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Good morning, everyone, and welcome to Strayer Education Incorporated’s First Quarter 2018 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. These statements are based on the company’s current expectations and are subject to a number of assumptions, uncertainties and risks that the company has identified in the paragraph on forward-looking statements at the end of its press release and that could cause the company’s actual results to differ materially.
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 would like to turn the call over to Robert Silberman. Mr. Silberman, please go ahead.
Thank you, operator, and good morning, ladies and gentlemen. Q1 was a pretty straightforward quarter from my perspective. So I’ll just turn it over to Dan for details on the financial results, after which Karl will comment on our operating activities, as well as provide an update on the status of our merger integration activities. And, of course, we will stay after our comments for as long as you have questions. Dan?
Thank you, Rob, and good morning, everyone. I want to start by noting that consistent with last quarter, our earnings release and 10-Q reference as reported or GAAP results and adjusted or non-GAAP results. This format is intended to illustrate both the financial performance of the core business as reflected in the adjusted numbers and our GAAP results, which in the first quarter of 2018 reflect the impact of our ongoing merger with Capella and associated transaction and integration expenses. No such expenses were incurred in the first quarter of 2017.
Now for our Q1 results. Revenue for the quarter grew 1% to $116.5 million from $114.9 million last year. Revenue per student declined approximately 5% in Q1, in line with our expectations and driven primarily by higher scholarship stemming from scholarship programs introduced in fall 2017.
Our GAAP income from operations for the first quarter was $11.3 million, compared to $18.4 million last year. GAAP income from operations in the first quarter includes approximately $5.3 million in merger-related costs. Excluding these costs, adjusted income from operations was $16.7 million. Our adjusted operating margin was 14.3% for the quarter, compared to 16% in 2017.
GAAP net income for the first quarter was $9.5 million, compared to $10.6 million in 2017. Excluding merger-related costs, adjusted net income in the first quarter of 2018 was $13.9 million. Our GAAP earnings per share was $0.84, compared to $0.95 in 2017 and our adjusted earnings per share grew 30% to $1.23 for the first quarter of 2018.
Diluted weighted average shares outstanding increased 2% to $11,311,000 million from $11,121,000 million in 2017. The effective tax rate for the first quarter of 2018 was 18.5%, reflecting the new lower federal tax rate, tax benefits associated with restricted stock that vested during the quarter and the impact of nondeductible merger costs.
Excluding the nondeductible merger costs, our adjusted effective tax rate for the first quarter was 18.1% For the remainder of the year, excluding the tax impact of merger costs and other discrete tax adjustments, we expect an effective tax rate between 27% and 28%.
Our bad debt for the first quarter was 5.5%, compared to 3.8% in Q1 2017. And as I reported last quarter, bad debt has been negatively impacted by an anomalous increase in the proportion of our students selected by the Department of Education for financial aid verification.
We saw slight decrease in this volume during the first quarter and expect it to recede further through the balance of the year, as the Department indicated they’re adjusting the verification algorithm back to normal levels.
We ended the quarter with $165.9 million of cash and no debt. We generated $17 million in cash from operating activities during the quarter, compared to $24.5 million during the first quarter 2017.
Regarding capital expenditures, we spent $4.2 million during the first quarter, compared to $3.8 million in the same period last year. We expect full-year CapEx to be in the range of 4% of revenue.
And finally, we continue to maintain $150 million in available credit on our revolver. Karl?
Thanks, Dan. Good morning, everyone. In addition to Dan’s comments, I’d just like to add that we continue to be very pleased with our enrollment results. In the first quarter, both our new student and our total enrollment grew 6% versus the prior year and our continuation rate increased 50 basis points.
Our outlook for the second quarter’s enrollment is for new students to grow approximately 7% and our total enrollment to grow 8%. That would be the strongest overall growth rate that we’ve had since 2011.
We also announced this morning that we’ve successfully opened our first new campus in several years in Macon, Georgia, and we’re already seeing pretty strong demand in that market. We’re also on track to open four additional new campuses in the second-half of 2018.
I’d now like to provide more commentary on the integration planning for our pending merger with Capella Education Company. The Strayer and Capella management teams have been engaged in detailed integration planning since December of last year, following our announcement of the merger agreement in October.
At the outset of our planning, both companies established business continuity as a key priority, as we work to build our integration plans. And with this morning’s announcements, I’m pleased that both Strayer and Capella have reported strong enrollment in financial results during a period, where many representatives of the companies respective management teams have been involved in detailed planning of the integration.
The integration planning itself is organized into three primary categories. First, we’re conducting a detailed cultural assessment to understand the unique attributes of each organization’s operating model that must be preserved, while also identifying opportunities to immediately port over best practices and other proprietary insights and methodologies.
The second major work stream involves identifying the synergies resulting from combining our corporate back-office functions post-close, such as finance, legal, human resources and IT.
Our planning has been – sorry, and the third area is preparing for day one close itself to make sure that all of our systems and processes have been stress tested. The planning has been highly collaborative, rigorous and detailed, and presently our plans call for the following.
