Mike Kraft - VP, Investor Relations Nate Davis - Chairman, CEO Tim Murray - President, COO James Rhyu - CFO, EVP.

Geoff Miller - Robert W. Baird Tom Bakas - First Analysis Trace Urdan - Wells Fargo Henry Chien - BMO Capital Markets Jerry Herman - Stifel.

Greetings, and welcome to the K12 Fiscal 2015 Second Quarter Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mike Kraft. Thank you.

You may begin..

Thank you, and good morning. Welcome to K12's second quarter earnings conference call.

Before we begin, I would like to remind you that in addition to historical information, certain comments made during this conference 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 in 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 Web site at www.k12.com. In addition to disclosing financial results in accordance with general 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 Web site. 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'd like to now turn the call over to Nate.

Nate?.

Good morning, and thanks for joining us on call today. Firstly, let me start by highlighting a few results for the quarter. Revenue was $231.1 million, up 3.3% year-over-year and within the range of our most recent guidance. Now, excluding the businesses we sold last year, revenue rose 5.5% versus last year.

And revenue growth was largely driven by gains in our managed and non-managed public school programs as well as in our international and private pay schools.

For the quarter, we posted operating income of $20.5 million compared to an operating loss of $8.9 million in the prior year and James will review how this significant increase in operating income is impacted by businesses we sold last year and charges we recorded last year. Today, I want to touch on two topics that I'm very excited about.

Both will impact our growth going forward. First, our business development for managed public schools is good news. And second, the revenue growth trends we are seeing in our institutional group Fuel Ed are now coming in as we planned.

From a school development point of view, we are working with various school boards to open new schools in both new states that don't get offer a virtual school option and new schools in states where we already operate at least one school.

For instance, The Maine Charter School Commission voted 6:1 to approve the charter application as the Maine Virtual Academy. The school initially serves students in grade 7 through 9 with a plan to expand up to grade 12. The Maine Virtual Academy Board hopes to enroll about 300 students in 2015/2016 school year and to grow from there.

In North Carolina, we continue to support our independent not for profit partner, the NC Learns Board, as they were the policymakers in the State Board of Education on their application to open a statewide online public charter school for the upcoming year. The final decision whether to move forward in North Carolina is anticipated in early February.

If approved the school could enroll up to 1500 students in the upcoming school year and increase this to about 3000 students by the fourth year of operation. We are also supporting our School District Partner Union Counting Public Schools as together we work to extend the Virtual Academy in Tennessee.

Tennessee is Virtual Public Schools Act to sunset in June of this year. But, with new legislation, the state legislature will determine the future of all online schools in the state including a Tennessee Virtual Academy and seven other programs, these programs support over 1500 students across the state.

With the potential of new legislation, the Union County Public Schools could extend to Tennessee Virtual Academy to more families all across Tennessee. Keep in mind, that the school had a significant number of student applications that it was unable to fulfill last enrollment season.

And our work at the state level doesn't stop there, we are also working with a number of new partners in other new states for both regional and statewide programs and I can't exactly tell you, which new laws will be passed, nor when new applications will be filed and approved.

But, the message is, I want you to know that we are working with partners to expand school choice and provide more quality digital educational alternatives in more states. At the same time, our school development teams are also working on expansion of schools within our existing current state footprint.

Each one of these planned schools or programs is at a different stage of development. In Colorado for instance, a charter proposal for a new school has moved beyond Local Board of Cooperative Education Services, which is the school sponsor, and is now being reviewed at the state level.

And in Minnesota, a Blended Charter School which was actually approved in 2014 should open this fall. All of our school development projects can be categorized into three groups. First, there are some states where we see strong ongoing demand and our existing school can't support the growth.

And now that maybe because the existing school partner wants their school to remain at a certain size, or there maybe enrollment caps at school level. But a way to grow these states is to open additional schools.

Second, we are seeing demand for specific types of offerings, for example, we are seeing great interest in college and career readiness offerings, which allows students to pursue a distinct career path-based on a national career cluster model.

These specialty programs or schools have enormous potential as they provide quality education for children who may not otherwise be able to obtain one. And they can significantly add to the skill trade workforce in this country. You will see us open new programs and even new schools focused on career readiness and trade school preparation.

