Strategic Education Inc
NASDAQ:STRA
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Strategic Education Inc
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Good morning, everyone, and welcome to Strategic Education Inc. Conference Call in which we will discuss Strayer Education Inc. and Capella Education Company's Second Quarter 2018 Results.
With us today to discuss the results are Robert Silberman, Executive Chairman for Strategic Education; Karl McDonnell, Chief Executive Officer for Strategic Education; and Daniel Jackson, Executive Vice President and Chief Financial Officer for Strategic Education. Following remarks, we will open the call for questions.
Please note that this call may include forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The statements are based on the company's current expectations and are subject to a number of assumptions, uncertainties and risks that Strategic Education Inc. has identified in today's press release that could cause actual results to differ materially.
Further information about these and other relevant uncertainties may be found in the Capella's 10-Q filed today and other filings with the Securities and Exchange Commission as well as Strategic Education Inc. future 8-K, 10-Q's and 10-K's. Copies of these filings and the full press release are available for viewing on our website at strategiceducation.com.
And now, I would like to turn the call over to Robert Silberman, Strategic Education Inc.'s, Executive Chairman. Mr. Silberman, please go ahead.
Thank you, operator, and good morning, ladies and gentlemen. As we reported in today's press release, this morning we closed on our previously announced merger of Strayer Education Inc. and Capella Education Company. So I'm delighted to welcome you to this, the first earning's call of our new company Strategic Education Inc. We want to particularly welcome to this morning's call the former shareholders of Capella Education. We're honored to have you as owners and rest assured that we as a management team and Board of Directors are committed to being good stewards of your invested capital.
We also want to warmly welcome all of Capella University's faculty and staff. We have a tremendous amount of respect for the educational institution which you have built and we look forward to providing you with all the resources you need so that you can continue to provide the highest level of academic outcomes to the students of Capella University. We have a lot of material to cover this morning. Karl will first run you through the operating results of both companies for the second quarter bearing in mind, of course, that they were separate organization for that time period.
He'll also walk you through our merger integration plans as well as how we intend to organize the new Strategic Education Inc. or SEI as well call it in short hand here. Dan will then provide more detail on each companies Q2 financial results before I wrap with a couple of comments. And finally we'll stay for as long as you have questions.
So with that let me introduce SEI's CEO, Karl McDonnell.
Thank you, Rob. Good morning, everyone. Before I begin my comments on the second quarter and the merger I would like to make everyone aware that in addition to our earning's announcement which is available on website strategiceducation.com. We've also made available a supplemental packet of information that you can download. These slides contain some additional information that you find helpful including information on future SEI segment reporting which will mirror our post-merger organizational design.
Moving forward operationally and as we've previously stated. We will be operating two separate universities, Strayer University and Capella University, each with its own board of trustees and management team. We will also have a third operating and reporting segment for non-degree revenue streams which will include our three coding schools. Supporting all of these entities are SEI corporate functions delivering shared services such as finance, HR, IT and legal. And now I'd like to make a few comments on our second quarter results.
Both Capella University and Strayer University had very strong enrolment results with both institutions posting multi-year highs in their performance. This is particularly noteworthy I believe that given large portions of both management teams have been spending the past nine months in detailed integration planning devoting literally 100 of hours of their time over that time period. And I would like to once again thank everyone at both Capella and Strayer for the dedication and hard work and all of the professionalism that has gone into generating the results that we've announced today.
Capella's 15% year-over-year increase in new student enrollment is the strongest performance in more than three years and it's the second strongest in more than 10 years. FlexPath Capella's fastest growing offering continues to perform extremely well and now comprises 23% of Capella's bachelors and master's degree enrollment. Strayer University's new student enrollment increased 7% from the prior year representing the university's eighth consecutive quarter of new student growth. Strayer's total enrollment increased 8% versus the prior year which is the highest growth rate for the university since 2010.
Strayer Education revenue increased 2% from the prior year as our enrollment growth was partially offset by 6% decline in revenue per student which was slightly more than what our original expectations were. Future revenue per student declines will be partially offset by 1% tuition increase being implemented in the fourth quarter. We also announced this morning, that Strayer University plans to open two to three additional new campuses during the balance of 2018. This is in addition to the successful opening of the Macon, Georgia Campus last quarter which actually has already achieved breakeven status.
