Strategic Education Inc (STRA) 2017 Q4 法說會逐字稿

Good morning, everyone, and welcome to Strayer Education, Inc.'s Fourth Quarter 2017 Earnings Results Conference Call. This call is being recorded. For those of you who wish to listen to the conference 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 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 this 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 go ahead.

Thank you, operator, and good morning, ladies and gentlemen. We have a fair amount of material to cover today, but I did want to make a couple of brief opening remarks from my perspective before turning it over to Karl and Dan.

First, with regard to our pending merger with Capella Education Company, we are executing on all of the key transaction milestones. In November, we received our FTC and Hart-Scott-Rodino approvals. On January 19, 2018, both companies received their respective shareholder approvals for the transaction. Last week, the U.S. Department of Education issued its pre-acquisition review of the transaction without any material conditions. And finally, Capella University has submitted its application for its change of [control to] its regional accreditor, the Higher Learning Commission. So consistent with our announcement of last November, we appear on track to close the transaction in the third quarter of 2018.

Now Karl will have more details on the status of our actual integration activities, but let me just say, from my perspective, what a pleasure it has been working with Kevin Gilligan and his team. As I mentioned at the time of the announcement, we have long been admirers of Capella's academic model and student performance, but we are even more so now after seeing the university up close and having the opportunity to work hand in hand with such a dedicated group of educators. After the last 6 months, it is certainly no wonder to us as to why Capella University is held in such high regard by both the Higher Learning Commission and the U.S. Department of Education.

The second general point I wanted to make with regards to this morning's earnings release is that due to both the Cappella transaction and the recently passed federal tax bill, we are introducing in this release some adjustments to Strayer Education's financial statements. Nothing out of the ordinary or difficult to understand, but Dan will walk you through the detail of these adjustments to get from our reported GAAP results to what I call our core owner's economics.

These adjustments fall into 2 categories. The first is a large noncash book increase to our 2017 tax rate to adjust our deferred tax asset to the new lower federal corporate tax rate. And then the second category are nonrecurring cash expenses associated with both the costs of executing our merger with Capella Education Company as well as costs to achieve the reduction in expenses made possible by the merger. These costs began in the third quarter of 2017, grew significantly in the fourth quarter of 2017 and will extend throughout 2018 and 2019 depending on the timing of the close of the transaction. Of course, after the close, in addition to these adjustments, we will also have some noncash amortization of intangible expenses.

To summarize at a high level, in terms of owner's economics, the cost savings which accrue from combining 2 such similar public companies as Strayer Education and Capella Education, along with the new lower corporate tax rate, will significantly increase our company's per share cash earnings in the future. However, in the short term, these increased cash earnings per share will be partially offset by severance and transition costs. And of course, the noncash amortization of intangibles will have no impact on the cash earnings per share.

Finally, the last point I wanted to make with regard to this morning's earnings release is to underscore, from my perspective, the importance of our decision to reintroduce investments in new campus openings for Strayer University in 2018. Karl will give you more details, but we are very excited to be in a position to put your capital to work again in expanding Strayer University to serve more students.

And with that, let me turn it over to Karl for more detail on our operating results. Karl?

Thank you, Rob. Good morning, everyone. I'd like to begin this morning by offering a bit more detail on our integration planning for our pending merger with Capella Education Company.

At this stage, our primary focus is to plan for the integration of the various corporate functions in both companies, specifically IT, finance, legal and HR. Functional teams have been established with representatives of both companies to work through detailed plans. Our current expectation is that these plans will be finalized by the second week of April. And during our planning phase, a primary focus of both companies is to avoid any disruptions to our current performance and to minimize the disruptions to our teams. And like Rob, I'm very pleased with where we are in terms of the planning and appreciate the level of collaboration and professionalism on part of both companies.

Next, I'd like to expand a bit on our plans to return to opening new campuses. Our new campus in Macon, Georgia will be the first new campus we've opened since 2012, and we plan to open an additional 2 to 4 campuses during the balance of 2018, subject to regulatory approvals. These new campuses will be in our new Campus of the Future format, which we've been testing over the past 18 months. This new format differs significantly from our legacy campus model, in which we opened from 2001 to 2012, in several ways.

