Graham Holdings Company — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. Graham Holdings is a diversified company operating in education, television broadcasting, healthcare, manufacturing and other businesses.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $659.4 million | $582.7 million |
| Operating income | $44.2 million | $10.3 million |
| Operating margin | 6.7% | 1.8% |
| Net income attributable to Graham Holdings common stockholders | $42.9 million | $21.1 million |
| Diluted EPS | $7.78 | $3.75 |
| Cash provided by operating activities | $19.0 million | $91.9 million |
- Revenue rose 13%, driven mainly by television broadcasting and manufacturing. Operating income increased primarily on improved results in education, broadcasting and manufacturing.
- Broadcasting revenue grew 19% to $108.8 million, including $8.6 million of incremental Winter Olympics advertising and an $8.2 million increase in retransmission revenue. Segment operating income rose to $40.5 million from $26.5 million.
- Education revenue increased 1% to $375.5 million; operating income rose to $22.7 million from $9.4 million. Kaplan International revenue grew 12% (3% on a constant-currency basis), while higher education and test preparation revenue declined 10% and 8%, respectively.
- Other businesses revenue increased 69% to $137.5 million, largely reflecting the Hoover acquisition. Manufacturing revenue rose 90% and operating income increased to $8.6 million from $3.7 million. Healthcare revenue rose 2%, but operating results weakened amid integration costs.
- Operating cash flow fell to $19.0 million from $91.9 million, which management attributed to reduced customer receipts and increased vendor payments. Capital expenditures were $15.6 million on an accrual basis; cash purchases of property and equipment were $17.5 million.
- At March 31, cash and cash equivalents were $315.8 million, restricted cash was $12.4 million, and marketable securities and other investments totaled $491.4 million. Management reported total cash, restricted cash and investments of $819.6 million, versus $964.7 million at year-end.
- Total debt was $497.7 million, including $399.6 million of 7.25% unsecured notes due February 1, 2019, classified as current. Working capital was $368.9 million, down from $857.2 million at year-end, mainly because of that reclassification. The company has a $200 million revolving credit facility expiring in 2020.
- The company repurchased 131,580 Class B shares for approximately $79.0 million during the quarter. Net cash and restricted cash decreased $79.4 million to $328.2 million.
Material changes and unusual items
- Kaplan transferred Kaplan University’s institutional assets and operations to Purdue University Global on March 22, 2018, receiving nominal cash consideration. Kaplan will provide non-academic support services under a long-term agreement. The disposed business contributed $91.5 million of Q1 revenue and $0.2 million of operating income before the transaction, compared with $110.9 million and $4.0 million, respectively, in Q1 2017.
- The Purdue agreement prioritizes Purdue Global’s operating costs and, during its first five years, a $10 million annual priority payment. Kaplan advanced $20 million at closing for the priority payments relating to fiscal years 2019 and 2020. Kaplan’s potential service fees and efficiency payments depend on available revenue; contingent sale consideration was not recognized.
- Reported Q1 2018 results included a $4.3 million pre-tax gain on the Kaplan University transaction, $14.1 million of net losses on marketable equity securities, and $1.8 million of income tax benefits related to stock compensation. Other non-operating income also included gains on business sales and a cost-method investment. Q1 2017 included $5.9 million of stock-compensation tax benefits.
- The company adopted new revenue-recognition guidance using the modified retrospective method, increasing opening retained earnings by $7.4 million. Under the former policies, Q1 2018 revenue would have been $1.3 million lower and expenses $3.0 million higher.
- A new accounting standard moved fair-value changes on marketable equity securities into net income and transferred $194.9 million of previously accumulated, after-tax unrealized gains to retained earnings at adoption. The resulting Q1 securities loss is a notable source of earnings volatility.
- Q1 effective tax rate was 24.0%, versus 11.4% in 2017; the prior-year rate reflected a substantial stock-compensation tax benefit. The company’s Tax Act accounting remained provisional, and it had not decided whether to account for GILTI as deferred tax or periodic expense.
Outlook, risks and contingencies
- Management estimates 2018 capital expenditures of $110 million to $120 million, including a UK academic and student residential facility and television-station spectrum repacking; the FCC is expected to reimburse most repacking costs. Management believes available cash and internally generated funds will meet cash needs over the next 12 months and said it may refinance some or all of the 2019 notes.
- No specific earnings or revenue guidance was provided. Management cautioned that quarterly results may not indicate future results.
- Key risks include whether Kaplan can deliver Purdue Global support services efficiently and whether Purdue Global achieves anticipated enrollment and revenue. Kaplan may receive no reimbursement or fee unless contractual conditions are met, and may have to advance funds if Purdue Global cannot meet priority payments.
- Management said reasonably possible future legal losses beyond recorded amounts could reach approximately $30 million. A separate UK VAT dispute concerns a £12.0 million receivable; an adverse outcome would result in a pre-tax operating expense charge of that amount. The filing also describes open Department of Education program reviews, whose outcomes remain uncertain.
- Disclosure controls were deemed ineffective at March 31, 2018 because of a material weakness involving processing student financial-aid refunds. Remediation was underway, with completion anticipated during 2018; the weakness would not be considered remediated until controls operated effectively for a sufficient period.
- Moody’s and S&P ratings were Ba1 and BB+, respectively; Moody’s outlook was Negative. The company disclosed exposure to equity-price, interest-rate and foreign-exchange risks.
Most important facts for investors to verify
- Progress and economics of the Purdue Global services agreement, including enrollment, operating results, fee eligibility and any required advances.
- Availability and terms of refinancing for the $399.6 million notes due February 2019, and liquidity after share repurchases and the Purdue advance.
- Whether operating cash flow recovers, and whether planned capital spending remains within the $110 million to $120 million estimate.
- Underlying earnings trends separate from securities fair-value changes, transaction gains, pension income and discrete tax benefits.
- Resolution of the student-aid refund control weakness, regulatory reviews, legal contingencies and the UK VAT appeal.
- Final accounting effects of the Tax Act and the adoption of new accounting standards, including the expected balance-sheet impact of lease accounting.