Graham Holdings Company — 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016; it is not a standalone fourth-quarter filing. Graham Holdings is a diversified education and media company, with Kaplan as its largest business, alongside television broadcasting, healthcare, manufacturing, digital advertising and publishing. Education contributed 64% of consolidated revenue. The company reported five television stations at year-end and acquired two additional stations on January 17, 2017.
Financial performance
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $2.482 billion | $2.586 billion |
| Operating income (loss) | $303.5 million | $(80.8) million |
| Income (loss) from continuing operations attributable to common shareholders | $168.6 million | $(143.5) million |
| Diluted EPS from continuing operations | $29.80 | $(25.23) |
| Net cash provided by operating activities | $261.3 million | $70.7 million |
| Capital expenditures | $70.7 million | $62.0 million |
| Cash and cash equivalents at year-end | $648.9 million | $754.2 million |
| Total borrowings at year-end | $491.8 million | $399.8 million |
| Working capital at year-end | $1.052 billion | $1.136 billion |
Operating margin was approximately 12.2% in 2016, compared with an operating loss margin of approximately 3.1% in 2015. The improvement primarily reflects the absence of 2015 impairment charges, including a $248.6 million Kaplan Higher Education goodwill impairment. The 2016 effective tax rate was 32.4%; excluding identified deferred-tax benefits, management reported an effective rate of 37.9%.
Cash flow from operations rose substantially, in part because of significant income tax payments in the first quarter of 2015. Cash and cash equivalents declined by $105.3 million during 2016, while borrowings increased by $92.0 million. Working capital remained positive. The company had a $200 million revolving credit facility with no borrowings outstanding at year-end and said it complied with its financial covenants. Its principal debt was $400 million of 7.25% notes due February 2019; Kaplan also borrowed £75 million, hedged to an effective fixed rate of 2.01% through 2020.
Segments and material changes
| Business | FY 2016 revenue | FY 2016 operating result | Change/comment |
|---|---|---|---|
| Education | $1.598 billion | $93.6 million | Revenue down 17%; result improved from a $223.5 million loss, primarily because 2015 included impairment charges. |
| Television broadcasting | $409.7 million | $200.5 million | Revenue up 14% and operating income up 22%; political, Olympics-related and retransmission revenue increased. |
| Other businesses | $473.9 million | $(22.1) million | Revenue up 58%, mainly reflecting acquisitions; operating loss widened from $13.7 million. |
Kaplan Higher Education revenue fell 27%, reflecting the 2015 sale of most ground campuses, school closures and lower Kaplan University enrollment. Kaplan University enrollment was 32,167 at year-end, down 19%; new higher-education enrollments fell 22%. Kaplan Test Preparation revenue declined 5% and operating income declined 43%, with investment in new skills-training programs contributing to losses. Kaplan International revenue declined 10%, including a 6% currency impact, as English-language and pathways enrollments weakened. Manufacturing revenue growth largely reflected acquisitions; SocialCode revenue grew 28% but its operating loss increased to $12.4 million.
Fourth-quarter 2016 revenue was $629.6 million, operating income was $109.5 million, net income attributable to common shareholders was $36.9 million and diluted EPS was $6.57. Quarterly results included a $1.6 million goodwill impairment in other businesses. FY 2016 results also included an $18.0 million pension settlement gain, restructuring charges, investment write-downs, foreign-exchange losses and gains on asset and business sales; reported earnings therefore include material unusual items.
Outlook, risks and contingencies
- Outlook: Management provided no consolidated earnings or revenue guidance. It estimated 2017 capital expenditures of $50–$60 million and a 2017 pension credit of approximately $59 million. Management stated that existing cash and internally generated funds should provide ample liquidity to meet 2017 needs.
- Education regulation: Kaplan University received provisional U.S. Department of Education certification through September 30, 2018, connected to an open program review. The ED had reported no negative findings as of the filing, but the review outcome was uncertain. Title IV aid represented approximately $437 million, or 71%, of KHE revenue in 2016. The university reported an estimated composite score of 1.8, subject to the ED’s determination.
- Program eligibility: None of Kaplan University’s active programs accepting students failed the first reported gainful-employment test, but three active programs that were not accepting new students had failed; 16 programs were in the warning zone. Kaplan appealed the relevant results. New borrower-defense rules were scheduled to take effect July 1, 2017 and could result in additional financial protections, including letters of credit.
- Other operating risks: Management cited declining education enrollments, foreign-exchange exposure, Brexit and changing student-visa policies, healthcare reimbursement and regulation, competition and potential effects of broadcasting spectrum repacking. Foreign-currency losses were $39.9 million in 2016; management estimated a 10% change in the pound and Australian dollar would change 2016 pretax income by approximately $21 million.
- Contingencies and unusual obligations: The company disclosed ongoing litigation and regulatory reviews, including matters involving former Kaplan campuses and wage-and-hour claims; management did not expect existing proceedings to have a material effect, while noting some outcomes were uncertain. The company retained responsibility for certain former-campus review obligations. Graham Healthcare Group’s 10% mandatorily redeemable minority interest is payable over time through 2026, with no stated cap on the redemption amount. The company also committed to lend up to £25 million to a University of York joint venture; approximately £11 million had been advanced by year-end.
Important facts for investors to verify
- Progress and findings in the ED’s Kaplan University program review, certification status, and any required repayment, reporting or letter-of-credit measures.
- Kaplan’s Title IV dependence, enrollment trajectory, gainful-employment appeals and ability to sustain compliance with aid-program requirements.
- Whether revenue and operating performance recover in Kaplan businesses and whether investments in skills training and other new businesses produce acceptable returns.
- Cash generation, acquisition spending, share repurchases and the company’s ability to address the 2019 notes and other contractual commitments.
- The effect of nonrecurring pension, tax, investment-valuation, foreign-exchange and asset-sale items on the sustainability of reported earnings.
- Potential costs or operational effects from broadcasting station repacking, healthcare reimbursement changes, litigation and the healthcare minority-interest redemption provisions.
Audit and controls: PricewaterhouseCoopers LLP issued an unqualified opinion on the financial statements and internal control over financial reporting as of December 31, 2016.