Capella University Company Q3 2008 Earnings Call Transcript

| About: Capella Education (CPLA)

Capella University Company (NASDAQ:CPLA)

Q3 2008 Earnings Call

November 06, 2008 09:00am ET


Steve Shank - Chairman, Chief Executive Officer

Lois Martin - Senior Vice President and Chief Financial Officer

Heide Erickson - Director of Investor Relations


Kevin Doherty - Bank of America

Mark Marostica - Piper Jaffray

Suzie Stein - Morgan Stanley

Amy Junker - Robert W. Baird

Trace Urdan - Signal Capital

Andrew Steinerman - J.P. Morgan

Corey Greendale - First Analysis

Jeff Silber - BMO Capital Markets


Good morning and welcome to the Capella University third quarter earnings conference call. Today’s call is being recorded. At this time I’d like to turn the call over to Ms. Heide Erickson, Director of Investor Relations for Capella University; please go ahead, ma’am.

Heide Erickson

Thank you, Tom and again good morning everyone, and again this is Capella Education Company’s third quarter 2008 earnings results conference call. Please note that this call may include information that could constitute forward-looking statements made pursuant to the Safe Harbor Provisions to the Private Securities Litigation Reform Act of 1995.

Any such forward-looking statements may involve risks and uncertainties. Although the company believes that the expectations reflected in such statements are based upon reasonable assumptions, the company’s actual results could differ materially from those described in the forward-looking statements and are subject to a number of uncertainties and risks that the company has identified in the third quarter news release.

These and other factors are discussed in the company’s most recent 10-K and 10-Q filed with the Security and Exchange Commission and changed factors may also be discussed in future 10-K and 10-Q filings. All filings and reconciliations of non-GAAP financial information presented in this call are and will be available for viewing on our website at

Now I would like to turn the call over to Steve Shank, Chairman and CEO of Capella Education Company; Steve.

Steve Shank

Thanks Heide. Good morning and thanks to all of you for joining us. With me on the call is Lois Martin, our Senior Vice President and Chief Financial Officer. On our call today, we will discuss our third quarter results and the outlook for the fourth quarter; update you on our progress towards resolving the issues which had impacted new enrollment growth and which we discussed during last quarter’s call; review the status of the CEO succession and provide an overview of the strategic initiatives we are pursuing to drive future growth, further enhance our learner experience and increase shareholder value.

To summarize our financial performance for the third quarter of 2008, we exceeded our guidance on enrollment, revenue and operating performance. Enrollment grew by 18.7% year-over-year to 24,100 learners. Revenue grew year-over-year by 17.5% to $65.2 million and operating margin improved by 80 basis points to 12.2%.

You might recall that during the second and third quarters, new enrollment growth was impacted by some issues related to the implementation of our Enterprise Resource Planning or ERP system. The principle issues involved the new application process and lower productivity.

During the third quarter we made good progress in turning around our new enrollment results. We were able to successfully address many of the disruptions by enhancing the self-serve functionality and making the entire new enrollment process more customer-friendly and supportive.

While we still have work to do, we see improving conversion rate and improvements in overall productivity. Our fourth quarter guidance reflects what we believe is a realistic expectation of continued improvements in light of the progress we’ve seen to date.

To provide you with additional context, September and October year-over-year new enrollment growth was in the high teen to low 20% range; a significant improvement from July and August, where the year-over-year new enrollment growth rate in those months was in the single digit to low teen percentage range. The application to enrollment conversion rate also improved. This conversion rate during September was above the September 2007 level. This good progress clearly demonstrates the improved momentum across our new enrollment process.

I’m very pleased with how the organization addressed our challenges. Our strong team leverage deep data and analytics capabilities to quickly identify and work through the primary issues. While we are still in a period of change, our focus now is on significantly improving our productivity levels and realizing the substantial benefits of the powerful, integrated infrastructure we have installed.

I am more optimistic today than even a few months ago about the opportunities to streamline processes and increase efficiencies across the organization. Examples of these opportunities include continued improvements in enrollment effectiveness; including strengthening our targeted marketing efforts and driving better leads; enhancing the end-to-end learner experience and continued organization wide productivity improvements to improve processing time and easier, quicker access to information for the learner, faculty and our staff.

The overall demand dynamics for enrollment remain positive. We continue to monitor the economic environment to anticipate any changes in the behavior of our current and perspective learners, which may be related to the credit crisis, recession or other concerns.

We do hear our learners express concern about the unprecedented global economic uncertainty and undoubtedly these concerns have impacted individual enrollment decisions, but we have not seen a material impact from external economics to overall business performance. Lead flow, application intake, persistence and customer satisfaction remain strong.

As a reminder, our learners have very little exposure to the private lending market. Currently fewer than 100 learners, accounting for well less than 1% of our enrollment and revenue utilize private loans. In addition, Capella learners’ loan default rate in 2006, the last reported year, was just 1.5%. One of the lowest default rates in the education market.

