Strategic Education Inc (STRA) 2016 Q1 法說會逐字稿

Good morning, everyone, and welcome to Strayer Education, Inc.'s first-quarter 2016 earnings results conference call. This call is being recorded. (Operator Instructions)

With us today to discuss the results are Robert Silberman, Executive Chairman for Strayer Education; Karl McDonnell, Chief Executive Officer; and Daniel Jackson, 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 made 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. For 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 would like to turn the call over to Robert Silberman. Mr. Silberman, please go ahead.

Thank you, operator, and good morning, ladies and gentlemen. We're going to begin this morning with Karl discussing our Company's first-quarter operating results, Dan will report our financial results for the quarter, and then we will stay as long as you need for questions. A pretty straightforward quarter, and we look forward to chatting about it.

Karl?

Thank you, Rob. Good morning, everyone. First, I would like to make a couple of comments on our first-quarter financials that we released earlier this morning. Both our revenue and our revenue per student declined 1% from the prior year, which was in line with our expectations.

We said last year that we expected a slight decline in revenue per student in 2016 and that, moving forward, the change in our revenue would more closely track our change in total enrollment. That was the case this quarter. We expect that will be the case throughout the year.

On the expense side, we continue to be as disciplined as we can, but there were a number of moving items this quarter. We were up about 10% in marketing, which really just reflects the fact that we have many more growth initiatives underway, all of which require additional marketing dollars such as the Jack Welch Management Institute, Strayer@Work, and now the New York Code and Design Academy. The 3% decline in I&E reflects both savings that we had in bad debt, but also some efficiencies that we were able to generate in our class scheduling methodologies.

Dan will provide more detail in a moment, but G&A was down about 11% due to a one-time approximately $1.6 million lease loss adjustment as we were able to sublet some of our corporate office space. Excluding this adjustment, our EPS is $1.06 per share.

Turning now to our operating results for the spring academic term, our total enrollment increased just under 1% as continuing enrollment grew 2% and new student enrollment decreased 7%. We were very pleased that our continuation rate increased 150 basis points, and now we're into our third consecutive year of annual improvements in student retention.

Regarding new students, all of the decline was in Strayer University's unaffiliated undergraduate student segment, which declined roughly 13%. Our affiliated new students, meaning students from national accounts, but also now Strayer@Work, grew 20%, and total enrollment for affiliated students grew 12%, reflecting the continued strength in our B2B relationships. And while we acknowledge the slight deterioration in new student performance in the second quarter compared to the first, going down 5% in the first quarter to down 7% in the second quarter, we believe the performance is part of what we have described as the natural volatility that occurs when people are contemplating returning to college. Our belief is that as Strayer@Work and our other national account activities continue to perform well, the unaffiliated student segment will become a smaller and smaller part of future new student cohorts.

Finally, a couple of quick updates on the New York Code and Design Academy. We were pleased that, within the last quarter, we received state approvals in New York. That approval was required as part of the transaction, but also approvals in Texas and Georgia. And, as a result, NYCDA will plan to offer their web and mobile app development boot camps at Strayer University facilities in Austin, Texas, as well as one of our campuses in Atlanta beginning in July.

We have also submitted license applications in 11 other states, and we expect to receive those approvals over the next six to 12 months.

Dan, you want to walk through the financials?

Sure. Thank you, Karl, and good morning, everyone. I will start with revenue, which, for the first quarter, was $111.2 million, down 1% from last year and, as Karl mentioned, the decrease was driven by lower revenue per student, which was down just under 1%, partially offset by slightly higher enrollment growth for our winter term.

Our income from operations was $20.1 million for the quarter, compared to $19.9 million for the same period last year. Income from operations in the first quarter of 2016 and 2015 includes non-cash adjustments to our liability for losses on facilities we ceased using during the fourth quarter of 2013. Excluding these items, income from operations was $18.5 million for the first quarter this year and $19.7 million last year. Our operating margin was 16.6% for the quarter, compared to 17.6% in 2015 when excluding the non-cash adjustments.

