Grand Canyon Education, Inc. (LOPE) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2019 Grand Canyon Education Earnings Conference Call. At this time, all participants are in a listen-only mode. And later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the call over to Mr. Dan Bachus, CFO. You may begin.

Thank you. Joining me on today's call is our Chairman and CEO, Brian Mueller. 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 a financial position in GCE. And with that, I will turn the call over to Brian.

Good afternoon. And welcome to Grand Canyon Education's first quarter fiscal year 2019 conference call. During the first quarter of 2019 enrollment in the programs at our university partner universities for which we provide services increased 11.3% to 101,679. This increase includes 3,384 enrollments in programs serviced by Orbis Education as of March 31, 2019. New working adult students attending at our partner institutions grew in the low-teens year-over-year. On a comparable basis, total enrollment grew 8.5% and new enrollments grew in the high-single-digits. I want to begin by reviewing the full scope of services offered by Grand Canyon Education to Grand Canyon University during the first quarter and eventually to additional partner institutions. It is the breadth of services that to be one of defining characteristics of Grand Canyon Education in the OPM marketplace. First in the curriculum development area four new programs were released in the university. These programs were Master of Social Work, Master of Arts in Higher Education and Student Affairs, Bachelor of Science and Public Health, and Education Specialist Teaching and Learning. There were three emphasis areas released in the quarter those were Master of Public Administration with an emphasis of non-profit management, Master of Science and Mathematics with an emphasis in education, Master of Science in Mental Health and Wellness with an emphasis in integrated health. There were also eight new graduate certificates of completion in areas of Communications, English, History, Mathematics, Sociology, Mental Health and Wellness with an emphasis in Christian Ministry, Mental Health and Wellness with an emphasis in Grief and Bereavement and Healthcare Quality and Patient Safety. Second in the faculty services area, there were 238 full-time and adjunct faculty recruited and trained. There were 202 sessions of faculty training in professional development offered. Third, in the admissions area, a total of 23,009 transcripts were evaluated, which provides prospective students the information they need in order to make a decision to start a program. Fourth, in financial laid, 157,334 files were touched. Fifth, in a scheduling area, 20,128 classes were scheduled with an average class size of 14.3. Sixth, our academic counselors performed 525,548 activities on behalf of students in the quarter, including activities such as welcome calls to new students, course reminder calls, GPA concerns, attendance, finance charges, missing documents, practicum or license for follow-up and schedules built or changed. Seventh, in technical support area, 52.64% of the calls were answered with no hold time, and if placed on hold, the average was one minute and 34 seconds. Eighth, our advertising work was very efficient and provided the necessary coverage to exceed our partners’ enrollment goals. Ninth, we continued to enhance our technology platform during the first quarter. We are currently working on over 50 software projects. We continue to increase the use of our cloud computing platforms for GCUs cyber security, IT and engineering programs. We are completing an upgrade of our learning management platform supporting all additional – all traditional and online GCU students. As of today, over 95% of all students are using the updated platform. We continue to use our deep analytics platform to improve student support. One of the areas we use this information is, in automating the request for and collection of the various documents and other agreements related to different program requirements. GCE has invested over $200 million in advanced technologies resulting in automated services and artificial intelligence to support students, faculty and counselors over the last 10 years. I have just reviewed some of those. The objective going forward is to implement those capabilities over six core