Grand Canyon Education (LOPE) Q3 2017 Results - Earnings Call Transcript

Grand Canyon Education, Inc. (NASDAQ:LOPE) Q3 2017 Earnings Call November 1, 2017 4:30 PM ET

Executives

Brian M. Roberts - Grand Canyon Education, Inc.

Brian E. Mueller - Grand Canyon Education, Inc.

Daniel E. Bachus - Grand Canyon Education, Inc.

Analysts

Peter P. Appert - Piper Jaffray & Co.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Chris Howe - Barrington Research Associates, Inc.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 Grand Canyon Education, Inc., 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 be given at that time. As a reminder, this call is being recorded.

I would now like to turn the call over to Brian Roberts, General Counsel. You may begin.

Brian M. Roberts - Grand Canyon Education, Inc.

Thank you. Speaking on today's call is our Chairman, President and CEO, Brian Mueller; and our CFO, Dan Bachus.

Please note that many of our comments today will contain forward-looking statements that involve risks and uncertainties. Various factors could cause our actual results to be materially different from any future results expressed or implied by such statements.

These factors are discussed in our SEC filings, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K. We undertake no obligation to provide updates with regard to the forward-looking statements made during this call, and we recommend that all investors review these reports thoroughly before taking a financial position in Grand Canyon.

With that, I will turn the call over to Brian.

Brian E. Mueller - Grand Canyon Education, Inc.

Good afternoon, and thank you for joining Grand Canyon University's third quarter 2017 conference call. In the third quarter of 2017, enrollments grew by 10.7% and revenues grew by 12.2%. New working adult students attending our online campus grew in the high-single digits year-over-year. Operating margins are at 25.3%. 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% without tuition increases primarily as a result of continued retention increases, traditional campus enrollment becoming a higher percentage of the total, and the growth of the ancillary revenues through new businesses. The room and board payments of our ground students continue to drive up annual revenue per student number. Operating margins will expand by 20 basis points to 30 basis points per year.

Driving the brand of the university through the vibrancy and accomplishments of the traditional campus will continue to be a priority. We now have nine colleges, over 220 programs, emphases and certificates and plan to grow the offerings by a minimum of 20 per year. The quality of the student body continues to grow. This year's freshman class has an average incoming GPA 3.5 and the Honors College is now at 1,600 students with an average incoming GPA of 4.1.

The highest academic growth areas are in STEM-related fields and our business programs. Many universities are cutting back in the performance areas, while we continue to invest in them. Music, theatre, dance, debate, athletics and club sports are great educational experiences for students and a positive way to lift the brand of the institution.

To support this growth, this coming year will be a big building year, as we will add a major classroom building, two residence halls, a club sports facility and a new parking garage. We will also pick up additional property as we expand to 400 acres to eventually accommodate approximately 30,000 students.

We are also continuing to invest in a 140,000-square foot innovation center. We have built a cyber security warfare range in that center but are contemplating investing in additional cyber security education options, additive and advanced manufacturing offerings and expanded computer science offerings including coding. We anticipate giving you more color on these initiatives in the first half of next year.

The focus of our online campus continues to be programmatic expansion, growing the graduate student number and continuing to increase the support services offered to students. We have exceeded our online enrolment numbers primarily because of new program growth. 14% of our new online students have come from programs rolled out in the last two years. 57% of the students studying in the new programs are graduate students.

We continue to invest in full time faculty, counseling services, library services, one-on-one academic support, online classroom enhancements and research around online education pedagogy. Over the most recent two-year time period, our faculty have written 65 scholarly articles and presented at 106 conferences, all related to increasing the effectiveness of online teaching and learning. Being recognized as a thought leader in this area is an important part of our plan going forward.

Our work in the community continues. In the last 18 months, we've opened two restaurants, a hotel, an office complex, a golf course, a coffee company, an advertising company and a promotions company. These businesses are all adding jobs in the community. We have renewed our crime suppression initiative with the City of Phoenix. We'll renovate approximately 100 homes this year through our Habitat for Humanity partnership with the goal of 800 within the next five years and expand K-12 tutoring and mentoring efforts to 75 schools in the local area.

Now turning to the results of operations. Net revenues were $236.2 million in the third quarter of 2017, an increase of $25.8 million or 12.2% from the $210 million in the prior year period. Operating margin for Q3 2017 was 25.3% in the third quarter compared to 22.4% for the same period in 2016. Net income was $39.3 million for the third quarter of 2017 compared to $29.2 million in the prior year period. After tax margin was 16.6% compared to 13.9% for the same period in 2016.

