Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Capella Education Company (NASDAQ:CPLA)

Q2 2008 Earnings Call

July 31, 2008 9:00 am ET

Executives

Heide Erickson – Director, Investor Relations

Stephen G. Shank - Chairman and Chief Executive Officer

Lois M. Martin - Chief Financial Officer and Senior Vice President

Analysts

Analyst for Kelly Flynn – Credit Suisse

Kevin C. Doherty – Bank of America Securities

Jeffrey M. Silber – BMO Capital Markets

Amy Junker – Robert W. Baird & Co.

Bob Craig – Stifel, Nicolaus & Co., Inc.

Marc Marostica – Piper Jaffray

Corey Greendale – First Analysis

Andrew Steinerman – J.P. Morgan

Brandon Dobell – William Blair

Operator

Welcome to the Capella second quarter earnings conference call. (Operator Instructions) At this time I would like to turn the call over to Heide Erickson, Director of Investor Relations for Capella University.

Heide Erickson

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.

Also, 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 second quarter news release. These and other factors discussed in the company's most recent 10-K filed with the SEC. Other unchanged factors may also be discussed in future 10-K and 10-Q filings. All filings are and will be available for viewing on the website at www.capellaeducation.com.

And now I would like to turn the call over to Steve Shank, Chairman and Chief Executive Officer of Capella.

Stephen G. Shank

With me today is Lois Martin, Capella’s Senior Vice President and Chief Financial Officer. On our call today we will discuss our second quarter results, address the residual impact of our ERP implementation on our third quarter guidance, review the status of the CEO succession and update you on recent progress on our strategy.

To summarize a solid financial performance for the second quarter of 2008 enrollment grew by 19% year-over-year to more than 23,700 learners supported by strong levels of lead flow and applications. Revenue grew year-over-year by 22.5% to $66 million. Operating margin improved by more than 200 basis points to 13.1% a solid performance as we continued to make investments in growth in business infrastructure initiatives. We completed a $50 million share repurchase program authorized in March. This demonstrates our focus on the efficient use of capital. We are funding our growth initiatives and also returning excess cash to shareholders. Continuing with that focus we announced today that our Board authorized another repurchase program of $60 million. We intend to execute this new repurchase program over time. Finally we completed the implementation of the ERP system with the financial aid module this month. An important point to reinforce is that we are done with the ERP implementation.

From a strategic perspective the completion of the ERP implementation is a major milestone for our learners and our employees. We now have a single integrated technology platform in place representing a best in class infrastructure. The learning curve we have gone through with the implementation while impacting our enrollment growth results in the short term has had the result of accelerating our understanding of the major opportunities we now have to streamline processes and increase efficiencies across the organization from enrollment effectiveness to our ability to enhance the learner experience to organization wide productive improvements. We now have the infrastructure in place to support future growth and efficiency gains for many years to come.

I want to recognize the effort of our entire staff and faculty and the patience of our learner population all of whom have been resilient and supportive through this complex infrastructure implementation. We are working through a residual impact from the implementation which is reflected in our guidance in the news release we issued earlier today. We estimate that our third quarter enrollment will be impacted by 600 to 800 learners. However our 2008 guidance for full year revenue and operating earnings growth remains unchanged. The overall demand dynamics for Capella remain positive. We see strong interest in our programs demonstrated by record inquiry and lead levels along with strong applications for enrollment.

Even in the current time of economic uncertainty our overall demand situation has not been significantly impacted by external factors such as the credit crisis, recession concerns, corporate reimbursement, student lending environment or regulatory actions. In fact several external developments are positive for our learners including Congress’ recent increase in Title IV limits and the passage of additional Veterans’ educational assistance. Again the overall demand dynamics for our business are strong. We don’t believe that access to credit or the economic cycle are in the aggregate impacting learners in their decision to pursue a Capella degree.

Our third quarter enrollment challenge relates to residual inefficiencies remaining after the ERP implementation. Let me describe what impacted enrollments, the actions we have taken and why we believe this impact is contained. The two primary impacts on enrollment results are first our new learner application process. We implemented a high level of self-service functionality with our ERP. This has been well received by most prospective learners. However we’re seeing that subset of prospects need higher levels of early and direct support from a live enrollment counselor. In response to this learning we’ve identified a number of enhancements to the application process to start addressing these issues including significantly easier access to and expanded support from enrollment counselors for those who need added help. A more comprehensive plan is being worked on to significantly enhance the processes from where we are today. This is a matter of tuning our processes to enhance the self-serve functionality and experience while providing direct support for the subset of learners I’ve mentioned who need more hands-on help.