Overall, we have identified $50 million in run rate savings to be fully implemented by the end of 2019 or approximately 18 months post-close pending our final pre-close regulatory approval in June. Of the $50 million in run rate savings, approximately $20 million will be implemented in 2018, and the remaining $30 million achieved in 2019. Excluding transaction-related expenses, we estimate the integration costs will equate to the synergy savings themselves at roughly dollar-for-dollar.
Finally, I’d like to thank both the Strayer and Capella teams for their professionalism, hard work and ongoing commitment to the merger success, which ultimately we believe will create the best platform to serve our students and learners in the years ahead.
And with that, operator, we’d be glad to take any questions.
[Operator Instructions] Our first question comes from the line of Peter Appert with Piper Jaffray. Your line is now open.
Thank you. Good morning.
Good morning, Peter.
I was hoping, Karl or Rob, maybe you could give us a little more granularity on the enrollment performance? Anything you’d call out in terms of programmatic areas, or is it continuing to be their corporate partnerships, just some more color on what’s driving the improved performance?
Sure, Peter. This last quarter, we saw strength across the Board. We continue to see strong performance at the undergraduate level. We’ve also seen a turnaround at the graduate student level, led by the performance of the Jack Welch Management Institute, which continues to grow 25%-plus per year. Our corporate partnerships were up. The degrees – the work enrollments were up. So we’ve seen strength really across the Board.
Yes, the other thing I would say, Peter, is that, clearly, the macroeconomic environment is helping us this morning’s announcements on labor participation rate and its growth. I’ve always felt that was probably the most significant indicator for us as to what was going to create consumer or student perspective, student confidence in their employability. And that’s been getting stronger for well over 18 months now. And it’s – I think, you see it particularly in our undergraduate enrollment results.
Right. On the pricing front, do we cycle through the increased scholarships in the third quarter, or is that fourth quarter event?
Peter, they’re going to likely recede throughout the year each quarter, probably slowly, but it’ll even continue into 2019 to some extent, because the students that, that received them in the fourth quarter of 2017 will keep them as long as they’re enrolled.
And then, I guess, because it had such a beneficial impact on enrollments, do you think about perhaps expanding the discount program and bringing tuition rates down further?
Affordability has always been something that we focus on considerably obviously with the 20% reduction in undergraduate tuition and the implementation of the graduation fund in late 2013. We feel like we’re fairly priced. But moving forward it is something that we want to maintain a strong focus on and make sure that our programs are not just accessible, but also affordable.
And the other thing, Peter, is bear in mind, those scholarships were put in place in the late summer, early fall of 2017, and they were coincident with some serious disruption we had in our admissions operations from the – there was two or three hurricanes that happened right at once in Texas and Florida and Georgia. So they were really situationally based. And outside of that, I think, our focus on affordability and our current tuitions structure, I think, is pretty relevant to our students.
Got it. Understood. And then on the – I’m sorry, two more things. One, on the marketing costs took a step up here in the March quarter. How should we think about the trend there over the balance of the year?
I think, on a year-over-year basis, marketing could be up 5% to 10% on a full-year basis. There is some timing depending on the activity – the advertising activities in any given quarter. We could move some of those dollars around. But on a full-year basis, I think, marketing expenses will grow somewhere between 5% and 10%.
Okay, great. And then just one last thing and I will shut up. On the new campus openings, and is there a specific incremental cost you would call out in terms of opening the new campuses? And just broadly, how we should think about the economics of them?
We – we’re right now fine-tuning the model, it’s relatively small. So I would say, it’s not really significant for the year, especially since most of the new ones are going to be back-end loaded. And as we continue to fine-tune it, we’ll have more to tell you about the broader kind of economic impact of the new campus roll out strategy.
I think, it’s safe to say, Peter, compared to the model we had before with the much larger campuses, which generated a pretty significant operating income hit in the year that they were opened, these smaller models don’t have that. They get break-even pretty quickly so.
Got it. Okay, great. Thanks very much.
Sure.
Thank you, Peter.
Our next question comes from the line of Corey Greendale with First Analysis. Your line is now open.
Hi, good morning.
Good morning, Corey.
First, did the Macon campus have its – have student start yet, or it’s just that you’re open to kind of enroll students?
No, no, they’re teaching their first academic term and we’re running a couple of on-ground classes, as well as serving students online.
Okay. Is it a sort of relevant question to ask how the student experience is going in the smaller footprint, or is it just like still like other campuses you already have that it’s not – it should be a focus of concern?
No, I mean, it’s early. We have tested the layout of the campus. We tested that on existing students in Jackson, Mississippi. We know the feedback has been quite strong. They’re in literally their first term of instruction. So we’re very early there, but we expect that these smaller footprint campuses are going to be well received
Okay good. And then, Rob, since you’re bringing up kind of the macroeconomist question. Just how – there was a time when generally speaking, education was viewed as countercyclical. Do you think that’s kind of broken at this point like we go into a downturn, would that be more a bad thing than a good thing?
Well, I never thought it was countercyclical, Corey. I thought it was a cyclical. And so you hit such a big perturbation in 2009 I mean, you had such an enormous financial crisis that put such a big hit on the economy as a whole. And that amount of disruption I thought made us somewhat cyclical. We got below the lower band of economic confidence that our students could really make decisions around. And it stayed that way for a long time. I mean, we had an economy that was – you had very, very low interest rates, which was certainly an issue – creating some demand and it certainly was creating asset price inflation.
