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Capella Education (NASDAQ:CPLA)

Q1 2014 Earnings Call

April 29, 2014 9:00 am ET

Executives

Heide Erickson

J. Kevin Gilligan - Chairman and Chief Executive Officer

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

Analysts

Corey Greendale - First Analysis Securities Corporation, Research Division

Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division

Adrienne Colby - Deutsche Bank AG, Research Division

David Chu - BofA Merrill Lynch, Research Division

Sou Chien - BMO Capital Markets Canada

Timothy Connor - William Blair & Company L.L.C., Research Division

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

Operator

Good morning, my name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Capella Education Company First Quarter 2014 Earnings Call. [Operator Instructions]

Thank you. Heide Erickson, you may begin your conference.

Heide Erickson

Thank you, Chris, 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. 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

Thank you, Heide, and good morning, everyone. Thanks for being with us this morning. I'm pleased to report that we continue to successfully execute against our strategy and delivered enrollment, revenue and operating margin performance in the first quarter within our guidance.

This quarter, we also achieved an important milestone by growing new enrollments 2.6% against positive new enrollment growth in the prior year first quarter of 8.2%. And we expect the positive new enrollment trend to continue into the second quarter, even as comparisons become more challenging against the 12.7% new enrollment growth we reported in the second quarter of last year. This is a strong indication that we are close to returning to total enrollment and revenue growth in addition to earnings growth.

Steve will discuss details regarding our operational execution in the first quarter and our second quarter 2014 outlook.

Our execution is critical to returning to long-term growth, as is our ability to innovate. At Capella, innovation extends from new educational models to innovative systems and processes. To remain a leader, we must continue to innovate to drive growth and differentiation in the education market. Today, I'd like to give you an update on what we are doing. The backdrop to our ability to innovate is Capella's history of innovation, regulatory compliance and our contribution to higher education. We were at the vanguard of online learning and, for the last decade, we've been a nationally-recognized leader in competency-based education. This has been the foundation on which we are building today, including our new educational category, FlexPath. As you know, FlexPath is our competency-based direct assessment model. Let me emphasize that all of our programs at Capella University are competency-based.

FlexPath combines our competency-based learning model with direct assessments, and this allows us to decouple FlexPath degrees from seat time. The approval of this new educational model required robust and collaborative interaction with the Higher Learning Commission; the Minnesota Office of Higher Education, which is our home state regulator; and the Department of Education to ensure compliance with all requirements. Our reputation as a compliance-focused, trusted partner was critical in getting our FlexPath offerings approved.

We believe that direct assessment programs like FlexPath hold enormous potential to lower the cost of a degree, increase value, better align to workforce needs and increase access while maintaining academic quality. However, for this model to work to its full potential, there are specific legislative and regulatory barriers we need to resolve in ways that strengthen the model while responsibly maintaining safeguards for students.

In addition, we are still building the operational model to provide the right support for our learners and a business model to deliver long-term, sustainable growth.

I recently had the privilege of testifying to the House Education & Workforce Committee by keeping college within reach in meeting the needs of working adults, specifically how direct assessments can contribute to this goal. Our political leaders are supportive of innovation in education that serves learners, expands opportunities and serves the country. This is a bipartisan issue that both parties are interested in, and they are listening.

We are pioneering direct assessment as the first institution approved by The Higher Learning Commission and the Department of Education to offer competency-based direct assessment programs at the Bachelor's and Graduate level, and we are taking this responsibility very seriously.

At this time, we've been focusing on learning as we refine the new category. We have now completed 2 quarters under our FlexPath model, and the results are highly encouraging. Our Bachelor Degree students, on average, successfully completed the equivalent of 2 to 3 courses during the first quarter of 2014. The initial course in the program took on average about 7 weeks to complete and about 3 weeks for subsequent courses. Our Master's Degree students successfully completed on average 2 or more courses in the first quarter of 2014, took on average about 7 weeks to complete the initial course in their program and about 5 weeks for subsequent courses.

The re-registration for the Bachelor's and Master's FlexPath learners from the fourth quarter 2013 to the first quarter of 2014 was over 90%. These results indicate that we are on the right path.

