Strategic Education, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts below are in millions of dollars except per-share data, enrollment, and percentages. Financial statements are unaudited.
Business context and reporting period
Strategic Education provides campus-based and online higher education and non-degree skills programs through Strayer, Capella, and Non-Degree Programs. The company completed its acquisition of Capella Education Company on August 1, 2018, issuing 10.3 million shares. Accordingly, 2018 results include Capella only from the acquisition date; the prior-year periods exclude Capella and are not directly comparable. The acquisition also brought substantial purchase-accounting adjustments and merger costs.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $160.9 | $108.5 | $392.1 | $336.1 |
| Operating income (loss) | $(57.1) | $8.2 | $(41.6) | $40.5 |
| Net income (loss) | $(52.8) | $6.2 | $(38.1) | $27.1 |
| Diluted EPS | $(2.97) | $0.56 | $(2.90) | $2.43 |
- Reported operating margin was approximately negative 35.5% in Q3 and negative 10.6% for the nine-month period; net margin was approximately negative 32.8% and negative 9.7%, respectively. These figures reflect acquisition-related and other unusual expenses.
- Management’s non-GAAP adjusted operating income was $22.1 million for Q3 and $52.0 million year to date; adjusted net income was $16.9 million and $40.7 million, respectively. Adjusted diluted EPS was $0.92 and $2.97. These measures exclude specified purchase-accounting, merger, impairment, and tax items; they are not GAAP results.
- Strayer Q3 enrollment rose 9.0% to 45,431; Capella enrollment rose 1.6% to 37,822. Strayer revenue increased 6.7% to $114.5 million, with enrollment growth partly offset by lower revenue per student. Capella reported $43.8 million of Q3 revenue, including a $26.2 million purchase-accounting reduction to acquired deferred revenue.
- Operating cash flow was negative $14.6 million for the first nine months, versus positive $44.4 million in 2017. Investing cash flow was positive $146.7 million, including $168.4 million of cash acquired with Capella; financing cash flow was negative $11.6 million. Capital expenditures were $16.0 million and cash dividends paid were $16.8 million.
- At September 30, cash and cash equivalents were $276.4 million and marketable securities totaled $71.5 million. Current assets were $391.4 million and current liabilities $116.1 million. No borrowings were outstanding under the $250 million revolving facility; the company reported covenant compliance. Total assets were $1.646 billion, including $730.7 million of goodwill and $342.5 million of intangible assets.
- The company said existing cash, operating cash generation and, if needed, revolving-credit borrowings should meet requirements for at least the next 12 months. It declared a Q3 dividend of $0.50 per share and had $70 million of remaining repurchase authorization through December 31, 2018.
Material changes and unusual items
- Q3 merger costs were $29.6 million; nine-month merger costs were $37.8 million. These included transaction, integration, professional-service, and severance costs.
- Q3 included $10.3 million of amortization of acquired intangible assets. NYCDA impairment charges were $13.1 million in Q3; nine-month impairment charges totaled $19.3 million, comprising goodwill and intangible-asset impairments.
- Capella purchase accounting reduced reported Q3 revenue by $26.2 million. The pro forma combined results, assuming the acquisition occurred January 1, 2017, showed nine-month revenue of $679.3 million and net income of $10.6 million for 2018; the company cautioned that pro forma results do not represent actual results or forecast future performance.
- Bad-debt expense was 6.1% of revenue in Q3, up from 4.9%. Management attributed pressure to a shift toward less experienced undergraduate students and delays in Title IV aid processing, which it expected to resolve by year-end 2018.
- The amended credit facility matures August 1, 2023 and includes financial covenants, including leverage, coverage, and Department of Education composite-score requirements. The filing reports no outstanding revolver borrowings at quarter-end.
Outlook, management commentary, and risks
- Management described the Capella combination as an opportunity to share academic and technology practices, improve affordability and career outcomes, and pursue cost and revenue synergies. It also noted ongoing integration and investment in the combined platform.
- Management expected a 25%–26% 2018 effective tax rate excluding discrete tax adjustments. No specific revenue or earnings guidance was provided in the filing.
- Education regulation remains a material risk. The 2016 borrower-defense rule was in effect following a court ruling, while proposed revisions remained pending. Proposed gainful-employment rule changes and other federal rulemaking could alter compliance obligations. Capella’s temporary provisional program participation agreement was extended month to month while the Department reviewed the merger.
- Other risks include Title IV and state authorization compliance, accreditation and licensure requirements, student enrollment and persistence, student ability to finance tuition, competition, integration execution, and the estimates used in goodwill and intangible-asset valuations. The company reported no pending material legal proceedings and no material changes to its previously disclosed risk factors.
Important facts for investors to verify
- Separate the acquired Capella contribution from legacy Strayer results when evaluating growth, and assess the effect of the $26.2 million deferred-revenue purchase-accounting adjustment.
- Reconcile GAAP losses to adjusted results, including the exclusions for merger costs, amortization, deferred revenue, impairments, and tax adjustments.
- Monitor operating cash flow, bad-debt expense, student-aid processing, and collection trends after the acquisition.
- Track merger integration, expected synergies, and any further NYCDA impairment or purchase-accounting adjustments; the acquired asset valuations were preliminary.
- Confirm ongoing compliance with credit-facility covenants and Title IV requirements, including Capella’s participation-agreement status and regulatory developments.