Strategic Education, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Strategic Education operates Strayer University and Capella University. Figures are unaudited; dollar amounts below are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $239.0 | $241.7 | $760.2 | $733.4 |
| Income from operations | $15.4 | $20.0 | $105.8 | $73.3 |
| Operating margin | 6.5% | 8.3% | 13.9% | 10.0% |
| Net income | $11.0 | $16.7 | $80.4 | $52.6 |
| Diluted EPS | $0.47 | $0.75 | $3.58 | $2.38 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $158.8 | $141.4 |
Q3 revenue declined 1.1% year over year, while nine-month revenue rose 3.7%. Nine-month GAAP operating income and net income increased substantially; management attributed the operating improvement mainly to enrollment-driven revenue growth and lower merger-related costs. Q3 operating income fell, chiefly due to $4.0 million of restructuring charges and higher merger and integration costs. Q3 adjusted operating income was $37.8 million versus $36.9 million, and adjusted diluted EPS was $1.18 versus $1.28. Nine-month adjusted operating income was $163.9 million versus $131.3 million; adjusted diluted EPS was $5.32 versus $4.54. These are company-defined non-GAAP measures that exclude specified items.
- Q3 operating trends: Strayer revenue fell 1.2% to $128.4 million; enrollment decreased 1%, with new enrollment down 28% and continuing enrollment up 6%. Capella revenue declined 1.0% to $110.6 million despite total enrollment growth of 4%, as revenue per student declined.
- Costs and margins: Q3 instructional and support costs decreased to $127.2 million, or 53.2% of revenue, from $132.5 million, or 54.8%. General and administration expense increased to $74.1 million, or 31.0% of revenue, from $72.3 million, or 29.9%. For nine months, instructional and support costs were 50.7% of revenue versus 54.2%.
- Cash and liquidity: At September 30, cash and equivalents were $717.8 million and marketable securities totaled $51.1 million, or $768.9 million combined. Current assets were $806.4 million against current liabilities of $195.3 million. Nine-month capital expenditures were $34.8 million.
- Debt and capital: No revolver borrowings were outstanding at September 30; the secured revolving facility had $350 million of commitments, and the company reported covenant compliance. August’s public offering of 2.185 million shares generated $220.2 million net proceeds. The company paid $41.3 million in dividends during the first nine months.
Material changes and unusual items
- Q3 other income fell to $0.9 million from $3.2 million; nine-month other income fell to $4.7 million from $10.7 million, reflecting lower investment yields and income from investments.
- The nine-month effective tax rate was 27.3%, compared with 37.4% in 2019. The prior-year rate included an $11.5 million discrete tax charge related to changes in deferred compensation arrangements. Q3 2020 tax rate was 32.9%, versus 28.2%, primarily due to nondeductible transaction costs.
- The company adopted the expected-credit-loss standard in January 2020, reducing opening retained earnings by $3.3 million net of tax. Tuition receivable net of allowance was $46.0 million at September 30; the allowance was $44.9 million, including reserves reflecting expected COVID-related collection deterioration.
- In Q3, the company began a workforce restructuring expected to reduce total headcount by 5%; $4.0 million in charges had been recorded, with further costs expected through March 31, 2021.
Outlook, commentary and risks
- Management projected 2020 revenue to be flat to slightly higher than 2019, with adjusted operating income and income before taxes expected to increase in the low- to mid-single digits. Revenue per student was expected to range from flat to down 2% versus 2019.
- Management cited pandemic-related deterioration in new enrollment and continuation rates. Strayer’s Q3 new enrollment fell approximately 28%; management expected a similar percentage decline in Q4. Capella was less affected. The company paused campus expansion plans for projects not yet started.
- COVID-19 risks include further enrollment and collection weakness, pressure on student and employer ability to fund education, operational and cybersecurity challenges from remote work, and uncertainty in the duration and economic effects of the pandemic. The company said current liquidity, operating cash generation and access to its credit facility were expected to fund operations for at least 12 months.
- Regulatory and accreditation matters include ongoing Department of Education review of Capella’s FlexPath program and uncertainty following a Department finding that Capella’s accreditor, the Higher Learning Commission, was partly noncompliant; no restriction on accrediting new institutions was imposed, but an appeal remained possible. Title IV compliance and changes in federal regulation remain material industry risks.
- Subsequent event: On November 3, 2020, the company completed its acquisition of Laureate’s Australia and New Zealand operations for approximately $662.0 million, funded with cash and credit-facility borrowings; it reported a $141.8 million borrowing. The final purchase-price adjustment remained subject to a true-up. The amended facility maturity was extended to November 3, 2025.
- Ordinary-course litigation was not expected by management to materially affect financial position, results or cash flows, though an unfavorable outcome could affect results in a particular period.
Important facts for investors to verify
- Whether enrollment weakness, especially Strayer’s decline in new students, persisted into Q4 and affected subsequent revenue and collections.
- Actual purchase-price true-up, integration costs, acquired-business performance and post-acquisition debt and liquidity following the Laureate transaction.
- Whether COVID-related credit-loss reserves and student receivable collections proved adequate as conditions evolved.
- Progress and total costs of the workforce restructuring, and whether expected cost savings materialized.
- Developments in Capella’s FlexPath program review, accreditor oversight, Title IV eligibility and other regulatory requirements.
- Reconciliation of reported GAAP results with management’s non-GAAP adjusted measures and the assumptions underlying the 2020 outlook.