Graham Holdings Company — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with FY 2016. Graham Holdings is a diversified company led by education (Kaplan), with television broadcasting, healthcare, manufacturing and media businesses. Its results include significant acquisition activity and a substantial one-time tax benefit.
Financial performance
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Revenue | $2.592 billion | $2.482 billion |
| Operating income | $209.1 million | $303.5 million |
| Operating margin | 8.1% | 12.2% |
| Net income attributable to common stockholders | $302.0 million; diluted EPS $53.89 | $168.6 million; diluted EPS $29.80 |
| Cash from operating activities | $268.1 million | $261.3 million |
| Capital expenditures | $57.1 million | $70.7 million |
| Net interest expense | $27.3 million | $32.3 million |
- Revenue rose 4%, primarily from growth in other businesses, including the Hoover acquisition. Education revenue declined 5%; advertising revenue fell 8%, largely because 2016 benefited from political and Olympics-related advertising.
- Operating income fell 31%. Television broadcasting operating income declined to $137.2 million from $200.5 million, reflecting lower political and Olympics advertising, higher NBC network fees and hurricane impacts. Education operating income fell to $75.2 million from $93.6 million, principally due to lower Kaplan University enrollment. Other businesses recorded a $22.8 million operating loss.
- Reported net income included a $177.5 million net deferred tax benefit from the Tax Cuts and Jobs Act, including deferred-tax remeasurement and treatment of undistributed foreign earnings. Excluding specified items, management reported an effective tax rate of 34.9% for 2017, versus 37.9% for 2016 excluding specified tax items.
- Fourth-quarter revenue was $675.8 million and operating income was $67.1 million. Common-stockholder net income was $214.2 million, including the fourth-quarter tax benefit of $159.7 million in the income-tax line.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $390.0 million at year-end, down from $648.9 million; restricted cash was $17.6 million. Working capital was $857.2 million, versus $1.052 billion.
- Total borrowings were $493.3 million, compared with $491.8 million. Principal debt included $400 million of 7.25% unsecured notes due February 1, 2019, and U.K. credit-facility borrowings. The company reported compliance with debt covenants and no outstanding borrowings on its $200 million U.S. revolving facility.
- Management said operating cash generation exceeded required interest and principal payments and expected ample liquidity for 2018. The company was evaluating whether to refinance all or part of the 2019 notes.
- 2017 investing cash outflow was $442.0 million, including acquisitions and investments; financing cash outflow was $100.1 million. The company repurchased $50.8 million of shares and paid $28.3 million in dividends. The annual dividend rate for 2018 was set at $5.32 per share.
Material changes, outlook and risks
- Education and Purdue transaction: Kaplan University enrollment fell 11% year over year to 28,718 students; KHE revenue declined 11%. Kaplan’s proposed transfer of the institution to a new Purdue-affiliated nonprofit remained subject to regulatory approvals, including Higher Learning Commission approval. At filing, the parties anticipated approval by the end of Q1 2018, but completion was not assured; either party could terminate if the transaction was not completed by April 30, 2018. Kaplan would provide support services under a long-term agreement and could be required to advance funds.
- Regulatory exposure: Title IV funds accounted for approximately $374 million, or 68%, of KHE revenue in 2017. Kaplan University was on provisional ED certification through September 30, 2018, amid an open program review. The filing also describes uncertainty around borrower-defense and gainful-employment rules, state authorization and other requirements. KU’s estimated 90/10 receipts ratio was below 74% in 2017.
- Refund accounting and controls: Kaplan recorded an $8.4 million estimated liability for previously unreturned student-aid funds after identifying a procedural change in refund processing. It self-reported the matter to the ED. Management and the auditor concluded that a material weakness existed in internal control over financial reporting at year-end; the auditor issued an adverse opinion on internal-control effectiveness, while giving an unqualified opinion on the financial statements. Remediation was expected during 2018.
- Tax and accounting changes: The company’s 2017 earnings benefited materially from provisional Tax Act accounting; management said the final effect could differ as its analysis continued. It expected adoption of new revenue-recognition guidance to increase opening retained earnings by approximately $7–$12 million. New financial-instrument accounting was expected to reclassify $194.9 million of after-tax unrealized gains to retained earnings and put subsequent fair-value changes in net income.
- Other outlook items: Management estimated 2018 capital expenditures of $110–$120 million, including U.K. Pathways construction and television spectrum repacking, for which reimbursement was uncertain. It estimated a 2018 pension credit of approximately $69 million. Acquisition integration, education enrollment and regulation, advertising trends, healthcare reimbursement and regulation, foreign exchange, and media competition remain risks.
- Contingencies: Management said future losses from existing and threatened legal, regulatory and other proceedings in excess of recorded amounts could reach approximately $30 million. Kaplan expected to recover £10.9 million of U.K. VAT assessments it had paid and was appealing; if unsuccessful, it said a pre-tax charge of that amount would be recorded. A U.K. student residence may require cladding remediation, but scope and cost were not yet clear.
Most important facts for investors to verify
- Underlying earnings and cash generation excluding the $177.5 million Tax Act benefit, and the final tax accounting.
- Whether the Purdue University Global transfer received all approvals, closed on acceptable terms, and produces sustainable service-agreement economics without significant funding advances.
- Progress on remediating the student-aid refund control weakness, ED review findings and any resulting repayment, sanction or compliance-audit requirements.
- Kaplan enrollment trends and exposure to Title IV, gainful-employment and borrower-defense requirements.
- Refinancing or repayment plans for the $400 million notes due in February 2019, alongside liquidity and covenant headroom.
- Resolution of the £10.9 million VAT appeal, the potential healthcare regulatory penalties, and the cost of U.K. residence remediation.