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Executives

Heide Erickson

J. Kevin Gilligan - Chairman and Chief Executive Officer

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

Analysts

Corey Greendale - First Analysis Securities Corporation, Research Division

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

Adrienne Colby - Deutsche Bank AG, Research Division

David Chu - BofA Merrill Lynch, Research Division

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Capella Education (CPLA) Q1 2013 Earnings Call April 23, 2013 9:00 AM ET

Operator

Good morning, my name is Bonita, and I will be your conference operator today. At this time, I would like to welcome everyone to the Capella Education Company First Quarter 2013 Earnings Call. [Operator Instructions]

Thank you, I would now like to turn the call over to Ms. Heide Erickson. You may begin.

Heide Erickson

Thank you, Bonita. Thanks and good morning, everyone. Welcome to our first quarter conference call. Kevin Gilligan, Capella's Chairman and Chief Executive Officer; and Steve Polacek, Senior Vice President and Chief Financial Officer, are here with us to discuss this quarter's results.

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 first quarter news release and the 10-Q issued this morning.

These and other factors are discussed in the company's most recent 10-K and 10-Q filed with the Securities and Exchange Commission. Other unchanged 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 available for viewing on our website at capellaeducation.com.

Following our prepared remarks, we'll take questions. With that, I'd like to turn the call over to Kevin Gilligan. Kevin?

J. Kevin Gilligan

Thanks, Heide, and good morning, everyone and thanks for joining us. It's nice to be with you this morning to report strong first quarter results, as we continue to execute our strategies. New enrollment growth exceeded our expectations because of stronger than anticipated bachelor growth, significant growth at the master's degree level and stabilization of our doctoral new enrollment.

Operating margins were better than anticipated due to higher than expected revenue and disciplined cost management across the organization. Building on this momentum, we expect continued strong performance during the second quarter, marking our fourth consecutive quarter of new enrollment growth, and another quarter of early cohort persistence improvements.

Steve will go into more detail on our first quarter performance and our outlook. I'd like to focus my comments on the path we're on, to return to revenue and earnings growth.

Our first quarter results and strengthening outlook for the second quarter give us increased confidence in our strategies and our ability to compete and create shareholder value and a change in still challenging market.

It's all about executing and following through on our strategic priorities, as we continue to undergo our business transformation. We are well underway in this process. Looking back, we arrested new enrollment declines, we stabilized new enrollment trends to our brand-driven relationship marketing strategy and by strengthening Capella's competitive position and differentiation. And we have now demonstrated 3 quarters and expect to report a fourth quarter of positive year-over-year new enrollment growth against quarters with negative new enrollment comparisons.

Our next challenge will be to deliver growth on growth, to generate new enrollment growth, while also lapping positive new enrollment growth comparisons, which will be the case during the second half of 2013.

Looking forward, volatility and year-over-year new enrollment growth remains possible. However, with our anticipated strong performance during the first half of 2013, we are increasingly confident that we will return to total enrollment growth in the first half of 2014. This will be critical in returning to revenue and earnings growth.

We're making steady progress against our strategies to position Capella for long-term sustainable growth and to drive differentiation as we improve affordability, increase speed of competency, further strengthen employer alignment, build our brand and optimize our relationship marketing efforts.

We are applying a thoughtful and disciplined approach as we execute our strategies and manage through our transformation to return to growth. Whenever possible, we pilot our initiatives, evaluate results and scale or adjust depending upon our learning. This has been a core part of our success as we return into enrollment growth and as we improve early cohort persistence.

To illustrate, our rolling fourth quarter early cohort persistence metric improved this quarter by 5% compared to the same period last year. This improvement is due in part to a number of pilots that we're now rolling out more broadly including refining our onboarding process, transforming or advising processes to be more proactive and more focused on at-risk learners and increasingly personalizing our first course offerings. In each of these areas, we used pilots to test our hypotheses, learn from the results, adjust it where necessary and when ready, expand it broadly.

An additional example is the rollout of our mandatory assessment for new learners, which started in the fourth quarter of 2012 and will be completed for almost all programs by the end of this April. These assessments allow us to deepen what we know about new learners. This is critical as we provide an increasingly personalized and learner-specific experience at Capella. In addition, the learner receives feedback about their personal strengths and challenges, receives tools to help them overcome these challenges and gains immediate feedback, which strengthens their confidence and their ability to succeed.

We believe these changes had no impact on new enrollment growth and will continue to contribute to learner persistence improvements.