I’d like to now spend a few minutes on two other subjects; an update on our CEO succession and an update on our strategic priorities. As you know the Board of Directors is conducting an external search for a new CEO to provide succession following my retirement. This is a disciplined, thoughtful process and the Board is proceeding in a selective manner.

We are looking for a CEO with the right attributes to lead Capella today and in the future. Specifically the attributes to fit we expect include a proven track record of execution and building an organization to deliver sustainable, profitable growth; the ability to continue to build upon the Capella culture with its focus on providing exceptional learning outcomes; a strong representative for Capella with our investors, regulators and other constituencies; a commitment to execute against our business strategy and strong leadership skills, including the capacity to further develop and expand the great talent within the organization.

At this point, I believe it is most likely that we will make the new CEO appointment in the first part of 2009. The timing of the appointment has no impact on our growth priorities for 2009 and on our focus to deliver against our goals. I will serve as Chief Executive Officer until the candidate selection process is completed and a full transition has been successfully concluded. Following that, I will remain on the Board and serve in any role the Board and new CEO deem appropriate to complete this important transition.

As my final topic, I’d like to spend a few minutes updating you on our strategic priorities. We are focusing on five strategic priorities, designed to drive Capella’s vision of leadership in delivering high quality, adult education for targeted professions and markets. The strategies we are pursuing are focus on markets and learners, build Capella brand differentiation, increase total enrollment effectiveness, deliver superior learning outcomes and a superior learner experience and finally drive successful new business development.

As investors, what does this mean to you? It means that Capella is well positioned to deliver upon our long term performance goals of annual enrollment and revenue growth of 18% to 22% and year-over-year operating earnings growth of 25% to 30%.

Let me comment briefly on how each of our strategic priorities work together to drive growth within our business model. Our focus on markets and learners involves application of strong marketing, data and analytics capabilities to build an increasingly diversified portfolio of programs. It focuses us on understanding our learners and ensuring that Capella’s value proposition fits the diverse professions we serve.

One example of this has been our recovery in new enrollment performance over the last several months. We were able to respond quickly to the needs of certain learner segments where we were not performing well. Our commitment is to use the capabilities we’ve invested in, to focus on markets and professions where Capella has large, attractive growth opportunities and to ensure that we are delivering a winning value proposition.

Our second strategic priority is to build Capella brand differentiation; to grow awareness of and preference for Capella within our key professions and markets. We’re doing this in a way that is efficient and is meaningful for our learners. We’ve had major success capitalizing on specialized accreditations, professional endorsements and alliances and on the reputation and achievement of our faculty, graduates and learners.

Our success in the field of counseling, where we are one of the largest graduate universities in the country provides on example. An addition example is our growing success in the field of Pre-K through 12 educations, where we received state approval in school counseling. This is in addition to the already approved programs we have in educational administration, reading and literacy and school psychology.

The third strategy is to increase total enrollment effectiveness. We’re achieving significant gains in the efficiency of our lead generation. We will also leverage our robust systems, our data infrastructure and improvements in processes to drive ongoing gains in selling, efficiency and productivity. These capabilities give us powerful tools to support ongoing improvements in both new enrollments and persistent performance.

Delivering superior learning outcomes and a superior learner experience is our fourth strategy. This is a basic pillar of Capella’s differentiation. Our focus is on delivering the richest mix of quality learning and reliable support and service. That is what learners who choose Capella want and expect. It is core to our program for new enrollment and persistence growth. Our leadership in the movement toward learning outcomes transparency is attracting national attention and reinforcing the quality reputation of our brand among important stake holders.

The fifth strategy is new program and new business development. The thrust here is to maintain a disciplined flow of new program introductions, to expand into adjacent professions and markets and to fill out and further differentiate our offerings. In 2008, we’ve introduced three new programs and 10 new specializations including the two launches announced in the fourth quarter, a PhD in counselor education and supervision and a master’s in child and adolescent development.

New programs and specializations introduced in the two years, 2007 and 2008 are having a materially positive impact on new enrollment. About 16% of our new enrollment growth in the third quarter of 2008 was related to these new product introductions. For the longer term we are also evaluating a number of new business opportunities that could leverage our core capabilities and extent our growth potential.

Capella has a solid strategy in place and is well positioned; we have achievable long term objectives. While we have more work to do I’m pleased with our recovery from the recent operational challenges and I’m very excited about the opportunities we see ahead.

With that, I’ll now hand the call over to Lois Martin, our Chief Financial Officer. Lois will discuss our quarterly performance and outlook in more detail.

Lois Martin

Thank you, Steve. As you’ve heard and read this morning, we exceeded the guidance we laid out for the third quarter and improved the application process for our perspective learners, which shows in our new enrollment growth.

In addition we remained focused on executing our strategy, including introducing two new specializations and continuing to improve persistence. Revenue for the three months ended September 30, 2008 was $65.2 million, an increase of 17.5% from the previous year.

Total enrollment at the end of the third quarter grew 18.7% year-over-year. Both revenue and enrollment growth exceeded our guidance primarily due to new enrollment growth. Quarter three enrollments grew faster than revenue due to stronger than expected new enrollment in September in addition to higher MBA second session enrollments.

