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K12 Incorporated  (NYSE:LRN)
Q2 2019 Earnings Conference Call
Jan. 22, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to K12 Second Quarter Fiscal 2019 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 remainder this conference is being recorded. I would now like to turn the conference over to your host, Mr. Mike Kraft. Please go ahead.

Mike Kraft -- Senior Vice President, Corporate Communications

Thank you and good afternoon. Wecome to K12's second quarter earnings call for fiscal year 2019. Before we begin, I would like to remind you that in addition to historical information, certain comments made during this conference call may be considered forward-looking statements. These statements are made pursuant to the safe harbor's provisions of the Private Securities Litigation Reform Act of 1995.

They should be considered in conjunction with cautionary statements contained in our earnings release and the company's periodic filings with the SEC. Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied in such statements.

In addition, these -- this conference call contains time-sensitive information that reflects management's best analysis only as of the day of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements.

For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC. These reports include, without limitation, cautionary statements made in K12's 2018 annual report on Form 10-K.

These filings can be found on the Investor Relations website at www.k12.com. In addition to disclosing financial results in accordance with Generally Accepted Accounting Principles in the U.S., or GAAP, we will discuss certain information that is considered non-GAAP financial information.

A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included in our earnings release and is also posted on our website. This call is open to the public and is being webcast. The call will be available for replay for 30 days.

With me on today's call is Nate Davis, Chief Executive Officer and Chairman of the Board; and James Rhyu, Chief Financial Officer and President of Product and Technology. Following our prepared remarks, we will answer any questions you may have.

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

Nathaniel Davis -- Chief Executive Officer and Chairman

Thank you, Mike and good afternoon, everyone. Thanks for joining us on the call today. Given we're in the middle of the school year, there's not

a lot of new news, so I'll be more brief than normal. First, let me start by highlighting a few financial results for the quarter.

Revenue was $254.9 million in the second quarter fiscal year '19 and increase of 17.4% year-over-year. Consistent with our first quarter, announcement revenue growth was a result of a strong Fall Enrollment season. Because of the strong revenue growth, adjusted operating income for the quarter was $37.4 million versus $20.9 billion in the prior year. Now James will provide more details on the financials in a few minutes. But importantly, our revenue operating income and capital expenditures met or beat the guidance we provided last quarter.

This underscores the predictability and reliability of our results. For the fiscal year '19, we predict revenue when operating income growth will be consistent with the guidance we provided last quarter. Revenues are anticipated to be between $1 billion and $1.01 billion and adjusted operating income in the range of $56 million to $60 million. And candidly, current trends do suggest that we will be at the higher end of this guidance.

As I noted a minute ago, we're in the middle of the school year, and at this time of the year, we're keenly focused on all of the behind-the-scenes blocking and tackling to support student academics, implement new tools and support systems for teachers, and fine tuning our curriculum. I won't bore you by revealing all of that work, it's in process.

However, the one initiative I want to provide an update on is Career Readiness. We've made significant strides in building this business and I'm optimistic about the impact Career Readiness will have on K12's future as well as what this option can do for students we serve. First, we're working with existing and new partners to expand the number of schools that offer Career Readiness. Given the status of current negotiations with our school board partners, we will likely add between three and seven new programs for the upcoming school year beginning fall 2019.

This will increase the number of Career Readiness programs between 16 and 20. With that number of schools, more than 30% of high school students across this nation will have access to a K12 power Career Readiness program. In future years, this market coverage should grow more than 50%. And all of this leads to opportunity to help more students with career-ready education and increase enrollment to the benefit of shareholders. To drive enrollment to those schools, our marketing team is in the midst of creating a unique marketing campaign for the destination career academies. We'll launch a separate website next month at destinationacademy.com.

Team is currently trialing new tag lines and messaging, developing new go to market strategies and investigating the use of targeted media approaches. They conducted surveys with prospective parents and high school students to segment the market, and identified those likely to be interested in an online Career Readiness school.

The marketing team is also using insights from another new partner, Burning Glass. Burning Glass is a market leader in real-time labor market analytics, and our newly signed agreement with them will allow us to use their data to create profiles for each parent and team segment. These profiles detail the demographic, the motivations and the media consumption of each group.

This in turn allows our spring marketing campaign to be more focused on offering career readiness to students and families for most in need of this program.

Third, we are revamping our entire Career Readiness course catalog. We will build our curriculum using both internally developed and best-in-class externally available content. This includes content curated by corporate partnerships to meet their specific hiring needs. We'll also be incorporating project-based learning into the curriculum.

