Zovio Inc
Q2 2019 Earnings Call Transcript

Published: 8 Aug 2019

[Operator:]

Good afternoon and welcome to Zovio's Second Quarter 2019 Earnings Conference Call. Today's call is being recorded.At this time, I would like to turn the call over to Ms. Dori Abel, Vice President of Corporate Communications. Please go ahead.

[Dori Abel:]

Thank you and good afternoon. Zovio's second quarter 2019 earnings release was issued earlier today and is posted on the company's website at www.zovio.com. Joining me on the call today are Andrew Clark, Founder, President and Chief Executive Officer; and Kevin Royal, Chief Financial Officer.We would like to remind you that some of the statements we make today may be considered forward looking, including statements regarding new enrollment growth, student retention, education partnerships and other programs and services, our ability to meet all required conditions and obtain all required approvals to close on the planned separation and conversion of Ashford and its timing and impact, our ability to transition to become an education technology services company, our ability to grow through acquisitions, our ability to successfully integrate and leverage acquired companies, future revenue growth, EBITDA, financial and related guidance, and commentary regarding fiscal year 2019 and later.These forward-looking statements are subject to a number of risks and uncertainties that could cause actual performance or results to differ materially from those expressed in/or suggested by the forward-looking statements.Please note that these forward-looking statements speak only as of the date of this presentation and we undertake no obligation to update these forward-looking statements in light of new information or future events except to the extent required by applicable securities laws.On the call today, we will also discuss certain non-GAAP financial measures. In our earnings release, you will find additional disclosures regarding these measures, including reconciliations of these measures with U.S. GAAP. Note that these non-GAAP financial measures are intended to supplement GAAP financial information and should not be considered as a substitute for our GAAP results.Please refer to our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2019, and our quarterly report on Form 10-Q for the quarter ended June 30, 2019, which we filed with the SEC earlier today. For a more detailed description of the risk factors that may affect our results, you may obtain copies from the SEC or by visiting the Investor Relations section of our website.At this time, it is my pleasure to introduce Zovio's Founder, President and CEO, Andrew Clark.

[Andrew Clark:]