As we outlined during the last call, our quarter three guidance recognized the challenges we were working through in our new enrollment process. I’m happy to say that the process changes we made took hold relatively quickly. Our enrollment counselors, advisors and IT staff did an outstanding job addressing the needs of our perspective learners. As a result, we were able to mitigate about half of the expected quarter three new enrollment shortfalls with strong September starts and second session MBA registration.

Enrollment in all of our degree programs increased in double digit percentages driven by new enrollment growth and persistent improvements of about 100 basis points. Enrolment in our master’s degree increased by 21.9% year-over-year to more than 11,000 learners; master’s is our largest degree program.

Third quarter doctoral enrollment increased by 12.3% year-over-year, up slightly from quarter two 2008, to approximately 9,000 learners within our goal of low to mid teen annual percentage growth in this degree area. Bachelor’s enrollment, which totaled approximately 4,000 learners increased by 26.7% compared to last year continuing strong growth performance.

Regarding degree mix, 84% of our enrollments is in graduate programs, learners in doctoral programs made up 38% of our total enrollment at the end of the third quarter, masters 46% and bachelors 16%.

The bachelors program is currently our fastest growing program. This is the reflection of strong demand dynamics and the shorter conversion cycle from application to enrollment for bachelor compared to graduate learners. The improvements we made to the new learner application process resonate therefore, first in bachelors’ growth. I will discuss our enrollment expectations for the fourth quarter in a few minutes including continued improvements in bachelor program’s profitability.

In addition to revenue growth of 17.5%, we delivered significant operating income and margin improvements during the third quarter. Operating income improved 26% to $7.9 million or the quarter, resulting in an operating margin of 12.2% of revenue, an 80 basis point improvement.

Operating margin without the $700,000 severance charge we incurred during the third quarter of 2008 was 13.3% of revenue, a 190 basis point increase year-over-year. Instructional costs as a percent of revenue in quarter three were up slightly from the previous year due to increased depreciation and amortization resulting from the ERP system implementation.

In addition we made several short term investments within the learners support and financial aid function. These investments helped mitigate the learning curve associated with our financial aid module implementation which was completed in July.

In addition a number of self lenders exited the student lending business during the summer and other lenders were slow to disperse funds. While we successfully transitioned these learners, the process for many was less than ideal and caused significant rework and productivity issues in our own financial aid department.

Marketing and promotional spending as a percent of revenue was 31.9% reflecting our alignment of spending with enrollment pattern and the volume of leads our enrollment counselors can effectively pursue.

We have been successful in tapping into more efficient lead sources, which has allowed us to control costs while generating a record level of leads. As a data driven organization, we continually monitored lead volume, flow and quality along with conversion patterns and the enrollment patterns of the specific professions we serve. With all of these data points, we are able to adjust marketing spend to continue to improve the return on our investments.

General and administrative expense as a percent of revenue was 10.6%, down 180 basis points from a year ago, primarily related to lower bonus accruals which were partially offset by $700,000 in severance expense and slightly higher bad debt expense.

As expected bad debt expense as a percent of revenue was 2.2% up from last year’s 1.8%. This increase in bad debt is related to higher credit limits granted to learners earlier this year in recognition of billing inconveniences associated with the implementation of the ERP. In addition we allowed certain learners who were not able complete their annual financial aid renewal on time after having to switch self lenders to carry a larger balance at the beginning of the quarter. These changes increased our accrual for bad debt.

Earnings before interest, taxes, deprecation and amortization were $11.1 million during third quarter 2008, up $2.3 million or 26% from lat year. As a percent of revenue EBITDA increased 120 basis points over last year. Depreciation and amortization for the quarter was $3.2 million, up $670,000 or 26% from the same period last year.

Other income for the quarter was $839,000, a decrease of about 33% from the prior year. The decrease in interest income was primarily due to lower interest rates. Average investment returns during the third quarter 2008 were approximately 2.75% compared to nearly 4% in the third quarter of 2007.

Our investment portfolio is primarily invested in highly rated, short term municipal bonds. Our investment philosophy is very conservative, focusing on capital preservation and liquidity. Reflecting the 26% increase in operating income and the decrease in interest income, net income for the quarter was $5.8 million, a 14.1% increase over the third quarter of 2007.

Diluted earnings per share for the quarter were $0.34, up $0.05 per share from last year. The share of common stock outstanding at the end of the third quarter 2008 was 16,581,000 shares. In connection with the share repurchase authorization in August; we repurchased approximately 84,000 shares for total consideration of $4.2 million during the third quarter.

Subsequent to the end of the quarter and through yesterday, November 5, we repurchased an additional 77,000 shares with total consideration of $3.1 million. About $53 million remains under our current share repurchase program. We will continue to use our share repurchase program to opportunistically buy our stock. Our focus is on creating long term shareholder value while balancing liquidity and other investment needs.

Shifting our attention to the balance sheet, as of September 30, 2008, we had cash, cash equivalents and marketable securities of $113.8 compared to $143.8 million at the end of calendar year 2007. Accounts receivable were up $3.8 million primarily due to higher credit limits granted to learners earlier this year in recognition of inconveniences associated with the implementation of the ERP and delays in disbursements from financial aid lenders.

