouldn't matter whether the student starts on grade level, above grade level or below grade level. We want every student to grow academically.

Next as a result of our partnership with Southern New Hampshire University, K12-powered educators can now enroll in a graduate degree program in online instruction. They can also take a variety of specialized teaching courses or sign up for individual professional development classes. We already have hundreds of teachers volunteering to participate in these programs. The work we've done this year and continue to do underscores our commitment to equipping teachers and leaders with the specific skills they need to help students learn.

Second, I want to provide a brief update on career readiness. Just a few weeks ago, we launched the first national Job Shadow Week. Companies like Salesforce, Cummins, Gulf Stream Construction and others participated in providing students with real-life examples of what they have been studying in online classes. In-person experiences were available to students in South Carolina and Indiana, while other students in other locations participated in virtual sessions. Keep in mind that national Job Shadow Week is just the first step toward working with many companies on internships and other hands-on learning experiences for Destinations academy students. Through our network of programs like Tallo and Nepris and through our own contact, we're leveraging over 500 partners for more hands-on experience for our students.

We're also working at the national and local level with dozens of companies that want to get involved in the career readiness movement. Companies view career readiness programs like ours as a viable option to filling their talent pipeline. We're working with several new corporate partnerships for the upcoming year, which may include mentorship sessions, career guidance, job shadowing and internships.

This quarter, we also continued to work with existing and new school board partners to expand the number of schools that offer career readiness. This will be 20 -- there will be 20 Destination Career Academies open for the upcoming school year. That means more than 8 million high school students across 17 states will now have access to K12-powered career readiness programs this fall. This presents K12 with the opportunity to grow our career readiness enrollment for FY '21 and beyond.

We're also working with a number of school partners on new programs that will open in fiscal year '21. Over the next 3 to 4 years, we plan to expand our coverage across all states in which we operate.

This past quarter, our career connection partner, Tallo, who we've talked about before, also made great strides. Tallo added more than 60,000 new users to the platform. And while Tallo has maintained a strong population at the high school level, the platform is also now attracting college students as well. As evidence, 28% of the new users added this quarter were college students or college graduates. This increases Tallo's total user count to over 0.5 million users.

Now through our new partnerships with the Camden Dream Center in New Jersey and the National College Resources Foundation, Tallo is increasing efforts to work with nonprofit and student organizations that support members of traditionally underserved student communities. Since the start of 2019, Tallo has linked more than 20,000 users to job opportunities through their platform. This is just the beginning. Tallo's new partners, users and connections are creating some truly encouraging career readiness experiences for both students and graduates.

Before moving on, I want to highlight the results of a recent study published by Morning Consult. It reinforces our decision to pursue this market opportunity. They found that only 12% of parents thought that the kindergarten through 12th grade school system in the U.S. is doing enough to prepare students for a career after graduation. Those parents were also deeply concerned about student debt.

On the positive side, they found that 92% of parents agreed that giving high school students more exposure to future career opportunities and experiences before they enter college will help alleviate student debt. This survey again supports why I'm excited about career readiness. We've made some good progress this year and expect this business to be a key driver of K12's growth for many years to come.

Third, I want to address an example of the ebb and flow of our business, as I described in my last quarter's remarks. Specifically, we filed a demand for arbitration with the Georgia Cyber Academy Board as the respondent. The demand asserts claims of GCA's breach of our contract for the upcoming school year. While we are presently unable to predict the outcome of this arbitration, what we do know is that the board of the GCA school has already engaged other service providers for the upcoming school year. These include providers for curriculum, computer equipment and other managed school services. And while we sought to renew the contract, it is now fairly certain that the school year 2019-2020 will be the last year of our providing service to this school.

In addition, we cannot be assured of how much service, if any, that we'll be providing in this transition year. But as with our strategy for all states, we have been seeking to work with other boards to open more than 1 school in a state, and such is the case in Georgia where we support the application of a career readiness school that we hope will be open and approved in the fall of 2020.

Now from an investor standpoint, we must conservatively assume that we will not serve GCA for the upcoming school year, and our financials will reflect that fact. We also cannot assume that the new school we support will be in service immediately. We may have a gap year where we only serve Georgia through our private school.

Now I don't want to provide official guidance for FY '20 since the enrollment season is far from over. However, we believe that even with FY '20 revenues -- without FY '20 revenues from GCA, we will post enrollment and revenue growth in the coming fiscal year. That means we believe we can grow through the loss of GCA's nearly 10,000 students. However, that growth will be modest and below current revenue consensus for fiscal year 2020.

However, and this is very important, from a profitability standpoint, we currently believe we can deliver double-digit growth and adjusted operating income in FY '20. This growth should exceed the current analyst consensus for fiscal year 2020.