First, the campuses require approximately 70% less investment capital to open and are designed to reach operating breakeven at roughly 50 students compared to 300 students in our legacy model. And as more of our students continue to prefer taking their classes online, we've been able to design a physical space that's significantly smaller at 3,000 average square feet compared to 15,000 to 20,000 square feet in the legacy model. And as such, they require a staff of only 3 to 5 people compared to 15 to 20 people in our legacy campuses. So we look forward to announcing the specific locations as they open throughout the year.

Turning next to our enrollment results for the fourth quarter and our outlook for the first quarter of 2018. Our fourth quarter total enrollment, which represents teaching our fall academic term, grew 6% versus the prior year, and our new students grew 4%. Our current outlook for the first quarter is for both new and total students to grow 6% versus the prior year.

And lastly, I wanted to provide some detail on our fourth quarter revenue and revenue per student. Notwithstanding the 6% increase in enrollment growth I just mentioned in the fourth quarter, our actual revenue declined 48 basis points versus the prior year. So our 6% enrollment growth was entirely offset by just over a 6% decline in revenue per student. Some of this decline was planned and expected as our Degrees@Work program continues to grow and as more of our total student population enrolls on our lower undergraduate tuition. However, approximately 500 basis points of this decline was due to a special set of scholarship programs we implemented during the fourth quarter in response to severe weather that impacted significant portions of our campus footprint, most notably Texas, Florida and the broader Southeast United States. These programs were onetime in nature, are no longer being offered anywhere in the university.

I should note, however, due to the multi-quarter nature of these scholarships, they will contribute to a small decrease in revenue per student in 2018 of approximately 1% to 2%. When combined with our planned decrease for 2018, we anticipate that total revenue per student will decline approximately 3% for the full year of 2018, assuming our current enrollment trends continue. Notwithstanding that reduction in the first quarter revenue per student, our current forecast shows that we will have revenue growth again in the first quarter of 2018.

And with that, I'll turn it over to Dan to cover our financial results in detail. Dan?

Thanks, Karl, and good morning, everyone. I want to start by orienting you to the new reporting format that Rob referenced. You'll note that our earnings release and 10-K now reference as-reported or GAAP results and adjusted or non-GAAP results. And as Rob indicated, this new format is intended to illustrate both the financial performance of the core business, which is reflected in the adjusted numbers, and our GAAP results, which in the near term will reflect the impact of 3 events: first, our ongoing merger with Capella and the associated transaction and integration expenses; second, the ongoing adjustments to the fair value of liabilities on our balance sheet, including leases on facilities we ceased using in 2013 and contingent liabilities associated with our NYCDA acquisition, which have been reduced to 0 at this point; and third, as Rob mentioned, the impact of the new tax law that was passed in the fourth quarter.

To provide this additional visibility, we are including in our latest disclosures new operating income and EBITDA reconciliations, with 3 columns illustrating the impact of each of these events on our reported GAAP results. We plan to continue with this format moving forward, albeit with refinements along the way.

Now for the results. I'll start with revenue, which for the fourth quarter was down slightly to $118.7 million compared to $119.3 million in Q4 2016. As Karl just mentioned, our revenue per student for the quarter was down 6% due in large part to a scholarship program we launched in response to widespread hurricane disruptions across much of our geographic footprint.

Our GAAP income from operations was $11.7 million for the fourth quarter compared to $19.7 million for the same period last year. GAAP income from operations in Q4 2017 includes approximately $8.5 million in merger-related costs. Excluding these costs, our adjusted income from operations for the quarter increased 10% to $20.2 million compared to $18.4 million in 2016. Adjusted income from operations in Q4 2016 excludes a $1.3 million noncash benefit associated with an adjustment to the value of contingent consideration for NYCDA.

