Grand Canyon Education, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparative period is Q1 2012. Grand Canyon Education provides online, campus-based and employer-site postsecondary programs, primarily in education, healthcare, business and liberal arts. Financial amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net revenue | $142.0 | $117.1 | +21.3% |
| Operating income | $33.6 | $24.2 | +38.9% |
| Operating margin | 23.7% | 20.7% | +3.0 percentage points |
| Net income | $20.9 | $14.5 | +44.7% |
| Diluted EPS | $0.46 | $0.32 | +$0.14 |
| Operating cash flow | $31.7 | $50.8 | Down $19.1 |
| Capital expenditures | $14.7 | $16.9 | Down $2.2 |
Revenue growth reflected higher online and ground enrollment, improved retention, selective tuition increases, and higher room, board and other student fees, partly offset by increased scholarships. Enrollment at quarter-end rose 15.7% to 53,559: online enrollment increased 12.2% and ground enrollment 44.6%. Scholarships reduced reported revenue by approximately $28.3 million, versus $23.9 million a year earlier.
Operating expenses were $108.4 million, up 16.7%, slower than revenue growth. Instructional costs rose 18.0% to $60.0 million; admissions advisory costs rose 15.0% to $23.0 million; advertising rose 16.8% to $15.9 million. Management attributed improved operating leverage to spreading personnel and campus fixed costs across a larger revenue base. Bad debt expense was 3.5% of revenue in both periods. Net margin was 14.7%, versus 12.4%.
Interest expense was $0.7 million, compared with $0.2 million. Interest and other income was $2.2 million, primarily a $2.187 million gain from settlement of a purchased note receivable. The borrower disputes $2.068 million of interest and penalties, held in escrow; the company has not recognized this disputed amount as income or a receivable. The effective tax rate was 40.4%, versus 39.7%, with the increase attributed primarily to nonrecurring tax items.
Balance sheet, liquidity and cash flows
At March 31, 2013, cash and cash equivalents were $127.7 million; restricted cash and cash equivalents were $49.9 million. Short-term municipal investments were $23.8 million. Current assets were $228.0 million and current liabilities $157.7 million, implying working capital of approximately $70.3 million and a current ratio of about 1.45.
Notes payable totaled approximately $98.1 million, including $6.6 million current; capital lease obligations totaled $0.7 million. The company reported no borrowings on its $50 million revolving credit line. Total contractual obligations were $180.2 million, including notes payable, purchase obligations and operating leases. Management said cash from operations, cash balances and the revolver should fund operations, planned capital expenditures and working capital needs for at least 24 months.
Operating cash flow decreased to $31.7 million from $50.8 million, which management primarily attributed to timing of income tax and employee-related payments. Investing activities used $10.8 million, including $14.7 million of capital expenditures and $23.8 million of investment purchases, partly offset by $29.2 million in note proceeds. Financing activities provided $1.7 million: option proceeds and share-based tax benefits partly offset share repurchases and debt and lease principal payments. Cash increased $22.6 million during the quarter.
Changes, outlook and risks
- Reporting presentation: The company separately presented admissions advisory, advertising, and marketing and promotional costs in Q1 2013 and reclassified prior periods. The change did not affect total expenses or operating income.
- Tuition and enrollment outlook: Management stated its current intention was not to increase tuition for online, professional studies or traditional programs in academic year 2013–14. It anticipated increased competition could pressure new and continuing online enrollments. No specific financial guidance was provided.
- Seasonality: Lower traditional-campus attendance in summer typically weighs on Q2 and Q3 margins; management expects this effect may become more pronounced as ground enrollment grows.
- Regulatory exposure: An ongoing Department of Education Title IV program review includes findings involving enrollment counselor compensation, program eligibility and procedures for students with non-passing grades, as well as individual student errors. The company had reserved $3.45 million in 2012 for certain Pell grant returns identified in its file review. The department had not specified potential additional refunds or penalties; adverse findings could require returns, fines or other sanctions and could materially affect results, cash flows or reputation.
- Policy and funding risks: Sequestration took effect March 1, 2013. Pell grants were exempt for one year, while lower campus-based aid allocations were anticipated for 2013–14; federal loan fees were scheduled to rise for qualifying disbursements beginning July 1, 2013. Proposed legislation and Department of Education rulemaking could further change requirements for Title IV participation.
- Capital allocation and interest rates: The company repurchased 215,187 shares for $5.1 million during Q1. On April 25, 2013, the board authorized an additional $25 million of repurchases, bringing the program authorization to $75 million, and extended it through September 30, 2014. Variable-rate debt exposure is partly hedged by an interest-rate corridor and swap.
- Other matters: Ordinary-course litigation was disclosed; management said outcomes and potential losses generally could not be estimated with certainty and did not expect pending matters to have a material adverse effect. Non-income-tax reserves were approximately $0.7 million. The filing reported no material change to previously disclosed risk factors.
Key facts for investors to verify
- Whether enrollment growth and retention continue to support revenue growth, particularly amid increasing competition for online students.
- The final outcome, timing and possible financial impact of the Department of Education program review, including any additional Title IV returns, penalties or sanctions.
- Whether the $2.068 million escrow dispute over the note receivable is resolved and whether any further amount is recognized.
- Cash conversion in subsequent quarters and the extent to which operating cash flow reflects payment timing versus underlying trends.
- Capital spending, debt service and repurchases relative to liquidity, while accounting for restricted cash and seasonal operating patterns.
- Effects of student-aid funding changes, rulemaking and management’s stated tuition plans on enrollment, net revenue and margins.