Second, our ongoing efforts to learn the new system have also contributed to continued lower year-over-year productivity levels which also in turn has had an impact on total enrollment growth. The transition to new processes has been complex and intense. The good news is that the ERP is a powerful integrated system. The short term downside is that it magnifies inefficiencies or disconnects in our processes and communications where they exist because everyone in the organization is now so interconnected in everything they do. As one example we found that our front line staff could turn on functionality within the new system that enhanced their immediate workflow and productivity but caused downstream issues and lower productivity and effectiveness for others in the organization. We’ve expanded business rules to prevent this from happening going forward. By uncovering this and other similar types of inefficiencies we are aggressively working to resolve the identified issues and have already made meaningful progress.

I am disappointed to have experienced any dislocation in our strong pipeline as we serve this pipeline of new or potential learners. We have been able to capitalize on our strong data rich environment to identify the sources of the operational disruption in our business model and move quickly to address these issues. Again as an example we identified the specific type of learner and degree programs that represented the subset of prospects who were not responding well to the new self-service applications in the application to enrollment process. In the future we believe that these learnings will ultimately enable us to continue to tailor our content and online experience in ways that will enhance the experience and maximize the satisfaction of each learner at Capella University.

Lois will go into more detail on the second and third quarters in a moment. I will now spend a few minutes on two other subjects, an update on CEO succession and an update on our strategy. First, on our CEO succession planning process as we communicated two weeks ago Capella’s CEO search is progressing as planned and is focused exclusively on external candidates. The Board’s Chief Executive Officer selection specifications are focused on a leader who will drive continued growth and differentiation for Capella. The objective is to name our new CEO by the end of 2008. I will serve as Chief Executive Officer until the candidate selection process is completed and a full transition has been successfully concluded. At that point I’m planning to serve in any transitional role the Board and the new CEO deem appropriate to complete this important transition. I will also remain on the Board of Directors.

As my final topic here is an update on progress against our strategies. We announced two new degree programs and six new specializations earlier this month. Both degree programs and five of the new specializations were at the Masters level focused in the field of human resource management. The sixth was a doctoral specialization in nursing education. Year-to-date Capella has introduced a total of 10 new offerings consisting of eight new specializations and two new programs. This is consistent with our stated goal to introduce eight to 12 new offerings per year.

On another front we received state approval from the Arizona Board of Education for our Masters specialization in School Counseling. This is important for all Capella counseling learners because many states require graduation from a state approved program as a condition of licensure. Finally for the Bachelors and Masters programs we completed the integration of direct assessments for program learning outcomes. This furthers our ability to measure demonstrated learning outcomes and is a significant step in our initiative to continuously improve professionally relevant learning.

We are focused on executing against our strategies, to continue to drive growth and differentiation and to achieve our financial targets. As we laid out upon going public in 2006 our three to five year objectives are annual enrollment and revenue growth of 18% to 22% and year-over-year operating earnings growth of 25% to 30%.

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

Lois M.Martin

For the second quarter Capella delivered solid financial performance while introducing several new educational offerings continuing to increase our program differentiation and completing the implementation of our ERP. Revenue for the three months ended June 30th, 2008 was $66 million an increase of 22.5% from the previous year and at the high end of our guidance for the quarter. To provide additional color on year-over-year second quarter revenue growth 19.3 percentage points of the growth came from enrollment drivers including higher attendance at our second quarter colloquia. In addition 4.5 percentage points came from pricing. As expected these increases were partially offset by a modest year-over-year shift in mix due to a larger proportion of Masters and Bachelors learners

Despite the ongoing mix shift we continued to deliver strong operating margin improvement and also revenue per learner increases providing a stable relationship between enrollment and revenue growth. Total enrollment at the end of the second quarter grew 18% year-over-year. Quarter two’s enrollment growth was within our guidance range even though we experienced slightly lower new enrollment growth due to the issues Steve has previously mentioned. Regarding degree mix 83% of our enrollment is in Graduate programs. Learners in PhD and Doctoral program made up 38% of our total enrollment at the end of the second quarter, Masters 45% and Bachelors 16%. Enrollment in all of our degree programs increased in the double digit percentage range, our Masters programs increased by 23.5% year-over-year. The Masters programs are our largest degree area with over 10,700 learners.

Second quarter PhD and Doctoral enrollment growth increased by 11.9% year-over-year to approximately 9,000 learners within our goals of low to mid-teen annual percentage growth in this degree area. Bachelors enrollment which totaled approximately 4,000 learners increased by 25.2% compared to last year. The strong growth in Bachelors demonstrates our ability to leverage Capella’s strong academic capabilities and instructional content from graduate programs into the Bachelors area and illustrates significant long term upside for the Bachelors offerings within our targeted professional market.

Operating income improved 45% to $8.7 million for the quarter. Operating margins improved year-over-year by 200 basis points to 13.1% of revenue for the second quarter of 2008. In addition to the leverage inherent in our business model a portion of the higher than expected quarter two operating margin was the result of our conscious decision to shift some 2008 marketing spend from second quarter into third quarter which I will describe in further detail in a moment. As anticipated instructional costs and services as a percent of revenue was 46.7% up 110 basis points year-over-year. While we continue to achieve good leverage in certain functions within this expense category they were offset by our investments in faculty engagement and higher depreciation and amortization along with IT and learner support expenses related to our ERP implementation.

