Graham Holdings Company — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Graham Holdings is a diversified education and media company, with additional healthcare, manufacturing, automotive, restaurant and other operations.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $738.8 million | $674.8 million | $2,168.6 million | $2,006.9 million |
| Operating income | $16.3 million | $60.7 million | $114.2 million | $170.6 million |
| Net income attributable to common stockholders | $43.1 million | $125.1 million | $182.0 million | $214.5 million |
| Diluted EPS | $8.05 | $23.28 | $33.96 | $39.54 |
Operating margin was approximately 2.2% for Q3 2019 versus 9.0% a year earlier, and approximately 5.3% for the first nine months versus 8.5%. Net income includes material investment gains, pension income and other non-operating items; reported earnings therefore do not solely reflect operating performance.
- Cash flow: Operating cash flow was $72.3 million for the first nine months, down from $191.9 million. The company cited working-capital changes and higher incentive compensation payments. Investing used $202.5 million; financing provided $25.6 million. Cash and restricted cash ended at $157.4 million.
- Liquidity and debt: Cash, marketable securities and other investments totaled $711.6 million at September 30, compared with borrowings of $502.2 million. Working capital was $545.3 million, down from $720.2 million at year-end. The $300 million revolving facility had $5 million drawn at quarter-end; that borrowing was repaid October 1. Management said liquidity should be sufficient for cash needs over the next 12 months.
- Balance sheet: Total assets were $5.49 billion and total liabilities $2.42 billion. Adoption of lease accounting in January added right-of-use assets and lease liabilities; reported lease liabilities were $541.0 million at September 30.
- Capital spending: Nine-month cash purchases of property and equipment were $75.7 million. Management estimated 2019 capital expenditures of $90–$100 million, including a UK education facility and FCC spectrum-repacking work, expected largely to be reimbursed.
Material changes and business drivers
- Revenue rose 9% in Q3 and 8% year to date, largely from the 2019 acquisitions of automotive dealerships and Clyde’s Restaurant Group. Healthcare and SocialCode also grew; declines in television broadcasting and manufacturing partly offset growth.
- Operating income fell substantially in both periods. For the first nine months, education, television, manufacturing, SocialCode and other businesses declined; healthcare improved.
- Education: Revenue was roughly flat in Q3 and down 1% year to date, while operating income fell to a $7.2 million Q3 loss from $22.3 million income, and declined 46% year to date. Kaplan International recorded the UK VAT provision and was also affected by weaker Singapore results. Higher education results reflected the Kaplan University transaction and uncertainty over service-fee collectability from Purdue Global. Test-preparation revenue and results weakened, particularly in retail comprehensive programs.
- Television: Q3 revenue declined 11% and operating income 34%, mainly because political advertising fell $19.9 million and network fees increased. Year-to-date revenue and operating income declined 4% and 15%, respectively; political-advertising and prior-year Olympics comparisons were partly offset by higher retransmission revenue.
- Manufacturing: Q3 revenue fell 11%, while operating income rose 33%; year-to-date revenue fell 8% and operating income fell 34%, with higher labor and operating costs at Hoover contributing to the decline.
- Healthcare: Revenue increased 15% in Q3 and 7% year to date. The segment moved from a prior-year impairment-related loss to operating income of $1.2 million in Q3 and $6.1 million year to date.
- Other items: Nine-month results included a $29.0 million gain on the sale of Gimlet Media and $49.3 million of net marketable-equity-security gains. Q3 included $17.4 million of such investment gains. These gains were lower than the $45.0 million recorded in Q3 2018, while the prior-year quarter also benefited from a $17.8 million deferred state tax benefit.
Outlook, risks and unusual items
- The company recorded a full provision against the £17.3 million UK Pathways VAT receivable after developments in its tax case. The filing gives differing dollar descriptions: approximately $20.4 million in the Q3 MD&A, about $21.0 million in the note, and $17.1 million for the nine-month period. The outcome is expected by the end of 2020; if Kaplan prevails, the provision may be reversed. Management estimated about $6 million of additional annual VAT expense for 2019 related to the matter.
- Kaplan Singapore’s workforce-qualification status was suspended for 12 months from July 2019, with course accreditation and funding terminated. The company said this would continue to adversely affect 2019 revenue and operating results.
- Kaplan had $72.3 million of accounts receivable from Purdue Global related to service reimbursements and a deferred service fee, plus a $20.0 million long-term receivable. Kaplan will assess service-fee collectability quarterly; Purdue Global’s marketing spend was affecting its cash generation and ability to pay the full fee.
- Management identified potential manufacturing goodwill impairment exposure: three reporting units had fair values less than 25% above carrying value in the 2018 test. Lower projected cash flows or growth, or higher discount rates, could trigger impairment.
- Management said existing and threatened legal, regulatory and other proceedings could produce future losses exceeding recorded amounts of approximately $15 million. Kaplan also remains exposed to certain leases guaranteed for the former KHE Campuses business; recovery from the counterparty was considered unlikely.
- The filing reported compliance with the company’s credit-facility financial covenants. The facility requires a maximum total net leverage ratio of 3.5-to-1 and minimum interest coverage of 3.5-to-1. The filing also cites market risks from equity prices, interest rates and foreign exchange.
Important facts for investors to verify
- Reconcile the filing’s different dollar descriptions and period presentation of the UK VAT provision, and monitor the expected case decision and potential further expense.
- Track Purdue Global receivable balances, service-fee recognition and collections under the TOSA.
- Assess whether the sharp operating-income and operating-cash-flow declines persist, separating recurring business results from investment gains, pension income and acquisition effects.
- Monitor political-advertising comparisons, manufacturing cost pressures, Kaplan Singapore impacts and the performance of recently acquired businesses.
- Review liquidity availability, including overseas cash restrictions, debt and lease obligations, covenant headroom, and progress against the $90–$100 million 2019 capital-expenditure estimate.