Accrued liabilities declined by $3.9 million, primarily related to timing and decreased bonus accruals. Year-to-date our capital expenditures were 5% of revenue compared to 8.7% of revenue in 2007. In 2007, it was the peak investment year for our multi-year ERP system implementation, which we completed in July of this year; at the same time free cash flow, defined as cash generated from operating activity less capital expenditures has increased almost 63% to $22.3 million year-to-date 2008 compared to the same period in 2007.

A data point that provides insight into the strength of our business model is free cash flow to EBITDA. Through the third quarter, free cash flow to EBITDA was nearly 68% compared to 56% in 2007. This metric demonstrates the strong characteristic of our business model and our ability to generate solid cash flow conversion. We retained more than half of our operating earnings to invest in strategic growth initiatives.

To summarize, during the quarter we made good progress to address the operational challenges discussed in last quarter’s call and we delivered operating income improvements of 26% in the third quarter and year-to-date a 63% increase in free cash flow. Our financial position is very solid, the significant investments in our infrastructure are behind us and we have the foundation in place for ongoing future revenue growth and operating performance improvement.

Now I would like to discuss our fourth quarter and full year outlook. Our outlook for the full year 2008 remains unchanged and within the range we outlined during last quarter’s call, which was year-over-year average enrollment growth of 18% to 20%, revenue growth of 20% to 22% and operating margins in the range of 14% to 15%.

Our expectations for the fourth quarter of 2008 are for total enrollment to increase by 18% to 19% and revenue to increase 17% to 18% from the fourth quarter of 2007. I would like to highlight that as of today we have greater visibility into the fourth quarter’s enrollment as compared to other quarters in the year since only a small percentage of fourth quarter’s enrollment comes in December due to the holidays.

Reflected in our quarter four enrollment expectations are the following assumptions; first, fourth quarter new enrollments are expected to show the strongest year-over-year growth since the end of 2007 especially in bachelors. In addition we expect continued improvements in conversion rates.

We are pleased with the bachelor program’s growth as it offers incremental enrollments and revenue, offers a solid future enrollment source for our graduate programs and positively contributes to our margin improvement. In fact we have been pleased with the continued increase in the bachelor’s program profitability.

During the third quarter 2008, bachelor program profitability increased 10 percentage points. We believe the bachelor’s program will a key contributor to Capella’s long term growth, profitability and shareholder value.

The second assumption reflected in our enrollment expectation is a timing impact associated with September’s start. Specifically, fourth quarter ending enrollment will have a timing impact as a result of our strong September new enrollment starts who complete their courses in November and don’t typically re-register until January. These learners will therefore not be included in our December 31, 2008 enrollment number.

Finally I’d like to point out that our recurring learner base, which has solid persistence is much larger than the new learners that we bring in each quarter. Therefore, it takes several consecutive quarters of strong new enrollment growth to see a material impact to the total enrollment growth percentage.

Our fourth quarter revenue growth is primarily driven by enrollment growth expectations and colloquia revenue. Annual 2008 colloquia revenue is anticipated to grow about 20% year-over-year, which is in line with our overall revenue growth. However, primarily due to timing colloquia revenue in the first half of 2008 grew 40%, but is expected to be virtually flat year-over-year in fourth quarter 2008.

Moving on to fourth quarter operating margins, we anticipate operating margins to be in the range of 20% to 20.5% of revenue, reflecting leverage and instructional cost and services and also general and administrative expenses. Marketing and promotion spending as a percent of sales is anticipated to increase year-over-year in quarter four reflecting our alignment of spending with enrollment patterns. On an annual basis we continue to anticipate marketing and promotional expenses as a percent of revenue to remain flat to slightly down compared to full year 2007.

As we’ve begun to focus on streamlining processes and increasing productivity, we realigned certain support staff functions and eliminated the associated overhead in October. Approximately $500,000 in expense associated with this activity is included in our operating margin expectations for the fourth quarter. Other income for the fourth quarter is expected to be less that $750,000 primarily due to lower interest rate environment.

As for our tax rate, we continue to estimate our annual tax rate to be about 35%. Capital expenditures for the fourth quarter are expected to be approximately $5.5 million. We are investing in co-locating all employees from two to one campus in Minneapolis and are expanding our data storage infrastructure.

With that I’d like to hand the call back over to Steve; Steve.

Steve Shank

Thanks, Lois. Let me close with the following summary. We exceeded our guidance on third quarter enrollment, revenue and operating performance. We quickly addressed and resolved the primary issues impacting new enrollments. Our focus now is shifting for leveraging our new system infrastructure to increase our productivity, improved processes and efficiencies and to start to harvest the power that this single platform enables.

We are successfully executing against five strategic priorities and we continue to make excellent progress against initiatives that drive a positive learner experience, exceptional learning outcomes and profitable growth. We have sound strategic priorities, a resilient business model and momentum to deliver on our short term and long term goals.

