Grand Canyon Education, Inc.
Q4 2016 Earnings Call Transcript

Published: 17 Feb 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Grand Canyon Education Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, today's conference is being recorded. I would now like to turn the call over to Mr. Brian Roberts, General Counsel. Sir, you may begin.

[Brian M. Roberts:]

Thank you for joining us to discuss Grand Canyon's 2016 fourth quarter results. Speaking on today's call are Chairman, President and CEO, Brian Mueller; our CFO, Dan Bachus. Our call is scheduled to last one hour, and we will try to answer all of your questions during the Q&A period at the end of the call. So we apologize in advance if there are questions that we are unable to address due to time constraints. Please note that many of our comments today will contain forward-looking statements that involve risks and uncertainties. Various factors 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 most recent annual report on Form 10-K and our current report on Form 8-K. We recommend that all investors review these reports thoroughly before taking up financial position in Grand Canyon. We undertake no obligation to provide updates with regard to the forward-looking statements made during this call. And with that, I'll turn the call over to Brian.

[Brian E. Mueller:]

Good afternoon, and thank you for joining Grand Canyon University's fourth quarter of fiscal year 2016 conference call. In the fourth quarter of 2016, enrollments grew by 9.9% and revenues grew by 13.3%. New enrollments grew in the low double-digits year-over-year. Operating margins are at 31.3%. We had another great quarter. I again want to thank our faculty and staff for their hard work and the incredible results they are producing. As many of you know, our long-term goals are to grow the university's enrollment by 6 percentage points to 8 percentage points per year, grow revenues by 8% to 9% per year, and grow margins by 20 basis points on an annual basis without raising tuition. Enrollment growth is a combination of online enrollments growing at 6 percentage points to 7 percentage points and our traditional campus enrollments growing by 8% to 10%. Revenue growth will happen as a result of continued increases in retention levels and ground enrollments becoming a larger percentage of total enrollment. Ground revenue per student is larger because of other ground revenue including room and board revenue as well as the increasing revenues of 24 restaurants, a hotel, golf course, coffee company, and the six GCU stores selling our merchandise, as well as additional retail outlets like Walmart. As you know, we accomplished our enrollment goal on a traditional campus this fall, with approximately 17,500 students on campus. The average incoming GPAs are about 3.5 and our Honors College has grown to 1,200 with average incoming GPAs of about 4.1. Applications for next year are now north of 22,000 and are significantly ahead of prior year at the same point. We expect about 7,000 new students with 550 of those students being in our Honors College. We are currently building a new apartment-style residence hall which will have 600 new beds. Our total enrollment on campus for next fall will be approximately 19,000, and we expect all residence halls will be at capacity. We continue to outpace our new online enrollment growth goals. The contributing factors for this are

[Daniel E. Bachus:]