But you laid on top of that a fairly heavy regulatory environment, not just in our space, but in general across the economy and higher taxes. So now, we’re moving into a situation, where the economy has healed itself. You get – you’ve got labor participation rates growing. You have greater confidence in employability. And at the undergraduate level, that generates that confidence for our students.
But if you think about it, Corey, if you focus on your academics and you’re not a really aggressive marketer, the swing factor is student confidence. And I would say, over the last couple of years, we have been in a healing and strengthening part of that and it’s reflected in our results.
All right. And don’t want to put words in your mouth and certainly we’ll see what happens. But it sounds like, you’re saying if you go into a meaning downturn, you think that would not be a good thing, because confidence would diminish?
Well, it depends which mean by meaningful. If it’s a normal cyclical downturn, I don’t think it has that much impact. If it’s like 2009, then, yes, that would be a problem.
Okay. And then just one quick question on Capella, which I realize you’re not going to say much at this point. But, Karl, you referred to their enrollment is strong. I think, it was actually down a little bit year-over-year. So I just want to make sure it’s within a band of what you had expected?
Well, I – we were encouraged, obviously, by their new student results. And we have a lot of respect for the work that they’ve done. And beyond that, I wouldn’t think it’s appropriate to comment on their results.
Okay, that’s fine. And then, Dan, I just had two quick ones for you. The – I think what I heard you say is that the reduction in revenue per student should narrow, generally speaking, with each quarter. But can you give us a sense of like for the full-year for you to average it? What you expect it to be down?
I’d say, for the full-year, you’re going to be somewhere in the neighborhood of 3%, 3.5% down.
Okay. Thank you. And then on the bad debt as the Department sort of normalizes the number of verifications they’re doing. do you think it gets back to kind of the 3%-ish range, or what should we think?
It’s hard to say, but I think once that problem is resolved and it’s back to normal levels, I think, we’re – we expect to see something closer to 4% below.
4% below.
I mean, that’s kind of what we’re looking at.
Okay, perfect. All right. Thank you.
Thanks, Corey.
[Operator Instructions] Our next question comes from the line of Jeff Silber with BMO Capital Markets. Your line is now open.
Thanks so much. Just wanted to circle back quickly to the new campus model, have you disclosed or will you disclose roughly the size of these new campuses compared to your current footprint?
Sure, Jeff. Depending on the location, they’ll be somewhere in the 4,000 to 5,000 square foot range, which compared to the previous were…
15.
15 to 20, yes.
Got it. Okay, that’s very helpful. Thanks so much.
And, Jeff, I would just add. We’ve designed these campuses purposely to have a break-even level of approximately 50 students.
Okay. That’s actually very helpful. Thanks so much. Actually wanted to shift gears to the New York Code and Design Academy. I know it’s relatively small piece of your business. But we’ve been seeing a lot of movement in that sector, mergers and acquisitions, including some nontraditional players in education getting into that space. I’m just wondering if you can tell us, how that business has been doing since you bought it? What are your plans going forward? Thanks.
Sure. The business is doing quite well. So far in 2018, we expect that they will achieve break-even in the second quarter of this year and begin contributing to our earnings albeit on a very small basis in the back-half of 2018. We think they have a very good great product.
I just feel like the coding boot camp space is still quite nascent. And it’s going to take some amount of time for the demands, organically grow to levels where you’d have meaningful sizes of revenue and ultimately earnings. But they’re performing well and we’re very happy with what they’re producing in the way of outcomes for students.
And we’re excited about the opportunity with the other two entities that Capella has to really get a broader view of this market and what works and how to fashion the right strategy to really serve these students well.
Okay. And then speaking of Capella, in terms of milestones for the merger, can you just remind me, are we just waiting for HLC approvals or anything else that we’re waiting for?
That’s it for pre-close. And our understanding is, they meet the last week of June and we understand that the merger is on their agenda and we’ll just wait to hear from them following their meeting.
Okay. And assuming everything goes well and the deal closes when you expect it, will you be booking the integration costs in the quarter that you close the deal?
It’s going to be in the quarter that it’s incurred, Jeff. So there will definitely be a big part of it in the third quarter. But it will – the integration costs will continue through the end of the year and into next year as that integration plan is executed.
Okay, great. I appreciate the color. Thanks so much.
Yes. And, Jeff, just to be clear that that’s different from the actual transaction costs, which will be booked in the third quarter right away.
Correct, yes. Third quarter will have the majority of the transaction costs.
Right. Yes I was just thinking, I was specifically looking at the integration costs that you just called out on the call earlier.
Yes.
But I appreciate the color. Thanks so much.
And I’m showing no further questions in queue at this time. I’d like to turn the call back to Mr. Silberman for any closing remarks.
Thank you, operator, and thank you, ladies and gentlemen. We’ll look forward to speaking with you in early August in the third quarter, at which point, we’ll review the second quarter results and the status of the transaction. Thanks very much.
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone, have a great day.