Grand Canyon Education, Inc.
Q2 2019 Earnings Call Transcript

Published: 7 Aug 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter Grand Canyon Education 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.At this time, I like to turn the call over to your host, Dan Bachus, CFO. You may begin.

[Dan Bachus:]

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 position in GCE.And with that, I will turn the call over to Brian.

[Brian Mueller:]

Good afternoon. And welcome to Grand Canyon Education's second quarter fiscal year 2019 conference call. During the second quarter of 2019, enrollment in the programs at our university partner universities for which we provide services, increased 11.4% to 90,906. This increase includes 3,316 enrollments in programs serviced by Orbis Education as of June 30, 2019.New working adult students attending our partner institutions grew in the low-teens year-over-year. On a comparable basis, total enrollment grew 8.1%, and new enrollments grew in the high-single-digits. I want to begin by addressing the issues regarding 2U. They have been leaders in the OPM space and we wish them nothing but the best going forward. However, I wasn’t to be clear about the GEC strategy is different and why we believe we will be successful.Number one, the Grand Cannon University online strategy is the strategy being replicated throughout the country. Namely taking academic programs that have been designed to teach traditional students in a face-to-face environment on a campus and redesigning them to be delivered online to working adult students. This is the quickest and least expensive way to begin operating in this space.Although this space is very competitive, Grand Cannon Education has some significant advantages. Number one, it has the world’s largest and most comprehensive platform to deliver both academic in operational services to GCU and other partners going forward. For the same or very similar revenue arrangements, GCE will offer over twice as many services, including operational services that most OPM’s don’t offer, but will allow programs to be offered at scale.These are fully automated services that include the following

[Dan Bachus:]

Thanks Brian. Included in 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 June 30, 2019. The non-GAAP amounts exclude the tax effected amount of the amortization of intangible assets and the 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 second quarter of 2019 was 2.2 million.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 June 30, 2019 is $1.9. Service revenue exceeded our expectations in the second quarter of 2019, due to slightly higher revenue per student.GCU and Orbis enrolments were generally in-line with our expectations. Included in investment interest and other is a one-time gain of 2.1 million. This resulted in $0.03 of the earnings fee. Our effective tax rate for the second quarter of 2019 was 21.7%, compared to 23.3% in the second quarter 2018, and our guidance of 24.5%, but lower than expected effective tax rate is due to a recent law change with respect to Arizona state taxes and higher than expected excess tax benefits to 2.2 million in Q2, 2019 from 1.2 million in Q2, 2018.The lower than expected tax rate resulted in $0.04 of the earnings beat. We repurchased 3,000 shares of our common stock in the second quarter of 2019, and the cost of 0.3 million and another 10,000 shares at a cost of 1.2 million in July. We had 77.8 million available under our share repurchase authorization as of June 30, 2019.Turning to the balance sheet and cash flows, the total unrestricted cash and short-term advancements at June 30, 2019 were 80 million. Restricted cash and cash equivalents were 300,000 as of June 30, 2019 and represents pledged collateral for a newly acquired lease site. GCE CapEx in the second quarter 2019, including CapEx for new Orbis partner sites was approximately 5.1 million or 2.9% 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 location. We funded CapEx on behalf of GCU through the secured note of approximately 139.9 million in the second quarter of 2019, which includes an advance of 99 million for estimated capital expenditures through the end of 2019.Some amounts may be repaid during the six months remaining in the year ended December 31, 2019. This funding is to finish the 2018, 2019 school year project and for the initial cost to build three additional apartment-style residence halls, a classroom building, and a parking garage for the 2019-2020 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 after this year as the University anticipates they will be able to fund its own CapEx moving forward.Last, I would like to provide color on the guidance we have provided for the rest of 2019. The guidance that we have provided continues to be non-GAAP, as adjusted net income and as adjusted diluted income per share as we exclude amortization of acquired intangible assets in the loss on transaction. We have increased revenue guidance for the full-year due to the second quarter beat.We have not adjusted revenue for the second half of 2019, but have increased revenue guidance for the third quarter and lowered it by the same amount in the fourth quarter as Orbis revenue will be slightly higher than initially predicted in the third quarter, but less than the fourth quarter, due primarily to timing differences in the cohort start dates.Excluding the effect of the contribution made in lieu of state income taxes that I’ll discuss in the second, we have raised operating margin for the third quarter from 31.1% to 31.8% and lowered it in the fourth quarter due to the Orbis revenue will shift and due to slightly higher projected Orbis spend in the fourth quarter on new site openings. All other expense assumptions remain the same for the second half of the year.In July, we made 4 million of contributions made in lieu of state income taxes, which has the effect of increasing general and administrative expenses and decreasing income tax expense. The entire year 4 million of expense is recorded in G&A expense in the third quarter, while three quarters or 3 million of this amount is recorded as a lower state income tax in the third quarter and a quarter or 1 million is included as lower state income tax in the fourth quarter. This along with us revising our excess tax benefit estimates result in our revised effective tax rates of 21.0% in Q3 and 22.6% in Q4.We have also revised our net interest income projections for the second half of the year based on the borrowings that took place in June, and our assumptions that no additional borrowings will take place for rest of 2019, but there’s some repayments might be made. We project net interest income in the third and fourth quarters of 2019 will be 13.0 million and 12.5 million respectively. Although we might repurchase additional shares during 2019, these estimates do not assume repurchases other than those made today.I will now turn the call over to the moderator, so we can answer questions.