We've been taking the same test, measure and expand approach to our marketing efforts, which has contributed to meeting new enrollment goals. Our market research shows that our targeted prospective learners are still apprehensive to make an educational investment. What's driving our performance is our ability to differentiate Capella's value proposition. This, combined with continued strong enrollment counselor effectiveness, improving overall quality of inquiries and continuous optimization of our marketing approach across channels has been driving conversion rates.

Capella University today is more competitive as we focus on first, learner success, which propels learner lifetime value; second, strengthening differentiation to generate results to our affordability, speed of competency and employer alignment strategies; and finally, shifting how we go to market.

At the same time we're improving our near-term performance, we're developing longer-term opportunities to expand our served markets.

I'd like to share a few examples of important progress this past quarter on the new business development front. Capella has been notified by The Higher Learning Commission that we, along with 3 traditional higher education institutions, will be participating in the development of a process for improving direct assessment programs.

We applied for approval for 2 programs just last week after many collaborative discussions with The Higher Learning Commission. This is significant in 2 ways: first, our unique expertise in competency-based programs and curricular infrastructure were key to be invited to participate; second, direct assessment will allow us to develop a new academic delivery model that will move away from seedtime and credit hour requirements.

This is a huge step to unlocking innovation opportunities to improve affordability, which includes not only tuition cost but also time to completion, flexibility and return on investment for our learners.

While this would take some time to be market ready, it has exciting potential to expand our served markets. Another new business development highlight this quarter is from SOPHIA, our subsidiary that offers a social education platform that empowers students to learn in many ways. The American Council on Education's College Credit Recommendation Service, commonly referred to as ACE CREDIT, has evaluated and recommended college credit for 5 of SOPHIA's online courses. These self-paced courses are offered to SOPHIA Pathways for College Credit and provides significant savings over traditional college classes. After successful completion, these courses are now eligible to be considered for credit in more than 2,000 colleges and universities throughout the U.S.

While we don't expect any material near-term impact, this is also an exciting long-term opportunity.

To wrap up, let me just say that we're pleased with the strategic progress of our innovation and new business development initiatives and we're very pleased with Capella University's ability to execute and produce results in a difficult market environment.

Our faculty and staff are focused, innovated and committed to our strategies. We continue to see opportunities ahead for further improvement and have increased confidence in our strategies and our ability to execute them.

I'd like to now hand the call over to Steve.

Steven L. Polacek

Thank you, Kevin. As we reported this morning, first quarter new enrollment, revenue and operating margin exceeded the guidance we provided during our last call. Total enrollment growth was in line with our guidance.

Revenue for the quarter was $105 million, down 3.8% year-over-year. Total enrollment declined by 3.1% from first quarter of 2012 as the new enrollment declines we experienced in the second quarter of last year continue to put pressure on total enrollments. Total enrollment for bachelor's degrees was up 6.2%, the fourth consecutive quarter of growth. New enrollment in the first quarter was up 8.2% compared to the same quarter in 2012. This growth is attributable to the strong growth in the bachelor's and master's programs and stabilization of growth in the doctoral programs.

We are particularly pleased that the doctoral programs are moving towards positive new enrollment growth. These programs require the most significant investment in terms of time and cost, and prospective learners have the longest decision cycles.

We expected our doctoral programs to be the last degree program to return to new enrollment growth.

As Kevin mentioned, our new enrollment performance is primarily driven by conversion improvements. Early cohort persistence improved by 5% over last year. This metric is a change in a four-quarter moving average early cohort persistence rate calculated from the learner's first quarter to the start of the fourth quarter enrolled.

First quarter performance was stronger than during the fourth quarter of 2012. We are very pleased with these results but do expect some quarterly volatility in this metric.

Revenue per learner, based on Capella University revenues, declined as expected by 1.8%, primarily related to discounts, including learner's success grants and degree mix shift.

We continue to be pleased with the performance of our grant programs and their impact on new enrollment and persistence improvements.

Consolidated operating margin for our first quarter was 14.4% compared to 16.4% last year. The slightly stronger than anticipated revenue performance, combined with diligent cost management across Capella were the primary drivers for operating margins being stronger than anticipated. This demonstrates the leverage in our business model.

Instructional costs and services as a percent of revenue, increased slightly, primarily related to investments in our diversification efforts, cohort retention initiatives and higher bad debt expenses. Bad expense, as percent of revenue, was 3.5% compared to 3.2% during the first quarter last year. The increase is primarily due to mix shift for bachelor's learners.