Over the longer term horizon we expect to once again see more consistent operating leverage in our instructional costs and services as a result of increasing scale and as we distance ourselves from the disproportionate recent infrastructure investments. Due to management’s decision during the second quarter to shift certain marketing spend to quarter three to ensure the best return on new enrollment spend marketing and promotional expense decreased by 170 basis points to 29.6% of revenue for second quarter 2008. Even with this shift in spending inquiries, lead and application volume has shown strong year-over-year growth. As has been our historical practice we continually monitor lead volume, flow and quality along with conversion patterns and the enrollment patterns of the specific professions we serve, adjusting marketing spend to ensure the best return on our investment.

General and administrative expenses decreased 140 basis points as a percentage of revenue to 10.6% in the second quarter of 2008 versus 2007. This reflects the completion of the implementation phase of the ERP. In addition bonus expense in quarter two 2008 was lower than in the prior year. Bad debt expense as a percent of revenue was 2% up from last year’s 1.7% and we expect a slight upward trend to continue into quarter three. This slight increase in bad debt is due to short term disruptions in our collection efforts and temporarily increased credit limits granted to select learners who experienced billing issues resulting from the ERP implementation.

Earnings [inaudible] interest, taxes, depreciation and amortization was $11.8 million during second quarter 2008 up $3.5 million or 41.6% from last year. Other income for the quarter was $1 million a slight decrease versus the prior year. This is primarily due to a decrease in interest income related to the lower levels of cash and investments compared to the prior year resulting from the completion of our share repurchase authorization during the second quarter. In addition interest rates were less than 3% this year compared to over 4% in second quarter 2007. The tax rate for the second quarter 2008 was 34.3% lower than expected due to discreet items associated with incentive stock option exercises. Net income for the quarter was $6.4 million a 32.9% increase over second quarter 2007. Diluted earnings per share for the second quarter were $0.37 up $0.09 per share from last year. The shares of common stock outstanding at the end of the second quarter 2008 were 16.6 million shares.

During the second quarter we completed our $50 million share repurchase program which was authorized by our Board of Directors on March 3rd, 2008. We repurchased approximately 465,000 shares for total consideration of $28.2 million during the quarter. Since the authorization in March we repurchased approximately 858,000 shares. The impact per share in the second quarter repurchase activity was actually offset by the related decline in interest income. However the repurchase will provide EPS accretion in the coming quarters and outward years benefiting all shareholders. Based on the successful completion of our prior program the Board recently approved another share repurchase authorization. This new authorization reflects our objective of efficient capital utilization in line with an appropriate long term capital structure for Capella while we continue to fund our growth initiatives. We plan to utilize this authorization to return excess cash to shareholders over time.

Shifting our attention to the balance sheet as of June 30th, 2008 we had cash, cash equivalents and marketable securities of $107.3 million compared to $143.8 million at the end of calendar year 2007. The reduction in cash has been driven primarily by the $50 million share repurchase program executed in the first half of 2008 partially offset by cash generated from operations. Year-to-date cash from operations totaled $19.2 million a 37% increase year-over-year primarily due to higher net income, an increase in depreciation and amortization and lower tax payments due to timing. These were partially offset by a decrease in cash from operating assets and liabilities. For the second quarter 2008 capital expenditures were $2.6 million or 4% of revenue down from 12.4% during the same period last year. Depreciation and amortization expense was $3.1 million or 4.7% of revenue up from 4.3% of revenue in 2007.

To summarize we delivered solid second quarter financial results. Our investments today combined with our strong financial condition will enhance our foundation for ongoing future revenue growth and operating performance improvements.

Now I would like to discuss our third quarter outlook which I’m sure you’ve all been eagerly awaiting. For the third quarter of 2008 we are expecting total enrollment and revenue to increase by 15.5% t 17% from the third quarter of 2007. Quarter three 2008’s revenue growth guidance reflects three primary drivers. One, a comparison against an exceptionally strong 2007 quarter three; two, an almost one percentage point lower year-over-year price increase; and three, the residual impact from the identified ERP related issues. Let me further explain the residual impact. The slight shortfall in quarter two’s new enrollment carried forward and impacts total active enrollment and revenue growth for quarter three.

In addition based on the length of our conversion cycle which typically spans three to six months and the timing of process enhancements we are making quarter three’s new enrollment growth rate is expected to be impacted by the application to enrollment issues previously identified. As a result we anticipate a cumulative enrollment impact of roughly 600 to 800 learners in the third quarter. Again while we have identified and scoped the needed corrective actions to facilitate recovery of new enrollment growth the design and process enhancements we are currently implementing will take several months to fully realize their benefits. While the absolute number of the anticipated enrollment shortfall sounds relatively modest compared with our total current enrollment base of almost 24,000 learners it translates into a 3 to 4 percentage points lower than our desired growth rate for quarter three. Nevertheless with the corrective measures that have been identified we believe we will continue to meet our revenue expectations for the full year even though we are now expecting slightly lower average annual enrollment growth in the range of 18% to 20% for the year.