Thank you, Dori and welcome to our second quarter 2019 earnings call. After I discuss some of the highlights for the quarter, Kevin will review our financial results and key operating metrics. After Kevin concludes, I'll offer my closing comments.First and foremost, as we announced on July 15, we received approval for Ashford University to return to independent, non-profit institution, which represented an important milestone in the process to separate and transform both Ashford and Zovio.We have been in discussions with the U.S. Department of Education regarding their abbreviated pre-acquisition review process. Through those discussions, we discovered that we had mistakenly provided partially incorrect information to the Department regarding a portion of the University conversion. We have corrected that error and are working with the Department to bring the abbreviated review quickly to conclusion.We anticipate that the close of the proposed separation and conversion of Ashford will occur sometime between September and the end of 2019. This step allows the Zovio team to further execute on our strategy to establish the company as a leading education technology services company, once we have separated the two organizations.Today, we have made tremendous progress transforming Zovio into a best-in-class provider that partners with higher education institutions and employers to deliver innovative, personalized solutions to help learners achieve their aspirations.Leveraging on our success in education, we are applying our technologies and capabilities to priority market needs including recruitment, retention, and the learner experience, which is creating a long runway for growth.As such, our strategy is centered on three pillars; first, delivering education services that meets the diverse and large-scale needs of educational institutions and corporate enterprises; second, capitalizing on the middle market opportunities through enhanced programs and services and building our capabilities; and third, expanding our skills to employment offerings to empower learners to better connect with in demand jobs.During the first half of the year, we acquired Fullstack Academy, an immersive coding boot camp, and TutorMe, a provider of 24/7 tutoring services. These businesses along with our organic investments in our team and technologies have established the foundation for Zovio's education technology ecosystem, which we will continue to build in the coming years.In addition, both Fullstack and TutorMe continue to expand their reach through key partnerships. For example, Fullstack recently announced partnerships with the University of North Florida and the University of San Diego's Division of Professional and Continuing Education.Starting in October, we will offer the University of North Florida coding boot camp. This program will offer training and crucial programming skills to students speaking competitive, in-demand technology jobs. In addition, we have partnered with USD to develop professionals to fight the global epidemic of cybercrime.We have also had similar success with TutorMe. During the second quarter, we have established more than 10 new partnerships with schools bringing the total to over 40 partner schools. Among these new relationships is McGraw-Hill, which partnered with TutorMe to offer on-demand tutoring for college students in 4 course areas, including anatomy and physiology, English, math and accounting. TutorMe will launch a research-focused pilot this fall to provide college students with one-on-one academic support as a natural extension of the digital coursework.With our strategic -- while our strategic investments are critical to driving topline growth, we remain steadfast in our commitment for long-term profitability as well. To that end, we have identified and implemented a number of actions that will enhance our operational effectiveness and strategically optimize our cost structure.For example, leveraging our predictive analytics tools to look critically at our business, we concluded that we can deliver superior performance for our customers and partners with fewer internal resources as evidenced by 100 basis point increase in our Net Promoter Score year-over-year from 49.8% to 50.8%. We expect these actions to result in cost savings of $8 million in 2019 and $15 million in 2020.As I've said in the past, we will be disciplined in our pursuit of growth. Our investments, which we expect to be largely focused internally in the near term, will be viewed through the lens of our strategic imperatives that I outlined earlier.That said, our goal remains the thoughtful execution of our strategy, which over a three-year period can drive low single-digit revenue growth in our core business and will expand to mid-single-digit growth. Over the same three-year period, as we execute on our strategy and pursue substantial growth through meaningful investments, our goal is to achieve double-digit revenue growth. From a profitability standpoint, we anticipate our non-GAAP EBITDA margin to return to low double-digit within a three-year period.Turning to our results for the second quarter of 2019, we reported revenue of $107.5 million and net loss of $17.6 million and a resulting net loss of $0.58 per diluted share. Excluding restructuring and impairment charges, separation and conversion transaction cost as well as acquisition costs, our non-GAAP net loss for the second quarter of 2019 was $4.6 million or a non-GAAP net loss of $0.15 per diluted share.New enrollment for the second quarter of 2019 was down as a percentage by low single digits when compared to the same quarter prior year. While we were successful in generating year-over-year growth in new student inquiries and applications, we gave these gains back during the first course as students in the course did not retain at similar levels to prior years.We have examined the student experience in the first course and are actively working for the University to enhance the first course with the goal of improving retention at/or above prior year levels. We anticipate this will take us the remainder of the year to complete those enhancements.As a result, we expect our new enrollment will be negative in the mid- to high single-digits throughout the remainder of 2019, peaking in the third quarter. We continue to drive growth in our education partnership programs as well as with our graduate student population who both retain at a higher rate.As of June 30, 2019, the enrollment in the education partnership programs represented approximately 28% of total enrollments compared to approximately 21% of total enrollments as of one year ago. New enrollments in the education partnership programs represented approximately 29% of new enrollment for the second quarter of 2019.The employee sponsorship by these global companies is a testament to the strength and quality of the programs offered through Ashford. For example, during the second quarter, we announced Zovio's partnership with Delta Care, an scholarship fund, to expand education options for Delta Airline employees.The program allows eligible Delta employees to pursue associate bachelor's and master's degrees at Ashford University at a discounted rate. Delta Care and scholarship fund coupled with the tuition assistance benefit offered by Ashford University enables these students to minimize the cost of earning a degree.As a reminder, our Full Tuition Grant or FTG program continues to outperform our expectations. However, an increase in the student population does lower net revenue, which is a dynamic we saw in the second quarter on a year-over-year basis.Establishing a strong foundation for Ashford as an independent self-sustaining, nonprofit, poised-to-flourish over the long term is a top priority for us. We have maintained our focus on improving new enrollment and student retention at Ashford through innovative, intervention strategies designed to assure student preparedness, raise academic quality, and improved student outcomes. Retention has continued its upward momentum.As of June 30, 2019, Ashford's annual cohort retention rate was 59.6% as compared to 59.4% for the same period in the prior year. Importantly, this was the sixth consecutive quarter of improvement, which is a significant milestone as the consistent improvement in retention has mitigated overall declines in total enrollment and should support a return to flat to positive growth in 2020.Clearly, there's a lot of activity at the company, we're incredibly excited about what lies ahead. We have a strong and growing team in place ready to execute and together, we are optimistic about the value-creation opportunity for all of our stakeholders.Now, I'll turn the call over to Kevin Royal to review our financial and operating results.