As expected, marketing and promotional expenses increased year-over-year as a percent of revenue but remained stable in absolute dollars.

Admissions advisory expenses declined from the prior quarter as expected due to a shift in IT-related spending and increase in enrollment counselor productivity compared to last year. Overall, we anticipate admissions advisory expenses to remain relatively stable with current levels for the remainder of the year.

General and administrative expenses increased from the prior year, primarily due to higher bonus expense compared to 2012 and investments in our diversification efforts. The income tax rate for the first quarter was 41.5% and we expect approximately the same rate for the full year. However, we will have quarterly fluctuations in this rate due to seasonality.

From a cash flow perspective, we generated $18.1 million in cash from operations during the quarter and ended the quarter with a cash position of $128 million. We paused our share repurchases during the first quarter 2013, as we continue to evaluate the best use of our cash in delivering shareholder value, including investments in our core business and diversification.

The remaining share repurchase authorization at the end of the first quarter remains at $8 million.

During the quarter, the 2011 2-year and the 2010 3-year draft cohort default rates were released by the Department of Education. Capella's 2-year draft rate is 10.3% and the 3-year draft rate is 10.9%. Although our cohort default rates have increased due to the economic environment and slight mixed shift towards bachelor learners, Capella's rates have historically been below the average of for profit institutions.

Let's turn now to our outlook for the second quarter of 2013. We're expecting year-over-year new enrollment growth for Capella University to be similar to our first quarter performance. This is expected to be the fourth consecutive quarter of new enrollment growth, including a return to doctoral new enrollment growth.

In addition, we anticipate continued year-over-year early cohort persistence improvements into the second quarter. As a result, total enrollment is expected to decline by about 2% to 3% from second quarter of 2012. This sets us up well for a continuing flattening of year-over-year total enrollment declines during the back half of 2013.

Total revenue is expected to decrease year-over-year by approximately 3% to 4%, primarily related to the total enrollment decline.

Revenue per learner, based on Capella University revenues is expected to decline year-over-year by about 2%, primarily due to lower cohort [ph] revenue, grants and mix shift.

Starting in July of 2013, we expect the average tuition to increase less than 3% compared to an approximately 2% increase in July of 2012.

We believe that we are offering our learners a very attractive value proposition and that net pricing, taking into account learner success grants, will be relatively stable.

As Kevin said earlier, year-over-year new enrollment growth comparisons for the second half of 2013 will be more challenging as we start to lap our first quarters of new enrollment growth. However, we are optimistic that we will return to total enrollment growth in the first half of 2014, based on our expectations for the first half of 2013.

Operating margin is expected to be about 13% to 14% of revenue compared to 17% during the second quarter of 2012, primarily related to the decrease in revenue resulting from the decline in total enrollments. With the stronger than anticipated first half 2013 operating performance, we now expect full year 2013 operating margins to be about 13% to 14% of revenue.

We expect marketing expenses during the second quarter to be flat to slightly down from current levels as we continue to optimize our spending throughout the year. We continue to make investments to further drive learner success, optimize our cost structure and upgrade our current infrastructure, including upgrading our course room, which is being implemented during the second half of 2013.

In closing, we are confident in our strategies and our ability to return to growth in a still challenging marketing environment.

We're pleased with the execution against our strategies and our progress. Next quarter, we expect to achieve a significant milestone and return to new enrollment growth at the doctoral level. This, combined with our persistence performance, will be key to return to total enrollment and revenue growth and ultimately, operating margin improvements.

Our strategies are focused on building Capella for long-term, sustainable growth. We are optimistic about achieving this goal as we are building momentum and are executing well against our strategies. With that, we will take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from the line of Corey Greendale with First Analysis.

Corey Greendale - First Analysis Securities Corporation, Research Division

I wanted to ask you about -- congratulations on the continued kind of progress. On the enrollment, could you just give us a little bit more detail on where you're seeing success in improving the new students? Is it primarily through the corporate partnerships or could you talk about those -- what channels are you seeing improvement in and is there any -- if there's any differential by program area?

J. Kevin Gilligan

Hi Corey, this is Kevin. We would continue to describe the market environment and demand environment as weak. And I think we mentioned in the last call, for example, we were seeing some weakness in search. I think that weakness has continued into the last quarter. So what we've been doing is focusing on: a, building our brand, increasing brand awareness and consideration to drive inquiry volume through our other channels; and then optimizing our investment across the higher performing channels to support and improving conversion rate. At the same time, we've been trying to equip our enrollment counselors with stronger tools around conversions. So I'd say we're really getting it from conversion, that's really been our strength. And I think that reflects the underlying differentiation that Capella brings to the market.

