Grand Canyon Education, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; financial statements are unaudited. Comparisons are with the three months ended March 31, 2017, unless otherwise noted. GCE operates a regionally accredited university offering online and campus-based programs.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net revenue | $275.7 million | $248.2 million; up 11.1% |
| Operating income | $90.1 million | $76.6 million; up 17.6% |
| Operating margin | 32.7% | 30.9% |
| Net income | $73.7 million | $55.9 million |
| Diluted EPS | $1.52 | $1.16 |
| Operating cash flow | $119.0 million | $109.7 million |
| Capital expenditures | $35.2 million | $21.7 million |
Net margin was 26.7%, compared with 22.5%. The effective tax rate fell to 18.8% from 26.5%, reflecting the lower federal corporate tax rate under the Tax Cuts and Jobs Act and favorable tax benefits from share-based compensation. The latter benefits were $5.3 million in Q1 2018 versus $8.5 million in Q1 2017.
At March 31, 2018, cash and cash equivalents were $242.8 million, restricted cash was $72.8 million, and investments were $91.9 million. GCE reported $334.8 million of unrestricted cash and investments. Notes payable totaled approximately $64.9 million, including current and noncurrent portions. The company reported total current assets of $435.4 million and current liabilities of $261.7 million.
Investing activities used $38.5 million, primarily for capital expenditures and investments; financing activities used $12.8 million, including debt principal payments and share repurchases/withholding. Cash, cash equivalents, and restricted cash increased by $67.7 million during the quarter. Management stated that available liquidity and expected operating cash flows should fund operations, planned capital spending, and working capital needs for at least 24 months.
Material changes and operating performance
- Enrollment reached 91,378, up 9.6% year over year; online and ground enrollment each grew 9.6%. Online students represented 81% of enrollment.
- Revenue growth reflected increased enrollment and ancillary revenue, partly offset by higher institutional scholarships. Management attributed some year-over-year revenue-per-student growth to ancillary revenue and the Spring 2018 term starting one day earlier.
- Operating expenses rose 8.2% in instructional costs, 9.0% in admissions advisory, 4.4% in advertising, and 13.8% in general and administrative. Expense ratios for instructional, admissions, and advertising costs declined as revenue grew; G&A costs included about $0.9 million of legal and professional expenses related primarily to the proposed nonprofit conversion.
- Capital spending increased, including construction of two residence halls, a classroom building, and a parking garage. Construction in progress was $50.0 million at quarter-end.
- GCE adopted the new revenue recognition standard on January 1, 2018 using the modified retrospective method. Management reported no material impact on financial condition, results, or cash flows; adoption produced a $1.2 million cumulative-effect adjustment to retained earnings.
Outlook, proposed transaction, and risks
No specific financial guidance was provided. Management noted that results are seasonal: most traditional ground students do not attend during May through August, which typically weighs on Q2 and Q3 revenue and margins. The company expects quarterly seasonality to continue and said the summer effect could become more pronounced as ground enrollment grows.
GCE was pursuing a proposed sale of its academic operations and related assets to a newly formed nonprofit, New GCU, and would thereafter provide services to it. A February 2018 nonbinding letter of intent contemplated an estimated $825 million–$875 million purchase price, primarily in a seven-year secured note with an anticipated interest rate of about 6%, and a long-term services agreement. The anticipated revenue share was approximately 60% to GCE and 40% to New GCU, subject to negotiation. The Higher Learning Commission approved the change-of-control application in March; the Arizona regulator approved a supplemental license application on April 26, 2018. Department of Education review remained pending, and definitive agreements had not been executed. GCE said regulatory issues and final terms remained unresolved and could materially change the transaction or prevent completion.
Key risks include extensive federal and state education regulation and dependence on student financial aid, competition for students, enrollment growth and retention, and the execution and regulatory approval of the proposed transaction. If completed, GCE would become a third-party services provider with limited experience in that role, depend initially on New GCU for all revenue, and rely on New GCU to repay the substantial secured note. Management reported no material change to previously disclosed risk factors. It stated that pending legal matters were not considered probable material losses, though outcomes and potential exposure could not be estimated with certainty. No legal proceedings were listed in Part II, Item 1.
Most important facts for investors to verify
- Progress toward definitive agreements and remaining Department of Education and other regulatory approvals for the proposed nonprofit transaction; confirm final asset valuation, note terms, and services-fee economics.
- Whether enrollment growth continues and translates into revenue, particularly amid rising competition and the seasonal slowdown in ground attendance.
- Cash generation and planned campus investment, including the funding needs and returns associated with construction projects.
- Debt maturity and variable-rate exposure: the term loan matures in December 2019, with an interest-rate corridor covering a $65 million notional amount through December 2019.
- Tax-rate sustainability, including the effects of tax law changes and share-based compensation benefits, which management cautioned may make tax expense more volatile.