K12 Gets High Grades On Profit, Sales Front

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As the nation's largest provider of online grade school education programs,K12 ( LRN ) has faced a number of head winds the past few years, from legal challenges to negative headlines.

So much so that Executive Chairman Nate Davis opened the May 3 third-quarter conference call addressing how the for-profit educator has met these challenges as it racked up the 15th straight quarter of double-digit sales growth and a hefty profit gain.

"As industry leader, K12 often takes the brunt of assaults for online education as our integrity and our effectiveness are sometimes questioned," he said on the call. "This is to be expected, but I am very proud of our employees and all we accomplished even in the face of these challenges."

K12 provides public school systems with the curriculum, software systems and educational services to deliver an individualized online education to students in kindergarten through 12th grade. Most of the schools it manages are virtual charter schools, which are public schools that are run by nonprofit charter boards that hire K12 to manage the schools.

They're funded largely by state and local taxes and, as a result, are under a lot of scrutiny. Like its peers in the for-profit online education space, K12 faces a lot of legislative and market hurdles. But it's making progress on those fronts.

'Real Truth'

The quarter, said Davis on the call, highlighted examples of the "real truth" about K12 and what it stands for. For instance, in March, K12 announced that after reviewing more than 1 million pages of discovery, the lead plaintiff in a class-action lawsuit against the company, voluntarily and permanently dismissed the claims it made about the academic performance and educational quality of K12-managed schools. Davis called the dismissal "a very powerful vindication of the company."

K12 has also been winning on the financial front. In the third quarter, profit rose 72% to 31 cents a share. It followed an 118% increase in profit the prior quarter. Third-quarter sales increased 22% to $218 million. Managed public schools revenue rose 26% to $39.4 million, primarily as a result of organic growth in existing states and funding increases in certain states. K12 also got a boost from a 12.2% rise in average student enrollments, improved funding rates and capture in certain states, and a decrease in the number of unfunded enrollments.

The growth comes amid the increasing acceptance of online education as a viable alternative to face-to-face learning, says First Analysis analyst Corey Greendale.

"In general, more states are becoming comfortable with virtual education," Davis told IBD. "And more parents are advocating it."

K12 offers individualized virtual learning via a mix of venues. In full-time online schools, most students take their courses from home. In K12's "blended schools," students learn in school buildings or learning centers. But they still use online courses, and have some face-to-face classroom instruction with teachers.

One of the benefits of online schools is that students can access their courses 24/7 and from any remote locations through technology, says spokesman Jeff Kwitowski. In a growing number of cases, K12-managed online schools offer more blended learning opportunities, he says. This way, students can drop into learning centers, community centers or school-owned facilities for remediation, face- to-face instruction, or access their lessons in a computer lab.

The ability to customize learning to individual students' needs is one of the strong suits of virtual education and a big draw for parents and students. The scheduling is flexible, says Davis, and teachers are online with students monitoring their progress. As a result, students are able to work at their own pace.

K12's growth has been driven largely by the growing acceptance of online learning as an alternative to brick-and-mortar schools for students, who aren't being served well by the traditional system, adds Greendale. "Students may not be well-served by the traditional system because they were bullied in school or because face-to-face teacher-led instruction tends to focus on the median student and may not meet the needs of students, who are either behind or accelerated," he said.

Or life circumstances, such as health or economic issues, may get in the way of a student's ability to attend school on a normal schedule, he adds.

"Meanwhile, K12's stock has significantly outperformed in 2013 as the company has begun to translate its top-line growth into better margin performance and free cash flow, and as some investors have become more comfortable with the political environment," said Greendale.

Analysts surveyed by Thomson Reuters expect full-year earnings to rise 53% to 69 cents a share. They see a 38% increase in 2014.

Davis says the first piece of his growth strategy is focused on providing the best educational products and individualized programs.

"The more and better we do, the more people use this form of education and that accelerates the growth," he said.

One of the things that has helped K12 is it's gotten more efficient in managing the schools and in turn, improving student retention.

"We spend more of our money on keeping the students we have by giving them a better education experience," Davis said.

"If they stay with us longer, we spend less on recruiting new ones."

The K12 program is offered through K12 partner public schools in more than two-thirds of the states and the District of Columbia, and through private schools serving students in all 50 states and 85 countries.

Half of the states where K12 manages public schools are capped, meaning there are limits on the number of students who are able to enroll in school.

Political Climate

"This is a tremendous market opportunity, and we anticipate as the caps are expanded or completely eliminated, we have the potential in the next three to five years to help at least 50% more students than we currently serve today," Davis said on the conference call.

Some of the head winds are abating. On average, the political climate is getting better because of an acknowledgment that the traditional system doesn't serve all students well, says Greendale.

He says new states approving online charters and existing states raising enrollment caps at online schools have been meaningful drivers of K12's growth. And the Obama administration's policies have encouraged states to pass laws that make it easier to open charter schools.

"But the political climate is very much 'two steps forward, one step back' rather than inexorable smooth sailing," he adds. "You'll see plenty of negative headlines about states denying or delaying approval of an online charter because of questions over the student outcomes at virtual schools. Whenever public funding for education goes to a for-profit entity serving students in a manner that's outside the mainstream of the education establishment, it's fair to assume policymakers will raise questions."

But that doesn't mean K12 won't continue to grow, he says.

"It's just that the company has to be vigilant in ensuring that it's doing the right thing for students as well as for shareholders," said Greendale.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

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