And lastly, there are states which require the service students on county-by-county basis. Therefore, the only way to serve more students is to open up in more counties. For example, in Florida, today our charter school partnerships serve only eight out of 67 counties across the state.

We estimate that we need to expand in about 12 to 15 schools in order to serve 90% of the students in that state. So this expansion will start in school year 2016/2017. The key takeaway I want to leave you with is that through a significant school development work occurring at both the state level and the school level.

You should expect to hear more from us on this front in the coming months. I believe these efforts are in conjunction with our efforts to expand enrollment in our existing partner schools, we will support long-term growth in the managed public schools business.

Before, I move on to talk a little about our Institutional Group Fuel Ed; I want to remind everyone that it's National School Choice Week. And throughout the week, over 11,000 events highlighting the importance of school choice will take place in the United States.

These events also have a positive effect, on a family's interest in K12 partner programs as they raise awareness about the benefits of providing education options and empowering parents with the choice to go to different schools and get different choices.

Now on to Fuel Ed, this quarter non-managed program revenue increased almost 65%, but as we noted in the past, you should be aware that some of these gains were due to managed programs in Colorado, Kansas and Hawaii transition to non-managed programs. But, if you exclude the reclassification of these schools year-over-year revenue growth was 39%.

In addition to that, our institutional and software services revenue grew over 8% and will combine with performance in non-managed programs, the institutional business may exclude the impact of Colorado, Kansas and Hawaii and we exclude the impact of the sold businesses is delivering almost 25% growth year-over-year.

By any measure, this is a dramatic turnaround. Because you have to keep in mind, just a year ago, we were seeing year-over-year declines in revenue in this segment. As we said we would, we have focused on this business, expanded our capabilities and are beginning to see the results of our investments.

There are a number of underlying trends that support this growth. One is state funding; more states are enabling funding sources that were traditionally allocated for textbook and prep materials to be used for the purchase of digital content including online courses.

In Florida, for example, the current textbook adoption process is now allowing for funding to be used on digital materials for French and for Spanish. Another reason for our growth is that more states are enabling and mandating access to online courses. Michigan is one of the best known examples.

The state requires students to have at least one online learning course in order to graduate. The state also provides students in grade 6 through 12, the ability to enroll in online courses through Michigan's online course catalog. Now for Fuel Ed, this has translated into student growth of 20% year-over-year.

More recently, Louisiana has developed its supplemental course academy to offer online courses. This has increased the demand for online learning in states for Fuel Ed single course options as well as its full-time programs. The result is that Fuel Ed will more than double its annual revenue from the state of Louisiana in the current fiscal year.

School districts are also expanding digital learning for a variety of reasons and re-envisioning the traditional classroom to a blended or a hybrid model. Districts are using digital content to supplement the classroom instruction for students require credit recovery and for advanced learners requiring advance placement courses.

They are also addressing their home-bound population using digital curriculum, have been very difficult to do with traditional textbook methods. And more district teachers are embracing online learning everyday. Fuel Ed saw a significant increase in school partners delivering online instruction using their own teachers.

Historically, we Fuel Ed provided instructional services to be a state certified subject matter expert teachers to the majority of our partners. While the demand for those services continues to grow in terms of absolute number of students taught by our own teachers, students taught by district employed teachers more than doubled year-over-year.

Today about half the course is purchased or taught by a public school district teacher. This means schools are beginning to accept online learning as a mainstream curricular programming solution.

Fundamentally, it also means districts and their teachers are using online courses to replace textbooks and other content historically utilized in the classroom.

In this environment, Fuel Ed has been successful for a number of reasons, and I would like all of our investors to understand the significant transition we are making from simply a school operator to accommodate us also significantly market opportunities in software and services to many public and private school districts in U.S.

First, Fuel Ed offers the industry's largest digital catalog that is aligned to national and state standards. Importantly, courses span all grade and more subjects. Uniquely, we offered kindergarten through fifth grade curriculum, which isn't offered by many of the digital providers. Many digital providers offer content at the high-school level only.

Additionally, the breadth of our world languages catalog is a real differentiator. For instance, this quarter we saw growth in Maryland and New Jersey for over 40 elementary schools due to our world language capabilities. Fuel Eds ability to offer a world languages for lower grades helped close these deals.