Bad debt expense was 2.8% for the quarter compared to 3.1% for the same period last year. Our lower bad debt reflects stable payment behavior among existing students, as well as our improving ability to collect on previously written off accounts.

Net income for the quarter was $12.4 million compared to $11.4 million in 2015. Excluding the non-cash adjustments, net income was $11.4 million this year and $11.3 million last year.

Net income this quarter was helped by lower interest expense resulting from the payoff of our term loan in the third quarter of last year, as well as a slightly lower tax rate, which was about 38% for the quarter, due to the timing of a few state tax benefits. We continue to expect a full-year tax rate in the range of 39% to 39.5%.

Earnings per share was $1.15 for the quarter compared to $1.06 for the same period in 2015. Excluding the non-cash adjustments, EPS was $1.06 this year compared to $1.05 last year. We ended the quarter with $117.5 million of cash and no debt. We generated $14.7 million in cash from operations during the quarter compared to $30.7 million in 2015. The $16 million reduction to our cash from operations was the result of three primary drivers. First, $9 million was due to unfavorable timing of payroll, rent and cash tax payments in the quarter and the impact of our lease loss adjustment. $5 million was a portion of our initial $7 million payment to the sellers of the New York Code and Design Academy, which we are treating as a compensation arrangement and, thus, operating cash flow, due to the inclusion of a management callback feature in our acquisition agreement. And about $2 million is due to what I would characterize as normal variability in working capital, about half due to the slower payment on some of our new Strayer@Work contracts, and the other half related to growth and the redemption of graduation fund credits.

Notwithstanding the confluence of unfavorable cash flow events in the first quarter, the fundamentals of our historically cash generative model remain largely unchanged and, for the full year, we expect distributable cash to exceed net income as it has in the past.

And regarding capital expenditures, we spent $2 million during the first quarter compared to $2.8 million in the same period in 2015. The lower CapEx for the quarter is due to the timing of our projects this year, and we continue to expect full-year CapEx to be up slightly from last year in the range of 3% to 4% of revenue.

Finally, we continue to maintain $150 million in available credit on our revolver. Rob?

Thanks, Dan. Just one note on Karl's and Dan's comments. When you think about owners economics as opposed to GAAP reporting, in the first quarter, our actual owners economics were slightly worse than the GAAP income statement would suggest, due to the positive impact of the lower interest expense and lease loss adjustments. However, on cash flow, our owners economics were better than what the GAAP statement suggests for the reasons Dan outlined, I think the most important of which is the categorization of our investment in New York Code Academy as a reduction in operating cash flow versus an investment. And so they kind of balance out a little bit worse than income statement -- a little bit better, I think, significantly better than what the cash flow statement says.

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

(Operator Instructions) Jeff Silber, BMO Capital Markets.

Actually, I wanted to focus on the distributable cash. Obviously, it is moving in the right direction again, which is great to see. Can you just refresh us on your plans regarding capital allocation?

Sure, Jeff. We look at it every quarter as a board, and we have a fairly disciplined set of analyses we go through. Our first priority, which is based on what we perceive to be the highest return on owners invested capital, is to invest in the core business in areas where we can accelerate its growth and create both high academic and high financial return projects.

We haven't done a lot of capital investment in terms of expanding campuses over the last three years for the reasons that we have outlined. And at this point, I am not sure we see significant changes in the macroeconomic environment that would suggest that we would be opening a lot of Strayer University campuses.

The second thing we like to do is look for, again, high return investment opportunities. Over the last, I would say, 24 months, that market has looked more attractive to us than it has in the past, and I think the investment in New York Code Academy is probably the best example of that. And we could see some capital investment associated not just with the expansion of Code Academy, but other acquisition opportunities that we may come across.

