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Edited Transcript of STRA earnings conference call or presentation 1-May-19 1:00pm GMT

Q1 2019 Strategic Education Inc Earnings Call

ARLINGTON Jul 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Strategic Education Inc earnings conference call or presentation Wednesday, May 1, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel W. Jackson

Strategic Education, Inc. - Executive VP & CFO

* Karl McDonnell

Strategic Education, Inc. - President, CEO & Director

* Robert S. Silberman

Strategic Education, Inc. - Executive Chairman of the Board

* Terese Wilke

Strategic Education, Inc. - Manager of IR

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Conference Call Participants

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* Corey Adam Greendale

First Analysis Securities Corporation, Research Division - MD

* Peter Perry Appert

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to Strategic Education's First Quarter 2019 Earnings Conference Call.

I will now turn the call over to Terese Wilke, Manager of Investor Relations for Strategic Education. Ms. Wilke, please go ahead.

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Terese Wilke, Strategic Education, Inc. - Manager of IR [2]

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Thank you, Ashley. Good morning, everyone, and welcome to Strategic Education's conference call in which we will discuss first quarter 2019 results. With us today to discuss results are Robert Silberman, Executive Chairman for Strategic Education; Karl McDonnell, President and Chief Executive Officer for Strategic Education; and Daniel Jackson, Executive Vice President and Chief Financial Officer for Strategic Education. Following remarks, we will open the call for questions.

Please note that this call may include forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The statements are based on current expectations and are subject to a number of assumptions, uncertainties and risks that Strategic Education have identified in today's press release that could cause actual results to differ materially. Further information about these and other relevant uncertainties may be found in Strategic Education's most recent annual report on Form 10-K, the 10-Q to be filed this week and other filings with the Securities and Exchange Commission as well as Strategic Education's future 8-Ks, 10-Qs and 10-Ks. Copies of these filings and the full press release are available for viewing on the website at strategiceducation.com.

And now I'd like to turn the call over to Rob. Rob, please go ahead.

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Robert S. Silberman, Strategic Education, Inc. - Executive Chairman of the Board [3]

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Thank you, Terese, and good morning, ladies and gentlemen. Q1 was a pretty straightforward quarter, not a lot to add from my perspective but a lot of information.

So let me just turn it over to Karl and Dan for details on our operating and financial results. After which, we'll stay for as long as you have questions. Karl?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [4]

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All right. Thank you, Rob. Good morning everybody. We were very pleased with our first quarter results that we announced this morning. Our operating and financial results are incredibly solid, and our merger integration remains on track to be completed this year.

First, regarding our financial results. On a pro forma year-over-year basis, the company generated a 31% increase in net income, resulting in $0.38 of additional earnings per share. That performance was the product of solid revenue growth of 8%, combined with operating expense growth of just 2.4%. Our $198 million of operating expense was net of $7 million of realized merger synergies in the first quarter. This resulted in a 38% increase in operating income, and our operating margin expanded 430 basis points. The operating margin expansion consists of 300 basis points as a result of merger synergies and 120 basis points from improved productivity in the business.

Within our segment, Strayer's operating margin increased 390 basis points, and Capella's increased 330 basis points. Our operating results remained quite strong at both Strayer and Capella Universities where new student enrollment increased 13% and 15%, respectively, while total enrollment increased 11.5% at Strayer and 3.5% at Capella.

Capella's FlexPath programs continued to perform exceptionally well, with new FlexPath enrollments increasing 52%, while total FlexPath enrollments grew 43%. FlexPath enrollments now represent 1/3 of all nondoctoral student at Capella.

Strayer University opened 2 new campuses in the quarter: 1 in Fort Worth, Texas; and the other in Mobile, Alabama. And the university remains on track to open an additional 4 to 6 new campuses in 2019 pending regulatory approvals.

Capella's first student support center will open in Atlanta, Georgia in the second quarter, while its second new location in Orlando, Florida will now open in the third quarter.