Second, Fuel Ed offers a differentiated tool set with PEAK and PEAK library branded products of ours with PEAK school need to consolidate into a single user experience. Think of PEAK has an aggregator allowing districts to combine multiple independent solutions into unified experience for teachers, students, administrators and parents.

Schools can enroll and activate students. They can assign courses and teachers and then manage the learning experience with ease-to-use reporting and analytics on student progress. And with PEAK library where our content itself is continuing, teachers can build and modify assignments and assessments and courses.

They can augment the classroom instruction and develop lessons for sharing across the school districts.

Through these tools, they have access to open education resources like Khan Academy, YouTube Education, paid contents and Fuel Ed partners and content pulled from a variety of sources like news sites, museum sites and just general information from the Internet.

The combination of these tools provides educators with a way to easily modify, create and curate content to personalize instruction for a class or students much likely we have been doing in the managed public schools.

PEAK and PEAK library have not only been responsible for closing sales, but once schools have access to these tools, they tend to expand used the cases to shield it within school districts and ultimately they grow this services and revenues with it.

Key volume metrics like enrollment and account revenue have increased significantly via PEAK this year. Going forward, I believe we will continue to see double-digit gains from the Fuel Ed business this year. Industry trends here are [queuing] [ph] for this business.

Teachers aren't picked and increasingly open towards the blended model; Fuel Ed is already well-positioned to support this transition. I hope you can see why I'm excited about K12's future growth prospects.

I'm particularly excited about the fact that gross margins are better in the segment and our business will grow more and will help provide a better economic efficiency in our business as we sell more in this segment.

We will throw updates and announcements in the coming months and quarters on both our business development for managed public schools and Fuel Ed related activities. Thank you so much for your time this morning. And now, I hand the call over to our CFO, James Rhyu.

James?.

Thank you, Nate, and good morning everybody. I want to remind everybody that we took a charge in Q2 of last year of $32 million and we divested some businesses in Q4 of last year.

So I will first take you through some actual reported results then focus some time on pro forma results, so that you have a more meaningful basis of comparison of the underlying business. As a reminder, we provide tables in the earnings release that lay up the quarterly trends from last year in our new format and excluding the sold businesses.

First a few words on our reported results. We ended the quarter with revenue of $231.3 million, up 3.3% from the year ago quarter. Operating income was $20.5 million compared to a loss of $8.9 million in the second quarter of last year.

And enrollment rose 0.9% from the year ago quarter with non-managed program growth of 41.3% offsetting a 3.9% decline in managed programs. Now, I will turn to the pro forma results excluding the impact of the $32 million charge in Q2 and the sold businesses.

For the quarter, reported revenues of $231.3 million, I mentioned that represents a 5.5% increase over the pro forma Q2 2014 revenue of $219.2 million. We saw growth in all segments of our business. Revenue for public school programs rose 4.2% year-over-year, while enrollments rose 0.9%.

You should note that we made some immaterial reclassifications for enrollments and revenues for the non-managed programs in institutional software and services for fiscal year 2014. And once again, we provided all the quarter-by-quarter detail in the appendices of the stated release.

Managed program revenue rose 2% year-over-year, this was in contrast to enrollment decline of 3.9% on a year-over-year basis.

The increase in revenues resulted from a 6.1% improvement in revenue per enrollment relating to a combination of factors including school mix, timing and improvement in funding in some states, activity specific funding and other variables.

We expect generally a positive rate environment to continue throughout the year largely offsetting the enrollment declines. Non-managed program revenue rose 64.8% through $11.4 million at the same time, non-managed program enrollments rose 41.3% and the revenue per enrollment rose 16.7%.

While enrollments and revenue per enrollment will fluctuate on a quarterly basis due to school mix, seasonality and variety of other factors, we would expect solid double-digit gains in non-managed programs on a full year basis.

Institutional software and services which includes core software technology, professional and other educational services sold by our Fuel Ed team posted revenues of $11.8 million for the quarter. This is an increase of $0.9 million or 8.4% on a year-over-year basis.

As Nate mentioned, we said that our Fuel business would begin to grow again at double-digit rates and the growth in institutional software and services together with the growth in non-managed programs excluding the impact of the States Nate mentioned both of which serve our Fuel Ed business demonstrated that in this quarter.

Our international and private pay schools, revenues rose $2.9 million or 35.1% on a year-over-year basis. This increase was due to the continued strong performance at our Keystone and high academy private schools as well as the addition of a new school, the Queen Elizabeth Academy in the U.K.