Steven L. Polacek

Corey, this is Steve. The only thing I would add is that the new enrollment growth that we're seeing is very broad-based. We've had a particularly strong growth at the master's degree level during the quarter and as well as bachelor's, which we've had for a little while. But as I mentioned in my comments, we're starting to see the stabilization in the doctoral level, which is really great for us. But then, when you get to the program level, it's very broad-based as far as where we're seeing growth. So it's just not one particular area but very, very broad-based.

Corey Greendale - First Analysis Securities Corporation, Research Division

Great. And I know it's early in implementing the competency-based programs versus seedtime but I'm just interested in kind of your longer-term strategic thoughts there. I think, in Southern New Hampshire, just got approval for a program where they're going to go to more of a pay by the time you're enrolled versus by the class kind of model. Do you see ultimately going to more of an all-you-can-eat some dollar amount per year model or how do you see that playing out?

J. Kevin Gilligan

I would say our focus right now is making sure that we get it right academically. Self-paced learning isn't for everyone and these learners are going to require some level of support in the course room. So we're actually, in the first quarter and continuing into the second quarter, we've been running some pilots at the course level to understand what it's going to take for learners to succeed. So that's where our focus is right now. We'll be addressing sort of our commercial strategies once we're confident that we've got the learning model part of this, where we want it.

Operator

Your next question comes from the line of Bob Craig with Stifel.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

Kevin, I was wondering if you could give us a little bit more color on the learner's success grant impact. Maybe some data points like the percentage of new and total students that are taking advantage of them, how starts compare in the programs that you're offering them versus not and also, now that you've had some history there, where you've added or changed that scholarship amount? Have you seen any impact one way or the other?

Steven L. Polacek

Bob, this is Steve. I think I'll take that question, if you don't mind. Relating to the learner success grants, just from a program perspective, it's in about 8 of our 40-some programs it represents. Those are obviously some of our larger ones, it does cover the majority of our bachelor programs. It's about 50% of the potential new enrollments. To date, if you look at our total enrollments, approximately 20% or so of our learners are receiving those learner success grants. I think it's important to note that we started these grants in the fourth quarter of 2011. And those had a certain time period that they were eligible for those grants. And those are starting to drop off. So what we're starting to see now is the lapping, a lot of our -- some of our grant programs and you're going to start seeing this more towards the back half of the year where our revenue per learner is going to start stabilizing. I know there's been some questions about the level of discounting and whether that's going to be impacting to revenue per learner. But we're starting to see some stabilization expected in the back half. When it comes to the performance, we're continuing to see the trends that we've talked about before. We do think it's from a new enrollment perspective. It's an important sort of dialogue with our learners and it's a good conversion tool. And as far as the thesis we had on improving persistence, we still see that being the case. So it's pretty much laid out the way we had hoped it would. And as you mentioned, we do go ahead and modify either the programs, the dollar amount, the requirements. And we tweak it to go ahead and look at what sort of learning behaviors we get, how it's accepted in the marketplace. And we'll continue to go ahead and do that. But I would say for the most part, we've been very, very pleased across the portfolio where we have those grants in place.

J. Kevin Gilligan

Bob, I just want to add to that. I think it's also worth noting that the growth rate of the programs that are not in the grant, the non-grant programs continues to be strong. And I think that it's a positive indicator for us that while price is important, affordability is important, that's not the only element of the value proposition that matters and there's plenty of room to differentiate in the market.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

And then a follow-up, I noticed the announcement earlier this year on the Psych program redesign. Perhaps you can give some color on the interest levels there? And also, you started up some scholarships, I think, in nursing and the doctorate programs. Is that having the desired effect?

J. Kevin Gilligan

Yes. So on the MS program, I think that was an example program that we had the grant on. And then we redesigned the program to make it more affordable and we just launched that program in the last quarter. I'd say the interest level in that was where we expected it to be.

Steven L. Polacek

And as far as the other programs, that you mentioned, whether it's nursing or the Ph.D., those are relatively early but we will go ahead and kind of pilot those, see what their results are going to go ahead and be and determine how we want to modify it or not or just keep them in place the way they are.

Operator

Your next question is from the line of Adrienne Colby with Deutsche Bank.

