Graham Holdings Company — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; unaudited. Graham Holdings is a diversified education and media company, with additional manufacturing, healthcare and other businesses. Kaplan completed the transfer of Kaplan University’s institutional operations to Purdue Global on March 22, 2018, and now provides support services under a long-term agreement.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $672.7 million | $676.1 million | $1,332.1 million | $1,258.8 million |
| Operating income | $65.6 million | $49.7 million | $109.8 million | $60.0 million |
| Net income attributable to common stockholders | $46.6 million | $42.0 million | $89.5 million | $63.1 million |
| Diluted EPS | $8.63 | $7.46 | $16.40 | $11.21 |
| Operating cash flow | Not separately provided | Not separately provided | $70.5 million | $131.6 million |
Revenue decreased about 1% in Q2 but rose about 6% for the half-year. Operating income improved in both periods; operating margin was approximately 9.8% for Q2 and 8.2% for the half-year, compared with approximately 7.4% and 4.8%, respectively, in 2017. Half-year net income included $44.4 million of non-operating pension and postretirement benefit income.
Operating cash flow fell $61.0 million year over year, which management attributed primarily to lower customer cash receipts and increased prepayments. Investing cash use was $44.1 million, versus $335.1 million in the 2017 first half, when business investment was substantially higher. Financing cash use was $126.9 million, including $94.1 million of Class B share repurchases and debt refinancing activity.
At June 30, cash and cash equivalents were $288.6 million, restricted cash $14.1 million, and marketable equity securities and other investments $474.1 million. Total debt was $485.3 million; working capital was $748.8 million. The company reported $776.9 million of cash, restricted cash and investments in marketable securities and other investments, and stated it expected to have sufficient liquidity for the next 12 months.
Material changes and business drivers
- Education: Q2 revenue declined 4% to $370.0 million, while operating income rose 13% to $37.6 million. For the half-year, revenue fell 2% and operating income rose 41%. Kaplan International benefited from improved results; Higher Education revenue was lower following the KU transfer and lower pre-sale enrollments. Test-preparation revenue declined on soft enrollments and the disposition of Dev Bootcamp.
- Television broadcasting: Q2 revenue increased 8% and operating income 3%, supported by retransmission and political advertising. Half-year revenue rose 13% and operating income 23%, also reflecting winter Olympics-related advertising.
- Other businesses/manufacturing: Manufacturing revenue rose 5% in Q2 and 34% for the half-year, with improved operating results primarily reflecting the Hoover acquisition. SocialCode reported operating losses of $1.7 million in Q2 and $5.5 million for the half-year.
- Revenue recognition guidance was adopted January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $7.4 million. The filing says the first-half impact versus prior accounting was $1.3 million lower revenue and $0.8 million lower operating expenses.
Debt, outlook and risks
In May, the company issued $400 million of 5.75% unsecured notes due 2026, then used the proceeds and cash on hand to redeem $400 million of 7.25% notes due 2019. The early redemption generated $11.4 million of debt-extinguishment costs. The company also extended and increased its revolving credit facility to $300 million, maturing in May 2023. It reported compliance with its financial covenants at June 30; the facility requires a maximum net leverage ratio of 3.5:1 and minimum interest coverage of 3.5:1.
Management estimated 2018 capital expenditures of $110–$120 million, including a UK Pathways facility and television spectrum-repacking work, largely expected to be reimbursed by the FCC. No specific revenue or earnings guidance was provided. Moody’s affirmed the company’s ratings and changed its outlook from Negative to Stable; ratings were Ba1 from Moody’s and BB+ from S&P.
- Kaplan’s Purdue Global support-service fees and cost reimbursements depend on Purdue Global’s available cash after specified costs and priority payments. Kaplan advanced $20 million for Purdue Global’s first two annual priority payments and will continue to assess fee collectability quarterly.
- Management said reasonably possible future losses from existing and threatened proceedings, above amounts recorded, could reach approximately $35 million. A UK VAT dispute includes a £15.4 million receivable; an adverse outcome could produce a pre-tax charge of that amount. Separate proposed UK VAT guidance could add an estimated £4.5 million annual expense to the Pathways business if enacted and no exemption is preserved.
- Other exposures include Department of Education program reviews and regulatory responsibilities related to Kaplan’s Purdue Global servicing arrangement. The company said the previously disclosed material weakness in controls over student financial-aid refund policy changes was remediated by the end of Q2 2018.
- Market risks include equity-price exposure from marketable securities, interest-rate risk and foreign-exchange risk. First-half 2018 included a $16.7 million net loss on marketable equity securities.
Key facts for investors to verify
- Whether Purdue Global generates sufficient cash to support Kaplan’s reimbursements and fees under the TOSA, and how much service-fee revenue is recognized in subsequent periods.
- Progress and potential financial impact of the UK VAT assessments, proposed guidance and open education program reviews.
- Cash-flow trends, planned capital spending and the company’s ability to maintain liquidity and comply with credit-facility covenants.
- How much of reported earnings reflects recurring operations versus debt-extinguishment costs, marketable-security losses, pension income and transaction-related gains.
- Comparability of segment results following the Kaplan University transfer and the company’s adoption of new revenue and financial-asset accounting rules.