Strategic Education, Inc. Q2 FY2021 Earnings Call

Welcome to Strategic Education's Second Quarter 2021 Results Conference Call. I will now turn the call over to Terese Wilke, Director of Investor Relations for Strategic Education. Mrs. Wilke please go ahead.

Thank you. Good morning everyone and welcome to Strategic Education's conference call in which we will discuss second quarter 2021 results. With us today are: Robert Silberman, Executive Chairman; Karl McDonnell, President and Chief Executive Officer; and Daniel Jackson, Executive Vice President and Chief Financial Officer. Following today's 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 has 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 the Form 10-K, the 10-Q to be filed 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 Karl. Karl, please go ahead.

Thank you, Terese, and good morning everyone. Our second quarter financial results released this morning were basically right in line with our expectations. This morning I'd like to cover a few highlights from our results and then open the call up for your questions, as Terese just said. Firstly, I'd like to begin with our Australia/New Zealand segment which generated $74 million of revenue and $16 million of operating income in the second quarter. The integration of Torrens University, Think Education, and the Media Design School onto SEI's infrastructure is mostly complete and we expect the last component of that integration to be complete by the middle of August, well ahead of our original plan which was the end of the year. At the beginning of this year, we assumed that the Australian borders would reopen to foreign travel, including international students, by this time of the year, essentially the third quarter. However, it now appears that borders will remain closed through at least spring of 2022, which we expect could have a moderately negative impact on this year's revenue. Notwithstanding this, we still believe ANZ's EBITDA will be essentially at their plan of $60 million. Next, I'd like to provide a few updates on our alternative learning segment which again includes Sophia Learning, Workforce Edge, which is our education benefits management platform for employers, and our Employer Solutions team. For the second quarter, alternative learning's direct revenue increased 52% from the prior year to $13 million. Their operating income increased 24% to $5.2 million and the reduction in their operating margin was the result of continued accelerated investments in new products and services to support their continued growth. Sophia Learning continues to perform exceptionally well and is now generating more than $1 million of subscription-based revenue each month and is on track to generate $15 million this year, which is up more than 300% from the 12 months preceding the pandemic. Additionally, Workforce Edge continues to gain good traction in the marketplace. Since launching Workforce Edge roughly five months ago, we've already signed 20 corporate agreements which collectively employ more than 415,000 employees. This compares to our internal goal of 250,000 total employees for the full year. Based on this strong traction, we expect to have more than 750,000 total employees on the Workforce Edge platform by the end of the year. Now turning to our US Higher Education segment. I thought it would be useful to talk specifically about both of our US-based universities starting with Capella. Capella University had a great second quarter and an incredibly strong first half of the year. Year-to-date Capella's total enrollment has grown 6% from the prior year and its continuation rate has increased by 50 basis points. Total FlexPath enrollments increased by 36% so far in 2021 and now comprise 35% of total enrollments, which is up 700 basis points from the prior year. Employer-affiliated enrollments at Capella have increased by 18% year-to-date. Now turning to Strayer University, where we continue to focus on reversing their enrollment declines and returning the university to positive enrollment growth following more than a year of COVID-related lockdowns. Strayer's spring term, or second quarter enrollment, was in line with our expectations. Strayer's summer academic enrollment, which ultimately will inform our third quarter financial results, continues to improve and was sequentially better than the second quarter, albeit at a level that was below what we had expected. As a result of this, along with the extended border closures in Australia, SEI's full year 2021 financial results could be at the bottom or low end of the indicative outlook we provided during our last earnings call. However, we are continuing to focus on reversing Strayer's enrollment declines by working to resume normal operating practices as quickly and safely as we can. We have already reopened 30 of Strayer's 65 campuses with plans to open all remaining campuses no later than October 1. We have also added additional resources to Strayer's advising and coaching functions, as well as our Employer Solutions team, which has also resumed in-person meetings with our network of corporate partners. Additionally, we have added operating managers to assist our campuses in resuming their activities supporting and enrolling students. Since the end of our summer enrollment period, we've seen strong increases in several leading indicators, such as inquiries into the university and applications for new enrollment, both of which are now positive on a year-over-year basis. Course success, defined as the percentage of students who complete a course and earn academic credit, was positive on a year-over-year basis in both the first and second quarter, which should aid us in the back half of the year. We remain very confident that these steps along with others will return Strayer University to positive enrollment growth. Strayer remains a strong institution with a rich 129 year history of serving working adults and has weathered other periods of declining enrollment before returning to solid growth. Across all of our institutions, we remain committed to providing the highest quality education that we can and working to help our graduates earn a substantive return on their educational investments. Before opening the call for questions, I want to note that SEI continues to have substantial liquidity of nearly $300 million of cash and marketable securities and has generated $125 million in cash from operations in the first six months of 2021, representing a 13% increase over the prior year. I would like to once again extend my thanks to all of my colleagues within SEI for their ongoing commitment to serving our students. With that, Dani, we would be happy to open the call for questions.

