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Q2 2016 K12 Inc Earnings Call – Final Fair Disclosure Wire (Quarterly Earnings Reports), Jan 28, 2016
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Regional Business News
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Q2 2016 K12 Inc Earnings Call – Final
Presentation
OPERATOR: Greetings and welcome to the K12 fiscal 2016 second-quarter earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.
I would now like to turn the conference over to Mike Kraft, Vice President of Finance for K12. Thank you, Mr. Kraft. You may now begin.
MIKE KRAFT, VP OF FINANCE, TREASURER AND IR CONTACT, K12 INC.: Thank you and good morning. Welcome to K12’s second-quarter earnings call for fiscal 2016.
Before we begin, I would like to remind you that in addition to historical information, certain comments made during the 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 day of this live call. K12 does not 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 operating 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 in 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 of the Board, 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 Nate. Nate?
NATE DAVIS, CHAIRMAN AND CEO, K12 INC.: Thank you, Mike. Good morning and thanks to everyone for joining us on the call today.
Before reviewing the results for the quarter, I wanted to first touch on the announcement we made yesterday naming Stuart Udell as K12’s Chief Executive Officer. Stuart comes to K12 with over two decades of experience in the education sector with a specific background in virtual learning. Most recently, he was first CEO and then Executive Chairman of Catapult Learning, a privately held provider of instructional services, professional development, and an operator of schools. Stuart’s depth of experience will provide a seamless transition to K12 and allow us to continue executing on the programs and initiatives that we have launched in the last two years. His experience spans curriculum and program development, school operations, educational services and technology innovation. Stuart has also been a leading proponent of providing education solutions for students regardless of their geographic location or socioeconomic background. His principles and his passion clearly align him with K12’s mission and our vision for the future of education.
Personally, I will continue to be actively involved in K12 and maintain my role as Executive Chairman of the Board of Directors. In addition to supporting Stuart, I will be focused on public policy and the issues that surround our public policy, we will continue to work closely with our schools and their boards, and additionally I will work with Stuart on strategic direction and acquisition opportunities as they arise.
As you have seen over the past few years since I stepped in from the board to management and with the support of the board, we have worked to strengthen K12’s culture by always putting student achievement above everything else.
We have also built a cadre of great teachers and school leaders while simultaneously strengthening the technology and content we provide. During this time, we have also improved our relationship with our boards, changed our marketing to lower costs and to be more focused on students who stay with our program longer and achieve better results. And, finally, we have begun growing our institutional business as a key way to position this Company for future growth.
Perhaps most importantly, we have built depth in our management teams to broaden the skills across many functional areas. This transition to Stuart’s leadership is just the next step in that long-term plan initiated in 2013 that will ensure K12 has the right mix of talent to support his growth and maintain a great culture for many years to come. Being able to attract Stuart to our Company caps the effort to bring great talent to K12.
I am really looking forward to working with students to support — Stuart to support students and families in our schools and deliver the best academic outcomes as possible. We will work together and look for opportunities to introduce Stuart to the investment community in the coming months.
Now turning to results. Revenue for the quarter was $208.8 million, a decline of 9.7% year over year. On a pro forma basis, excluding the impact of the Agora transition, revenue grew 2% from the second quarter of last year. Operating income for the quarter was $14.7 million versus $20.5 million in the prior year. James will be providing more details on the financials in just a few minutes.
Importantly, our revenue, operating income and capital expenditures were within the guidance we provided last quarter. Now, this underlines the predictability and reliability of our results. For the past 12 quarters, we have consistently delivered results that were in line with the guidance we provided on an annual and a quarterly basis.
I also want to highlight our enrollment results for the quarter. Average enrollments for managed programs in the second quarter was 103,751. Now, keep in mind, this was the second quarter figure that was the average. As you would expect, I also look out at weekly operational performance and the reports on enrollment levels every week. Those reports show that we ended the quarter on December 2001 — from December 31 with enrollments of 105,015. This compares to our count date enrollments of 104,429 in the first quarter. And that is an increase of 586 enrollments or 0.6%.
Now, just to put this in perspective, if I look at the same periods from last year, from our October count date to December 31, enrollments declined 2740 or 2.5%, which is our normal seasonal pattern. But, as I said, this year we increased 586 or 0.6%. That is a great turnaround. Looking historically, I believe this is the first time we have seen this trend in eight years. This means we are retaining more students and having to spend less for marketing expenses.
We believe this significant improvement is the result of our comprehensive companywide approach to address student retention of what we call persistence. This started with providing a streamlined student enrollment experience for families, a process that is much smoother today than several years ago. Once students have enrolled, our teachers and our school leaders implement a set of programs designed to improve student persistence. For example, we expanded our strong start initiative in 18 schools this year. These initiatives are focused on starting students off strong and keeping them on track through various actions. Those actions include programs such as walk to class and our interventions through Family Academic Support teams.
Through the second quarter of the current fiscal year, K12 has improved student retention by 140 basis points compared to the performance through the same period last year. I have got to tell you, I couldn’t be more proud of this organization and its response to the challenge to improve in this area. This data gives us confidence that our investments and programs and processes that we have been putting in place now provide a very solid result.
Now, everyone understands that improved student persistence is obviously important to enrollments and revenues. But, more important, it is how it directly correlates the academic outcome. As we outlined previously, students enrolled three or more years in K12 managed programs achieve much higher proficiency compared to students who enroll less than a year: 22% higher in English language arts, 17% higher in mathematics, according to the testing data from school year 2014/2015. And we certainly have a lot more work to do, but I am encouraged by the progress we are seeing.
Moving on, I want to highlight another announcement that we made earlier this month. That is K12’s sponsorship in the launch of the foundation for blended and online learning. The mission of this new foundation is to advance the availability and quality of blended and online opportunities across all types of schools. Not only is this a great way to K12 to give back to the community, to students, and to educators, but it will also advance the field of digital and blended learning beyond what K12 is doing itself through its scholarships to students from blended and online programs, be able to support students’ post secondary education. It will also support innovation in teaching in the digital and blended learning environment. The foundation will bring key stakeholders together to reinforce why digital learning and digital technology in our schools and even school choice is critical in delivering on great educations to students across the United States.
To give you an idea of the importance of this effort, take a look at that foundation board in our announcement. It includes prominent industry leaders and experts. Each have chosen to participate because of the importance of the foundation’s mission. In particular, they all believe in empowering students and parents by giving them choice and availability of digital learning opportunities. I am excited about this effort and the potential impact it will have on digital learning in our country.
Before I hand the call off to James, I wanted to leave you with some thoughts on how K12 is valued in the market today. With where K12’s stock has been trading, our market capitalization is about $300 million. This is well below our book value of $535 million. Think about that valuation in light of where we are today. The results in our managed public schools programs are improving. Student persistence, revenue per enrollment and, importantly, academic outcomes have all shown improvement and are increasing the lifetime value per customer.
From a school development point of view, we are working with various school boards to open both new schools in existing states, as well as open up new states that don’t yet offer a virtual school program.
Our institutional business continues to hold great potential for future growth. School districts are always reevaluating how they deliver academic programming to meet their ever-growing digital revolution needs. Districts are using digital content to supplement classroom instruction, address their homebound population, and even as replacements for traditional textbooks, and we are well positioned to benefit in this digital education explosion.
We are also expanding our business in new areas. Last year we launched English language learning programs, which met with great interest. This year we are bringing career technical education, or CTE, offerings to the market. These programs allow new students to pursue distinct career paths based on the national career cluster model. We believe CTE has enormous potential to provide quality education for students who might not otherwise be able to obtain one and can significantly add to the skilled trade workforce in the country.
Our technical and our product teams are on schedule to deliver significant upgrades to the curriculum infrastructure on top of what we delivered last year in our new high school experience. I believe our next generation curriculum will enhance our speed to market and the flexibility in providing solutions to schools, to districts, families, and students.
So overall, I hope you can see why I am excited about K12’s future growth prospects. I am particularly excited about the improvement in enrollments in our managed programs business. All of this and a new industry leader in Stuart Udell, who can help take K12 even further, tells me that we are beginning to hit on all cylinders.
Thank you so much for your time this morning. I will now hand the call over to James. James?
JAMES RHYU, EVP AND CFO, K12 INC.: Thanks, Nate. Good morning, everybody. First, a few words about our reported results.
Revenue for the quarter declined 9.7% from the year ago quarter to $208.8 million. This quarter we posted an operating income of $14.7 million. This compares to $20.5 million in the second quarter of last year.
In order to look at the underlying trends in our business, I want to spend some time discussing revenue and enrollments on a pro forma basis, excluding the impact of Agora transition last year. We believe this approach will provide you with a clearer picture of the underlying trends in our business.
Due to the fact that our infrastructure shared across all of our schools and businesses, we won’t extend that approach for operating income or other components of our results. So excluding the impact of Agora, total Company pro forma revenue increased 2%. Revenues for managed school programs would have risen approximately 3.2% year over year, while average enrollments would have declined by 2%. However, as Nate mentioned, our ending quarter enrollments were actually higher than our count date enrollments. We normally have some drop-offs after count dates while the average is lower, but ending at a higher count explains how some of our investments are beginning to pay off for us, as Nate indicated.
Average revenue per enrollment increased more than 5% year over year for managed programs. The revenue for enrollment trends relate to a combination of factors including school mix and improved funding environment in some states.
For our nonmanaged public school programs, excluding the effect of Agora, revenues would have been $15.6 million. Nonmanaged program enrollments grew 2% as we continue to see benefits from new programs launched this year. Offsetting this rise in enrollment, revenue for enrollments declined 7%, largely due to mix.
Our institutional software and services business, which includes core software, technology, professional and other educational services sold by our [field ed] team posted revenues of $12.2 million for the quarter. This is a year-over-year increase of 3.1%. We continue to believe in the opportunities in the institutional market, and as we have previously discussed, we continue to invest in targeted products and distribution in that market. As these products roll out and gain traction, we came to expect institutional to be a growth driver for K12 over the long-term.
Revenue for our private private pay and other businesses was $10.7 million, a reduction of 5.5% from the prior year period. This area is comprised of a number of consumer-related products, as well as our remaining international operations. We continue to evaluate these businesses and look to maximize growth opportunities and profitability here, so we will both invest and prune as we go. Therefore, results in this area will likely be somewhat variable in the coming year as we refine our strategy here.
Gross margins improved steadily from 37.3% last year to 37.9% in the current period. On a full-year basis, we anticipate gross margin to continue to be flattish, plus or minus.
Selling, administrative and other expenses of $61.4 million declined 1.9% on a year-over-year basis. We continue to look to manage these costs tightly and have been largely flat for three consecutive years.