Gross margins declined from 39.6% last year to 37.3% in the current period. We have been consistently telling you that we plan to continue to invest in academic programs and that proved out in this quarter and pressing margins.

In addition to that some of our revenue gains this quarter related to new schools including the Hill House Blended School in Pittsburgh and the aforementioned Queen Elizabeth Academy in the U.K. These schools have negligible margins in the early days of operations.

Selling, administrative and other expenses increased $2.1 million or 3.5% year-over-year to $62.6 million, product development expenses for the quarter were $3.2 million which is flat on a year-over-year basis.

Operating income for the quarter was $20.5 million and on a pro forma basis this represents a decrease of $2.6 million or 11.3% year-over-year.

Turning to some other items, we ended the quarter with cash and cash equivalents of $124.2 million, a decrease of $38.7 million from the prior year, which is largely the result of $7 million stock repurchase program we completed in September of 2014.

We ended the quarter with accounts receivables of $266.8 million largely the same as our balance at end of the second quarter of the prior year and DSOs remain largely inline with last year as well. While we are on the topic of cash and accounts receivable, I want to spend a minute discussing our balance sheet relative to our current valuation.

We had networking capital of over $300 million for the past nine quarters; most of this is attributable to the cash and AR balances I just referenced. That translates into approximately $7 to $8 a share. It also generally builds from Q1 to Q4 excluding the impact of the share repurchase program last year.

That implies our underlying business is trading at approximately $4 a share or about 1.5x to 2x EBITDA. You can determine if that serve valuation and op, but I wanted to make sure I laid it out for everybody.

Continuing on to CapEx, as we have historically defined it, which includes curriculum and software development, computers and infrastructure was $15 million in the quarter.

This represents a $2.4 million decrease from last year, which is a result of higher spending on some capitalized software projects offset by some lower expenditure on student computers.

Our tax rate for the quarter was 42% which is largely the same as the adjusting rate for the second quarter of the prior year, our guidance for the full fiscal year of 2015 remains the same in a range of 38% to 40%.

Turning to our expectations for the third quarter, we expect revenue of $230 million to $240 million; operating income between $20 million and $24 million; and capital expenditures between $18 million and $22 million.

Thank you for your time today and now I will hand the call back over to Nate?.

Well, thank you, James. I believe that we are ready for Q&A. So if you got any questions, operator, Kevin, we are ready for questions..

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Geoff Miller from Robert W. Baird. Please proceed with your question..

Yes. Thank you. So thanks for all the detail made on the business development activity glad to hear that going better recently.

I guess can you help us understand, all the states and school boards and everybody that you have to deal with, are they recognizing all of the investment that you guys, this current management team has been putting into academics improving academic outcome, systems.

So is that, what is driving the improved business development environment or if not what is?.

Good morning, Jeff. So the answer is, obviously, it's across the board, it's different depending on the states that you are in. Some states we have been working on for a long time like Maine. Maine has been something we have been working on for a long time. Tennessee is a reserve situation.

I think in Tennessee, there is some recognition of the progress that's been made. So while Maine has been – it's kind of a long standing story, Tennessee has really been more about the last 12 months of them understanding we are and the changes we have made and the progress we are making. So yes, people are beginning to recognize that.

Even in the places that I didn't talk about boards that who have been concerned a year ago, two years ago are now saying to us, we like your change, we like what you are doing. And thank you. So we are getting some recognition for it. And we are pretty pleased about that..

Okay. Good to hear.

And then I hear you guys on the working capital out of the tangible book value, but can you maybe talk about as the business transitions to or as you grow your Fuel Ed institutional business, what are the working capital requirements of that business?.

So Geoff, its James. So I think what we see is and just referencing Nate's comments, we do think that the managed public school business show some growth going forward. So obviously, that's going to continue to be just given the relative sizes, a large part of what's driving our working capital.

So I don't think the dynamics of our working capital on the balance sheet are actually going to change dramatically over the next couple of years.

However, the dynamic that sort of the Fuel Ed business will drive it slight change in over time would be the way that we sell those services, some of them will drive greater deferred revenue on the balance sheet, I mean more cash upfront. So working capital wise, it's sort of offsets in the period in which you sell that business.

