Graham Holdings Company — Q3 2016 Form 10-Q
Business context and period. Diversified education and media company with Kaplan education businesses, five television stations, healthcare, manufacturing and other operations. This unaudited report covers the three and nine months ended September 30, 2016; comparisons are with the same 2015 periods. Cable ONE and certain sold businesses are presented as discontinued operations in 2015.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $621.6 million | $641.4 million | $1,852.3 million | $1,969.7 million |
| Operating income (loss) | $68.0 million | ($213.7) million | $194.0 million | ($148.6) million |
| Income (loss) from continuing operations attributable to common shareholders | $33.1 million | ($231.2) million | $131.7 million | ($194.6) million |
| Diluted continuing-operations EPS | $5.87 | ($40.32) | $23.21 | ($34.18) |
| Operating margin, approximate | 11.0% | (33.3%) | 10.5% | (7.5%) |
- Revenue declined 3% in Q3 and 6% for the nine-month period. Education revenue fell 20% in both comparisons, while television broadcasting and other businesses grew.
- Q3 2015 results included a $248.6 million Kaplan Higher Education goodwill impairment; nine-month 2015 results also included a $6.9 million long-lived asset impairment. These charges substantially explain the reported operating-loss comparisons.
- Operating cash flow was $144.2 million for the first nine months, versus $116.1 million in 2015. Investing cash outflow was $284.8 million, including $242.5 million for acquisitions; financing cash outflow was $17.3 million. Cash and equivalents fell $161.0 million to $593.2 million.
- At September 30, cash, restricted cash, marketable securities and other investments totaled $1,029.9 million, versus borrowings of $497.4 million. Working capital was $961.5 million. Total debt comprised $398.9 million of 7.25% notes due 2019, a £75 million Kaplan UK facility and other debt. The company reported compliance with its financial covenants.
- Total assets were $4.44 billion and total liabilities $1.93 billion. Prepaid pension cost was $1.02 billion.
Material changes and segment results
- Education: revenue declined 20% in Q3 and nine months. Kaplan University enrollment was 34,462, down 20% year over year; new enrollments declined 17% in Q3 and 25% for nine months. Higher Education operating income improved from the prior year, but Test Preparation and Kaplan International operating income declined.
- Television broadcasting: Q3 revenue rose 25% to $112.4 million and operating income rose 46% to $59.2 million, supported by Olympics and political advertising and higher retransmission revenue. Nine-month revenue rose 14% and operating income 19%.
- Other businesses: revenue grew 75% in Q3 and 72% for nine months, partly reflecting acquisitions, but operating losses widened to $10.8 million and $21.6 million, respectively. SocialCode’s losses included $11.3 million of Q3 expense from phantom-equity appreciation plans.
- The company acquired four businesses for a total preliminary purchase price of $254.8 million in the first nine months. It also repurchased $90.3 million of Class B shares. The planned $60 million purchase of two television stations remained subject to regulatory approvals and closing conditions.
Outlook, commentary, risks and unusual items
- Management estimated 2016 capital expenditures of $65–$75 million; $43.4 million had been incurred in the first nine months. Management stated it expected sufficient liquidity for cash needs through 2016, primarily from cash balances and internally generated funds.
- Q3 2016 unusual items included a $15.0 million investment write-down, $3.8 million of foreign-currency losses and a net $8.3 million deferred tax benefit related to Kaplan’s international operations. For the nine months, non-operating items included gains on land, business and securities sales, offset in part by $33.3 million of foreign-currency losses and $15.2 million of investment write-downs. The nine-month effective tax rate was 28.9%; excluding specified tax adjustments, management reported 36.4%.
- Kaplan faces continued enrollment pressure and regulatory uncertainty. Draft gainful-employment rates placed four currently enrolling Kaplan University programs in “zone” status; they generated $41.5 million of revenue in the first nine months. Final rates were expected in early 2017. New borrower-defense rules issued November 1, 2016, effective July 1, 2017, could increase loan-discharge and institutional reimbursement exposure and may require a letter of credit; management said the impact could be materially adverse.
- Kaplan University was provisionally certified through September 30, 2018 while an Education Department review continued; the department had not notified Kaplan of negative findings. Other program reviews and litigation remained ongoing. Management said existing legal proceedings were not expected to have a material effect based on information then available. The Higher Learning Commission reaffirmed Kaplan University’s accreditation for ten years.
- Graham Healthcare Group’s 10% minority interest is mandatorily redeemable by 2026, with puts beginning in 2020 and required redemptions in later years. Redemption is based on an EBITDA multiple and has no stated cap, creating a future cash obligation whose amount is not clear from the filing.
Key facts for investors to verify
- Whether Kaplan enrollment declines stabilize and whether the four “zone” programs meet final gainful-employment requirements.
- The financial and compliance effects of borrower-defense rules, open Education Department reviews and any required letter of credit or reimbursement.
- Whether broadcasting growth persists after Olympics and political advertising, and whether other-business losses—particularly SocialCode’s incentive expense—moderate.
- Cash generation and spending against acquisition, capital expenditure, repurchase and healthcare minority-redemption obligations.
- The valuation assumptions behind the $15.0 million investment impairment, goodwill from recent acquisitions, and the sizable prepaid pension asset.