[Operator:]

Thank you, sir. [Operator Instructions] I show our first question comes from Jeff Silber from BMO Capital Markets. Please go ahead.

[Jeff Silber:]

Thank you so much. Wanted to start with Orbis. You’ve been putting up some really good numbers in those programs since you purchased the company. I’m just curious what has gone better than your expectations, why does it seem to be growing faster than you might have thought?

[Dan Bachus:]

I would say that the success levels of the initial partners have given a lot of confidence to the whole organization. We have been making the rounds and meeting with some of the universities, and every single institution not only wants to build their current location to larger amounts, but they want additional locations. And so, if – we happen to buy it at a time when they were really starting to turn the corner. The end collect results are consistently high and they are consistently hitting their enrolment numbers, and so the confidence levels of the model are growing and people are very excited about expansion.

[Jeff Silber:]

Okay. That’s great to hear. I appreciate the color you gave on the overall OPM or managed services market, I’m just curious is there any update in terms of potential timing on any announcements of any new partnerships from your perspective?

[Dan Bachus:]

Yes. We are working hard. We have been on the road for two months now and we’re going back on the road next week for additional meetings with three potential partners, which will be, you know we're down the road with all three. Some of the meetings will include as many as 100 people from those partner institutions. And so, I think it’s a long kind of process the way it's been traditionally done in this OPM industry, but this is a little bit longer because we are, we are not looking to picking off a program and prove we can do it well with 100 students or 200 students on 300 students.We really are looking for an institution, three or four institutions like I said, who’s President is behind this and is wholeheartedly behind it. And who has their entire academic infrastructure behind it, and excited about it. So, that when we hit ground running that we can produce not results that are nice, but not really – that don't really change anything. Grand Canyon University and Grand Canyon Education has fundamentally altered the economic structure of higher education.Our students now on our traditional campus here are on average, going for less room board – tuition room board fees than our average State University student in this country. Probably two-thirds under the Private University’s average student. And so, if we can find the right – and it’s probably going to be Private University partners in the Midwest or Northeast that want to scale to 5,000 between 5,000 and 7,000 over a five-year to seven-year time period, it won't have a dramatic effect on their institution as it had on ours, but it will have a significant effect, and it will be transformative in a sense. And so, making sure that we’ve got an entire institution versus just a couple small programs is why it is taking a little longer, but we think that in the next, for certain before the end of the year we will have partners in place and start working towards starting students in the fall.

[Jeff Silber:]

Okay. I appreciate the color. If I could just sneak one more in. Over the past few weeks, there has been some noise in the market about changes to state authorization rules in California and potentially limiting their residents from getting Title IV financial aid to go to an online non-profit institution out of their state. Hopefully, this has been resolved, but do you think there was any impact on your upcoming enrolments for the next few quarters or so because of this issue?