Most business today is done virtually and collaboratively. Project-based learning mimics this environment. With this approach, students work on projects and in teams, which helps build their capacity to collaborate more effectively. They're essentially learning by doing. So for example, rather than having students take notes and learn how to design a business plan. They will do market research and develop an actual business plan for a local business.

This plan will then be evaluated by employees of corporations in our students field of interest. So to do this, we'll use yet another new partnership we've established with Nepris. Nepris is a new and innovative leader in connecting students virtually with real world industry professionals. Our partnership will also allow our students a way to explore career options to Nepri's library of video assets. With project-based learning, students feel like they're trying a course to solve real world problems rather than just learning rope material. In fact, research by the Buck Institute of Education shows that project-based learning can promote student engagement and may be more effective than traditional instruction in social studies, science, mathematics, and literacy. We're working to provide a roll-out of 20 new courses with project-based learning for this fall with the remaining of the Career Readiness catalog being transitioned over the next few years.

Fourth, the team has started building third party partnerships that allows students to have hands on a virtual business experience in the form of job shadowing, internships and mentorships. And as part of this effort, we'll be launching our first ever National Job Shadowing Week, this July. Job Shadowing Week will provide students with an early career exposure and experience in real-world workplace settings. Each participating company will be able to customize the job shadowing experience for their students. For corporations, this will help create a more robust pipeline of talent while supporting their employment branding and community goodwill.

In parallel, we're working with higher education institutions with very large national footprint, online universities and community colleges to provide students with the possibility of dual enrollment. This will allow students to graduate from high school with a deployment and their chosen career path as well as transferable college credits. In some cases this could include earning an associate's degree at no cost for the student which will be a powerful benefit of this program.

And finally, alongside our new partner, STEM Premier, we're working to integrate their platform into the entire K12 ecosystem. That includes rolling out the service to middle and high school students in existing K12-powered schools across the nation. We're also working on integrating STEM Premier into the onboarding and the graduation planning process, so the students can sign up and receive the benefits as soon as they enroll. By the way the STEM Premier's rebranding their company to be named Tallo in February. Look for a host of new updates in Tallo, including a new partnership with Lockheed Martin. With the addition of Lockheed Martin, the number of corporate partners on the Tallo platform increases to over 200. We're very excited about the potential of Tallo and we expect a number of students who have access to the platform to more than doubled in the next few years.

Now keep in mind, while we're working to add high school students to the platform we can grow. Tallo continues to work with adult learners as well. Taken in total, our team has made significant strides in building our Career Readiness business in just a few months. I'm very excited about the initial results. I believe we're in a unique position with a unique solution that will help students prepare for their life after high school, including better understanding of their choices as they enter college. So whether their path leads them directly into the workforce or to the military or to higher education, our Career Readiness program will provide them the skills they need to excel.

We're still in the early phases of this business, but we are moving fast to become the national leader in career education at the high school level. I continue to believe the Career Readiness will drive a major portion of each year's student enrollment growth at K12-powered partner schools.

So thank you for your time today. And now I'll turn the call over to our CFO and President of Product and technology, James Rhyu. James?

James Rhyu -- Chief Financial Officer and President, Product and Technology

Thank you, Nate. Good afternoon, everybody. First, let me recap our reported results. Revenue for the quarter was $254.9 million, an increase of 17.4% from last year. Adjusted operating income was $37.4 million, an increase of 79%. And capital expenditures were $9.6 million, an increase of $1.4 million.

And as Nate already mentioned, in each case, these results met or beat the expectations we provided in our guidance last quarter. And we continue to feel comfortable with a full year revenue and adjusted operating income guidance. Revenues for the quarter were driven by increases in our managed public school programs.

For the quarter, managed public school programs revenue increased $39.4 million or 21.5% to $222.8 million. The strong performance is the result of year-over-year increases in enrollments of 7.3%, an increase in revenue per enrollment and the impact of the new revenue recognition standards from this year. For the quarter, revenue for enrollment rose 13.3% largely, from the impact of the new revenue recognition as well as school mix and improved funding and we continue to expect full year revenue per enrollment to be up 4% to 6% year-over-year driven by strong mix and an overall positive funding environment.

In our institutional business, revenue declined 9.1%. We still believe this business will be down close to 15% -- plus or minus 15% as we indicated last quarter. Private pay revenues were $9 million, up $0.6 million from the year ago quarter and we still believe that this business will finish the year more or less flat.

Gross margins were 37.1%, up 120 basis points from the second quarter of last year and this is largely the result of the impact of revenue recognition in the quarter. We expect gross margins for the full year to be flat to the prior year, plus or minus 100 basis points.