Product development expenses for the quarter were largely flat at $3 million. Operating income for the quarter was $14.7 million compared to $20.5 million in the prior year. Reduction in operating income was predominantly due to the transition of (technical difficulty) contract.
Now turning to some other items, we ended the quarter with cash and cash equivalents of $171.3 million, a $20.4 million increase from the prior quarter. Our cash balance increased approximately $47 million versus the year ago period. That is important to note. Even with the impact of Agora, cash balances have risen. Even if you discount the stock purchases we made last fiscal year, the cash balances are higher by approximately $20 million in the current period.
DSOs have improved by seven days on a year-over-year basis, which is in part due to the improvement made in managing accounts receivable. There are always some timing issues in there, so I would not extrapolate this trend. But clearly we are seeing more discipline.
CapEx, as we’ve historically defined it, which includes curriculum and software development, computers infrastructure, $27.9 million year to date versus $30 million in the previous year. We also had approximately $2 million in computer-related equipment that falls under our capital lease program. But we expense these so it is not part of our CapEx number I just mentioned.
The $10.1 million decline in this quarter versus last year was a result of lower spending on certain property and equipment, as well as student computers.
Our tax rate for the quarter was 45.8% versus 42% in the year ago quarter. Our guidance for the full year still remains in the range of 39% to 41%. We continue — now that we are a cash taxpayer, we continue to work on tax strategies to further improve our rate. I will keep you informed if there are any changes in our guidance for the year.
Now turning to our expectations for the third quarter, we expect revenue of $215 million to $225 million, operating income of between $16 million and $20 million, and capital expenditures of $20 million to $25 million.
Looking ahead, I believe we are on track to deliver revenues at the upper half of the guidance range for the full fiscal year. At the same time, we remain confident in the operating income guidance provided for the full year of $17 million to $23 million.
Thank you for your time today, and now I will hand the call back over to Nate. Nate?
NATE DAVIS: Okay. We are completed with our prepared remarks. Operator, we are ready to take questions.
Questions and Answers
OPERATOR: (Operator Instructions) Corey Greendale, First Analysis.
COREY GREENDALE, ANALYST, FIRST ANALYSIS SECURITIES: A few questions. First of all, congratulations on the persistent improvement. I realize this may be a little hard to parse, but how much of the improvement do you think is due to the things you have been doing to try to make sure the people that are coming to your school are more likely to succeed in the first place versus things you are doing once they are in school to improve their retention?
NATE DAVIS: It is hard to parse that. I would say it is a little more weighted toward the efforts to retain students after they have joined the program. We call out to those students and to their families to make sure any problems that they’ve run into are resolved quickly. We make sure we provide a lot more support to them to help them understand what work they have to go through, what the process should be so, and that it really changes their life.
We spend a lot more time trying to make sure that their teachers are in touch with them more frequently. So I think this has a little more impact. And the reason I say that is because the efforts of the new promotional program, it is really new this year. So it has not yet had its full impact because it is a brand-new program. We expect it to have more income impact in the coming years. But the actions to be more in touch with our students and be more in touch with the parents, those actions I think have a little bit more impact than a new market program.
COREY GREENDALE: Okay. And in terms of the fact that the end of the corporate enrollment was higher, I know there was a time when you would take students who were not funded, based on the fact that they came in after the account date and then maybe went back. Can you just update us on where you are on that? Are you enrolling students who are not getting funded for this year?
NATE DAVIS: Yes. We still take students who are not going to get funded for the year. A student comes to us and there’s two reasons why we do that, by the way. First of all, we want to make sure we provide access to the program to all students. But, secondly, if we can provide great services to those students, they will stay in the program and then that becomes a reimbursable student the next year. So we want to retain them. So yes, we still take students who come in after the count date and state that we may not get funded quickly.
JAMES RHYU: I think, Corey, James, I think the only thing I would just remind you of is we previously talked about how we are changing our acquisition approach to optimizing against students who we think will come in, we won’t get funded for them, and leave. That doesn’t — as Nate was mentioning, that doesn’t mean that we are not going to take those students, but our acquisition activities are more focused where we are going to generate greater revenue and profit for students.
So it is sort of just a nuance there, but we have never really gone away from taking those students. We are just trying to focus more on those students where we will make sure that we do get funding for them.
NATE DAVIS: In other words, we don’t promote to them. But if they come to us, we still take them.
COREY GREENDALE: Okay. That helps. And actually, James, on a related point, can you give us some help on how to model revenue per enrollment for both managed and nonmanaged for the rest of the year?
JAMES RHYU: Yes. I mean, I think for managed revenue per enrollment, for the rest of the year, you’re going to see year over year, you will continue to see similar declines that you have seen in first half of the year. So the first half of the year, we saw between 2% and 2.5%. Starting to see something similar for the full year, so your back half of the year is going to be something similar. That is for the managed. And, remember, that includes the impact of a quarter.
And as for the nonmanaged, which also, again, includes the impact of Agora, we will likely see something again in a similar range of the first of the year half. We’ve got some lumpiness quarter over quarter, but I think the full year, you’re going to see a similar kind of year-over-year improvement.
COREY GREENDALE: Okay. And then one more, then I will turn it over. On the institutional, can you just talk about price versus volume trends? And I think the growth there is a little less than maybe you had talked about earlier, potentially getting this year to what is happening in that business and what you expect for the rest of the year there.
NATE DAVIS: I will talk about that. Number one, the first part of your question, rate versus volume, we see most of the growth coming from volume and not necessarily competitive pricing issues. We are not seeing the competitive pricing issues we saw maybe a year, year and a half ago. But the market has settled in just a little, but it is not like our fees still are not competitive. They are certainly competitive, and there is certainly no pressure. But it is not nearly the pressure we saw a year and a half ago where we saw prices just across the board sort of dropping.
The volume increase — we are seeing more RFPs from school districts. We are seeing more school districts look for various solutions, not just traditional solutions of supplemental content, but English-language learning content, particularly math specific needs. So we are seeing school districts start to expand a little bit more.
Now, for the second part of your question, you talked about our growth and what does growth look like. Remember that we look at growth for the full year. Even last year, if you looked at last year’s quarters, you would see one quarter was 4% growth, other quarters were 30% growth, and another quarter was 16% growth. So it is not consistent across the year because the selling season really varies across the year, and so you are going to see the same thing this year. You’re going to see some quarters that are not high growth and others that are high growth.
We also are going to be very much impacted — and I hope you know — I think you know this — by whatever we do in the managed public schools business, when we enroll students in managed public schools, we also get more students enrolling in these full-time programs that the districts are running. Because when we promote in the state, we promote on a broad basis, and it is not just for managed schools. We promote for all the schools.
So generally, when we are up in enrollment for managed schools, we are also going to be up in enrollment for institutionals. And the reverse is also true. So this year, you may see less of these enrollment in these school districts. We think that comes back next year. So overall, it is the quarterly variance that you are probably seeing. We still believe that this is strong growth for the full year.
OPERATOR: Jeff Silber, BMO.
HENRY CHIEN, ANALYST, BMO CAPITAL MARKETS: It is Henry Chien calling in for Jeff. I wanted to ask about total enrollment. You mentioned it is growing a little bit this quarter. Could you talk a little bit or add more color on that growth? Is it just the broad retention improvement, or are there any schools that you would highlight — new schools or any trends?
NATE DAVIS: It is primarily a broad — it is across the board retention efforts that have really driven the growth. It is not like there is some new trend in brand-new enrollment. As a matter of fact, we have sort of gone off the promotional eras. We haven’t spent as much money on promotional efforts in the second quarter as we do in the first quarter or as we will do in the fourth quarter of this year.
So it has actually been a relatively period of promotions after October.
So really, improvement comes from turning around the previous year’s decline to this year’s increase of just maintaining more students. So it really has been that.
Now, relative to which schools, it has sort of been all of the schools that we rolled out these new programs to. We have seen a difference between the retention in schools we rolled out programs to versus the schools that don’t have it yet. So which is why we are optimistic about next year because we end up rolling it out to all the other schools next year. Does that help you?
HENRY CHIEN: Yes. That is helpful. And just a sort of related question. Can you remind us the difference between your nonmanaged program revenues and institutional revenues? I’m trying to understand how to understand the growth of either of those and whether they are related. Thank you.
JAMES RHYU: Yes. If I understand your question correctly, the nonmanaged revenue versus institutional, the nonmanaged program revenue is really — those are essentially like the full-time equivalent programs that we manage for district partners. Whereas, in the institutional software and services, that is, in a sense, sort of everything else. Meaning that would include everything from platform solutions, one-off solutions that will provide professional development, as well as course enrollment that are not like these full-time program — district programs that we manage for them. So it is sort of everything else in that institutional software services.
HENRY CHIEN: Got it. And are these usually in the same schools are you seeing? I am just trying to understand this new add business is (multiple speakers).
JAMES RHYU: Generically, I think that you are asking, the nonmanaged enrollments are generally distinct from the programs in the institutional software and services.
NATE DAVIS: But the customer relationship — James is right. The distinct programs and actually a different marketing way we market to them, but the customers tend to be related. What I mean by that is that if we develop a good relationship with a school district and once you develop a good relationship, not only are you running the programs for them, but you are also delivering the software and the content to that same customer. So there is a relationship there. Relation building. The more we build a relationship with a big customer, the better off we are not only running the program, but also providing software services.
OPERATOR: (Operator Instructions) Okay. Gentlemen, we have no further questions at this time. Would you like to make any additional or closing comments?
NATE DAVIS: No additional closing comments, other than one point I guess we didn’t talk about and people didn’t ask about was what is our new business development activities. We announced in Alabama last year, we expect to see more students in Alabama. We have got programs that we are working on in places like West Virginia and Nebraska, Missouri, Connecticut. None of these are firm programs approved yet, but these are all places where there are conversations going on, and there are expansions going on in places like New Mexico, Texas, Wisconsin, Nevada and Virginia. So there is a lot in the business development activity that we think over the next couple of years we should benefit from as well.
So I appreciate everybody’s time today, and thank you for the time, and I guess we’re done, operator.
OPERATOR: You’re welcome. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time, and thank you for your participation.
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Source: Fair Disclosure Wire (Quarterly Earnings Reports), Jan 28, 2016
Item: 32U0607395473FDW
Presentation
OPERATOR: Greetings and welcome to K12 2015 fourth-quarter and year-end 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, Mike Kraft. Thank you. You may begin.
MIKE KRAFT, VP IR, K12 INC.: Thank you and good morning. Welcome to K12’s fourth-quarter earnings call for fiscal-year 2015.
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 operating performance and results, please refer to our reports filed with the SEC, including, without limitation, cautionary statements 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, Chief Executive Officer and Chairman; Tim Murray, President and Chief Operating 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 Nate. Nate?
