Grand Canyon Education, Inc. (LOPE) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Grand Canyon Education’s Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded. I’d now like to introduce your host for today's conference Mr. Brian Roberts, General Counsel. Sir, you may begin.

Thank you, operator. Good afternoon and thank you for joining us today on this conference call to discuss Grand Canyon’s 2015 third quarter results. Speaking on today’s call is our President and CEO, Brian Mueller; and our CFO, Dan Bachus. This call is scheduled to last one hour. During the Q&A period, we will try to answer all of your questions and we apologize in advance if there are questions that we are unable to address due to time constraints. We’d like to remind you that many of our comments today will contain forward-looking statements with respect to GCU’s future performance that involve risks and uncertainties. Various factors that could cause GCU’s actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in GCU’s SEC filings, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, our Quarterly Reports on Form 10-Q and our current reports on Form 8-K. We recommend all investors thoroughly review these reports before taking a financial position in GCU, and we do not undertake any obligation to update anyone with regard to forward-looking statements made during this conference call. And with that, I’ll turn the call over Brian.

Good afternoon and thank you for joining Grand Canyon University’s third quarter fiscal year 2015 conference call. In the third quarter of 2015 enrollments grew by 10.2%, and net revenues grew by 10.5%. New online enrollments grew in the mid single-digits, total new enrollments grew in the high single-digits, operating margins are at 25.3% for the quarter. The leadership team, the faculty and staff continue to work hard to produce these results and again I want to thank them for their efforts. This is our 20th consecutive quarter of leading consensus and recent expectations and I want to briefly review the differentiated strategies and I have led to the success and will guide us going forward. Most important is the commitment to building a high quality student body. Our traditional campus admissions requirement is the high school GPA of 3.0 and our institutional scholarship start at that level. Over 90% of our traditional students are on institutional aid. The scholarship program is weighted towards the highest GPA students and is helping produce an average income in GPA of approximately 3.5, almost 70% of the students are studying in a very rigorous science, technology, engineering, math, or business areas. We started to semester with about 15,500 students attending Phoenix campus. Our target next fall is 7200 new traditional student with the average incoming GPAs again being approximately 3.5. That with bring total enrollment and on campus to somewhere between 17,500 and 18,000. Our goal in four years just to have 25,000 students on the campus. Our online student body continues to grow from a quality perspective as well. 47.5% of our working adults are studying at the graduate level which is 230 basis points up from year ago. 67.7% of our students are studying in areas to produce the highest graduation rates. That is 170 basis point improvement from one-year ago. Our third quarter online student persistence rate was 91.9% which is up 40 basis points from the third quarter prior-year. We will continue to grow the online campus between 6% and 8% per year with high-quality students. Second the remain committed to a very traditional educational model. The average classifies on our Phoenix campus is 25 and online it is 13. In addition, we continue to increase the number of sessions taught by full-time faculty both on ground and online. On our ground campus or students have over 50% of classes taught by full-time faculty. Our goal is to grow that 65% in the next three years. The first six courses in every online bachelors program are now taught by full-time faculty. Third, we continue to invest in counseling services for students and continue to invest in technology attractive performance. President Obama has indicated as a significant efficiency that exist in higher education today is the lack of adequate counseling services provided for students. Every student at GCU is find a counselor before they begin your program. Our online students speak to their counselor a number of times before they start to program and continue to communicate with them as they move through their program discussing various topics including course schedule, academic performance, use of library and other academic support services, financial aid et cetera. On ground each student has one required appointment per semester, but the majority of our students meet multiple times with their counselor to discuss similar issues. Fourth clinical quality strategy is the commitment to building new academic programs that are relevant in today's economy and lead to good paying jobs. On our Phoenix campus we have rolled out 17 new programs in the last 12 months, but many of them being in the STEM categories. In order to accommodate these STEM programs we are building a second engineering building that will have a 170,000 square foot of new high-tech classrooms and laboratories. The building will be completed by August of next year. We will implement 20 new programs on ground in the next 12 months. We have rolled out 26 new programs online in the previous 12 months and we’ll roll out an additional 31 in the next 12 months. This critical strategy, quality strategy is the commitment to invest in educational infrastructure. In the last six years, we have invested hundreds of millions of dollars in classrooms, laboratories, residence halls, eating facilities, fitness and recreational areas and athletic facilities. We anticipate