Now while next year's revenue growth will be somewhat dampened, we believe that fiscal year '21 and beyond we can achieve revenue and profitability growth rate at or above current analyst expectations. In fact, our multiyear internal projections call for us to deliver low double-digit growth and adjusted operating income for the next few years. Again, I want to emphasize these are not official guidance numbers but only our best estimate of the trends in our business at this point in time. We will provide official guidance for fiscal year '20 at the end of October when we announce our first quarter results.

So in summary, we had an excellent year. First and foremost, we posted solid financial results in each quarter of the year. We met or exceeded the guidance we set back in the fall of 2018. Our Managed Public School business, our core business, is growing, and the environment for full-time blended and online education continues to be strong. We ramped up our career readiness business. We've grown the number of schools and programs by more than 50%. Curricula continues to be developed with a significant expansion in project-based learning courses, which means more hands-on experience. We launched new branding efforts. And importantly, Tallo has flourished this year with more than 0.5 million users.

We enhanced the K12 technology platform and curricula. We developed adaptive curricula tools using cutting-edge artificial intelligence capabilities, which we believe will be an important differentiator for student outcomes. And through it all, we produced more than $93 million in free cash flow and ended the year with $284 million cash on hand. We continue to be in a strong position to invest in the organic growth of our business while also having the balance sheet to allow us to pursue inorganic opportunities when and if they arise.

Overall, I'm excited about what K12 has ended this fiscal year with solid academic results, solid financial results. Marketplace demand for the K12-powered online and blended education remains strong.

Thank you very much for your time today. Now I'll hand the call over to our CFO, James Rhyu. James?

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James J. Rhyu, K12 Inc. - CFO and President of Product & Technology [4]

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Thanks, Nate. Good afternoon. First, let me recap our reported results. Revenue for the quarter was $256.3 million, an increase of 7.3% from the prior year. For the year, as Nate stated, revenue was $1.016 billion, an increase of 10.7%. I want to remind everyone that the new accounting standards we implemented this year affected the seasonality of revenue recognition and impacted the year-over-year quarterly comparisons. However, revenue recognition over the full fiscal year was largely not impacted.

For the quarter, operating income was $2.7 million, a decrease of $7.2 million. For the full year, operating income was $45.5 million, an increase of $20 million or 78.4% compared to last year. Adjusted operating income was $7.2 million for the quarter, a decrease of $8.6 million for the year. Adjusted operating income was $62.2 million, an increase of 15.8% or 34% from last year. As a reminder, adjusted operating income excluded stock-based compensation.

Capital expenditures for the year were $48.4 million, an increase of $5.3 million. And as already mentioned, in each case our results met or beat the expectations we provided in our original guidance. Now this is now the sixth year in a row where we have met or exceeded our annual guidance numbers for revenue, profitably and capital expenditures.

Now I'll turn to some additional details for the fourth quarter and the full year. For the quarter, the Managed Public School Programs revenue increased $16 million or 7.7% to $224.3 million. For the year, revenue increased $109.5 million or 14%. The year-over-year growth in this business was driven by strong enrollment growth of 6.3% and an increase in revenue per enrollment of 7.2%. This revenue per enrollment growth was driven by strong mix and an improved funding environment. As we've mentioned previously, we expected this to be a strong year for revenue per enrollment growth. Going forward, we would expect revenue per enrollment growth to be closer to the 0 to 2% range we have previously indicated before any adjustments from mix.

In our Institutional Business, which includes both Non-managed Public School Programs and Institutional Software and Services, revenue for the quarter grew 6% and finished 10.6% lower on a full year basis. Revenue for the quarter benefited from timing due to the revenue recognition changes. Non-managed Public School Program revenues declined 10.8% for the year. This decline was largely due to lower revenue per enrollment driven by changes in school mix. Institutional Software and Services revenues were down 10.3% as a result of softer sales.

Private pay revenues were largely flat for the quarter and the year at $9 million and $35.5 million, respectively. We expected institutional revenue would decline this year, and we worked during the year to mitigate the impact of this decline. And as we move forward, the size and strategic importance of our career readiness business will play an increasingly important role in our growth story. And while we will continue to maximize how we operate all of our businesses, we will be focusing our discussions increasingly on the core business and career readiness.

Gross margins for the year were 34.7%, down 70 basis points from the prior year. Margins were impacted by our continued investments in school initiatives to support academic outcomes as well as business and school mix.

Selling, administrative and other expenses were up $5.3 million to $75.2 million in the quarter. The increase was driven by additional marketing spend in our career readiness and Managed Public School businesses. For the year, expenses were up 2.4% to $297.4 million. We continue to focus on driving improved operating leverage in our business. Notably, we were able to keep expenses reasonably flat year-over-year while still making investments in our career readiness business.

Product development costs increased by $0.6 million to $2.6 million for the quarter and increased by $0.3 million to $9.5 million for the year. For informational purposes, beginning next year we will be combining these lines -- combine them into a single SG&A line item, as the stand-alone product development costs are no longer mature enough to be separately discussed.