NATE DAVIS, CHAIRMAN, CEO, K12 INC.: Thank you, Mike, and good morning, everyone. Thanks for joining us on the call today.
I am pleased to report that K12 ended fiscal-year 2015 with solid financial results, both for the quarter and for the full year. Excluding certain charges recorded in the quarter that James will review with you later, we slightly exceeded our guidance for both revenue and operating income.
Revenue for the year was $948.3 million, up 5.1% year over year. We recorded revenue growth in managed public schools programs, despite a slight decline in enrollment. We posted strong double-digit revenue growth in the nonmanaged public school programs, and importantly, these nonmanaged programs produced consistent double-digit revenue growth each quarter this year. This is a testament to the strength of that business and to the underlying industry trends.
In addition, we delivered solid double-digit gains in our international and private-pay schools, as well as our institutional software and services.
Operating income for the year, excluding the charges recorded in the fourth quarter, was $43.7 million, down 19.9% year over year. This decline was a result of our ongoing commitment to investments we believe will deliver better academic gains. These investments include hiring more teachers with better training and professional development and implementing student and family support programs that focus on improving academic results.
Capital expenditures were $76.5 million for the year. The majority of that went toward upgrading software and curriculum to improve the student online learning experience. Notably, we produced $46.5 million in free cash flow and ended the year with nearly $200 million in cash on our balance sheet.
These results are precisely aligned with the guidance we provided last fall. Performance in the quarters and for the full year consistently met or even beat the guidance we provided.
Now let me turn to some commentary on business operations for the year. First, this was a breakout year for our institutional business, FuelEd. As we anticipated last year, the adoption rate at which school districts nationwide are integrating online components into the classroom is escalating. FuelEd is a great alternative for school districts that want online options to range from a single remedial course to a full-time online school. This business leverages all of K12’s curricula to offer the largest digital catalog that is aligned with national and state standards in the industry.
FuelEd provides schools with a consolidated user experience through its family solutions that we put under the PEAK brand. Schools can enroll and activate students, assign courses and teachers, and then manage the learning experience with easy-to-use reporting and analytics. They can either create and load their own content from non-K12 sources and integrate all that content using the PEAK platform.
As a result, FuelEd revenue was up more than 17% on a pro forma basis, including nonmanaged and institutional software and services.
Full-time enrollments increased 38%. Importantly, we saw growth from existing schools and expanded the number of new districts’ nonmanaged programs. Our investments in the PEAK platform, curricula, and personnel are delivering solid results.
FuelEd online course enrollments were up over 28%. This year’s gains were a result of higher usage per student for district customers, as well as adding new schools onto the PEAK platform. And moreover, we expanded third-party partnerships available through PEAK to increase the suite of offerings available. These include English Language Learner, or ELL; LearnBop for a math degree; PresenceLearning for online speech and occupational therapy.
We have mentioned in the past that we will partner or acquire new technology to continue developing our product line, and these moves demonstrate our seriousness about continuing to enhance our capabilities.
FuelEd growth can also be driven by the number of states or school districts in which we are preapproved to provide services. This year, both Chicago and Philadelphia public school districts designated FuelEd as a preapproved curriculum provider. This will allow schools within these districts to place orders directly with FuelEd.
In addition, the University of California expanded the number of courses approved for the state by 40%. FuelEd has more than — more approved courses than any other online or blended provider in California. This is especially valuable because many other states and school districts view California’s endorsement as sort of an informal seal of approval.
Net net, we are very excited about FuelEd. It is on a strong growth path, and while we have to wait until the fall to see how nonmanaged enrollments come out for the year, we believe FuelEd is a key driver for our growth going forward. It remains a business development priority and we will seek to continue to grow FuelEd both organically and inorganically.
Now on the managed public schools, we have been changing and improving our marketing strategy and we have continued expansion into existing and new markets, both of which will help ensure the long-term economics of our business. We are aggressively leveraging data analytics to hone in our marketing efforts and we are investing to attract those students who are most likely to succeed in an online environment. This is a concerted effort on how we inform families about their online education options at K12 partner schools.
Our focus on student success versus student volume slowed near-term growth in enrollments in FY15. However, we believe this messaging that we have now begun to use will result in a student body that is better matched to our core curriculum strengths and therefore substantially more likely to gain academically over time and stay with the program longer. The results will translate into the appropriate balance between enrollment levels and financial return for our investors.
At the same time, this year we succeeded in expanding our network of K12 powered schools. We grew our existing presence in Colorado. We opened schools in the state of North Carolina and Maine, and in the next fiscal year we look to expand into states like Alabama, which passed legislation this year to allow for the formation of a statewide online charter school. Growth prospects also look good in some other states, including Virginia, New Jersey, and Connecticut.
As you know, this process is often a multiyear effort, so we will have to keep you informed as progress happens. However, it bears repeating we continue to see solid demand for managed programs, which remain the cornerstone of our business.
During this year, we continued to invest in improving academic outcomes. A successful academic outcome for each and every student is at the heart of the K12 mission. We remain focused on that and a multiyear program to improve teacher hiring, compensation, supervision, observation, and professional development. The goal is to develop K12 in conjunction with our partner schools into a center of excellence for online teaching.
A parallel program focuses on developing our schools’ administrators, principals, and instructional coaches. This effort begins with recruiting talented, experienced educators and provides a comprehensive training, professional development, and coaching program that continues throughout their tenure with K12.
Fourth, to improve the overall online experience for students, families, and teachers, we invested in our curriculum and systems architecture. A major progress step this year was the rollout of the new K12 online high school experience for the upcoming school year. You have heard me mention this in the past as a partnership with Desire2Learn.
This was an intense 18-month effort that included migrating and upgrading more than 700 courses. This new K12 online high school will benefit more than 35,000 students and teachers. The platform takes the online learning experience to a new level by empowering students, teachers, and learning coaches to find what they need when they need it, and of high importance, it allows us to operate more easily on mobile platforms, a thing of the future.
Most importantly, it will also help us achieve better academic outcomes with instant access to actual student data.
Also this year, we began to see the benefit of almost two years of investment toward improving student performance. Test scores in the 2013-2014 school year showed proficiency gains over the prior school year and we’ve described this in our annual academic report, which was published earlier this year.
There was stable performance in reading and encouraging performance and improvement in mathematics. We are proud of our teachers, our administrators, and our students as they put in tremendous effort to improve our results.
In summary, we met or exceeded the goals we set for the year. Our institutional business is growing, as we predicted, with three consecutive quarters of growth and full-year revenue over $70 million. Our updated marketing strategy is designed to attract these students who are best suited for our program in an online environment.
The K12 managed-school footprint is growing. Moreover, we anticipate our ongoing effort with legislators and independent school boards will further expand the number of schools we support in current and new states. K12 private-school revenue grew 16% year over year. Academic results this year are now trending in the right direction.
Key pieces of the K12 technology platform and curricula were significantly improved. We have begun to build on a future vision of the next platform in a multiyear program that will keep us at the forefront of educational technology, and we ended the year with almost $200 million in cash. We are in a strong position to capture both strategic opportunities, as well as inorganic growth.
I’m excited about where K12 ended the fiscal year. I believe we are in a great position to continue growing financially and fulfilling our mission as an academic leader in online and blended education.
So thank you very much for your time this morning, and now I will turn the call over to James Rhyu, who will cover financial results. James?
JAMES RHYU, EVP, CFO, K12 INC.: Thank you, Nate, and good morning, everybody.
As you saw in our press release, we reported net income for the year of $11 million. Included in this were $28.4 million of charges that I’m going to describe in more detail, but I wanted to point out that they are not part of core operations for the fiscal-year 2015. Excluding those charges, we would have reported net income of $29.4 million and operating income of $43.7 million.
Let me start by giving you some color on the $28.4 million in charges. We had a confluence of things happen in Q4 that precipitated these charges. First, we had invested in previous years in a UK curriculum that we realized was not going to give us the return we wanted. So we sunset that, along with some other products, as we switched to our new LMS. This resulted in a charge of approximately $3.1 million.
Second, we made some decisions with regard to the computers and related peripherals that are distributed during enrollment season. Some of the equipment has changed and we are no longer going to distribute or refurbish certain devices, and we therefore decided we needed to write off approximately $6.4 million of inventory.
Third, in an effort to improve some operational processes, we will no longer be using some older internal software that was developed years ago and never reached its proper potential. So we’re going to write off approximately $4.8 million of those assets.
Fourth, we updated our estimate of the collectability of some of our receivables and we have recorded a charge of $10.7 million associated with schools that closed this year and could not pay us, a funding issue in one state from a couple years ago that we’re trying to work through with that department state of education, and the interest on one receivable.
These were one-off type events that we do not believe are indicative of the overall strength of our AR balance, which remains solid. In fact, our DSOs improved year over year by approximately 5 days.
Finally, we also recorded about $3.4 million in severance-related payments in the quarter.
In total, $9.6 million of the charges have been reported in cost of goods sold; $15.7 million have been reported in selling, administrative, and other expenses; and $3.2 million in interest and other expenses.
For your reference, we have provided additional information at the end of our press release that shows our income statement, excluding these charges, on a line-item basis. I also want to mention that all but about $0.5 million of the $28 million are non-cash charges.
So with that as background, let me provide some further insight into our fourth-quarter and full-year results. My comments will exclude the charges I just described, as well as the charges we took in Q2 of fiscal-year 2014 and the businesses we sold last year.
Revenue for the quarter was $235.7 million, an increase of 3.1% over the year-ago quarter. For the full year, revenue was $948.3 million, which represents a 5.1% increase over the prior year. The growth in the quarter was largely driven by increases in our institutional business, FuelEd, and our international private-pay businesses. On a full-year basis, we saw growth across all segments of our businesses.
Revenues for managed programs were flat for the quarter, with a 2.3% increase in revenue per enrollment offsetting a similar decline in enrollment volume. On a full-year basis, managed program revenue rose 2.5% year over year. This was in contrast to an enrollment decline of 3.9%.
As we have seen through this fiscal year, increases in revenue are resulting from positive revenue per enrollment trends that are more than compensating for the enrollment declines.
The revenue per enrollment trends are related to a combination of factors, including school mix, an improved funding environment in some states, and other variables. While we continue to work with states to improve funding for our partner schools, we are cautious about the continuation of current revenue per enrollment trends and will watch them carefully through the next year.
Nonmanaged program revenue rose 27.2% in the quarter and 36.4% for the full year to $8.3 million and $39.3 million, respectively. These increases for both the quarter and the year were driven by enrollment gains. This is the fourth quarter in a row we posted solid double-digit revenue gains in nonmanaged programs for both enrollment and revenue.
We continue to see positive trends in the market for nonmanaged programs as we move forward into the new fiscal year.