Our adjusted operating margin was 17% for the quarter compared to 15.4% in 2016. We are reporting a net loss of $6.5 million in the fourth quarter, which is primarily the result of a $11.4 million noncash charge to Q4 taxes, associated with the reduction in value of our deferred tax assets due to the recently lowered federal corporate tax rate. Excluding this charge as well as the merger costs, adjusted net income for the fourth quarter grew 18% to $12.3 million compared to $10.5 million in 2016.

Our GAAP net loss per share for the fourth quarter was $0.61 compared to diluted earnings per share of $1.07 for the same period in 2016. Adjusted earnings per share grew 15% to $1.09 compared to $0.95 in 2016. And our diluted weighted average shares outstanding increased to 11,273,000 from 10,971,000 for the same period in 2016.

Our bad debt expense was 5.8% in Q4 compared to 4.6% last year. Bad debt in 2017 was impacted significantly by an anomalous increase in the proportion of our students selected by the Department of Education for Title IV verification. We expect this problem to recede in 2018 as the department recently indicated they are adjusting the verification algorithm back to normal levels.

Moving on to our full year 2017 results. Total enrollment for the year was up 6%, while average revenue per student declined by about 3%, contributing to a 3% increase in total revenue to $454.9 million. Our GAAP income from operations was $52.2 million for the year compared to $57.5 million in 2016.

Adjusted income from operations increased 4% to $56.6 million in 2017 from $54.3 million in 2016. Adjusted operating margin for the year was up slightly to 12.4% compared to 12.3% last year.

GAAP net income was $20.6 million for the year compared to $34.8 million in 2016. Adjusted net income increased 8% to $34.9 million in 2017 from $32.3 million in 2016. GAAP diluted earnings per share for 2017 was $1.84 compared to $3.21 last year. Adjusted diluted EPS increased 4% to $3.11 compared to $2.98 last year. Diluted shares outstanding for 2017 increased to 11,199,000 from 10,845,000 in 2016.

As discussed earlier, our income tax expense in 2017 includes a charge of $11.4 million resulting from a reduction in the value of deferred tax assets due to the lower federal corporate tax rate passed into law during the fourth quarter. Notwithstanding this onetime charge, we expect meaningful cash tax benefit from the new federal tax rate and are projecting a 2018 effective tax rate of approximately 25% to 26% on an adjusted basis, which excludes the impact of merger costs that are largely nondeductible. On an as-reported or GAAP basis, we expect our effective tax rate in 2018 to be in the range of 27% to 28%, reflecting the impact of nondeductible merger costs.

Our effective tax rate will vary from quarter-to-quarter due to the timing of stock-based compensation vesting and variability of merger costs. We are projecting an effective tax rate of between 21% and 22% in the first quarter of 2018 on an adjusted basis, excluding the merger costs. The Q1 tax rate is lower than our full year projected tax rate due to higher book tax deduction associated with employee stock vesting at values that exceed the original grant prices. Recall that we had a very -- we had variability in our tax rate in the first quarter of 2016 and 2017 for similar reasons.

And finally, regarding our Q1 2018 outlook, as Karl indicated, we expect enrollment growth of approximately 6% for the quarter, revenue per student declines of about 5% and positive revenue growth for the quarter. For the year, we are estimating revenue per student decline of approximately 3%. And for the first quarter operating expenses, not including merger or other onetime expenses, we're estimating total operating expenses of approximately $101 million.

Rob?

Thank you, Dan. One more comment before we open it up for questions. At this time of year, we always like to run through at a high level and comment on our capital allocation decisions of the prior year.

We started 2017 with $129 million of cash on our balance sheet and no debt. Even after spending the roughly $12 million that Dan and Karl mentioned on the Capella deal expenses in 2017, Strayer Education generated $82 million in pretax cash from operations during the year.