[Kevin Royal:]

Thank you, Andrew. Let me begin by providing some key financial and operating information for the quarter ended June 30, 2019. Revenue for the second quarter of 2019 was $107.5 million compared to revenue of $119 million for the same period in the prior year. The decrease is primarily related to a year-over-year decline in average enrollment, partially offset by an increase in tuition rates year-over-year.For the second quarter of 2019, instructional cost and services were $55.1 million or 51.3% of revenue compared to $54.4 million or 45.7% of revenue for the comparable prior period. The increase as a percentage of revenue was primarily driven by the acquisitions in the period, partially offset by a decrease in bad debt expense. Our bad debt expense in the second quarter of 2019 was $3.9 million or 3.6% of revenue compared to $5.5 million or 4.6% of revenue for the comparable prior year period.Admissions, advisory, and marketing expenses for the second quarter of 2019 were $44.8 million or 41.7% of revenue compared to $39.9 million or 33.5% of revenue for the comparable prior period. These costs increased as a percentage of revenue due to increased advertising as well as an increase in consulting services.General and administrative expenses for the second quarter of 2019 were $22.5 million or 21% of revenue compared to $12.5 million or 10.5% of revenue for the comparable prior period. The increase as a percentage of revenue was primarily driven by higher legal and professional fees, which include approximately $1.8 million of cost relating to the planned separation and conversion, and approximately $8.3 million of acquisition-related expenses.Restructuring and impairment charges for the second quarter of 2019 were $5.4 million or 5% of revenue compared to $2.7 million or 2.3% of revenue for the comparable prior period. Net loss for the second quarter of 2019 was $17.6 million or a net loss of $0.58 per diluted share. This is compared to net income of $15.1 million or net income of $0.55 per diluted share for the second quarter of 2018.From a tax perspective, our annual effective tax rate for the second quarter of 2019 before any discrete items was low single digits. And we anticipate this trend will continue through 2019. Our non-GAAP, net loss for the second quarter of 2019 was $4.6 million or a loss of $0.15 per diluted share compared to the non-GAAP net income of $13.3 million or income of $0.49 per diluted share for the second quarter of 2018.Non-GAAP net loss for the second quarter of 2019 excluded restructuring and impairment charges of $5.4 million, separation and conversion cost of $1.8 million, acquisition cost of $8.3 million, partially offset by an income tax benefit of $2.5 million. As of June 30, 2019, we had combined cash, cash equivalents and investments of $107 million compared to $168.4 million as of December 31, 2018.We used $22.1 million of cash in operating activities during the six month ended June 30, 2019. By comparison, we used $9.2 million of cash in operating activities during the same period in 2018. The year-over-year increase in the cash used in operating activities was primarily driven by a decrease in earnings, partially offset by improvements in working capital.The net accounts receivables was $33.7 million as of June 30, 2019, compared to $27 million as of December 31, 2018. The increased balance is consistent with our business cycles and full growth of our Full Tuition Grant enrollment and the addition of the Fullstack Academy accounts receivable.Capital expenditures for the year-to-date period ended June 30, 2019, were $17.8 million as compared to $1.3 million in the same period last year. From a profitability standpoint, while we expect our core business to be slightly positive, our investments in systems, people and our three subsidiaries will result in consolidated negative EBITDA margin in 2019.Now, I will turn the call back over to Andrew for his closing comments.

[Andrew Clark:]

Thank you, Kevin. We have reached a critical point in Zovio's future and our team couldn't be more excited. The approval for Ashford University to return to an independent, non-profit institution was one of the final hurdles to complete the separation of Ashford and Zovio, both of which are well-positioned for the future.For Zovio, we have made tremendous progress on our transformation to a leading education technology services company. We have experienced many successes as of late with the attractive acquisitions of Fullstack Academy and TutorMe as well as our organic investments in our team and technologies. We believe through the execution of our strategic priorities, we will create long-term growth and meaningful value for all of our stakeholders.At this time, I'll ask our operator to open the phone lines for your questions.

[Operator:]

[Operator Instructions]Your first question comes from the line of Alex Perez from Barrington Research. Your line is open.

[Alex Perez:]

Hi guys.