Thanks, Brian. Revenue per student increased between years, primarily due to our residential traditional campus enrollment growing at a rate higher than our working adult enrollment. When factoring in room, board and fees, the revenue per student is higher for ground students than for our online students. In addition, as we have previously discussed, the fall semester began five days later in August in 2016 than in 2015, which had the effect of moving $4.9 million of revenue from the third quarter to the fourth quarter. Online revenue per student was down slightly year-over-year, primarily due to the timing of the holiday break, mix changes and the fact that we did not raise tuition levels during 2016. Scholarships as a percentage of revenue increased slightly from 18.6% in Q4 2015 to 18.7% in Q4 2016 due primarily to growth in our ground traditional student base, partially offset by a decrease in the traditional scholarship rate year-over-year as a percentage of total revenue and due to an increasing ancillary revenues. Online scholarship as a percentage of related revenue were up slightly year-over-year. Bad debt expense as a percentage of revenue stayed flat at 2.4% year-over-year. Our effective tax rate for the fourth quarter 2016 was 37.2% as compared to 38.6% in the fourth quarter of 2015. The variance in the effective tax rate year-over-year is primarily due to the university making higher contributions in lieu of state income taxes to school sponsoring organizations in 2016. As a reminder, in Q3 2016, we contributed $4 million, an increase of $1.2 million over the $2.8 million contributed in Q3 2015. As you might recall, these payments are included in G&A 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 rate, and the remaining is reflected in the lower tax rate in the fourth quarter. We repurchased 416,000 shares of our common stock at an aggregate cost of $15.4 million during the year ended December 31, 2016, although no stock was repurchased from the fourth quarter of 2015. We have $99.2 million available under our share repurchase authorization as of December 31, 2016. Turning to the balance sheet and cash flows, total cash unrestricted and restricted and short-term investments at December 31, 2016, was $193.5 million. Accounts receivable net of allowance for doubtful accounts was $10 million at December 31, 2016, which represents 4.2 days sales outstanding compared to $8.3 million or 3.9 days sales outstanding, at the end of the fourth quarter of 2015. CapEx in the fourth quarter of 2016, excluding our off-site development of $18.9 million, was approximately $20.7 million or 8.5% in net revenue. Total CapEx for the year was $178.3 million, which was slightly under our $180 million estimate. Our off-site CapEx of $18.9 million in the fourth quarter was related to the new student services center and parking garage in close proximity to our traditional ground campus in Phoenix, Arizona. We estimate that 2017 CapEx will be between $80 million and $100 million. Included in current portion of notes payable December 31, 2016, was $25 million in borrowings on our revolving line of credit. This amount was repaid in early January 2017. We continue to have $150 million available to borrow on our line. Our cash base of 90/10 amount for 2016 was 72.3%, down from 74.8% in 2015. We believe that this decrease is primarily due to the continued growth in our ground traditional student body which has a much lower 90/10 ratio than our working adult students. Last, I would like to provide color on guidance we have provided for 2017. As you probably noticed, we have again provided estimates for each quarter of 2017. We do this because our financial results continue to become more seasonal due to the significant growth of our ground traditional campus. A large percentage of these students only attend class between the end of August and the end of April. However, a large percentage of the ground traditional campus costs are fixed, and these costs continue to grow due to our anticipated growth. We must hire additional support staff to service the increasing student body in the spring or summer of each year so that they are trained and can start working with the soon-to-be students when these students are ready to be registered for the fall semester. Our enrollment guidance assumes low-teens online new start growth in the first and second quarter of 2017 and mid-single-digit new-start growth in the third and fourth quarter of 2017. The anticipated deceleration of start growth in the second half of 2017 is due to the higher than expected growth in new-starts that occurred in the second half of 2016. 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. This results in online year-over-year growth rate. They accelerate in the first half of the year, and then start to slow in the second half of 2017. We estimate our total ground enrollment, ground traditional and professional studies students, to be 15,800 in the spring, 5,700 in the summer, 19,000 in the fall, and 18,800 at year-end. We are starting to experience larger numbers of graduates at our ground campus due to our increase in enrollment base and a high percentage of our students graduating in less than four years. And although we anticipate our term-to-term retention rates to be flat to slightly better between years, the larger enrollment causes bigger fluctuations between fall and spring semesters. Our revenue guidance assumes no tuition increase for our ground campus or our online campus. We anticipate that revenue per student will continue to grow year-over-year as a result of the growth of our ground traditional student body as a percentage of our total student body. However, we'll be impacted in the first quarter 2017 by one less day of revenue due to 2016 being a leap year, resulting in $1.9 million of less revenue in 2017. In addition, our revenue per student will be impacted by changes between 2016 and 2017 of when the traditional campus semesters begin and end and when the online breaks the curve. The spring and summer semesters start five days later in 2017 than in 2016, pushing revenue from Q1 to Q2 and from Q2 to Q3, while the fall semester will start one day earlier this year than last, pushing revenue from Q4 to Q3. We estimate the effects of these changes are $5.3 million of less revenue in Q1, $4.7 million more in revenue in Q2, $1.7 million more revenue in Q3, and $1.1 million less revenue in Q4. We're also anticipating a decrease in online revenue per student of approximately 1% due to programmatic mix changes, higher scholarships, and the fact that we do not plan to raise tuition level. On the expense side, we have forecasted instructional cost of services as a percentage of revenue to be up again year-over-year. This is being caused by the investments we continue to make, significant increases in depreciation and occupancy expenses, as well as growth in ancillary revenues that have forecasted margins in the mid-single digit. This includes food and merchandise sales and revenues earned at the Grand Canyon University Golf Course and the Grand Canyon University Hotel, as well as the additional businesses Brian discussed. Although the revenues are small, we estimate that in total these revenues will grow approximately 16% this year. In addition, the minimum wage increase approved in November 2016 by Arizona residents will increase our costs by approximately 40 basis points year-over-year as we were required to increase the minimum paid of the majority of our approximately 2,500 student workers to $10 per hour on January 1. As a result, we anticipate IC&S as a percentage of revenue to be up 60 basis points year-over-year with the primary drivers, being employee compensation-related expenses, which we estimate will be up as a percentage of revenue 40 basis points; depreciation, up 60 basis points; and occupancy cost to be up 50 basis points year-over-year, primarily due to an increase in property tax. We plan to continue to invest in new program development and various community projects. Bad debt is projected to be flat year-over-year. We anticipate that advertising will be up slightly as a percentage year-over-year. We estimate that we will get slight leverage in admissions advisory and related expenses and G&A between years. We are hopeful for margin expansion in 2017 as we have been able to accomplish in the past and are working extremely hard on operational efficiencies to accomplish this. But due to the factors discussed above, we anticipate it being more difficult this year than in the past. Interest expense net of interest and other income will be approximately $1.7 million. Although our borrowings should be down year-over-year, the amount of capitalized interest should be less due to the decrease in CapEx. Our guidance this year assumes an effective tax rate, excluding the contributions made in lieu of state income taxes, of 35.3% compared to an effective tax rate, excluding the contribution made in 2016 of 38.2%. The estimated decrease in the effective tax rate is the result of our adoption of a new accounting pronouncement in January 2017 which requires that the excess tax benefits from our equity award be recorded as reduction in income tax expense rather than additional paid-in capital. In the period, stock options are exercised and restricted stock awards (22