In addition, we're in the process of evaluating physical student support location for Capella University and we should have more details on that in coming quarters. Also in the second quarter, Strayer's results include a $6.2 million non-cash write down of our New York Code + Design Academy's asset value as we begin to rationalize, our now combined company's investment in the coding boot camp space.
And one final comment on operational results. Strayer University completed its summer term enrollment during the second quarter. These are students who enrolled in the second quarter, but who are attending now in our summer term, so we have some visibility into our third quarter enrollment results and we expected new student would grow approximately 12% versus the prior year and total enrollments to grow approximately 9%.
Now turning to an update on our merger. After spending the past nine months working with leaders of both Capella and Strayer on our integration. I can tell you that I have a very high level of confidence in achieving our previously stated objective of realizing $50 million in synergies and capturing those synergies within 18 months of today. Steve Polacek [ph], our Chief Integration Officer has led a process that has resulted in very detailed plans by function and by quarter. Based on these plans and on a run rate basis, we expect $20 million of the synergies to be implemented in 2018 with the remaining $30 million implemented in 2019.
We also estimate within these savings approximately $5 million to $7 million will actually be realized in 2018 and approximately $30 million to $40 million will be realized in 2019. Implementation expenses are still estimated to cost $1 for every $1 of synergies and now that we've closed the transaction, our team can also work more closely on potential revenue synergies which might include physical locations for Capella University, improved marketing optimization and more integrated B2B offerings. We'll report progress on these and other items in future quarters.
And in closing and once again, I just want to thank everyone in our now combined company for all of their efforts over the past nine months since the announcement of this merger. We're fortunate to have an incredibly talent group of individuals and we wouldn't be where we are today, without their hard work and dedication. And now I'd like to turn it over to Dan to walk through the financials.
Thank you, Karl and good morning, everyone. First as Rob mentioned, we changed our name this morning to Strategic Education Inc. However to avoid confusion in both our earnings release and on this call. We'll refer to Strayer Education Inc. when describing the second quarter results. This morning I will also comment on Capella Education company's second quarter financial results which are included separately in our earning's press release and also are filed this morning with the SEC in a separate Capella Education company 10-Q.
Please note as I mentioned in the last few quarters, our earnings release references as reported or GAAP results and adjusted or non-GAAP results. This format is intended to illustrate the financial performance of the core business as reflected in the adjusted numbers in addition to our GAAP results. Adjusted results for both Strayer Education and Capella Education exclude fair value adjustments to intangible assets. One-time asset impairments, adjustments related to facilities no longer in use, cost associated with our merger and certain discrete tax adjustments.
Now for few comments on Strayer Education's Q2 adjusted results. Strayer's GAAP income from operations for the second quarter was $4.2 million which as Karl mentioned includes a $6.2 million non-cash impairment to intangible assets associated with the New York Code + Design Academy and also $2.8 million in merger related costs. Strayer's comparable Q2 2017 income from operations was $13.9 million which included a $2.3 million non-cash benefit resulting from the elimination of contingent liabilities associated with the New York Code + Design Academy and $300,000 non-cash charge resulting from an adjustment to the value of leases for facilities no longer in use.
Excluding these items Strayer's adjusted income from operations for the second quarter of 2018 was $13.2 million compared to $11.9 million for the same period in 2017. Strayer's adjusted operating margin was 11.5% for the second quarter of 2018 compared to 10.5% in 2017. Strayer's adjusted effective tax rate for the second quarter was 27.5% which excludes the impact of merger cost and other discrete tax adjustments. We're reporting a GAAP tax benefit for Strayer for the second quarter due primarily to the favorable tax impact of stock-based compensation that vested during the quarter and accelerated deductions enabled by the new federal tax law.
Now for few notes on Capella Education Company's Q2 results. Capella revenue for the quarter grew 1.8% to $111.6 million from $109.6 million last year driven by higher enrollment and slightly higher revenue per learner. Capella's GAAP income from operations for the second quarter was $15.1 million compared to $15.4 million last year. Capella's GAAP income from operations in the second quarter of 2018 includes $900,000 in merger related costs and $900,000 write-down of capitalized software development costs associated with the job raise skill segment. Excluding these costs, adjusted income from operations were $16.9 million. Capella's adjusted operating margin was 15.1% for the quarter compared to 14.1% in 2017.
