Strategic Education Inc (STRA) 2013 Q2 法說會逐字稿

Good morning, everyone, and welcome to Strayer Education, Inc.'s second quarter 2013 earnings results conference call. This call is being recorded. For those of you who wish to listen to the call via the Internet, please go to strayereducation.com where the call will be archived. With us today to discuss the results are Robert Silberman, Executive Chairman for Strayer Education; Karl McDonnell, Chief Executive Officer; and Mark Brown, Executive Vice President and Chief Financial Officer. Following Strayer's remarks, we will open the call for questions and answers.

I would like to remind everyone that today's press release contains and certain information on this call may contain statements that are forward-looking and are pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act. The statements are based on the Company's current expectations and are subject to a number of assumptions, uncertainties, and risks that the Company has identified in the paragraph on forward-looking statements at the end of its press release and that could cause the Company's actual results to differ materially. Further information about these and other relevant uncertainties may be found in the Company's annual report on Form 10-K and its other filings with the Securities and Exchange Commission. Copies of these filings and the full press release are available online and upon request from the Company's Investor Relations department.

And now, I'd like to turn the call over to Robert Silberman. Mr. Silberman, please proceed.

Thank you, operator, and good morning, ladies and gentlemen. As we just hosted most of you at our extensive Investors Day a couple of months ago, we decided not to belabor you on this morning's call with a lot of introductory prepared remarks and instead try to get right to your questions. All of our operational and financial data for the quarter are included in our earnings release issued this morning, which is available on the website so I'd refer listeners there for any of the specifics on the quarter. Karl and I each have just a few amplifying comments on our results before we open up the call to questions.

First from my perspective, I did want to call attention to several positive accreditation and regulatory results we announced this morning. During the quarter, Strayer University achieved accreditation by two specialized program accrediting bodies. Our School of Business received accreditation from the ACBSP, a specialized accreditor that focuses on business management accounting programs, and our School of Education received accreditation from TEAC, which you'll recall is Teacher Education Accrediting Council. Both of these specialized accreditations are in addition to our University regional accreditation through the Middle States Commission on Higher Education.

Also just last week, Strayer University received its Final Program Review determination from the US Department of Education with no material adverse findings and no required further actions. This closes out the Open Program Review, which many of you may remember took place in the third quarter of 2010. Now, we're obviously pleased by these third-party affirmations of the quality of our academic and administrative programs and, of course, we very much appreciate the hard work of our faculty and staff in achieving these important milestones.

The second issue I wanted to briefly touch on is our distributable cash flow and that is that while that distributable cash flow for this first six months of the year looks spectacular, it's up 27% year-over-year on net income which is down 29%. I do want to point out that much of that increase is due to timing differences in both unearned tuition and income taxes payable. The unearned tuition is really just the reversal of the negative impact we had last year on the Veterans Administration payment terms, and we will actually have that through the whole year. The income taxes is a timing difference that will reverse itself during the year. When you normalize for those timing differences, you still have very positive distributable cash flow of some $46 million on roughly $32 million of net income for the first six months of the year, but not quite as good as the year-over-year comparison would make it appear.

And then finally from my perspective on the overall environment, there's no question that some of the themes that we discussed at our Investor Day -- decreased demand, increased competition in the post-secondary education space -- both continue to affect our enrollment results. I know Karl wants to comment on these results in more detail. But before he does, I just wanted to emphasize from our Board of Directors' perspective that we continue to believe strongly in both the value of high quality post-secondary education and specifically in Strayer University's mission of making such post-secondary education achievable for working adults as we have for the last 120 years. Karl?

Thank you. Good morning, everybody. I just would like to comment on a couple of the key issues coming out of the second quarter. First, just a couple of highlights from our income statement.

Revenue per student was strong in the second quarter, was down about 40 basis points so we've continued to see improvement there throughout the year. And based on our summer term enrollment, we expect the third quarter to also be strong; and on a full-year basis, right now we're expecting revenue per student to be flat versus the prior year. Of course, over time as more of our students begin participating in the Graduation Fund, we will see some impact, but at least in 2013 on a full-year basis, we expect to be essentially flat on revenue per student.