I would also like to take a moment and provide additional color on the quarter two to quarter three 2008 sequential revenue growth rate. Quarter three’s expected growth rate is not only impacted by the residual effects of the ERP related issues but also by several timing issues which were expected and reflected in our previous annual 2008 guidance. Specifically, one, lower anticipated colloquial revenue due to the timing and size of quarter three’s events; two, the additional week of revenue during the second quarter; and three, a lower average tuition increase effective in the third quarter. These three factors reduced sequential quarterly revenue growth by an estimated 4 percentage points.

Moving on to earnings prior to any estimated severance expense of approximately $800,000 and despite the lower top line growth rate and a shift in the movement of certain marketing expenditures out of quarter two and into quarter three operating margins for the third quarter is expected to increase year-over-year to approximately 12% to 12.5% of revenue approximately a 30% increase in operating earnings year-over-year. In addition this margin reflects an increase in depreciation and amortization which we expect to be approximately $3.5 million compared to $2.5 million during the third quarter of 2007 reflecting the severance expense related to the departure of Ken Sobaski our former President and COO. The reported GAAP operating margins is estimated to be in the range of 11% t 11.5% for quarter three 2008.

Instructional costs as a percent of sales in quarter three are expected to be virtually flat with the prior year due to the inherent leverage in our business model offset by increased depreciation and amortization from the ERP. We anticipate higher third quarter year-over-year marketing and promotion spending as a percent of sales reflecting our more effective alignment of spending with the enrollment patterns and the capacity of enrollment counselors combined with the seasonal strength of late summer leads and applications. We continue to expect marketing and promotion spending on an annual basis to decrease modestly as a percentage of revenue. We expect third quarter G&A spending to be down as a percent of revenue from a year ago primarily related to solid leverage partially offset by the slightly higher anticipated bad debt expense I previously discussed and the severance expense.

Other income for the third quarter is expected to decline slightly from second quarter 2008 levels primarily due to our lower average cash balance. As for our tax rate we continue to estimate our annual tax rate to be about 35%. Reflecting on year-to-date results and our guidance for the third quarter we continue to expect full year revenue growth to be in the range of 20% to 22% and operating margins including severance related to the COO departure to be in the 14% to 15% range consistent with our previous guidance. Reflecting quarter three’s lower enrollment growth rate we expect annual average annual enrollment growth for 2008 to be in the range of 18% to 20%. We reiterate our long term financial objective of 18% to 22% enrollment and revenue growth and annual operating earnings growth of 25% to 30%.

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

Stephen G. Shank

Let me close with the following summary. We are focused on supporting the success of our learners. We had solid second quarter financial results. We have completed the implementation of our ERP system. There is a residual impact of the implementation which we are still dealing with while we see progress and improvements throughout the organization. Importantly our inquiry and application flow remains very strong. We are focused on executing against our five core operating strategies and we continue to make excellent progress against our growth initiatives including continuing to drive greater differentiation of our programs. Operationally the company is strong and we are seeing encouraging potential for ongoing efficiency improvements to drive revenue and increase earnings growth. My perspective on Capella’s future opportunities has become even more positive based on our newly added capabilities, the potential improvements we have identified and the resilience of our business model.

We will now open the call for your questions.

Question-And-Answer Session

Operator

(Operator Instructions) We’ll go first to Analyst for Kelly Flynn – Credit Suisse.

Analyst for Kelly Flynn – Credit Suisse

I was wondering if you could give some color on, given the conservative Q3 guidance and the ERP issues, where the confidence comes from to reiterate the annual revenue and margin targets and is there an expected revenue per student acceleration in Q4?

Lois M.Martin

The reason we are reiterating full year guidance is due to the fact that the price increase that we implemented as of July for the back half was slightly higher than what we had anticipated. In addition we have had much higher colloquia than we had expected when we had originally planned the year.

Analyst for Kelly Flynn – Credit Suisse

On the sequential fall in G&A costs are you implementing any cost cuts there and if so, where at?

Lois M.Martin

The leverage in the G&A really reflects the wrap up of the implementation of the ERP along with the continued leverage of the significant amount of fixed costs that are there. There is about I want to say 60%, 65% of the expenses in that category are fixed and therefore as we continue to grow we see very nice leverage there.

Analyst for Kelly Flynn – Credit Suisse

Just one more, what are the target share count and tax rates for Q3?

Lois M.Martin

We provide our annual estimate for the tax rate, it can vary slightly by quarter due to discreet items but our annual estimated tax rate is 35%. We don’t try to estimate what might happen with share count through a quarter. We do obviously report what actual share count is as of the end of the previous final quarter which was 16.6 million common shares.

Operator

We’ll go next to Kevin C. Doherty – Bank of America Securities.

