Grand Canyon Education, Inc. — Q1 2011 10-Q
Reporting period: Three months ended March 31, 2011; comparisons are with Q1 2010 unless noted. The company provides undergraduate and graduate programs online, at its Phoenix campus, and at employer locations. Unless otherwise indicated, financial figures below are in millions.
Financial performance and position
| Metric | Q1 2011 | Q1 2010 / prior date | Change |
|---|---|---|---|
| Net revenue | $101.7 | $89.3 | +13.9% |
| Operating income | $19.2 | $19.6 | -1.9% |
| Operating margin | 18.9% | 21.9% | -3.0 percentage points |
| Net income | $11.3 | $11.5 | -1.6% |
| Diluted EPS | $0.25 | $0.25 | Flat |
| Operating cash flow | $23.4 | $49.1 | Down $25.7 |
| Capital expenditures | $14.7 | $11.6 | Up $3.1 |
| Cash and cash equivalents | $30.2 | $33.6 at Dec. 31, 2010 | Down $3.4 |
| Restricted cash and equivalents | $50.2 | $52.9 at Dec. 31, 2010 | Down $2.7 |
| Notes payable | $23.4 | $23.9 at Dec. 31, 2010 | Down $0.5 |
- Instructional costs rose 25.0% to $45.8 million and increased to 45.1% of revenue from 41.0%. Selling and promotional costs rose 11.0% to $29.8 million but declined as a share of revenue to 29.3% from 30.1%. General and administrative costs were $6.8 million, or 6.7% of revenue.
- Bad-debt expense increased to $7.0 million from $4.8 million, equal to 6.9% of revenue versus 5.3%. The allowance for doubtful accounts was $13.2 million at March 31, 2011.
- Income tax expense was $7.8 million in both periods. Management reported a 40.0% effective tax rate in Q1 2011 excluding the effect of Arizona tax-rate changes on deferred tax balances, versus 40.6% in Q1 2010.
- Property and equipment, net, was $140.7 million, up from $124.0 million at year-end, reflecting investment that included campus construction. Current liabilities were $127.0 million and total liabilities were $151.2 million at March 31.
Material changes and operating developments
- Enrollment reached 42,505, up 9.4%. Online students were 90.9% of enrollment; graduate students were 43.4% of total enrollment. Revenue growth primarily reflected increased online enrollment, with contributions from tuition and course-load changes.
- Revenue growth was partly offset by higher institutional scholarships ($19.8 million versus $13.8 million) and reduced revenue associated with the transition to a borrower-based, non-term financial-aid system.
- Management attributed higher instructional costs to staffing and faculty compensation, bad debt, depreciation, and instructional supplies needed to support enrollment growth. Operating income and net income nevertheless declined year over year.
- The company repurchased 945,200 shares for $14.2 million during the quarter at an average $15.03 per share. Approximately $10.0 million remained under the $25.0 million authorization at March 31.
- Operating cash flow fell substantially, including because of working-capital movements; deferred revenue contributed $3.4 million in Q1 2011 versus $20.5 million in Q1 2010. Investing used $11.9 million and financing used $14.9 million, including the stock repurchases.
Outlook, risks, and unusual items
- Management expected operating cash flow, cash, and the revolving credit facility to provide adequate funds for operations, planned capital expenditures, and working capital for at least 24 months. It anticipated greater pressure on new and continuing enrollment from economic conditions, regulation, and competition. No specific financial forecast or earnings guidance was provided.
- On April 8, 2011, after quarter-end, the company amended its bank loan: maturity was extended to March 31, 2016, the spread over LIBOR was reduced from 225 to 200 basis points, and a $50 million revolving facility was added. The debt is secured by company assets and subject to covenants, including financial and regulatory requirements.
- The Department of Education issued a new provisional Title IV participation agreement on April 8, 2011, effective through December 31, 2013, replacing month-to-month participation status. The agreement imposed no special conditions beyond standard provisional requirements.
- A Department of Education program review covering award years 2008–09 and 2009–10 remained open. Preliminary concerns involved enrollment-counselor compensation and whether certain liberal arts programs met gainful-employment requirements. The company said outcomes could include fines, repayment of Title IV funds, or other sanctions; the timing and result were uncertain.
- A $5.2 million qui tam settlement liability remained accrued, with a matching amount in restricted cash pending payment under the settlement terms. Other pending litigation losses were generally not considered probable or estimable; management said additional charges, if any, were not expected to have a material adverse effect.
- The company paid $8.5 million in January 2011 under a December 2010 agreement ending its related-party revenue-sharing arrangement with Mind Streams and obtaining a student-lead database. Q1 selling and promotional expense included $0.4 million for related-party arrangements, compared with $2.3 million in Q1 2010, excluding that settlement arrangement.
- The company used interest-rate derivatives to hedge variable-rate debt through April 2014. It reported no hedge ineffectiveness at March 31; a counterparty collateral call was reflected in $0.4 million of noncurrent restricted cash.
- Management cited seasonality in enrollment and operating results, particularly the effect of lower traditional-campus attendance in summer months. It also noted regulatory, student-financing, enrollment, competition, and technology risks. Disclosure controls were deemed effective, with no material change in internal control reported.
Important facts for investors to verify
- Progress and final outcomes of the Department of Education program review, including any effect on Title IV eligibility, repayment obligations, or sanctions.
- Enrollment trends, student retention, tuition and scholarship levels, and the effect of the borrower-based financial-aid system on revenue and collections.
- Whether elevated bad-debt expense and the decline in operating cash flow persist, and how much of reported cash is restricted or otherwise unavailable.
- Execution and funding of campus construction and other capital plans, alongside the $50 million secured revolving facility, debt covenants, and contractual obligations.
- Use of remaining share-repurchase authorization and the effect of buybacks on liquidity and share count.