Your first question comes from Tobey Sommer from Truist Securities. Please ask your question.

Thank you. I'm curious about the impact so far and expected future impact of reopening physical campuses on particularly your marketing and enrollment trends?

Well, we have many years of data to suggest that both enrollment rates – new student enrollment rates, as well as academic achievement rates are substantially higher in areas where we have campuses versus areas that we don't. We have some early preliminary data on the campuses that we've reopened after more than a year of being shut down due to COVID, and it suggests that they are performing better than the campuses that remain closed. We've already reopened 30, and we have plans to open the remaining 35 for a total of 65 no later than October 1. We expect that this will improve the performance both on our new enrollment as well as retention and academic achievement.

Have you had to roll any of that back based on localized geographic conditions? Or have you maintained the openings?

We've not had to pivot and close a campus that we've reopened. Obviously, we're working to open our campuses as safely as we can and, of course, we would always comply with any local or state regulations. But to-date that has not been an issue. We continue to plan to open all 65 campuses by October 1.

Pivoting a little bit, what are your future plans to expand FlexPath across the schools, whether it's specifically FlexPath or conceptually something like it? How has the last 16 or 17 months of experience informed your view?

FlexPath is a great program designed to allow Capella learners to complete their degree essentially in half the time at half the cost. It's been a major driver of Capella's enrollment growth. We've recently launched the first doctoral FlexPath program, so there are probably areas to extend into doctoral as well as expanding some of the bachelor programs into FlexPath. We have looked at bringing FlexPath over to Strayer University, which is a longer lead-time issue just given the regulatory approvals involved. We continue to believe that FlexPath has a lot of runway ahead and we're very happy to support its future growth.

With respect to the Australia/New Zealand newly acquired business, is there an opportunity for this kind of concept there, or is it maybe not applicable?

We are looking at that along with some other revenue synergies by exporting existing US-based curricula into Australia. The first program we plan to implement by the end of this year is the Jack Welch Management Institute's MBA program. There is an opportunity to consider a FlexPath-like program for Torrens University in Australia as well.

Okay. Last question for me. Could I get your perspective on the medium and long-term outlook for pricing across your schools? Terese if you could touch on the geographic differences as well? Thank you.

On a notional basis, a lot of our strategy as we've said is FlexPath, which we know reduces the cost of a degree and has slightly lower revenue per student. Our strategy to continue driving higher corporate enrollments also contributes to this. We plan notionally for pricing overall to be relatively flat; this would be a mix of taking some modest tuition increases where we think there's value in the degree program and where there might be an opportunity to do so. But that normally is offset by increases in corporate enrollment and FlexPath growth.

Thank you very much.

Your second question comes from the line of Gary Bisbee from BoA Securities. You may ask your question.

Hey good morning.

Hey Gary, good morning.

A couple of questions. So, on Strayer, I guess it’s positive that some of the leading indicators are looking up after this difficult period, but you also acknowledge some are trending below what you thought earlier in the year. What does that really mean? I mean, previously you said you thought new students could potentially turn back to positive in Q4, but it might more likely be in the first half of 2022. Is that still fair? Or does this make it look like it's later in 2022? It's just hard to define from those two statements what you're really telling us. Thanks.

The best way to describe it, Gary, is that Strayer's enrollment has been steadily improving since the first part of this year. The third quarter was actually better than the second quarter; however, those enrollment numbers are not final, because we still have students attending the summer term and some could drop. The third quarter is also the first quarter from a year ago where we saw the first new student declines at Strayer. From a sheer expectation standpoint, we had thought the enrollment might be higher than it was. Notwithstanding the fact that it continues to get better and was better than the second quarter, we're seeing positive trends in leading indicators, such as inquiries into the university and applications for new enrollment, which are now positive on a year-over-year basis for the first time in close to 16 months. So, we remain confident that we are on the trajectory to return Strayer to growth at some point relatively soon, whether that’s in the fourth quarter or the first quarter of next year.

Got it. So the comp's gotten a lot easier. That's probably part of the year-to-year improvement you're seeing. But even that aside, sequentially as you've moved through the year, things have gotten a little better off the bottom. Is that…?

Yes, that's fair.