And finally, our merger integration remains on track to be completed this year. In the first quarter, we implemented run rate synergy savings of $13 million, bringing our cumulative total run rate savings to $37 million. Merger integration expense was $7 million for the first quarter, and we expect an additional $8 million as the integration expenses spread mostly evenly through the second, third and fourth quarters of 2019. And while I think it's likely we will continue to generate merger-related savings in 2020, the initially communicated $50 million synergy target will be achieved this year.

There continues to be widespread enthusiasm and collaboration across our organizations as our teams work together and deepen our best practice sharing. And again, I would like to thank and commend all of my colleagues across SEI for the tremendous commitment to our students and for all of their efforts that went into producing these results this morning.

Dan?

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Daniel W. Jackson, Strategic Education, Inc. - Executive VP & CFO [5]

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Thank you, Karl, and good morning, everyone. First, I want to remind everyone that our consolidated results include 3 segments: the Strayer University segment, consisting of Strayer University and the Jack Welch Management Institute; the Capella University segment, consisting solely of Capella University; and the nondegree program segment, which includes our coding boot camp businesses and Sophia. Note also that our consolidated results exclude the financial results of Capella Education Company that occurred prior to August 1, 2018.

For a pro forma view of our first quarter 2019 segment-level results, please see the first quarter earnings release slide deck posted to the Investor Relations section of our website.

I also want to remind everyone that our earnings release references as reported or GAAP results and adjusted or non-GAAP results. This format is intended to illustrate the financial performance of the core business as reflected in the adjusted numbers, in addition to our GAAP results. Our adjusted results exclude amortization expense related to Capella assets acquired in the merger, transaction and integration costs associated with the merger, income from investments in partnership interests and certain discrete tax adjustments. Please refer to the non-GAAP financial information included in the first quarter earnings release we issued this morning for additional information.

In addition, as we commence our first full year as a combined company, we are simplifying the presentation of our income statement to better align our financial reporting with how we think about expenses operationally. Instructional and educational support and admission advisory expenses are now combined under instructional and support costs, and marketing and general and administration costs are now combined under general and administration. We will include in our 10-Q later this week a detailed illustration of how our previous expense line items map to the new line items.

Now for a few comments on our consolidated Q1 results. SEI's revenue for the first quarter of 2019 was $246.5 million compared to $116.5 million in 2018. Our adjusted income from operations for the quarter was $48.3 million compared to $16.7 million for the same period in 2018. Our adjusted operating margin for the quarter was 19.6% compared to 14.3% in 2018. Approximately 75% of our Q1 general and administration costs related to marketing investment compare to about 65% in Q1 2018.

Our first quarter 2019 adjusted operating income excludes $15.4 million of amortization expense related to intangible assets acquired in the merger and $7.2 million in merger-related costs. First quarter 2018 adjusted operating income excludes $5.3 million in merger-related costs.

First quarter 2019 adjusted net income was $36.7 million compared to adjusted net income of $13.9 million for the same period in 2018. And adjusted diluted earnings per share was $1.66 compared to $1.23 in 2018.

Our adjusted effective tax rate for the first quarter of 2019 was 27.5%, which excludes amortization of intangible assets, merger costs, income from partnership interests and a onetime book tax expense associated with the elimination of our deferred compensation plan. We continue to expect our adjusted effective tax rate for the second quarter and full year 2019 to be approximately 27.5%.

Moving to our first quarter segment results. Strayer University segment revenue for the quarter increased 11.1% to $128.1 million from $115.3 million driven by higher first quarter enrollment and stable revenue per student. For 2019, we continue to expect revenue per student for the Strayer segment to decline between 50 and 100 basis points on an annual basis due to continued use of scholarships and the continued mix shift to lower-paying corporate-sponsored students. Strayer University segment income from operations for the first quarter increased to $25 million from $18 million last year, and operating margin improved to 19.5% for the quarter compared to 15.6% in 2018.