We will now open the call for your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Kevin Doherty - Bank of America Securities.

Kevin Doherty - Bank of America

I just wanted to revisit some of your prepared comments about the improved opportunities. I think you mentioned for efficiencies and for growth. What’s sort of the driving the change there? Is that something that makes you inclined to revisit some of your three-to-five year targets or maybe how should we just put some of your comments into context?

Steve Shank

Good morning, Kevin. So to put this into context; our commitment is to drive ongoing margin improvement. We’ve been clear about that. We have given guidance that over the three-to-five year period of time, the objective is to increase margins to the high teen low 20% range. We believe that we have substantial tools in place to continue now to improve processes, scale the business, adding learners while adding less staff to serve those learners and actually provide a better experience.

We think all of this is going to help us drive revenue and enrollment growth too. We are not at this point in time communicating any changes to our long term guidance, we are definitely saying that we think our objectives are highly achievable and we’re very optimistic about what we see for the future of this business.

Kevin Doherty - Bank of America

And then just a question on the ERP, could you just walk us through what some of the costs were involved as you resolved some of those issues on the application side and I just think that last quarter you mentioned just potential staffing levels. Was there any increased support for some of those additional folks?

Lois Martin

Absolutely, Kevin; as I mentioned in my prepared comments, we did add some additional support staff functions to help with some of our productivity issues.

In addition, we also made certain process and system changes. Not deep software changes, but processes or changes in our processes and the interface with the learner. So for example on the self-serve functionality, making that a little more user friendly; also allowing them to get to an enrollment counselor easier; those type of changes, which again clearly took some additional resources, but were not significantly material.

Kevin Doherty - Bank of America

Okay and then just one last question to wrap up. Lois, you made some comments at the end just about the strong up tick in bachelor profitability. Could you just drill down a little more on what drove that?

Lois Martin

Absolutely; one, Steve had mentioned we are continuing to get more and more efficient in our lead generation and that really resonates well within bachelors and we have been able to get much more efficient there. In addition, just with the ERP system, our ability to continue to do a lot of our internal or back office processing much less manually and much more automated and with that also, just the beauty of scale that happens within this business model and as we’ve talked over the years, we’ve seen that same pattern within PhD and masters as they grew and we are seeing the same thing on bachelors.

Kevin Doherty - Bank of America

And is there any reason more that started to hit this quarter versus in prior periods?

Lois Martin

Again, I think we mentioned in the last coupe of quarters that we have seen improvements in bachelor’s profitability. We saw a very nice up tick again here in the third quarter and I would correlate that again to the beauty of just adding incremental volume onto this business model.

Steve Shank

Again, just to emphasize, we do have a shorter enrollment conversion cycle with bachelors, so we saw the biggest impact from all the work that we’ve been doing on bachelor’s enrollments and scale higher conversion have a very positive impact on the profitability of that segment.


Your next question comes from Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

Yes, thank you. I just wanted to follow on that question on bachelor profitability. I believe you mentioned that margins for bachelor programs were up 10 percentage points year-over-year in the quarter and I wanted to get a sense, on a relative basis, could you give us some color as to how the bachelor program profitability relates to masters and/or PhD?

Lois Martin

Absolutely, Mark. If you look, as we’ve mentioned over the time, all of our programs are profitable on a contribution margin basis and only bachelors had remained unprofitable at a fully allocated basis. If we now look at the contribution margins for each, again the majority of the profitability comes from the graduate program. Having said that, again bachelors, the significant increase that’s been really happening all year and really also jumped in the third quarter is adding some very nice incremental volumes to the bottom line.

If you also look at it on the year-over-year fully allocated basis, that’s also where we are identifying the 10 percentage point increase. So I’m highlighting the 10 percentage points, not just on contribution but actually on the fully allocated. With that again, they still remain unprofitable fully allocated, but much less so than our historical pattern.

Mark Marostica - Piper Jaffray

I also wanted to Lois, get a sense of the impact in terms of number of learners who you mentioned I think will take the holiday off and will impact your Q4 enrollments but will spill over into Q1.

Lois Martin

In that and I can take it offline with you too Mark, if it gets a little too wonky here as I try to talk through it, but we always clearly have some seasonality in the September, October timeframe, but this year with the enrollment changes that we made or the changes in our process we made, the significant or the difference, the growth in September was even more disproportionate this year than it was in traditional years.

So while we always have this pattern, this September, because of the spike and the disproportionate growth it provided in third quarter, it has a bit of a disproportionate impact in the fourth quarter. Based on my estimations, that will cost us about a percentage point of enrollment growth when we report 12/31 enrollment numbers and again that’s a year-over-year comparison of how much that September impacted us.

Mark Marostica - Piper Jaffray

On the new program front Steve, you mentioned that new programs contributed, I think 16% of the new enrollment growth that you saw in the quarter and first question related to that is, is that in line with what you were thinking, much better than what you were expecting coming in?

Steve Shank

I would say Mark, we are pleased with the performance of the new programs in aggregate and then of course as life works, you’ve got some really outstanding performers of some that hit expectations, some that haven’t hit expectations and then we’ll have to assess what we do with those.