We used that $82 million as follows. We paid $26 million in federal, state and local taxes. And as I mentioned before, that number is likely to go down significantly under the new tax bill in the future. We invested $18 million in capital expenditures, most of which was concentrated in the technology area. And we distributed $11 million in dividends to our owners, leaving an additional $27 million, which was added to our balance sheet, bringing our total cash and cash equivalents at year-end 2017 to $156 million and no outstanding debt.

We have a rock-solid balance sheet, which could be made even stronger by the Capella acquisition, providing us with significant opportunities to invest in our students' experiences in the future.

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

(Operator Instructions) And our first question comes from Peter Appert of Piper Jaffray.

First, on the merger, I'm just wondering if you could give us an update on your confidence around the visibility on the cost synergies you've outlined previously, if the numbers have changed at all.

No. Our estimate of synergies has not changed, and we're about, I'd say, 1/3 of the way through our detailed planning. And I would say even at this early stage, we have pretty good visibility. And so none of our estimates when we made the announcement have changed at all.

Got it. And is the expectation that HLC will consider the merger at their June meeting?

That is our understanding. We've made the application -- or I should say that Capella has made the application. A site visit was conducted here in Herndon, Virginia with representatives of both Capella and Strayer. And our understanding is they will consider it at their June meeting.

Which conceptually -- not to put you on the spot here or anything, but that would imply that perhaps a July closing is realistic.

A July closing would be realistic if HLC acts and approves the transaction during their June meeting.

Got it, understood. And then can you talk a bit about the -- a bit further about the decision process around new campuses and the economics of new campuses? What's driving your decision to step up campus openings again?

Well, Peter, let me talk about the decision process and then ask Karl to comment on the economics. When we stopped opening campuses in 2013, we said at the time that what would be required for us to reinitiate investing in campus openings was really 2 things. One was a firming of the economy such that our ability to attract students, particularly at the bachelor's level, in new markets was such that the investment in the new campus could recover and create a positive return within a reasonable period of time. And then the second thing was a more stable regulatory structure, one which we could plan around that was somewhat less adversarial. I think both of those circumstances are now in place over the last 12 months. We're very excited about the firming of the economy. The lessening of the reduction in labor participation rates, they haven't really started to grow yet, but they haven't been shrinking for at least the last 24 months. And so when we see that, I think some of that's reflected in the strength of our enrollment. Our view as a board was that it was time to get back into the investment mode and expand our brand in a way that allows us to build the university. Karl, why don't you run through sort of the economics on the near-term basis?

Yes, sure. So in our legacy campuses, it basically required about $1 million of capital to open, and then that campus would require roughly 300 students to break even, which typically would take up to 3 years. This new format, given its size and staffing model, what have you, is designed to require only about $0.25 million of CapEx. It requires only 50 students, not 300, to break even. And just to put a little context around that, on average, almost all of our campuses generate about twice that in any 1 quarter. So the breakeven amount is half of what a campus does in a quarter. You need that level over the course of a campus' first year to achieve essentially 1-year payback. I think the most important point, though, is that when we look at academic and retention metrics for campus-based students versus out-of-area students, across the board, every metric that we care about is substantially better for the campus-based students. Even amongst campus-based students who are taking their classes online, that remains true. And our view is the campuses help us get students who appear to be more serious about their education given that they perform at significantly higher levels. So the physical footprint we know is quite important, and given the vastly improved economic metrics designed around a new campus, we think it makes a lot of sense, to Rob's point, to continue to open them.

Right, understood. And just one last question maybe for Dan. Should we be thinking about any implications around the financial responsibility score in the context of the charges and incremental costs you're going to have to take? Will that have any bearing on the score?

No, we don't expect it to have a significant negative impact on the financial composite score.

Well, to be more specific, we expect to be at 3.0 for both universities going forward. So...

And our next question comes from Jeff Silber of BMO Capital Markets.

Wanted to go back to the decision to open up a new campus. I'm just curious why Macon. What are the type of criteria that attracted you there? What will you be looking for, for new locations going forward?