As I wrote in my letter to shareholders, we are particularly interested in relatively higher growth education and training opportunities and ones which diversify us away from Title IV revenue for reasons that I think the recent history would support.

And then, in the absence of either investable opportunities within the business or acquisition opportunities, our plan is always to return capital to owners in the most value enhancing way. And at this point, we have not been a returner of capital over the last couple of years. We have seen some pretty significant, I think, opportunities like the Code Academy that we have been focused on, but we don't consider ourselves indefinite holders of our owners capital. If we cannot use it, we will return it.

Okay. Fair enough. I appreciate that. Just moving back to your operating performance. You mentioned the 13% decline in unaffiliated new students. Can we get a little bit more color on that where there are certain areas that were weaker than others?

Jeff, not really. The unaffiliated new student segment, what we said in the past is this is a segment of student who, historically, comes to us with no prior college experience, traditionally. They seem to be very sensitive to economic conditions around us. And, while we are not in a period of severe economic distress, we are also not in a period of great prosperity, particularly for that segment of students. And so for years, going back five-plus years, that particular segment of students has bounced around quite a bit, and it is well within the range that it has been.

A couple of years ago, when we started to really focus on furthering our national account work and standing up Strayer@Work, it was to begin to build cohorts of new students who traditionally have performed exceptionally well academically, very strong retention, and so forth, and that seems to be working. We are just under 1000 students with FCA and Degrees@Work.

That is Chrysler. Fiat Chrysler.

Fiat Chrysler. And our affiliate national account students has outperformed the broader university for going on three years in that channel. So we expect the unaffiliated channel to sort of remain consistent with its historical trend, but, as I said in my prepared remarks, we also expect that that is going to become a smaller and smaller set of each new student cohort that moves forward.

And how large is your total national account program now?

It is about 330 companies -- Fortune 1000 companies. And, on average, we get probably five to 10 new agreements every quarter.

And if we measured it as a percentage of students?

In total enrollment, it is probably around a third. It is approaching half of every new student cohort that we have.

Sara Gubins, Bank of America.

This is David Chu for Sara. Can you just update us on start trends by degree vertical for the first quarter?

Well, if you mean just undergrad and grad, JWMI was up 30% in its enrollment. Overall Strayer University, meaning non-JWMI graduate students, was flat, and so the decline was really, as I said, in the undergraduate segment.

Okay. Got it. And then, even adding for the contract expenses for losses on facilities, it looked like costs were down year over year in the first quarter. Do you still expect expenses to be up 1% to 2%?

Yes. And when we made the comment about expenses being up 1% to 2%, that excluded any of the investment that we will need to make to support the growth of New York Code and Design Academy. So I think that is still fair for the core university, 1% to 2% expense growth. And then as we invest to expand NYCDA, we will obviously report that in our consolidated financial statements and we will comment on it at the time.

Okay. And I am sorry if you mentioned this, but in regards to Strayer@Work, how many students are now enrolled and how does that compare to a quarter ago?

As I said, it is just under 1000 total students. We don't really have a comparable from a year ago, so it is all growth, and we expect that that is going to continue to grow each quarter.

Okay. And has this been launched nationally?

Yes.

And how long ago was the launch?

It has been launched nationally for just over a quarter, and it is going to have a natural maturation over some number of years. I can tell you the feedback has been very strong. The students perform well. The retention rates are significantly higher than our average students. The net promoter score is the highest in the university, higher even than the Jack Welch Management Institute, which, historically, has been our highest NPS score. So we couldn't be happier with that program.

And to be clear, Karl is referring specifically to the Chrysler program. We have other smaller Strayer@Work programs, and we are in pretty heavy dialogue to try and expand those and add to those as well.

Corey Greendale, First Analysis.

First, I apologize if this is a little bit of a remedial question, but could you give me a quick glossary on -- I want to make sure I am understanding the difference in the terms national accounts, affiliated, and Strayer@Work.