Selling, administrative and other expenses were $60.2 million, which is consistent with our spend last year. We expect our full-year cost to be flat to up a couple 100 basis points on a full year basis. Product development costs were $1.1 million, compared to $2.4 million last year. EBITDA for the quarter was $51 million and adjusted EBITDA was $55.1 million, operating income was $33.3 million and adjusted operating income was $37.4 million, up $16.5 million, compared to the $20.9 million last year.

Improvements in all of these metrics have largely been driven by the increased enrollments in our managed public schools. Some other items to note is we ended the quarter with cash, cash equivalents and restrict cash at $205.3 million, an increase of $60.3 million compared to the first quarter, and this increases in line with normal seasonal trends and we would expect this balance to increase throughout the remainder of the year.

CapEx, which includes curriculum and software development infrastructure, was $9.6 million, an increase of $1.4 million compared to last year. This is in line with expectations as we continue to invest with our products. We came in lower than our guidance range due to the timing of some cash payment. Our effective tax rate for the quarter was 27.7%, compared to 4.1% in a year ago quarter last year's tax rate as you may remember was impacted by the new tax legislation.

Summarizing our guidance for the upcoming third quarter, revenue in the range of $250 million to $255 million, adjusted operating income in the range of $24 million to $26 million and capital expenditures of $9 million to $11 million.

Thank you. That concludes our prepared remarks. We'll now be happy to take any questions. Operator?

Questions and Answers:

Operator

At this time, we will be conducting question-and-answer session. (Operator Insturction) Our first question comes from a line of Jeff Silber with BMO Capital Markets. Please shoot the question.

Jeff Silber -- BMO Capital Markets -- Analyst

Thank you so much and congratulations on the quarter. Wanted to focus on the Career Readiness business to start. Can you just give us a little bit more color in terms of who the buyers are? Are these different students than you've typically been teaching? And how large do you think this business could be?

Nathaniel Davis -- Chief Executive Officer and Chairman

Hi, Jeff. Thank you for being on the call today. Thanks for the congratulations. It's been a good quarter. First of all, the students that we think we can address here are both. We -- this is an option for students who are already in the program and in fact the enrollments we reported on in the first quarter, at the end of the first quarter, were largely students that came to us because they were coming to the normal NPS schools, and then once they got here, we talked to them and they realized the program was great for them. The growth, however, that we plan to see is because we think there are -- we did some market analysis and we believe there is a significant market opportunity of people who would never had considered online schools before, who now will consider it because an online school with a Career Readiness bent is something they consider. So, the big benefit of this is a new market opportunity.

How large can the business become? It's hard to make a quantitative analysis and not be held accountable to it, but I can tell you this is in the hundreds of millions over the next few years, this is not a $30 million or $40 million or $50 million, we're looking at hundreds of millions over the next three to four years. So I think that it's a very significant size if we do this right now. So I have to go right, we have to open up new schools, we have got to get some authority in some states, but we're working on that, and as I said, we've already got three to seven schools that we think will open up next year, and if the same thing happens the year after that, this is going to continue to grow.

Jeff Silber -- BMO Capital Markets -- Analyst

Now, you mentioned the openings in the state. I'm assuming, the funding comes mostly at a state level. I know the federal government has been talking about this as well.

Nathaniel Davis -- Chief Executive Officer and Chairman

Yes, this -- the funding that we've put in our internal business plan is all funding from the state level. So, think of it as the same funding that would go to a traditional student who goes to our NPS School, they simply are going to a school that gives them still math and science but they take on these career pathways. So it's the same funding sources we've got today. The federal source, the Perkins Funds and things like that, we've not factored in yet

Jeff Silber -- BMO Capital Markets -- Analyst

Okay, great. And then you're recording this right now in the MPS line, correct?

Nathaniel Davis -- Chief Executive Officer and Chairman

I'm sorry? Yes. (Multiple Speakers)

It's in the MPS line. That's great. Okay, great. I'll jump back in the queue and let somebody else ask questions. Thanks so much.

Thanks, Jeff.

Operator

Our next question comes from line of Chris Howe with Barrington Research. Please proceed with your question.

Chris Howe -- Barrington Research -- Analyst

Good afternoon, everyone. Great quarter.

Nathaniel Davis -- Chief Executive Officer and Chairman

Hi, Chris, thank you.

Chris Howe -- Barrington Research -- Analyst

Yes, just had a follow-up question just focusing in on this Career Readiness. You mentioned the three to seven new programs by fall of '19, 20 new courses. As we look at students as they move through the timeline of their enrollment at a Career Readiness institution, how should we think about retention, reregistration, and Career Readiness' impact on that and retaining students through their journey?