And then they both sort of a track down over the course of the year to the extent that there is margin built into that obviously the deferred revenue weans off over the course of the year and we keep more of that cash.

So you sort of have some slight working capital picked up, but I don't think it's really going to be material over the coming couple of years..

Okay.

And then just finally, maybe an update on the systems investments and transitions and now that you have stuffed up your phase of investments spend, is this your spend level roughly the right level, the work-off going forward?.

Hey, Geoff. It's Tim. First of all, yes. The current spend level we think is appropriate. We are seeing the benefits in terms of better efficiencies for our schools. We expect over time those spend levels will come down modestly.

James, if you want to add anything to that in terms of the current expectations going forward?.

I would – this is Nate speaking. Think about it this way. Our desired learn implementation comes in. We are in the pilot right now. We will turn up the high school experience in September. We have a decision to make as to whether we roll it down to the grade school level the following year.

Work that we are doing on all of the content we should then expect to see in the next 18 to 24 months. CapEx start to come down. We are also doing a number of things in the area of the kinds of computers we buy and use of our content that will be more mobile sort of be on tablet devices as well.

While, I expect to see the cost of computers in the next couple of years come down. So I expect to see that over the next probably 24 month period, you will start to see CapEx dip down. Right now, we are in a high CapEx period because of the investments we are making primarily in that new high school platform..

Okay. Thank you, gentlemen..

Thank you. Our next question today is coming from Corey Greendale from First Analysis. Please proceed with your question..

Hi, good morning guys. This is Tom Bakas on for Corey. Just noticing there is a pretty wide range of estimates for fiscal 2016, I suspect it has a lot to do with questions over the Agora impact. I know you have discussed it in broad terms.

But I think it might be helpful to discuss more specifically just to help expectations?.

Hey, Tom. Excuse me, its James. So I think there is a lot of variance out there. I agree with you in the essence for next year. I think if you actually – the easy way I think is, if you look at the consensus, I think the consensus has hit the impact models in about right.

So unless you want me to – I wasn't going to – I wouldn't going to spend a lot of time detailing out, what I think I have detailed out in past couple of quarters. But, I think the consensus is factoring in the Agora impact next year appropriately.

Does that help or do you want me to go into a little more detail than that?.

No. It's really up to you. If you are not really want to make this point that's certainly okay..

No. I think – so just to be – maybe – just to be safe, I will go into a little bit of detail. If you remember, Agora is about $120 million, $130 million of revenue. About half of that is no margin revenue and all that no margin revenue is going away. The remaining half about half of that we won the business for, which is the highest margin business.

However, so three quarters of the revenue approximately will go away, however, of the operating income, the operating income that we retain on the higher margin businesses serve the 25% that's retained is fairly a high margin. Having said that, we do lose some margin business on the Agora contract.

Obviously, we are not going to go into all the details of exactly how much we gain or lose and we are still in fact internally working through how we make sure that we adjust our cost structure for the impact of Agora. So we don't have any real guidance out there.

But, that sort of direction tells you I think we are – where we talked previously about the Agora contract and how it would impact next year..

And Tom, this is Nate speaking. I'm going to add one more piece of information for you, which I hope doesn't confuse you, but it's important to understand. And that is, when we talk about the high margin business primarily we are talking about the curriculum, we are still going to use the K12 curriculum. And that is the highest margin business we have.

However, you have to remember that that would depend on a number of students. And we simply don't know that number of students. Now, if Agora maintains the number of students they have [times our] [ph] rate in our curriculum then we don't lose as much money. If Agora shrinks its school, which they may well decide to do.

I mean we no longer manage so we don't know what they are going to do. But, if they were to shrink the school, then we would see additional shrinkage in revenue. And that's why James is hesitant to give you a specific number, he is more giving you a range because it is depending upon the enrollments next year, which they may or may not shrink..

Okay, terrific. That's very helpful..

Thank you. Our next question today is coming from Trace Urdan from Wells Fargo. Please proceed with your question..

Thanks. I'm afraid my questions are going to be rather mundane. So James, I'm trying to decide for all of the various restatements and tables here.

In your prepared remarks you seem to suggest that the $231,304 number was the number that excludes that comparison the $231,304 versus the 223.9 is the number that excludes the write-offs includes the restatements and excludes the sold businesses, is that correct?.

Sorry. The 231 is the 231. If you look in the table in the back you will see –.

