Grand Canyon Education, Inc. quarterly report, Q2 FY2017

Grand Canyon Education, Inc. — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017. Financial statements are unaudited. The company operates a single educational delivery business, offering online and ground programs.

Financial performance

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Net revenue	$218.3 million	$191.3 million	$466.5 million	$418.2 million
Operating income	$55.1 million	$44.7 million	$131.7 million	$113.4 million
Operating margin	25.2%	23.4%	28.2%	27.1%
Net income	$39.8 million	$27.6 million	$95.8 million	$71.3 million
Diluted EPS	$0.83	$0.59	$1.99	$1.52

• Q2 revenue increased 14.1% and net income increased 44.2% year over year. For the first six months, revenue rose 11.5% and operating income rose 16.1%.
• Net margin was 18.3% in Q2 versus 14.4% a year earlier; for the six-month period it was 20.5% versus 17.0%.
• Six-month operating cash flow was $133.7 million, compared with $112.5 million. Investing cash outflow was $86.7 million, including $50.5 million of capital expenditures; financing cash outflow was $32.2 million. Cash and restricted cash totaled $145.7 million at June 30.
• At June 30, unrestricted cash and investments totaled $155.7 million; restricted cash was $79.4 million. Notes payable were $69.9 million in total contractual obligations, including $6.7 million current and $63.3 million noncurrent on the balance sheet. No revolver balance was outstanding.
• Total assets were $1.169 billion and stockholders’ equity was $872.2 million at June 30, 2017.

Changes and operating drivers

• Enrollment was 74,485, up 10.5% year over year: online enrollment grew 10.4% and ground enrollment 10.8%. Graduate students represented 47.9% of enrollment.
• Management attributed revenue growth to enrollment increases and higher room, board, and other student fees, partly offset by increased institutional scholarships. Traditional ground enrollment grew faster than working-adult enrollment, contributing to higher revenue per student.
• Operating expenses grew more slowly than revenue overall. Six-month instructional costs were 42.4% of revenue versus 42.9%; admissions costs were 13.5% versus 14.0%. Advertising rose to 10.6% of revenue from 10.3%.
• Income tax expense fell to $35.6 million from $44.0 million for the six-month period, despite higher pretax income. The effective tax rate declined to 27.1% from 38.2%, primarily because of a newly adopted share-based compensation accounting rule that produced $13.8 million of excess tax benefits. Management warned that this treatment may make tax expense more volatile.
• Capital expenditures declined from $115.6 million to $50.5 million for the six months, reflecting the timing of campus construction spending. Projects included a dormitory and campus-adjacent land and facilities.

Outlook, risks, and unusual items

• No specific revenue or earnings guidance is provided. Management said operating cash flow, cash and cash equivalents, and the revolving credit line should fund operations, planned capital expenditures, and working capital for at least 24 months.
• Management expects seasonal quarterly fluctuations to continue. Summer periods typically have lower traditional ground enrollment and margins; a growing share of ground students could make this effect more pronounced.
• Key risks include compliance with Title IV and other education regulations, students’ access to financial aid, competition for students, enrollment conversion and retention, marketing costs, and execution of campus expansion and other growth initiatives. The university reported that its accreditation was reaffirmed without monitoring or interim-report requirements and that management believed it was materially compliant with applicable regulations.
• The filing reports no legal proceedings under Part II and no material changes to previously disclosed risk factors. It also notes ordinary-course litigation and regulatory exposure; management did not expect such matters to have a material adverse effect, while acknowledging that some potential losses could exceed existing reserves.
• Revenue-recognition guidance was scheduled for adoption in 2018; management expected no material impact on tuition recognition but was still assessing other revenues and fees. The forthcoming lease standard was expected to increase assets and liabilities modestly.
• The share-repurchase authorization had $99.2 million remaining and was set to expire December 31, 2017; no program repurchases were made in the first half. Cash used for shares withheld for employee taxes is distinct from program repurchases.

Important facts for investors to verify

• Whether enrollment growth and the shift toward residential ground students continue to support revenue and margins, particularly through seasonal periods.
• The sustainability of earnings growth after separating operating performance from the $13.8 million share-based compensation tax benefit and its potential volatility.
• Cash generation, planned campus spending, and the timing and funding of contractual obligations, including the credit facility’s December 2017 revolver availability period and debt maturity in 2019.
• Developments in Title IV regulation, accreditation, student financial-aid access, and competitive pressure on online enrollment and marketing.
• Implementation effects of the new revenue and lease accounting standards; the filing says some impacts remained under evaluation.