Instructional costs and services grew from $91.7 million in the third quarter of 2016 to $104.3 million in the third quarter of 2017, an increase of $12.6 million or 13.7%. This increase is primarily due to the increased number of faculty and staff to support the increasing number of students attending the university. Also, we incurred an increase in benefit cost between years.

In addition, we continue to see an increase in occupancy cost, including depreciation, amortization, and occupancy cost as a result of us placing into service additional buildings, especially laboratory-intensive STEM buildings to support the growing number of ground traditional students.

During the third quarter of 2017, we wrote-off the remaining book value of two buildings that will be replaced by a new classroom building that is needed for the fall of 2018.

As a percent of revenue, IC&S increased 60 basis points to 44.2%, primarily due to an increase in depreciation, amortization, and occupancy costs including disposals as a percentage of revenue over the prior year as well as an increase in employee compensation and related expenses over the prior year, primarily due to staffing for the growth in the ground traditional enrollment.

Admissions advisory and related expenses as a percentage of revenue decreased 40 basis points to 13.3% from 13.7%, primarily due to our ability to leverage our admissions advisory personnel across an increasing revenue base. Advertising expense as a percent of net revenue decreased 60 basis points from 11.4% in quarter three 2016 to 10.8% in quarter three 2017.

With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2017 third quarter, talk about changes in the income statement, balance sheet and other items, as well as to provide updated 2017 guidance.

Daniel E. Bachus - Grand Canyon Education, Inc.

Thanks, Brian. Revenue exceeded our expectations in the third quarter of 2017 primarily due to the reasons Brian cited earlier. Revenue per student also increased between years, primarily due to one additional day of traditional campus revenue in the fall semester of 2017, as compared to 2016, and six additional days of revenue from our summer term in 2017, as compared to 2016, due to favorable shifts in the timing of our residential traditional campus start date.

Online revenue per student was up slightly year-over-year. Scholarships as a percentage of revenue increased from 15.2% in the third quarter of 2016, to 15.7% in the third quarter of 2017, due primarily to a slight increase in online scholarships year-over-year, and the growth in ground traditional students. Although, ground scholarships as a percentage of the related revenue are down year-over-year, there are more ground students and their scholarship rate is much higher than the online students.

Bad debt expense as a percentage of revenue stayed flat at 2.3% for the third quarter of 2017, compared in third quarter of 2016. Our effective tax rate for the third quarter of 2017 was 35.1%, compared to 34.2% in the third quarter of 2016.

The effective tax rates for both quarters were lower than our annual effective tax rates due to the contributions made in lieu of state income taxes to school sponsoring organizations. Our contributions decreased from $4 million in Q3 2016, to $2 million in Q3 2017. As you might recall, these payments had the effect of increase in general and administrative expenses in the third quarter of each year, and these payments reduced dollar-for-dollar our state income taxes.

Three quarters of the lower 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 a lower tax rate in the fourth quarter.

The decrease in contributions over the prior year was offset by the adoption of the share-based compensation standard in the first quarter of 2017, which resulted in the recognition of excess tax benefits from share-based compensation awards that vested or settled in 2017 to be recorded in the consolidated income statement. Previously they were recorded directly to equity.

Our effective tax rate of 35.1% for the third quarter was higher than the rate we projected at 33.9% primarily due to the higher income before taxes, which lowered the impact of our discrete tax items.

We did not purchase any shares of our common stock in the third quarter 2017, but did purchase 10,000 shares subsequent to the end of the third quarter at a cost of approximately $850,000. We had $99.2 million available under our share repurchase authorization as of September 30, 2017. Our Board of Directors has extended the expiration date for our share purchase program to December 31, 2018.

Turning to the balance sheet and cash flows. Total cash unrestricted and restricted and short-term investment at September 30, 2017, was $345.4 million. Accounts receivable net of the allowance for doubtful accounts is $12.2 million at September 30, 2017, which represents 4.8 days sales outstanding compared to $10.4 million or 4.5 days sales outstanding at the end of the third quarter of 2016.

CapEx in the third quarter of 2017 excluding our offsite development of $0.8 million was approximately $25.1 million or 10.6% of net revenue. The campus building projects (11:15) for the 2017-2018 school year completed on or under budget. Total CapEx for the year is still estimated to be between $80 million and $100 million excluding the offsite development and additional land purchases that have been or might still be made adjacent to the campus. We continue to have $150 million available to borrow on our line.