That's helpful. Last quarter, you identified three factors affecting us: the economic difficulties faced by students, which we know many in your demographic still encounter due to schools and daycares not being fully operational. Reviewing the BLS data, it doesn't seem to have improved significantly. I'm also curious if you have any updates on the level of competitive intensity. Additionally, you mentioned operational challenges in getting campuses open with more staff and focus. Are these still ongoing issues? Has there been any meaningful change in the first two factors compared to your comments a quarter ago?

I wouldn't say there's any change. The biggest lever we have available to us is getting our campuses reopened. It has been encouraging to see the higher level of performance in the campuses that have reopened; that was our expectation, and it has borne out. We have added some resources both at the student-facing level as well as the management level just to resume as much normal activity as we can as quickly and safely as we can. Our focus now is getting all campuses open and shifting the advertising dollars into those local campuses, which historically we've relied on to drive brand awareness among prospective new students. So the quicker we can return to normal campus operations, the better, and we're on target to do that by October 1.

Great. And then just one on Australia and New Zealand if I could. Last year the border was closed, but my understanding was they allowed students that were enrolled to do it remotely from wherever they were. I guess what changed now? The year-to-year change in new enrollment flowed sharply. Is it that the international students either weren't allowed to do that or didn't want to do online for a second year? Or is that what's going on? Or is there something else that would explain the deceleration in the pace of enrollment growth?

What we've seen specifically in Torrens, with the inability of foreign students to enter the country, is that many students that were enrolled or those who would prospectively enroll came from areas hit hard by COVID, including India. We think that this is kind of a one-time issue. If the borders continue to remain closed for some indefinite period of time – and all we know is what we read in the Australian press, which suggests it could be the middle part of next year before the country reopens to foreign travel – this is likely to have a moderately negative impact on their enrollment. However, it is also impacting the other 42 universities in Australia that rely on international students. In that respect, Torrens is well-positioned given their capability to teach all programs fully online, which we've been doing; this is a unique competitive position because none of the other Australian universities are in that position. So assuming sustained border closures in Australia, we expect to continue attracting domestic students and do our best to teach online offshore students as we've done this past year.

Hey, Gary, it's Rob. Just one other comment on that. The simplest way to think about it is that at first when the borders were closed, most of the international students that Torrens had were those who were inside Australia, obviously staying enrolled. Those outside Australia most of them enrolled online. As the borders continue to stay closed, it seems to take a little bit of the excitement off the top of growth from international students, and that's really what's reflected in Karl's comments.

Right. Presumably that would normalize once we get through this.

Correct.

One last tactical question on that. Considering the $73 million adjusted revenue and the seasonality and timing of the school year, is there any reason aside from foreign exchange that this would not be a reasonable assumption for the next quarter?

Yes, Gary, I don't think so. I think there's seasonality there, so I don't think you should carry forward ANZ revenue. We still don’t know what the enrollment will be for the third quarter for the most part.

Is the seasonality better or worse? I had assumed Q2 and three were essentially the same based on some of your preliminary guidance when you closed this year...

I’d say they're similar.

Yes, that's what he was asking. Gary, it is. Q2 and Q3 are similar in terms of seasonality.

Yes. I understand there’s certainly some variability with enrollment. Okay. That's all I had. Thank you.

Yes, thanks, Gary.

Your third question comes from Greg Pendy of Sidoti. Please go ahead.

Hey guys. Thanks for taking my question. I appreciate the color on the inquiries and applications at Strayer, but can you provide a little bit on whether you think job growth might be impacting demand? And maybe on that topic as well, whether you're seeing any different mix in demand for degrees based on job growth in areas like business versus IT?

On the Capella side, we see very strong growth in health care. The health care programs, including the RN-to-BSN degree at Capella, are the highest growing reflecting strong job growth in the health care field. The Strayer side is predominantly undergraduate, and the primary focus or area of demand has been business; that continues to be the case. Our teams are always looking at ways to expand programs if we believe there’s an area to add a program where strong job growth is expected. But for now, we haven't seen any shift away from historical strongest areas of demand for our degree programs: counseling, health care, and other masters and doctoral programs in Capella, and mostly undergraduate business at Strayer.

Great. Can you compare the downturn you experienced around 2008 at Strayer with the current situation? What is different about the recovery this time? Any insights on that?

We've seen several downturns at Strayer related to suppressed economic activity. What was different this time is that it was pandemic-induced, and we weren't able to operate our campuses; our entire network was shut down for more than a year, which I think is why we had such disparate impacts compared to prior periods. However, what we know from those prior periods is that when we return to normality in terms of economic activity and when we can fully open our campuses, we expect Strayer will return to growth as it has done during prior periods of enrollment decline. It's also worth noting that we are now a much larger, more diverse organization with our Australia/New Zealand assets, Capella University, and our fast-growing alternative learning division. This positions us to better weather what we believe will be a relatively short-lived period of enrollment declines and return to normality beginning next year.

