Graham Holdings Company — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods. Graham Holdings is a diversified education and media company, with Kaplan, cable, television broadcasting and other businesses. The results exclude businesses reported as discontinued operations, including WPLG and the China schools sold by Kaplan.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $898.9 million | $856.1 million | $2,609.8 million | $2,540.7 million |
| Operating income | $81.3 million | $78.9 million | $261.7 million | $221.7 million |
| Income from continuing operations attributable to common stockholders | $83.3 million | $54.1 million | $588.6 million | $121.9 million |
| Net income attributable to common stockholders | $76.4 million | $30.1 million | $958.6 million | $79.5 million |
| Diluted EPS, continuing operations | $14.32 | $7.28 | $85.24 | $16.41 |
| Diluted net EPS | $13.12 | $4.05 | $138.79 | $10.70 |
| Cash from operating activities | Not separately reported by quarter | $336.9 million | $347.6 million |
Revenue rose 5% in Q3 and 3% year to date. Operating income increased 3% in Q3 and 18% for the first nine months. The nine-month earnings comparison is heavily affected by gains on asset sales and exchanges; reported net income is not a straightforward indicator of recurring performance. Q3 operating margin was approximately 9.0%, versus 9.2% a year earlier; nine-month operating margin was approximately 10.0%, versus 8.7%.
Q3 revenue was essentially flat in Education, down 3% in Cable, up 19% in Television Broadcasting and up in Other Businesses, partly reflecting acquisitions. For nine months, Education revenue was nearly flat; Cable declined 1%; Television Broadcasting increased 17%; and Other Businesses increased, primarily due to acquired businesses.
Financial position and liquidity
- At September 30, 2014, cash and cash equivalents were $441.8 million; total debt was $448.8 million, including $398.2 million of 7.25% unsecured notes due February 2019 and $43.7 million of Australian-dollar revolving borrowing classified as current.
- Cash, restricted cash and investments in marketable securities and other investments totaled $687.2 million, down from $1,175.8 million at year-end 2013. Working capital was $249.6 million, versus $768.3 million.
- Nine-month capital expenditures were $162.4 million. Management estimated full-year 2014 capital expenditures of $235–$260 million and said it expected sufficient liquidity for 2014, primarily from cash and internally generated funds.
- Moody’s downgraded the company’s long-term rating to Baa3 and short-term rating to Prime-3 in June 2014, with a stable outlook. S&P ratings were BBB long-term and A-2 short-term.
Material changes and unusual items
- June Berkshire transaction: Berkshire Hathaway exchanged 1,620,190 Graham Class B shares for a subsidiary that included WPLG, Berkshire shares held by Graham and $327.7 million in cash. Graham recorded a $266.7 million gain on the Berkshire shares in continuing operations and a $375.0 million gain on WPLG in discontinued operations. The transaction reduced diluted share counts and boosted per-share results.
- Other gains: Nine-month continuing results included a $127.7 million gain on the headquarters sale, a $75.2 million gain on wireless spectrum licenses, and a $90.9 million gain related to Classified Ventures’ sale of apartments.com. In October, after quarter-end, Graham sold its Classified Ventures interest for net proceeds of $408.5 million and expected to record an approximately $393 million pre-tax gain in Q4.
- Q3 items: Continuing results included the $75.2 million spectrum gain, $10.6 million of unrealized foreign-currency losses, and $13.6 million of education restructuring and corporate early-retirement-related charges. The filing reports Q3 discontinued-operations losses of $7.0 million.
- Nine-month operating cash flow was $336.9 million, compared with $347.6 million in 2013. Cash declined by $126.5 million during the period, reflecting investing and financing activity, including share repurchases and dividends.
Outlook, management commentary and risks
- Education: Kaplan Higher Education revenue and operating income declined, reflecting weaker demand, lower average tuition and campus closures. New student enrollments fell 11% in Q3; total students were down 5% year over year. Kaplan continued restructuring and planned additional campus closures and workforce reductions, with possible further restructuring costs in 2014 and 2015.
- Regulation: New Department of Education rules published October 30, 2014, effective July 2015, include program debt-to-earnings tests and other requirements. Graham said the effects were uncertain and could require limiting or eliminating programs, with potentially material adverse effects on Kaplan revenue, operating income, cash flow and valuation. Management estimated continuing KHE campuses would be 90/10 compliant in 2014, but gave no guarantee for future compliance. Two ED program reviews remained open.
- Legal matter: In October 2014, Massachusetts’ Attorney General sent Kaplan a notice of intention to sue concerning two campuses closed in 2013. The company said it could not predict the outcome.
- Operating trends: Cable emphasized higher-margin broadband and business services while reducing focus on video, amid customer declines and rising programming costs. Television results benefited from political advertising, Olympics-related advertising and retransmission revenue; these factors may not recur at the same level.
- The filing provides no specific earnings or revenue guidance. Management stated it expected adequate liquidity to meet 2014 cash needs and estimated 2014 capital expenditures of $235–$260 million.
Important facts for investors to verify
- Separate recurring operating performance from the Berkshire, headquarters, spectrum and other asset-sale gains, and assess the impact of share repurchases on EPS.
- Track Kaplan enrollment, revenue and margins, campus closures, restructuring costs, 90/10 compliance and the effects of the new federal rules.
- Confirm the reported October Classified Ventures sale proceeds and gain in the subsequent filing, including the $16.5 million escrow.
- Monitor liquidity and working capital, debt maturities and ratings, and actual capital expenditures against management’s estimate.
- Follow the Massachusetts inquiry and open Department of Education reviews; the filing does not establish their eventual outcomes.