[Operator:]

And our first question comes from the line of Peter Appert with Piper Jaffray. Your line is now open.

[Peter P. Appert:]

Thank you. So, Brian, could you spend a second talking about the areas where you're seeing strength from a programmatic standpoint in terms of the online business? I'm asking this in the context of trying to understand better given how strong the numbers have been, and I understand the comps get tougher, but why you're maybe not a little more confident in terms of the sustainability of the recent improvements you see?

[Brian E. Mueller:]

The places where we are gaining in terms of programmatic development are mainly niche areas. And so, when you look at our education program, for example, a program like (24

[Peter P. Appert:]

Okay, fair enough. And then just to clarify, the adult students who are coming on campus at night, does that count in the ground traditional enrollment numbers?

[Brian E. Mueller:]

Yeah. Campus-based students, yes.

[Peter P. Appert:]

Okay. Got it. And then a different topic. Obviously, given the reduced cash flow and the success you've had in driving revenue growth and profitability, we're going to see presumably dramatic improvements in the free cash flow here in 2017. I'm wondering, if you could just remind us how you're thinking about the priorities for the use of that cash and how comfortable you are just accumulating large cash balances?

[Brian E. Mueller:]

Well, the first is to continue to look at ways that we can invest in the ground campus – classrooms, laboratories, residence halls, those things. One of the little – when we announced that we're going into the next two years, we know that there's a huge need and desire for students that want to go into electrical, mechanical, biomedical engineering, computer science, information technology. Our program is growing but not at an accelerated rate as we think may happen in the future because we're not ABET accredited. So we're going to reserve cash in order to pump it into those programs. If we see – once we get close to ABET accreditation, that, that would really pay off for us. Second thing is – interesting thing that's happening now is on our ground campus, we're starting to attract students, more out-of-state students. Housing is going at a very rapid rate. And so California is growing, but we're really starting to grow in the Midwest. Arizona State and University of Arizona always did well in the Midwest because kids wanted to get out of the winter. But what happened over the course of the last 5 to 10 years is their tuition rates have become exorbitant. And now the word is getting out that you can get out of the winter and get into Arizona at very low tuition rates and stay in brand-new residence halls and study at brand-new campus. So that's starting to grow. So if our total student body that wants to stay on campus – as a percent of the total student body goes up, we want to reserve the cash to build additional dormitories because there's not a better investment that we can make than to build more residence halls. That being said, the cash is going to pile up, and we certainly will continue to develop new programs but we will also take a look at repurchasing stock when there is weakness. And so that will be the third part of our strategy.

[Peter P. Appert:]

So not ready, basically, to commit to some sort of more methodical share repurchase program at this point?

