K12 Flunks Second Quarter

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Investors were dropping out of child educator K12 (NYS: LRN) today as the company missed earnings expectations.

The stock was down over 10% after the virtual-schooling pioneer reported that quarterly profits dropped 46% from a year ago to $4.2 million. K12 management blamed the decrease on an $8 million adjustment in revenue related to potential funding reductions, as well as higher levels of instructional costs, product development costs, and general and administrative expenses to support the growth of the business. Investors seemed surprised by the disappointing numbers, as the stock had moved up 8% on Monday in anticipation of the earnings report.

It wasn't all bad news for K12, however. Revenue jumped by 29%, an increase of $37.5 million to $166.5 million. Enrollment numbers also moved up by nearly 50%, though this means that average revenue per student actually dropped.

Management affirmed fiscal 2012 projections of revenue between $680 million and $690 million, and EBITDA of $85 million to $95 million. The company declined to give net income guidance because of variability in depreciation and amortization.

K12 Shareholders were looking for some reassurance after a scathing New York Times investigative report last December called into question the effectiveness of the company's virtual schools and sank the stock price by 25%, from which it hasn't recovered. Investors can at least take some solace in the strong revenue and enrollment growth.

Some bargain hunters may see this as a buying opportunity, but I'd wait for consistent earnings growth to materialize first. With a trailing P/E ratio now over 50, K12 is priced for perfection. Investors should wait on better news.

Profit margin already appeared to be an issue with the virtual educator, and this quarter's report only confirmed those worries. Compared with peers in the for-profit education sector, K12 lags well behind. The company converted just 2.5% of revenue into net income for the quarter, and posted a profit margin of 2.62% in the 12 months before. Meanwhile, industry leaders like University of Phoenix parent Apollo Group (NAS: APOL) clocks in 10.61%, and Bridgepoint Education (NYS: BPI) is dominating the sector with a 19.48% margin.

K12's first homework assignment for the new quarter is clear. Find a better way to hold on to its growing revenue dollars.

If you're looking for an investment that won't get stuck in detention, check out another company with exciting growth prospects. It's a Latin American retailer that our chief investment officer has called "The Motley Fool's Top Stock for 2012." You can read all about our new free report.

At the time this article was published Fool contributorJeremy Bowmanholds no positions in the companies above. The Motley Fool owns shares of Bridgepoint Education.Motley Fool newsletter serviceshave recommended buying shares of K12.Motley Fool newsletter serviceshave recommended creating a put write position in Bridgepoint Education. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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