Sure. When we use the term affiliated, what we are referring to is students who are coming to us from a national account, a community college articulation agreement, and now Strayer@Work. Historically, it would not have included Strayer@Work, but that is just because the entity didn't exist.

To Rob's point, we expect over time, we could potentially have thousands of students coming to us from Strayer@Work and Degrees@Work type programs, and so that is going to obviously become a meaningful part of our new student cohorts moving forward.

Unaffiliated, by definition, then, are students who are not coming to us through an articulation agreement. We don't have an agreement with their employer, and they are obviously not a part of Strayer@Work in any way.

Corey, think of it as wholesale versus retail or B2B versus B2C. I mean, it is the same concept.

Okay. That helps. And are community colleges included within national accounts?

It is not included within national accounts, but it is included when we are using the term affiliated students. National accounts refers to the 330 agreements that we have with these companies. And when I say the national accounts has outperformed the broader university, I am speaking specifically to the employees of these 330 or so employers.

Okay. That helps. Thank you. And then, the New York Code and Design Academy, what was the revenue contribution from that in Q1?

We are not breaking that out yet, Corey. We are just going to report it as part of our consolidated financial statements.

I'm just trying to get a sense of what happens to revenue per student excluding that. So is it totally immaterial?

Yes. I mean, it is down about 1%. There was a slightly less tuition (inaudible) just based on the mix shift of slightly more undergraduate students, but we have better drops offsetting that. So all-in-all the 1% decline is roughly right.

I mean, we only had -- there was only a few hundred students in the term at Code Academy, Corey, so it is a positive impact, but I wouldn't describe it as material.

Okay. And then, I had a question for Dan, if I could. I understand what you're saying about the cash flow statement treatment of the consideration for NYCDA. Is there anything unusual about the income statement treatment, or is there a compensation kind of spread evenly as they are working?

No, it is consistent with what we said before, Corey. For the year, we are still looking at roughly 20% to 30% -- or $0.20 or $0.30 of dilution. Half and half operating, half the accounting treatment of the acquisition, which is non-cash.

And I think my last question is, on the marketing spend increase, can you give us some sense of how much of that is focused on the affiliated channels, or are you spending more to market to the unaffiliated as well?

The increase, really, Corey, was driven to expand marketing across not just Strayer University, but as I said specifically to support efforts like the Jack Welch Management Institute, Strayer@Work, and we are starting to do branding work for NYCDA now in anticipation of its national rollout.

We are always looking at ways to build brand. We are always looking at different channels within which to advertise. Sometimes you can get synergies between the core university and, say, Strayer@Work, but we are not -- I think to answer your question directly -- doing anything specifically to market to a particular part of an unaffiliated channel. That is just through our brand building. And as people become aware of Strayer University, that is where that brand building will go.

And, sorry. I actually did have one more. I think, Rob, in answer to one of I think it was Jeff's questions, or I could be misremembering, but you said something about looking for acquisitions that diversify away from Title IV, which makes sense. We are hearing similar things from probably most of the public companies in this space. Are you seeing more kind of competition for those things?

Well, we haven't been that active an acquirer over the last 15 years. So I am probably not the best judge of how competitive that market set is. But we have a pretty narrow aperture we are looking at. I mean, we want education and human workforce improvement type businesses that are characterized by great learning outcomes and strong management teams with a cultural fit. And I would say that that is not the broadest target set, which is one reason why the acquisitions have been relatively few and far between.

The biggest one before this had been our partnership with Jack Welch and the Jack Welch Management Institute. The next one was -- which, obviously, is a Title IV supported entity, but given Jack's tremendous reputation and our ability to source students that have their own sources of credit, has significantly reduced Title IV exposure in that area.

Next one, obviously, Code Academy for which there is no Title IV, so its growth will be totally non-Title IV. And the other entities that we are looking for will have similar characteristics, but I assume that there is -- the kinds of deals we are going to do are with people that specifically want to be acquired by Strayer Education because of our reputation and cultural background and the kinds of things that drive us and there may not be a lot of them, but we hope the ones that we have are very high quality.