On the bad debt line, we improved about 10 basis points from last year coming in at 4.3%. So, we're pleased to see the progress in those two metrics.

Secondly, with respect to the Graduation Fund, we did fully roll out the program for our summer academic term, which means that all our new undergraduate students were automatically enrolled in the program. Again, this is a program that is intended to drive improvements in retention and over time graduation rates. And so we're really going to have to wait until the end of our fall term enrollment in October to begin assessing the early impact from the Graduation Fund because obviously fall would be the first term that our new summer cohort of students would have the opportunity to continue into. So once the fall enrollment is complete, we plan obviously to sit down and do a comprehensive analysis on the continuation impact for our new summer cohort of students and we'll have more information to share once we complete that analysis.

We are very pleased with the performance of the Jack Welch Management Institute. They had a very successful quarter. They had the highest continuation rate in the university. They also had the highest net promoter score in the university with a score well over 60%. We actually increased tuition for the JWMI EMBA by roughly 9% in the summer academic term and we continue to see strong demand on the part of new students there.

Just one other quick note on JWMI. We are out in the market now with our new Welch Way corporate training courses. We have our first three courses live and our B2B teams are now out working with our various national account partners to begin bringing those products into their various organizations.

In addition to JWMI, our overall graduate level performance continues to do well. Continuation rate at the graduate level for all students was up 43 basis points on a year-over-year basis. And the net result of that is that graduate students now comprise 36% of our total student population, which is the highest mix of graduate students that we've ever had.

In terms of broader national accounts and institutional alliances, they also continued to perform well. Total enrollment from these accounts declined roughly 1% compared to the minus 13% that we had for the full university reflecting outperformance on both new students as well as continuation rates in that respect and we did add six new national accounts during the quarter.

Lastly, we continue to see the most challenges with both new student enrollment and continuation rate declines within our unaffiliated undergraduate students. Now of the two, new students and continuation rates, the priority for us is initially to begin improving the continuation rates of these students. We think that has the biggest long-term impact on the University.

We've done a good amount of research to better understand the issues that this particular segment of students is facing and there's no doubt that affordability is clearly the prevailing theme that we see there. So in addition to all the various steps that we've already undertaken and to the extent we need to do more, we'll make whatever changes we feel are appropriate to address these concerns while still attracting the type of students that we feel are going to be successful in the University.

And with that, operator, we would be happy to answer questions.

Thank you. (Operator Instruction) Corey Greendale, First Analysis.

Hi, good morning.

Morning, Corey.

I want to pick up on last thing you mentioned, Karl. So I know the Graduation Fund scholarships are intended to improve persistence not the new student number, but one would think that if affordability is the issue, that would have at least had some impact on new students' willingness to enroll. So can you just comment on any initial feedback, whether they were aware of the program and if it did influence those decisions at all?

Well, we rolled it out for the summer academic term, Corey. And in a few of the states, there's a little bit of lead time to get state approval for various programs that you're running so there was a little bit of a staggered rollout, if you will, across the full campus footprint, which we've completed now. By the time that we had implemented the Graduation Fund, our media plan had already been complete and implemented and so other than just some advertising that we did on our own website, there wasn't any media advertising the Graduation Fund, which we plan to have moving forward.

But again, the construct of the plan is intended to improve retention and graduation rates. The feedback from students has been strong. If there is a benefit on new students, that would be a plus from our standpoint given that its primary design is intended to improve retention.

Okay. And in terms of doing what you need to do to address affordability then for people coming into the system, is the most likely possibility there are some additional scholarship programs that will enter new students or what else would be on the table?

It could be. I mean I would just remind everybody of all the things that we have done on affordability. Again, we froze tuition for all of our current students, we announced that we're going to forego any tuition increase next year, obviously we rolled out the Graduation Fund. But as we continue to listen to the needs of our students and to the extent that those needs would require us to do additional steps on tuition pricing, we would look at that.

