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Capella Education Company (NASDAQ:CPLA)

Credit Suisse 15th Annual Global Services Conference

March 11, 2013 5:00 pm ET

Executives

Steven L. Polacek - Chief Financial Officer, Senior Vice President and Principal Accounting Officer

Analysts

Kelly A. Flynn - Crédit Suisse AG, Research Division

Geoff Webster

Kelly A. Flynn - Crédit Suisse AG, Research Division

All right. We're going to get started with the next presentation. We have Steve Polacek, the CFO of Capella, joining us. And he will give the presentation. With that, I'll turn it over to Steve. Thanks.

Steven L. Polacek

Thanks, Kelly, and thanks, everybody, for joining us for the Capella Education Company presentation. Just a reminder relating to some of the comments I will make will be considered to be forward-looking statements in accordance with the Private Securities Litigation Reform Act.

A little bit about Capella University. We are celebrating our 20th anniversary as a university. We started out as a Ph.D. program and expanded to Master's and bachelor’s degrees levels as we've progressed through our history. We were one of the first fully online universities. Graduate-degree focused, that's where our roots are and that's what our primary learner base is and we continue to be primarily in that degree level that's unique in the industry, we have a unique position there. We are known for our rigorous academic experience, our focus on learner success and our regulatory metrics. And we have a very strong balance sheet and cash flow generation capabilities that we can leverage into not only expanding our business at Capella University, but broader in some of our diversification initiatives, as well as returning funds back to shareholders.

So a little slide, it's a little busy but it kind of lays out some of the key verticals that Capella University is focused in on. We look at verticals that have above average growth prospects from an employment perspective, and the percentages there in that first column in some of those verticals are meant to be the 10 years sort of compounded annual growth rates that exist for new workers coming into those verticals, as well as replacement workers. So those are the sort of the statistics of about a 3%, 4% sort of growth rate there.

The middle columns relate to the fully online individuals that are above 25 years or older. Those are generally the population of working adults that are focused in the programs that we offer. So this is unique. And so there's about 1.4 million current learners in the United States that are in the degree programs that we offer.

And the far right columns layout some of the experience relating to those particular programs that are looking for advanced knowledge workers. So we're focused in on verticals that are high-growth but also demand higher sort of degrees of attainment in our offerings.

A little bit about the profile for Capella learners. I just mentioned about 75% are focused in at the graduates program level. These are mid-career adult professionals, the average age is around 40 years old. There are about 3/4 female and about 50% people of color. And it's an average household income of about $50,000. And so when you look at some of the vacated gainful implement regulations, we showed very favorably in those metrics mainly because of our seasoned employment base, the turnout into our graduates and online [ph]. What's important for the learners that we have-- that we reiterate in our differentiation and value proposition is that these are serious professionals that are looking for advancement in their career. And when they go and look at an educational alternative, they expect a lot from the education that they receive because they want to apply it immediately into the positions that they're at. They look at job promotions, salary compensation increases, relating to what are they learning at school. These are busy working adults, they have families. They're very seriously minded. And so they want to have a coursework that is very academically rigorous, as well as value added to them. I think that's a different sort of learner profile than clearly if you are much more of a traditional student of how can I get by the easiest and the fastest. These are working professionals who are looking for it.

Our competency-based model that is really tied to what employers are looking for is really valuable to our learners. And we know that by some of the surveys that we've done, we have an independent survey done by Noel-Levitz in our business programs recently that looked at what -- how we -- our alums compared to alums of traditional universities, for-profit institutions and we scored very, very high in a number of metrics, particularly as those relate to the relevance of their course work and what they learned for their careers and for their jobs. We think that's a clear differentiation when we look at traditional universities and we scored very, very high on there.

This is just a mix of our graduate programs. So about 30% of our learners are at the doctoral Ph.D. level, 43% at Master's and the balance at -- pretty much at our bachelor’s level. We have about 35,000 learners at the end of our fiscal 2012. The average time that a learner is with Capella is about 3 to 5 years. We have a benefit with the stacking of our programs that about 20% to 25% of our graduates out of our bachelors program go on to get a Master's at Capella. And about 15% to 20% of our Master's graduates who want to get another degree at Capella. That doesn't always mean they go out and get a doctorate degree, they may go ahead and get another Master's degree. So we have a high average annual revenue per learner, these are part-time learners, it's about $11,000 on average from an annual basis. And we have very loyal alumni who readily recommend others to Capella to seek their academic endeavors.