During the last few weeks, we introduced 5 new FlexPath specializations for our business Bachelor's and MBA programs and 4 new FlexPath degree programs: a Bachelor's and Master's in IT and a Bachelor's and Master's in Psychology, as well as 4 new FlexPath certificates in Business. We have submitted an application to the Department of Education, so the new degree programs may also be eligible for financial aid.

We're moving ahead in building our FlexPath offering, but are proceeding deliberately. The new programs in specializations we just introduced will help us understand the needs of different learner populations. In addition, the new enrollment process for FlexPath programs takes longer than our other programs. First, prospective learners need to understand the benefits and expectations of them to succeed in FlexPath; and, second, we have higher admissions standards and it's common for prospective learners to take additional time to meet our requirements.

We are excited about the game-changing potential of FlexPath, but we are patient and are making the necessary investments to get the model right to support our learners' success, to prove out the model to our regulators and to ensure that the model makes financial sense to drive long-term shareholder value. It will take time before we move to building the adoption rate of FlexPath, just as it took time building the adoption rate of online learning.

Innovation is also taking place at our subsidiaries, including SOPHIA, our social learning platform; and RDI, our U.K.-based international subsidiary. SOPHIA Learning just announced that, through a partnership with Edgenuity, high school students will now be able to earn high school and college credit through SOPHIA's Pathways for College Credit. Edgenuity provides online and blended learning solutions primarily to high schools. With this partnership, we are expanding the market opportunity for SOPHIA's Pathways for College Credit.

RDI recently received Taught Degree-Awarding Powers, commonly known as TDAP. This is the culmination of over 20 years of RDI's work to provide students with affordable and flexible online education while building trusting -- trusted relationships with the regulators in the U.K. Achieving degree-awarding powers is the result of rigorous scrutiny by the Quality Assurance Agency for Higher Education. While RDI will continue to work with their partner universities, RDI now has the regulatory approval to grant its own degrees. This is an exciting development, but it will take time to build the new offering.

We're making investments across Capella Education Company to position us for growth. Throughout our history, we've worked hard to earn the trust of our learners, regulators, employers and the education community. We are building on this foundation to innovate and to deliver short-term and long-term results.

We are on track to meet our annual performance goals, including moderate annual new enrollment growth, continued early cohort persistence improvements, a return to total enrollment growth and operating income improvements. We're also on track to expand the growth opportunities for Capella through innovation.

Steve will now provide you with additional details on our operations. Steve?

Steven L. Polacek

Thank you, Kevin. Earlier today, we reported a solid first quarter 2014, with new enrollment up 2.6% and total enrollment down just over 1%. Revenues and operating income were flat with the prior year's first quarter. All results were within our expectations.

This performance demonstrates our ongoing ability to execute in a challenging market environment. I'm particularly pleased with the work of our organization to innovate and invest for the long term, while continuing to focus on learners -- our learners' success and driving efficiencies throughout Capella.

Revenue for the quarter was $105.6 million, up 0.3% year-over-year, primarily due to lower total enrollment, offset by a tuition increase of 2.8% in July 2013 for Capella University. Total enrollment declined by 1.4% for the first quarter. Early cohort persistence improved 4%, calculating the change based on a 4-quarter moving average from the learner's first quarter census date through fourth quarter census date.

Achieving new enrollment growth compared to last year's first quarter, when we also saw new enrollment growth, is a testament to the hard work of our organization and strong execution against our strategies. New enrollment in our Master's programs was specifically strong this quarter. And as expected, Bachelor new enrollment, while still modestly negative, improved significantly from the fourth quarter 2013.

Our current learner success initiatives to drive early cohort persistence are focused on scaling key initiatives, including new learner orientation and pathways to first course. About 2/3 of our learners are now going through orientation, and we expect to have orientation fully rolled out by the middle of this year. At the same time, we have expanded our analytics in the course room to help our faculty and advisers efficiently identify and provide personalized support to at-risk learners. This includes the release of new tools and implementing an even stronger support system for learners during the first 4 orders. First quarter -- first course success rates continue their positive trend. That's a strong indication that we are on the right track of improving learner success.