growth strategies. The goal is to work with partners to provide high quality academic services that will produce quality outcome metrics for the university and career opportunities for students. The metrics include but are not limited to high graduation rates, high pass rates on – program tests where appropriate, low debt amounts and low default rates on student loans. First, GCU provides the marketing, recruiting and counseling purposes for GCU’s traditional campus. I indicated in the fourth quarter call, university expected about 8,000 new students this fall. However, it looks like that number will be closer to 7,700. The 300 fewer new students are the result of not having enough beds to accommodate the demand. GCU built three new residence halls for the upcoming year bring the total number of residence halls on campus to 23. And every bed on its campus will be filled in the fall. There are actually two positive developments here. One, the number of returning students to campus is estimated to be up 300 over what we predicted and returning students were given priority over new students in reserving a bed. Two, the revenues on GCU’s ground campus is still anticipated to be what we initially predicted even with the 300 fewer new students. The room and board revenue will be up because as a percent of all students living on GCU’s campus will go from 59% to 63% and an increase of 7% in the student body. The additional deposit uses at GCU starting in 2020 will have the cash to continue to invest in the building part of its campus to over 30,000 students. Second GCU’s online campus grew at a high-single-digits in the first quarter. GCE provided the marketing recruitment and callcenter services for this effort and as we have said for a number of years, we expect the growth level to eventually be between 6% and 7%. GCU continues to rollout new programs to support this effort and has plans to rollout 18 new programs, emphasis areas and certificates during the remainder of this calendar year. Third, GCE is in a strong position to support the rapid expansion of ORBIS. ORBIS currently has 17 under contract. 11 of those partners are currently enrolling students with three more set to enroll students in 2019 and the other three in 2020. ORBIS expects to sign between three and five additional partners by the end of 2019 bringing its total to between 20 and 22. We expect to open five to seven new sites during the rest of 2019 bringing the total sites to between 23 and 25. This represents more than the necessary amount of activity to achieve a greater than 35% enrollment growth rate in programs serviced by ORBIS Education in 2020. Fourth, ORBIS will partner with GCU and its pre pre-licensure program to add locations in the western region of the United States. GCU's pre-licensure program produced 91.5% first-time pass rates on NCLEX exam in 2018 and a 98.2% pass rate in the quarter just completed. This was accomplished while having - also having the largest program in the state, which is important given the nursing shortage predicted over the next five years. Fifth, we will continue to work with Orbis to expand additional healthcare programs to its partner. Eventually, programs such as the nurse practitioner program, occupational therapy and physical therapy will be added. Sixth, GCU will continue to work to gain additional university partners. We are currently working with four universities in the Midwest and Northeast and believe we will have something to announce before the end of the calendar year. We continue to focus on universities through geographic and programmatic differentiations. It continues to look like our expanded group of services will provide and point of differentiation in marketplace OPMs. Now turning to the results of operations. As a reminder, beginning July 1, 2018, results of our operations do not include the university operations of GCU, but rather reflect the operations of GCE as a service technology provider. Therefore for comparability purposes, we will discuss amounts on an adjusted basis as is discussed in a minute. Additionally, on January 22, 2019, GCE completed the acquisition of ORBIS. Therefore, the results for the first quarter of 2019 includes ORBIS financial results from January 22, 2019 through March 31, 2019. Service revenues were $197.3 million in the first quarter of 2019, compared to $275.7 million of university-related