Yes. Macon is a market that we've looked at for some time. It's got the demographics that are favorable, we think, to new campus openings in terms of educational attainment, income level, so forth. It's somewhat adjacent to Atlanta, which enables us to scale media dollars a little bit. So moving forward, our team has looked at between 50 and 100 MSAs around the United States. I think we will try to concentrate, in 2018 anyway, in existing states, meaning states where we already have campuses, and maybe similar to Macon, in areas where we might be able to extend media dollars by trying to locate somewhat close to existing Strayer University markets. And as we said in our release, we plan to open between 3 and 5 of them this year.

And in states that you have retrenched from, are you -- is your licensing still available? Can you easily enter some of those new states?

It kind of depends on the state, Jeff. Some of them will have lapsed, and we'd have to reapply. Others, the license is still good.

Okay. And then just shifting gears to the merger, can you just remind us what the milestones we need to be watching for going forward?

Well, there's really only one left, and that's the North Central -- the Higher Learning Commission approval of Capella University's change of control. Everything else is basically done. So that's, for us, one to keep an eye on.

Okay, great. And then you mentioned the potential for -- I guess you used the word meaningful cash tax savings from the tax reform. Can you describe what meaningful is and what your plans are for that cash?

Jeff, in 2018, we're estimating, call it, $6 million to $8 million of cash tax savings from the lower federal tax rate.

Yes. And the other thing I would say is that Capella's income statement looks a lot like ours. And so we expect that there's significant savings -- tax savings -- cash tax savings for them as well. So on a combined basis, it's well in excess of $10 million. In terms of the use of that capital, Jeff, it really goes into the overall planning process that we do with regard to all investment decisions. The first thing we look at is investments in our universities because over time, that's proven to have the highest and most sustainable long-term returns. And then the next -- and by the way, new campus openings, we consider part of that process. And then after that, we want cash available for other investments outside of the existing universities that may lend themselves to us. And then finally, for cash, which is truly in excess of what we need to support and grow the universities, we'll look for ways to return that to owners in the most value-enhancing way. So it -- there won't be any difference in the decision process for the incremental dollars that come from tax savings than it does for any other cash that we generate.

Got it, okay. And then just a couple of numbers questions, I guess, for Dan. You had mentioned the effective tax rate to be 21% to 22% in the first quarter. Would that be the same thing for the GAAP tax rate?

The GAAP tax rate will be a little bit higher because again, we -- on an adjusted basis, we can't deduct some of the transaction-related costs, but it's not going to be much higher.

Okay, great. And then what's -- I'm sorry, what should we be modeling for capital expenditures for this year?

4% to 5%.

(Operator Instructions) And our next question comes from Corey Greendale of First Analysis.

First, a couple of follow-up questions on the expansion, geographic expansion. In terms of the way you're talking about it, should we be thinking that's sort of the function of a physical campus and what the activities that take place on that campus are different than what they were under the old model, like can students take a lot of classes in person there? Or is that not going to be offered?

The -- on-ground classes will be offered, but over the last 5 years, student preference has really shifted quite significantly to online. And that's true in cases where both one particular class would be offered on ground and online. In cases like that, more and more students are choosing online. The legacy campuses would have anywhere from 10 to 15 classrooms. These new campuses probably will only need 2. And so yes, there'll be some on-ground instruction, but we're anticipating that student preference will continue to prefer online. Everything else, you would be able to do in this new campus format. So obviously, you can come in, you can talk to the staff members, you can enroll. We probably will have a very small computer lab as we do in our existing campuses today. So really, the only change is going to be the number of classrooms.

Okay. And going back several years when you used to report separately on-campus and online enrollment, I think the way it worked, if you opened a new campus and there were students who are within -- I can't remember if it was 50 miles or something of that campus, you shifted them into the online. So the reason I'm asking that is, when you talk about 50 students to reach breakeven, are you looking in places where there are already a significant number of online students in those areas, so you'd hit that 50 pretty quickly potentially?

Yes. The one clarification is we would shift the other way, Corey. We would take students that we reported as online and shift them to the campus. But Karl, go with...

Sorry, I misspoke.

Yes.