Although success initiatives may impact new enrollment growth from time to time, would characterize current quarter fluctuations in new enrollment as within a normal range given the current market environment. It takes a deep commitment from everybody involved, the right infrastructure and strategic focus, investments and innovation to improve learner success. And we are an institution that is making progress where many others have struggled.

Revenue per learner, based on Capella University revenues, was up slightly related to tuition increases, offset by our learner success grants. The consolidated operating margin for our first quarter was 14.3%, at the lower end of our guidance, primarily due to the timing of investments.

During the quarter, we also continued to roll out our updated brand advertising, which we launched in the fourth quarter. This is part of a comprehensive, relationship-focused brand strategy. The data is confirming that our new branding campaign is contributing to increases in the awareness and consideration of Capella by prospective learners. Our messages are being well received and are highlighting these important differentiators. First, that our competency-based programs are designed to teach our learners what they need to know to move forward in their profession; second, that our course work is designed around professions so that learners can immediately apply what they learn; and, third, that Capella offers the most direct path to achieve their educational goals without wasting time or money on the journey.

Inquiry and application growth generated through marketing channels outside of the aggregator channel continues to be solid, and we are on the right track for moderate annual new enrollment growth. To drive long-term results, we continue to invest in optimizing and building our relationship-driven marketing strategy, including employer relationships and communicating directly to prospective learners by engaging them earlier in their decision cycle.

Operating performance benefited from lower depreciation expenses and reduction in bad debt expense to 3.3% of revenue compared to 3.5% during the first quarter of last year. Other expense for the quarter was $342,000. The increase from last year's first quarter is primarily related to RDI achieving Taught Degree-Awarding Powers. You might recall that when we acquired RDI we entered into an agreement that once RDI achieve TDAP, a payment of GBP 4 million was due. We accrued $6.3 million as of the end of the fourth quarter and made a final adjustment this quarter to reflect the liability for the payments we made in the second quarter.

The income tax rate for the first quarter was 40.4%, down from 41.5% in the prior year first quarter, primarily related to changes in our foreign tax rate.

The timing of investments and the TDAP-related expense -- increase in other expense during the quarter, combined with a slightly higher-than-expected tax rate, resulted in flat year-over-year earnings per share this quarter.

From a cash flow perspective, we generated $15 million in cash from operations during the quarter and ended the quarter with cash and marketable securities of $161 million.

During the quarter, we paid our first quarterly cash dividend of $0.35 a share, or $4.3 million, and declared our second quarterly cash dividend. We also repurchased 56,000 shares during the first quarter of 2014. The remaining share repurchase authorization, as of the end of the first quarter, is approximately $46 million.

In the first quarter, Capella's 2011 3-year draft cohort default rate of 13.1% was provided to us by the Department of Education. Our cohort default rate has increased due to the economic environment and a slight mix shift toward Bachelor learners.

Let's turn now to outlook for the second quarter of 2014. We're expecting year-over-year new enrollment growth for Capella University to be up in the mid-single-digit percentage range compared to the same period in 2013, total enrollment to decline about 1% to 2% and total revenue to be flat to up 1% year-over-year compared to the 2013 second quarter.

The main driver for mid-single-digit year-over-year new enrollment growth expectations in the second quarter is our execution in overall volatile market environment and in expected improvements in Bachelor new enrollment.

Total enrollment in the second quarter is expected to still be negative, as it takes a few quarters of consistent new enrollment growth in addition to the early cohort persistence improvements for total enrollment to turn positive.

We expect year-over-year revenue growth to decline less than total enrollment. This is primarily related to our expectations that Capella University revenue per learner for the second quarter will be up slightly compared to the second quarter of 2013 and due to the contribution from our businesses outside of Capella University.

Starting in July of 2014, we expect average tuition to increase about 2.5%, similar to the increase in July 2013.

We believe that we're offering our learners a very attractive value proposition and that net pricing, due to learner success grants, will be up slightly.