continuing to invest hundreds of millions of dollars in the next four years. This has become important to Arizona’s future, because the demand for highly skilled college graduates is increasing. We are proud of the fact that we have made these investments while freezing tuition for our traditional students for the eighth consecutive year. We continue to preserve a return to a not-for-profit status for the university. I think it’s important to note that when the university was on the verge of bankruptcy going to a for-profit status in order to get access to capital from the public markets was the best thing for our students. Faculty and staff and the community and is worked out well for investors. We now have an organization and economic model is sustainable for years into the future. We don't have a need for a secondary offering. We now believe it is in the best interest of our students, faculty and staff, the community and our investors that we pursue a not-for-profit model. I also think is important to note that all universities who look like us having a large and vibrant traditional campus as well as having online students, having not-for-profit status. It is also true that hundreds of not-for-profit universities are outsourcing services like residence halls, online delivery, food services et cetera to service companies, many of whom are for-profit and publicly traded. We believe that we have identified a potential structure that would accomplish this conversion and allow the university to operate in a manner that’s consistent with the hundreds of other public and private universities with which it competes. University as a strong financial position and a strong record of regulatory compliance, University has no problem with any of the current or proposed regulations placed on for-profit universities, under Department of Education, this includes the 90/10 Rule, the gainful employment rule and cohort default rate limits. With regards to the 90/10 Rule, we are at 76.5% and continue to decline and this is without any state subsidies. With regards to the loan defaults, our three year rate for the 2013 cohort will be under 10% when the maximum allowable rate is 40%. Because of our low tuition rate especially the actual tuition paid by students after scholarships. We do not anticipate any material issues with the gainful employment rule. However, given the university strong financial position and record of regulatory compliance, it is imperative to any conversion transaction not jeopardized. The university’s long-term viability and then all regulatory bodies that oversee the university provide a degree of comfort that any chosen structure will meet with their approval before moving forward. We have provided extensive information to the IRS and to the HLC. HLC will be performing a site visit in November as required by its change of control regulations. We will continue to work with these regulatory bodies on a structure of the transaction, which is currently a very fluid process. Please keep in mind that there's a great deal of work yet to be done and no assurance can be given at the transaction will be completed. I also want to emphasize it whether the transaction is completed or not, there will be no change in the university strategy. As we have previously disclosed the Board of Grand Canyon Education has established an independent committee to oversee this process and to ensure that this transaction would be in the best interest of our shareholders. We’ll provide updates if and when material developments occur, although it is likely that it will not be until early 2016. Net revenues were $193.4 million in the third quarter of 2015, an increase of $18.3 million or 10.5% from the $175.1 million in the prior year period. Operating margin for quarter three 2015 was 25.3%, compared to 26.3% for the same period in 2014. Excluding contributions made in lieu of state income taxes in 2015 and 2014, operating margin for Q3 2015 was 26.8% compared to 27.8% for the same period in 2014. It is important to note that tuition and housing has been frozen for eight years on our ground traditional campus, and there was no increase in tuition for the online campus in the past three years until the University made a slight increase starting in September 2015 for online tuition which averaged approximately 1% for online programs. Net income was $33.3 million for the third quarter of 2015, compared to $29 million in the prior year period. After-tax margin was 17.2%, compared to 16.6% for the same period in 2014. Instructional cost and services grew from $71.7 million in the third quarter of 2014 to $83.2 million in the third quarter of 2015, an increase of $11.5 million or 16%. This increase is primarily due to the increase in the number of faculty and staff to support the increasing number of students attending the university as well as increases in occupancy expenses and depreciation expense due to the additional ground campus buildings and higher instructional supplies, licensing cost, food cost and related expenses. As a percent of revenue, IC&S increased 2% to 43%. Admissions advisory and related expenses decreased 1.4% to 14.2%, primarily due to our ability to leverage our admissions advisory personnel across an increasing revenue base. Advertising expenses as a percent of net revenue increased to 60 basis points from 9.4% in Q3 2014 to 10% in Q3 2015. The slight increase is a result of continued focus on digital media and brand advertising in the Southwestern United States region. Marketing and promotional expenses as a percent of net revenue decreased 20 basis points from 1.1% in Q3 2014 to 0.9% in Q3 of 2015. With that I would like to turn it over to Dan Bachus, our CFO to give a little more color on our 2015 third quarter, talk about changes in the income statement, balance sheet and other items.