There are a lot of tables in the back.

Can you just speak in terms of the numbers rather?.

Yes. So the number four in the back that as the revenue for Q2 fiscal year 2014 that's comparable is 2 – sorry..

219..

$219,154 on Page 13 of the release..

Okay.

So that $219,154 and everything that comes above it that's the apples-to-apples comparison with the business as it is constituted today?.

Correct..

And that that's the 8% growth in the institutional business that Nate referred to?.

Correct..

Okay. Thank you..

You are welcome..

Thank you. Our next question today is coming from Jeff Silber from BMO Capital Markets. Please proceed with your question..

Hi. Good morning guys. This is Henry Chien calling in for Jeff. I had a question – I think last call, you mentioned there were a few schools that maybe up for some kind of contract renewal or charter renewal.

I was wondering if you could give any color on – is there any developments there, any expectations on any of these schools are transitioning to more of a curriculum type contractor, any color around there? Thanks..

There are no schools that we know off that are transitioning other than the ones we already announced. So obviously, Ohio and Colorado already made their decision instead of Agora.

But, of the other schools that we are under negotiation with – none of them have made that decision and none of them have communicated that they are considering that decision. So we will believe there is going to be any movement beyond the ones that we have already announced.

We think that the ones that are announced are – we have a good relationship and we moving in negotiations and the contracts are moving on. So I don't see any move from managed to non-managed from those current negotiations.

Tim, do you know any of that I don't know off?.

No. I think I would characterize all of those discussions and negotiations as being very positive, constructive and moving forward. We feel very good about them..

Great. And from the Fuel Ed perspective, a lot of publishers are seeing some very strong sales from their digital product as well.

I mean, could you expand upon on where Fuel Ed has more of a say competitive advantage against some of the big publishers when you go through the adoption process which will let you are there?.

Sure. Sure. Let me note that for the most part, we are not directly competing against a very large base of curriculum publishers. The category of competitors we are competing against are all typically in either the direct credit, supplement credit or credit recovery market.

We think our advantage is coming in four areas and Nate touched on all of them in his remarks. One, very broad curriculum and content library Nate referred to it as PEAK library. We have the largest catalog in the industry. Second, we got full range of solutions.

You can come to us and buy everything from courses to original credit to credit recovery to part time programs to full time programs where you can earn a diploma.

And third, the PEAK platform that Nate mentioned is really simplifying the complexity that our customers are confronted with as they deal with more and more vendor solutions in a digital domain. Take those three things coupled with a great team on the field and we feel very good about our competitive position..

I would add to Tim's comments because I think he is 100% right. Number one, remember that we can go down in a grade school level with our online curriculum and most people cannot. They offer and they are focused on high school a little bit at that middle school level, almost nobody offers online courses at the lower level.

And it's because we have done it in the managed public schools, we know how to do with this, what we call learning curve. So we can teach that. Secondly, we offer teachers, most people who sell their supplement content give it to a school and if its here it is, go use it. We say here it is but by the way we will have a teacher accompany that content.

So if you don't know how to teach online, we will provide teachers to do that. That's our second advantage. And the third advantage that I talk about would be Middlebury languages. We offer world languages at all levels. And the world language capability is something that many schools are looking for.

The last one I will talk about is not something that we actually are doing today. But, something that I think will be an advantage for us going forward. And that is not only will it be world languages, but helping us – the Obama administration is pushing everyone to do helping with English language learning.

So we have some things that we are going to do there as well. So all of those I think are advantages for us that puts ahead of the competitors. Hope that helps..

I got it. Thank you. Thanks for the color..

Thank you. Our next question today is coming from Jerry Herman from Stifel. Please proceed with your question..

Thanks. Good morning everybody.

Tim, I was hoping that you would maybe revisit the comment about consensus and I just want to be clear because it looks right now like the consensus for this year is $0.63 and the consensus for next year is around $0.43, which would suggest that the impact of Agora, if the numbers play out would be about that $0.20 differential, is that the way we should think about that?.

Yes. And I think again just echoing Nate's comment, the Agora impact is very difficult to gauge as we sit today because of the enrollment factor. But, on a like-for-like basis, that is a range that that type of range is we think is pretty appropriate..

Great. Thanks. And Nate, I appreciate the comments on business development and your earlier commentary about contract load.