Operating margin in our 2014 second quarter is expected to be about 16.5% to 17.5% of revenue compared to 16.8% during last year's second quarter. This excludes a charge of approximately $2.5 million related to a lease amendment, which will result in expense savings of about $800,000 for the second half of 2014 and $7 million for the total lease period, which expires in October 2018.

Investments in learner success and marketing are expected to be at similar levels as in the same quarter last year.

Other income and expense during the second quarter is expected to be slightly negative. The tax rate for the second quarter and the full year 2014 is expected to be about 39.5% to 40%.

We're on track to meet our performance goals for the year and continue to invest in innovation to drive long-term, sustainable growth. Capella is in a strong financial position, and we are confident in our strategy and our ability to execute in the current environment.

With that, we will take your questions.

Question-and-Answer Session

Operator

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

Corey Greendale - First Analysis Securities Corporation, Research Division

First, I wanted to ask about FlexPath. I know, last quarter you said that you had caps enrollment at less than 100 [ph]. If you could just update us on where does the entire thinking about capping or not capping enrollment growth there going forward.

J. Kevin Gilligan

Yes. So good question. We -- as I emphasized in my comments, we're still very much in the learning mode as opposed to a growth mode with FlexPath. And as a result of higher admission standards, I would say that the enrollments in the first quarter were similar to the enrollments that we saw in the fourth quarter. And we're going to continue to manage growth in a very disciplined, responsible way until we get enough experience with the model.

Corey Greendale - First Analysis Securities Corporation, Research Division

And what is the difference in the admission standards?

J. Kevin Gilligan

Well, so, for example, at the Master's level, we require Bachelor applicants to have completed all the general education credits and to have a minimum GPA of 3.0. And those are -- that's a higher standard for our other Bachelor students. And at the MBA, we require a higher grade point average and either a Bachelor's in Business or 5 years of related business experience. And so, what we're seeing, with some of the applicants is that they don't have all that and they're interested in the model. And let's take the example of the Bachelor student, who doesn't have gen ed credits, that learner may choose to finish up their gen ed before entering FlexPath.

Corey Greendale - First Analysis Securities Corporation, Research Division

Okay. So, sorry, so that gen ed, that means they either have to come in with credits from a prior college experience or go through SOPHIA learning to get those credits?

J. Kevin Gilligan

They have to meet our general education requirements of 45 credit hours.

Steven L. Polacek

Yes. Corey, this is Steve. I would just add on that they can do it in multiple different ways. You pointed out a couple of different ways. They could also take gen ed requirements within the traditional Capella courses. The other comment I would make to FlexPath, just to sort of put it in perspective, when we look at, for the year, we would expect that FlexPath new enrollment should probably contribute maybe a couple of points to our new enrollment growth in 2014 versus what we would've expected otherwise.

Corey Greendale - First Analysis Securities Corporation, Research Division

Okay, that helps. And, Kevin, you also mentioned legislative and regulatory things that need to change for the direct-assessment model. Can you just elaborate on what you're referring to there?

J. Kevin Gilligan

Yes, I'd be happy to. And that's really one of the things I was talking about when I was testifying before the House a few weeks ago. There are really 2 big issues from our point of view. The first is that the current federal financial aid system is largely designed around the credit hour. And a competency-based direct assessment model doesn't -- you earn a degree by demonstrating mastery of competencies, not accumulating credit hours. So in order to be eligible for federal financial aid, we have the credit equivalencies, and we have to map those equivalencies. That adds cost and complexity to the model and I think it will slow the adoption rate from the industry if this is something that the government would like to see successful on a broader scale. So we have suggested, in that instance, that Congress consider a demonstration project because they are the ones who have the authority to change federal financial aid and create mechanism for direct assessment programs. The other issue is related to a department rule that stipulates a learner has -- can enroll in either a credit hour program or a direct assessment program. But once they enroll on that path, they can't switch over. And our view is that there's going to be learners that are going to want to take some courses in a direct assessment mode. Other courses, maybe where they're less confident and have less knowledge, are going to want the -- what a credit hour offering provides. And so, we're encouraging the Department to consider experimental sites and other initiatives where hyper models could be tested and perhaps the rules could be changed in the future. So those are the 2 big issues.

