Graham Holdings Company — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Unless noted, dollar amounts are in millions. Graham Holdings is a diversified education and media company. Cable ONE was spun off on July 1, 2015; its results are reported as discontinued operations for all periods presented. Kaplan sold substantially all KHE Campuses assets on September 3, 2015, in exchange for a preferred equity interest in Education Corporation of America (ECA).
Financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $641.4 | $703.2 | $1,969.7 | $2,009.4 |
| Operating income (loss) | $(213.7) | $41.2 | $(148.6) | $133.7 |
| Continuing operations attributable to common stockholders | $(231.2) | $10.1 | $(194.6) | $459.4 |
| Net income (loss) attributable to common stockholders, including discontinued operations | $(230.8) | $76.4 | $(152.5) | $958.6 |
| Diluted EPS, continuing operations | $(40.32) | $1.73 | $(34.18) | $66.52 |
- Revenue and operating performance: Q3 revenue declined 9%, principally from education and other businesses; television broadcasting revenue increased. Nine-month revenue declined 2%. Education revenue fell 11% in Q3 and 6% year to date. Television revenue rose 3% in Q3 and 1% year to date, but operating income declined in both periods.
- Impairment and unusual items: Q3 results included a preliminary $248.6 impairment charge against KHE goodwill; the nine-month impairment total was $255.5, including a $6.9 long-lived-asset charge in Q2. The company also reported Q3 restructuring costs of $9.5, $18.8 of stock-option expense related to the Cable ONE spin-off, $26.3 of net losses on business sales, and $13.0 of unrealized foreign-exchange losses. The impairment estimate was based on preliminary assumptions and remained subject to adjustment in Q4.
- Cash flow: Nine-month operating cash flow was $116.1, down from $346.9 in 2014. Investing activities used $274.9; financing activities provided $373.8. Cash and cash equivalents at September 30 were $978.0. Cash capital-expenditure payments were $120.0; management separately reported capital expenditures of $114.0 for the period, including assets acquired.
- Liquidity and debt: The company reported working capital of $1,191.4, versus $639.9 at year-end 2014. Cash, restricted cash, marketable securities and other investments totaled $1,346.4, versus $1,024.4 at year-end. Debt was $402.8, including $398.6 of 7.25% notes due 2019. A new $200 revolving credit facility runs to 2020; financial covenants were met at quarter-end. Credit ratings were Moody’s Ba1 and S&P BB+.
- Margins and profit drivers: The operating loss and negative operating margin were dominated by the KHE impairment; the filing does not provide an adjusted consolidated margin. Excluding the impairment would not by itself represent a company-reported adjusted result. Interest expense was $7.3 in Q3 and $23.3 year to date.
Material changes and management commentary
- The Cable ONE spin-off removed its assets, liabilities and future operating results from continuing operations. Its distribution generated a net $447.1 cash inflow to Graham Holdings before related cash flows; Cable ONE’s debt is no longer the company’s obligation.
- Comparisons with 2014 are affected by large one-time gains: nine-month 2014 included a $266.7 Berkshire-share exchange gain and a $127.7 headquarters-sale gain in continuing operations, as well as a $375.0 WPLG sale gain in discontinued operations. Consequently, reported year-over-year earnings comparisons are not indicative solely of current operating trends.
- Management said continued KHE enrollment declines and difficult industry conditions prompted the goodwill review. Kaplan University new enrollments fell 11% in both Q3 and the first nine months; total enrollment was down 7% year over year at September 30. Management was pursuing further cost savings and expected additional restructuring plans and costs in Q4.
- Management estimated 2015 capital expenditures of $125–$135 and stated it expected adequate liquidity to meet cash needs through 2015. The company reduced its regular quarterly dividend to $1.15 per share following the spin-off. No earnings or revenue guidance was provided.
Risks, contingencies and other matters
- Education regulation: Kaplan University received an October 2015 Department of Education letter stating it had failed to report data for a number of programs and could not start new programs until the matter was resolved. Kaplan submitted additional data and was awaiting a formal response; unresolved issues could lead to administrative action. Gainful-employment rules may also put programs on warning or threaten Title IV eligibility. Management estimated continuing KHE campuses would comply with the 90/10 rule in 2015, but gave no assurance.
- Retained obligations: Kaplan retained responsibility for liabilities related to pre-sale conduct of KHE Campuses and for financial obligations from certain Department of Education reviews. Under the ECA sale agreement, Kaplan may be required to provide up to approximately $45 of credit support for two years if required by the Department of Education; the support could be drawn if ECA defaults on student obligations.
- Other risks: Existing legal proceedings were not expected by management to have a material effect based on information then available. The company identified exposure to equity-price, interest-rate and foreign-exchange risks. Pension assets include material equity and foreign-country concentrations.
- Estimates and controls: The KHE impairment depends on preliminary valuation assumptions, including forecast cash flows and a 13% discount rate; the company expected to finalize any adjustment in Q4. Management reported disclosure controls effective and no material quarterly change in internal control over financial reporting.
Key facts for investors to verify
- Final amount and assumptions for the KHE goodwill impairment, and subsequent KHE enrollment, revenue and operating trends.
- Resolution and potential consequences of the Department of Education’s missing-program-data matter, open program reviews and gainful-employment requirements.
- Terms, valuation, distributions and any credit-support obligations associated with the ECA preferred equity received for KHE Campuses.
- Post-spin liquidity, debt and covenant headroom, including the effects of the lower dividend and the $200 revolving facility.
- Underlying operating performance separated from impairment, restructuring, disposition losses, spin-off costs and unusually large 2014 transaction gains.