Strategic Education, Inc.
Q3 2018 Earnings Call Transcript

Published: 12 Nov 2018

[Operator:]

Good morning, everyone, and welcome to Strategic Education, Inc. conference call in which we will discuss Third Quarter 2018 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 the remarks, we will open the call for questions. Please note 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 has identified in today’s press release that could cause actual results to differ materially. Further information about these and other relevant uncertainties maybe found in Strategic Education’s 10-Q to be filed today 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 would like to turn the call over to Robert Silberman, Strategic Education’s Executive Chairman. Mr. Silberman, please go ahead.

[Robert Silberman:]

Thank you, operator and good morning ladies and gentlemen. This is our first opportunity to report on SEI’s consolidated results since the consummation of our merger between Strayer Education and Capella Education on August 1 of this year. So, we have a lot of material to cover this morning. I am going to first ask Karl to comment on our operating results for the third quarter as well as provide an update on our merger integration activities. Next, Dan will provide details on both our GAAP and adjusted financial results for the third quarter. And finally, I will make some brief comments on our capital allocation, after which we will stay for as long as you have questions. Karl?

[Karl McDonnell:]

Thank you, Rob. Good morning, everyone. As Rob just mentioned, Dan will cover our detailed financial results momentarily, so I intend to focus my comments primarily on our operating results and a merger integration update. And at the outset, I would like to begin by saying how proud I am of everyone within our organization for generating incredibly strong results while simultaneously first planning and now executing a highly complicated integration. Many of these results are the strongest the universities have generated in many years and speak directly to the level of talent and professionalism that our team has working on behalf of our nearly 90,000 students and learners. First, with regard to our operating results, both Strayer University and Capella University continue to be aided by a very strong U.S. economy and we continue to see broad increases in overall interest and demand. Strayer University’s new student enrollment grew 12% versus the third quarter in 2017, continuing student enrollment increased 8% and the university’s total enrollment grew 9% versus the prior year. That’s the highest level of total enrollment growth since the fall quarter of 2010. Strayer University’s revenue increased 7% to just under $115 million while Strayer’s operating margin increased 290 basis points to 10.4%. Strayer University opened its second new campus of 2018 during the quarter in Montgomery, Alabama. It is on track to open 2 additional new campuses by the end of the year. Strayer’s preliminary 2019 campus expansion plan calls for an additional 6 to 8 new campuses, pending regulatory approvals. And again, all of these new campuses are in our significantly smaller model, consisting of roughly 3,000 square feet per campus as opposed to more than 20,000 square feet in the model that we used between 2001 and 2012. It also has a significantly smaller staffing requirement and operating breakeven for each campus has been reduced from over 300 students to fewer than 100. Capella University’s new student enrollment increased 13% versus the prior year and their total enrollment increased 2% to just under 38,000 learners. Capella’s FlexPath program, they’re highly differentiated direct assessment instructional model continues to be a primary driver of overall enrollment growth with new learners within FlexPath growing 34% from the prior year. 26% of all non-doctoral Capella learners are now enrolled in FlexPath and that’s up 300 basis points just in the last quarter. Capella’s revenue increased 2.5% to $106 million and Capella’s operating margin was unchanged at 15.7%. Capella is also on track to open its first two physical locations in Atlanta, Georgia and Orlando, Florida during the first half of 2019. During the quarter, we also reorganized SEI’s non-degree business components into a single management structure and began to organize a single shared service to support all three coding boot camps in order to increase productivity and reduce overall operating expenses. And following a strategic review of these non-degreed entities, we have decided to eliminate the New York Code + Design Academy’s asset value in its entirety. Turning now to our integration update, today marks the 99th day since our merger closed back on August 1 and all key integration-related activities are on track. By the end of 2018 and on a run-rate basis, we will already have implemented just under half of our $50 million synergy target, equating to $22 million in savings of which $9 million will actually be realized in 2018. The remaining $28 million in run rate savings will be implemented in 2019. Realized savings in 2019 are estimated to be $30 million, which when added to the $9 million saved in 2018 means approximately $40 million of savings will have been realized by the end of 2019 with the full impact of the total $50 million in synergies occurring in 2020. We continue to forecast the cost to achieve these synergies will be approximately $50 million or $1 for every dollar saved. In addition to the work on implementing our synergies plans, our teams are also actively working to implement numerous innovations and best practices across the two universities, including the deployment of Strayer-developed artificial intelligence tools inside of Capella and evaluating the potential opportunity to seek regulatory approvals to offer FlexPath programs within Strayer University. We also plan to complete our first major systems integration in December of this year, migrating Capella on to Strayer’s HRIS system. Lastly, with respect to the overall integration, we continue to place a great deal of emphasis on our new combined culture, which starts by continuing and ultimately deepening our commitment to our students and our learners’ success. So 100 days into our merger, our company has delivered exceptional operating results is on track to deliver our target synergies and is already beginning to harvest gains as a result of implementing best practices across our organization. And once again, I would like to thank our team for their incredible efforts over the last quarter. And now, I will ask Dan to run through our financials in more detail.

