Three quarters out of the last four, educational software maker eCollege (NASDAQ:ECLG) succeeded in trumping Wall Street estimates. Last quarter, the firm merely met consensus expectations -- but investors gave it extra credit anyway, in the form of a 12% stock price boost.

Ever since, the stock has been failing investors. Today, as we look ahead to tomorrow's report of Q2 2006 earnings, the stock is off 19% from its post-Q1-earnings news high. When we get the papers back tomorrow, will we see why eCollege has been falling behind?

What analysts say:

  • Buy, sell, or waffle? Six analysts follow eCollege. Five of them rate the stock a buy, and one a hold.
  • Revenues. On average, they expect to see sales rise 26% to $28.6 million.
  • Earnings. And profits up 36% to $0.15 per share.

What management says:
Way back in March 2006, in previewing Q4 2005 results, I highlighted a possible issue with the company's cash profits -- to wit, that they weren't growing as fast as revenues. But in its most recent quarterly earnings report, eCollege put those concerns to rest, and then some.

Describing a quarter in which its sales climbed 15% and profits per diluted share leapt 67% year over year, eCollege addressed the issue of free cash flow thusly: "For the first quarter of 2006, the Company generated free cash flow of $2.2 million, an increase of 22% from $1.8 million for the first quarter of 2005." The firm went on to describe how it calculates "free cash flow," which differs from the standard definition of "operating cash flow minus capital expenditures." (This is important to know if you usually accept a company's statements rather than do the math yourself.) To wit, management calculates it as "earning before interest, depreciation, and amortization, plus stock-based compensation expense, minus cash interest and capital expenditures." This is important, because under the standard definition, eCollege's free cash flow didn't rise 22%, but rather declined year over year, from $4.3 million to $4 million.

Which isn't to say that it's doing something wrong, or hiding bad news (after all, if you combine the Q4 2005 and the Q1 2006 results and compare them to the previous year's results, you see that FCF climbed 28% -- superb performance by any measure). You just need to be aware that not everyone means the same thing when they say "free cash flow."

What management does:
So why do we use free cash flow at all, if the definition is subject to change? Perhaps because -- when used consistently -- it gives you a more stable reference point than you get from the chart below. When you're looking at free cash flow, the big $18.6 million one-time tax credit that eCollege recorded in Q4 2004 doesn't skew the rolling net margins high. It also doesn't mask the fact that in the last six months, eCollege grew its sales by 18%, but reduced its operating costs by 1%, and thus derived higher profits from its operations.

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

47.6

48

48.1

48.6

47.5

47

Op.

9.3

9.6

11.1

12.4

13.2

13.4

Net

21.7

21.3

21.8

22

5.8

6

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
One final note on the subject of free cash flow. Whatever I say about eCollege's cash profits, and whatever the company itself says, there's one thing that isn't up for discussion: eCollege is acting like a company with good free cash flow, which suggests that it's not just spinning its financial results for public consumption.

In June, CEO Oakleigh Thorne announced that the firm had repaid $1.5 million of its long-term debt ahead of schedule. In making the announcement, Thorne noted that "these prepayments demonstrate [eCollege's] continued business success and strong cash flow." Class dismissed.

Competitors:

  • Apollo Group (NASDAQ:APOL)
  • Blackboard (NASDAQ:BBBB)

Customers:

  • Corinthian Colleges (NASDAQ:COCO)

Who else likes eCollege? Fellow Fool Tom Taulli, for one. Read what he has to say about last quarter's earnings news in eCollege Getting Good Marks.

Blackboard i s a Motley Fool Hidden Gems pick. Try Hidden Gems today and get insights on all the firms that are helping Tom Gardner and Bill Mann wallop the market by more than 20% as of this writing. An all-access pass is free and good for 30 days. All you have to lose is the prospect of richer returns.

Fool contributor Rich Smith does not own shares of any company named above.