Adrienne Colby - Deutsche Bank AG, Research Division

I was wondering if you could update us on how we should be thinking about the revenue contribution from RDI. I know in the past, you've given us some guidelines so just when we think about the revenue per student just for Capella, how we can kind of adjust that number?

Steven L. Polacek

Adrienne, this is Steve. Relating to the RDI, I would broaden it to a broader base than just RDI and refer to it at sort of non-Capella University sort of revenues we have, a number of diversification and other initiatives that generate revenues that are outside of CU when you do your sort of calculation for that. That not only includes RDI, which is the largest piece of those non-C revenues. But we also have revenues from SOPHIA for example, we also have nondegree programs with some corporate relationships as well. The overall, we're expecting that to probably be around 4% to 5% of overall revenues. That will vary quarter by quarter, particularly when related to some of the programs we have in place, relating to nondegree revenues, that can be some onetime sort of revenues. But that's kind of the -- sort of the number that I would go ahead and use when you do your calculation of revenue per learner.

Adrienne Colby - Deutsche Bank AG, Research Division

That's helpful. And if I could ask another, was the bad debt expense lower than what you had expected for this quarter? I know that you've talked about some volatility around that line item. But just wondering how we should be thinking about the level for this year versus 2012?

J. Kevin Gilligan

Which line item were you referring to?

Adrienne Colby - Deutsche Bank AG, Research Division

The bad debt expense.

J. Kevin Gilligan

Oh, sure. Bad debt expense, yes. So for the year, I think at our last call, we talked about being approximately 4%. We would see that being the rate for the year. Now, there won't be quarterly volatility, a lot of it ties into the timing of this new financial aid year. So typically, you'll see a second or a third quarter have a different sort of trajectory than the other quarters. But overall, that would be about the sort of rate that we would expect as we sit here today.

Adrienne Colby - Deutsche Bank AG, Research Division

But could you comment, was the first quarter level better than what you had expected to see?

J. Kevin Gilligan

It was slightly a little bit better than what we had planned for.

Operator

Your next question is from the line of David Chu with Bank of America Merrill Lynch.

David Chu - BofA Merrill Lynch, Research Division

So you noted that some of the scholarship impact should start to drop off and revenue per learner should stabilize in the back half. I'm just curious on how to think about that, given the longer duration of your students and I mean, the fact that it was introduced like say, in second half of '12?

Steven L. Polacek

Well, so David, this is Steve. So as far as the learner success grants, I think now, we're going to get into the like, say the back half of 2013 where the number of sort of learners that are in there are -- some are going to fall off, some are going to come off as I mentioned earlier. That's why you're going to see a little bit of the sort of the stabilization of that. Now, the price increase that we are putting in place effective July 1, of around a little bit less than 3%, that's going to negate some of those sort of impacts. So that's why a combination of the lapping impact, as well as the price increase, you start getting some flattening of the revenue per learner for Capella University.

J. Kevin Gilligan

Hi David, it's Kevin. The grants range 4 to 8 quarters. So once you've passed the first 4 quarters, you're lapping on those programs. And when you start to get out to the longer grant programs, 8 quarters, you're starting to get your learner success benefit and the incremental contribution margin is helping to offset some of the impact of the pricing.

David Chu - BofA Merrill Lynch, Research Division

In terms of enrollment, should we expect the sequential improvement kind of going forward for our bachelor's and master's or could there be some kind of fluctuation?

J. Kevin Gilligan

Well, David, as far as the -- and you're talking about total enrollment or new?

David Chu - BofA Merrill Lynch, Research Division

Yes, total enrollment at bachelor's and master's.

J. Kevin Gilligan

So from a total enrollment perspective, I think if you just look at the sort of trajectories, you see the stabilization happening because we're starting to see a significant number of quarters where we started new enrollment growth at the bachelor's level so that we are now have achieved or expect to achieve 4 quarters of total enrollment growth at the bachelor's level. The master's programs, they -- we obviously had very robust growth in the third quarter of last year. Again, we had a very, very strong quarter in the first quarter. We're going to have to have some of that, just like we did in the bachelor's, to get back to total enrollment growth at that level. But we are on that sort of trajectory. Overall basis, we're talking about, in 2000 -- the back half of '13, with what the performance we saw here in the front half, and if we continue to see good persistence improvements, then we'll see that sort of flattening out overall. But it will take some time, particularly at the longer sort of degree levels. Ph.D. will obviously, be the last one to turn to a total enrollment growth because we just are expecting our first quarter of new enrollment growth here coming in the second quarter.

