Mike Kraft - VP, IR Nate Davis - CEO and Chairman James Rhyu - CFO.

Jeff Silber - BMO Capital Markets Ken Wang - First Analysis.

Greetings, and welcome to the K12 First Quarter Fiscal 2016 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. It is now my please to introduce your host, Mike Kraft.

Please go ahead, sir..

Thank you, and good morning. Welcome to K12's first quarter earnings conference call for fiscal year 2016.

Before we being, 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 made in K12's 2015 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 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 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; 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?.

Thank you, Mike. Good morning everyone, and thanks for joining us on the call today. Without a lot of fanfare, let's go straight to the results, which are in line with the guidance we provided a few weeks ago. Revenue for the quarter was $221.2 million, a decline of 6.5% year-over-year.

Excluding the impact of the Agora transition from a managed to a non-managed program, revenue grew 3.9% from the first quarter of last year. We posted revenue growth across all of our businesses, including managed public school program, the institutional, and private pay. As you know, our business is very seasonal.

The operating loss for the quarter of 20.5 million is in line with our guidance, and the seasonal trend we would anticipate for the first quarter of a fiscal year. James will provide more details on the financials in a few minutes. But this is early in the fiscal year, in fact, too early for a lot of discussion on financials.

I'm going to focus my remarks on our projects and our programs, and less about financial statistics. As we kickoff another school year our missions remains the same, to support our students, and help improve their academic outcomes, while helping our partner school boards build great schools.

I've said this many times in the past, but I'm repeating it, because it's the very fabric of who we are and our culture. Simply put, we believe this mission will deliver a company with a great reputation, and students who want to come to our program, and stay in our program.

This will in turn reduce the need for a high marketing spend because we'd have a lower student turnover. We've been on this path for about 18 months. And so I'd like to give you some early evidence that this is working. First, while we don't disclose withdrawal statistics, we saw a slight decline in our withdrawal rates in FY'15.

Our strong start program, which supports students as they transition into an online environment, is showing great promise. The first 10 weeks of school is a critical period, and this year we sent 50,000 school-branded mailers to families to help them get started with school.

Additionally, 45,000 families received a personalized outreach call, confirming their Internet access, their log in, and their approach to navigation. They were also briefed on how to track materials and how to find and use the Strong Start sites. And these sites house a getting started checklist. They house our online learning coach university.

And included in the tutorials are 25 videos, options for more than 40 synchronous training sessions, and drop-in office hours for our learning coaches. This programming even includes live on-demand web-based sessions to help students and parents ramp up quickly in an online environment.

We are also using our data analytics teams to identify students and families who may need the most help, and proactively reaching out to them early in the year. A dashboard was developed to track student engagement even before school started, which enabled us to intervene rapidly.

Gone are the days that parents have to wait for a parent-teacher conference or the first test or a paper note from a teacher. Parents can now log in at any time to check their student's class participation, grades, and assignments.

And for this school year, over 27,000 students were identified through this early detection program, and received a differentiated on-boarding or a specialized kind of walk-the-class call. Initial results of this effort are promising, but it's very early. Overall, we saw a 4% increase in log-ins during the first week of school.

These are all encouraging results, and we continue to refine this initiative going forward. We do all of this to improve retention and help teachers and administrators engage students, and keep them in the program. Our data tells us that the longer they are in the program the more academic improvement they had.

And all of this improves retention and the results and economics in our business. Now, I've talked to you in the past about the importance in investing in teachers and local school leaders. We began the rollout of a year-long teacher induction and apprenticeship program for new teachers.

We also rolled out a coaching program, using the best teachers in our network of over 6000 teachers. This program is just one part of a wider vision to make K12 a world-class employer of the best students and the best teachers across the nation.

The vision includes training and professional development for all of our teachers and also our school leaders. Now, let me move to the curriculum and infrastructure part of our business. We are part way through a multi-year program to modernize and innovate our curriculum, and our infrastructure.

While this has kept capital expenditures higher than I'd like at a consistently annual level rather than a significant decline, we have had to put our money behind our verbal commitment.

We believe, however, that these efforts will also drive expense in capital efficiencies, they're going to aid retention, improve student outcome, and drive curriculum and software sales, all at the same time. The first phase of the next generation curriculum work was to implement the Desire2Learn platform at the high school level.