And our view is we would make whatever changes we feel are necessary without impacting obviously our ability to deliver a high quality academic program or in some way affect enrolling the types of students that we feel are going to be successful. So, it's something that we're going to look at through the balance of the year.

Okay. And related question I think for Mark or whoever wants to take it. Coming out of the Investor Day, I think you talked about the accounting for the Graduation Fund that you're going to be accruing for that as students enroll even though they're not getting the benefit until further down the road.

So given that, I'm a little surprised that you don't expect some negative between that and the tuition fee, that you wouldn't see some negative revenue per student later in the year. Can you just comment on that and just give some perspective on at what rate you're accruing per new student or expect to be accruing?

Yes. Well, we won't know the exact rate until we get to the end of the quarter. And the reason why it doesn't have more of a detrimental effect on our revenue per student is because we also had scholarship programs in the prior year that we're comparing it against. But the design of this program is such that we would expect there to be some reduction in revenue per student going forward, it's just not likely to happen this year.

Okay. Thank you.

Sara Gubins, Bank of America/Merrill Lynch.

Hi, thank you. Maybe just a follow-up on that. So there were some scholarships that effectively go away and then there's the reserves for the new one. But the revenue per student decline of only 40 basis points was certainly better than what you've seen recently and what we would have expected. Can you talk about what else might be driving that?

Well, as I said in my couple comments, Sara, we have seen an increase in mix in graduate students. Those students are at a higher tuition price point. They also tend to have higher continuation rates so the combination of more mix, better continuation at the graduate level would certainly impact that. And I think it's just -- the Graduation Fund is going to have a longer-term impact on revenue per student where the scholarships we had last year where we were offering $1,000 off per term, that impact of the revenue per student was in that quarter. So I think the combination of those two is primarily what's driving the improvement.

Okay. And then as we try to model out the scholarship program, retention rates and graduation rates will be important. Could you walk through graduation rates for the various student segments that you have?

Sure. Our graduate students tend to have a graduation rate that is in the mid 60%, 70% range. At the undergraduate level, it's more complicated to model because it obviously depends on the number of transfer credits that a student will bring in.

For students who tend to bring in a year or more of college credit, their graduation rate within six years is in the 50% to 55% range and then it will decrease as a student will have fewer transfer credits coming in all the way down really to close to 15% for a student who has no transfer credit whatsoever. And so I'd say on a fully blended basis, it's probably around 40%.

40% including graduate students?

Yes.

Okay. And within your undergrad, what percentage are actually bringing in a year or more of credit versus those that are coming in with pretty much no transfer credits?

Well, of the undergraduate students, which will be about 65% to 70% of the new student cohort, about 40% of those students will have a year or more of transfer credit.

Okay, great. And then just last question. I know you're not giving guidance a quarter ahead anymore because of the uncertainty around the reserve, but could you give us some thoughts about what you're expecting in terms of various cost line items? Thank you.

Which ones did you have in mind, Sara?

I'd take them all, but I mean obviously instructional support and marketing are the two biggest.

Yes. I think on a run rate basis, our third quarter is always going to have the highest marketing expense because that's our biggest enrollment gauges for the fall term. Our G&A tends to be relatively flat through the year and the instructional and education will vary on the basis of the number of students. So, it's down on a real basis in the third quarter and it's going to be up in the fourth quarter with a higher student population.

Okay. Thank you.

Jeff Volshteyn, JP Morgan.

Good morning and thank you. On the Analyst Day, we talked about changes in remediation for incoming students. Is there an impact that you can point to us from those changes and does that fall into the new enrollment declines that we've seen this quarter or is that still coming up in the following quarters?

Well, I think, Jeff, the efforts you're speaking to were improvements that we made by adopting some more adaptive leaning models in both our English and Math developmental courses. We have been piloting that throughout 2013 and are preparing a full university rollout for the second half of this year. The outcomes have been positive in the sense that we've seen higher pass rates.