A little bit about our position currently. We've had positive trends in new enrollment of late. In the back half of 2012, our new enrollment growth year-over-year was about 5%. Our expectations for the first quarter of 2013 is also about 5%. We're looking at a very weak demand environment, a very competitive environment. And we've been able to, in some of the key strategies that I'll be talking about, been able to break the negative decline of new enrollments and are starting to see new enrollment from a positive perspective. We also have a second initiative that I'll talk about outside of our marketing initiatives and that is our learner success initiatives to retain the learners that we have longer to get higher graduation rates and that's been a benefit in our economic and our business model, as well.

We're starting to see some stabilization. It's been a long time coming. I joined Capella at the end of 2010 where we have a lot of the determination that was going on relating to online aggregators, where we got about 1/3 of our enrollments but less than 10% now from an enrollment perspective in that sort of the channel and we've had to reshift a number of things that we've done internally, including how we have our enrollment councilors engage with learners. Not necessarily from a regulatory compliance perspective but what enrollment count -- what learners are looking for from a differentiation perspective.

We continue to expect quarterly volatility, but with that, in the initiative that we put in place, we want to make sure that we have sustainable new enrollment growth. And always trying to maintain a very strong regulatory position. I think if you talked to -- numbers, people follow the industry, they've known that Capella's got a very sort of high-quality standard and a good regulatory reputation in our history.

From a future growth perspective, want to make sure that we're focusing on serving large attractive market, as I laid out in that slide. We want to compete in a changed market environment and focusing in on expanding our market share even in an environment of weak demand. We're looking at building our brand, which we'll talk about, as well as differentiating our value proposition and expanding our served markets.

Here's a little bit about our profile. We look at our longer-term growth from a diversification perspective. So Capella University focuses, not only on the graduate level, but also the bachelor level and a number of years ago, we also expanded into the full bachelors market. We have an international subsidiary that we acquired in the latter part of 2011 called RDI based in Coventry, U.K. RDI does not issue their own degrees. They partner with other universities in accordance with the university, the model that exists in the United Kingdom. But not only do they serve residents in the United Kingdom but also in the EU but also in other countries such as in East Africa, Hong Kong and other places where those individuals that are in that rising middle class are looking for a U.K.-awarded degree. That's a value to them and they're generally in countries that were part of the British Commonwealth.

And so RDI is -- we're investing there. It is still relatively small. But we have high hopes for it as it gets to more scale and can expand, serve markets outside of the United States.

Another investment we made is in a social learning platform called SOPHIA. And SOPHIA is kind of our R&D lab. We've done a number of things there, particularly in the education field, working with educators at the K-12 area, doing things such as flipping the classroom, providing them tools to help them help -- help with their sort of supplemental -- their course assignments. We've also recently launched what we call Sophia Pathways for College Credit. And that of late learners who are in our bachelors program at Capella University can take courses, which are generally the general ed requirements for a Capella bachelors degree and take that on a self-paced basis at a much lower cost than a fully instructed Capella-University-led course. And that's attractive to learners who want to take a led course but also self-directed course to help them get through faster but also reduce their overall sort of investment in their bachelors program.

I'm going to talk about 3 initiatives now. The first one is going to be about learner success. So in learner success, we're looking at taking the population of adult learners, working professionals and improving their persistence rates to improve their graduation rates. We embarked on this endeavor in the 2011 time period, start putting some pilots in place in 2012 and are looking at expanding that in 2013. With our 100% online delivery mechanism, we have lots of rich data on every interaction that a learner has in the course room. We also have rich data of how our faculty engage in the classroom with our learners. And we can use that to do predictive analytics relating to when learners seem to be falling off the trail of getting successful completion of their course work. And then we can have an academic advisor, a faculty member, intervene in their academic endeavors to get them back on track. We also have the ability to do assessments. So we started this a couple of years ago at a bachelors level to make sure that they had the right writing and comprehension skills to go ahead for their academic endeavors.