Institutional software and services, which include core software, technology, professional, and other educational services sold by our FuelEd team, posted revenues of $13.1 million for the quarter and $48.8 million for the year.
This is an increase of 10.5% for the quarter and 9.6% for the year. This is the third quarter in a row we have posted double-digit gains in this business. We continue to see product investments we have made in our institutional business pay off. We believe we will continue to see this business grow into next year as school districts continue to adopt virtual education options and as K12 continues to introduce additional products and services.
Our international private-pay schools, revenue rose $4.1 million or 46.5% for the quarter and $11.1 million or 31.3% on a year-over-year basis. We continue to see strong performance in our Keystone and iCademy private schools. These schools posted gains of 20% and 18%, respectively, and 15% and 21% for the year. We are pleased with the trends we are seeing in this business and will look to expand our private-school business over time.
Gross margins declined to 33.2% in the quarter. This is in line with our typical seasonal trends for the fourth quarter. The full-year margin of 36.9% is in line with our increased investment in academics and our operating income guidance for the year.
Selling, administrative, and other expenses declined 11.2% to $65.1 million for the quarter and were flat on a full-year basis and declined as a percentage of revenue by about 150 basis points. We will continue to manage these expenses and invest where we see the best return.
Product development expenses for the quarter were $4.3 million, compared to $2.2 million in the prior year. For the year, they increased 5.8% to $14.4 million. The increase in the quarter and the year reflect investments we were making in our product, including our new LMS Nate referred to earlier.
Operating income was $8.9 million for the quarter and $43.7 million for the year. The declines versus last year for the quarter and for the year are consistent with our strategy to invest in academics, but also above the guidance we had previously provided.
Turning to some other items, free cash flow was $43.6 million for the year, compared to $50 million in the prior year. We ended the quarter with cash and equivalents of $195.9 million, which was essentially flat from the prior year. This includes investing $26.5 million to repurchase shares earlier in the fiscal year.
Net cash provided by operating activities for the year was largely flat at $120 million. Even with increasing revenues, Accounts Receivable declined slightly, which provided for an overall improvement to DSOs.
CapEx, as we have historically defined it, which includes curriculum and software development, computers, and infrastructure, was $76.5 million for the year and is in line with our guidance. We saw a $9.8 million increase in software and curriculum tied to projects like our new high school running platform largely offset by a $9.4 million reduction in expenditures for computers. The reduction in the computer CapEx is the result from some operating improvements in our reclamations program and the declining cost of hardware on a per-unit basis.
Our tax rate for the year came in slightly better than expected, at approximately 36%.
In summary, we continue to invest in product and academics across our businesses. We believe these will provide the greatest long-term return for our shareholders.
Thank you for your time today and I will now hand the call back over to Nate.
NATE DAVIS: Thanks, James. I think that we are finished with our prepared remarks, so we can move into Q&A, David.
Questions and Answers
OPERATOR: (Operator Instructions). Corey Greendale, First Analysis.
COREY GREENDALE, ANALYST, FIRST ANALYSIS SECURITIES: So congratulations on the progress during the year. I just had a few questions. So, first, I have to ask. I know you’re going to give guidance later this fall, but any indications you can give on how the managed and nonmanaged enrollment is trending relative to this time last year?
NATE DAVIS: (laughter). You know, it’s always interesting. That question gets asked many ways and I appreciate you asking, Corey.
We are pleased with the results, but it would be inappropriate for me to give any kind of indications where we are going. I can only say that we think the new marketing program is working. It certainly is a different kind of program. It expects fewer leads, but greater ability to convert students and students who are going to stay longer.
And so far, we are seeing the things that we wanted to see. But it is still in the middle of the season, and so it’s hard to predict where we will end up for the full year.
COREY GREENDALE: Okay, I had to try. You met my expectations on what you can say now, but let me (technical difficulty) I think you can probably more directly address.
So on the institutional software and services business, James, you gave a gross number that, first of all, I missed and, second of all, it sounded like it was higher than the reported number. Were you excluding divested businesses from the year-ago number?
JAMES RHYU: Yes, it excludes the divested businesses in the year ago. That’s correct.
COREY GREENDALE: All right.
JAMES RHYU: And I, just to reiterate, if you didn’t hear, my comments included revenues for institutional software and services of $13.1 million for the quarter, fourth quarter, and $48.8 million for the year.
COREY GREENDALE: Okay, and you said it was up 10%?
JAMES RHYU: 10% for the quarter and 9% for the year.
COREY GREENDALE: So that is good growth, but it has decelerated. I think last quarter it was up more than 30%, ex divested business. Can you just talk about the moving pieces there?
NATE DAVIS: Yes, you will remember last quarter the year-over-year comp was very soft, so last year, fiscal-year 2014, Q3 had institutional business at around $12million, which was the lowest level we had for the year.
COREY GREENDALE: Okay. And then, just — again, not asking for guidance here, but I saw some data recently that suggested overall school spending on instructional materials was up 9% this year, somebody said nice — recovering nicely. So can you just talk generally about what your long-term thoughts are on the growth rate of that business and whether you expect to grow above market growth rates or in line?
NATE DAVIS: Tim is here, and so — Tim is managing that business. I’m going to let Tim answer that and I will probably chime in as well. Go ahead, Tim.
TIM MURRAY, PRESIDENT, COO, K12 INC.: Corey, we are seeing the same things you are in terms of improved environment for spending, in particular increases in spending in the digital environment.
Our goal is to grow faster than the industry, so to take share in this market. As we look at our current pipeline, our pipeline is up well over where we were at this time last year, especially for new customer opportunity, so we are very, very comfortable about how the market is developing here and our position in it.
COREY GREENDALE: And are you mostly using a field sales force or inside sales, and can you talk about just the size of your sales force relative to this time last year?
TIM MURRAY: I don’t want to give you specific numbers for competitive reasons, but our sales force is about the same size as last year. Think of it as being two-thirds external salespeople, feet on the street, one-third inside sales. A relatively small, but long-standing, footprint with a couple of independent resellers who have been with us for a long time.
Our productivity, most of our growth this year has been achieved through increases in sales productivity, as opposed to increases in sales force.
COREY GREENDALE: And is that more driven by process or sales force maturity or by product set being larger?
TIM MURRAY: I think in particular these last couple of quarters we have really focused on the entire sales process, sales management systems, so I would say we have had benefit of tenure. Our sales force has matured, although many of our salespeople have been with us a good number of years and have a great amount of experience in this industry. So it’s both tenure, as well as sales process and sales execution.
NATE DAVIS: And Corey, this is Nate speaking. I had asked Tim to focus on making sure that we grew the productivity of the sales force, and once we saw that, we would be able to expand it.
So just this year, we are going to — going into FY16, we are going to expand the sales force by about 20%, based upon the fact that I have now seen us improve the sales productivity, so I think we ought to go into more and more markets and we are going to try to do that with a greater sales force, so we are increasing the size this year.
COREY GREENDALE: Okay, and I hope you don’t mind my spending a little bit of time on this business, because I think it is an interesting one. So with that in mind, do you need to have the salespeople in place — salespeople you hire starting now, will they more impact fiscal 2017 because of the timing of the selling season or could they still impact 2016?
NATE DAVIS: For the most part, they’re going to impact fiscal-year 2017, by the time they are trained and they go through the bookings.
But remember that the sales for the next fiscal year will primarily happen in the second half of this fiscal year, so the sales activity that impacts 2017 will all happen in the spring. That’s when schools are making decisions, a little bit into the summer, but primarily in the spring. So, we have to get the folks on board now to be able to impact that selling season.
COREY GREENDALE: Okay, I’m going to ask one more and that I will jump back in the queue if my other questions don’t get answered. My other question is — I guess I will ask James. Can you just talk a little bit about how the mix shift, which I think will be, just given what’s happened with Agora, more pronounced potentially next year, what that does to your CapEx relative to your — I am assuming that some of these other businesses are less capital intensive because of computer purchases in the managed school business, but can you just confirm whether that’s right and directionally talk about what happens to CapEx with the mix shift?
JAMES RHYU: Yes, so let me try to address it in a couple of ways for you, Corey.
First of all, Agora specifically doesn’t change, really, our capital expenditure makeup significantly. It will have some impact, but it is not really that dramatic.
Secondly is the investments that we are making, which are multiyear investments, and Nate referred to one of the big ones, which is really Desire2Learn, which we are rolling out for high school now, we’re going to migrate middle school and then elementary school in the coming years. So those investments are multiyear investments. I don’t think that at least for the next year, while we — we’re not giving guidance yet for next year and we haven’t finalized our guidance for next year around CapEx, I wouldn’t see a dramatic shift.
We have seen now about three or four years of pretty consistent CapEx. I would expect to be in that similar range in the coming year.
COREY GREENDALE: Thanks. I will get back in the queue.
OPERATOR: Jeff Silber, BMO Capital Markets.
HENRY CHIEN, ANALYST, BMO CAPITAL MARKETS: It is Henry Chien calling in for Jeff. Can you talk a little bit more about the marketing program you mentioned? What is the changes and what kind of new type of students that you’re looking for? I’m just trying to get a sense of how that also impacts your enrollment growth.
NATE DAVIS: Yes, that’s an important question and I will be as specific as I can without giving all my competitors who jump in our calls and listen in.
Our focus has been to try to move to more digital communication, more social media, more viral communication with prospective customers, number one. And number two, to make sure that they have a chance to understand what they’re getting into earlier and earlier in the season. So the more they understand the program, the more they understand the work that’s required and how this fits their student, the better chance they’re going to have when they log on.
In addition, our marketing programs trying to focus on not just helping them get into the queue for the coming enrollment, but also helping them make it through the queue faster, meaning there is more self-enrollment process there. Instead of us always calling somebody and talking to them on the phone, we give them a chance — a button that basically says enroll now. It gives them a chance to go through a self-enrollment process. Processes documents faster. It makes the entire process simpler. That’s a part of what we do as well.
And then, lastly, we try to have a very strong — and this is the end of the marketing process, beginning of the school operations process, a very strong — what we callstrong start process, which helps the students and the parents as they migrate from being an enrollment that did the enrollment online to actually getting all their material, getting a computer set up, getting their courses set up. So we want that to happen earlier — and getting introduced to their teachers earlier.
So that entire process, from how we reach them through our marketing programs — and, by the way, the last thing is the messaging. You have probably seen a new set of commercials centering around a campaign that we call Uniquely Brilliant, communicating to the parents that this program is all about the individuality of your student. It is not like sitting in a classroom of 35 students and everybody is at the same pace. This really is about your child’s unique speed.
And so, those messages are in our marketing campaign as well. So how we reach them, the messaging we deliver, and how we get them enrolled all are part of the new programs we introduced.
HENRY CHIEN: Got it. Okay. Thanks for the color.
