Grand Canyon Education, Inc. (LOPE) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Q2 2017 Grand Canyon Education, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question-and-answer sessions. And our instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Brian Roberts, General Counsel. Sir, you may begin.

Thank you. Speaking on today's call is our Chairman, President and CEO, Brian Mueller; and our CFO, Dan Bachus. Please note that many of our comments today will contain forward-looking statements that involve risks and uncertainties. Various factors could cause our actual results to be materially different from any future results expressed or implied by such statements. These factors are discussed in our SEC filings, including our annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. We undertake no obligation to provide updates with regard to the forward-looking statements made during this call and we recommend that all investors review these reports thoroughly before taking up financial position in Grand Canyon. And, with that, I will turn the call over to Brian.

Good afternoon, and thank you for joining Grand Canyon University's second quarter 2017 conference call. In the second quarter of 2017, enrollments grew by 10.5% and revenues grew by 14.1%. Excluding the impact of the shift of our residential traditional campus start days, revenue growth would have been 11.7%, which we will explain later. New working adult students attending our online campus grew in the high single digit year-over-year. Operating margins are at 25.2%. I want to thank our faculty and staff for another great quarter. Working adult students attending our online campus continue to grow at a rate that exceeds our goal of 6% to 7% annually. This has been true now for four consecutive quarters. First reason for this has been high-single-digit new enrollment growth. The continued growth of the University's brand, 76 new programs, certificates and emphasis areas rolled out in the last 24 months, and positive results from new branded advertising campaigns designed 15 months ago have all been contributing factors. Second, the retention rates of online students continue to go up. Graduate students have always had and continue to have high retention rates. These students represent over 50% of our online student volume. However, we are now seeing accelerated retention rates of undergraduate students attending online. About one year ago, we implemented a one-on-one tutoring service, utilizing our traditional campus students as tutors. The academic counseling the traditional students provide has positively impacted the non-traditional students as they return to an academic setting. As retention rates continue to climb, we are pleased to report that our estimated 3-year cohort default rate on student loans for the 2015 cohort is on track to decline to just over 6%. We are now just a few weeks from opening the fall semester of the 2017/2018 school year. We expect approximately 6,800 new students. Their average incoming GPAs will be 3.5; 41% will be from Arizona and 28% will be from California. Colorado, Washington and a number of states from the Midwest are also experiencing significant growth. That will bring our total enrollment on [indiscernible] over 19,000 students. Our Honors College will grow to 1,500 students with their average incoming GPAs being 4.1. Approximately 10,500 students will be living in campus residence halls which will be near capacity. Participation levels on campus will be at an all-time high. Music theater, dance, intermural sports, club sports, and clubs related to our nine colleges continue to grow every year. We will also hit a new high with the number of students participating in career-related internships. This will be our first year of eligibility for NCAA Division I tournament play and a number of our teams will compete for post-season spots. We expect our ground campus will continue to grow by about 2,000 students per year. For the 2018-2019 school year, we will add two new apartment-style residence halls, a major classroom facility, a club sports facility and a parking garage. Revenue continues to exceed our goal, because ground students, as a percent of the overall student body, continues to grow. Average revenue per student is higher on ground due to room and board payments. This is important because we intend to continue to meet or exceed our revenue goal without raising tuition for either ground or online students. Plans are in place to make an even larger impact on the community that we live in this school year. We will continue to focus on bringing new employment opportunities to the neighborhood, both on our campus and in the new small businesses we are building. We renewed our five-year agreement with the City of Phoenix Police by committing new resources to drive crime out of the area. Our goal is to raise $2.7 million to the state tax-credit program to continue our work with Habitat for Humanity. Our objective is to renovate 800 homes in a five-year time frame. We currently have 150 homes completed and housing values are up in our neighborhood 30%. When school begins in the fall, we will have 1,500 GCU students providing one-on-one tutoring and mentoring to 65 K-12 schools on the west side of Phoenix. The goal is to transform an intercity community and make it a middle class highly desirable place to live. Now, turning to the results of operations, net revenues were $218.3 million in the second quarter of 2017, an increase of $27 million or 14.1% from the $191.3 million in the prior year period. Operating margin for quarter two 2017 was 25.2% in the second quarter compared to 23.4% for the same period in 2016. Net income was $39.8 million for the second quarter of 2017 compared to $27.6 million in the prior year period. After tax margin was 18.3% compared to 14.4% for the same period in 2016. Instructional costs and services grew from $84.6 million in the second quarter of 2016 to $95 million in the second quarter of 2017, an increase of $10.4 million or 12.3%. 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. In addition, we continue to see an increase in occupancy costs including depreciation and amortization, and property taxes as a result of us placing into service additional buildings, especially laboratory-intensive STEM buildings to support the growing number of ground traditional students. As a percent of revenue, IC&S increased 70 basis points to 43.5%, primarily due to a decrease in employee compensation and related expenses, and other instructional costs and services as a percentage of revenue, partially offset by the increase in depreciation and occupancy expense. It's important to note that salaries at the university continued it to increase. The technology and automation has allowed revenue increases to outstrip employee costs. Admissions advisory and related expense, as a percentage of revenue decreased 90 basis points to 14.2% from 15.1%, primarily due to our ability to leverage our admissions advisory personnel across the increasing revenue base. Advertising expense as a percent of net revenue decreased 30 basis points from 11.6% in Q2 2016 to 11.3% into Q2 2017. With that, I'd like to turn over to Dan Bachus, our CFO to give a little more color on 2017 second quarter, talk about changes in the income statement, balance sheet and other items, as well as to provide updated 2017 guidance.