We've also seen because of some changes we made to the diagnostic testing that we do on the admissions side that fewer of our students actually are being put into these developmental courses meaning a greater percent are going right into our credit bearing English and Math courses. But I wouldn't ascribe any of the new student performance to any changes that we've made on the developmental side.

Okay. And could you give us maybe a little bit of color on performance of students online versus on ground like you used to report in the past?

Do you mean how they're performing academically or just what's the --?

No, no. Just in numbers, growth rates?

I haven't seen, I don't have that table in front of me, Jeff. We thought it was confusing, which is why we stopped providing it in the press release. But from my standpoint, Mark, I don't think there is any changes based on sort of the trends that we've had in terms of the students who are taking their classes online.

Correct.

All right. Thank you.

Jerry Herman, Stifel.

Thanks. Good morning, everybody. Maybe start with a couple of numbers questions with regard to some of the line items and G&A in particular in this quarter looked to be higher than we expected and certainly up sequentially from the first quarter. Mark, can you help us with the run rate on that number or what caused the absolute increase sequentially in the quarter?

Yes, sure, Jerry. And I think we touched on this at Investor Day where we talked about a run rate of closer to $12.5 million per quarter for the year. It was a little bit down in the first quarter compared to the run rate that I'm giving, primarily due to stock-based compensation, which was a little lower in the first quarter due to the roll-off of some of the restricted stock programs. But for your modeling purposes, I think using something around $12.5 million on a quarterly basis is probably a reasonable number to use.

Great. And with regard to the accrual for the Grad Fund, will it get material enough so that it will be separately disclosed in any way in the balance sheet?

No.

Okay. And then finally, just a follow-up to Corey's question. The Grad Fund is prominently displayed on your website, which I would think would generate some interest. I'm wondering, maybe framing the question a little bit differently, if in fact you are garnering some interest because of that prominence and that large discount being available?

Well, we have seen good traffic to our website. It may or may not, Jerry, translate into more interest for new students. It wasn't as I said at least for the summer academic term supported by any other media dollars, broadcast media, et cetera. And it's early; we have one quarter under our belt --

Not even a full quarter.

Yes, not even a full quarter, and a quarter that had no associated advertising or media. So I can tell you that the feedback from students has been very favorable and so I think we're just going to have to wait until we get a few more quarters under our belt to know if it's having an impact on the new student side or not.

Great. Thanks very much. I'll turn it over.

Suzi Stein, Morgan Stanley.

Hi. I just wanted to follow up on the marketing expense for the second half of the year. I mean I understand the seasonality of the third quarter, but in terms of the whole second half, should we expect a bigger increase just because of marketing around the graduation scholarship?

No, Suzi, I wouldn't expect any other increases other than the seasonality in the third quarter. We feel confident in our marketing budget for the year. How we use that marketing budget in terms of what campaigns we decide to ultimately run, that may shift around a little bit, but the actual dollar amount I don't expect to move around.

Okay. And then at Investor Day, you mentioned that CapEx should be around $15 million for the year, you're tracking well below that for the first half. Is that still a good number to use or do you think you'll run lower than that this year?

Yes, Suzi, it's a good question. I think in reality, we are likely to spend less than the $15 million. I would estimate it to be closer in the $12 million to $13 million range at this point.

Okay, great. Thank you.

Jeff Silber, BMO Capital Markets.

Back to modeling 3Q. Given the I guess ramp up in G&A looking at a $12 million, $12.5 million run rate, excluding the impact of the reserve for the new Graduation Fund, would you expect the Company to report an operating loss in the third quarter?

No.

Okay. All right, that's helpful. And I know it is early, but we're half way through the year, I'm just wondering what your preliminary thoughts are on new campus openings for next year?

Well, when we looked at this issue, Jeff, last year and we decided not to open new campuses in 2013, we really talked about two areas of uncertainty that caused us to want to hold on to capital. One was regulatory and the other was economic.