So just looking at the managed program enrollment, it looks like the year-over-year declines are improving or getting less worse pretty nicely. Just trying to understand with the Agora impact, can we still — without giving explicit guidance, is it — are we nearing the potentially turning around for growth maybe in 2017 in the managed program enrollment?
NATE DAVIS: I am not sure I got all of your question, but I think you are asking when Agora goes out of the program, are we seeing a potentially growth cycle in managed (technical difficulty) schools? Is that what you are asking?
HENRY CHIEN: Yes, exactly.
NATE DAVIS: Okay, so, again, without giving guidance, I would say one of the reasons I mentioned the number of states that are coming on and some of the activity we are seeing in states like Alabama, a bill that is passed in Virginia that just now has to go through the funding process. We’re seeing some trials in New Jersey. We are seeing Connecticut begin to open up a little bit. North Carolina, of course, is now on.
So the answer to your question is we are seeing more states. We’re also seeing more schools within existing states. We haven’t talked a lot about our pre-readiness program. A pre-readiness program gets another curriculum that students, we think, will benefit from.
So all of those things together make us optimistic about the future. It is difficult for me to tell you that there is going to be a specific amount of growth in FY17, but you can see, I think, from the tone in my comments and from the specific states I mentioned that we are optimistic about the kind of growth that can happen in this industry. Demand is there.
HENRY CHIEN: Got it, okay. And if you could — just last question, could you touch a little bit upon — your revenue students have been increasing in part. I know you mentioned in the past basically or essentially a positive or a favorable funding environment. Can you talk a little bit about what your expectations are for 2016 on that front from the funding side?
NATE DAVIS: Yes. I will remind you that some of the funding increases come along with expenditure of commitment, so states might increase funding for specific programs, like they want you to put more money into teaching or they want you to put more money in the areas, but that notwithstanding, we do see a continually strong economy and when the economy is strong, one of the things that all communities ask for is let’s put some money into education. Every politician stands up and says let’s put more money in education.
So we think that the public schools, as well as the charter schools, benefit from a stronger funding environment, so we continue to see a positive funding environment. It may not be as strong as the 6% we saw this year, but overall we definitely see a strong funding environment.
HENRY CHIEN: Okay, thanks for the color.
OPERATOR: (Operator Instructions). Chris Gassen, Faircourt Valuation.
CHRIS GASSEN, ANALYST, FAIRCOURT VALUATION: The first question relates to the charges that you took in the fourth quarter for the reserves and write-downs related to end-of-life products and the reserves for the Accounts Receivable. Would you consider these to be very unusual types of charges or are these the types of charges that you would expect to take from time to time on an ongoing basis because of the nature of the business that you are in?
JAMES RHYU: So I think — we evaluate every period, every quarter, off the AR balance sheet generically all of our asset classes. And the accounting rules help dictate when we would take charges.
The nature of those two charges for this quarter, the receivable pieces of it were pretty unusual. I won’t comment on the exact frequency, but we really haven’t seen these types of receivable write-downs in a long time, that I am aware of, so — dating back to prior to my joining the Company.
So I wouldn’t — I don’t really think that these are certainly not common events. We don’t really see — we think that the quality of our receivables is very high. We actually had some very unusual circumstances.
One of the biggest components of this actually relates to an event that happened back in 2013 with this particular state that they had a certain, I’ll say, funding snafu. So, I certainly don’t see those as being things that we see happen very often.
On the asset write-down pieces of it, we evaluate the longevity of our curriculum. In general, what we have seen is we depreciate or amortize our assets over what we think is an appropriate period of time, meaning as we amortize them, they get fully written off in the time that we use them, and we don’t see a lot of these types of charges.
So, again, while I won’t comment on the frequency of them, we certainly don’t think that these are a thing that — they’re not happening all the time and we try to manage our balance sheet and the assets, I would say, for the useful life. But we certainly do the appropriate accounting determinations every period.
CHRIS GASSEN: Well, let me ask a more general question. With advances in technology in general, has it been your experience that the actual economic or useful life of your software products is greater or less than what you originally anticipate when you start your depreciation schedules?
JAMES RHYU: So I think in general we find that they are greater, and generally speaking, I would say not substantially greater, but we tend to — I will give you the best example, actually, which is something that we are changing over, but the LMS that we invested in probably upwards of 10 or 12 years ago, which we continued to develop and maintain, et cetera, over the course of those years, is something that we continue to use today.
So that’s probably one of our singular biggest investments. Our curriculum, which again we started investing in over 10 years ago, much of that curriculum and many of those assets we continue to use to this day, even though they are depreciated.
NATE DAVIS: Chris, one of the things that — and James is 100% right. I believe that if we look at all the assets we have in place, they have actually lasted longer, generally, than the periods that we have depreciated them.
But one of the things that happens with every company is when you start new technology approaches, which the Company started several years ago and then we decided to go a different direction. The main direction change that we made was we decided we would lease or license more content and especially more technology than we built ourselves.
We weren’t sure that was going to work, and so we continued a set of software that we were using until we got the desire to learn implementation in place. Once that went in place, some of the programs that we have started some years ago, we didn’t really need any more, and so that was an event that occurred once we actually started using the Desire2Learn implementation.
So, some things are driven by the change we made and actually a change that started its implementation in this quarter.
CHRIS GASSEN: Not to get too far into details, but I am somewhat curious. When you were — when you set up a depreciation or amortization schedule for curriculum, do you make a distinction between, let’s say, the curriculum for math, which would not likely change very much from year to year or even for long periods of time, versus other curriculums that would require significant revisions on short-term basis, such as computer technology, those types of cases?
JAMES RHYU: Sure. I think the short answer to your question is yes. We do try to track it at a reasonably project type of level.
In your specific example, it is not — we don’t really have just, let’s say, one math. We do state customizations and things like that in order to scope and sequence things differently. So when we invest in things, it is probably a little less, I will say, straightforward than a simple here is a simple math course. So we look at that at that project-level basis and track it that way.
CHRIS GASSEN: Okay, but the sum of substances is that you would say, then, that you guys spend a fair amount of, let’s just say, time and effort in trying to come up with a depreciation or amortization schedule which you would think would be as accurate as possible, given the circumstances?
CHRIS GASSEN: Yes, and it depends on not just the circumstances, but the type of asset. So you mentioned computers. They have a much shorter life and different life than will math courses, which will be a different life, by the way, than the technology we use to sell to public school districts, the PEAK platform and the things we do there, which would have yet a different life than some of the information we use, for example, for a student information system.
All of the systems, each one is looked at on a very specific basis to say how long do we think this is going to last, given the technology that is in the marketplace, given technology changes we are making.
CHRIS GASSEN: Okay, that would lead to my last question, then, related to your capital expenditures. Do you have a budget that you would be willing to share for the next fiscal year for property equipment, capitalized software, capitalized curriculum? And where do you see the longer-term trend in terms of the amount of money that you’re going to need to remain competitive in the business?
JAMES RHYU: Chris, these are all great questions. I think the first piece of it is we don’t yet — we are not yet providing guidance for fiscal-year 2016, so we don’t have any numbers for you for that.
Longer term, I think we have a belief that we are investing now over a certain cycle and that longer term we do actually think trends will go down, but we haven’t provided any specific guidance around the time frame of that longer term and how much we think it will go down. But yes, we do think it will go down.
CHRIS GASSEN: Why so?
JAMES RHYU: Well, because I think we have a certain set of investments that we are doing now. Nate referred to a couple of these in his remarks.
Pivoting to a new LMS is a big one. That is a fairly significant investment this year. It will continue into next year, and so I think we will — as that investment matures over the next year or two, that significant investment will actually come down.
CHRIS GASSEN: Okay.
JAMES RHYU: And we will provide — and I think this may be the first time, at least in my experience, that you have come onto the call, so our normal cadence will be that we’ll provide some greater guidance come October when we have enrollment numbers, and at that point we will give some better guidance around CapEx as well.
CHRIS GASSEN: Thank you very much.
OPERATOR: Corey Greendale, First Analysis.
COREY GREENDALE: Thanks for taking the follow-up. I will just ask one quick follow-up, which is you are continuing to generate cash nicely and, Nate, I heard you talk about inorganic and organic growth. It was about — I think it is still about a year ago you were repurchasing shares. Can you just talk about whether a repurchase is potentially on the table and just how you are thinking about potential uses of cash?
NATE DAVIS: Well, the uses of cash would be share repurchases, dividends, CapEx, internal CapEx programs, as well as, obviously, acquisitions. And I would say that we believe that there is opportunities in the inorganic market to acquire. We believe that investing in our own capital programs is a smart way to grow the business. We see a number of improvements we want to make in the business and that would be the two places we would spend cash.
We do not see at this point in time a need to do dividends or a need to do a share repurchase program. The Board always looks at these things every year; we have the conversation and then we decide based on the times. Right now, though, the view is that it is more important to put this cash into the areas I just mentioned. So there is no plans for a share repurchase on that basis.
COREY GREENDALE: Very helpful. Thank you.
NATE DAVIS: Any other questions, David?
OPERATOR: There are no more questions at this time. I would like to turn the call back to Nate Davis for closing remarks.
NATE DAVIS: I don’t have much else to say. I think it was a great set of questions. I appreciate everyone’s time this morning.
I would say — this is probably a paid commercial message to not just investors, but to everybody else — I am really proud of the team and what they have accomplished this year. It has been a year in which we put a lot of effort into making sure that our culture is focused on students and I hope the investors see that we’re building a business for the long term, a business that is strong, fundamentally strong, and sound in its underlying principles. And if you can see that, I think you’re going to see that we’ll continue to get better and better.
Thank you for your time. I appreciate you listening to us and have a great week.
OPERATOR: This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.
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Source: Fair Disclosure Wire (Quarterly Earnings Reports), Aug 04, 2015
Item: 32U1362922987FDW
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2015
Presentation
OPERATOR: Greetings and welcome to the K12 2014 fourth-quarter and full-year earnings 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 Investor Relations. Thank you, sir, you may begin.
MIKE KRAFT, VP OF IR, K12 INC: Thank you and good morning. Welcome to K12’s FY14 earnings conference call.
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 2014 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 on our website for 30 days.
With me on today’s call is Nate Davis, Chief Executive Officer and Chairman; Tim Murray, President and Chief Operating 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 Nate. Nate?
NATE DAVIS, CHAIRMAN & CEO, K12 INC: Good morning, everyone. Thanks for joining us on the call today. I’m pleased to say that we ended FY14 with solid results. For the quarter and full-year, our results met the guidance we provided.
Revenue for the year was $919.6 million, increasing 8.4% year over year. Our operating income, excluding the charges recorded for the second quarter, was $55.1 million, increasing 20.6% year over year. Our capital expenditures were $73.5 million, slightly below the $75 million we invested the prior year.
