Capella Beats on Bottom Line

Capella Education Company (CNLA), the provider of online education, recently delivered better-than-expected second-quarter 2011 results. The quarterly earnings of 89 cents a share beat the Zacks Consensus Estimate of 90 cents, and grew 25.1% from 76 cents earned in the prior-year quarter.

Behind the Headline

Total active enrollment dropped 1.5% to 38,072 during the quarter. Management had earlier guided enrollment to fall by 1% to 3%. New enrollment plunged 41.6% reflecting tough market conditions, changes with respect to program accreditation and stringent admissions criteria.

The quarterly revenue of $106.4 million rose 1.2% from the prior-year quarter but fell short of the Zacks Consensus Estimate of $107 million. The increase in the top line dovetails with management’s guidance range of flat to 2% growth. Capella now expects revenue to fall by 2.5% to 4% in third-quarter 2011.

Operating income for the quarter jumped 6.3% to $23.9 million, whereas operating margin expanded 110 basis points to 22.5%. Capella now expects operating margin in the range of 13% to 14% for third-quarter 2011.

Falling Enrollment

We observe that Capella is witnessing a fall in enrollment. After increasing 7.3% in first-quarter 2011, total active enrollment slipped 1.5% in the second quarter. Capella now expects total enrollment to fall by 6% to 8% in third-quarter 2011.

The current potential risk looming over the education sector is the regulation proposed by the Department of Education that is weighing upon students’ enrollments and the company’s profits. The Department of Education proposed that an educational program could qualify for Title IV funds, only if it helps in achieving gainful employment, which includes the criteria of loan repayment rate and debt-to-income ratios.

The institutions are under the scanner due to the rise in the default rate of student loans, and are now being asked to submit information relating to recruitment procedures and use of student’s grant.

Capella cautioned that new enrollment in third-quarter 2011 is expected to tumble by approximately 30%. Management hinted that other for-profit education institutes facing tougher norms are chasing out Capella's students who are financially sound and have better loan repayment rates. The company generally focuses on working adults, and in order to draw students it is also ramping up its marketing and promotional expenditures, which rose 7.8% to $30.8 million during the quarter. To counter sluggishness in students’ enrollment, education companies are also resorting to restructuring their cost base.

Other Financial Details

Capella ended the quarter with cash and cash equivalents of $72.2 million, shareholders’ equity of $189.1 million and no debt. Cash flow from operations for six-month period ended June 30, 2011, was $45 million.

During the quarter under review, the company repurchased 529,000 shares, aggregating $25.6 million. Capella indicated that it has $60 million at its disposal under its share repurchase authorization.

Currently, we have a long-term "Neutral" rating on the stock. However, Capella, which competes with Apollo Group Inc. (APOL) and Strayer Education Inc. (STRA), holds a Zacks #2 Rank that translates into a short-term ‘Buy’ recommendation.