Is it too early to get any read on Ohio?.

It is. But, let me give you some color because I don't want to get ahead of the negotiation ahead of the Board and upset anybody. But, I will give some color. I met with them on January 12. I met with the entire Board. I met now couple of times the Chairman of the Board. Our Head of School, who has a really good relationship with the Board.

We are working together on the things that Board is concerned about. So I don't believe the Board is concerned about K12. They are more concerned about a couple of other topics that relate to the way the schools are measured in Ohio and the way data and information is tracked by students in Ohio. So their concerns don't appear to be with K12.

So I feel pretty good that the Ohio Board and K12 have a great relationship, they are working well together. And then I personally know the Board Chair. Unlike, I know you guys – I'm going to be probably more candid, if somebody might want me to be, but I'm just going to do it.

I know you guys would be worried, how did Agora happen in, why wouldn't that happen in Ohio? In Agora, we had not as good relationship and they did not spend their time trying to understand K12. The Ohio Board has done the opposite. They have spent time with us. They looked at our curriculum. They come to visit our location. They love our Head of School.

So it's a completely different situation. So I feel very good about the situation. I hope that helps Jerry..

It does. Thanks. And Tim, a question for you with regards to Fuel Ed, have you guys effectively sort of lapped the transition from a license model to the subscription model.

And then sort of consistent with that, how do you think, or how should we think about OI margins, operating margins in that business and not to belabor the question maybe some commentary about your sales and just distribution there as well as a potential lever?.

I will tag team this with James. As you heard us talk over the last six or eight quarters. We have steadily been declining the license mix, it was attributable to perpetual licenses and that is now a nominal part of our business. So short answer to your question is, yes, I think that is largely behind, it's single digit percentage of our revenue.

The quality of our revenue has got much better as we now see greater than 50% of our revenue in annual licenses we see higher growth in our annual license and our per enrollment license type. So we feel good about the quality of the revenue there. In terms of sales, we continue to invest in our sales and distribution model.

We just had our – in fact had our sales team in for four days of sales training just last week. We have extended that training into our resale channel as well, extended additional tools to some of our resellers to help them to be able to sell more effectively.

So all in all we managed to improve our expense to revenue ratio from a sales perspective achieving greater efficiencies in our sales expense and we will continue to do that.

James, do you want to comment on the operating income margin?.

Yes. The only thing I would say is, so I think we sort of thought about this business at scale as being a pretty significant margin business. We talked about how we think of it as sort of a combination software service business that Nate mentioned in his comments.

And a significant service component to it which includes predominantly teacher services and that structure had a lower margin. The way we defined scale is 100 plus million and so I don't think that right now we are at scale.

And I don't think that you should think of our business at this size as having a margin that's materially accretive or dilutive to our overall business margins..

Thanks..

So hopeful that helps..

And let me just have one more question if I may, sorry, use of cash and in particular I think about the expansion of the portfolio in the software business.

But likewise with the stock trading below book value, how you guys think about the relative investment opportunities?.

Yes. You are right. This is Nate speaking. This is something we talk about at the Board level probably every quarter we have a conversation about what's the right place to put your money, is it putting it back to investors and directly in the form of dividends and share repurchases or do you put it into core business investments.

And my core business investments doesn't just mean more teachers and more curriculum, it means new product development as well. And in the course, we will look at acquisition. I think there are a number of small acquisitions on the marketplace.

The marketplace that we will do – can announce some specific ones, hold me to this specific one, but I can tell you that we are actively looking and wanted to expand the business especially the Fuel Ed business. And we are also looking into some new product ideas.

You might imagine because you talked about this before, the new product ideas would be in the career readiness area, in English language learning that's the place we think it's smart to spend money.

So right now, the Board is concluding that it doesn't make sense to go and do another share buyback program and above this $75 million we already did because these other opportunities are there and they should grow shareholder value more directly, so that's the current thinking..

Great. Thanks for the patience guys..

Thank you. We’ve reached the end of our question-and-answer session. I have to turn the floor back over to management for any further or closing comments..

Management doesn't have any additional comments. I just want to again thank everyone for taking time this morning to be on our call. And hopefully see our results within the guidance we gave. And we intend to do that again next quarter. And I look forward to talking to you again. Thank you..

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Have a wonderful day. We thank you for your participation today..