As I said last quarter, our financial performance this year is a direct result of the discipline we have instilled in the assignment of resources. Regarding operational performance, the entire organization is very committed to our core focus on academic outcomes.
Our investment philosophy over the next couple of years is to drive operational excellence in academics with well-placed expenditures in three key areas. As well as key investments in products to serve the growing market of online programs in public school districts.
The three areas are: First, we will invest in the effectiveness of our school work force. We’re expanding our training and professional development programs for our teachers.
And we recently established a new program to better develop our local school leaders, or what we call Heads of Schools. We will seek to provide more teachers and more teacher coaches, as well.
Second, we will continue the development of new instructional approaches that increase student and parental engagement. An example would be more hybrid or part-time face-to-face learning environments for those students who need it the most.
Third, we will enhance our curriculum and our systems architecture. We’ve talked about this before.
This includes improving core systems with an eye toward mobility and more information for teachers about individual student progress, greater accessibility for students with disabilities and updating our content as state standards and state assessments change. This is a multi-year effort that will support growth initiatives and performance for our Managed Public Schools in the short run, as well as our international, Private Pay and Institutional groups, over time.
I’ve been asked multiple times for the vision of where this Company is headed. I want to be clear that our number one mission will always be improving the academic outcomes for all students we serve and supporting the independent boards in their quest to build great schools.
But I do see a transition in education to more hybrid models and more traditional school districts offering online summer courses, online supplemental programs, and full-time district-run online programs. This is why our institutional business that we’ve branded Fuel Education, is so important to us.
This is the way we will participate in the growth of technology in the classroom in the United States. I’m encouraged by the number of programs we see coming online for which we are a competitive provider.
Before I hand the call off to Tim to review some operational highlights, I wanted to provide you status on our Managed Public Schools enrollment season which began in early April and will go through early October of this year. From an operational standpoint, we have effectively executed on our commitment to improve processes, streamline operations and provide new reporting and tools for the enrollment season.
I believe the majority of the issues that we faced last enrollment season have been addressed. The new parent portal application process has been built and deployed. This portal is performing as expected and reduces the number of steps to enrollment.
This provides families better information and better control over the enrollment process. Families can upload compliance documents on their own, easily add multiple students to the family account, track their enrollment process and perform other functions.
In addition, the new K12 all-in cloud-based telephony platform is now live. This improves our management of inbound calls.
The new family support center in Knoxville, Tennessee opened on schedule in May. We have hired, trained and onboarded 152 employees to date and plan to increase total employee capacity to approximately 330 by the end of the year as we prepare for next year’s enrollment season.
And, we built and deployed a new suite of internal reports that provide greater (inaudible)visibility from media acquisition through student interest to applications all the way to enrollments. At the same time, while it’s too early to predict with any certainty, our total enrollment for the 2014-2015 school year, there have been a few developments which are creating some headwinds and challenges to enrollment growth. I’d like to highlight some of those for you, now.
First, in Tennessee. The Education Commissioner reported that annual assessment scores for the 2013-2014 school year at Tennessee Virtual Academy, which we manage, in total the scores were low. At the same time, he concluded those students who persisted in the school for two or more years performed at a reasonable level, scoring in three out of five, which is significant improvement from previous years.
The Commissioner stated that the Tennessee Virtual Academy students have shown improvement in years two and three, and that the challenges rested primarily with first-year students. The net result was that the Commissioner asked the Union County Public school, our partner, not to take new enrollments after the July 10, because it was the new students who were bringing down the school’s overall score. BAM
Just so you understand, the potential impact in the first two years, the last two years of the school, we had an average of approximately 3,000 students per year in enrollments in the Tennessee Virtual Academy. When this cap on new student growth was enacted, K12 had to turn away approximately 2,000 students within the enrollment process who were already interested in attending the program this fall, and potentially more as the season progressed.
The positive point here is that the Tennessee experience again underscores what we’ve said repeatedly about persistence. For those students who stay with the K12 program, even for students who come into the program behind grade level, academic results improve each additional year they are in the program.
Second, Colorado. In Colorado, one of our partners took longer than expected to finalize their state-authorized charter renewal. Subsequently, the contract with K12 took longer.
While that renewal was eventually secured, the result was a delay in the beginning of the enrollment season for this fall. Last year the school opened for enrollment it mid-June. This year enrollments began in late July. We believe the short enrollment time-frame will translate into lower Colorado enrollments this season compared to previous years.
Third, on a more macro level, while I see the overall market adoption for online education growing because families today have more choices in choosing full-time and part-time virtual programs for their child. In the past, if you were a family seeking a virtual education option for your son or daughter, the only choice you had was a full-time managed program like the ones K12 manages.
Today, there are more public schools and districts that offer summer online courses, in-season electives online, supplementary skill-specific online programs and full-time programs run by the public school district itself. The number of online options is broader. We believe that the overall demand for virtual choice is increasing.
As I mentioned earlier, K12, through our institutional group, FuelEd, is participating this market shift and we’re seeing increase in the interest of our services we offer. However, in the short-term, these market dynamics create a challenge to enrolling students in the public schools.
To bring that home for you in specifics, in the state of Pennsylvania the overall growth rate for enrollments for online charter schools, according to the Pennsylvania Department of Education, has slowed from 11.7% in school-year 2010-2011 to 4.1% in 2013-2014. In Ohio the growth rate in the same periods slowed from 5.5% per year to 0.5% in 2014, according to the Ohio Department of Education and the National Education Policy Center. There are similar stats in Arizona, another state where online schools had existed for some time, but the growth in online programs has now slowed down.
To give you a balanced point of view, Texas, Michigan and Georgia are relatively new markets compared to Ohio, Arizona, and Pennsylvania. The penetration in those markets is less for us. Growth in Texas, Michigan and Georgia online programs remains strong.
At some point, we do believe New Jersey, Illinois, Connecticut, Kentucky and New York will become states allowing online charter schools, and will experience the same growth that these other states experienced. In fact, legislation in North Carolina was enacted this past year, allowing two online charter programs to be authorized and to convert to permanent programs in four years, if successful. We certainly will attempt to be one of the education management organizations for the charter boards who receive authorization.
All of the headwinds I just mentioned are all on top of our school boards and K12 itself, pushing to keep students enrolled only if they’re truly engaged and ready to learn. We help students in every way we can. But, if they are not engaged, they often have to shift back to the structure of the traditional brick-and-mortar school. Those withdrawals hurt our enrollment as well.
With all these key factors, keep in mind we just started in the busiest portion of the enrollment season. Every day we are enrolling new students for the upcoming academic year and will continue to do so through the end of September.
There will continue to be a lot of variability over the coming weeks. Therefore, we can not take final enrollments and where they will land. In the meantime, we wanted to share with you these events and challenges we are facing to help you understand the growth trends we’re seeing for the upcoming year. Thanks very much. Now let me hand it off to Tim. Tim?
TIM MURRAY, PRESIDENT & COO, K12 INC: Thanks, Nate, and good morning, everyone. It’s been a very busy quarter, closing out the school year with students participating in year-end state standardized exams before heading off to summer vacation. We moved a number of initiatives forward and once again our education solutions and products won industry awards that acknowledge K12’s innovation and quality.
Operationally, student experience levels through the end of the year were consistent with expectations. System-wide performance exceeded 99% availability for our learning management platform and for our PEAK solution for school districts.
We of course continue to build out K12 portfolio of courses. This quarter, we released a number of new course options, and clearly enhanced assessments for primary and middle school students, and expansion of our use of games as part of our mobile and desktop applications and customized curriculum to meet state-specific requirements.
We were always proud to be recognized by our peers in this sector, and once again the K12 team garnered new accolades. K12’s EmbarK online and Noodleverse applications won both the 2014 Parents Choice and the 2014 Mom’s Choice Awards.
Turning now to our institutional business. We expanded the PEAK library to include more choices for schools, and added the capability for schools to utilize additional third-party applications like YouTube education and the Khan Academy through the PEAK application.
The K12 platform now also allows teachers to upload their own content to create new courses or supplemental information. We will continue to invest to expand the capabilities of this platform to provide schools with the choice of a single application for online course management, analytics, and reporting.
K12’s technology team continues to excel, moving many projects forward this quarter. We’ve enhanced school analytics, improved the efficiency of school management solutions and addressed upgrades and improvements for the existing learning management solutions, including the ability to publish new mobile-compatible content for our middle school students.
In addition, we successfully migrated our software development and reporting hardware environment to increase performance, stability and future scalability needs. Going forward, we expect to be able to accelerate our software deployment capabilities through the use of new automated software-building deploy capabilities developed by the team in this quarter.
I want to note here that we are especially excited to end this year with over 6,000 students graduating from K12 partner schools. This is a 50% increase over last year, and therefore, we’ll have to replace some 2,000 more students than we did the previous year.
Those K12 graduates are going onto schools and universities of all types, including names like Boston University, New York University, George Washington University, Texas A&M, Georgia Tech and the University of North Carolina, just to name a few. Graduates are also going into the military or vocational training or directly into the workforce. We’re very proud of each and every one and excited about their accomplishments and wish them well in their next endeavor.
Finally, let me note that we launched four new schools this quarter will be open for the school year starting in the fall. The Insight School of Oklahoma; the Insight Schools of California, one in Los Angeles and one in San Diego; and the Hill House Passport Academy in Pittsburgh.
These schools will specifically support at-risk students and those behind grade level, with a comprehensive set of support programs in addition to academic courses. These schools represent the best of what we do, serving students across the learning spectrum.
It’s especially gratifying to recognize K12’s very positive impact on students and families that need that extra support to achieve success. We are excited about the challenges we have before us and keenly focused on our students and our schools.
Thanks very much. Let me now hand the call over to James.
JAMES RHYU, CFO, K12 INC: Thanks, Tim. Good morning, everybody. As Nate already mentioned, we posted revenues of $919.6 million for the year and an operating income of $55.1 million, excluding the impact of the $32 million of charges we posted in the second quarter.
The operating income is right in the middle of the range we had been providing and revenues came in a bit above the range we last provided in Q3. We achieved our financial goals this year while continuing to make investments in our business, as Nate previously mentioned. Our primary investments this year have been to improve academic outcomes and that will continue into next year.
It’s worth noting that while we expand investments in our key academic initiatives, we were also able to more than double free cash flow to $50 million, from $20 million we posted last year. We began the year indicating we were going to be disciplined in our investment approach, and I think we demonstrated our ability to do so.
Now, let me take you through some details of our quarter and the full year. Revenue for the quarter was $232 million, an increase of 14% over the year-ago quarter. For the full year, revenue at $919.6 million was an 8.4% increase over the prior year.