Capella's adjusted effective tax rate for the second quarter excluding the impact of non-deductible merger cost was 24.9%. Moving forward, we expect the adjusted effective tax rate for the consolidated SEI to be in the range of 26% to 27%. Moving to the balance sheet and cash flow, Strayer Education generated $30 million in cash from operating activities in the first six months of 2018 compared to $32.8 million during the same period in 2017 and ended the quarter with $171.6 million of cash and no debt. The decline in Strayer's cash from operations was primarily due to cash merger cost offset by lower cash taxes.
Capella generated $39.4 million in cash from operating activities in the first six months of 2018 compared to $36.2 million during the same period in 2017 and ended the quarter with $189.9 million of cash including marketable securities and no debt. Regarding capital expenditures, Strayer spent $8.6 million during the first six months of 2018 compared to $8.4 million during the same period last year. Capella spent $9.1 million through the first half of 2018 compared to $12.1 million during the same period year.
For the full year, we're estimating consolidated capital expenditures in the range of $35 million to $40 million. And finally today, SEI amended Strayer Education Inc.'s existing credit facility to reset the maturity for another five years through July, 2023 and increase available borrowings from $150 million to $250 million. Currently there are no outstanding borrowings under the amended credit facility. For more information on the credit facility, please see the 8-K exhibits we filed this morning. Rob?
Thank you Dan. Just a couple of final points from my perspective before we throw it open for questions. First on capital allocation, today's merger of Strayer and Capella into SEI creates a very financially strong institution with healthy free cash flow and a rock solid balance sheet. We therefore announced this morning, that SEI's Board of Directors set its initial annual dividend at $2 per share to be paid quarterly. The board will review our annual dividend each year at our February board meeting when we know the actual distributable cash generation of the company for the previous year and after we have committed to our planned investments and academic outcomes and our operating budget for the upcoming year.
However as 2018 has only partial year, this initial $2 per share dividend is intended to be in place through year end 2019. My second point regards the very positive student enrollment results which Karl reported for both Strayer University and Capella University. Both institutions were clearly buoyed [ph] by a very strong US economy in the second quarter. The May and June, employment numbers were both very positive with national labor participation rates continuing to increase. More importantly, in both months the number of domestic job openings exceeded the number of unemployed adults looking for work. This is likely to further increase labor participation rates and employment confidence which in turn leads to more motivated perspective adult students.
Indeed job opening exceeding the number of adults looking for work is partly a measure of friction in the labor markets and we feel the best way to ease that friction is through increase educational achievement. Now we don't forecast or provide guidance on either our enrollment or financial results. But I did want to say, that if these favorable economic condition persists. They do bode well for strong enrollment growth through the balance of the year.
Finally, as this is SEI's first earning's call. We want to state as a first principal. Our belief that the achievements of our students and alumni are the only true long-term generator of increases in the value of our shareholders invested capital. We therefore, as both the management team and Board of Directors are committed to our student's academic success, first foremost and always. And with that operator, we'd be pleased to answer any questions.
[Operator Instructions] our first question is from Jeff Silber from BMO Capital Markets. Your line is now open.
Congratulations on the closing of the merger. I was wondering if you could share with us some of the goals maybe over the next 12 months for the combined entity. I know you're not going to specific issues but at a high level what should we expect in terms of what this company will look like over the next year? Thanks.
Sure, Jeff. We have a number of goals. One of them is relating to activities that actually was pre-closed which was just business continuity. We wanted to make sure that we didn't create any distractions or disruptions and I think with the results that we've announced today that's real testament to the management teams of both organizations to be able to focus on their students. We want to successfully implement our detailed integration plans. As I said in my prepared remarks, we estimate that will take us all the way through 2019. We want to explore any and all revenue synergies that we can, we want to look for ways that we can cross purpose all the innovations that both organizations have had to benefit our students. And we want to create as healthy and vibrant of a culture that we can and we feel that, the new scale that this merger brings provides us with a great opportunity to accomplish all those things.
