Grand Canyon Education, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Results reflect GCE’s ownership and operation of Grand Canyon University (GCU) through June 30. On July 1, 2018, GCE completed a transaction that changed it from a university operator to a services provider. Amounts below are in millions except per-share data and enrollment.
Financial performance
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Net revenue | $236.8 | $218.3 | $512.5 | $466.5 |
| Operating income | $58.5 | $55.1 | $148.6 | $131.7 |
| Operating margin | 24.7% | 25.2% | 29.0% | 28.2% |
| Net income | $46.0 | $39.8 | $119.7 | $95.8 |
| Diluted EPS | $0.95 | $0.83 | $2.47 | $1.99 |
- Revenue rose 8.5% in Q2 and 9.9% in H1. Management attributed growth primarily to higher online and ground enrollment and, to a lesser extent, ancillary revenue, partly offset by increased scholarships.
- Enrollment at June 30 was 81,620, up 9.6% year over year: online enrollment rose 10.1% and ground enrollment 3.9%. Online students represented 92.3% of enrollment.
- H1 operating expenses increased 8.7% to $363.9 million, below revenue growth. Instructional costs were 41.6% of revenue versus 42.4% a year earlier; advertising was 10.4% versus 10.6%. Q2 operating margin narrowed to 24.7% from 25.2%, including higher advertising, admissions, and transaction-related professional costs.
- H1 effective tax rate was 20.6%, compared with 27.1%; Q2 was 23.3%, compared with 28.0%. Management cited the lower federal corporate tax rate under the Tax Cuts and Jobs Act and share-based compensation tax benefits. Those share-based benefits can make the tax provision volatile.
Cash flow, debt and liquidity
- H1 operating cash flow was $143.7 million, up from $133.7 million. Capital expenditures were $78.8 million, versus $50.5 million, principally for campus construction and technology. Investing cash outflow was $67.4 million; financing cash outflow was $14.7 million.
- At June 30, cash and cash equivalents were $221.6 million and investments were $76.5 million, or $298.2 million combined. The company reported $87.9 million of restricted cash transferred as part of the transaction and classified within assets held for sale.
- Notes payable totaled approximately $63.2 million, including $6.6 million current and $56.6 million long-term; the term loan was due December 2019. GCE reported no revolving-line borrowings at June 30. Its July 1 credit-agreement amendment added cash collateral pending Department of Education approval and collateral assignment of rights under transaction agreements.
- Management said available liquidity and expected operating cash flows should fund operations, planned capital spending and working capital for at least 24 months. GCE also had $96.2 million remaining under its share-repurchase authorization, which expires December 31, 2018.
Material change, outlook and risks
- July 1 transaction: GCE transferred GCU’s campus and related academic assets to New GCU, an independent nonprofit, for a $869.1 million senior secured note, subject to a post-closing price adjustment. The note bears 6% interest, is secured by New GCU assets, requires interest-only payments, and matures June 30, 2025, with principal and accrued unpaid interest due at maturity.
- Under a 15-year Master Services Agreement, GCE will provide technology, counseling, marketing, financial-aid processing and other support services for 60% of New GCU tuition and fee revenue. New GCU may terminate early after the later of seven years or full note repayment, subject to a termination fee. GCE expects to lend New GCU amounts for approved capital expenditures during the first three years; anticipated funding was $65 million for July–December 2018 and $100 million in 2019.
- GCE expected no book gain or loss on the transaction but anticipated approximately $23.7 million of Q3 2018 transaction-related expenses, including $17.4 million of share-based compensation and a $3.0 million asset impairment.
- The Department of Education’s review of the change in control was not complete at filing. Following closing, New GCU participated in Title IV programs provisionally on a month-to-month basis pending review and a new program participation agreement. The Department could impose conditions, restrictions or a letter-of-credit requirement, or deny recertification; adverse action could harm New GCU enrollment and GCE revenue.
- GCE’s post-transaction revenue depends entirely, for the foreseeable future, on its relationship with New GCU, its sole university client. Risks include service-provider execution, New GCU enrollment and payment performance, potential divergence of the parties’ interests, regulatory compliance and the legality or treatment of tuition-based bundled-service compensation. GCE also cited competition, seasonal enrollment patterns, technology and cybersecurity risks, and possible changes in education regulation.
- Management reported no material legal proceedings and said it believed the company was materially compliant with applicable regulations as of June 30. It did not provide quantitative operating guidance in the supplied filing text.
Important facts for investors to verify
- Progress and final outcome of the Department of Education’s review, including New GCU’s Title IV status and any imposed conditions.
- New GCU’s ability to make payments under the $869.1 million secured note and fund its planned capital expenditures, as well as the final purchase-price adjustment.
- GCE’s performance under the Master Services Agreement, its continued relationship with its sole client, and the resulting revenue and margin profile after the business transition.
- Recognition and timing of the anticipated Q3 transaction expenses, and post-transaction cash requirements, debt covenants and liquidity.