revenue in the prior year. Had GCE, GCU transaction occurred on January 1, 2018 comparable service fee revenue would have been $165.4 million in the first quarter of 2018. This represents an increase of 19.3% between first quarter of 2018 and first quarter of 2019 on a comparable basis. The increase year-over-year is comparable as adjusted revenue was primarily due to our ORBIS acquisition on January 22, 2019 and the increase in GCU enrollments between years. The partnership agreements that were acquired as part of the ORBIS acquisition generally generates a higher revenue per student in our partnership with GCU, as these agreements generally have higher revenue. The ORBIS partners have higher tuition rates than GCU and the majority of these students are studying in the accelerate bachelor of science and nursing programs. So these students take on average more credit per semester. End of period enrollments increased 11.3% quarter-over-quarter to 101,679 from 91,378. As adjusted operating income and as adjusted operating margins for the three months ended March 31, 2019 were $78.2 million and 39.6% respectively. As adjusted operating income and as adjusted operating margin for the three months ended March 31 2018 were $68 million and 41.1% respectively. GCE will continue to reinvest profits to create additional educational infrastructure for our partner institutions that will create more opportunity for students and families. Technology and academic services grew from $10.7 million in the first quarter of 2018, to $19 million in the first quarter of 2019, an increase of $8.3 million or 78%. This increase was primarily attributable to the partner agreements acquired in the Orbis acquisition, which requires certain technology and academic services including, headcount, classroom facilities and equipment to be provided to each university partner. These costs, along with increased cost to service our existing client GCU’s increased enrollment results in the increase. As a percent of comparable revenue, these costs increased 320 basis points to 9.7% from 6.5% primarily due to the partner agreements acquired, requiring a higher level of technology and academic services than our partner agreement with GCU. Counseling services and support expenses grew from $50.7 million in the first quarter of 2018 to $53.1 million in the first quarter of 2019 an increase of $2.3 million or 4.6%. This increase was primarily attributable to the partner agreements acquired in the acquisition, which requires certain counseling services that support principally headcount to be provided to each university partner. These costs, along with the increased cost to service our primary university partner, GCU’s increased enrollment resulted in the increase. As a percentage of comparable revenue, these costs decreased 380 basis points compared to 26.9% from the 3.7% primarily due to the counseling services and support cost to service the acquired partner agreements being less as a percent of revenues and the cost to service GCU and due to our ability to leverage our counseling services and support expenses across an increasing revenue base. Marketing and communication expenses as a percent of comparable revenue increased 80 basis points from the quarter one 2018 to quarter one 2019. This increase is primarily due to the advertising cost associated with marketing on the University partners programs. General and administrative expenses increased $4.1 million between years, and as a percentage of comparable revenue, increased 130 basis points to 5.8% in Q1 2019 from 4.5% in Q1 2018. This increase was primarily due to increases in professional fees, increases in employee compensation and benefit cost between years, and increases in occupancy and depreciation. Our increase in professional fees is primarily related to a payment made to an outside provider that assisted us in obtaining these state tax refund with a favorable tax impact of $5.9 million in the first quarter of 2019. Our increases in employee compensation and occupancy and depreciation are primarily related to the acquisition including additional headcount and office space in Indiana. With that I would like to turn it over to Dan Bachus our CFO to give a little more color on our 2019 first quarter and talk about changes in the income statement, balance sheet and other items as well as to provide guidance – 2019 guidance.

