Will K12 Inc. Get Sent to the Principal’s Office? 3 Things to Watch as the Company Reports This Week

By now, most people have heard about all the troubles that for-profit colleges and universities have gotten themselves into. Aggressive recruiting tactics, terrible outcomes for students, and a heavy reliance upon government money combined over the last four years to spur massive investigations into their operations.

Most of us Rule Breaking Fools could rest fairly easily knowing that K12 (LRN -1.22%), by focusing on a much younger demographic and not requiring students to take out loans, was exempt from such controversies.

Or so we thought. When noted hedge fund manager Whitney Tilson published his short-thesis on the company in September of last year, cracks began to emerge. When the company offered disappointing guidance a few weeks later, shares plunged over 30% -- and they haven't recovered since.

In fact, since Tilson's presentation, shares of K12 are down 60%. Are there better days ahead for the company? Here are three things Fools should keep their eyes on to see if that's a possibility when the company reports earnings on Thursday morning.

First, the basics
Though we Fools don't think any three-month span should make or break an investment thesis, its prudent to at least keep an eye on how a company performs versus Wall Street expectations.

If nothing else, this helps us understand why a stock may make huge moves following earnings. That's especially true in the case of K12, which currently has 12% of its shares sold short. Here's what Wall Street is looking for on Thursday.

Source: E*Trade

It's important to note that the company's third quarter has always shown a loss, as it reflects the seasonality of the company's business. If the company meets these expectations, it would reflect a 2.6% growth in revenue.

It all comes down to enrollments
Essentially, K12 sets up virtual schools — which usually take the shape of charter schools — throughout the United States. The company lends its platform, virtual teachers, and supplies to these subsidiaries and gets paid through per-pupil monies from state and local governments.

There's no metric more crucial to understanding the underlying business than enrollment. As you might expect, enrollment usually gets a noticeable bump during the third quarter — when back-to-school season is in full swing — and trends downward over time as attrition sets in.

Keeping that in mind, here's what the last three years have looked like for the company's U.S. managed public schools division.

Source: SEC filings

Moving forward, management has decided to reorganize how it recognizes enrollment figures and revenue. In one camp, there will be managed programs. These are essentially the same as what has previously been measured. In this realm, enrollment is expected to drop 4.7%. That's a huge red flag for investors.

Why is this the case? As CEO Nate Davis recently pointed out in a conference call:

"We're ... seeing more traditional school districts offering their own full-time online programs, along with supplemental learning options and online summer courses ... these market dynamics have also created a challenge to enrolling students in our traditional managed programs." 

If managed enrollment were to fall anywhere beneath the 118,609 threshold that the company recently stated, it would be a major problem for the company.

Can they make up the difference?
Although per pupil reimbursements are expected to be higher in K12's managed programs segment, declining enrollment is obviously a big concern. If public schools are essentially offering the same programs, there's not as much need for K12's services.

But the company hopes to make up for that by increasing the number of students enrolled in its non-managed programs. The difference between these two is that, as Davis recently pointed out, "Non-managed Programs include schools where K12 is the primary provider of content and technology and we may even provide instruction, management, or other educational services, but K12 is not providing primary administrative oversight for the virtual school program." 

In this segment, overall enrollment is expected to grow 39%. But while that number looks good, there are three key things to note: First, enrollment in these non-managed programs is just one-sixth the size of enrollment in managed programs.

Second, some of the growth was from schools choosing to shift from managed to non-managed arrangements. Without this, organic growth would have been 24%.

And perhaps most importantly for investors, it's not quite clear how margins will be effected in the long run by a shift toward non-managed programs.

Listen closely for details on this in the company's conference call, and look to see if K12 can meet its enrollment expectation of 20,630 in non-managed schools.