Great. Thank you. That helps.

Peter Appert, Piper Jaffray.

I am just wondering if you can talk a little bit about any initiatives you have got underway, if there are some specific things to talk about because I am trying to stabilize the unaffiliated enrollments?

Well, our approach to new students is to focus on building a brand so that when people are contemplating returning to college, as part of their due diligence, they are going to consider Strayer University. The specific initiatives that we are focused on really revolve around our affiliated channel. That is one we are very actively trying to grow and build, and that is really a two-pronged approach. It is deepening the relationships that we have with national accounts, and that means expanding the numbers of arrangements we have and also the numbers of students that we get from each individual one. And there is a lot of work that goes into that, activating those relationships at a deep level. And we think we are aided in the fact that we have 78 physical locations, and within those communities, our campus staff members are able to network and make relationships at a local level with these various employers. So that is a big part of what we do.

The other thing is obviously Strayer@Work. We created what we consider to be a pretty groundbreaking program with degrees@Work. We have -- yes, Chrysler Automotive is the first customer. We expect that, over time, we will have thousands of students from that relationship. So, in terms of specific initiatives, that is where our management team is focused.

In terms of unaffiliated students, we obviously welcome them. We want to do a good job educating them. To the extent that we are building brand and advertising, it may or may not reach them, but in terms of a specific initiative to try to get more unaffiliated students, we are actually doing the opposite. We are trying to build the affiliate channel to be as big as we can get it.

But I would say, Peter, just to add one other thing is that, ultimately, the thing that is going to draw students is academic performance. So a fair amount of our investment is in constantly improving the academics and the learning outcomes, which is one reason why the increase in continuation rate and ultimately graduation rate we see as such a positive event. That, I expect, will ripple through reputationally, and I think it is positive on the unaffiliated side for the types of students that we want to attract.

No. Understood. So I guess, then, the arithmetic is that you continue to see very positive growth in the affiliated students to the extent that it is now half or more of your starts that offsets the decline in the unaffiliated. But this mix shift is basically going to continue, I think is the message.

Well, we hope the mix shift continues to more affiliated students. We expect that that will be the case, and we also expect that there will be quarters where the unaffiliated segment grows. That has happened in the past.

Right.

This particular quarter --

I'm sorry. Go ahead.

No, I was just going to say, the longer trend line will be to more affiliated new students and fewer unaffiliated students.

Although I would say I think it is somewhat macroeconomic dependent.

Right.

You get back to a situation where you have a higher level of baseline employment, greater consumer confidence, we -- for 120 years we have done pretty well with unaffiliated students, so I wouldn't see them going away. In the current macroeconomic environment, there is no question that the affiliated is a stronger source for us.

Well, I guess it is a certainly interesting observation on the arithmetic. To the extent that the affiliated students represent, I think you said, half or more of the new student cohort at this point, maybe we are close to that tipping point where the growth there should fully offset the decline on the affiliated -- excuse me, the unaffiliated students, which would get us to more consistent positive starts.

Yes. And just to clarify, I said the mix was approaching half of the new students, not that it is over half. And I can't predict, obviously, future enrollment, but I can tell you that our plan is that will be the case. The primary contributor to new student growth would be the performance of our affiliated channel.

Got it. And then, on the Code Academy, I am wondering if the rollout -- the national network, if there are some fairly meaningful cost implications associated with that. Is there significant -- should we anticipate significant startup costs as you enter new markets?

No, the startup costs will be quite low. For the most part, we will be using existing Strayer University facilities, meaning our campuses that requires virtually no change to the footprint. Really, the only startup expenses are a handful of people that are needed to teach the courses, maybe an administrator, so that the startup and operating expenses are actually pretty low.

(Operator Instructions) Trace Urdan, Credit Suisse.