Kevin C. Doherty – Bank of America Securities

I wanted to see if you can just quantify the ERP disruption that you did see to enrollments in 2Q because you mentioned lowest 600 to 800 being cumulative. I’m just curious how that might have played out, is it mostly just the flow through from 2Q or is there going to be an incremental in 3Q as well?

Lois M.Martin

The impact that we saw towards the end of Q2 was around 200 to 300, that would obviously flow through to active enrollments in quarter three and then the different between our 600 to 800 being the impact in quarter three.

Kevin C. Doherty – Bank of America Securities

Could you help us understand it a little more, how far along in the application process were these folks when they experienced this disruption and have you been able to re-engage them to any extent for those folks who may have fallen through?

Stephen G. Shank

Individuals where we saw this impact were well along in their application process and then dropped out. Yes, we have systems and processes in place to re-engage them or continue to re-engage them. But we’re seeking to communicate the Q3 impact that we think is realistic to project from this.

Lois M.Martin

Kevin, if I could just add on to that, our application growth as Steve has previously mentioned has been very strong and where we have seen the issue is between the app to enrollment process where the official acceptance happens, the additional work happens, where you need to provide a lot more detailed information, etc.

Kevin C. Doherty – Bank of America Securities

Switching gears could you provide an update on the profitability between your Bachelor programs and your Master programs? Obviously the growth there continues to be significantly faster than the more profitable Doctoral programs, but is there a certain scale that you could communicate in terms of just thinking about the long term margin expansion, maybe getting somewhere near a mid-teens margin? Is there a certain enrollment threshold? Then in terms of timing is that something we can expect over the next call it two to three years or is that more the longer term driver?

Lois M.Martin

As we’ve communicated before all of our programs are profitable on a contribution margin basis. When you look at fully allocated where you allocate corporate overhead including things like the ERP, PhD and Masters are profitable on a fully allocated basis, Bachelors is not, however, all of them, the trending for profitability has continued to improve nicely. We do expect and as we look at Bachelors and the nice improvement we’ve seen in their contribution margin we are looking for them to be profitable or break even at a fully allocated basis by the end of 2009.

Operator

We’ll go next t Jeffrey M. Silber – BMO Capital Markets.

Jeffrey M. Silber – BMO Capital Markets

I hate to return to this ERP issue, just had a couple follow up questions. Do you see any impact in the fourth quarter and if not, why?

Stephen G. Shank

I would say, Jeff, we have now given our guidance for the third quarter calling it as best we can. We’ve reiterated our guidance for revenue and earnings growth for the full year. In terms of is there an impact on the fourth quarter, I think we communicated our best outlook at the present time. Obviously we are working very hard to move through these issues we’re seeing. We’re seeing good progress and we hope to see a good recovery going into the fourth quarter.

Jeffrey M. Silber – BMO Capital Markets

I realize the implementation portion is done, how about the training portion?

Stephen G. Shank

I would say the training portion is done as planned. Obviously there are some areas where we’ve identified we need to improve efficiency. We’ll be asking questions, do we need to improve or go over certain aspects of the training. I wouldn’t describe that as a huge productivity impact but continuing to improve productivity and efficiency will be our focus and training may be a part of that

Jeffrey M. Silber – BMO Capital Markets

Just a couple quick numbers questions, you mentioned the price increase was a percentage point lower than last year, can you give us just a rough gauge what the price increase was that you just implemented?

Lois M.Martin

In average the price increases ranged from 2% up to a little over 5%, on our average based on our mix it’s estimated about 3.9% for this coming year and if you remember last year the price increases averaged closer actually just under these 5%.

Jeffrey M. Silber – BMO Capital Markets

In terms of the quarter what was stock-based compensation?

Lois M.Martin

It was about $1.4 million.

Jeffrey M. Silber – BMO Capital Markets

In terms of your capital spending guidance for this year, has that changed at all? Can you just remind us what that is?

Lois M.Martin

The guidance was 6% to 7% and that remains.

Jeffrey M. Silber – BMO Capital Markets

6% to 7% of revenues?

Lois M.Martin

Yes.

Operator

We’ll go next to Amy Junker – Robert W. Baird & Co.

Amy Junker – Robert W. Baird & Co.

Just a quick follow up question on the pricing and maybe I misheard but I think during the first question you had mentioned that you’re confident or the difference in the revenue in enrollments was partially because price increases are higher than you had anticipated? So they’re lower than last year, but they’re higher than what you thought they’d be?

Lois M.Martin

When we had first talked in the year we had said we expected maybe somewhere in the low 3% range for price increases. As we went through and as you know we go through a very strategic view by program and what the price increase should be, we identified and came up based on the mix to an average of 3.9%. So it was slightly higher than what was in the original guidance.

Amy Junker – Robert W. Baird & Co.

Just trying to understand, Steve you talked about the students were pretty far along who had ended up dropping out of enrollments and I guess I’m just, what was it exactly that had them throw in the towel and say geez I just don’t want to do this and do you have a sense of did they go someplace else, did they decide to delay going to school? Has the ERP system helped you gather that information at all?