Thanks Brian. Revenue per student was up slightly year-over-year due to the 19.9% student growth in our ground traditional campus, although, we only generated a little over one month of revenue from the fall semester in the third quarter. When factoring in room boarding fees, the revenue per student is higher for these students than for our working adult students. Online revenue per student was down again this quarter due to the continued mix-shift to programs that earn less revenue per student per day. We believe this trend to slightly lower online revenue per student will continue. Scholarships as a percentage of that revenue increased from 15.7% in Q3 2014 to 16.3% in Q3 2015, due primarily to the growth in our ground traditional student enrollment between years. Online scholarships as a percentage of related revenue was up slightly year-over-year. Bad debt expense as a percentage of revenue decreased to 2.1% in Q3 2015, as compared to 2.2% in Q3 2014. This decrease is primarily a result of continued improvements in processes and the quality of our student body. Our effective tax rate for the third quarter of 2015 was 31.8%, as compared to 36.1% in the third quarter of 2014. Both quarters had favorable tax effect as a result of the $2.8 million of contributions made in those state income taxes. And the third quarter of 2015 additionally benefited from some favorable non-recurring items as compared to the prior year tax rate. We did not repurchase any shares of our common stock during the third quarter of 2015. Although, it is our intention to put a 10b5-1 plan in place this quarter. We have $25.9 million available under our share repurchase authorization. Turning to the balance sheet and cash flows, total cash unrestricted, restricted and short-term investments at September 30, 2015 was $226.9 million. Accounts receivable, net of the allowance for capital accounts is $9.5 million at September 30, 2015, which represents 4.6 days' sales outstanding, compared to $8.3 million or 4.6 days' sales outstanding at the end of the third quarter 2014. CapEx in the third quarter of 2015 was approximately $57.8 million or 29.9% of net revenue. This was consistent with our expectations. All of the major construction for the 2015, 2016 school years was completed on time and on budget. Construction will begin in the next 60 days and 170,000 square-foot engineering and technology building, three apartment style dorms and additional parking garage for the fall 2015, 2017 school year. We are currently estimate the 2016 CapEx will be a approximately 150 million. Last, I would like to provide some color on the guidance we have provided for the fourth quarter of 2015. We have reaffirmed our revenue operating margin and tax rate of 37.5% for the fourth quarter. We now anticipate that our weighted average shares outstanding will be 47.6 million shares. I will now turn the call over to the moderators, so we can answer questions.

Thank you. [Operator Instructions] And our first question comes from the line of Paul Ginocchio of Deutsche Bank. Your line is now open.

Thanks Brian you peek my interest with the commentary around you kind of identified structure and you are moving through early 2016. It’s too much to ask for some color and maybe is there – could you comment on any share price you think you could do the transaction. Thanks.

Yes, we really can’t comment on the structure at this point, we have a very important visit from HLC in two weeks and we will – we are working hard to get ready for that visit and we think that that’s going to go well. If that goes well that will set in motion some other things and we think we will know more early in 2016, but we don't want to comment any further publicly on that until we’ve got some good advice from HLC.

Maybe actually the other way – with all the public shareholders we bought out in any structure, is that always the case or is there some situation whether it would be publicly traded shares still out there?

Yes, the second is true. Market structure that we’re pursing would allow or people to be invested in existing pressure.

Great, thanks for that. Dan just on that slight decline in the online revenue per student. Can you just talk about what where the programs that you are seeing the mix shift towards. Thanks.

Yes, so we are seeing mix shift to a number of programs it just generate us in most cases more revenue over the lifetime of the program but slightly less revenue on a daily basis. So we are seeing that with some of our new counseling programs that have been rolled out over the last year or two those are mostly eight week, three credit programs versus a lot of our other programs that are eight week, four credit or even five week, three credit. We are seeing really good growth in masters and nursing which is slightly lower revenue per student per day program. I think that it's really the counseling programs and the masters and nursing that are driving that.

The mix shift is delivered on our part and when we are working hard to get more students involved in those programs because the retention and graduation rates are high and revenue over the lifetime of student is higher.

And one other and we’ve seen this for doctoral-to-doctoral although you know it has slightly higher tuition rates and a long program on a days revenue approach, it’s actually slightly below average and we’re obviously seeing significant growth in that program.

Great. And then if I can just follow-up on – it looks like you slightly tweaked down enrollment growth for the fourth quarter, is that correct and is that related to the slightly fewer nurses that we talked about last quarter or is it is something else? Thanks.

Yes, as we talked about last quarter, we thought that ground enrollment would be about 500 less than what we had projected and that’s with that slight tick down is because of that played out as we expected.

Thank you.

Thank you. And our next question comes from the line of Sarah Gubins with Bank of America. Your line is now open.

Hey, this is David Chu for Sarah. Correct me if I'm wrong but you guys revised the ground enrollment to 16,000 from 16,500 and it came in 15,500. Is that correct?