I would say that in both cases they've gotten more uncertain over the last six months. We're just starting our planning process or we're actually in the teeth of our planning process for 2014 now, but we haven't really seen anything through the first half of year that materially changes our view at this point. And so, we'll make a final determination announcement in October, but I think a reasonable assumption is that we're certainly not early in the year going to be an aggressive opener of new campuses, let me put it that way.

Okay. That's very helpful. Thank you so much.

Peter Appert, Piper Jaffray.

Thanks. Good morning.

Hi, Peter.

I guess I am slightly confused in terms of the marketing strategy and plan. It would seem to me that you've got a significant differentiating factor here in terms of the scholarship program you're offering and if I'm hearing this right, it sounds like you're not really looking to promote it that aggressively. Is that the message?

No. When we made the decision to launch the Graduation Fund, we initially intended that we would have that for our fall enrollment term. We finished some of the analysis earlier than we expected, our legal team was successful in getting some of the state approvals that we needed a little bit earlier than we thought so we pushed forward the implementation by a quarter. But given that our media plan had already been completed, it was essentially too late to go back and produce new radio commercials, new television commercials, and so forth.

We've done that now because it's in line with what our original plan was to support our fall term enrollment. So my comment really was reflecting the fact that the Graduation Fund was rolled out in a quarter where our media plan had already been implemented and it was too late to support it with any of our advertising.

But Peter, the direct answer to your question is we do intend to communicate broadly and strongly the value of that and that will be in our media and in our marketing plan during the third quarter for our fall term enrollment.

Got it, of course. And then, I guess the real issue is you've been sort of reticent to talk about how that could impact starts and I understand the focus on continuation rates, but why wouldn't that have a measurable impact on your starts over the next several quarters?

Well, it may have an impact. Our view is that in sharing the design of the program, we're saying that the program was designed to impact retention and, as I said, ultimately graduation. The feedback has been very strong and it may have some impact on our new student enrollment, but it's too early to tell and if it does, that would be a positive in addition to how the program was designed.

Okay, great. That's helpful. Thank you. And then just really quickly, the last thing, can you remind me how big the Welch program is?

This year, it's going to be in the range of 500 students.

At the MBA level, the corporate training would be a lot more obviously.

Got it. Great. Thank you.

(Operator Instructions) Paul Ginocchio, Deutsche Bank.

Thanks, I've just got a couple. I'm sorry if I missed it. Did you give the overall continuation rate for the second quarter?

And I'm just wondering if you even wanted to talk about do you think new enrollment trends with the marketing program and the fall quarter of graduation, the Graduation Fund, would get better on a year-on-year basis from here?

And then finally going back to a comment you made earlier about not having an operating loss, I guess that would imply you're going to see a pretty big decline in the instructional costs and services QonQ. Because I'm sort of getting right at breakeven if you look at the trend for the first two quarters, down $0.50 on earnings, down $0.42 on earnings and you did $0.36 a year ago. It would just seem like you're getting pretty close to the mark. Thanks.

Yes. On the instructional and education, Paul, it's always much lower in the third quarter, we have less students and it's also the term in which our full-time faculty take off and so we have a higher percentage of the classes that are taught by adjuncts. So, that's more of a seasonal effect, I wouldn't just straight line what you've seen for the first two quarters.

The raw continuation rate, Paul, was in the high 80%s. On a year-over-year basis accounting for all students, it declined 180 basis points.

Thank you. And then just did you want to hazard a guess on whether new -- is this a quarter where new enrollment can get better or is it too early yet?

It's far too early on and we don't comment on future enrollment anyway.

Great. If I could, could we just go back to this revenue per student because I guess I'm a little bit lost. So when you just look at it in the back half of the year -- because it seems like at least on my calculations, it's been down in the first half, but it's going to be you say flat for the year; so it's actually going to be up in the second half on a year-on-year basis?

Yes. (technical difficulty)

By a small amount.

And that's just because you had bigger scholarships last year versus this year?

Correct. And the ramp rate of the Graduation Fund.

Okay. Thank you.

That's basically it. The answer to your question is yes, Paul

Thank you.

Tim Connor, William Blair.