The growth in the quarter was largely driven by a 17% increase in our Managed Public Schools revenue. A combination of factors impacted revenue in the quarter, including timing, revenue capture and year-end planning adjustments, among other variables. We don’t see this revenue increase as a structural trend carrying into next year.
The full-year revenue increase in our Managed Public Schools, at 10%, was in line with our expectations. Keeping in mind that we’ve told you that our phasing of revenue through the year was going to be more evenly spread than the prior year.
Institutional sales revenue decreased $0.5 million or 3.1% from the prior year and rose sequentially almost 23%. As we previously discussed, we see this business in transition heading into next year.
In addition, for this fiscal year, we recorded approximately $4 million of institutional sales that were related to divested businesses in June of this year. The year-over-year comparison next year will need to consider the divested amount.
Our International and Private Pay Schools revenue was flat on a year-over-year basis. The year-over-year comparison was also impacted by the business that we divested toward the end of the year. For the full year, the divested businesses contributed almost $13 million of revenue.
On a full-year basis, the International Private Pay business grew almost 10%. Gross margins increased from 36.4% last year to 38.8%, due to higher revenue in the quarter and came in line plus or minus where we expected to be for the year.
Selling and administrative and other expenses increased 13% to $74.8 million on a year-over-year basis. As we previously indicated, we ramped up some of our promotional activities earlier in the season as compared to last season.
Product development expenses for the quarter was $2.3 million compared to $6.3 million in the prior year. This is consistent with the trend we’ve been seeing throughout the year. Operating income was $12.8 million for the quarter versus $1.4 million last year.
Let’s turn to some other items. We ended the quarter with cash and cash equivalents of $196.1 million, which represents an increase of $14.6 million from the prior year. Net cash provided by operating activities was $123.5 million, which is an increase of $28 million from the year-ago period, largely as a result of improvements in network and capital, somewhat offset by the lower starting net income.
Accounts receivable rose 4.4% to $194.7 million, largely in line with the enrollment group for the year. Our DSO was also marginally better this quarter compared to last year.
The Company continued to repurchase shares in the quarter, investing $21.9 million to purchase 953,000 shares of common stock. We had $26.5 million remaining available under authorization as of June 30.
CapEx, as we’ve historically defined it, which includes curriculum and software development, computers and infrastructure, was $18.3 million for the quarter. Or, basically flat on a year-over-year basis.
On a full-year basis, CapEx came in at $73.5 million. Which, on the same basis, is marginally lower than either FY13 or FY12, which were in the $75 million to $76 million range.
We indicated earlier in the year we would be between $75 million and $85 million of CapEx, but that we would also be disciplined in our spend. We are going to continue to invest in key areas, whether that’s for platforms or content, consistent with what we’ve been saying all year.
Our tax rate for the quarter and for the year came in better than we previously indicated, at approximately 38%. We drove some better discipline in our tax planning compliance, which has helped our effective tax rate for the year.
As previously announced, we closed the sale of select businesses during the first half of June. Those businesses had revenues of $16.9 million for this fiscal year and are close to breakeven on an operating income basis. We also recorded a gain on the sale of $6.4 million, or about $0.11 per share.
I’ve already provided you the split between our Institutional sales and International Private Pay business. Please be mindful of that as we discuss our results for those businesses next year. With that, I’ll hand the call over back to Nate.
NATE DAVIS: Thank you, James. Before we move to Q&A, I want to remind everyone that we are in the midst of the enrollment season. And therefore we are unable to address questions regarding FY14 enrollment and revenue guidance.
I know everyone is keenly interested in our progress, but I ask you to refrain from asking questions that attempt to get at specific revenue or specific enrollment guidance that we’ll be giving in October.
Now, let’s move to Q&A. Operator, who’s our first question from?
Questions and Answers
OPERATOR: (Operator Instructions)
Corey Greendale, First Analysis.
COREY GREENDALE, ANALYST, FIRST ANALYSIS SECURITIES: Nate, I will honor your request, but I did have a couple of more specific questions. Is there any update on Agora? And either the timing or any feedback you’ve heard on that?
NATE DAVIS: They had one Board meeting. Agora did have one Board meeting where they made some decisions and indicated a clear interest to be a self-managed organization.
Beyond that, we don’t really know, because we’re not going to hear until the next board meeting, which is August 25, I believe. After that Board meeting, I’m sure we’ll hear more. There really isn’t much to update you on other than the next Board meaning is August 25 and we will learn more then.
COREY GREENDALE: Okay, did you expect that there would be some decision and a press-releasable event?
NATE DAVIS: As of August 25, are you asking about that date?
COREY GREENDALE: Yes.
NATE DAVIS: I think they will make a decision. I don’t think they will issue a press release. We probably won’t until they talk to us and explain the decisions they made.
Of course, we will be at the meeting. We will be talking to them, but there will be conversations right after that. I think you should not expect on August 26 there will be a press release. But you should expect in the coming weeks, as soon as we understand whatever decisions they make, we will then issue a press release.
COREY GREENDALE: Okay. You were nice enough to give us some sense of the impact from Tennessee. Could you help us get our heads around the potential Colorado impact? Like just what the number was last year?
NATE DAVIS: Well, we don’t give by-school enrollment numbers. I gave you Tennessee because it’s actually in the public domain. I will tell you that Colorado, I think, is not in the same size as Tennessee. It’s smaller than that impact. But other than that, I try not to give state-by-state enrollment projections, for obvious reasons.
COREY GREENDALE: Okay. Tim somewhat gave part of this. But, could you help — I understand you’re trying to set reasonable expectations. Just tick off a few of the offsets. What are some of the positives that could help drive growth, offsetting some of the things you pointed out?
NATE DAVIS: I’ll take a little bit of t hat. Tim, you do some as well. We talked about the operational improvements we put in place. And I think those operational improvements are allowing us to get greater conversion from leads into ERs.
It’s easier for parents to get into the parent portal, to get their documents uploaded, to become a completed application. We are also seeing, because we put more money into the promotional activities earlier in the year, we saw greater lead volumes early in the year.
However, I want to temper all of that by saying I think the big issues that I gave you as trends, big states like Ohio and Pennsylvania, where we traditionally got a lot of growth, those states are slowing down. We’ve had some offsets. More leads but less conversion in states like Pennsylvania, Ohio and Arizona, that are offsetting each other. You want to add anything, Tim?
TIM MURRAY: Yes, I would just say we are a couple of weeks earlier this year having this conversation than we were last year. So we still have more of the enrollment season in front of us. All the operational improvements that Nate just alluded to, we’ve got a good six weeks ahead of us to see the impact of those.
The other thing I would add is, in terms of the new schools that I noted that are opening this coming season, each of those will get started in a small way. But they are targeted in the 100 to 200 per students school range, Hill House Passport Academy, the Insight School of Oklahoma, et cetera. We do expect some positive benefit there and more in the future.
COREY GREENDALE: Okay, that helps. James, you characterized the marketing spend as being pulled forward. Does that suggest that we would expect a lesser growth rate in Q1 because it was pulled forward into Q4 2014? Or is it more likely to be up at a similar rate year over year in Q1, as it was in Q4?
JAMES RHYU: Correct. I apologize. If I said pulled forward, I actually — I didn’t think I said pulled forward. I think we started a little bit earlier this year in this season.
We are monitoring our commercial spend very closely. I’m not going to give guidance yet on what we’re going to end the year with. We are going to continue to invest in promotional activities throughout the course of this season that’s going to end in early October.
COREY GREENDALE: Okay, you are correct. I interpreted the earlier start as pull forward, but thanks for the clarification.
One more on the cost side. The things that you talked about, about providing more teachers, more hybrid learning environments, that all sounds like it grows the market opportunity and improves outcomes. It also could change the margin profile. Could you comment on the impact on the cost side from doing those things?
NATE DAVIS: I do believe that it will increase costs in the coming fiscal year. It’s the right investment, we think, to make. It’s primarily focused on student outcome more than it is market opportunity. It’s really the student outcomes we’re focused on.
So, yes, I think, teachers cost money. And to the extent that we add teachers, we will incur some of that cost. The boards and their own funding sources from the state, will incur some of that.
So it’s not like 100% of that hits our P&L. Some will actually come out of their surpluses or come out of funding sources they’ll get from the state. Certainly, it will change our cost structure a bit, and we’ll have a little higher costs on the instructor side.
JAMES RHYU: Just a little more context for you, Corey. We discussed this a couple of quarters ago. We indicated that we probably would have some gross margin contraction during the course of this year.
We experienced about 80 basis point contraction during the course of this year relative to last year. As Nate indicated, we are going to continue to invest. I think you would expect some continued contraction.
We’ll give you a little more color as we get into next year and provide some guidance for the year. I think that we are going to continue to invest. Just from that pure metric, you’ll expect a little more contraction, I think.
NATE DAVIS: So James is giving you the numbers. Let me give you one quick statement about why. We believe it’s really important to make sure that we give every effort to making sure that students have the right teacher support and getting the right academic support. Because that keeps schools open, that keeps boards happy, and that’s what keeps us in business. This is a critical investment we have to make.
COREY GREENDALE: That is all very helpful. Thank you.
NATE DAVIS: That was a number of questions, Corey. Operator, who is next?
OPERATOR: Jeff Meuler, Robert W. Baird.
JEFF MEULER, ANALYST, ROBERT W. BAIRD & COMPANY, INC.: Let me ask you about your Choice Awards. Nate, you were using the phase — growth trends — directionally. Are you trying to indicate that you would still expect this fall next year to be an enrollment growth year?
NATE DAVIS: You know, over multiple years, I would say yes, we expect them to grow. The volume of growth is something that is very difficult for us to project.
As we go through the season we are learning more. We learned in the bigger, older, more higher-penetrated states, we’re going to get less growth and in the newer states we get more growth. The offset for those, I really can’t tell you at this point.
But, do I expect some positive growth? I do expect it. But, I just can’t tell you how much.
JEFF MEULER: Okay, that’s helpful. Can you talk about how the competitive landscape tends to evolve over the first 10 years after a state opens up to online schools? I’m asking from the standpoint like, is it more that you and your large for-profit competitor tend to be the main players in a state for the first five years?
And then once there’s a certain level of market demand, you tend to see the state-hosted offerings coming into the market? Trying to figure out if you are largely funding the investment for the first however many years, and once there’s critical mass on the market, if that’s when you see the state-sponsored entities come into the market?
NATE DAVIS: This has changed over time. The answer to your question is, today, yes. What generally happens is that we and the largest competitor tend to be the first two in.
And we tend to spend the most on the process of getting approvals and getting authorization and getting the state to adapt the laws. Nationalize the charter schools also helps, so there’s a number of parties that participate on that process.
Once the first set of applications come along in this current environment, we tend to be the two large players that come in at first. However, in previous years, in the early years of this industry, there were other players who were significant players, especially when you look at Ohio and Pennsylvania.