But I would say in aggregate the new enrollment contribution is meeting our expectations and as we look at driving growth for this business in the future, we are looking for a balanced revenue contribution from both new enrollments and continuing growth of the existing core programs.

Mark Marostica - Piper Jaffray

And then one last question related to that. As you look out to ‘09 and consider that you’ve rolled out three new programs this year, 10 new specializations so far, what do you expect for ’09 and are we also going to see the introduction of a new vertical in ‘09 and any color on what that might be. Thank you.

Steve Shank

What we have guided consistently over the year is, look for 10 to 12 new program or new specializations from us in 2009. We’re looking for balance, we want to do new introductions, which have a meaningful contribution to the business and not just be doing activity. We have indicated that we expect to announce a fourth market introduction in the later part of 2009 or early 2010. That continues to be our expectation.


Your next question comes from Suzie Stein - Morgan Stanley.

Suzie Stein - Morgan Stanley

I know you talked about this a little bit, but can you elaborate on the bad debt issue? Is this something that’s temporary or should we see this start to improve in the next quarter or two?

Lois Martin

We had anticipated earlier this year that our bad debt this year would run slightly higher than it has traditionally by 30 to 40 basis points. We did have, just to provide some context, for the learners that had really some inconveniences or issues as we rolled out part of our ERP earlier in the year; there were approximately 11,000 learners that were impacted by that ERP billing issue.

That resulted in approximately $3 million of additional receivables, which we felt it was a good business decision and as we’ve analyzed that group and have seen how they’ve paid, it has turned out to be a very good business decision, because the issues were really ours that we inflicted on the learner that we should allow them to carry an additional balance.

As of now, the vast majority of them no longer have any past due balance. They have done a very nice job of paying down that balance. If we were to have taken out those learners and those exceptions we made, bad debt would have been very comparable to the past, around 1.8%.

Suzie Stein - Morgan Stanley

And one more question, just looking ahead and given the mix of bachelor degrees and sort of balancing that with potential price increase, how should we think about the average tuition per student going forward?

Lois Martin

In our long term guidance, the 18% to 22% we have assumed more nominal or I would say modest price increases. Our expectation of price increases would be around 3% and we believe that’s prudent in today’s economic environment along with just the focus on the affordability of education.

From that standpoint as we’ve talked about revenue per learner, we do believe that we can continue to offset, I would say the difference in mix with price increases along with again looking at other options whether its colloquia, other things that we can provide the learner that could and would provide additional revenue in the future, but with that we believe that revenue per learner will remain consistent if not, potentially small increments of increase over the longer term.

There could clearly be changes on a quarterly basis depending upon certain growth patterns of certain degrees, but that’s our overall expectation.


Your next question comes from Amy Junker - Robert W. Baird.

Amy Junker - Robert W. Baird

If I can just follow-up on the new vertical launch; I guess my question is really expectations for ramp up in costs associated with that and I’m not asking what it is, but have you actually decided what that new vertical is and how should we expect the investments to ramp as you move through 2009?

Steve Shank

With respect to have we decided what that new vertical is, obviously at this point in time, the answer is yes, we’re well down the path of building the programs and the resources we need to do the introduction.

I’ll ask Lois to respond to the cost pattern, but just basically say that in terms of having to add significant costs other than the marketing costs of introductions, this is not a big cost increment for us and we would expect to manage the introduction consistent with our commitment to continue to improve margins. Lois, do you want to tell us more?

Lois Martin

Absolutely; overall the investment that is happening for example in the fourth degree much like our other new product introduction, really increments over time and is reflected in our guidance.

The initial upfront investment really is very minimal. It increases slightly as we go through because the closer we get for example, we would begin to hire some faculty, some content experts. We’d begin to develop more and more of the curriculum, but the biggest investment truly happens at the time of launch and shortly thereafter, as we build awareness in that new program or that new offering and gear up to taking enrollment.

So from that standpoint, I would say overall it’s minimal, it’s reflected in our guidance and again it will be the launch for which it would be reflected in our 2009 specific guidance when we give that on our year end call.

Amy Junker - Robert W. Baird

And then just another one for you Lois. When you went public, you kind of talked about a 20% operating margin target within three to five years and since you went public in 2006, implies 2009 to 2011, I’m going to assume you’re not going to hit that in 2009, but is that still an achievable target by 2011 or does anything push that out further or lead us to believe that it might take a little bit longer to get there? Thanks.

Lois Martin

Actually we think we are actually on the path to the guidance that we set out when we went public, actually slightly ahead. When we had set that out when we talked specifically on margins and I apologize if there was any confusion, on the three-to-five years when we talked about margins, we had highlighted that we expected to be in the mid teens in the three year timeframe which would be again in the 2009 timeframe with the high teens 20% being in the five year timeframe. So with that, we actually think we are on the path, actually a little bit ahead of that path that we laid out.


Your next question comes from Trace Urdan - Signal Hill.