More recently, we've put it on a voluntary basis in a number of our Master's programs where they can take the assessment and on a voluntary basis, we have a very high percentage of learners who take advantage of that. Because these are adult learners questioning themselves, are they ready go back to school. And so they can take an assessment relating to their time management skills, they can take an assessment relating to their ability to utilize technology in an online environment. Their sort of -- what's going on in their lives, what's happening financially and we can then take those learners and put them in specific personalized pathways in their first course environment and provide additional sort of support for those who need it. If they don't need it, they don't need to go through that sort of personal pathway. They may go through a different way that they need some sort of help on. We found that adult learners really like that because they want to -- they're concerned about do they have what it takes to get it done. And it's not necessarily always how smart they are from an academic perspective, but it's how are they ready to go ahead and take the time management skills as working adults, as family members to go ahead and do that academic endeavor. And so we're doing some of those personal pathways. We have a number of other things that we're doing but those are just a couple of them. And so what are seeing in our results? We started announcing in February earnings call a persistence metric, and we're looking at is focusing in on the first four quarters that a learner is with us. For adult learners, that's particularly crucial because that's where they get through with us for four quarters. The chances of them continuing on and completing their degree is very, very high. So we focus our attention on those particular cohorts and what we're trying to do is, we're measuring that. And our measurement for -- that we announced in February was our early cohort persistence for our 2012 year compared to the same cohorts that would have been there a year earlier. So what do we improve year-over-year with a lot of our efforts? And we saw a 4% improvement in those early cohort persistence.

Now that's going to be something that we're going to have to sustain and continue to improve on but as we look at getting to total enrollment growth, a key component will be the persistence of our learners. And we're looking at eventually that was we run through our population will help increase our graduation rates, which will be good from a regulatory perspective, will be great for the learners but, particularly great for shareholders because the incremental revenues for those persisting learners will have a very high incremental contribution margin.

A little bit about the aspect relating to the learner success initiative that we put in place and we call them learner success grants. We initiated these in our bachelors and certain of our Master's programs in the fourth quarter of 2011. This was designed to reward and promote progression in the course work by our learners. And so to qualify, they need to go ahead and apply. It doesn't apply to all our programs, only 9 of our 44 programs that we put these learner success grants in place. And you need to pass first course and then register for your second course. And if you're doing that, what we do is we give a grant that averages about $5,000. And it's generally earned on an average of about 6 quarters. If you take a quarter off, you're not going to get the grant. You'll lose part of that $5,000 and we made that specifically to make sure that a learner, an adult learner, doesn't take a quarter off. Because we know that when a learner takes a quarter off and they're adult learner, they have a hard time sometimes getting back into their course work. So part of our initiative is that we want you to stay with your program. What the early results are is that we're starting to see some improvement in our persistence rates relating to those learners versus when those programs weren't in place, that learner success grant, and we also believe we've got incremental new enrollment for putting those grants in place. So we believe there's a positive ROI. It did have some short-term impacts relating to our revenue per learner but in the long run, when we look at lifetime revenue, we think it's been a benefit for us.

A little bit about our sort of positioning relating to product, price and innovation. Just going to talk about one example. So one thing that we've done is, is that we look at the competencies that we have that are required in our programs. And recently, we announced in our Master's in psychology, redesigning our programs effective in the first quarter of '13, I believe, it was, relating to people who are now going into that particular program. We mapped the competencies against the course work and we were able to take out 25% of the credit hours because we already found that they were duplicating some of those competencies in some of our courses. That has reduced the overall time it's going to take do a degree, as well as expanding our served market. But that's part of our pricing innovation that we're looking at, in addition to things such as learner success grants.

A little bit about driving differentiation, affordability and speed to competency. So when we look at affordability, this is from a learners perspective, one thing that's important to them is program cost and how fast are they going to get their degree so that they can start getting the results from that. What we also add to that is that it's important for them to know what the certainty of their outcomes are. So we look at their learner outcomes and their career outcomes. Adult learners want to know that they're learning something in the course room now and they also want to know that with this degree they completed that they're going to have advancement. That's how they look at their sort of return on investment threshold. And we have a number of metrics that we look at. One is that we see a majority of our graduates advancing their career within 1 year of graduation. We see the medium income level as put up by the gainful employment rules be at top of the range. Importantly, a 10% annual salary increase, while graduates are pursuing their degrees. They're learning competencies, going to the employers and saying, hey, I've learned this in my coursework, can I apply it in my job? So they're differentiating themselves in there. And we, see from our surveys, the value propositions is showing out as well.

A little about our relationship-based marketing strategy. So with the issues that were happening at the end of 2010 and '11 in the sector, and the overreliance on aggregators, we embarked on a different sort of marketing plan and that was building relationships through brand building in relationships with employers. We're looking at focusing in our target sort of industries, and understanding what those employers are looking for, particularly the ones that are leading the industry and making sure that our programs, as we design them, have those sort of competencies involved because that is what employers are looking for. That's what they expect out of a recurring program. But importantly, learners who want to go into those particular programs want to make sure that what they're learning is relevant to the market out there.