Capella University segment revenue for the quarter was $114.7 million, reflecting higher enrollment and increased revenue per learner. For 2019, we expect flat to slightly higher revenue per learner at Capella University, reflecting tuition increases that commenced in July 2018, offset by continued mix shift to our lower-cost FlexPath programs. Income from operations for the Capella segment was $24.2 million for the quarter, and the operating margin was 21.1%.

Q1 2019 revenue for the nondegree program segment increased to $3.8 million from $1.2 million last year mainly due to the inclusion of revenue from DevMountain, Hackbright Academy and Sophia. Loss from operations was $800,000 compared to a loss of $1.3 million in the same period in 2018.

Moving to the balance sheet and cash flow. We generated $58.7 million in cash from operations during the quarter compared to $17 million during the first quarter of 2018 and ended the quarter with $420.7 million of cash, cash equivalents and marketable securities and no debt. Bad debt expense for the first quarter was 5% of revenue compared to 5.5% for the same period in 2018.

For capital expenditures, we spent $8.8 million during the first quarter compared to $4.2 million in 2018. And for the full year 2019, we continue to expect capital expenditures to be between $40 million and $45 million.

And finally, we continue to maintain $250 million in available credit on our revolver.

Rob?

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Robert S. Silberman, Strategic Education, Inc. - Executive Chairman of the Board [6]

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Thanks, Dan. With that, operator, we'd be pleased to answer any questions.

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Questions and Answers

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Operator [1]

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

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Peter Perry Appert, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [2]

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To start, performance continues to be very impressive. Capella -- for Capella, obviously, I assume it's the FlexPath. But for the Strayer University, anything you would call out in terms of the either programmatic offerings, marketing programs, et cetera, that are driving the start performance and your thoughts on the sustainability of it?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [3]

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Sure, Peter. The only thing that I might call out that would be different than our last quarter, we continue to open new campuses on the Strayer side, and all of those new campuses are performing well. As with the case last quarter, we still see pretty sound macro conditions. So I think just a strong fundamental economy combined with continuing to open physical locations on the Strayer side is clearly aiding us on new student growth.

On sustainability, as you know, we don't provide forward guidance. But as I said, the macro conditions are quite favorable right now, and so we're optimistic heading into the rest of the year.

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Peter Perry Appert, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [4]

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Got it. And then, Karl, the continuing student -- continuing enrollment growth at Capella, how do I interpret that? Is this just a function -- the fact that, that's significantly lower than the new enrollment growth that you've seen for the last several quarters, is that just a function of shorter programs? Or anything else I should know?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [5]

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Are you referring to their total enrollment, Peter?

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Peter Perry Appert, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [6]

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No. I'm looking at the continuing enrollment was up 0.7%.

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [7]

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Yes. It is a function of a mix shift to FlexPath where, in some cases, particularly in the nursing program, students are getting through those programs in 12 months, 14 months. And so over time, as Capella's new student enrollment continues to grow, I suspect that the continuing students will increase, but that will be offset to the extent that FlexPath is one of the primary drivers of growth because students are getting through those programs so much quicker.

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Peter Perry Appert, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [8]

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Understood. And is there a significant difference in student acquisition costs for the FlexPath offering versus traditional offerings? And therefore, with the margin profile, that offering would be different?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [9]

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No. They're relatively similar. A fair number of FlexPath enrollments, again, particularly nursing, come through corporate channels where there's a relatively low acquisition costs. So they're relatively on par, Peter.

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Peter Perry Appert, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [10]

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Got it. And then lastly, Karl, just interested if -- your thoughts -- the margin performances have been better certainly than I had anticipated in the first couple quarters of the transaction. I'm wondering if you're rethinking your expectations in terms of where the run rate margins could get in the next couple of years.

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [11]

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Well, it's not dissimilar from what we've talked previously. We estimated that the value of the $50 million synergies versus the Strayer pro forma stand-alone performance would be worth about 500 basis points, which gets you to roughly 20% margin. From there, as you know, we're focused on various productivity initiatives. And so should our enrollment continue to grow, what we ultimately see is margins in the low- to mid-20s.