[Andrew Clark:]

Hey Alex.

[Alex Perez:]

I got most of the call, somehow I was disconnected and I got back on, but if I ask anything which you've already answered, I apologize in advance. First, I do want to focus on new student enrollment, I know a lot of investors focus on that as a measure of health for Ashford University. Even though it's a rather small number in the grand scheme of things, particularly, when you're talking about six consecutive quarters of improvements other than in retention and that sort of thing.First quarter was below expectation; we had some hopes that second quarter would see a small increase; sounds like you got a small decrease. And you explained that had to do with first course issues. As I recall, first course issues were brought up on the first quarter conference call, changes haven't been made there yet at this point?

[Andrew Clark:]

Yes, Alex, you recall correctly. So, we're still working through those and as I indicated, it's going to take through the remainder of the year. It's really frustrating obviously for us because we outperformed in terms of student inquiries and applications, just to give you a sense of things, by mid-single-digits. So, we were doing quite nicely there.And then tremendously frustrating to give that all back and then a little bit more in the first course around that experience. So, the good news to that is we know exactly what it is that's kind of standing between us and positive new enrollments in the quarter. And everybody -- the institution as well as Zovio are focused on correcting that.We just think it'll take some time for that to -- for us to get those changes in place and it takes time really for that to kind of manifest and show up. And so I think we felt it was appropriate to effectively kind of guide the new enrollments down in the mid to high single-digits with probably the peak being in the third quarter.

[Alex Perez:]

So, does that mean high single-digits in the third quarter and mid-single-digits in the fourth quarter, is that the way I should be thinking?

[Andrew Clark:]

Yes, I think that's fair.

[Alex Perez:]

Okay. And then a question, semantics I suppose. You had mid-single-digit growth in inquiries and applications. Did you have a positive show rate that was only reduced after first quarter -- after first course, I'm sorry?

[Andrew Clark:]

Yes, I mean that's really -- it was slightly negative in terms of students in the first kind of week of the course. But then, we call it -- you call it the show rate, we call it the matriculation rate, which is the end of the fourth course, effectively the -- or fourth week, excuse me, effectively the same thing. And yes, that was meaningfully negative and what gave back all the positive gains that we had.

[Alex Perez:]

And as I recall, this illustrates the independence of the university versus the corporation. First course is designed and conducted by the University and in order to change the first course that'd be a decision that Ashford University would have to make as opposed to Zovio's management; is that correct?

[Andrew Clark:]

Yes, that's correct. But we're definitely partners here. And we have an instructional design and curriculum team that supports the University in its academic decisions and obviously, takes their direction.So, I think it's incumbent on both of us, Zovio as well as the institution, to fix the retention issue that we have in this first course and we all want to do that. There's nobody here that's not trying to get that in a place where it's a better experience. Things are more successful, there's better outcomes in that first course. And obviously, that would flow through. I mean the good results that we've had on retention in the last six quarter quarters would be even higher if we're able to accomplish that.

[Alex Perez:]

And tell me this, why would your expectation for new student enrollment growth worsen in the back half of this year rather than stay the same?

[Andrew Clark:]

I think it's a lot of conservativeness on my part, Alex. I really believe, for good reason, we thought we'd see new enrollment growth in a variety of quarters over the last kind of three -- including this quarter, last four quarters and for one reason or another, we haven't. And so I think -- I felt at this point it was appropriate to kind of be more conservative in our view. I'm hopeful that we'll outperform that, but I think we're better off being conservative at this point.

[Alex Perez:]

I agree. All right. I may jump around here a little bit but I think it was you, Andrew, that mentioned cost savings initiatives of $8 million in 2019 and $15 million in 2020. Are these new programs -- do they begin on January 1st? And if so, if they're new, we're going to get $8 million in savings in the back half or we've already realized some of those savings in the first half?

[Kevin Royal:]

So, we had -- they are new in the second quarter, Alex. There was a slight benefit in the third month of the quarter, but that $8 million is primarily Q3, Q4. And then the number that was quoted, the $15 million, would be the impact to the 2020 year period -- full year period.

[Alex Perez:]

Okay. And then while I got you, Kevin, I think you talked about, on a consolidated basis we should expect a negative EBITDA margin for the year. I'm already expecting a negative EBITDA margin for the year. Are we talking worse than my estimate? I think I have negative $1.5 million or so adjusted EBITDA number for the full year?