[Dan Bachus:]

No. We will be fine.

[Jeff Silber:]

Alright. That’s good to hear. Alright, I’ll get back in the queue. Thank you so much.

[Operator:]

Thank you. Our next question comes from Jeff Meuler from Baird. Please go ahead.

[Jeff Meuler:]

Dan, thanks for the detailed guidance. I just want to make sure that I have it right because there is a lot of timing factors and moving around in terms of geography on the P&L with big contribution move for the income taxes. So, I just, in terms of underlying, if I adjust for the timing in that movement, are the only two real underlying changes here flowing the upside from Q2? And then a little bit of incremental expense for Orbis in Q4 like-for-like given that you’re opening a greater number of locations than previously contemplated, are those the only underlying changes other than the timing and P&L movement?

[Dan Bachus:]

Yes. You’ve hit it on the head. We are – we’ll have a little bit additional expense in the fourth quarter related to Orbis, and we’re making up for that with slightly higher interest income and slightly lower effective tax rate on a combined basis. Everything else is basically nets out. The revenue shift nets outs and the other expenses, other than the slightly higher Orbis expenses in the fourth quarter all net out. So, what you said is exactly correct.

[Jeff Meuler:]

Okay. And then Brian is there interest on your part that you would potentially do three OPM partnerships to sign them all at once, and is there any framework for what, like 2020 margin implications could look like? Just thinking if you would potentially do 3 OPMs plus you are stepping up the pace of Orbis launches, is there any sort of like intermediate-term margin framework you can provide?

[Brian Mueller:]

I don't think that we would sign three at the same time. I think it is likely that we will probably sign two within a reasonable amount of time, and the – but if we do that in the next 60 to 90 days, we wouldn't actually be starting students until the fall. And so, there would be some expense that would be incurred, but it would be an extreme amount of success that would have hugely material impact on the financials.

[Dan Bachus:]

The only thing I would add is, I think there is still a lot of things that have to be resolved. We’ve mentioned before how material the upfront expenses are? How significantly the biggest factor in that is, how fast the partner wants to scale? So, coming to agreement on that or them telling GCE how fast they want to scale is a critical component. So, as soon as we have a partner in place, and we have those plans finalized, we will be able to give you a lot more detail on the impact it will have both on the expense side, but then on the revenue side.

[Jeff Meuler:]

And, are you seeing fall 2019 you could have students starting at these programs or are you saying fall 2020?

[Dan Bachus:]

For 2020. That’s why we’re not – we might sign an agreement in the next 60 or 90 days, but we wouldn't start students for 9 months after that. But that's not like we're going to be throwing a bunch of expense in the first 30 days, that’s no.

[Jeff Meuler:]

Okay. That’s helpful.

[Brian Mueller:]

And it could be those programs don't roll out even till January of 2021. So, fall 2020 or spring of 2021, I think is as early as …

[Dan Bachus:]

Fall 2020 is the earliest.

[Jeff Meuler:]

Got it. And then just as a follow-up to the other Jeff's question. The around kind of the California and state reciprocity or [indiscernible], so, I guess you are saying you would be in good shape, it sounds like Ed is going to accommodate the California proposal, but maybe it did not take off all of the boxes, just if there continues to be future noise about this, so I'm thinking like if there – if the judge in the original court ruling would chime in or something. Even if there would be a period where California students were not eligible for Title IV, did the University or GCE have some sort of stop gap financing plan or they did not even go that far down the path given that it was so short lived?

[Brian Mueller:]

What GCE was told by GCU is they continue to do the right thing for the students in terms of enrolling new students and retain the students that it would add. And it took the risk on its own balance sheet that the Department of Ed and the State of California would come to a reasonable conclusion on this, and the financial aid would be disbursed. And so that's why there is really no impact on GCE and frankly other than a short-term cash impact on GCU there was no impact on GCU. And if something happens in the future, I would assume that the same would occur.

[Jeff Meuler:]

Helpful. Thank you.

[Dan Bachus:]

We have 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 myself, Dan Bachus. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day.