Thanks, Brian. Including our Form 8-K filed with the SEC, we have included non-GAAP net income and non-GAAP diluted income per share for the three months ended March 31, 2019. The non-GAAP amount excludes the tax effected amount of the amortization of intangible assets, and a loss on transaction amounts included in our consolidated income statement. The amortizable intangible assets acquired in the ORBIS acquisition totaled $210.3 million and amortization expense in the first quarter of 2019 was $1.7 million, the loss on transaction of $4.1 million primarily represents advisory and legal fees associated with the ORBIS acquisition. We believe the non-GAAP financial information allows investors to develop a more meaningful understanding of the company’s performance over time. As adjusted non-GAAP diluted income per share for the three months ended March 31, 2019 is $1.62. Service revenue exceeded our expectations in the first quarter of 2019 due to three factors. First, revenues generated through our partnership with GCU was higher than expected, primarily due to higher ancillary revenues during the period. GCU enrollments were generally in line with our expectation. Second enrollments and programs serviced by Orbis were slightly higher than our expectations which resulted in higher revenues for the quarter. Last, as we finalize the accounting for the Orbis acquisition, we realized an additional day of revenue, which represents approximately $1 million will be recognized in the first quarter. We’ve reduced second quarter estimates by an equivalent amount. Our effective tax rate for the first quarter of 2019 was 13.5% compared to 18.8% in the first quarter of 2018. The decrease in the effective tax rate resulted from an agreement with the Arizona Department of Revenue regarding previously filed refund claims related to income tax obligations for prior calendar years, which resulted in a favorable tax impact of $5.9 million recorded as a discrete tax item in the first quarter of 2019. Also, we continue to receive a benefit of excess tax benefits and recorded a favorable impact from excess tax benefits of $4.5 million in Q1 2019, compared to $5.3 million in Q1 2018. Our effective tax rate was lower than expected. First quarter guidance was 17.3% primarily due to a higher than expected excess tax benefit. Thus, approximately $0.06 of the earnings beat is due to the lower effective tax rate. We repurchased a 107,527 shares of our common stock in the first quarter of 2019 at a cost of approximately $10 million. We had $78.1 million available under our share repurchase authorization at March 31, 2019. Turning to the balance sheet and cash flows, total unrestricted cash and short-term investments at March 31, 2019 were $102.7 million. Restricted cash and cash equivalents were $300,000 as of March 31, 2019 and represents pledge collaterals for newly acquired lease sites. GCE’s CapEx in the first quarter of 2019 including CapEx for new Orbis partner sites was approximately $4.6 million or 2.3% of net revenue. We continue to believe that GCE’s 2019 CapEx should range between $20 million and $25 million consisting primarily of software development and the build out of Orbis partner locations. We funded CapEx on behalf of GCU through the secured notes of approximately $30 million in the first quarter of 2019, and still expect to fund approximately $100 million in 2019. This funding is finished at the 2018, 2019 school year project and three additional apartment style residence halls and apartment rights for the 2018-2020 school year. Based on recent conversations with GCU, it continues to be likely that the university will not request us to continue to fund its CapEx as of this year as the University anticipates that it will be able to fund its own CapEx moving forward. At January 22, 2019, in conjunction with the closing of the Orbis acquisition, GCE entered into an amended and restated credit agreement and two related amendments together to provide a credit facility of $325 million comprised of a term loan facility of $243.8 million and revolving credit facility of $81.3 million, both with a five year maturity date. The term facility is subject to quarterly amortization of principal commencing with the first quarter ended June 30, 2019 and equivalent installments of 5% of the principal amount of the term facility per quarter. Both the term loan, the revolver have monthly interest payments currently at 30 day LIBOR plus an applicable margin of 2%. The proceeds of the term loan together with $6.3 million drawn under the revolver and cash on hand were used to pay the purchase price in the acquisition. Concurrent with the acquisition and credit agreement, we repaid our $59.9 million in term debt and a cash collateral of $61.7 million was released. Last I would like to provide color on the guidance we have provided for the rest of 2019. The guidance we have provided continues to be non-GAAP adjusted net income and net income per share as we exclude amortization of acquired intangible asset and loss on transactions. We have increased revenue guidance for the full year due to the first quarter beat and have reduced second quarter revenue guidance by $1 million as I explained earlier. We raised operating margin slightly for the second quarter given lower than initially expected expense trends such that second quarter operating income remains the same as originally forecasted. Our guidance still assumes an effective tax rate excluding contributions made in real estate income taxes to be 24.5% in Q2, 24.6% in Q3 and 24.1% in Q4. The year-over-year increase in the effective tax rate, especially in the fourth quarter is due to higher estimated state income tax as a result of the transaction, a one-time method change benefit received in the fourth quarter of 2018 and due to the contributions in lieu of state income taxes not being factored into our guidance. If a contribution in lieu of state income tax is made in the third quarter of 2019 you will have the effect of increasing general, administrative expenses and increasing income tax expense. Although we might purchase additional shares during 2019, these estimates do not assume repurchases other than those made in the first quarter. I will now turn the call over to the moderator, so that we can answer questions.