Corey Greendale - First Analysis Securities Corporation, Research Division

Okay. Just one last quick one, if I could. The comment that you expect operating margin improvement in '14, does that exclude the lease charge in Q2 or even absent the lease charge, you expect operating margin to be up in '14?

Steven L. Polacek

Yes. Corey, this is Steve. That would exclude the $2.5 million charge that we are to be taking in the second quarter. If we didn't have the sort of lease piece of it -- lease charge, we would have expected 2014 in our operating plan that we would see margin improvements on relatively sort of flat revenues from a modeling perspective, because the continued efficiencies that we're getting in our business model, whether it be our marketing efforts or other success initiatives, those are helping contributing to improve margins with relatively flat to down revenues.

Operator

Your next question comes from the line of Jason Anderson.

Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division

I was wondering if you can comment on RDI a bit more. I know you mentioned it would take some time. But I was wondering maybe if you could -- if there is a timeline on getting the university status. And then maybe broader than that, could you be able to frame how you view the RDI opportunity after such status, including both sides of the House, whether you're providing degrees for other universities or under their own brand?

Steven L. Polacek

Sure, Jason. Good question. This is Steve. So related to RDI, when we acquired RDI in 2011, they were in the process -- kind of in the initial process of getting TDAP, or Taught Degree-Awarding Powers, and we have continued on that journey and, as you referred to, we recently received validation from the Quality Assurance Agency, as well as the Privy Council to be able to issue degrees. What RDI in the U.K. is somewhat of a unique market there that it's very common for universities to partner with other institutions to go ahead and offer degrees. And RDI has been doing that for some 20 years in their history. That's an important part of their business model. It will continue to be an important part of their business model. We have seen, since we've acquired RDI, sort of double-digit growth. When we look at getting a university title, what that means, really, is that it's really a branding opportunity for RDI. The U.K. government really protects the use of the university name by institutions. And so, you need to go through an application process. That's going to take 3 to 6 months. But even after we complete that in -- are hopeful to get that, we will then -- we'll need to go ahead and market our own brand under our own degree-awarding powers. But we are going to continue to do a both -- a dual sort of business model strategy. I think that's important to recognize. So it will take some time for us to build their own brand through our degrees. Now our primary focus, as it relates to RDI, is to maintain the academic quality, which I think this proves, but also to go ahead and turn it -- get it to a profitable base. And we're still losing money at the operating income line, and we need to make sure that we get that shorted up before we go ahead and expand. So that's the comments I would make relating to RDI. But we believe it's a long-term opportunity and a unique situation there in the United Kingdom.

Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division

Great. And does -- is there a further investment required, I guess, as you look at that, particularly related to the university status, or more that would, I guess, extend the dilution there from RDI? I know you've talked about this year there being some improvement in dilution from RDI.

Steven L. Polacek

Yes -- no, I think, for -- when you look at 2014, there will be minimal investments and it's going to fall within our, sort of, operating plans. As we move forward into 2015, we're going to be very disciplined about that. I wouldn't expect to see a significant sort of increase in investment to date. If the opportunity provides, we will make an investment as appropriate. But it's a little bit too early for us to comment on that.

Operator

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

Adrienne Colby - Deutsche Bank AG, Research Division

I was wondering if you could help us frame how we should be thinking about the impact of the various grants you're going to be rolling out over the remainder of 2014. Would most of that impact be felt in the fourth quarter, as it's after students have completed their first course? And also, wondering if you could talk a little bit about your decision for a broader roll-out of the grants at the Bachelor level.

Steven L. Polacek

Adrienne, this is Steve. So related to our learner success grants, the level of grants that we have has been relatively -- pretty consistent over the last 6 quarters or so. So the sort of increase in level of discounts is not going to be that sort of significant. So even the ones that we've introduced, for the most part, it still represents about 50% of our new enrollments. And because we've had these in place for a few years now, since the end of 2011, we're pretty much lapping a lot of the impacts relating to that. So we do not see significant impact in those learner success grants, whether the new ones we've introduced or the lapping of the others affecting our revenue line. As I commented in my prepared remarks, we're seeing, because of our tuition increases offset by some discounting, is that we do expect revenue per learner to be up slightly. It was in the first quarter. We're expecting that in the second quarter as well.