We've completed that phase for this school year. The second phase's project is to expand the use of Desire2Learn down to the middle school platform. And the third phase is to implement a new Student Information System or an SIS, to have one or more modular math courses, redesigned, interactive, including video.

We plan to have the second and third phases of this project completed by the fall of 2016. And importantly, the upgrades to our content and infrastructure are being done to enable greater mobility, which is the way young people absorb content.

Phase 1 made most of our high school content mobile ready, and in future phases, we'll make all of our content optimized for mobility. Our investments also support our diversification into new markets, including career readiness and English language learning courses.

The modular courses we are building can be used by employers, who want their employees to have a better understanding of math, to speak and read English better, and to write better. Today, large employees who have geographically dispersed employees have trouble developing cost effective training courses.

With our new career-ready content, they will be able to use Fuel education content customized to their employee needs, online, available 24 hours a day, with instruction from trained and accredited teachers on mobile devices. That's a powerful combination for corporations. We will start selling this product later this year.

Finally, let me touch on this past enrollment season. We work to improve acquisition efficiency through a new segment marketing campaign. We changed our marketing messages and the channels we focused on. Importantly, we improved parent education and the enrollment experience.

That meant we provided additional information upfront to reduce friction in the enrollment process. The result was that our conversion rate of families who submitted an application to those who ended up enrolling in the programs, improved 50 basis points year-over-year.

This is the first year that ratio actually increased in the last few years, and so a sign that our new direction is beginning to work. And at the same time, we achieved these results with lower acquisition cost. Overall, we reduced our cost per enrollment by more than 7%.

Now, we continue to remain focused on building the managed public schools business as well. As I reviewed our guidance call a few weeks ago, we are working closely with our boards to balance enrollment levels, student academic success.

That means, in some years, as we have seen the past year, this year, and last year, we may experience a decline in enrollment. However, we continue to believe that a full-time program is a great alternative for an increasing number of students across the nation. Online tools are becoming more prevalent in many areas of our society.

More local schools are rolling out their own full-time programs.

More states open up education alternatives, like Maine, North Carolina, and Alabama just did, where online alternatives are open to both higher education in corporate America, and all of these trends tell us that the acceptance and the demand for online charter schools will continue to expand.

At the same time, we will aggressively look to improve the revenue per enrollment, which allows us to provide more student services, and pay teachers more. The revenue per enrollment increase comes from managing mix, working with states on school funding levels, and other approaches.

Our managed public school program revenue per enrollment is expected to increase a few percent, excluding the impact of Agora. Outside of managed schools, we're well positioned to take advantage of the digital education content adoption curve I've been talking about. In short, this means focusing on our institutional business as well.

This quarter, the institutional software and services revenue increased 5.2%. And as more districts shift to online and digital models, FuelEd is well-positioned to take advantage of this growth. For the year, we continue to expect the institutional software and services portion of our FuelEd business to grow at a double-digit pace.

In closing, I am pleased with the indicators that suggest we're building a better business in terms of technology, curriculum, student support, and software sales. Our transition has its ups and downs, but it's exciting when you talk to employees, school boards and teachers, and they tell me that they are now proud of the business we are building.

We are challenging ourselves to take our efforts and support our students to the next level. Our investments in academic programs, professional development for teachers, and innovative curriculum and technology, all support our mission to improve outcomes for student.

At the same time, these investments will help us build a more efficient business as already seen in our lower marketing cost per enrollment. Thank you for your time this morning. And now, I will turn the call over to James Rhyu.

James?.

Thank you, Nate, and good morning everybody. I want to start with a quick word on disclosures. While we haven't subsequently changed the disclosures from prior quarters, we have regrouped them, and a couple of things that should make it more consistent with how we talk about our business.

Specifically, we are grouping non-managed public school programs and the institutional software and services business together into what we will refer to as institutional. This now aligns with how we're managing this business internally to facilitate our discussion of trends in this business going forward.

On to the results, revenue for the quarter declined 6.5% from the year ago quarter to $221.2 million. This quarter we posted an operating loss of $20.5 million. This compares to a $13.2 million loss posted in the first quarter of last year.