Okay, great. And if we can just circle back to the quarter that just ended. The enrollment results were pretty strong especially the new enrollment numbers at Capella. Can we get a little bit more color whether specific programs. I know you called out FlexPath at Capella, but I'm just wondering even on the Strayer side, if there's some items to highlight.
Actually we saw strong enrollment growth across really all degree levels. At Capella they saw growth across all three degree levels that they have, we've seen the same thing on our side. JWMI continues to perform quite well, our Macon, Georgia campus had a significant enrollment increase. So it was really quite balanced across the board, Jeff.
Okay, great and from a modeling perspective. Are you guys going to breaking out I guess the pro forma historical results on a quarterly basis, so we can build up a quarterly model that's something we can get before you report your third quarter numbers?
Jeff, we'll report an updated pro forma similar to what we disclosed in the S4 last year, but it will not be a part of our normal quarterly disclosures.
And I'm sorry, when will that be reported?
In October.
In October, so nothing before then. I'm sorry.
It will be in October, just before we report our Q3 results.
Before you report the results. Okay, great and then one final question, I'll jump back in the queue. Rob had mentioned the dividend policy and your dividend going forward. I'm just wondering in terms of other uses of cash besides investing in the business. Is there anything else that - will be might be looking towards?
Well Jeff we, each quarter as a board look at cash utilization and capital allocation and as you stated the primary and the first objective is investing in the academic outcomes of our students because overtime that really has produced the highest returns for our owners. The outside of the business, the use of capital for acquisitions is always on our agenda I would have to say that we were not the most prolific acquirers over an 18-year period but we've just done a fairly large one. So the horizon that we look at its pretty board, but there hasn't been a whole lot of things that we've seen besides Capella that really attracted our interest.
I can't say that something might not in the future but it's - it would be inaccurate to say that our intent is to be a prolific or a serial acquirer. And then after we get done with use of capital inside the business and potentially investing it outside of the business, we want to return it owners in the most value enhancing way. We think that over a long period of time, a predictable dividend policy is probably the best way to manage an institution that owns universities and then we have a share repurchase authorization, which is available to the board in those circumstances, where we feel that the intrinsic value of the stock is so - actually the trading value of the stock is so far below its intrinsic value that, we can take that option away from our owners that we give them by just giving them a dividend.
So we'll continue to go through all four of those things at each quarter and then, obviously as we have developments, we report them if and when we were able to accomplish any of that.
Okay, fair enough. Thank you so much for the color.
Thank you. Our next question is from Peter Appert from Piper Jaffray. Your line is now open.
So back to the start performance, the numbers at Capella University I think are particularly noteworthy given that they've basically been struggling for a while to get to sustained positive growth in this, the move to double-digit growth this quarter as they say the best in, I think in eight years. so any more color in terms of specific programmatic offerings that are driving and or other marketing initiatives that might be driving that and your confidence in the sustainability of that better start number.
Well the first thing I would reference, Peter is Rob's comments that. We've heard from both of our teams that, there is a sense that the economy is stronger and I suspect that definitely played a role in the enrollment results that both Capella and Strayer generated specifically to Capella. I know that they are always working in terms of crafting the right message and campaigns from a marketing standpoint. I know that they were quite pleased with the level of interest in terms of demand that was being generated in the quarter. FlexPath continues to grow. I think that's a combination of just solid macro conditions combined with a very effective marketing team. Robust programmatic offerings and the continued strength of FlexPath.
Okay, so nothing new this quarter specifically in terms of marketing initiatives [indiscernible].
There was no sort of silver bullet if you will, they did one thing and it sort of generated these results. It's a combination of, I think everything that I just referenced.
Right so your comments Karl and Rob's earlier comments are a little bit counterintuitive in terms of I think of how people thought about the education sector historically. We've historically thought about this business being countercyclical, you're seeing it being more pro-cyclical these days, is that a function of your increased focused on the corporate channels and these corporate partnership deals. And can you remind us, what percent of enrollment that is currently.
Peter I would say, I personally and I think as institution, we have never felt that, what Strayer University provides was a counter cyclical product or service. And the reason being is that, the decision to go back to school as an adult it's such a large investment of time, money, emotion. There are belief unlike some sort of lower level programs or job training programs. It's not truly advantaged by a downturn in the economy. It's actually advantaged by a high level of employment confidence in a shifting economy, in an economy that's shifting from a manufacturing and based to a more of a knowledge base. And I think if you look at the history of both Strayer and Capella in the period prior to the crash of late 2008, 2009 you had pretty robust enrollment growth.