Adrienne Colby - Deutsche Bank AG, Research Division

Okay. Could you comment on the contribution from non-Capella University revenue in the quarter and what you're expecting for the remainder of 2014?

Steven L. Polacek

Yes. Adrienne, the contribution outside of Capella University has hovered around that 4% to 5%. It's been consistent over that -- over the last quarter and kind of our near-term expectations.

Operator

Your next question comes from the line of David Chu of Merrill Lynch.

David Chu - BofA Merrill Lynch, Research Division

Can you update us on how orientation impacted demand trends in the second quarter -- or the first quarter?

Steven L. Polacek

David, this is Steve. So as it relates to our orientation, again, it has -- as we continue to roll that out, probably has continued impact of a couple of points related to our new enrollment growth rate. But as we've said, the improvement in first course success rates rate and learner persistence is the benefit we'd get through -- going through that sort of orientation process. As I mentioned in our prepared remarks, we saw a significant improvement at the Bachelor's level. That's where you particularly see the impacts relating to the new orientation. So we still were slightly negative in the first quarter. Our expectations for the second quarter is that, that's going to turn back to a positive. So we're kind of getting that through -- kind of rolled out through the program, through the system. And by the time we get past the second quarter, we'll pretty much be fully rolled out and the impacts should be negligible going forward.

David Chu - BofA Merrill Lynch, Research Division

Okay, great. And can you provide some details on start trends by degree level? I mean, you talked about strength in Master's. Just wondering if that was up double digits.

Steven L. Polacek

Yes. David, this is Steve again. So as far as the trends relating to new enrollment trends by degree level, we already commented on the Bachelor's level. The Master's has been particularly strong in the last quarter. And our expectation for the second quarter, again, is Master's is going to be strong again. It's going to lead our degree programs. We are seeing more challenges, as it relates to our PhD and applied doctorate programs. We've had -- we've had a little bit more inconsistency there relating to new enrollments. You may recall that the second quarter of last year, we had double-digit growth across all our degree programs, including at PhD. We've had some negative new enrollment quarters for PhD. That continues. That's a degree program that is very, very -- obviously, very, very different than Bachelor's or Master's, has more unique challenges to it. So we are focused clearly on that degree program. We have taken a senior leader -- executive leader here at Capella and focused their time directly related to our PhD programs to get that back on the growth curve, so that we can then return to total enrollment. But that's going to be a little bit more challenging because of the longer decision cycles and some of the unique aspects related to the PhD learners.

David Chu - BofA Merrill Lynch, Research Division

Okay. Now that's helpful. And lastly, you guys have had a lot of success in improving early cohort persistence. I mean, do you think there's significant more room here? Or are you kind of plateauing at this point?

Steven L. Polacek

David, I think, to your point, we've had under our belt, for the learner success initiatives, we've been doing it for 2 to 3 years or so. The -- getting the constant improvements becomes more and more challenging. We've been able to do it the last 6 quarters or so. We do think there's still some room there. It will become a little bit more challenging going forward. The benefit we are seeing is that once they get through the first 4 quarters, and we see that -- the elevated level, above that 4% level that we've seen over the last couple of years, that we are seeing improvements in the later cohort, particularly, say, the second year in the 5 through 9 [ph], we call it. So there's some continuing benefits moving as it kind of goes through the -- sort of the system. But it will become more challenging on the front end.

J. Kevin Gilligan

And, David, I would just add to that. I mean, the way I think about it was that there was so little improved [ph] I think we were able to capture it. I think there's more potential remaining, but it's going to take innovation in our model. And that's why we're investing significantly in the use of data analytics to more personalize assessments and on-boarding and orientation as a way to support learners. So I think there's more opportunity, but it's going to take continued investment and a real focus around innovation.

Operator

Your next question comes from the line of Jeff Silber of BMO Capital.

Sou Chien - BMO Capital Markets Canada

This is Henry Chien calling on behalf of Jeff. Just had a quick question about operating margins for the first quarter. Given that it was on the lower end of guidance, I was wondering if you could just put a little color on that. With some of the costs shifted into first quarter and how should we look at operating margins going forward?