Stephen G. Shank

I would say, Amy, that a big aspect of people dropping out of that system was that the process of navigating the self service maybe in some cases the specific steps we didn’t make them as easy for a set of our population or the communications about what to do wasn’t as easy as they showed it to be and in dealing with certainly some of our learners particularly in our large human services and health segments, that did appear to be an impact. I would characterize a lot of this had to do with usability of the system for people who needed more help. In terms of did they go anywhere else, our focus has been really to pinpoint what we needed to fix. I would say I can’t respond to the question of did they go somewhere else or are they still sitting there. I just don’t think I could give an accurate response to that.

Amy Junker – Robert W. Baird & Co.

Last question and I’ll turn it over, unrelated to ERP, just thinking of the fourth vertical that you’re planning on launching sometime next year, when should we expect the bulk of the expenses related to that curriculum development to start to show up and will that fall primarily into institutional costs and services as you go through that process? I don’t need an exact pinpoint of which quarter, but we should expect it this year, next year?

Lois M.Martin

Actually we are already expending some costs on developing the fourth vertical as we speak. What we’re anticipating and what’s in our plans is that expense level will continue to increase over time, until we’re about ready to launch there wouldn’t be a significant spike or jump in those costs. Even in comparison to the entire expense level for Capella it’s not significant but if you look just at the budget so to speak for the fourth market vertical, that spending will increase over time and sort of ratably as we add faculty, content, experts, etc. and then as we begin to build out the marketing piece as we get ready to launch and the advertising that’s when I would say the delta happens the most which we wouldn’t do until we were ready to launch which we’ve said is late 2009, early 2010. Again I think it’ll happen more ratably and it will happen between instructional initially and then also marketing and promotion towards the end.

Operator

We’ll go next to Bob Craig – Stifel, Nicolaus & Co., Inc.

Bob Craig – Stifel, Nicolaus & Co., Inc.

Steve, I just wanted to follow up a little bit on the front end of the app process again, will the greater amount of support needed, direct support, necessitate a build in your EC count?

Stephen G. Shank

The answer to that, Bob, is no we don’t think so. This is a matter of refining substantial productivity improvements that we put in place and quite frankly over time we’re expecting to get a significant productivity lift. I would characterize this as a refinement but refinements that are necessary to deal with these impacts with some learners who need more help.

Bob Craig – Stifel, Nicolaus & Co., Inc.

As far as the lower productivity levels, could you describe the most prominent of those downstream and when all those should be fully rectified?

Stephen G. Shank

I would say that the productivity impacts are like a thousand different things when people did their job one way and they had to learn how to look at information another way or do their job another way. We are seeing literally daily recovery of productivity. In some cases already we’re seeing very good impacts. We are working through this and of course now this is an area we’ve given our best guidance that we can as to what to expect for Q3 and the year but we do expect ongoing improvement and I do want to reiterate that the learning curve we’re going through is shining a big light on opportunities for future improvement and that I find very exciting.

Bob Craig – Stifel, Nicolaus & Co., Inc.

Steve, you mentioned the 10 new programs and specializations. Are you basically done there for the year in intro?

Stephen G. Shank

We don’t make specific announcements about new programs until we’ve actually introduced them so I would have to answer that question in our conference call for the third quarter looking into the fourth quarter.

Bob Craig – Stifel, Nicolaus & Co., Inc.

A couple of quantification questions and I’ll turn it over. Lois, could you quantify the amount of marketing and promotional spending that is going to shift quarter-to-quarter?

Lois M.Martin

If you look at second quarter and we’d mentioned that we had exceeded the high end of our expectations which our guidance has been 12% to 12.5% and the bulk of that over delivery from 12.5% to 13% was driven by the marketing which I’ll give you some idea to quantify that amount.

Bob Craig – Stifel, Nicolaus & Co., Inc.

Also could you quantify to the best of your ability the ERP cost in the second quarter?

Lois M.Martin

Actually the project so to speak, the ERP project, actually really wound down in the second quarter so you see the lift within G&A. Capital was very nominal because the build out had already been done prior to second quarter. We did have dollars that we used for ERP risk mitigation. Those were primarily up in instructional and again for quarter two as we talked about back in quarter one that was several hundred thousand dollars that we spent year-to-date on ERP risk mitigation and that’s really I would say a term that reflects accelerated hiring for example of advisors, learner support, associates, etc. We had additional bodies to help deal with the lower productivity of the existing learner account people. From that standpoint then we’ve already got that pipeline filled and then as volume grows we won’t have to hire as aggressively.

Operator

We’ll go next to Marc Marostica – Piper Jaffray.

Marc Marostica – Piper Jaffray

I’d like to back to the topic of the day and that’s the enrollment pick up for Q3 and first ask the question in regards to the new learner application process enhancements, will they require any change in systems functionality or are we solely talking about process changes with respect to more handholding?