In order to look at the underlying trends in our business, I am going to spend some time discussing revenue and enrollment on a pro forma basis, excluding the impact of Agora. We believe this way of looking at our results provide you with a clear picture of the underlying trends.

However, due to the fact that the infrastructure shared across our schools and businesses, we won't do the same for the operating income. We saw growth across our business. Total company pro forma revenue increased 3.9%. Revenues for managed public school programs would have risen about 2.5% year-over-year, while enrollments declined 3.7%.

As we've seen in previous period, the increase in revenues resulting from positive revenue per enrollment trends relating to a combination of factors including school mix and improved funding environment in some states and other variables.

The net of that would have resulted in a revenue per enrollment increase of more than 6% year-over-year, excluding the impact of Agora. Non-managed public school program revenues were largely flat at 10.5 million. Non-managed enrollments rose approximately 4%, and we benefited from new programs launched in Alabama, Georgia, and Pennsylvania.

Offsetting the rise in enrollments, revenue per enrollment in non-managed public programs declined approximately 4%, largely due to the mix of schools.

Institutional software and services, which includes core software, technology, professional developmental and other educational services sold by our FuelEd team, posted revenues of 13.3 million for the quarter. This is an increase of 5.2% on a year-over-year basis.

Year-over-year growth should accelerate in Q2, and our overall outlook for this business is double-digit growth for the full year. Revenue for our private pay and other businesses rose 3.6 million to 14.8 million. This is a 31.9% increase on a year-over-year basis.

This increase was due to the continued strong performance of our Keystone Private School, which posted year over gains of 12% as gains internationally primarily relating to our school in the U.K. Gross margins declined slightly from 38% last year to 37.2% in the current period.

The overall margin in this quarter was impacted by some of our academic initiatives. However, we anticipate full year margins to be flat to marginally better year-over-year. Selling, administrative, and other expenses of 99.3 million were essentially flat on a year-over-year basis.

Keep in mind, first quarters are sequentially the highest quarter of the year for our selling, and administrative cost, we would expect these expenses to decline significantly in the next quarter.

Product development expenses for the quarter were largely flat at 3.4 million, and operating loss of 20.5 million compared to an operating loss of 13.2 million in the prior year. The losses for the first quarter are seasonal in nature and don't impact our full year operating income guidance that we previously have given.

Now let's turn to some other items. We ended the quarter with cash and cash equivalents of 150.9 million, which represents a $45 million decline from the prior quarter, and approximately $40 million increase from the year ago period.

CapEx as we historically define it, which includes curriculum and software development, computers and infrastructure were 16.8 million for the quarter versus 22.9 million in the previous year.

The $6.1 million decline this quarter versus last year was a result of lower spending on property and equipment and student computers, which was somewhat offset by some investments in -- additional investments in capitalized software and curriculum. Our tax rate for the quarter was 39% versus 50% in the prior year.

As you may recall, tax rate last year was somewhat influenced by the sale of our ventures business in the prior year. For this year, we still emphasize our guidance for the full year in the 39% to 41% range.

Turning to some expectations for the second quarter, we expect revenue between $205 and $215 million, operating income of between $10 and $15 million, and capital expenditures of between $15 and $20 million. Thank you for your time, and now I'll hand the call back over to Nate.

Nate?.

Thanks James, and thanks operator. I believe that we are finished with our prepared remarks, so we're ready to go to question-and-answer..

Thank you. [Operator Instructions] Our first question today is coming from Jeff Silber from BMO Capital Markets. Please proceed with your question..

Thanks so much. I had a question about your second quarter revenue guidance. You mentioned in your remarks you expect institutional software and services year-over-year growth to accelerate, but yet your 2Q [ph] revenue guidance implies a sequential decline.

Where are we going to see the sequential declines in which line item?.

So, if you look at our managed public school programs, we actually historically have a Q1 to Q2 sequential decline in revenue, and that's predominantly driven by the fact that we shift in Q1. We shift things like materials and things like that, that we've recognized the revenue for in the quarter.

So you'll see predominantly the sequential decline there. You will also –- there will be probably a small sequential decline as well in the non-managed programs..

And then once we get to that 2Q run rate, at least on the managed public school side, is that something that will remain relatively flat for the rest of the year?.

Yes, you continue to see a little seasonality. Some of them will depend a little bit on second quarter enrollments, but it will be largely flat.