Yes, Greg, I would add that running a university tends to involve a lot of fixed costs, making it highly operationally leveraged. You pay for professors, curricula, and technology in classrooms. When you add students, you're increasing revenue without incurring significant additional costs. Conversely, when you lose students, enrollment declines lead to rapid operating margin decreases, while growth in enrollment can result in quick margin expansion. We expect this cycle to be similar to those previous enrollment declines where we currently face margin pressure and will see significant margin expansion when enrollment resumes growth.

Very helpful. Thanks a lot.

You bet.

And your next question comes from the line of Jeff Silber from BMO Capital Markets.

Thanks so much. You mentioned earlier regarding parsing out some of the issues you had at Strayer University; one side has been seeing some economic hardships. I'm wondering in states where the extra unemployment subsidies ended a bit early, are you seeing any meaningful change in either applicants or enrollments from those locations?

Good morning, Jeff. We are seeing increased demand overall; for the first time in 16 months, demand is up year-over-year. It’s hard to pinpoint exactly why that is, but the factors seem to include the reopening of our campus network, a focus on marketing dollars in local markets, and healthier economic activity. My guess is it’s a combination of all these factors, which is why we plan to reopen our entire network of campuses by the end of the summer. We expect this will help improve our performance and ultimately return Strayer's enrollment to growth.

That's helpful. Transitioning to ANZ, despite ongoing issues, are you still optimistic about your EBITDA guidance for the year? How can you reach it if there’s an enrollment or revenue shortfall?

We expect any revenue shortfall to be relatively modest. It's a very efficient organization. If we have fewer students, there will be fewer instructional costs. We have a management team very focused on cost discipline, and given the seasonality of the ANZ academic calendar, most of their revenue occurs in the first part of the year. The smaller intake periods are in the back half of the year. Based on everything we see, we're not expecting them to come in below their EBITDA target of US$60 million.

Okay. That’s really helpful. Thanks so much.

Sure. Thank you, Jeff.

Your next question comes from the line of Tobey Sommer of Truist Securities.

Just wanted to ask a question on expected regulatory changes or impact. Could you update us on potential changes from the Biden administration?

We always take a long-term view in managing our universities, basing all decisions on providing the highest quality education possible. We're confident that both of our US-based universities will comply with any reasonable set of regulations. The department is in the very early stages of announcing a negotiated rulemaking, so we don’t have many details at this point. We hope to be a constructive party in any new rulemaking. If asked, we’d be delighted to share our opinion on what regulatory reforms might look like.

Have you been asked to participate in prior rulemaking processes? Do you expect to be invited during this one?

We have participated in several rulemaking sessions with SEI executives being members of the rulemaking committee. We have no expectation to be invited, but should we be, we would participate and do so constructively.

And your next question comes from the line of Gary Bisbee from BoA Securities. Go ahead please.

Just one follow-up. Regarding the Workforce Edge product, with 20 companies and 400,000 going to 700,000 workers at those companies, what does this really mean? In the past you've stated hoping to achieve 1% to 3% of their employees signing up for enrollment at your universities. Is that still how you're thinking about it, and what kind of timeline are we talking about?

Everything you said, Gary, is exactly right on point. The monetization strategy for Workforce Edge is first to get as many employees as we can on the platform to achieve scale. You're correct that we allow employers to use the platform at no cost. The monetization comes when members of those companies decide to enroll in an SEI institution, either Strayer or Capella. Having that said, based on national averages around participation rates in companies with educational benefits, we think it's reasonable to expect that somewhere between 1% and 3% of employees on the Workforce Edge platform will ultimately enroll in either Strayer or Capella. We don’t expect it to be that long term; this first year was all about entering the market, continuously improving the platform, and achieving scale, which we are on track to do. If we can get close to a million employees by the end of the year, that would be a tremendous success. Looking towards 2022, we anticipate seeing scale in new enrollments stemming from this initiative.

Hey, Gary, one other comment on that. I think as compared to other entities in this space, we're providing a better product at zero cost, with zero tuition revenue taken from traditional universities.

Okay, that's helpful. Thank you.

And there are no further questions at this time. I'll hand the call back to Karl.

All right. Thank you very much everyone. We appreciate your time today and look forward to having another call with you next quarter.

And this concludes today's conference call. Thank you for participating. You may now disconnect.