Grand Canyon Education, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; interim financial statements are unaudited. Dollar amounts below are in millions, except per-share data and student counts.
Business context
Grand Canyon Education provides undergraduate and graduate education online, at its Phoenix campus, and at employer and leased locations. Enrollment was approximately 51,200 at June 30, up 15.2% year over year; online enrollment was 47,785 (93.3% of total), and ground enrollment was 3,415. Ground enrollment rose 47.6% and online enrollment 13.4%.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net revenue | $141.5 | $119.3 | $283.5 | $236.4 |
| Operating income | $31.5 | $25.4 | $65.1 | $49.6 |
| Operating margin | 22.3% | 21.3% | 23.0% | 21.0% |
| Net income | $19.1 | $15.6 | $40.0 | $30.1 |
| Diluted EPS | $0.42 | $0.35 | $0.88 | $0.67 |
| Net margin | 13.5% | 13.1% | 14.1% | 12.7% |
Q2 revenue increased 18.6% and six-month revenue 19.9%. Management attributed growth mainly to enrollment gains, improved retention, higher room and board and other fees, and selective online/professional-studies tuition increases during the 2012–2013 academic year. Institutional scholarships reduced six-month revenue by approximately $49.6 million, versus $44.1 million a year earlier.
For the six months, instructional costs were 42.9% of revenue (44.1% prior year) and admissions advisory costs were 16.3% (17.1%); management cited scale efficiencies. Advertising and marketing/promotional costs rose as a share of revenue. The six-month effective tax rate was 39.6%, versus 39.1%.
Cash flow, liquidity and debt
- Six-month operating cash flow was $44.0, down from $79.6, primarily due to timing of income tax and employee-related payments.
- Investing cash outflow was $64.1, including $38.0 of capital expenditures, $6.9 for land and a building related to future development, and net investment purchases. Financing cash inflow was $5.7.
- At June 30, cash and cash equivalents were $90.8, investments $48.4, and restricted cash $51.5. Unrestricted cash and investments totaled $139.2. The company reported no borrowings on its $50.0 revolving credit line.
- Notes payable totaled approximately $96.4, including $6.6 current; capital lease obligations totaled approximately $0.6. Total liabilities were $253.1.
- Management said cash flow, cash and investments, and the revolving credit line were expected to fund operations, planned capital expenditures, and working capital for at least 24 months. Contractual obligations totaled $173.6, including $96.4 of notes payable, $40.3 of purchase obligations, and $36.3 of operating leases.
Material changes, outlook and risks
- Six-month net income included a $2.2 gain related to settlement of a note receivable. The borrower disputes $2.1 of amounts held in escrow; this disputed amount was not recorded as income or a receivable pending resolution.
- The company repurchased $7.5 of shares in the first six months and had $28.3 remaining under its authorization at June 30. The board authorized a total $75.0 program and extended it through September 30, 2014.
- Management reported increased competition from traditional colleges offering alternative learning formats and anticipated pressure on new and continuing online enrollment. It also noted seasonal effects: lower traditional-campus attendance in summer can weigh on margins, and management expects this effect may become more pronounced as ground enrollment grows.
- No specific financial guidance was provided. Management reported no significant change in key trends from its prior filings.
- A Department of Education Title IV program review remains unresolved. Findings raised issues involving counselor compensation, program eligibility, and procedures for students with non-passing grades and possible unofficial withdrawals. The company offered to return funds for certain students and not seek repayment from them; the Department had not responded. The company reserved $2.55 in the first half of 2013 for related refunds, after reserving $3.45 in 2012. Potential additional refunds, fines, or sanctions are not quantified; management warned an adverse final finding could materially harm the business and financial results.
- Other risks include extensive education regulation, student access to financial aid, enrollment and retention, competition, growth execution, and variable-rate debt. The company used interest-rate hedges; the corridor instrument had a $87.3 notional amount and the swap a $9.3 notional amount at June 30.
Most important facts for investors to verify
- Developments and final resolution of the Department of Education review, including whether the proposed Title IV returns are accepted and whether further liabilities arise.
- Whether enrollment and retention growth can continue amid greater competition, and whether expense growth and advertising spending remain supportable.
- Operating cash flow conversion, capital spending needs, and liquidity after restricted cash, share repurchases, and debt obligations.
- Resolution and collection of the $2.1 million disputed escrow balance related to the note receivable.
- Exposure to variable interest rates, covenant requirements, and the effectiveness and costs of the interest-rate hedges.