Steven L. Polacek

Henry, this is Steve. So for the first quarter, yes, our -- the guidance that we've provided, we're within guidance but on the lower end of the range. It was primarily related to the timing of investments in the quarter, so we can have some fluctuations that do occur. That resided more, I would say, that we experienced in the first quarter. As we look, kind of, going forward, we expect and are planning for improvements at margins during the 2014 period. Some of the items that we've spoken to in the past have been continued efficiencies in marketing. The effects that we have and benefits we get from early cohort persistence helps improve margins. We've been able to reduce our bad debt expense, as well as depreciation, as we've been very disciplined in our CapEx spending over the last couple of years. So we do see, we are very sort of cost-conscious at putting in the very strong budgetary disciplines. We took those difficult decisions back in 2011 to reduce our cost structure, and we're maintaining those disciplines and given the current environment. But we do believe that, even in the near term, with flat to slightly improving revenues that we can get some margin expansion.

Sou Chien - BMO Capital Markets Canada

Got it. And if I could just stay a little bit more into that. Would you be able to point into which specific line items that might have affected in terms of the timing of the costs?

Steven L. Polacek

It's generally been in the instructional costs and services line, for the most part. There's been some fluctuations in marketing, but that happens quite regularly.

J. Kevin Gilligan

I just would add that our view of first quarter is on track. We view it from an operating standpoint. We came in where we wanted to come in. I think we're well positioned for the year.

Operator

Your next question comes from the line of Tim Connor of William Blair.

Timothy Connor - William Blair & Company L.L.C., Research Division

I heard that you mentioned that you're going to offer some new programs in the FlexPath delivery. Are there programs or degrees that you would not consider offering FlexPath in? And if so, what are those?

J. Kevin Gilligan

Yes. Timo, it's Kevin. That's a really good question. I think that's one of the things that we're trying to understand as we get more experienced with the model. There are some programs that I think will have challenges -- yes, some unique challenges. For example, licensure track programs will have some unique challenges around FlexPath. So at this point, we're not ruling programs out. But we are -- in order to get experience with the model, we're trying to pick programs where there are fewer hurdles because we want to get experience with learners and understand how to best support them. And our plan on FlexPath is we're evaluating every quarter based on our experience. And we will keep you posted as to our thinking and our planning going forward. My personal view is I think FlexPath has enormous potential to be a game-changer across a wide range of applications. Right now, I think we're starting on a very focused way to make sure we -- that, as we scale, we're doing it in the right way.

Timothy Connor - William Blair & Company L.L.C., Research Division

Okay. And with SOPHIA, are you seeing more students come out of SOPHIA and enroll into Capella?

J. Kevin Gilligan

We're seeing some.

Steven L. Polacek

Yes, Timo, this is Steve. So, related to SOPHIA, the -- we've gone ahead and offered an additional option to our Bachelor learners, as you're probably aware of, with our SOPHIA advanced grant, where they can take free SOPHIA courses. So it's a differentiator, obviously, in the marketplace in addition to learner success grants that we provide. We've also mentioned in our prepared remarks a partnership that we have with Edgenuity that focuses a lot on the high school market and preparing for college. And our dual-credit offering that we've engaged with them is kind of an exciting opportunity for SOPHIA, and it shows that it's got applicability not only at the degree level from a collegiate perspective, but also from a dual-credit perspective to help students to get into more affordable degrees by getting some of their gen ed and elective requirements taken care of.

J. Kevin Gilligan

Yes. And I guess I would add to that. I think both FlexPath and SOPHIA have significant differentiating value to us beyond those learners that just choose to take advantage of those options, because, typically, we're discussing all of our capabilities with the prospects. And I think the innovations around FlexPath and SOPHIA and the highly affordable nature of those programs and the quality of those programs, I think helps to different Capella in the eyes of the prospect, even if they don't choose to take advantage of them. So in my point of view, there's value not only because it creates alternative ways to enroll learners, but it also, I think, helps differentiate our core credit-hour programs.