Yes, about 500 students where the students that we talked about in the last conference call, which is a shortfall on our ground traditional campus mainly nursing students. And then our cohort students on our campus that’s down a little bit, but a lot of those students have decided to go online. And so the total number is up and good in terms of working adult students, it’s just that there's a little bit of a shift away from those that are attending on campus versus those are attending online. So it didn't affect us from the standpoint of our overall enrollment or our revenue growth.

Again the reduction I want to make this point very clear, the reduction in the fourth quarter enrollment number was related to what we talked about last quarter is being a strong likelihood not this other thing the Brian just talked about that was just a shift between ground and online for some of our cohort students.

And so last quarter you guys mentioned that – you guys were making some changes to drive online start growth, just wanted to see how these efforts are been going?

They are going good. October is a good month from both the new enrollment standpoint online, and a total enrollment growth online. So we're off to a good start for the fourth quarter.

And can you just remind me like what are some of these initiatives in place?

We just moved some enrollment counselors around, we moved into more productive programs where we’re getting a higher level of interest. And there is we a little bit of a decline in the RN to BSN program and that’s now accelerating again. So that’s one of them.

Okay. And lastly just I know it might be a little bit early but just any initial thoughts on 2016 margin profile?

Yes, it is too early, we haven't done our budget Brian talked about trying to raise margins 50 basis points a year, operating margins 50 basis points a year that will be our goal but we have not started the budget process for next year, so once we do we’ll set a goal.

Okay, great. Thanks, guys.

Thank you. And our next question comes from the line of Jeff Silber with BMO Capital. Your line is now open.

Thank you, so much. A few weeks ago there were some press reports that the company had decided not open the campus in Mesa for next year. I was just wondering if you can comment about that.

Yes, that decision was made a while back and we were little bit surprised there [and resurfaced] which was fine and again it’s the same thing, we just the growth that we are having on our ground campus and keeping up with that growth is consuming and every dollar that we invest right now on this campus is going to return a lot more to investors than starting new at another location. So we’re not rolling out additional locations at some point in the future. But right now to invest dollars on this campus and grow it out to 25,000 will be the best return – the best what we did, knowledge is for students but it be the best return for investors.

And can you quantify how much was spent on that effort?

No, but it was not material, is minimal. Yes, we put a down payment in on some land, but that was it. And those costs were written-off back a year plus ago when that decision was made.

Okay, great. I just wanted to clarify that. Thank you so much.

Thank you. And our next question comes from the line of Jeff Mueller with Baird. Your line is now open.

Yes, thanks. Can you give the investors some sense of what the financial implications of the model you're exploring would be? Meaning, will the service [indiscernible] likely preserve or retain the vast majority of the company's current EBIT streams or if not is there a cash payment for monetization of real estate and it becomes a more capital efficient or CapEx like business or just anything that you can say to help investors understand the financial implications which you are currently exploring I guess not that where you can do it? Thank you.

Well, I think the goal would be to make sure that this is a deal that’s good for investors and so I think it'll be a combination of what you just talked about. I think there would be a return of capital to investors as part of any transaction and then there would be the ability to participate in the remaining entity on a go forward basis with the hope that ROIC on that business would be equal to if not greater than the ROIC as it currently stands.

Okay, that’s helpful. And then I just to circle back this and I know it’s too hard and make it perfectly clear, but yes it’s not perfectly clear yet for me so maybe I’m just slow today. On the Q4 enrollment guidance being reduced, if that’s a result of the 500 students that you talked about last quarter, why is that the Q4 guidance being reduced now if it's based upon something that was known as of the time of the last call?

We didn't know about the last call, we gave a good sense at the last call where we thought that we are going to end up from a ground enrollment standpoint. You're right, we could have and maybe should have brought down that enrollment number guidance for the fourth quarter at that time, but we didn't know exactly where the ground campus was going to end up and so we didn't and so we could take some criticism for not bringing down that enrollment guidance at that time, but that's where we are at.

What’s the total growth CapEx to build out the ground campus to get to the 25,000 student capacity and now that it looks like you're inflecting and start throwing off some good free cash flow almost a plan for the free cash flow in the mean time?

Well, I think the first question is hundreds of millions. We don't know exactly what that number is. It will continue to decline on a raw dollar basis and as a percentage of revenue basis as we go out, because the net increase in enrollment year-over-year won't be as high as it was this year or as high as that will be next year, in the future. So that’s first question and the second one will explore avenues for our free cash flow as we go.

Okay, thank you. End of Q&A

Well, I think we’ve reached the end of our third quarter conference call. We appreciate your time and interest in Grand Canyon Education. If you still have questions please contact either Dan Bachus or Bob Romantic. Thank you very much.