Once the severity of the downturn and as I've written before in letters to shareholders I think the most important metric is the labor participation rate. As that started to go down in 2010 and continued to go down through 2015. The willingness of perspective students to uproot their lives and enrolling in a post-secondary program went down significantly and I think what you're seeing is over the last two years and it's accelerating over the last probably six to nine months, that labor participation rate is starting to grow because I mentioned the mismatch between job openings and unemployed workers is just driving, I think a more growing and healthy economy which generates more employment confidence and in order to make the sacrifice, both the financial and the time sacrifice for a 35-year old to go back to school. The only reason to do that, is if they feel that at the other end of that, that there is a likely opportunity for them to recover that in terms of better employment.
So I would say that we're certainly not counter cyclical and I think on the last call, I had a question where someone asked us. My belief is within certain bands were a cyclical, if the economy falls below the lower end of one of those bands, then you are truly cyclical and I think that's what happened over a five or six year period from 2010 to 2016 and now we're kind, we're the beneficiaries or a much stronger and healthier economy.
And can you remind me Rob, what portion of current enrollments for the new entity is corporate partnerships?
It's about a quarter, Peter.
And do you have a vision in terms of what that could be?
Well we wanted to go as high as we can get it. I mean we have extensive relationships with the employers Capella does too. One of the plans that we have with the merger and as I said earlier is to integrate as many of your B2B offerings as we can, so that will be a primarily focus going forward.
And then coding businesses has been a bit of a struggle I think for both companies historically, can you talk about your vision for that business and the opportunities there?
Well I continue to believe that over the long-term it's going be a viable and a great investment. My own view is that, it's a nascent space, your average person on the street is not aware of the coding boot camps. When you look at the actual product and the experience the students have, I think there is a very tangible return for people. You basically invest somewhere between 12 and 16 weeks of your life. You spend somewhere between depending on the school $8,000 to $10,000 and roughly 90% plus of the time, you get a job that pays you somewhere between $55,000 and $75,000 as a junior web developer. So that's a real ROI. The problem is, the levels of awareness amongst the population at large is just so small, which why our strategy continues to be, get them to a breakeven level and then be patient and wait for sort of the organic demand to come, but I still feel like over the next decade it's going to be an important pathway for people to have to get a good paying job.
Okay, thank you. And then lastly, can you talk a little bit about marketing costs and the trajectory in marketing cost for the new entity?
Sure on the Strayer side we actually saw a reduction year-over-year and our cost to acquire new students. If you look over a more normalized period say two to three years. I think marketing expenses have been increasing somewhere between 3%, 4%, 5% and somewhere in that range seems reasonable moving forward in 2019 and beyond.
Great. Thank you.
Peter, just one of the thing one the coding schools I wanted to add, which is - one of the real advantages I think of the transaction is, it gives us more scale and specifically it gives us more scale in that area, well we now have three platforms which are all different in terms of their approach. So we've got an area of experimentation and lessons learned that we can go after in the several months to really try and understand that market.
Right, great. Thank you and congrats on closing the deal.
[Operator Instructions] our next question is from Corey Greendale from First Analysis. Your line is now open.
I appreciate you guys sticking around and answer multiple questions. So as far as - the guidance or the thoughts on the cadence of the synergies was helpful. I just want to make sure I understood Karl you're saying like $5 million to $7 million will actually hit the P&L in 2018 is your expectation.
Yes.
And is the bulk of that stuff that happens today or does even that kind of ramp in over the next few months.
No there are some activities and changes that are being implemented today and week-by-week between now and the end of the year additional changes will be implemented. The sum of all of those changes on a run rate basis will equal about $20 million and we estimate $5 million to $7 million of it will actually be realized in savings in 2018.
Okay understood. And then if I can jump around a little bit, on Capella. So I think that they are at least based on what it says, it says in the Q's, but they've actually been net, net increasing revenue per student and like the discount for students is actually coming down. I know you've done a lot of stuff to adjust kind of the value prop on the Strayer side, any thoughts on what tuition pricing, the strategy might be on the Capella side going forward?