They had schools that were sponsored by other parties. Some of those parties have gotten themselves in some trouble legally and have gone away. Others are still there.
If you look at the large schools in Ohio and the large schools in Pennsylvania, it’s not just us and Pearson. There are a couple of large players.
We think going forward, there will be even more competition for the big schools in big states. We think we will always be the leader, but there’s no doubt about it, more people have looked at this market and said, wow, there’s attractive market there and I want to be in it.
JEFF MEULER: Okay. Finally, on how to think about the expense year and kudos to you for coming in to your guidance. I will call myself out that I was skeptical entering the year. Kudos on hitting the EBIT guidance.
How should I think about the expense management? I’m asking that from the standpoint that during the call, I think that you referenced being more disciplined around how you think about what investments you should fund and things along those lines.
But, my recollection was that in the past, James, that you’ve also cautioned that in the year-ago period that you’re comping against, you had some investments in anticipation of a big enrollment year. Just trying to think about how expenses will trend going forward, how we should think about incremental margins.
JAMES RHYU: Yes, Jeff, thanks for the call. I do remember your skepticism earlier in the year. I think that as we think about the business, Nate and Tim and I, we are really focused on academic outcomes, primarily. When we think about investments, whether their CapEx, whether there will be instructional costs we mentioned earlier, even when we think about our promotional activities, we are considering investments that will improve academic outcomes.
So, I mentioned that there’s probably a little bit of contraction in the gross margin side because of some of the educational investment that we’re going to make that Nate referenced. I think that if you look at the trajectory of the product expenses, we have tightened up on those from an OpEx perspective. However, we are going to continue investing in product and curriculum.
So, if you just look year-over-year, this year to last year, the P&L got, I think, some benefit from it. But you should expect some continued investment in curriculum and product.
Similarly, on things like software investments and things like that, our platform investments, and Nate mentioned in his prepared remarks, investments in the PEAK platform for our Institutional side of the business. Those will continue.
I can’t give you — some of that, there’s a mix of CapEx versus OpEx in that. I’m not going to give you exact guidance, but in the long term, we do think that there’s margin growth in this business over the long term. It might be a little bit choppy over the shorter term.
JEFF MEULER: Okay, thanks, guys.
OPERATOR: Jerry Herman, Stifel.
JERRY HERMAN, ANALYST, STIFEL NICOLAUS: Nate, I want to start with a high-level question. You were helpful in terms of explaining some of the changes and transitions and shifts in the business.
There’s been a couple of examples where your partner has talked about taking some of the services that you provide in-house, i.e. Kansas City, Pennsylvania. Do you see that as a developing trend in some way? If so, how do you think it impacts the business model over time?
NATE DAVIS: Very interesting. I think some positives and some negatives from that. I don’t know that I can say it’s a trend, but I will just give you some facts.
It was May of 2006, I believe, when PABCS decided that they were going to be self managed and go in-house. At the same time, we established another school that we were working with, called Agora. And Agora has grown dramatically and PABCS has been a good school, staying at the same size.
Since that time, yes, we’ve disclosed, Colorado and Hawaii have done the same thing. But we’ve got other schools in Colorado.
So, I think you will see that we continue to pursue second and third schools in the state, both for academic at-risk and for other reasons, including CTE. So, when you look at that, there’s some balance.
In terms of the business model and how it changes the business model, remember that there’s a lot of expense associated with managing a school. If the Board decides to take that work on themselves, that expense comes out of our P&L. We were the curriculum provider for PABCS. We hope to be the curriculum provider for Colorado. And we hope to be the curriculum for anybody who decides to go self-managed.
The strength of our program is in our curriculum. We think that’s one of the great assets we have. So, I think there will be some change where costs come out of the P&L, revenue comes out of P&L, but we still continue what I consider to be a very good margin curriculum business. And that’s how I think it changes.
JERRY HERMAN: Great, thanks. One for James, and all of you, for that matter. Your cash balance is obviously very healthy. You’ve taken action to buy some shares.
Again, given the sum of the transitions in the market, how do you look at the portfolio right now? And what role might acquisitions and M&A take in terms of business positioning and use of cash going forward?
NATE DAVIS: We’ve been asked that question many times. If you look at the cash we have, why don’t you dividend it to shareholders, why don’t use it to buy back more shares? We did it to the tune of an authorization program of $75 million. But we didn’t do bigger, higher numbers because the Board believes and I believe that this is a growth market and an opportunity.
We do look, that as we got the core business more better managed, we do look at opportunities to do acquisitions. We’ve looked at a couple in the last six months. Neither one actually came about, but we are looking at more out in the marketplace.
As you know, the multiples are very high in many of the businesses that are out in the marketplace. So we try to be very smart about it. Some people have been frustrated because we are sitting on the money. But it’s not we are not looking at opportunities, it’s simply we’re trying to make sure we make right investment.
I think you will see more acquisitive activity going forward. Not in the core business, but in those adjacent businesses, especially in the institutional area, that give us an opportunity to keep growing and participating in that market.
JERRY HERMAN: Great. Thanks very much, guys. I’ll turn it over.
OPERATOR: Jeff Lee, Wells Fargo.
JEFF LEE, ANALYST, WELLS FARGO SECURITIES: I just want to get a little more background about Agora. Do think you can give us some color on the parent (technical difficulty) or teacher satisfaction scores of Agora relative to the national average? Also, maybe some color on state test scores at Agora and what sort of either improvement of decline they’ve showed recently?
NATE DAVIS: Let me comment on state test scores and then Tim can comment on parent satisfaction scores. On state test scores, they have not yet been released for this year. So I don’t know where they stand, at this point in time.
The state is a little slow in getting its data out. I don’t think they are slower than their normal average, but slower than some others. I don’t really know where it stands.
We don’t expect a dramatic improvement or decline. We expect Agora to get slightly better and that’s our expectation. I haven’t seen the stats yet.
TIM MURRAY: Jeff, we can refer you back to the K12 annual academic report that was published earlier this year, where you can see the historical Agora results against all the other schools that we support as well. In terms of the parent satisfaction results, we don’t typically disclose how they compare between one school and another. As Nate said, we see trends there that are consistent with past years in Agora.
We are just now collecting and processing those results across all of our schools. It’s a little early to draw any firm conclusions just yet.
NATE DAVIS: You asked also about teacher satisfaction. I’ll remind you that teachers work for Agora, they don’t work for K12.
And Agora did go through significant discussion about unionization, multiple times, multiple years. The board has been working with us to make sure that we satisfy teachers as best we can, Because we don’t think that unions could do a better job than us.
So, there are some concerns among a set of teachers. There’s also some very strong support for teachers who don’t believe a union should be in between them and their board. So, there’s some, I would say, mixed results on teacher satisfaction at the Agora School.
JEFF LEE: Okay. One more for me. I know you made disclosures about Agora revenue in your 10-K. I was wondering if you could give us some color on EBITDA contribution from Agora?
NATE DAVIS: Well, we don’t report on a segment or school basis, as you know. So we can’t. But, it’s pretty obvious to everybody that Agora has a higher reimbursement rate because the State of Pennsylvania does. I think it a good margin business. I don’t think we can disclose any more than that.
JAMES RHYU: You also have to remember that most of our cost, or many of our costs, except for those direct costs like teachers, are structural costs across our network. Things like our platforms and things like that, are not school-specific often.
Sometimes we do school-specific things and we make school-specific adjustments, but a lot of our curriculum is across our network, et cetera. You don’t really get to a contribution margin type of line for any school. You’d never get to EBITDA anyway.
NATE DAVIS: Remember, in Pennsylvania, I’ll go back to one other thing that’s very, very important to remember. That is the teachers are on the payroll of the school. So, it’s the cost associated with that this a direct cost that the school incurs on teachers. While there’s a high reimbursement rate, there’s also a teacher cost the school really deals with.
JEFF LEE: Okay. Thank you.
OPERATOR: Jeff Silber, BMO Capital Markets.
HENRY CHIEN, ANALYST, BMO CAPITAL MARKETS: It’s Henry Chien calling in for Jeff. I wanted to ask a little bit about the increases in revenue per student. I know you mentioned some of it was due to shifts in the calendar. Is there anything else driving that in the quarter?
JAMES RHYU: Henry, it’s James. Every quarter there’s a number of puts and takes. The year-over-year comp is a little bit — we mentioned earlier in the year that the way that the timing of the revenue is going to come in this year would be a little bit different.
Some of the quarterly year-over-year comp is driven by that phasing during the course of the year. This year is different than last year. We have everything from capture, as I mentioned, which we are continually trying to improve. There’s some timing issues.
We do get some adjustments in some quarters, either from state audits or things like that. A lot of puts and takes, so we really don’t go into detail. As I said, the quarterly year-over-year result is not really going to be a trend going forward.
NATE DAVIS: The year-over-year total — this is Nate speaking, Henry — the year-over-year total revenue per student is affected by some rate increases. There were these two states last year that had rate increases.
I think I mentioned in previous calls that as the economy gets better, the educational community fights for its portion of the state budget. We want a good portion of the money, the tax money that gets collected, to go back into education and local schools.
We are a public school. For that reason, we end up with some positive rate variances in good economic times. I don’t think that’s going to be 5% to 10%; it’s going to be in the very low single-digits. But we did get some of that benefit this year.
HENRY CHIEN: Got it. In terms of the low single-digits, if you could clarify, is that trending upwards? Is it flat in terms of year over year for 2015? I know you’re not giving guidance.
JAMES RHYU: We want to be careful. What Nat’s referencing is the funding environment overall looks to be trending favorably.
How that translates to K12 revenue, isn’t always direct one for one. It depends on our student mix, which again, we are very early in the enrollment season. Funding rates can vary pretty widely.
Our capture rates vary wildly. The way that we capture revenue through enrollments in every state is different. We have single count date, double count date, et cetera.
So, until we get through our enrollment season and we know the mix of states and how we count them, et cetera, our revenue picture growth across rates, specifically, we won’t know until October. The general funding environment we see overall is improving.
NATE DAVIS: I know the funding environment, I don’t see a change in it from year to year. I think it will be positive. But, I don’t think it’s going to be more positive in FY15 than it was in FY14.
I’m not sure, Henry, exactly your question. If you’re asking do I see even more rate increases coming on a funding level, then I saw last year? No. I think we will see some, but I don’t think it will be any bigger than we got last year.
HENRY CHIEN: Got it, that’s very helpful. Thank you.
MIKE KRAFT: Operator, I think that was the last question on the board. So, if we don’t have any more questions, Nate, I don’t know if you want to take some closing remarks.
NATE DAVIS: I don’t have any closing remarks. I appreciate everybody’s time this morning and thank you for signing on.
OPERATOR: Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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