Trace Urdan - Signal Capital

My question first of all is if you guys are seeing the enrollment in September and October timeframe trending into the high teens and the low 20% range, why are we not seeing that reflected in the Q4 enrollment growth guidance?

Lois Martin

Trace, it’s Lois, I will take that. First as I mentioned, we do have that impact from the disproportionate growth within September, so that probably takes up about a percentage point of enrollment growth, when we report our 12/31, because those learners will actually be completed with their studies at the end of November and so we’ll be in a active enrollment phase at 12/31 which we report.

Second, as I’d mentioned in my prepared comments, with the strong persistence and therefore learner base that we have, to really see the material impact on the total enrollment growth rate, you’re going to need or you will see that after a few consecutive quarters of higher new enrollment growth.

So again, we are very pleased with what we consider a leading indicator in the significant demand that we’re seeing on the front end; seeing very nice increase in new enrollment growth. Again based on the dynamics of just the numbers, it will take a few quarters to see a material increase in that total enrollment growth from that higher new enrollment.

Trace Urdan - Signal Capital

Okay and then I guess related to that, Lois is that there was a drop off in the enrollment growth from the first quarter to the second quarter and now what we are seeing is sort of the second through the fourth quarter enrollment growth is pretty steady at that reduced level. Can you help us with what it is that we cannot see underneath that that describes the process of discovering the ERP problems and then resolving them, because on the surface it looks like we’re sort of still at the same level that we have been for the last two quarters and the fourth quarter?

Lois Martin

Trace, hopefully this will answer the question; several of the indicators that we look at and we actually talked about on last quarter’s call also; for example, the application to enrollment conversion rate and as Steve mentioned, we have been seeing very nice increases in that over the last several months, actually even moving a little bit faster that we had even hoped, so we’re happy about that.

In addition as we’ve talked about, we do have a relatively longer conversion cycle from inquiry to enrollment due to the graduate focus. Bachelors’ learners clearly have a shorter conversion time from lead to enrollment. Master’s and PhD learners, it’s a longer term decision, therefore that conversion pattern actually moves out into even the six months and plus timeframe for someone to make that decision.

So some of the changes that we’ve made here in the last quarter will take a little bit longer to resonate or see in the PhD and masters new enrollment growth. Some of the other indicators that we look at that again give us great comfort is just the front end demand, the front end of the funnel; both inquiries, the quality of inquiries and the cost for obtaining those. So we’ve been pleased with the progress on that front.

Trace Urdan - Signal Capital

Okay and then just one other question, Lois. I know Steve made some comments about the economic climate, but it kind of begs the question, I don’t know that those of us that watched this space have ever really experienced what doctoral programs -- how those programs tend to behave in recession and I wonder if you could speak to the funding sources that doctoral students rely on; how they differ from the masters and the bachelor student; do you get a significant amount of corporate reimbursement dollars behind the doctoral programs or do those students tend to fund their programs from another source?

Lois Martin

Trace, I’ll mention that and then I think Steve wants to add a couple of points. One, for graduate learners, they have access to much more significant title for dollars. Therefore, when you look at the funding that’s available to them just through Title four compared to the cost of their education in a year, they are in good position even just through Title four to pay for their tuition.

Specifically on the economic and how PhD behaves during a recession, in the past we have not seen significant changes in that enrollment pattern. Again it tends to be more acyclical. We’d be the first to say though, and I think most would, that this economic downturn has some different dynamics or color to it than previous downturns. Therefore we are watching this very closely, but it’s also one of the reasons we remain confident in our long term guidance.

One of the benefits of Capella or the beauties of the business model is the diversification. It’s diversified not just across markets but it’s also diversified across degrees and therefore again, we believe that helps support an acyclical business model. Steve.

Steve Shank

Trace, a couple of specific points in answering your question. We are seeing enrollment growth at the PhD level trend towards the low teen range. That is consistent with our longer term guidance.

In terms of reimbursement, much fewer doctoral students receive reimbursement than either masters or bachelors and that’s probably for obvious reasons. These are less immediate career impact jobs for the business employer and the education employer does not tend to reimburse. To the extent that doctoral learners do get reimbursement, the employer reimbursement would be in the $4,000 range versus an annual spend of $14,000 plus with us for doctoral.

Then finally the point is the doctoral program is the longest program; probably the economic payback is the least immediate. So with all of that, we are saying we think our guidance in the low teen rate is realistic but we do think it will be the slowest growing category we have.


Your next question comes from Andrew Steinerman - J.P. Morgan.

Andrew Steinerman - J.P. Morgan

I wanted to ask about marketing spend. Obviously you spoke a lot about enrollment and effectiveness and targeted marketing. I was wondering if the current advertising market in the current recession has provided a favorable backdrop for advertising rates and if you’re able to get kind of more for you money here?

Lois Martin

What we have seen is a relatively flat overall cost out there in the advertising world; however, with our improved process for sourcing leads and even scoring and filtering leads, our actual cost per inquiry has actually gone down. So we have been pleased with that and continue to expect to capitalize on that especially using the analytics and the data rich environment that we have.