I think that you have to be determined, but you're right. They've had very strong revenue per student performance. On the Strayer side as I said, our decline was a little more than we thought, but any future declines will be partially offset by the 1% tuition increase that we're putting in for all students in the fourth quarter.
All students for Strayer University.
All students for Strayer University. And the scholarship programs that we did earlier or last year I should say as a result of the disruptive whether, all of this has been discontinued so we expect revenue per student to flatten out as we begin to head into 2019.
And these lower than expected Q2 result, was that because of a mix in the corporate who get discounts or what drove that?
Well it was definitely impacted by growth in the corporate channel since those students are paying an effective lower tuition rate. We had slightly fewer receipts per students, so was the combination of two or three things.
Okay and I think I'm just repeating what you said about Capella, I think you talked about the master's level being more competitive, generally so is it fair to say that something you'll look out whether adjustments to discounting at Capella side makes sense.
Yes, I mean we look at everything Corey. But based on the quarter that we reported today they're seeing pretty strong growth across all degree segments including masters.
Okay. Then another Capella question, as you look at everything I think another group that's looking at everything is the Department of Education and as they look at the definition of the credit hour again, it sounds like part of the goal is potentially somewhat opening the flood gates on competency based programs more broadly. If and when that happens, is there anything about the experience in the technology at Capella that provides a sustainable competitive advantage in FlexPath type programs or does that get more competitive overtime?
I think Capella has a number of competitive advantages relative to competency base learning. Everything from the design of the curricular, the course specific outcomes that are measured at a course level. So it's not just the delivery. It's the combination of the design. Delivery, measurement, all of that. I feel like Capella is way ahead of most of higher education and competitively advantage as a result.
Particularly the head start, the last point I think is very powerful.
Okay and then for Dan, I think I know what's been driving the increase in bad debt at Strayer. I expected it would start trending down over the verification changes, but what is still keeping it high and when does it start trending down?
Corey we expected to see a down turn in the volume of the Title IV processing issues by the end of this year. So I think the Q2 was about what we expected, I think the additional factors. Of course the continued shift to under grad students. I think in the long-term we believe that bad debt can be managed back down to the 4% range, it may.
At Strayer University.
It maybe 2019 before we get to that point.
Okay, I appreciate that Dan and then going back to one of the questions. Peter, as the Capella new student result is obviously very strong, the comp was a lot of easier than the prior quarter, should we look to the year ago. There are new student growth that's been much more volatile quarter-to-quarter than Strayer's has, should we kind of take that into account as we think about what's going to happen quarter-to-quarter in their new student results.
Well I think Corey you should definitely assume that our policy with regard to new student enrollment hasn't changed, which is that we're comfortable with a high degree of volatility, students come when they want to come, we're not trying to drive a particular number in any specific quarter. We just report it, when it happens. We were obviously delighted to see the results at Capella in this last quarter. But we cannot get too wrapped around the axel [ph] on quarter-to-quarter comparisons or whether it's a tough comp or an easy comp. I think in general, the macroenviroment is supportive of working adults going back to school right now and I think that's helping both institutions and beyond that, we don't really pay that much attention to it, to be honest.
Okay and one, I think this is my last one. I understand making fit breakeven [indiscernible] give some sense how much it contributed to the either the enrollment number or the new student number?
It was pretty strong. I mean it definitely exceeded all of our expectations. It was probably 75 basis points.
To the overall enrollment number.
To Strayer's new student growth rate.
To student growth rate. Okay. Great. I think that's all I had. Thank you.
Thanks Corey.
Thank you. At this time I'm showing no further questions. I would like to turn the call back over to Rob Silberman for closing remarks.
Thank you operator and again I want to reiterate, what both Karl and Dan have said, our extreme gratitude to both sets of faculty and staff and the management teams of both organizations to have accomplished as Karl stated this, closing of the transaction and all of the planning around the integration at the same time that you've had such strong performance really a testament to everyone's commitment and hard work and we are very, very appreciative. For our shareholders and particularly our new shareholders from Capella. Please feel free to contact us, if you have questions and we look forward to talking everybody in November with our third quarter results. Thanks very much.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.