[Brian E. Mueller:]

Not in the first six months. We're going to take a really close look at how this moves. And in the next six months, we're going to take a really close look at how we're going to end up with our enrollment on ground this fall and see both in terms of residence halls and additional classroom buildings and how much we might need for the following year.

[Peter P. Appert:]

Understood. Okay. Thanks very much.

[Brian E. Mueller:]

Thank you.

[Operator:]

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

[Henry Sou Chien:]

Hey. Good afternoon, guys. It's Henry Chien calling for Jeff. I just had a...

[Brian E. Mueller:]

Hi, Henry.

[Henry Sou Chien:]

Hey, guys. Just a question on your capacity. Just if you could show us what's your current capacity and just how you're thinking about expanding this with the new residence halls and any upcoming constructions, just curious your thoughts on that?

[Brian E. Mueller:]

Yeah, in the fall, with the new dorm going up, it's going to be about 11,000 beds. And what I said we were going to be at capacity, we expect it to be out in front. But the request for living on campus is really going up this year as compared to last and so we're going to watch how that goes for the rest of the spring. And if it goes as it is, we're going to be at capacity and maybe have to transfer students away. And so the 11,000 of the 19,000 is a little bit above the percentage we thought but the way things are going now, that's going to probably go up in the next coming years which for us would be a good thing because the revenue for students just goes up when we have the additional students stay on campus.

[Henry Sou Chien:]

Got it. And this is including the new residence hall that's going to open at the end of this year?

[Brian E. Mueller:]

Yes.

[Henry Sou Chien:]

Okay. Got it. Thanks. And just wonder if you could comment on just the political environment there in Arizona and how supportive it is for Grand Canyon or any thoughts there?

[Brian E. Mueller:]

Well, that's why I did go through that kind of lengthy explanation of that press conference because with the new administration, and we've got some contacts, but we hope that people are willing to take a fresh look at this thing. And after eight years of just being beat down nationally, I think this is becoming kind of a model that can be replicated, and we can reinvigorate this for profit, publicly traded education company concept. It's overwhelming in Arizona right now. We had the governor. And it was a sea of 3,000 people in purple shirts out there at an outdoors press conference, but we had the governor, we had the mayor of the sixth largest city in the country, we had Jerry Colangelo who's a nationally respected businessman. And they made glowing comments about the university, its contribution to the economy, its contribution to city revitalization. And so, there's just this whole – this thing, we have a very pro-business governor, extremely pro-business governor. He's also extremely pro-school choice, and he wants to give people as many options from pre-schools through higher ed as he can, and he thinks competition is good. And so, obviously, we have a slight detractor in terms of the presence (33

[Henry Sou Chien:]

Got it. Okay. Sounds promising. Thanks.

[Brian E. Mueller:]

Thanks.

[Operator:]

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

[Jeff P. Meuler:]

Yes. Thank you. Brian, I think you just said you're not planning on being methodical with share repurchase in the first half. You're saying, you think the model can be replicated if state and real estate taxes become more economically equitable, is there a change in thought on the potential to do another standalone campus?

[Brian E. Mueller:]

Possibly. We certainly have a lot of people who would like us to – people are looking at the model, the increasing inefficiencies of the state university model. And how this has been such an economic catalyst in the state. People are certainly looking at this. And so we have people in different states approaching us on a consistent basis. And so it's something that we're going to continue to evaluate and consider. It's not something that we plan on doing in the next two years. We believe that we can build this thing out to 30,000 students over the next five or six years and the dollar we invest in this thing will return far more than starting something new. But we're not going to hold it – there is a potential that we will do something eventually.

[Jeff P. Meuler:]

Okay. And then I just want to understand the comment on the online new enrollment outlook. I understand the tougher comps as the year unfolds, but is the message that that's the guidance assumption or if – would you instead if new enrollment growth is running hot, would you pull back on marketing expense or, in other ways, try to govern it lower?