Andrew Steinerman - J.P. Morgan

Has your cost per start also gone down?

Lois Martin

Our cost per enrollment would not have because of the issues that we talked about last quarter with the lower conversion rate. So when we factor all of that in, while cost per inquiry is down, obviously we had some productivity issues etc during conversion, which would have offset and therefore put some pressure on cost per enrollment. However, we are clearly starting to see improvements since Steve mentioned our conversion rates are beginning to improve very nicely.

Andrew Steinerman - J.P. Morgan

Just to finish that off; is there any shift in the type of media that you’re choosing in advertising in the current environment?

Steve Shank

I would say Andrew, no shift in the types of media. We think that we are doing a better job of assessing the productivity of this advertising vehicle or that advertising vehicle, but in general, no.


Your next question comes from Corey Greendale - First Analysis.

Corey Greendale - First Analysis

First, I was hoping you could just extend the answer you gave to Trace’s question about PhDs and talk about corporate or employer reimbursement for bachelor and masters; in particular I’m interested in school districts and other state and local agencies given the budgetary issues there facing. In general would you expect to see a lesser part for education?

Steve Shank

Yes Corey; the primary reimbursement sources for our learners are business employers and the military programs, we see no change there. In terms of other segments that are important to us, school districts, higher education employers are very important to us; generally they do not tend to reimburse, so there’s no change, but there’s no real contribution and the learners are looking for, either they got to have the degree or they’re looking for a fairly quick salary increment to justify the expenditure.

The other important employer for us is social service type agencies. I’ll say two others; social service type agencies do not tend to reimburse, so no change there; governments are an increasingly important employer for our students. We haven’t seen the impact yet, as we grow and it feels like criminal justice, local employers will be important to us. We haven’t seen an impact yet, but I certainly wouldn’t say there would be no impact.


Your next question comes from Jeff Silber - BMO Capital Markets.

Jeff Silber - BMO Capital Markets

I wanted to circle back to the colloquia issue. Can you give us just a sense in terms of what the colloquia programs represent; wither as a percentage of revenues, and how that profitability is different or is same to some of your other programs? Thanks.

Lois Martin

Colloquia, as we’ve talked about over the time, clearly does vary by quarter depending upon the number of colloquia we happen to offer in that quarter along with the size of those colloquia.

In the case of quarter four, we’re actually offering three colloquia; however, they are quite a bit smaller in size than the colloquia that we had earlier in the year and some of that again is just the location that we’re offering them at and again the timing of the year.

Overall we have given a range of colloquia. It can range in size of what it contributes on revenue, anywhere from $500,000 to $1.5 million, depending again on its size. These tend to be on the smaller side for us, these three and fourth quarter, so I would caution you to use more of the mid term there or the mid average there on the price range to the little lower side for those three.

If you look year-over-year, the amount of revenue dollars we’re going to get from the colloquia in the fourth quarter ‘08 is virtually identical with the revenue that we’re going to get or that we did get in fourth quarter ‘07; and again, really a timing difference.

Now we are clearly sensitive in today’s economic environment that the cost of colloquium could be or maybe will begin to be a challenge for our learners. So we are actually continuing to be very active on the scheduling of our ‘09 colloquia to make sure that we are finding very low cost venues and alternatives for those learners, so again if any economic pressure doesn’t distance a learner from attending colloquia.

As we previously mentioned, there is a requirement in PhD graduation to have attended three colloquia. So again it’s a requirement, but we want to make it the most economical we can for those learners.

Jeff Silber - BMO Capital Markets

I think there was a question about relative margin from colloquia, too.

Lois Martin

Margin overall on colloquia is a little bit lower than our margin on a course, but again still in the significant double digits.

Jeff Silber - BMO Capital Markets

Okay and as a percentage of revenue on an annualized basis, what do those programs represent?

Lois Martin

It would be less than 5%.

Jeff Silber - BMO Capital Markets

And how does that impact revenue per student if at all it’s the same student; do you count them in your enrollment headcount as well?

Lois Martin

They would already be in the enrollment count in the active enrollment because they would be doing course work, so they’re not an incremental headcount at all. They clearly do impact the revenue per learner.

Jeff Silber - BMO Capital Markets

And just on quick follow-up; on the G&A line item you mentioned bonus accruals being a little less in the third quarter, is that a trend we should expect in the fourth quarter as well?

Lois Martin

I think on a year-over-year basis, I would expect that. Again, the lower bonus was pretty much completely offset in the third quarter with the severance along with the slightly higher bad debt etc, but in our guidance is our projection on what we believe that continued bonus accrual will be.

Steve Shank

With apologies, I know we have a couple of calls in the queue yet and we would be happy to take those in continuing dialogue, but we’ve reached the end of our appointed hour here. So at this point I’d like to thank all of you for participating in our third quarters earnings release call. As we’ve indicated, we are pleased with the progress we are making this quarter; we’re pleased with the momentum we see and if there are further questions, I’d invite you to contact Heide Erickson. Thank you and have a good day.


Ladies and gentlemen, this does conclude today’s conference call. We appreciate your participation. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!