Thanks, Brian. Revenue exceeded our expectations in the second quarter of 2017 primarily due to higher online enrollments as a result of higher than expected new enrollments and better than expected retention. We also recognized higher than anticipated traditional campus summer school revenue and ancillary revenues. Revenue per student increased between years, primarily due to our residential and traditional student body growing faster than our working adult student body. When factoring in room, board and fees, the revenue per student is higher for residential students than our other students. In addition, we saw a favorable shift in the timing of our residential traditional campus star date, as a spring semester ended later in 2017 than in 2016 giving us six additional days of traditional campus revenue in 2017 compared to 2016. Online revenue per student was up slightly year-over-year, primary due to fewer students taking summer breaks compared to 2016. Scholarships as a percentage of revenue increased from 14.2% in Q2 2016 to 14.5% in Q2 2017 due primarily to a slight increase in online scholarships year-over-year. Bad debt expense as a percentage of revenue improved from 1.8% in Q2 2016 to 1.6% in Q2 2017. Our effective tax rate for the second quarter of 2017 was 28% as compared to 38.4% in the second quarter of 2016. The lower effective tax rate year-over-year is due to our adoption of the share-based compensation standard in the first quarter of 2017, which resulted in the recognition of excess tax benefits from share-based compensation awards that vested or settled in 2017 to be recorded in the consolidated income statement. Previously, they were recorded directly to equity. The inclusion of excess tax benefits and deficiencies as a component of our income tax expense will increase volatility within our provision for income taxes as the amount of excess tax benefits or deficiencies from share-based compensation awards are dependent on our stock price at the date restricted awards vest, our stock price on the date an option is exercised, and the quantity of options exercised. Our restricted stock vests in March each year so the favorable benefit will have the greatest impact in the first quarter each year. This quarter, we've recorded an excess tax benefit of approximately $5.3 million, which was approximately $1.6 million higher than we anticipated, resulting in $0.03 of the second quarter EPSB. We did not repurchase any shares of our common stock in the second quarter 2017. We have $99.2 million available under our share repurchase authorization as of June 30, 2017. Turning to the balance sheet and cash flows, total cash unrestricted and restricted and short-term investments at June 30, 2017 was $235.1 million. Accounts receivable net of allowance for doubtful accounts is $10.9 million at June 30, 2017, which represents 4.1 days sales outstanding compared to $9.1 million or 4.0 days sales outstanding at the end of the second quarter 2016. CapEx in the second quarter of 2017, excluding our offsite development of $1.5 million was approximately $28.8 million or 13.2% of net revenue. The campus projects for the 2017-2018 school year are on schedule and on budget. Total CapEx for the year is estimated to be between $80 million and $100 million, excluding the offsite development and additional land purchases that have been or might still be made adjacent to the campus. We continue to have $150 million available to borrow on our line. Last, I'd like to provide color on guidance we have provided for 2017. We've upped our ending enrollment and revenue guidance for the second half of 2017, due to us exceeding our online enrollment expectations in the first half of 2017. We have also upped our third quarter revenue guidance due to higher than expected traditional campus summer school enrollment, which is not reflected in the third quarter enrollment amount. Our enrollment guidance still assumes mid-single-digit new start growth in the third and fourth quarter of 2017. The anticipated deceleration of start growth is due to the higher than expected growth in new starts that occurred at the end of the second quarter of 2016, and continued into the second half of 2016. Our guidance still assumes a slight increase in retention and an increase in graduates between years of approximately 13% for the year. The significant retention gains, which we have seen in recent years and the continued shift to a higher percentage of graduate students continues to result in year-over-year increases in graduate that exceed our total enrolment growth rate. We continue to estimate our total ground enrollment, ground traditional and professional study students to be 19,000 in the fall, and 18,800 at year-end. Our revenue guidance continues to assume no tuition increase for our ground campus or our online campus. The margin for the third quarter has been raised 50 basis points, excluding the $2 million contribution in lieu of state income taxes made in July of 2017, which has the effect of lowering margins by 90 basis points in the third quarter. As you might recall, these statements have the effect of increase in general and administrative expenses in the third quarter of each year, and these payments reduce dollar for dollar, our state income taxes. Three quarters of the lower tax rate is reflected in the third quarter, as we true-up our annual effective tax, and the remaining is reflected in a lower tax rate in the fourth quarter. We have lowered the margin slightly in the fourth quarter as we plan to reinvest greater than originally planned. We continue to invest in new program development and various community projects. Our effective tax rate of 33.9% in Q3 and 37.4% in Q4 are best estimates at this time. The lower rate includes the effect of the contribution in lieu of state income taxes and taxes will be further impacted by fluctuations in our stock price and differences in the timing of estimated option exercise. Although, we might repurchase additional shares during 2017, these estimates do not assume repurchases. I will now turn the call over to the moderator so that we can answer questions.

Thank you, sir. [Operator Instructions] Our first question will come from the line of Peter Appert with Piper Jaffray. Please proceed.

Thank you. So the numbers continue to be impressive. Brian, can you give us some more color in terms of maybe programmatics areas, where you're seeing particular enrollment strength?

Yeah, we continue to invest in IT programs at the baccalaureate level especially. We continue to invest in programs that are in education areas like autism, which is a fast growing area and need in public school systems throughout the country. And we continue to invest in counseling programs, both at the undergraduate and graduate level. Addiction counseling and areas like that are fast growing occupation areas. And there's a lot of need for it in the country, so those programs are growing too.

So those three that you called out, IT, specialized education, counseling, those are incrementally the things that are driving the accelerated growth.

Yeah, and in there, there is a lot of offshoots in other programs. Data analytics is really a fast growing program that comes out of our business programs. Sports business is a growing at an accelerated rate, because of the Klanso [ph] school and that brand. And then, of course, on the ground, we've got to seven engineering programs that are growing, that will - in fact, we'll be entering the third year of our first - our students. And so, next year we'll have our first graduates in electrical, mechanical, biomedical engineering. And there are four others in addition to that. So the 97 - I'm sorry, 79 new programs really are pretty broad-based across all nine colleges. But if there is one area that's more focused than the other one is IT and technology.

Got it. And you called out the ground enrollments in terms of 41% Arizona, 28% California. Can you talk about how that's evolved over time?

Yeah, a number of years ago we were in the mid-50s in terms of Arizona and probably in the mid to high teens in California. And so as the base of students in Arizona has just got bigger, the percentage increase has gone down some. California just continues to be a huge area for us, as well as Colorado, Washington and Oregon. And then, as we said last time, there are states in the Midwest that are now really starting to grow. People have caught on to our low tuition rates. And so that word is spreading and so we continue to grow. We are growing in an accelerated rate in the Midwest.

Great. And then, you addressed this, I think, to some extent on the call. But just the sequential slower growth rate in online starts beyond the comp, is there anything you'd call out about that?

No, that's strictly a year ago, just a little bit under - or a little bit over a year ago at this time things just really started to pick up. Our brand is getting very strong in the Southwest. And the number of working adult students who want to attend online, and not just online but the number of working adult students who want to come to campus in the evening and be a part of all this, that really was one of the catalysts that got this thing started. And so, going into the third and fourth quarter, we're going to have - our enrollment growth is going to continue. It's just the comp is a little bit different.

Understood. And then, last thing for me. So, Dan, can you talk about any preliminary thoughts around CapEx spending at 2018?

Yeah, it's going to be higher than 2017. This year we built one dorm. We're going to build two dorms. We did not build a parking garage or a classroom building. We're going to do both of those. So we still feel very good about our $100 million dollar on average over the five-year period with 2017 being a little bit under that $100 million and 2018 will be a little bit above that. The only thing that would cause those numbers to change a little bit and we're seeing a little bit in 2017, is whether we're able to buy property adjacent to the campus. There is property available and we'll pay a reasonable amount for it, but we're not going to be held hostage for it. So if there is reasonable buys out there, we'll buy. If there isn't, we don't need to, and so we won.

Great. Thanks very much.

Yes, thank you.

Thank you. Our next question will come from the line of Jeff Meuler with Robert W. Baird. Please proceed.

Hey, guys, here Nick Nikitas on for Jeff. Dan, you mentioned the change in ground start dates year-over-year, but relative to the guidance you guys gave, was there any stable little variance, or was that already incorporated?

It was already incorporated in the guidance we gave. The higher revenue than our guidance was really driven by the things I talked about on the call, the higher online enrollments over the entire quarter. And then it's higher summer school enrollment that don't - that aren't necessarily reflected in the enrollment numbers we give, because by the time the end of the third quarter happens, we have our fall enrollment number in there. So we are generating more revenue than we expected on the ground campus this summer, and much more revenue than we expected from our online campus.

Okay. Perfect. Just want to make sure on that. And then Brian, I apologize if I missed this. But I think you said online enrollment was trending above the - the starts are trending above the long-term range. Did you guys give a specific number for the starts?

We just said high-single-digits?

High-single, okay.

Yes, so our goal is about 6%, and then with our ground enrollments, we're trying to get 8%. So high-single-digits in online enrollment accelerates the growth.

Okay. And just on the regulatory front, I think year-round Pell Grants were recently reinstated and there's been some talk of it expanding the G.I. Bill. Do either of those have potential to be needle movers or incremental over the back half of this year or into 2018? Or are they pretty small for you guys?

Pretty small. The year-round Pell Grants may impact students willingness to stay in school through the summer. And so that's - and that's something we encourage students to do, because there are so many part time jobs here on campus, and if they stay here and work, and they pick up additional 12 credit hours, many of you can graduate in three years, which is huge for them and their families. And then expanded in G.I. Bill, I don't think that's going to have a huge impact. So no, I wouldn't say those are going to be catalyst that will cause anything unusual to happen.

Okay. And then just last one for me. The online persistent rates, as we continue to improve despite being at a really high-level and I think this is the first quarter where you start to talk about the undergrad improvements from some of the academic initiatives you put in place. Just what kind of runway or how early [any in so] [ph] that kind of opportunity and room for growth or continued improvement there?

The improvement really is with the working adult students, the 32 to 34 year old students who are coming back to school as an adult, attending our online campus and continuing in their careers and raising their families. That's always been the toughest student, just because life gets in the way, it's hard. But what we've done is we've provided them a lot of academic help in their first three classes, which has made the transition a lot more comfortable for them, they've gained confidence. I'd say we're about a year into this where we started to see the improvement. And how far that can go, we'll see. We're not baking anything into our budget at this time, but it's encouraging to see that group of people be even more successful.

Yes, thanks for taking my questions, and congrats on the continued strong results.

Thank you, Nick.

Thank you. Our next question will come from the line of Jeff Silber with BMO Capital Markets. Please proceed.

Thanks so much. I always get a lot of questions about the competitive environment and obviously, you folks compete both on at the campus level in the Southwest, and then more nationally online. Are you seeing new competitors or are you seeing existing competitors doing anything different than what we've seen over the past few quarters?

No, I don't think so. The most interesting phase - it's a very competitive environment, there's no question about that. I think the way we've differentiated ourselves. Obviously, it's the brand of Grand Canyon University in the ground campus that's attractive to people. But more important than that, it's the thing I keep emphasizing, which is you're not going to be successful in this if you're not really watching where the economy is going and making sure that you're building programs to meet specific needs that people have in specific career areas. And so, that's been as much of our success as anything. The interesting thing from our standpoint is people are watching the whole thing. It's going on with Purdue and Kaplan. And they're very interested in us being a service provider. And so, there are a lot of people looking into this. But when they - and lot of people are doing it, because a lot of people who - when they start to understand the significant investment that has to be made in order to do this right and to do it in a high quality way, they start to think about other ways to make it happen. And so we get a lot of interest from that standpoint. But, no, we have seen people doing a lot of different things. We just - it's competitive. And we're doing everything we can to stay out in front of it.

Brian, you actually started answering my second question before I asked it. In terms of providing those services to some of the other colleges across the country, what would it entail, what kind of infrastructure would your company have to build? Would there have to be any type of regulatory permission given? Any color you can provide would be great.

Yeah, I mean, we've had some pretty high profile interest - high profile institutions expressing interest. Who knows what's going to happen. I don't know what's going to happen with the Purdue/Kaplan thing, we're just watching it. And so, we'll see where that goes. We have an interest in doing it possibly, because we wouldn't have to add a lot of infrastructure. We've put hundreds of millions of dollars into building out this infrastructure and both from a learning standpoint, from a curriculum standpoint, instruction, the ability to assess learning, but then also all the front end - all the back-end stuff, admissions processing and the transcript evaluation and the financial aid advising and all of that, it's all automated. And so we wouldn't have to add very much in terms of technology infrastructure and we wouldn't even have to add that much in terms of personnel in order to do this on a limited basis. And I think it would be a service that would especially allow certain private universities to stay in business and prosper. And so it would be an interesting thing for us to do. We feel like we're equipped and could do it well without investing a lot. But we'll just see. We'll see how the next six months goes. We're just watching it carefully.

Okay. Great. And then just one question for, Dan. You mentioned that the change in the timing of the semester. Anything else we need to be aware of going forward over the next few quarters, when we're comparing on a year-over-year basis?

Yeah, there is a little bit of a difference between - in the fall semester. It's about a one-day difference. One day of additional revenue in the third quarter and one less day in the fourth quarter, but that - I think the number is about $1 million. I gave our estimate to that at the original guidance call. You can go back and look at that, so there is a little bit of impact between the third and fourth, in comparison to the prior year. But it's much smaller than what we saw between the first and the second this year.

Okay, and thanks so much.

Thanks, Jeff. We've now reached the end of our second quarter conference call. We appreciate your time and interest in Grand Canyon Education. If you still have questions, please contact either myself, Dan Bachus or Bob Romantic. Thank you very much.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody, have a wonderful day.