Timothy Connor - William Blair & Company L.L.C., Research Division

Okay. And then the new enrollment trends in regards to the second quarter come on, on very difficult comparables, both for first quarter and the second quarter in 2013. It seems like the comparables moderated a little bit later in the year. Do you have any expectations for new enrollment later in the year and full-year trends?

J. Kevin Gilligan

Yes. So I would say at this point we are, I'd say, on the positive, we are very encouraged by our traction and our momentum and I'm excited about the things we have in our pipeline. At the same time, visibility is limited and the market environment still is challenging. It certainly hasn't got any less competitive. So at this point in time, I feel confident that we're on track to deliver moderate annual new enrollment growth. And as we go through the year, if trends strengthen, then we'll comment on that.

Timothy Connor - William Blair & Company L.L.C., Research Division

Okay. Very good. Final one for me. What expense line items are the lease charges and the savings going to see through it?

Steven L. Polacek

So, Timo, this is Steve. So the lease charge that we'll take will be almost labeled as a restructuring charge, so the actual $2.5 million will be a separate line item. When it comes to the benefit in the back half, which will be about $800,000 for the back half of 2014, that's going to get spread across the various sort of line items, based on essentially where our people are at. So you're going to probably see a little bit more on the instructional cost and service line than the other 2 lines. But I think as we -- maybe in our next call, we can kind of identify for you, for modeling purposes, where we could see that coming, because that will also impact the go-forward years beyond 2014.

Operator

[Operator Instructions] The next question comes from the line of Trace Urdan of Wells Fargo Securities.

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

I'm going to ask a question I've asked in the past. You've gotten a couple of quarters of FlexPath under your belt now, and I'm wondering if you have a better sense of how the addressable market for FlexPath compares with your core addressable market, whether you think this is an alternative product that you're offering to a similar market served by Capella traditionally or whether you have a sense now that maybe this is something that expands the addressable market beyond what you've been historically serving.

J. Kevin Gilligan

Hello, Trace. Good morning. That's a great question because that's the question that we're most focused on, is to understand that. I would say, it's clear that the value proposition is very appealing to both populations that are engaged in credit-hour programs in populations that are on the sidelines because they don't think credit-hour programs best meet their needs. The -- we're still trying to understand what the relative sizes of those markets are. So I'd say, it'd be premature to draw any conclusions on that, other than I think that this is an opportunity to creating new category. And that's strategically the way we think about it. Related to that question then is, how do you best develop channels to serve those markets and develop that addressable market? And that's part of the learning process that we're in. So I'd say, it's still a work in progress for us. But I continue to be encouraged about the potential for FlexPath as a new category.

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

So just a follow-up there. I think Steven indicated that you thought that maybe FlexPath was adding a couple of points to your growth. That seems to imply that you at least at this point don't feel that you're cannibalizing your existing market. Is that a fair statement?

J. Kevin Gilligan

There's probably some going on, but I'd say it's a net positive. And I think the positive is coming from a couple of places. I think, in some cases, we're expanding the addressable market. I think in other instances, we're just getting better conversion because our offering is more attractive than credit-hour alternatives people are considering.

Steven L. Polacek

Trace, this is Steve. Maybe this is just a couple of small sort of data points early on in the profile of the learner. Clearly, we have higher admissions standards. But there's 2 things that we are at least initially seeing is that generally the learners that are taking, adopting FlexPath are a little older and have slightly higher incomes. So that almost speaks to more experienced people who are coming back and looking at getting a degree. So whether or not that trend continues, but there might be little bit of a shift in the demographics that we're seeing as far as the learners that we may be attracting. But that's a little bit sort of early in our first couple of quarters.

Operator

There are no further questions. I'll turn the call back over to Kevin Gilligan.

J. Kevin Gilligan

Okay. Thank you, Chris. Well, I just want to thank everyone for joining us today. We hope that the comments were helpful. And we continue to be very excited about the company's prospects and the many exciting things that are under way at Capella. If you have any additional questions, I'd ask that you please contact Heide Erickson. Thanks again, and have a great day.

Operator

This concludes today's conference call. You may now disconnect.

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