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Operator [12]

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

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [13]

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A couple of questions. On FlexPath, I think you said that new FlexPath students were up 50%. I don't know that we've had that number before. Can you give us a sense of how that's -- what that is relative to what it has been over the past year or so?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [14]

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It was 52% this quarter, and it's been growing. New FlexPath learners have been growing 30-plus percent for the last couple of years, Corey. I don't have the full history, but we're happy to dig that out for you.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [15]

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Okay. Yes, that might be helpful. And so it sounds like it could actually accelerate. And anything that you'd point to that would have helped with that?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [16]

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Other than just the continued strength of the nursing program in FlexPath, that's both the largest and fastest-growing program in FlexPath within Capella.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [17]

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Okay. And I think that there's been some talk from the department of making it somewhat easier to -- for universities to open direct assessment programs. Do you expect -- so I think the competitive environment has been relatively benign, and that might start changing. Do you think, even if you had -- a head start there that you can kind of maintain the strength as competition may increase?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [18]

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I think FlexPath is incredibly differentiated. It's got tremendous outcomes. There's strong word of mouth. So we feel very good about FlexPath, and we're very confident that, that's a very differentiated program, notwithstanding the fact that others may attempt to do it. Capella has developed a real expertise in direct assessment and competency-based assessment. And I suspect FlexPath will just continue to get stronger and stronger as we go.

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Robert S. Silberman, Strategic Education, Inc. - Executive Chairman of the Board [19]

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Yes. Hey, Corey, this is Rob. Just -- the only other thing I would say on that with regard to competitive pressure is just that our experience is it's very difficult to do a academically sound, well-run direct assessment program. And I think in the short term, there may very well be, if there's a lessening of regulations, more academic institutions attempting to do that. But over the long term, which is what we're focused on, I'm not particularly concerned that people will be able to build what Capella University has been able to build over the last 5 years with the same level of academic rigor. And that's what's really going to drive the performance of these programs.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [20]

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That's fair. And given that you have that expertise in-house, any updated thoughts on Strayer University doing top or direct assessment program?

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Karl McDonnell, Strategic Education, Inc. - President, CEO & Director [21]

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It's something that we're actively considering. FlexPath is a very unique program that is a best fit for individual students who bring a lot of workplace competencies into the classroom. And we see that there may be some fit on the Strayer University side. It would have to go through 2 layers of approval. It would have to be approved, first, by Strayer's accreditor, Middle States; and then, subsequently, by the Department of Education. But it is something that we're actively considering, Corey.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [22]

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Okay. And as long as we're on the regulatory point, it hasn't been a huge topic of conversation of late, but I'm sure you know there's some things that are being proposed and popping up at a state level, including some things -- I think, some states are proposing requiring institutions to spend at least 50% of revenue on instruction, which may not make heck a lot of sense if you can be more efficient doing some of the things you're doing with AI. So anything going on at a state level that you're particularly focused on or concerned about?

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Robert S. Silberman, Strategic Education, Inc. - Executive Chairman of the Board [23]

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We pay attention to all initiatives at any governmental level that would affect how we operate. But having been at this for a while, we know it's a very heavily regulated business, and it ought to be given the availability of government credit that really propels students' opportunity to get their educations. So we keep track of everything, but there's nothing that's really popped out to us at this point that is significantly different from things that we've heard about before. And we'll always operate the universities in compliance with whatever regulations are out there.

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Operator [24]

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Ladies and gentlemen, this concludes today's Q&A session. I would now like to turn the call back over to Rob for any closing remarks.

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Robert S. Silberman, Strategic Education, Inc. - Executive Chairman of the Board [25]

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Thank you, operator, and thanks to everybody that participated. If you have other specific questions, please feel free to call Karl or Dan. And we look forward to speaking with you again in July. Thank you.

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Operator [26]

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