[Daniel Jackson:]

Thank you, Karl and good morning everyone. Today, we are reporting consolidated results for Strategic Education, Inc. which now includes three reporting segments

[Robert Silberman:]

Thank you, Dan. Just one amplifying comment from my perspective on the financial results, as Dan reported, our financial statements have grown slightly more complicated as a result of the merger and particularly with the impact of the non-cash adjustments associated with purchase accounting. But ultimately, when you cut through all the purchase accounting and the merger-related expenses, the figure which I look at each quarter which I think most closely reflects our owner’s economics, is the distributable cash flow per share generated by our business. And for the third quarter, our businesses generated $46.5 million in after-tax cash from operations. If you think about capital allocation, we invested $8.5 million of those dollars in CapEx during the quarter, leaving $38 million in distributable owner’s cash flow or roughly $1.75 per share. This cash flow per share compares very favorably to the $0.92 per share of adjusted EPS that we reported. We paid a $0.50 per share dividend during the quarter or roughly 28% of that distributable cash flow. And finally, we used, as Dan mentioned, $47 million of our cash during the quarter to fund our merger transaction and integration expenses. And with that operator, we would be pleased to answer any questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Jeff Silber from BMO Capital Markets. Your line is open.

[Jeff Silber:]

Thanks so much. Rob, I just wanted to get I guess the segue off the theme that you ended on. Can you talk about your capital allocation strategy going forward? How if at all it’s changed from before the merger?

[Robert Silberman:]

Well, it hasn’t really changed, Jeff, in that our first and foremost highest return use of capital we think is improving the academic outcomes of our students because that generates the highest long-term financial return. And so we are always going to fund as much of that as Karl and his team can find in terms of opportunities. As he mentioned, we have got a quite a bit of work in the area of artificial intelligence, some of which, I think will be ported over to Capella University as well. So I would guess that our CapEx will be a more fulsome use of capital, but probably analogous to sort of the quarterly numbers that I described on a pro forma basis for the third quarter. And then we are going to continue to look for opportunities to employ capital outside of the business, if we can’t put it into the business, on a high return basis. I don’t think we would be described as particularly acquisitive. We have done one major acquisition in 15 years. But we will always look for those opportunities. And then finally, for that capital, which truly is excess of those internal or investment requirements, we want to return it to owners in the most value-enhancing way. We do think that a predictable and reasonable dividend for an entity that owns educational institutions is a positive way to return capital to owners. And we maintain a fairly healthy share repurchase authorization, which we will use in those circumstances in which we feel like the shares are trading at a significant discount to intrinsic value. Because as we have talked in the past, when we repurchase shares, we are taking that option away from our owners to redeploy that capital and we are essentially giving them a dividend of additional ownership of the company and we only want to do that when we feel a very large discount to intrinsic value.

[Jeff Silber:]

Okay, got it. Appreciate that. If I could switch back to the core operations, the enrollment numbers that Strayer University has been putting up has been stellar for a while. Capella, we have seen new enrollment improved the past couple of quarters pretty dramatically. What’s underlying that, nobody else in the industry is really putting up those kind of numbers?