[Operator Instructions] Our first question comes from the line of Peter Appert of Piper Jaffray. Your line is open.

Thanks. Good afternoon. So I didn’t have a chance to look at the Q. But are you breaking out the – specifically, the revenues and the operating income of Orbis?

We don’t. other than the pro forma disclosures that are required under the 10-Q or SEC rule. So, there is some disclosure in terms of Orbis revenue in the 10-Q, as well as some pro forma operating income information.

Okay. That sounds really complicated to answer. Maybe you can just give me the answer in terms of just current profitability of the Orbis business and expectations and how that trends?

Yes, great question. So, Orbis, as we talked about last quarter, our expectation with Orbis would be net breakeven from an EBIT standpoint for the year excluding the amortization of the intangible assets. And obviously the interest expense which is at the GCE level. They did slightly better than that – better than we expected in the first quarter. But our expectations for the rest of the year remain the same. And so, we expect they will make a little bit of money this year from an EBIT standpoint and revenue is generally in line with our expectations. It was a little bit higher than we expected excluding this $1 million that moved from a – or the $1 million that we talked about in the first quarter. But – so, revenue, we are expecting to be generally be in line with the guidance that we gave for the year for that.

Got it. And then, Dan, does the profitability of Orbis take a step up or a meaningful step up next year as the cohorts mature?

Yes, the expectation is, and until we finalize exactly how many rollouts of new sites will occur next year, it moves. But the expectation is, with all of the sites that we’ll be opening in 2018 and 2019, moving towards full occupancy it will be more profitable next year than it is this year.

Got it. And then, just thinking for Orbis for a sec, the partnership with Grant Canyon University, could you expand a little bit on that and are you getting Grand Canyon University with an exclusivity on a geographic basis in certain markets and just how big do you think that could be?

There is no exclusivity. We are just including GCU’s program as another program that can be used to expand its in-markets. And so, there are markets in the west, where it would be very logical for GCU’s program to be the provider. We are not really talking specifically about which markets those are, but if they really make sense, we have a very large program and it literally double or even triple the size of most university programs in the country. So, our capabilities are significant. Our NCLEX results are significant and so, it would be logical to use GCU's program in certain markets. We just haven't identified specifically which one they are yet.

Okay. Thanks, Brian and just one last thing. The start number up high-single-digits, I think you said, I believe that compares with low-teens last quarter. So any comments Brian in terms of that relative performance this quarter versus last?

No. Fourth quarter was strong. This quarter was strong, not quite as strong, but it’s still good. Is it competitive out there? It’s incredibly competitive out there. And so, we still are saying there are long-term goals with online enrollments through GCU was 6% to 7% and we want to be able to hit that with high quality students and so, we feel good about what we did in the first quarter, why we feel good about what we did. An important point is, it was in line with our expectations of high-single-digits. One thing to make sure everyone remembers is that, this business is very seasonal. The first and third quarters are much bigger start periods, because of the traditional spring and fall starts. And so, a high-single-digit new start for the first quarter is, in my opinion and probably Brian echoes this is, it’s just is impressive as a low-teens second or fourth quarter new start.

Yes.

I guess, but it’s – we are comparing quarter-over-quarter, quarter-over-second quarter, so.

Right. Thank you.

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

Thank you so much. Forgive me, I kind of cut out there earlier. But I think you said in terms of the potential new partners update, would you be providing us more color by the end of the year, is that was the goal?

Yes. We are making progress with a number of potential partners and I did make a conservative statement that we expect to have an announcement before the end of the calendar year. I expect it to be before that. But we are working with four potential partners pretty diligently in the Midwest and the Northeast and feel good that something good is going to happen before we get there.

Okay. All right. That’s great. And you did say, it’s a conservative estimate and obviously, there is a lot of moving parts to maybe think about your control, but hopefully we get some information towards the end of the year, Orbis before the end of the year that will be great. If I can just shift back to Orbis, you’ve owned this business, I guess, a little about 3.5 months or so, what did you learned over that time period that you might not have known before?