[Kevin Royal:]

Yes. It will be worse than your number. It'll be in the single-digit.

[Alex Perez:]

Okay. So single-digit millions?

[Kevin Royal:]

Correct.

[Alex Perez:]

And we can have a conversation offline as I work through the model. Okay. And then free cash flow. Obviously, a big user of free cash flow in the first half -- user of cash in the first half. What's your outlook for the second half, are we kind of cash neutral or cash positive in the second half of the year?

[Andrew Clark:]

So, as I said, there's a couple of data points I would look at there. One is that we'll have negative EBITDA. And then the second is that we've had much more significant capital spending and as we complete our new headquarters facility, we will have an additional amount of capital spending in the $7 million to $10 million range.

[Alex Perez:]

So, $7 million to $10 million more on top of the $17 million you spent in the first half on CapEx?

[Andrew Clark:]

That's right.

[Alex Perez:]

Okay. So, that's $24 million to $27 million for the full year is the target?

[Andrew Clark:]

That's right.

[Alex Perez:]

Okay. And then back to -- obviously, congratulations on getting your approval from WASC. The -- so what's the timetable? At one point we were talking third quarter that this could happen, it's looking more like the fourth quarter given the delay at Department of Education?

[Andrew Clark:]

Well, as I said it, Alex, and you might have missed this as we mentioned because you got -- had some difficulties on the upper front part of the call, some technology challenges there. But we think it could be anytime between September and the end of the year. We're working with the department actively as we speak.So, we're having those conversations right now with them. So, I just provided a range because you never know things could take longer for some reason that I'm unaware of, but we're working expeditiously to try and -- to get the conversion completed.

[Alex Perez:]

So, to be clear, you have your accreditor's approval, you have the IRS approval, we're just waiting for Education Department preapproval prior to the transaction occurring?

[Andrew Clark:]

Yes. So, it's not really technically in a pre-approval, right? It's a -- they're doing an expedited, pre-acquisition review process. So, they give you their view about a variety of different things, and then you know what the Department's view is and then you take that into consideration. And there's usually approximately like a 10-day requirement after the close where you would then do whatever was required, if anything. So, they don't really grant an approval per se.

[Alex Perez:]

Got you. Could you do the transaction without this Education Department approval that we're talking about?

[Andrew Clark:]

I mean, yes, technically you could and certainly others have. As I know you're aware, others have gone forward without it. I think it's been the view of Zovio and the University that we prefer to have the Department's view before we proceed forward.

[Alex Perez:]

All right. And then one final question and I'll let you go. The EBITDA in the single-digit -- EBITDA loss in the single-digit millions for the full year, what are the -- Kevin, what are the contributors to that? A little lower revenue due to the success of the corporate programs, revenue per student, the fact that we didn't get new student enrollment positive yet, although you do have continued growth in retention, these added expenses associated with the spin-off offset, at least, to some degree by cost reduction programs. So, what are the puts and takes there to get us to our EBITDA bottom-line?

[Kevin Royal:]

Yes, I think you summarized it well, Alex. A little bit lower than revenue than what we had expected. And with the delay associated with the conversion, our cost continue to be -- run high in that area.

[Alex Perez:]

Speaking of which, how much more money is going to have to be spent on the conversion pre-spin, like Q3, Q4? A couple of million dollars a quarter, orders of that magnitude, I guess, I'm looking for?

[Kevin Royal:]

Yes, I would say that the lion's share of the spending has taken place. But as we get close to the conversion, we finalize documents, I could see that combined both sides would be in the range of $0.5 million to $1 million as we wrap things up and close the transaction.

[Alex Perez:]

Okay. So, very little left of that, $0.5 million to $1 million over the balance of the year until the spin occurs?

[Kevin Royal:]

That's right.

[Alex Perez:]

Okay. Well, thank you very much. I appreciate it.

[Kevin Royal:]

Thank you.

[Operator:]

This concludes our question-and-answer session. I would now like to turn the call back over to Andrew Clark for any closing remarks.

[Andrew Clark:]

We'd like to thank all of today's callers for your interest in Zovio and for your participation on the call today.

[Operator:]

That concludes today's conference call. You may now disconnect.