[Brian E. Mueller:]

No. We wouldn't pull back. We would not pull back on marketing expense. If the demand for what we're doing grows at an unanticipated rate, we would fill that demand but it would have to be, as it has been, with higher and higher quality of students. The reason I mentioned the 19,500 graduates that we had at Grand Canyon this year, that's a big number. And so as that goes up – that's the other thing that we are being a little conservative about because it took us a little bit by surprise. Of the students that graduate on our ground campus, 70% of them are now graduating in less than four years. And that's becoming part of the brand. It's attracting people. But in the short run, that caught us a little bit off-guard. In our models, we anticipated the average student to graduate in four years, but 70% are now graduating in less than four years. And 54% are graduating in exactly three years. It's because we've got hundreds and hundreds of agreements with high schools and we're delivering dual credit to them, so good students are coming to us with already earned 20, 30, 35 college credits in addition to the fact that our students, who may go home in the summer, will take an online class or two. And so all of a sudden, they've graduated in three years for an average tuition rate of $8,300 to $8,600 on an annual basis which, from a value proposition, is incredible. And that word is spreading and that's becoming part of our brand. So we have to monitor what kind of increase that will cause in our ground enrollment versus the amount of graduates that we'll lose before we initially anticipated.

[Jeff P. Meuler:]

Okay. Thank you, and thanks for pointing out the forever youthful Mr. Appert's historical knowledge of the industry instead of my own.

[Brian E. Mueller:]

Duly noted.

[Operator:]

Thank you. And our next question comes from the line of Trace Urdan with Credit Suisse. Your line is now open. Trace Adair Urdan - Credit Suisse Securities (USA) LLC Thanks. I wanted to ask about the – what was it, the ever youthful Peter Appert question. When you were talking about needing to hang on to cash for various purposes, that doesn't change your outlook for CapEx that you guys provided to us at your Investor Day, does it? Is that guidance still operative from your perspective at this point?

[Brian E. Mueller:]

Yes. $80 million to $100 million. I would say it's probably going to be closer to $100 million than $80 million. Trace Adair Urdan - Credit Suisse Securities (USA) LLC Okay. But that's within the same framework that you had outlined originally. So, when you're talking about things like more students coming from out of state and possibly needing more dorm space sooner, at this point, you haven't kind of altered your outlook for sort of the buildings you need to build over the next four years?

[Brian E. Mueller:]

Not for 2017, but possibly, correct. Trace Adair Urdan - Credit Suisse Securities (USA) LLC Okay. TBD after that. Right. I understand.

[Brian E. Mueller:]

Yes. Trace Adair Urdan - Credit Suisse Securities (USA) LLC And then I also wanted to ask about the comments that you made about the shifts in the program offerings and maybe ask for a little bit more specific color. I understand conceptually that there are some programs that are large that may be maturing and then others that are smaller and more nascent might be growing nicely but are still relatively small. Can you talk about that maybe a little bit more specifically? Like what are the programs that you guys are seeing that may be approaching maturity? I could speculate, but I'd rather have you kind of speak to that. Or have I mischaracterized the situation, is that not what you said?

[Brian E. Mueller:]

No. No. You're right. When talking about maturity, RN to BSN, is just a very large program for us and so having to grow off of a very large number, that there's a little bit of maturity that we're seeing there. In terms of revenue per student, the counseling programs at both the baccalaureate and masters degree level are growing fast. And those programs from a revenue per student perspective are lower than some of our other programs but we've developed a little bit of a reputation in that area. And so those things are growing. And that's having a little bit of negative impact on the revenue per student. Trace Adair Urdan - Credit Suisse Securities (USA) LLC Okay. And then I know you talked before about the challenges in particular for undergraduate education degrees. Have you kind of made any progress on that front? I guess it maybe sort of early to ask you whether you've had any contact in Washington, but have you had any contact in Washington.

[Brian E. Mueller:]

We don't have an appointment with (40

[Brian E. Mueller:]

But we have a tremendous relationship with the staff at the Higher Learning Commission and so we are in constant contact with them. We would like to have some influence and some impact on what happens if the Higher Ed Act gets potentially reauthorized in the next two years and we think there are some very, very significant things that could be put into that new act that could be very beneficial. And so given – I did mention the support of our U.S. senators. John McCain is a huge supporter of ours, as is Jeff Flake, and they do have contacts in Washington. And if we can provide some influence around what will happen in the next couple of years, we really like to do that. I think there are some very practical common sense things that could be done that will help everybody. So we'll see. We're going to try. Trace Adair Urdan - Credit Suisse Securities (USA) LLC Okay. Fair enough. Thank you.

[Brian E. Mueller:]

Yes.

[Brian E. Mueller:]

We have reached the end of our fourth 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.

[Operator:]

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