I have another housekeeping question following Jeff's question. So when you say that Strayer@Work students are included in affiliated, does that mean non-degree seeking students as well?

No. Good question, Trace. It means students who are enrolled in Strayer University in a degreed program. There is other revenue at Strayer@Work that is non-degreed, and I am not including that in those comments.

But it does help on revenue per student. Yes, that is clear.

Yes.

Yes. And then, I guess, the NYCDA students will kind of fall into that same category. They won't be reported as students, but obviously we will see the revenue?

Yes. Correct.

Are you guys thinking about maybe starting to tease out non-degree revenues at some point as material?

Only to the extent that it would be material, and at this point, it is not.

Okay. Fair enough. Karl, I had the pleasure of seeing you present at the GSE conference. Very cool slides.

Thank you.

But one of the things you talked about was kind of upgrades to your content, and you haven't really talked about that very much in these investor calls. And I wondered if you could just sort of speak to that: where you are in that process, how relevant you think it is for your business going forward, whether it might actually be a driver at some point for demand? Can you -- yes?

Yes. Thank you. It is a big part of what we are planning for this year. So we are into a multi-year effort to really focus on outcomes and retention. And we started down a three-pronged strategy, Trace, really. And the first one was just really getting better at adaptive learning. So being able to deliver up highly personalized interventions to people, particularly early on in their first year, where the vast majority of attrition happens over a cohort's lifetime.

So we have been pretty successful at that. We have talked a lot, I think, about our use of predictive analytics. That was a game changer for us, too. We were able to really hone in on what drives both faculty engagement and student engagement, and that has been a big driver of the retention gains that we have had.

The third and final prong of that is to try to reinvent online learning, really. Online learning tends to be boring, dull, in some cases, and so we are creating an internal, what we are calling, studio. But it is really -- it is part filmmakers, part instructional designers, part faculty subject matter experts, to really redefine what an online course is, to use more short form documentary, nonfiction storytelling. Because what we know from our experience with adaptive learning, if students will just take the time to interact with the material, they, by and large, are very successful.

The problem is, the material has not sort of kept up -- the quality and engagement of the material has not kept up with the advancement in analytics and adaptive learning, and we are trying to address that by really creating very immersive content.

We have done a couple of courses as tests, and the results have been really positive. We have seen retention gains in excess of 500 basis points when we have run these tests, so we think that there is a lot of opportunity here. And it will be the primary focus of our academic leadership team over the next 12 to 18 months to take every one of our high-volume courses and build it with this sort of storytelling arc and really try to redefine what an online course even is.

It doesn't sound cheap. Is there some impact on your CapEx that we might see as you sort of embark on this?

It will all be part of what we expect to be our normal spin on CapEx. We think we're going to be able to produce these courses in a very economic way. And when you are leveraging talent across 10 or 20 or even 30 very high-volume courses, the actual cost per course is not that significant. And so we are just looking forward to getting them rolled out.

Although, to be fair, our CapEx is up about 50% over last year.

For the quarter, it is not. It is actually down. But for the year, we still expect higher CapEx, Trace, than last year by a few million dollars.

Most of which is associated with the Strayer studio. So it is a good question, Trace.

Okay. And then, last question, is there any way that we can see some of this stuff online somewhere?

You can certainly enroll.

You know, when we get to a point where we are going to roll one out, we would be happy to do a demonstration for you, Trace. Happy to let you kind of see what we think a course could look like. The team is working on the first one. It is an introductory business course. It is kind of, let's say it is in the early 10% done range, but we are hoping to have it done before the end of this year in time for our fall term, and we would love to give you a demonstration of it.

Okay. Excellent.

I am showing no further questions. I would like to turn the call back to Robert Silberman for closing remarks.

Thank you, operator, and thank you, ladies and gentlemen. We will look forward to talking to you again in July and, of course, if you have any other questions, please contact Karl, Dan, or myself. We are happy to discuss the quarter. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.