[Karl McDonnell:]

Good morning, Jeff. As I said in my prepared remarks, we continue to see really strong macroeconomic conditions, which is generating large increases on a year-over-year basis and interest in organic demand. The new student growth has been pretty widespread, and by that, I mean, geographically, on the Strayer side, well represented across our campus footprint, but also on the Capella side, they are seeing strong interest and growth across their program portfolio with particular emphasis on FlexPath, particularly in healthcare. So I would say, it’s very good macro conditions combined with a diversified portfolio that’s generating a lot of interest.

[Jeff Silber:]

Alright, great. And you mentioned the, I guess, it’s the learner support center that Capella is going to be opening, I believe next year. Can you just tell us a little bit more about that? I know how your new footprint differs from your old footprint, but what do those learning centers look like?

[Karl McDonnell:]

They are essentially going to mimic a Strayer location. We are going to leverage the Strayer design so they will be roughly the same size, call it roughly 3,000 square feet. These will be learner support centers, meaning they will be there for enrollment services, advising services. They will not have any on-ground instruction in the Capella locations, but we are interested in testing those. And we expect that they could open in the middle to latter part of the first quarter, but no later than the second quarter.

[Jeff Silber:]

Okay, great. I will jump back into queue. Thanks so much.

[Karl McDonnell:]

Thanks, Jeff.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Peter Appert from Piper Jaffray.

[Kevin Estok:]

Hey, good morning. This is Kevin Estok in for Peter Appert. My first question has to do with pricing strategy, I was wondering how we should think about this and if you have seen anything industry-wide with pricing?

[Karl McDonnell:]

Good morning, Kevin. When we are thinking about pricing first and foremost, our primary concern is to maintain an eye on overall affordability. You may recall that Strayer University back in 2013 reduced the cost of their undergraduate programs at that time by about 40%. So, we do think affordability is an issue. It’s something we want to be constantly focused on. That being said, we think about the overall cost of the degree to be in a range of alternatives that prospective students may have, particularly given local public institutions. And I think both Strayer University and Capella University are within a moderate band where there maybe small increases that we maybe able to take in any particular year. And in fact in the fourth quarter of this year, we announced in the prior quarter that Strayer University will have a 1% tuition increase and Capella will have an effective 2% increase, but tuition changes may vary slightly based on the program. So these are relatively modest increases this year and again our overall concern is to make sure that we maintain that eye on the overall program’s affordability moving forward.

[Kevin Estok:]

Okay, great. Thank you. And my second question has to do with the current enrollment mix. So between campus and online, I guess I was wondering how important it was for you to maintain a physical campus network?

[Karl McDonnell:]

Well, over about the last decade, we have seen a strong shift in student preference to more and more online. So 8 to 10 years ago, you might have had close to half of Strayer University classes being taught on ground in a physical location. By the end of this year, fewer than 10% of Strayer University classes will be taught on ground. However, because we also, on the Strayer University side, have about 10% of enrollments that are purely online, meaning there is no optionality to attend at campus, we’ve always been able to compare academic outcomes for campus students as opposed to out-of-area students. And on the Strayer University side, there continues to be quite a difference in that campus-based students tend to achieve at significantly higher levels than purely out-of-area students. So even in a world where student preference continues to shift more and more online, we think the campus network on the Strayer side helps us attract a more serious student. The analogy we use is banking. Very few people probably would want a bank with a purely online bank. They like the optionality of having a bank branch, and we think that’s analogous to the Strayer campus network. We will see, once we open the Capella learner resource centers, if we see similar trends, but that will take some time into 2019. So the campuses for Strayer continue to be very important. As I said, we plan to open 2 more this year and up to 8 next year, pending regulatory approvals and we think it helps us generate the types of students that we want to have.

[Kevin Estok:]

Okay, guys. Thank you.

[Operator:]

Thank you. And I am not showing any further questions from our phone lines. I would now like to turn the conference back over to Robert Silberman for any closing remarks.

[Robert Silberman:]

Thank you, operator. Well, we appreciate everyone’s participation. As Dan said, we have got some amplifying data on our website that particularly crosswalks between the as-reported and the adjusted results. And if anybody has any other questions, please give us a call directly and we look forward to talking with you again in the first quarter. Thank you.

[Operator:]

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