Nathaniel Davis -- Chief Executive Officer and Chairman

Well, first of all, we believe in some early data indicated to us that when a student is -- understands the impact of what they're studying and how it's going to impact their lives and help them get a job, it increases their engagement, increases their desire to stay in the program, and therefore increases retention. So, we think this is going to have a positive impact. I don't want to predict that retention is going to double or something because of this, but I do believe that it's going to have -- it's going to help us with our annual goal of continuing to improve retention. Difficult to quantify, but it's one of those many elements, great customer service, putting students in this kind of program are all things that will help retention. So, I believe, it's of great value in terms of that.

Chris Howe -- Barrington Research -- Analyst

Okay. And then coming in perhaps at the higher end of your guidance. Is this a reflection of your level of confidence in Career Readiness or is there something else that's part of that mix that moves you toward that positive outlook?

Nathaniel Davis -- Chief Executive Officer and Chairman

No, actually this is a reflection of our confidence in our core business. Core business is very strong right now and retention is going as well as it did last year. Our new enrollments are going well as well. So we are seeing just a positive year. We're effectively -- we've taken a look. I think at this point in time, more midway through the year, we pretty much know what's going to happen with enrollments and we're confident in where we are. The improvement that's going to come over time with the Career Readiness program should actually impact FY '20 more than the current results. And we'd like to say about that, this is all about the core business confidence.

Chris Howe -- Barrington Research -- Analyst

Yes. Got it. Thank you. I'll hop back in the queue.

Operator

Our next question comes from the line of Greg Pendy with Sidoti & Company. Please proceed with your question.

Greg Pendy -- Sidoti & Company -- Analyst

Hey guys, thanks for taking my question. Can you just -- I think earlier in the call you gave us the three to seven new programs, but I guess as you're trying to build out all the pathways, can you kind of give us a percentage of where you're at right now and kind of where the goal is to get and what what the CapEx spend might be on that?

Nathaniel Davis -- Chief Executive Officer and Chairman

Well, first of all, hi Greg, and welcome to the call. I know this is your first call with us. I appreciate you joining and asking. So, I don't have a percentage for you off the top of my head of the courses, but I can say it's just a start. We have -- we license content from others for the most part for CTE. So of our own content, this is probably around a little less than 50% of our content, the 20 courses. But of our content I don't really have an estimate off the top of our head. In terms of CapEx that we'll spend on this, we don't envision right now seeing CapEx jump because of this. This is money that we traditionally would have spent on NPS courses. And as that cost has come down we're now going to spend that money on CTE courses.

We may, I want to be clear though, we may decide to accelerate some of that spending, and may see a slight increase, but I don't think anything dramatic from our current spend in capital. I would say think of our capital today, the guidance we've given, we're still going to be within that guidance. We're not going to exceed that guidance for these new courses.

Greg Pendy -- Sidoti & Company -- Analyst

Okay, got it, and is the longer term goal here to be offering, I guess, the entire pathways?

Nathaniel Davis -- Chief Executive Officer and Chairman

First of all, we have 30 pathways today, the five pathways that will be our focus on building these project based learning courses and being enforced in house of the three to five will be a focus for us. And those five will be a kind of a, -- I won't say a test, they're going to be a prototype for what we do and all the other all the other pathway so this five is to the first approach, but again, I want to be very clear the approach here is not to just build them ourselves approaches to partner with as many other parties as we can so I will go out and license courses as well as development we may even licences of someone else the course to put into our own internal development. So we actually might see the cost per course in terms of capital costs come down a little bit as we licensed questions from from others.

Greg Pendy -- Sidoti & Company -- Analyst

That's helpful. Thanks a lot.

Nathaniel Davis -- Chief Executive Officer and Chairman

Good.

Operator

(Operator Instruction) This are no further questions left in the queue. I would like to turn the call back over to Mr. Davis for closing remarks.

Nathaniel Davis -- Chief Executive Officer and Chairman

Well, once again, thanks everybody for joining the call. I notice this is the middle of the school year so there's not a lot of questions we didn't provide, a long discussion on our core business. The bottom line is the core business is doing well. We feel great about our guidance and great about being at the high end I really do appreciate Greg joining us, and everybody else who follow us. So everybody have a great week, and thank you for being on the call.

Operator

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.

Duration: 25 minutes

Call participants:

Mike Kraft -- Senior Vice President, Corporate Communications

Nathaniel Davis -- Chief Executive Officer and Chairman

James Rhyu -- Chief Financial Officer and President, Product and Technology

Jeff Silber -- BMO Capital Markets -- Analyst

Chris Howe -- Barrington Research -- Analyst

Greg Pendy -- Sidoti & Company -- Analyst

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