Thanks, guys. The Welch Way corporate training courses, is that something that you're going -- are you going to count those in enrollments and starts?

No. We will not be counting any of The Welch Way certificate enrollees in our student enrollment.

Okay. And then other than The Welsh Way and that corporate training initiative, are there other things you can do to soak up any excess capacity at existing campuses?

We don't really think about it as excess capacity. I mean the reality is in our model, you've got empty classrooms during the day because we're a working adult designed institution so it's just not a concept that we've used.

We've never really been around fixed asset utilization because frankly for ten years, we've allowed students to take whatever courses they want online. It's all part of the general opportunity that we offer to our students to take classes in different modes.

The Welch Way corporate training is a really I think important adjunct to what we do because it does take content, which we think is valuable and important, and begins to distribute it in non-credit bearing, non purely academic forms, which we do think will be valuable. But frankly it's all online, or at least it is now, so it doesn't really do anything in terms of fixed asset utilization.

Okay. And then you talked about not opening new campuses. I guess is there some tipping point at which you would consider reducing your fixed capacity?

Yes. I mean you're not going to run campuses permanently at a loss. I mean you would fail your financial composite score if you did that. So the answer to your theoretical question is, yes, but that's really not part of our planning scenario right now.

Okay. Got it. And then the CapEx numbers that you quoted, which is $12 million to $13 million, is that all maintenance at this point or is there still some lag from some of the campuses you opened late last year that rolled into this fiscal year?

Yes, it's mostly maintenance at this point.

Okay. And then final one from me. Any differences in demand trends by program? Any differences at all there?

No. The interest in demand on our programs has been somewhat steady. Of course, my comments on Jack Welch are pertinent there. We do continue to see a good amount of demand for the JWMI EMBA. It's not so much program variation that we see, but more type of student meaning students with transfer credit, students without, and for those unaffiliated undergraduate students, that's where we have seen the biggest declines.

I think it's fair to say, Karl, isn't it, that the demand has been higher for graduate programs for you?

Absolutely.

That those are growing or at least shrinking at a much slower rate. But between business accounting, IT, things of that nature; it's pretty stable is what you're saying.

Yes.

Thanks very much, guys.

Trace Urdan, Wells Fargo Securities.

Hey, good morning, guys. I was sort of curious about whether there might be some impact from the sequestration and the lay-off of federal workers that's still coming through the system. Can you remind us to the best of your knowledge how many of your students are employed by the federal government?

And do you have any color from the campuses that are concentrated in the mid-Atlantic region about what they may or may not expect to see there? I know you don't like to comment on future starts, but I'm just wondering whether that could have an impact on your business at least in those campuses.

In terms of the number of federal workers, it's a small number. I don't have the actual number, Trace.

Less than 5% you'd say?

I would say it is less than 5%.

Well, you've got almost 3% military. If you got military in there, I would say it's between 5% and 10% probably.

Okay.

But we'll get you a real number, Trace.

And then on sequestration, to be honest with you, Trace, that's not something that I've heard come up through our campuses so it's not something that's on our radar screen right now.

Got it. All right. Thank you.

The one place, Trace, where I would expect that frankly to be more of an issue is not so much with government employees, it's with government contractors. And we'll see that, to the degree we do, in both D.C. and in markets that have heavy military and defense concentration; Hampton Roads, Norfolk, places like that. But so far, as Karl said, we haven't -- it hasn't happened.

I'm no expert in this, but my understanding is that the effect on the contract workers may already have been felt. No?

Yes.

I think some may have; so the specific sequestration may not. The ongoing fiscal pressure on the Department of Defense I think is likely to maintain. But nothing that we would point to that specifically has moved the needle for us in the last six months.

Okay. Thank you.

I am not showing any other questions in the queue at this time. I'd like to turn it back over to Mr. Silberman for closing comments.

Thank you, Sean, and thanks, everybody, for participating. We look forward to talking to you in October. And obviously, if you have any other questions or specific questions, modeling questions, please give Mark a call. Thank you.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.