David Chu - BofA Merrill Lynch, Research Division

Sure. And one last question if I may. So you guys are focused on reporting this new kind of cohort retention metric but like overall persistence, the way I calculated it, which includes graduations has been down for about like, 3 or 4 quarters. When could we see that actually turn positive?

J. Kevin Gilligan

Well, I don't -- we don't know how you're exactly calculating it but we're focusing in on our learner success initiatives related to those early cohorts. That's where these particular -- like for example, the mandatory assessments that we talked about, the first course revisions, are really focused in those early cohorts. So we want to make sure that we said before, if we're going to lose learners, it's going to be in those first few quarters of their academic endeavor. And so we want to put enough support and enough initiative there to keep them in that early sort of stages, give them the confidence to go ahead and complete their work. That's why we're focusing in on that early cohort metric. Now, some of that will have some benefits in the later cohorts, but it also, those later cohorts came into Capella at a much, much different time when we didn't have these learner succession initiatives in place.

Steven L. Polacek

I think I would add that the graduation rate is a 6-year graduation rate from the beginning of our second quarter over 6 years. So it’s going to take some time before we see the improvements from the early cohorts reflecting in the graduation rate.

David Chu - BofA Merrill Lynch, Research Division

Okay, so let me ask it in a different way. I mean, are you seeing more graduates today or say, should we expect more graduates in 2013 relative to 2012?

J. Kevin Gilligan

Yes. Our graduations have been going up every year and we expect them to continue. Those graduations relate to cohorts that came into Capella a number of years ago.

Operator

Your next question is from the line of Jeff Volshteyn with JPMorgan.

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

I wanted to ask you about the admission expense. It seems that you continue to realize some cost efficiencies there. But now that we're going to see several quarters of positive new enrollments, how should we think about productivity improvements there? And at what point will you have to start expanding this role and hire more people?

Steven L. Polacek

Jeff, this is Steve. Relating to the admissions advisory line, we expect that to be relatively stable from a dollar perspective as we go forward here into 2013. The decline that you saw from -- and you'll see that throughout '13 compared to 2012, we had a number -- we had some IT allocated costs that expensed into that particular line item in the prior year which are not the same sort of level. So that's a major reason for the decline year-over-year. And then we do have improved productivity. I think as we look forward into 2013, as far as the tools that we put in place, we've seen significant productivity, as well as results from our enrollment counselors. They've done a great job of converting the available inquiries that we have into enrollments at Capella. So we think we still have got some more productivity and leverage that we can have in that particular model. But as far as the growth from a new enrollment perspective, we've obviously had significant new enrollment growth with the staff that we have in place. When you get to the back half of 2013, I think it's important to take into account about the -- that we're going to now look at growing new growth -- new enrollment growth year-over-year on periods of new enrollment growth. So when you get to the back half of 2013, it would not be appropriate to say, well, this is what Capella has done in the first half, they're going to be able to repeat that. The first half here, we've gone against negative comparisons. It will be a much more difficult to have significant positive enrollment growth with those new enrollment pieces. But having said that, I think we're staffed at appropriate levels to handle the volume.

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

That's very helpful. Let me ask on seasonality. When I look at the guidance, the margin guidance for second quarter, it implies contraction from the current level in the first quarter and when I go back a couple of years, even in declining -- sequentially declining revenues between the first and the second quarter, we've seen second quarter margins to be a little bit higher. So is this just increased investments in the second quarter of '13 or is there some shift in seasonality?

J. Kevin Gilligan

Well, I think one thing to remember, when you look at the second quarter results and in particular, when you compare them to last year, there's a couple of things. One is, we will have a higher bad debt expense in our second quarter 2013 compared to the second quarter of 2012. Another important one is if you remember last year, we had a resolution of an OIG matter that we had reserved that was long-established, that was reversed in the second quarter last year, which impacted positively, the margins in last year's second quarter. And as we disclosed, that was $1 million plus some other sort of accruals that we have relating to sort of interest and penalties and things of that sort. So that's a significant one-time event that happened last year that we'll be going against in the second quarter.

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

Okay. Last question if I may. Tax rate. I think you've indicated that it's going to be similar to the first quarter and I think that's higher than you talked about last quarter. What has changed in your expectations for taxes?