Yes. Corey, if you would have just looked at our -- what today is considered out of area, a significant portion of them reside in the Southeast United States. So they would likely be in areas where we would be opening new campuses.

And just as far as how we're thinking about breakeven, if I am thinking about it the right way, that if there's like 30 people within however many miles of Macon, that those count toward the 50, as you're thinking about it?

No, it's all incremental is our anticipation, Corey.

It's all incremental?

Yes.

Okay. All right, fine. Sorry. And then any early -- given the way you're talking about physical locations, any early thoughts on whether it would make sense to add physical locations for Capella? And if so, what would be the reasons to or not to collocate those with Strayer locations?

It's an interesting concept that we have discussed with our counterparts at Capella. We, obviously on the Strayer side, have seen a significant value from having physical campuses. So it's something that we'll continue to explore with our counterparts over there, and it may be something that we look quite seriously at in the future.

Okay. If I could ask you a couple more, I'm not sure if anyone else is waiting in the queue, but if too many, I can get back in. But on a couple of things from -- in the K, maybe just an easy numbers question. It says in the K that you would expect, just kind of given current trends, that operating expense would be up slightly in 2018. I just want to clarify, is that up slightly off of as-reported OpEx in 2017 or excluding nonrecurring items in '17?

That's excluding all of the nonrecurring, so on an adjusted basis, Corey.

Okay. And in terms of the numbers that were in the proxy, did those contemplate new campus openings?

The 5-year projections?

Correct.

Not significantly, no. The Macon campus, yes, but not much beyond that.

So is there anything in terms of what you're announcing today or what you've seen over the past couple of months that would make you think those projections would shift?

I think those projections were done at the time for the proxy, and at this point, our plans are changing. So I wouldn't assume too much from those projections.

And the other thing I would say, Corey, is that these are much smaller units. So they're quite positive investments, but they are individually not going to move the needle significantly. And over time -- over the 5-year period, we could do enough that there could be a meaningful difference, but we haven't really gone beyond the planning for next year.

Okay. And I apologize, there's a couple of other quick ones, if I could be -- I realize walk before you run. But in terms of sort of looking at addressable market for these smaller footprint campuses, I think, Karl, you said your team looked at 50 to 100 MSAs. Is that like potentially the number that could open eventually? Or what are your thoughts on that?

I mean, it depends on the time horizon, Corey. Over a decade, yes. We want to get these 3 to 5 under our belt. We've already tasked a team to be thinking about the number and locations for 2019. So we'll have more to report on that as we get through the balance of this year.

Okay. And then the last question I had. Also, from the K, it looks like the trends in undergrad-versus-grad enrollments are pretty divergent. Just I would love to hear your kind of macro thoughts on why that is. And do those factors normalize at some point?

Well, I'd say at the highest level, we continue to see a very strong performance at the undergraduate level. If you look at most quarters over the trailing 12 months, undergraduate -- new undergraduate enrollment has grown 15% to 20%. We have continued to see a decline in overall graduate enrollments, albeit excluding JWMI. When you look at Jack -- the Jack Welch Management Institute alone, that continues to grow 30-plus percent per year, and they're getting to be a sizable-sized institution now at 1,700 students. So we're very pleased by its growth. The graduate market as a whole is one that we know has a high degree of competitive intensity. Part of the rationale for the transaction with Capella was they're quite strong in that area. So we help -- we hope and believe that once approved, that the transaction, on a combined basis, will help continue to grow the graduate-level education. But for us, it's really been a story of we have considerable strength at the undergraduate level. We have a unique program in JWMI that continues to grow. And we're going to continue to work on this transaction and believe that, over time, the graduate programs will grow.

And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Mr. Silberman for any closing remarks.

Thank you, operator, and thank you all for participating. We look forward to communicating with you. If you have any questions on the financial statements, please contact us. Our objective is to be as transparent as possible as we are sort of changing the nature of the organization with this transaction. And we look forward to communicating again in May on our second quarter conference call. Thank you very much.

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.