Graham Holdings Company — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Unaudited results; Graham Holdings is a diversified education, media, manufacturing, and healthcare company.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $657.2M | $621.6M | $1,916.0M | $1,852.3M |
| Operating income | $44.6M | $68.0M | $142.0M | $194.0M |
| Income attributable to common stockholders | $24.8M | $33.1M | $87.9M | $131.7M |
| Diluted EPS | $4.42 | $5.87 | $15.64 | $23.21 |
| Operating margin | 6.8% | 10.9% | 7.4% | 10.5% |
Q3 revenue grew 6%, while operating income and diluted EPS fell. For the first nine months, revenue rose 3%, but operating income and diluted EPS declined. The reported Q3 net income included $1.4M of non-operating foreign-currency gains; the comparable 2016 quarter included a $15.0M investment write-down, foreign-currency losses, and an $8.3M tax benefit. Nine-month comparisons were also affected by substantial 2016 gains from asset and business sales, foreign-currency losses, and tax benefits, and by a $5.9M 2017 stock-compensation tax benefit.
- Cash flow: Nine-month operating cash flow was $220.9M, versus $151.5M. Investing used $410.5M, primarily reflecting $299.9M of net business acquisitions; financing used $74.6M. Cash and restricted cash ended at $416.4M.
- Liquidity and debt: Cash, restricted cash, marketable securities, and other investments totaled $936.0M at September 30, down from $1,119.1M at year-end 2016. Debt was $493.0M, including $399.4M of 7.25% notes due 2019 and borrowings under Kaplan’s UK facility. Working capital was $804.7M. The company reported compliance with debt covenants and said it expected adequate liquidity for the next 12 months.
- Margins and segment trends: Education revenue was down 3% in Q3 and 6% year to date, with operating income down 18% and 13%, respectively. Television broadcasting operating income fell 44% in Q3 and 32% year to date. Other businesses’ revenue rose sharply, partly from acquisitions, but the segment recorded a $26.5M operating loss year to date.
Material developments, outlook, and risks
- The company acquired six businesses in the first nine months for $318.7M in cash and contingent consideration and assumed $59.1M of pension and postretirement obligations. Hoover Treated Wood Products accounted for $206.8M of the disclosed net cash acquisition cost.
- Kaplan University’s proposed transfer to a new nonprofit affiliated with Purdue remained subject to approvals. Indiana had approved and the Department of Education had given conditional preliminary approval; Higher Learning Commission approval remained uncertain and was not expected before Q1 2018. Either party could terminate if the deal had not closed by April 30, 2018. The proposed 30-year support agreement includes potential funding obligations for Kaplan.
- Kaplan University enrollment was 30,461, down 12% year over year; new enrollments fell 8% in Q3. Dev Bootcamp, most of Kaplan’s new-economy skills training activity, was scheduled to close by year-end 2017. Management expected additional restructuring costs in Q4.
- Broadcasting results faced higher NBC network fees, reduced political and Olympics-related advertising versus 2016, and hurricane-related estimated revenue losses of $2.1M plus $0.6M of additional Q3 expense. Higher retransmission revenue partly offset these pressures.
- Forney recorded a $9.2M goodwill and long-lived-asset impairment in Q2 due to lower expected revenues and weak demand. Nine-month results also included a $5.9M discrete tax benefit from stock compensation; excluding it, the effective tax rate was 35.9%. Management said an international legal restructuring could affect Q4 tax expense.
- The company estimated 2017 capital expenditures of $60M–$70M. In October it made $45.0M of additional investment commitments expected to close within 12 months. Moody’s revised its outlook to negative while affirming its Ba1 rating; S&P’s rating was BB+.
- Management said existing and threatened legal and regulatory matters were not expected to have a material effect, but reasonably possible future losses above recorded amounts could reach approximately $25M. Kaplan also faced an appeal concerning UK VAT assessments, open Department of Education program reviews, and a California citation concerning use of non-employee student recruiters.
Investor verification points
- Track the Purdue/Kaplan University transaction approvals, closing timetable, and potential obligations under the support agreement.
- Assess whether enrollment declines and pressure on education and broadcasting operating income persist, and whether restructuring improves results.
- Review acquisition performance, especially Hoover, and the sustainability of losses in other businesses and investment-stage operations.
- Monitor cash deployment, the $45.0M investment commitments, debt maturities and ratings outlook, and the company’s reported liquidity.
- Follow resolution of Kaplan’s regulatory, legal, and UK VAT matters, and the potential Q4 tax impact of the international restructuring.