Stephen G. Shank

I would say, Marc, the primary changes actually relate to what I characterize user usability features and we are not looking at significant changes in system functionality and maybe some process changes. But these are primarily usability issues.

Marc Marostica – Piper Jaffray

I would presume then, and maybe you could answer, from a timing perspective in order to implement these changes, these improvements, can you give us when they will be up and running?

Stephen G. Shank

We are implementing batches of changes on a weekly basis so some of the changes are up and running right now, we’re moving very fast. The issue that we want to be cognizant of in the guidance we give is that we are in our peak period right now and in terms of getting fully to the recovery basis this involves an estimate as to when the fixes take hold in terms of impact.

Marc Marostica – Piper Jaffray

Maybe a lag effect in terms of when they’ll have an impact versus when they’re actually up and running?

Stephen G. Shank

We believe that’s reasonable but these fixes are going in on a real time basis.

Marc Marostica – Piper Jaffray

Steve you also mentioned that this month or perhaps last month you installed the financial aid module and I’m curious whether or not that module has been exercised at this point, particularly on the disbursement, and what your experience has been with the financial aid module?

Lois M.Martin

I’ll answer that one. Yes, the financial aid module is completely up and running and we have done disbursements on it. The platform is working very well. That’s not to say we haven’t had some good learning curve on that clearly and as we expected productivity as we implemented that final module for the financial aid group, but overall it has been very successful and we are continuing to move forward with that but no major hiccups at all.

Marc Marostica – Piper Jaffray

Lois you did mention in your remarks that one of the positive impacts the back half of the fiscal year is the higher than expected colloquia. Could you give us a sense of some numbers around the positive impact of colloquia versus you expectations in the second half of the year [inaudible]?

Lois M.Martin

If you look at just second quarter we had from a year-over-year standpoint due to some very high attendance at that colloquium, colloquium actually contributed to about 2.5 percentage points of our year-over-year growth. From that standpoint very successful. Now we knew some of that was also timing because the ones in the third quarter are much smaller than what we had in the second quarter. But if you look at total year-over-year colloquia we are expecting growth out of colloquia of in the mid-20s.

Marc Marostica – Piper Jaffray

For the back half of the fiscal year?

Lois M.Martin

I’m sorry, I was giving you the full year. Let me back into that. The back will be slightly lower than that because the first half colloquia growth was higher than that.

Marc Marostica – Piper Jaffray

One last question and I’ll turn it over, curious with regards to the new programs and specializations launched last year how they’re performing in the most recent quarter? Are there any standouts our any comments you might have on [inaudible]?

Stephen G. Shank

What I’d say is the new programs are making a positive impact on our enrollment performance but a clear assessment of that has got to take into account that the new program enrollments like all of our enrollments were impacted to some extent by this application to enrollment issue that we’re facing. They are making a positive impact but there’s a macro impact at play here too.

Operator

We’ll go next to Corey Greendale – First Analysis.

Corey Greendale – First Analysis

The issues that you discussed with the disruptions and the process changes needed was there any impact on student service or advising kinds of processes such that retention was affected in the quarter by some of the ERP issues?

Lois M.Martin

Actually we saw a slight improvement in persistence. So again when we look overall the changes in processes, etc. have not had a significant nor negative impact to our overall learner base and it does appear to be very isolated to those that were new to the experience and new to Capella. We were actually pleased having implemented or thrust all of the change on our learners we saw a slight uptick in persistence.

Stephen G. Shank

I would add, Corey, that also wit existing learners we did have some less than optimal experience incidents to be straight. The good news is the persistence trend was good but it’s not our game plan to have disruptions in a high quality experience so there was a piece there.

Corey Greendale – First Analysis

Is it fair to say, I think Lois in your comments you reiterated the long term target range, the 18% to 22% enrollment growth, given that is it fair to say that as these issues are worked out you fully expect that there will be quarters again where the enrollment growth is in that 20% to 22% range?

Lois M.Martin

I will reiterate that we do stand by that long term financial target growth which is enrollment and revenue growth of 18% to 22%.

Corey Greendale – First Analysis

Next question I had is have you seen any changes in media costs generally that have helped the sales and promotion spending?

Lois M.Martin

Actually ours we’ve seen is relatively flat.

Corey Greendale – First Analysis

In scanning through the queue there was a comment in there about some disruptions in billing I believe around the ERP system. Has that issue been resolved already and have you collected whatever would have been delayed because of that disruption?

Lois M.Martin

Because of those disruptions which we talked about on last quarter’s call we actually allowed some select learners to carry a higher balance than we traditionally do. Those learners are on payment plans but based on our nature and just our internal policies we have reserved those amounts at a higher amount because the payment plans are relatively new to us, we don’t usually have learners carry a balance greater than $1,500. From that standpoint things are progressing and to Steve’s previous point we are continuing to make improvements in all of those areas and continuing to improve productivity. The underlying core issue is fixed, it’s just now moving and dealing with these learners who we provided that extra carrying allotment to.