Steven L. Polacek

Yes. So related to the income tax rate, we've revisited the rate for the full year and it relates to our inability to recognize the income tax benefits associated with losses in our RDI in the U.K. jurisdiction. So as we look at that, we're not able to benefit those that had a negative impact on our effective rate. It's been a little -- be a little bit of seasonality relating to that rate during the quarters. It'll be a little bit higher in the third quarter and a little bit less in the fourth quarter and that's mainly related to how CU's revenues and operating margins kind of fluctuate. That's where our seasonality comment is. But we're expecting it to be about the rate that we had here in the first quarter for the full year.

Operator

Your next question is from the line of Trace Urdan with Wells Fargo.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

I'd like to go back to the competency-based program initiative and I just had a couple questions there. This was the Department of Education that reinforced seedtime standards because of concern around program integrity. So I'm wondering, in your discussions with them, where are their concerns, where is their focus and have you been asked or have you taken steps to address program integrity issues in dealing with competency-based approach?

J. Kevin Gilligan

Trace, it's Kevin. That's a good question. So I can tell you that we have been in extensive dialogue with both The Higher Learning Commission and the Department over the last 6 to 9 months, around ways to improve affordability and how we might leverage a competency-based model around a direct assessment approach. So I'd say we're -- it's a highly collaborative process. In terms of how we move from where we are today to something that's in the market, the first step is to have The Higher Learning Commission approve our request for program approval, which is part of the pilot that we're in. And that will take some time and once that occurs, then we would be submitting an application to the Department of Education for those direct assessment programs to be eligible for federal financial aid. So it's a two-step process that will take some time to go through. But I think we have a good understanding of what's important to both those entities. And I think, they're showing continued interest in our ability to move in this direction.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

Okay. I guess where I was trying to driving to with the question, Kevin is, I was sort of wondering whether you might be needing to employ additional technologies or additional verification steps or is it just too soon to comment on that at this point?

J. Kevin Gilligan

Yes, I would say it's too soon to comment on that. I think the one thing you could be sure of Capella is that we're going to make sure we get right, both from an academic rigor standpoint, as well as a regulatory standpoint, before we launch into the market.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

I know you're not prepared to comment on the business implications of this initiative but how do you think about the number of people out there who could benefit from this? And do you think that this kind of approach expands the market of learners or is it simply about serving the existing market in a more efficient way?

J. Kevin Gilligan

I'm happy to comment. I think it's both. There's no question that there is a large potential market of adults out there, working adults that have competencies that I believe, if given the opportunity, could demonstrate those in a different academic model, which would lead to much more increased access to higher education, more affordable higher education, a faster path to completion. We just have to make sure that the model works in a way that serves their interest. I think the potential market is huge. I also think that as technology develops, the technology is going to help enable more of this type of approach. So the potential is huge. In the near term, I think there is probably some portion of the existing Capella learners that this would appeal to. I would say these are people that are ready and equipped today to operate in a more self-paced environment. The larger market, the bigger market opportunity that I described, not everyone in that market is going to be able, with current technology, to operate in a self-paced way. But I think technology will be developed to support that. So I think it's a pretty significant strategic development. And I guess, my last thought here would be, Capella spent the last 10 years developing a very unique set of capabilities from a competency-based learning and assessment. And I think we're at a very interesting time in the market where those capabilities can really be key to unlocking growth, unlocking value and really addressing some of the big problems in higher education, around affordability, learning outcomes, and completion rates. And I think we're in a great position to lead. So strategically, this is a big deal, which is why we want to make sure that it's undergirded with the appropriate academic rigor so that the department and our creditor could be totally confident in what we're doing.

Trace A. Urdan - Wells Fargo Securities, LLC, Research Division

Last question related to this, Kevin. Do you think -- I won't put words in your mouth but do you think this kind of a product could make you more competitive against some of the traditional universities that have stepped into the online market?

J. Kevin Gilligan

Let me respond this way, Trace. I think the key to growth and differentiation is going to be innovation. Your ability to innovate, to solve problems like affordability and completion and better employment outcomes. And I think that's a strength of ours. I think the competency-based direct assessment model gives us the additional wherewithal to do that and I think we have a unique set of capabilities in this area compared to most competitors in the market, including traditionals.

Operator

[Operator Instructions] This question is from the line of Brandon Dobell with William Blair.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

I just wanted to focus on a couple of things. First, state authorization, what are you guys hearing about, kind of what course of action the department may take or what you may need to do to respond to that? And then a follow-up, I might hit on enrollments for a second.

