Grand Canyon Education, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited fourth-quarter results. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context and reporting period
On July 1, 2018, GCE sold Grand Canyon University (GCU) to an independent nonprofit entity and transitioned from operating the university to providing it bundled education and administrative services. Under a 15-year Master Services Agreement, GCE receives 60% of GCU tuition and fee revenue. GCU was GCE’s sole services client during 2018. After year-end, GCE acquired Orbis Education, which supports healthcare programs at 17 universities; the acquisition closed January 22, 2019.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net revenue | $845.5m | $974.1m |
| Operating income | $258.1m | $282.8m |
| Net income | $229.0m | $203.3m |
| Diluted EPS | $4.73 | $4.22 |
| Operating cash flow | $199.1m | $304.9m |
| Capital expenditures | $94.9m | $124.0m |
| Adjusted EBITDA (non-GAAP) | $274.1m | $245.1m |
Reported revenue and operating income fell 13.2% and 8.7%, respectively, largely because GCE reported university revenue before the transaction but only its 60% service fee afterward. On management’s adjusted comparable basis, revenue was $640.5m, up 9.6% from $584.5m; adjusted operating income was $248.6m, with a 38.8% margin, versus $219.8m and 37.6% in 2017. These adjusted measures are not GAAP measures. Reported FY 2018 operating margin was approximately 30.5% and net margin approximately 27.1%; comparisons are affected by the transaction and its accounting.
Fourth-quarter 2018 revenue was $177.5m, operating income $80.1m, net income $75.5m, and diluted EPS $1.56. Fourth-quarter 2017 revenue was $271.4m, operating income $91.3m, net income $68.3m, and diluted EPS $1.41. Revenue comparisons across the transaction are not directly like-for-like.
At December 31, 2018, the balance sheet showed cash and cash equivalents of $120.3m, investments of $69.0m, and restricted cash of $61.7m. Notes payable were $59.9m. GCE also held a $900.1m secured note receivable from GCU, bearing 6% interest, with principal due June 30, 2025; interest-only payments are due during the term. Operating cash flow declined year over year, which management attributed partly to transaction-related liability changes, higher receivables from GCU, and timing of tax payments. GCE reported $1.214bn in stockholders’ equity and $1.324bn in total assets.
After year-end, the Orbis acquisition cost $365.8m in cash. GCE amended its credit facilities, ultimately providing a $243.75m term loan and an $81.25m revolving facility, with a five-year maturity and variable-rate pricing. The filing says the term loan amortizes quarterly beginning in 2019. Management believed available cash, operating cash flow, and credit access would support operations, planned capital expenditures, and working capital for at least 24 months.
Material changes, outlook, risks, and unusual items
- GCU enrollment rose 7.8% year over year to 97,369 at December 31, 2018. Management attributed comparable revenue growth principally to enrollment and ancillary revenue growth, partly offset by higher institutional scholarships.
- The $870.1m sale consideration was paid with the secured note rather than cash. GCE advanced another $30.0m for GCU-approved capital projects in the second half of 2018; it expected to fund approximately $100m of GCU capital expenditures in 2019 under the note arrangements.
- GCE recorded an $18.4m loss on the transaction, including transaction costs, a $3.0m impairment, and $9.6m transferred to fund deferred compensation for former GCE employees. A separate $7.9m share-based compensation charge related to accelerated vesting was included in university-related expenses.
- Net income increased despite lower reported operating income, aided by $26.9m of interest income on the GCU note and a lower effective tax rate: 20.2% versus 28.3% in 2017. The lower 2018 rate reflected the federal corporate tax-rate reduction, school tuition organization credits, and share-based compensation tax benefits.
- No specific earnings or revenue guidance is provided. GCE noted seasonality tied to GCU enrollment, including weaker traditional-student attendance in summer months, and expected quarterly fluctuations to continue. The Orbis acquisition expanded GCE to 18 university clients, but GCU was expected to remain its most significant client.
- Key exposures include dependence on GCU and its enrollment, GCU’s ability to repay the secured note, execution and integration of Orbis, and extensive higher-education regulation. Following the ownership change, GCU’s Title IV participation was provisional and month-to-month while the Department of Education reviewed the change in control. The filing also highlights uncertainty around the revenue-sharing model and incentive-compensation rules, compliance audits, data privacy and cybersecurity, and possible regulatory limits on programs or enrollment.
- Management said routine litigation was not expected to have a material adverse effect. The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded internal control over financial reporting was effective at year-end.
Most important facts for investors to verify
- Whether the Department of Education approves GCU’s change in control and issues a new Title IV participation agreement, and whether it imposes conditions or restrictions.
- GCU’s capacity to make interest payments and repay the $900.1m secured note at maturity, including the scale and terms of additional capital advances.
- Whether GCE can sustain GCU’s enrollment and service performance while reducing customer concentration through Orbis and other clients.
- Orbis integration, acquisition returns, and compliance with the post-acquisition credit agreement’s amortization and financial covenants.
- How comparable operating results develop under the new services model, separating recurring performance from transaction charges, tax effects, and non-GAAP adjustments.
- Whether GCE’s 60% tuition-and-fee revenue-sharing arrangement remains compliant with applicable incentive-compensation rules and related regulatory guidance.