Again, you might see a little bit a more in Q3, depending on second quarter, and then you might see a little bit of a dip in Q4, because Q4 is sort of at the tail end of the year, some of our programs fall off..

Some of the schools end early in the summer, so you'll have the last month of the quarter without as much revenue. So you'll see a little dip in the fourth quarter, but that's seasonal, so it happens every year..

Yes. Thanks, I got it. Next question is dealing with the political environment. I know we've got elections coming up in many states.

Are there any ballots we should watch that could potentially impact your business?.

Individual ballots in States? No, but I do think there is -- every state has some set of issues going on. California is probably one of the more aggressive states. Pennsylvania has some budgetary issues going on that they haven't settled on yet. We'll see some of the ups and downs across the year.

I think Florida will continue to look at whether or not it should go statewide in its virtual charters, or not. We'll expect to see more clarity in Alabama on its program. They opened up a program last year for managed public schools. I know there are a couple of other states that are looking on as well.

I know Mississippi is trying to look at it, as is Kentucky, but I'm not sure we'll see actual legislation in the year. So, we will see some of these things across the country. Hard to predict at this point any individual state is going to have a major change..

Okay, great. Thanks so much..

Thanks. [Operator Instructions] Our next question today is coming from Corey Greendale from First Analysis. Please proceed with your question..

Hi, yes. This is Ken Wang on for Corey. Just wondering what drove your managed revenue per enrollment to be higher than the high single-digit decline that you discussed a couple of weeks ago? And in addition, on the non-managed side, the revenue per enrollment was better than the flattest expectation that you previously discussed.

So, just wondering or hoping to get a little bit more information around that..

Yes, so let me just make sure we clarify. The reported revenue per enrollment for managed, in fact, did decline. If we exclude the impact of Agora, which had a high revenue per enrollment, then the revenue per enrollment did in fact increase, and we have been indicating that we did think that we would see some increases in revenue per enrollment.

We ended up with, on a pro forma basis about 6%, that's excluding the impact of the Agora again. So you'll see sort of have two different factors at play there, one is the reported number with Agora, and it is in fact driving it as on a reported basis down, offsetting that or excluding that, you do have the structural increase excluding Agora.

On the non-managed side, we saw enrollments increased, again excluding Agora, and then we had actually a slight decrease in the revenue per enrollment. Again, that was excluding Agora, and that was largely mixed. We had actually a couple of programs that had a fairly good revenue mix that actually declined a little bit in enrollment.

So that hurt our rate for the non-managed side..

Does that help, Ken?.

Yes, thank you.

And let's see, I guess just wondering also, and what is your view on whether the -- your quarter one results are sustainable for the rest of the year as far as these revenue per enrollment figures, specifically in non-managed?.

Yes, we see -- I think we see that the revenue per enrollment for -- specifically for non-managed is probably going to be pretty consistent. We don't actually -- we don't report on them, so we don't -- sorry, we don't give guidance on them, but we do think that they'll be fairly consistent through the year..

We have seen a number of states making positive changes to their reimbursement rates to the schools, and probably there are a good 10 or 12 of them. In addition to that, this mix issue, we've been very focused on making sure that we managed the mix with the school boards on where they think they can grow.

So all of those things give us good insight to what's happening with revenue per enrollment, and that's why we think it's stable to up..

Okay, great. That's helpful. And then on the managed programs side, I guess what I was getting at before, it looks like it was only down very slightly. I'm showing it was down 0.4% year-on-year, whereas I think we were expecting it to decline a little bit more than that.

Is that what you're expecting for the rest of the year as well on the managed side?.

Yes, it is.

And as I mentioned, I think one of the things that's affecting that, is that while Agora causes it to go down, the mix of Agora being out of the managed category, but at the same time we're seeing these other states that I mentioned with an increase in reimbursement rate per pupil, and we are also seeing a better mix in the rest of the states.

So that's counterbalancing what you're seeing with Agora, which is why the rate didn't go down as much as you might have expected..

Okay, great. Well, thank you very much..

Okay..

Thanks, Ken..

We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments..

Okay. We have no more further comments. I appreciate everyone's time this morning. Thanks for spending time with us, and everybody have a great day. Bye-bye..

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