Operator

We’ll go next to Andrew Steinerman – J.P. Morgan.

Andrew Steinerman – J.P. Morgan

Lois could you just go over the G&A comments in the second quarter into third quarter again? I couldn’t catch what you said about bad debt expense into the second quarter and I did hear that you said that G&A will go down again in the third quarter year-over-year. I assume you mean as a percentage, that the percentage of G&A will go down as opposed to that the dollars of G&A will go down. If you could talk about why that is?

Lois M.Martin

Yes, it is the percent. The quarter two G&A leverage was due to reduced ERP spending because the project group so to speak had virtually gone away because the ERP is fully implemented but lower bonus expense and then slightly offset by higher bad debt expense in quarter two. I had mentioned for quarter three again we expect to continue to see leverage within G&A due to its fixed cost nature offset by the slight increase in bad debt that I expect and severance.

Andrew Steinerman – J.P. Morgan

What’s driving the bad debt?

Lois M.Martin

That comes back to the billing and the productivity issues that we had talked about last quarter and then in reference to the question I had just answered with Corey that we had had the disruption when we first went on SA. Based on some billing issues that we had had with certain learners we’ve allowed those learners to carry a higher balance than we normally do.

Andrew Steinerman – J.P. Morgan

So that should normalize a little further out, right?

Lois M.Martin

Exactly. I expect again we would be to the 30, 40 basis points higher in the next quarter or so. I would expect bad debt for the full year to be more in the range of about 2%.

Operator

We’ll go next to Brandon Dobell – William Blair.

Brandon Dobell – William Blair

I want to see if I can frame something here, the implications for the full year guidance and how that tracks back to Q4 for enrollments it’s a pretty wide range. As you think about that range the level of confidence in the bottom versus the top, how important are the next couple of weeks of getting these patches done on the ERP or how important are some of the things that you’ve figured out the last two months? How important are they to hitting different part of that range or is the range more going to be impacted by what happens it, let’s call it, the next two or three months from a new student perspective?

Lois M.Martin

From that standpoint I would say all of these enhancements that we’re trying to make are important, why we’re getting them out as soon as we can in these batches rather than waiting to do it all at one point. Clearly for us there’s a seasonality factor here as there is every year with September and October being the largest intake periods of the year. Why we’re pushing to get as much done as possible before then. Also what you’re seeing is this band, or I would say this conversion timeframe where a lead that comes in as they experience the enhanced or better app to enrollment process again you won’t see that build until over time or over a few months again because of the conversion lag. But again our focus as Steve mentioned is to get as many of these in to improve that experience ahead of this heavy intake period. We have actually already made some changes, we’re continuing each week to put in other changes. We are confident. We think we know what the problems are, we have identified various enhancements that we believe we can do fairly quickly to get back to the recovery. Again I think you would see the growth build over time.

Brandon Dobell – William Blair

Is it fair to assume that the enrollment impact or that process impact was fairly only spread across the enrollments just like the mixed enrollments are? Or was it caused by any particular type of student or program or anything?

Lois M.Martin

It actually was more impacted within our health and human services area. Those learners specifically seemed to want and need much more engagement or much more personal connection with an enrollment counselor, not quite as comfortable doing as much independently or self service. Very isolated there and just based on the degrees that we have within that market vertical or within those professions, obviously more heavily towards PhD and Masters.

Brandon Dobell – William Blair

On a different topic, any recent changes good or bad that you’ve seen in other corporate alliances, reimbursements or how school districts are relating back to paying for education for teachers?

Stephen G. Shank

Brandon, I would say that we have not seen significant changes in any of that environment. The corporate reimbursement environment and other employer reimbursements or treatment of the value of an educational degree is performing stably.

Brandon Dobell – William Blair

Final question, from a competitive perspective anything that’s changed in the last three or six months as state is trying to figure out how to increase revenue enrollments and therefore relative online programs, do you see your core list of the usual competitors rolling out new innovative programs or anything differently or I guess from the opposite perspective are they pulling back their horns a little bit as state budgets come under pressure?

Stephen G. Shank

I don’t know that I can comment particularly on activity of state schools. I would say that competitively it’s a dynamic environment but we view the demand opportunity for us as being quite strong here in terms of the flow of inquiries we’re seeing, strong flow of applications and our issue is just to get the conversion efficiency with this new system between the strong applications we’re getting to the strong enrollments to get that fixed fast.

Operator

At this time I’d like to turn the conference back over to Mr. Steve Shank for any additional or closing remarks.

Stephen G. Shank

This concludes our conference call. I’d like to thank you for attending and to summarize that we are confident in the operational strength of the company, the strong flow of the demand we’re seeing at Capella and we believe the enrollment impacts we described are constrained, will be a short term. We’re moving rapidly to address those. Thank you for joining us today.

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

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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

Source: Capella Education Company Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts