Grand Canyon Education, Inc. (LOPE) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the First Quarter 2018 Grand Canyon Education Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time [Operator Instructions]. And as a reminder, this conference call is being recorded. I would now like to turn 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 report on Form 10-Q and current report on Form 8-K. We undertake no obligation to provide updates with regard to forward-looking statements made during this call, and we recommend that all investors review these reports thoroughly before taking a financial position in Grand Canyon. And with that, I'll turn the call over to Brian.

Good afternoon. And thank you for joining Grand Canyon University’s first quarter 2018 conference call. In the first quarter of 2018, enrollments grew by 9.6% and revenues grew by 11.1%. New working adult students attending our online campus grew in the mid single digits year-over-year. Operating margins are at 32.7% for the quarter. I want to thank our faculty and staff for another great quarter. As you know, our long-term goals are to grow enrollments 7% to 8% on an annual basis. 6% to 7% will come from online enrollments and the rest from our ground campus. Revenues will grow 8% to 9% primarily as a result of continued retention increases, traditional campus enrollment becoming a higher percentage of the total and the growth of ancillary revenues through new businesses. The room and board payments of ground students, even though according to the college board they are 30% less than the average cost of room and public universities and 38% less than the average cost at private universities continue to drive up the annual revenue per student number. We began the 2017-18 academic year with approximately 19,000 students on our campus. Last Thursday and Saturday, we had eight graduation ceremonies and had nearly 60,000 people on campus for the three day period. 9,009 students graduated in the spring semester, and we estimate for 2018 calendar year approximately 21,500 students will graduate. This group will join our Alumni group, which is now over 141,000. Most of these graduates will contribute at increasing levels to the economy as they forward in their careers. It is also significant to note that we don't receive tax subsidies from the state are on track to pay nearly $100 million in total taxes for the year, and yet according to The Institute for College Access & Success. Our students graduate with less debt than the average public university students on less debt than the average private university student. The relatively low student debt amounts are due to three core strategies; one, our commitment to dual credit enrollment, which results in students transferring in college credits earned while they are in high school; two, students taking courses online in the summer; three, we haven't raised tuition on a traditional campus in 10 years, including our upcoming academic year. Three strategies have resulted in over 54% of our traditional students who graduate doing so in three years. In addition, these three factors combined with a growing reputation of our academic programs the new very modern campus, which was ranked 8th best campus in the country by niche.com, and the strong sense of community on campus makes GCU a very attractive proposition value preposition to families. Last year at this time, we had 26,438 applications for the fall semester on our traditional campus. This year we have 29,019, which is up 10%. We expect about 7,250 new students, which would bring the total students on campus to 20,500. The average incoming GPAs of the newly accepted students is about 3.5, 50% are studying in a natural sciences, engineering and technology. We expect that online campus to grow between 6% and 7% on an annual basis. 14% of our new online students in the past two years are enrolled in new programs rolled out in the last two years. Managing the quality of both student bodies has been a very important part of our strategy. I will talk in a minute about our not-for-profit strategy. Before I do, I want to make clear this strategy has nothing to do with current regulations imposed by the DOE and core profit institutions. Our 90/10 number is now down to 71.5%. None of our programs failed to gain good employment guidelines mainly because of our low tuition rates. Tuition on our traditional campus hasn't been raised in ten years, including the upcoming academic year. And we have generally not raised tuition for our working adult students. We anticipate the cohort default rate for the most recently completed cohort will be approximately 6.5%. On March 5, 2018, the HLC notified University that it’d approve the change of control application that it is filed in connection with the proposed transaction. The approval is subject to customer conditions, including as there’ll no material changes prior to the closing of the proposed transaction as presented in the application, and at new GCU post an HLC evaluation within six months following the closing. In addition on April 26, 2018, the Arizona State Board for private co-secondary education also approved the University's supplemental license application for a change of ownership and control effective upon the closing of the proposed transaction. University has also filed a pre-acquisition review application with the United States Department of Education, and is currently awaiting a response. University continues to review various regulatory issues that could impact the viability of the sale of the University's academic related assets; real estate and related intangibles to a newly formed as not for profit corporation, new GCU; as a means of enabling new GCU to conduct itself as a traditional not profit university; consistent with the University's history in a level playing field with other traditional universities with regards to tax status and among other things; the ability to accept philanthropic contributions, pursue research grant opportunities and participate in MCA governance. That review is not completed at this time. The University does not intend to execute any definitive agreements until issues have been evaluated and resolved in University's satisfaction. At this time, GCE and new GCU have entered into a non-binding letter of intent. University is continuing to prepare for the possibility of the transaction occurring, including allocating employees to new GCU, financial modeling and planning asset transfer processes. If the proposed transaction is ultimately consummated in various aspects the University's operations would change in important ways. These changes include, but are not limited to, the following; our academic and related operations in assets, as well as approximately 35% of our full-time employees and substantially all of our part-time employees and student workers, would transfer to new GCU. Following this transfer, it longer own and operate a regulated institution of higher education, but would instead provide a bundle of services in support of new GCUs operations. This is a very common practice in higher education today. New GCU would be a separate non-profit entity, under the control of an independent Board of Trustees and independent management. Accordingly, our relationship with new GCU, both pursuant to the shared services arrangement and operationally, would no longer be as owner and operator but as third party contract provider. While we believe this relationship would remain strong, new GCU's Board of Trustees and management would have fiduciary and other duties that would require us focus on the best interests of new GCU. Initially all of our revenue would be derived pursuant to the shared services arrangement with new GCU. Accordingly, new GCU's ability to continue to increase its enrollment and tuition and fee revenue, and our ability to continue to perform the services necessary to enable new GCU to do so, would be critical to the success of our service business. It’s anticipated that the consideration payable by new GCU for the acquired assets, which will be material, will be in the form of a long-term secured note. Our ability to realize the negotiated value of the acquired assets would be subject to new GCU's performance, and its ability to pay amounts due under the secured note as they come due. Now, turning to the results of operations. Net revenues were $275.7 million in the first quarter 2018, an increase of $27.5 million or 11.1% from $242 million in the prior year period. Operating margin for quarter one 2018 was 32.7% in the first quarter compared to 30.9% for the same period 2017. Net income was $73.7 million for the first quarter of 2018 compared to $55.9 million in the prior year period. After-tax margin was 26.7% compared to 22.5% for the same period in 2017. Instructional costs and services grew from $102.6 million in the first quarter of 2017 to $111 million in the first quarter of 2018, an increase of $8.4 million or 8.2%. This increase was primarily due to increases in faculty compensation, employee compensation and related expenses due to the increase in a number of staff and faculty to support the increasing number of students attending University, and increased benefit cost between years. In addition, we had an increase in dues, fee, subscriptions and other instructional supplies between years, primarily due to increased licensing fees related to educational resources, and the increased food costs associated with the higher number of residential students. And we continue to see an increase in occupancy costs including depreciation and amortization as a result of us placing into service additional buildings, especially laboratory intensive stem buildings, to support the growing number of ground for additional students. As a percent of revenue IC&S decreased 100 basis points to 40.3%, primarily due to our ability to leverage our instructional costs and services expenses across an increasing revenue base. Bad debt expensed a flat at 180 basis points year-over-year. Admissions advisory and related expenses as a percentage of revenue decreased to 30 basis points to 12.6% from 12.9%, primarily due to our ability to leverage our admissions advisory personnel across an increasing revenue base. Advertising expenses, as a percent of net revenue, decreased to 60 basis points from 9.9% in quarter one of 2017 to 9.3% quarter one of 2018. General and administrative expenses, as a percent of revenue, increased 10 basis points to 4.1% in quarter one of 2018 from 4% in quarter one 2017. This increase was primarily due to increases at legal and other professional costs incurred, primarily as a result of our consideration of a not-for-profit entity conversion. With that, I would like to turn over to Dan Bachus, our CFO, to give a little more color on our 2018 first quarter, talk about changes in the income statement, balance sheet and other items, as well as to provide updated guidance for 2018.

Thanks, Brian. Revenue slightly exceeded our expectations in the first quarter of 2018, primarily due to higher ancillary revenues. Revenue per student also increased between years due to a favorable shift and the timing of our residential campus start dates, as the spring 2018 semester started one day earlier in 2018 than in 2017. Online revenue per student was down slightly year-over-year due to a slight increase in the online scholarship percentage. Scholarships as a percentage of revenue for all students decreased from 18% in Q1 2017 to 17.9% in Q1 2018 due primarily to the decrease in ground scholarships as a percentage of revenue year-over-year, partially offset by the increase in online scholarships as a percentage of revenue. Bad debt expense as a percentage of revenue stayed flat year-over-year as Brain discussed at 1.8%. Our effective tax rate for the first quarter of 2018 was 18.8% compared to 26.5% in the first quarter of 2017. The lower effective tax rate year-over-year is a result of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017. The act reduces the corporate federal tax rate from a maximum of 35% to a flat 21% rate effective January 01, 2018. In addition, excess tax benefits of $5.3 million and $8.5 million from share-based compensation awards that vested or settled in the first quarter of 2008 and 2017 respectively was recognized. The 18.8% effective tax rate was lower than our estimated rate of 21.7% as the excess tax benefit amount in the first quarter was greater than we expected due to the higher stock price at the restricted stock vesting date, which occurs in that quarter each year. This lower rate contributed approximately $0.05 of the earnings beat this quarter. We purchased 5,379 shares of our common stock in the first quarter of 2018 at a cost of approximately $0.5 million. We had $97.2 million available under our share repurchase authorization as of March 31, 2018. Turning to the balance sheet and cash flows, total cash unrestricted and restricted and short-term investments at March 31, 2018, was $407.6 million. Cash receivable net of the allowance for doubtful accounts was $9.5 million at March 31, 2018, which represents 3.5 day sales outstanding compared to $8.4 million or 3.4 day sales outstanding at the end of the first quarter of 2017. CapEx in the first quarter of 2018, excluding our offsite development of $0.2 million, was approximately $35.2 million or 12.8% of net revenue. We elected not to renew our revolving line of credit of $150 million which expired on December 31, 2017, which resulted in lower quarterly interest expense in Q1 2018 as compared to prior year. Last, I would like to provide color on the updated guidance we have provided for the rest of 2018. We have raised full year 2018 revenue and earnings guidance due to the first quarter beat. We have reaffirmed enrollment revenue and earnings guidance for the rest of 2018. Our enrollment guidance continues to assume mid to single digit online new start growth. Our guidance assumes a slight increase in retention and an increase in graduates between years of approximately 13%. The significant retention gains 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 enrollment growth rate. We estimate our total ground enrollment, which is ground traditional and professional study students, to be 6, 000 in summer, 20,500 in the fall and 20,300 at year end. The summer and fall semester start one day earlier in 2018 and in 2017, pushing revenue from Q2 to Q1 from Q3 to Q2 and from Q4 to Q3. The 2018 Christmas break has the net impact of pushing two days of revenue from 2018 to 2019. We estimate the effects of these changes are $1 million of less revenue in Q2, $1.1 million of more revenue in Q3 and $1.6 million of less revenue in Q4. The net loss of revenue of $1.4 million for the year is related to the timing of the online Christmas breaks. We’ve increased our full year operating margin guidance, primarily due to the higher-than-expected first quarter margin. Although, some of the higher than forecasted margin in the first quarter was due to timing differences and when certain spend will occur, we have not adjusted the margins for future quarters as we continue to see leverage in other areas. We continue to believe that our effective tax rate, excluding contributions made in lieu of state income taxes, will be 24.4% in Q2, 24.6% in Q3 and 25.3% in Q4. The lower rate in Q1 is due to the majority of restricted stock vesting occurs in that quarter each year. As contribution in lieu of state income taxes is made in the third quarter of 2018, it will have the effect of increasing general and administrative expenses and decreasing income tax expense. Although, we might repurchase additional shares during 2018, these estimates do not assume repurchases. I will now turn the call over to the moderator so that we can answer questions.

Thank you [Operator Instructions]. Our first question comes from the line of Jeff Silber of BMO Capital Markets. Your line is open.

Just wanted a little bit of clarification on the potential transaction, and forgive me if you mentioned it and I missed this in your remarks. Was there an update in terms of timing when you expect the transaction to be completed?

No, it remains the same. The Department of Ed has told us they will have their review done sometime the month of May, and we anticipate closing by July 1st.

And what are the milestones that we need to follow to make sure that that happens by then?

Mainly the Department of Ed review been completed by the end of May.

Nothing else from a state perspective that needs to get done?

No, that was completed last week, so we’re in good shape there.

Just one more question about this, and I know the transaction is not done yet. But since it’s been in the papers and you’ve got a lot of publicity. I am just wondering have you been approached by any other schools to provide services to them like you will be doing the Grand Canyon campus?

We had a number of projects prior to making it official that we were reapplying, but not since then.

And then just turning to the core business, again the numbers continue to be very strong. How high can margins go? I know people ask this question virtually every quarter, but they just keep on going up. I mean is this -- what is the feeling on this business?

Let me -- I would just correct it. We have had two approach us since we started the reapplication process. We have had three numbers approaches. It's mainly what happens to our cost to acquire students, and that continues to drop. But as the brand grows with strength, that continues to drop. We're saying 20 to 30 basis points on an annual basis, it's all that we’re going to guarantee. But the efficiencies growth -- we're not going to be like -- bad debt at 1.8%, we are not going to get a whole lot more out of retention, because quarter-over-quarter we are already at 92%. But as the brand grows, we might get some out of sales and promotion, the cost to acquire students. And there is no question that the hybrid campus and the efficiencies of a low, of a higher -- of a greater student body leveraging common infrastructure, there was opportunity. But at this point, we’re not raising tuition on the ground campus, and very sell them at online campus. And so we’re being conservative, but it will probably go up 20 or 30 basis points.

Thank you. Our next question comes from the line of Peter Appert with Piper Jaffray. Your line is open.

Brain, I am wondering if it's possible to give us any -- or Dan, any preliminary thoughts on some more detail on the economics of the transaction. Or if not now when might you’d be prepared to share that with us?

I think we've shared everything that we know at this point. We've shared what we think the purchase price of the assets will be. I mean it's a range -- interest rate on the note, revenue split percentage, et cetera. The one piece obviously that has not been shared and it's because it hasn’t been finalized is the expense split. And thus, what the expenses on both sides will be. We continue to work through what individuals, what departments, what things will be at the University and what will be at the service company. The vast majority of that work is done and has been done for a long time, but there continues to be a refinement around that. So when will we be able to share that, I think probably in the next 60 days or so. But we continue to work through all those things.

And then Dan is your expectation at this point that the transaction will be basically EPS neutral on a near current basis?

I think as we said before, I think it will be slightly dilutive. But we are working hard to make that dilution as small as possible. So that's been our goal from day one with this transaction and we continue to refine things, as I said, to see how close to neutral we can make it.

And Dan, I think you said or maybe Brian, mid to high single digit online starts for the year. I think you’re at mid-single digit you said in the first quarter. So is the implication that you expect to see some -- if the implication would be, that you’d expect to some modest acceleration and start growth as the year goes on. And what’s driving that?

It’s going to depend on the quarter, number of starts in the quarter all those type of things. And so you’re going to have quarters we believe over the course of the year that are technically high single digits, and some that are technically mid-single digits. Although, we're talking about 1% or 2% difference between quarters. I think this quarter was technically mid single-digit but frankly, it was in line generally with our expectations. And so it’s more of a technical term than anything else. I think we believe that we’re generally -- there isn’t going to be a big difference quarter-to-quarter in what that number is.

And lastly, Brian anything new or any additional commentary on how you see the competitive dynamic in the market, both I’m wondering about in terms of just the competition for traditional online students and also the competition we hope the end markets. And how you deal with that?

The traditional student market is very -- definitely competitive. Our advantage is so significant that we just keep adjusting our strategies to attract higher and higher quality of students. And so we're not concerned about the traditional campus and reaching our goals on that side. In terms of non-traditional side of it, it is very, very competitive. The good thing is that most of the competition is coming in the form of universities doing partnerships, which means they charge substantially more tuition because they have display revenues. And so we've been able to stay out in front of this by one. We have a tremendous advantage in terms of our ability to roll out new programs if we’re not dealing with a service provider. And so we could be very nimble that way. And 14% of our new starts in the last two years have come from new programs that we’ve rolled out in the last two years. And so we have an advantage in that perspective. And then we also have an advantage from a pricing perspective. Our brand is growing but our price point doesn't reflect that, which gives us an advantage. And so even though it is competitive and getting more competitive, we’re confident about our ability to produce what our goals are.

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

Can you give us any sense of what the expected timeline would be to start signing additional online program management or school services or university partners post the transaction closing, assuming it closes as expected. As well as what would be the targeted, I guess cadence of signings. Is it two year or is it significantly higher than that?

We’re doing a lot of research right now. We’re doing a lot of work on that. But we want to figure out is what our role should be in that whole market. It’s going to be very different than most, because we have a customer already that has 90,000 students. And so the role that we play in the marketplace is going to reflect a positioning to take that into account. And so when the thing gets done, we’ll take three to six months and talk to people and figure out what our position should be. And then we’ll move into it on a gradual basis. But we have a tremendous advantage, because we've got a customer that’s got 90,000 students that’s producing 30% plus margins, which is going to put us in a lead role and they’re staying right away and allows us to be very selective in terms of who we bring on.

And then just maybe some additional detail on the increased online scholarship, it wasn’t clear if that was just mix or if that's discounting. What's driving that?

As you know, we don’t do a lot of scholarship for online, it's primarily -- we do the military discount as everyone does. We do some partnerships. And so I think it's really being driven by increased partnerships with hospitals, school districts and employers. So I think that's been a focus of our as it is for a lot of the universities. And I think we’ve been successful in that area. And the number of those partnership agreements continues to go up.

The cohort model is coming back, and so we've got people who are starting groups of students in the same hospital, same school district, the same business et cetera. I mean it's a little bit of discounting that goes into that.

And then you gave us some detail on GPA and programs of study. But any other color on the ground student fall applies just in terms of geographic location of the high school student or any other details on what the evolution of that applies looks like?

Well, the one thing that we were seeing for a number of years is that we were going to be primarily a southwest play, and that was true. It was moving in that direction, but it's reversed itself in the last 24 months. And we are starting to get a lot of interest from families and students that are in the mid-west, in the southeast, a little bit in the north east. But we’re just getting through the private school system that there is a private university that has a similar model that has very low tuition rates. And so you can buy lot of plane tickets to get your son and daughter into the sun for the difference in the tuition rates that they are typically expecting a private school to have. And so that trend is happening and we expect that to continue to happen. In fact, we like that, because when we get students on our campuses, parents or families are used to paying private school tuition. The two reasons of student drops out; one is the academic work is too hard, which our programs are very rigorous on our traditional campus. Students are in pre-med, they’re in engineering, nursing, during the rigorous academic programs; or two their families can't afford it financially. And so when you get students that are coming out of private schools where they’re used to paying even more tuition, you go to high school and they have to pick college, you take one of those things out of the equation. And so that's a positive thing for us. The more we get kids out of those schools across the country, the higher our graduation rates going to be.

Thank you. Our next question comes from the line of Alex Paris of Barrington Research. Your line is open.

This is Chris Howe sitting in for Alex Paris. I guess just as it relates to your advertising strategy, what were some of the successes that you saw in the quarter that might have led to the outperformance in your online enrollment long-term target?

We’ve got to share a lot about that, because we do think that is a strategic advantage, we’ve been doing this for 30 years and so we keep some of that internal. But I will say what I think most of you know, which as our brand strength grows and as we get more and more efficient using traditional advertising methodologies, which allow us to build the brand at the same time, we do less and less with the Internet lead providers. We created that space or were a big part of creating that space 20 years ago, but we wanted to be out of it as quickly as we can, because it's completely deteriorated in terms its efficiencies, because there are so many people getting into it. And it’s an expensive way to get into this business. You don't have to spend money on expensive campaigns. You can simply buy leads and try to get them into school. And it’s very negative from a brand building perspective, and it's very efficient as compared to where it used to be. So we continue to get out of that.

And then I just had a few more questions. One is just -- I don’t know if you highlighted it, but the retention rates that you continue to see for undergraduate students attending online. And then my last question, one of your peers reported that they would target the adult undergraduate market. So as it relates to the transaction and moving forward, is there a certain type of student that you would target per se?

We do have undergraduate working adult students or working adult student private complete their baccalaureate degrees. But we keep that number to a minimum, because graduation rate -- it’s just tough to get good graduation rates because life is very difficult. You’ve got a career, you’ve got family, other obligations and you’re trying to complete a degree that could take up to three years to do it. And so we limited for that purpose. As we look to get into the other market, we would first look at the graduate school market that would be our preferred thing. But we will look at the schools that have strong brands and specific marketplaces where there's not a cannibalization with our own programs and where we could support, either graduate growth for them or undergraduate growth. But it will be handled on a case-by-case basis, and it will be handled on a market by market basis, brand by brand basis, what can we price the product at, making sure that it doesn't cannibalize what we do. And we’re confident we can find universities in the right place where we can help them with if not been at all negative for us.

Okay, thank you for the color. And then…

Did we lose Chris? Well, with that, we’ve reached the end of our first 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.

Ladies and gentlemen, thank for your participation in today’s conference. This does conclude the program you may now disconnect. Everyone have a great day.