We knew that when you get into this many partnerships and potential locations, there is always hiccups that you don’t have quite enough control over when it’s just a single entity like when we were Grand Canyon University. So, sometimes, a start might have to be pushed back for a few months and so there are those things that we are learning about. But we are also on the other side of it, learning how big this marketplace is. We are going to conservatively need a 1 million additional nurses in this country in just the next five years. And the current supply or inventory of the traditional universities isn’t – been composed to meeting that need. And that’s pretty universal throughout the country. That’s not by geography. That’s pretty universal throughout the country. And so, we think Orbis has a tremendous model and with our ability to support it with funding and with automated technology services, we are bullish and we think that this is going to be a very good business and one that is going to fit a really strong.

And this is…

Go ahead.

No, I was going to finish, I apologize.

No, I was just saying, it is such a win-win deal. The universities need help. Orbis is willing to provide it. We are supporting Orbis and the students are really benefiting, because they are moving into good paying jobs and hospitals are elated. So, it’s a very positive business.

Okay. That’s great. And then just, finally just shifting back to Grand Canyon University, I think you had mentioned that you hope to be informed by the university that they will be able to fund themselves beginning in 2020. Roughly when will the university make that decision? And what does that impend us?

Yes. I think it will happen in the second half of this year and I think it’s just come down to their comfort level in their growing cash balances and what their CapEx needs are for 2020. But, the university is doing extremely well financially. And their cash balances are growing. And so, what we’ve been told is, I think they are getting more and more comfortable that they can fund their own CapEx next year.

Okay. Great to hear. Thanks so much.

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

Hey thanks. Good afternoon guys. This is Nick Nikitas on for Jeff. Just for a clarification on the new enrollment, I may have missed this, Brian, I thought you said something was up low-teens. Was that not the working – the working students not the online starts?

When you include the Orbis starts, it’s up low-teens. But then we took that out as for our comparables, compare a fair comparison was up single-digits – high-single-digits. But low-teens if you include Orbis.

Got you. That’s helpful. Just looking into Q2 and over I guess, the back half of the year, the comp will get a little bit tougher. But have you seen any change in demand over the recent months or pretty consistent with Q1?

Change in demand isn’t there. The increase in competition is what is there. There is just more choices. And there continue to be more choices. So, I think that’s a very good question, because I think people are expecting because of the surge in economy and the fact that there are lots of jobs available that there would be at some point, a decrease in the demand. I think, we are a little bit fortunate in that we tend to have students in areas where in spite of jobs being available, they are looking to improving their current positions. And so, we haven’t been impacted by it to this point. But it is something to watch very carefully because I think there is a lot of people anticipating it.

Okay. And then, just shifting to Orbis, given everything going on there and what seems like a really nice runway, how are you guys thinking about the timing of the potential OPM announcement? I mean, Brian, you said that you still expect something by the end of the year, but is there any thought that with the potential with Orbis especially leveraging GCU’s brands that are out the West Coast that – maybe that allows you to push back your timeline at all and focus on Orbis more? Or how are you guys thinking about that?

No, we certainly have our handful with Orbis and really, really love their business and things are going well and it’s really well run. But that’s not negatively impacting the time we spent on the other side. We just – we are looking for – as we’ve been telling you, we are looking for the right programmatic differentiation. The right geographic differentiation. We are looking for high quality partners mainly in the Midwest and the Northeast. But I think the exciting thing about what we have the potential to do is, number one, our services will be far greater in terms of the extent of the services. But then it’s all kinds of exciting things there we are going to be able to do with potential partners that we will – it will be truly more of a partnership than a clients relationship. And I don’t want to talk more about that now. But when we make some announcement, I think, you will understand what I am talking about.

Okay. Great. And then just one last one on the CapEx. We are thinking post-2019. Is this kind of $20 million to $25 million a good runrate assuming GCU handle that internally on their books? Or will that continue to grow with Orbis launching new partnerships?

It’s highly dependent on how many new locations that are rolled out in the year. But I think, somewhere probably $20 million to $30 million is probably a good estimate.

Okay. Thanks guys.

We have 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 myself, Dan Bachus. Thank you for your time.

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