So a little bit on our marketing strategy. What we're trying to do is get to learners early into their decision cycle, kind of go up funnel when they're starting to consider getting an academic endeavor. What we've done is we've done some mass media, whether it be TV, print, display, advertising, building strategic relationships with employers. These are investments that we started making a couple of years ago, kind of getting advanced sort of funnel. And then we look at supplementing that, how do we go ahead and connect with them, either through direct media or having them engaged somehow with Capella, either viewing our website, our visitor center or getting into a chat conversation, social media, things of that sort. And then eventually, talking to an enrollment councilor. By the time we get to an enrollment councilor, we want them to be very well-educated. So when they make their sort of decisions, that they're ready for that piece of it. And we're seeing, obviously, with our new enrollment, some progress in our marketing initiatives.

As I mentioned, we're moving more from a direct response to more of this relationship building, much more sustainable. And what we've been able to do is we look at our financials, we're spending less on marketing and promotion in 2012 versus 2011. And we're starting to see some enrollment piece of it. So we're getting some positive leverage from a cost per new enrollment perspective.

The last thing I'll cover is just quickly on our financial model. So a little bit about the highlights, our graduate focus, we have a strong revenue per learner. They're here with us for a long period of time. The grant innovation that we put in place reward learner success, help improve the affordability. Once we see the total enrollment growth happening and what we're looking at is if we continue to have the new enrollment growth that we have, as well as the consistency relating to some of our learner success initiatives from our persistence that if we continue to do that in 2013, we're expecting in the first half of 2014 returning to total enrollment growth. That will then lead to revenue growth and then margining expansion.

And this is just a little -- some highlights just relating to our revenues and operating income. So you've seen some flattening of our revenues. We also have the RDI acquisition in there, which benefited 2012. It's about 3% to 4% of our revenue base. Our operating income has come down in our margins, part of it is related to our investments in diversification whether it be RDI or SOPHIA, that's about 2 to 3 points dilutive to our margins. Plus when you have the declining Capella revenues because of the positive -- the sort of negative leverage that's happening on the revenue decline, that's impacted margins. But with the stabilization, we see that leveling out as a get to the back half of 2013.

This is a graph that we've shown relating to our total and year-end -- our new enrollment and our total enrollment and you can see the stabilization happening in 2012. And we're starting to break into the positive new enrollment growth. We, obviously, have strong cash flow. We generate more cash that we can invest in our business. We do look at diversification opportunities, and over the last 3 years, we've done a fairly aggressive share repurchases, buying about $200 million of our stock over the last 3 years. So we say we're positioned for long-term growth and the initiatives that we put in place the last couple of years are starting to bear fruit. But again, it's a weak demand environment and we're continuing to look at how we differentiate our programs.

So we're about out of time. But if there's a question in the audience, I can take that. Otherwise, we can move to the break room for those who want to do that.

Question-and-Answer Session

Kelly A. Flynn - Crédit Suisse AG, Research Division

Can you talk a little bit more about your international expansion strategy? I know you said leverage your existing U.K. platform, but do you anticipate other acquisitions internationally? Are there any other countries that you're particularly interested in?

Steven L. Polacek

So with RDI, it's all online, and we can have university partner relationships and serve a number countries outside of the U.K. Right now, we're not looking at any sort of expansion outside of what RDI can do. RDI can go ahead and operate a number of different countries. So that's really going to be our primary focus of late. As we expand RDI from a scale perspective, if there's an opportunity in a particular country that might help us from enrollment perspective, we might look on that. But for the most part, we're satisfied with RDI from international perspective.

Geoff Webster

Geoff Webster, INTO University Partnerships. Staying with the international theme just for a second. The RDI business, is that a combination of in person, face-to-face delivery, as well as your distance-learning program?

Steven L. Polacek

RDI, as it exists today, is primarily going to be the online piece of it. We used to have a business there London, in Coventry area, there was some face-to-face but we're no longer in that business. We're exclusively online, so the tutors are involved with the students on an online basis.

Geoff Webster

That's great. And can you comment on when you expect RDI to get its own degree-awarding powers. I believe that is the plan.

Steven L. Polacek

Right, it is the plan. We currently have an application process that we're going through and it's talked degree-awarding powers. Once that's awarded by the counterpart to the Department of Education in the U.K., we'd then be able to issue our own degrees. It will be a little bit of time yet. We've been -- RDI was working on that before we even acquired them. But it's all kind of dependent upon the approval process but we're in the middle of that. Thank you.

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