For the quarter, EBITDA decreased $6.7 million to $20.8 million. And for the year, it increased by $15.1 million to $116.9 million. Adjusted EBITDA for the quarter was $25.4 million, a decrease of $8.1 million from the prior year. And for the year, adjusted EBITDA was $133.6 million, an increase of $12 million. Operating income was $2.7 million for the quarter, a decrease of $7.2 million. And for the year, operating income was $45.5 million, an increase of $20 million or 78.4%. Adjusted operating income for the quarter was $7.2 million, down $8.6 million. It grew to $62.2 million for the year, an increase of $15.8 million or 34%. Improvements in the year-over-year comparison -- comparisons in these metrics were driven by the strength of our Managed Public School business, including our career readiness business, and effectively managing our cost structure.

Some other items to note. We ended the quarter with cash, cash equivalents and restricted cash of $284.6 million. This was an increase of $51.5 million compared to the end of last year. As Nate mentioned, free cash flow for the year was $93.2 million, up almost 50% year-over-year and the highest level of free cash flow we've ever posted.

CapEx, which includes curriculum and software development infrastructure, was $48.4 million, an increase of $5.3 million compared to last year. Our effective tax rate for the year was 22%, and this was the first full year -- full fiscal year at the lower federal corporate tax rate. We still expect our long-term effective tax rate to fall between 25% and 30%.

In closing, I'm pleased with our performance this year. We saw strong growth in both revenue and profitability for the third consecutive year, and we've been able to accomplish this while continuing to make investments to improve the academic outcomes for all the students we serve. As we look to fiscal year '20, I want to highlight Nate's comment on profitability. Specifically, we will see no pause in a trajectory of delivering double-digit profit growth for fiscal year '20 and beyond.

With the businesses we are building, we believe we can deliver this double-digit profit growth on a consistent basis. Again, this is not official guidance, only our best estimate of the trends in business at this point in time. We will provide official guidance when we release earnings at the end of October.

Thank you, and now I'll hand the call over to the operator so that we can move to Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Corey Greendale with First Analysis.

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Logan James Bender, First Analysis Securities Corporation, Research Division - Analyst [2]

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This is Logan Bender on for Corey. Congratulations on the quarter. As far as the career readiness, what are some industries that you see in high demand? And do you see that being geographically concentrated as you roll it out?

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Nathaniel Alonzo Davis, K12 Inc. - CEO & Executive Chairman [3]

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Corey, thanks for the comment and the question. Yes, we do see it geographic. The highest demand is most likely in the IT areas. I mean we're clearly seeing so many jobs not just in programming but in software and hardware maintenance and network support, network communications equipment, cybersecurity. Those areas are all the highest-growth areas that we see. Healthcare administration is the second-highest growth area we see, obviously healthcare overall. But high school students can't be doctors, so we're talking about healthcare administration, and that's the areas we see for them. Beyond that area, there is some work in manufacturing and in agriculture, but primarily it is healthcare and IT.

And it does show itself in geographic areas. Obviously, you know across this country what some of the high IT areas are. A lot of them are in Texas and in Southern California and in the Utah area. So we -- up in the Northeast a lot. Then you don't see agriculture nearly as much in those areas. You see it more probably in the middle of the country. Healthcare administration is everywhere.

So all of our schools have to be focused on what's the high need in their particular area. And that's how we do what we call centers of excellence. And we focus our centers of excellence that way.

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Logan James Bender, First Analysis Securities Corporation, Research Division - Analyst [4]

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Okay, that's great. And then as far as the GCA goes, looks like you were -- you think that you can grow adjusted operating income and it can exceed consensus? What are some of the levers that you would go about that? Is that just managing cost structure more tightly? Or could you just give us a little more color on that?

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Nathaniel Alonzo Davis, K12 Inc. - CEO & Executive Chairman [5]

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Yes. And I'm sorry, I thought that was Corey, but I guess it's Logan in for Corey, right? The first thing to remember is that we were spending a lot of money on GCA toward the latter part of the year, and we won't have to spend that money. So the school wasn't really that profitable. A matter of fact, it was getting near breakeven for us.

The second thing is to remember we have new statewide schools in Florida and Texas. We have a new school in Missouri. We've got 8 new Destinations Career Academies and 3 expansions. I mentioned 11 total, but it's made up of 8 new and 3 expansions. And then we're seeing some good same-store growth in some of the existing schools. So that growth is really what's driving our ability to drive some profitability. And yes, we're always focused on expense controls, and I think we see some efficiencies in some of the things we're doing.

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Operator [6]

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(Operator Instructions) There are no further questions in the queue. I'd like to hand the call back to management for closing comments.

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Nathaniel Alonzo Davis, K12 Inc. - CEO & Executive Chairman [7]

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Well, thanks to everybody for being on the call today. We don't have any additional comments. We are finished. So everybody have a great day, and thanks for being on. Goodbye.

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Operator [8]

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Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.