J. Kevin Gilligan

Brandon, so you talked about the next round of negotiate or rule-making. I guess so far, I'd say I don't know if there's a lot new there. I think those are issues that we're well-positioned to respond to and as in the past, our goal is to be a constructive voice in the process.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Maybe just aggregate, in terms of both new enrollments as well as total enrollments, kind of order of magnitude, did you see people's, I guess, willingness or kind of that the sales cycle start to change, or did you see enrollment performance driven by new programs that maybe weren't there a couple of quarters ago, or is it just maybe geography-wise, you're seeing better traction in some of the marketing programs you put in place? I think I'm just trying to get an idea of those big buckets, big drivers of enrollments, where things came in? If they're ahead of expectations or how we should think about the opportunities for you in the next couple of quarters?

J. Kevin Gilligan

Yes, So I'll start and Steve can chime in behind me. As Steve said, the growth in the second -- in the first quarter was broad-based. We saw nice growth in bachelor's and master's and a stabilization in doctoral. We saw across different programs, for example, we saw it not only strength in our business and healthcare programs, but we saw strength in some of our key education programs. So the nature of it was broad-based. I'd say the big thing, the big area we're making progress on is around conversion rates. The demand environment, as I said, remains weak. Some of the channels are not generating the same level of increase that they had in the past, particularly search, that we're having to drive more inquiry volume through other channels. I'll give you a small example. We drive a lot of traffic to our visitor center and historically, our visitor center was a very static site where there really wasn't much room for any interaction with prospects. So we had totally redesigned that site to make it a much better web experience, to make it more interactive, to sort of engage the prospect where they are in the funnel. And we're driving more applications, more of those learners from inquiry to application, off of that chain. So it's things like that, it's things like continuing to expand our corporate alliances, adding more partners but getting deeper penetration with the partners that we have. I would say, as we share our competency model and our ability to not only design and deliver competency learning but measure learning outcomes with employers, the conversation's changing where they're interested in us developing unique special cohorts for them and integrating their company-specific competency requirements into our programs. That's driving a lot of interest, a lot of growth. So we're trying to optimize the channels where the demand exists, strengthen the demand for Capella by building our brand and then driving conversion execution across all those channels. And I'll just go back and say, what I'm feeling particularly positive about is our ability to improve conversion rates in this environment, I think speaks to the fact that we are differentiated. There's more room for differentiation. This is a market where you can compete successfully and win share by being differentiated.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. And then final one for me. I think last year in the second quarter, there was a couple of things that stood out. Some one-time expenses, those kinds of things. And I remember that correctly, that last year, there was -- I think it was an OIG or some kind of accrual?

Steven L. Polacek

Yes. That's right, Brandon. We had a reversal of the reserve in the second quarter last year, relating to a reserve that we had established, relating to the -- an OIG review.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. So as we think about the cost structure year-on-year but also sequentially, any major things that we should I guess, think about here in the second quarter, is there a line items shifts or ramp down in marketing spend, ramp up in marketing spend that we should be aware of? Just trying to get the kind of the run rate cost structure right for the second quarter but also back half of the year.

Steven L. Polacek

Yes. It's related to the second quarter of '13, nothing that's unusual during the quarter there. We've commented that our marketing and promotional expenses. When you compare them to the prior year, we're expecting to be essentially flat to maybe slightly down but no significant change at all. When you get to the back half of 2013, I think as far as our productivity that we have, cost management, things of that sort, we're going to see some benefits, I think in the back half. Part of it is going to be related to -- we had a fairly high bad debt expense in the back half of 2013. We're not expecting that, we're expecting a little bit of a moderation of that. I'm sorry, in 2012, more moderation in the back half of '13 as well as some of our depreciation that's going to be again, falling off in the back half. So that'll be a little bit of an improvement. When it comes to the guidance that we've given for the full year at margins of 13% to 14%, given our sort of expectations for the first half performance, we're expecting the operating income to exceed what we did in the back half of last year. Part of that has to do with that, those efficiencies, but we also are going to have some contributions year-over-year as it relates to our non-CU type of revenues as well.

Operator

And there are no further questions. I'll turn the call over to Mr. Kevin Gilligan for any more remarks.

J. Kevin Gilligan

Okay, well, thank you, Bonita. And to all of our participants today, thanks for joining us. We look forward to updating you on our second quarter performance at our next earnings call in July. If you have any questions about today's call, or our first quarter performance or outlook, I'd ask that you give Heide Erickson a call. Thanks again, everyone. Have a great day.

Operator

And thank you for your participation in today's conference call. You may now disconnect.

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