Grand Canyon Education, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; unaudited. Grand Canyon Education provides undergraduate and graduate programs online, on its Phoenix campus, and at employer locations.
Business context and enrollment
Enrollment was approximately 39,525 at June 30, up 8.9% from 36,301 a year earlier. Online students represented 95.9% of enrollment; 43.6% of online students pursued graduate degrees. Management attributed revenue growth principally to online enrollment growth, tuition increases and more students taking four-credit courses, partly offset by higher scholarships and the transition to borrower-based, non-term financial aid processing.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net revenue | $103.1 million | $97.5 million | $204.8 million | $186.8 million |
| Operating income | $22.7 million | $20.5 million | $41.9 million | $40.1 million |
| Operating margin | 22.0% | 21.0% | 20.4% | 21.5% |
| Net income | $13.3 million | $12.4 million | $24.6 million | $23.9 million |
| Diluted EPS | $0.29 | $0.27 | $0.54 | $0.51 |
Q2 revenue rose 5.7%; six-month revenue rose 9.6%. Q2 instructional costs increased 9.5% to $45.7 million, with bad-debt expense rising to $7.6 million (7.4% of revenue) from $5.5 million (5.6%). For the first half, instructional costs rose 16.8% to $91.5 million and bad-debt expense was $14.6 million (7.1% of revenue), versus $10.3 million (5.5%). Management cited aged receivables, economic conditions and the BBAY transition. Selling and promotional expense declined 4.4% in Q2 to $27.7 million, partly due to compensation accrual reversals and termination of the Mind Streams revenue-sharing arrangement. The six-month effective tax rate was 41.3%, versus 39.9%; management attributed the increase to non-recurring tax items.
Cash flow, liquidity and debt
- Six-month operating cash flow was $36.0 million, compared with $30.1 million in 2010. Capital expenditures were $38.3 million, up from $22.4 million, primarily for campus construction and technology projects.
- Cash and cash equivalents were $14.7 million at June 30, down from $33.6 million at year-end. Restricted cash was $45.9 million; much of it consists of student-aid funds and is not freely available for general use.
- Notes payable totaled approximately $22.6 million, with $1.2 million of current capital-lease obligations. The amended bank facility extended existing debt maturity to March 2016, reduced the spread to LIBOR plus 200 basis points, and added a $50 million revolver; none was drawn at quarter-end. Debt is secured by company assets and subject to covenants.
- Management said cash from operations and other liquidity sources, including the revolver, should cover operations, planned capital spending and working capital for at least 24 months.
Material changes, outlook and risks
- First-half net income increased modestly despite faster growth in instructional costs. Operating margin declined year over year for the six-month period, while the quarterly margin improved.
- The company repurchased 612,000 shares in Q2 for $8.2 million, at an average $13.33 per share. First-half repurchases totaled $22.4 million. On July 28, the board authorized an additional $25 million repurchase program through September 30, 2012.
- The Department of Education approved a new provisional Title IV participation agreement through December 31, 2013, without special conditions. A 2010 program review remains open, including concerns about enrollment-counselor compensation and whether certain liberal-arts programs met Title IV requirements. Adverse findings could require repayment of aid, fines or other sanctions and could materially affect the business.
- New federal rules concerning incentive compensation, state authorization and gainful employment were taking effect or were scheduled to take effect from July 2011 onward. The company warned that compliance demands, enrollment effects and possible Title IV eligibility impacts are uncertain. It also cited potential pressure from competition, economic conditions, student financing availability, and possible reductions in federal or state aid.
- Management anticipated increasing pressure on new and continuing enrollment from the economy, regulation and competition. The filing provides no specific revenue or earnings guidance. Results are seasonal, with ground-campus enrollment generally lower in summer.
- The $5.2 million qui tam settlement payment was made in Q2 against a previously accrued amount. No material off-balance-sheet arrangements were reported. Management stated that disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Progress and final outcome of the Department of Education program review, particularly the compensation and liberal-arts issues.
- Whether new Title IV rules, state approvals or gainful-employment measures affect program eligibility, enrollment, persistence or student financing.
- Trends in bad debt, aged receivables, scholarships and revenue effects associated with the BBAY transition.
- Execution and funding of substantial campus capital projects alongside share repurchases, and compliance with secured-debt covenants.
- Whether enrollment growth and tuition changes can offset rising instructional costs and seasonal variability.