Last, I'd like to provide color on guidance we have provided for the fourth quarter of 2017. We have upped our ending enrollment and revenue guidance for the fourth quarter of 2017 due to us exceeding our online enrollment expectations at the end of the third quarter and due to higher projected ancillary revenues. Our enrollment guidance still assumes mid-single-digit new start growth in the fourth quarter 2017.

Our guidance also still assumes a slight increase in retention and an increase in graduates between years. 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 graduates exceed our total enrollment growth rate.

We continue to estimate our total ground enrollment, ground traditional and professional study students to be 18,800 at year-end. Our revenue guidance continues to assume no tuition increase for our ground campus or our online campus, and continues to reflect a $1.1 million decrease compared to the prior year for the one day shift in the start date of the ground traditional campus. The estimated margin for the fourth quarter is consistent with what we have previously provided as expenses are tracking in line with expectations. Continue to invest in new program development and various community projects.

Our effective tax rate of 37.4% in Q4 continues to be our best estimate at this time. The lower rate includes the effective contribution in lieu of state income taxes and share-based compensation and thus will be impacted by fluctuations in our stock price and differences in the timing of estimated option exercises. Although, we might repurchase additional shares during 2017, these estimates do not assume repurchases.

I will now turn the call over the moderator, so that we can answer questions.

Question-and-Answer Session

Operator

Our first question comes from Peter Appert of Piper Jaffray. Your line is open.

Peter P. Appert - Piper Jaffray & Co.

Thank you. The strength, Brian, in online starts is pretty impressive, particularly against these tough comps you're facing. And I'm wondering, if it gives you any reason to rethink your longer term expectations in terms of growth that's part one. And then part two is just any more color you can provide in terms of the drivers of the online strength in particular?

Brian E. Mueller - Grand Canyon Education, Inc.

No. We're still – we are ahead of what we've been telling people, but we do expect this to slowdown next quarter. And so, we've been saying for a number of quarters now that the comps do get tougher. We did exceed our expectations to some extent this quarter, but we do expect that to slowdown in the next couple quarters and be more – meet more in terms of what our long-term guidance has been.

The drivers are the building of the brand. The brand is very strong and it resonates to our surprise throughout the country. For a while, we were talking about this being mainly a Southwest play, but our brand is getting very strong in other parts of the country and people recognize the name and so that's one part of it.

The advertising strategies have been very effective. They've communicated our message very efficiently. And, but I think still the most important thing is, the students that we're getting from the new programs. I have been saying for a while that the most important part of strategy for this business is to understand where the economy is going, where the jobs are going to be and develop programs that will help people gain those jobs. And we're trying very hard to do that and I think that's the biggest reason we're exceeding our goals in the short run. But the numbers are getting big. So, we're trying to caution people about that.

Peter P. Appert - Piper Jaffray & Co.

Got it. Okay. Thank you. The 10,000 shares you repurchased it's like almost a teaser I think in terms of not even toe in the water, thought process in terms of maybe stepping up the share repurchase plan?

Brian E. Mueller - Grand Canyon Education, Inc.

Well, somebody will probably ask this question later anyway. So, we'll just answer it now. We, obviously what's going on at Purdue and with Kaplan, people are asking the question about whether we would go back and consider that and the answer is, yes. We have not made a decision to do that, but consider it, yes, we would. And so, in case we would decide to more aggressively pursue a not for profit status and a for-profit public traded service company, which we think we would be well positioned to execute on if we decided we want our cash balance to be as large as possible.

And so, you can expect us to be more aggressive as that cash builds up but we have some big decisions to make in the next number of months and we want that cash amount to be as high as possible.

Peter P. Appert - Piper Jaffray & Co.

Understood. And then just on that for a second Brian, can you expand on sort of what the decision criteria are, what you need to see that to move forward, what the structure could potentially look like?

Brian E. Mueller - Grand Canyon Education, Inc.

It's the rules, they're going to establish rules in November, and so the criteria...

Peter P. Appert - Piper Jaffray & Co.

(17:10).

Brian E. Mueller - Grand Canyon Education, Inc.

Yes, yeah.

Peter P. Appert - Piper Jaffray & Co.

Yeah, okay.

Brian E. Mueller - Grand Canyon Education, Inc.

Yes, the Higher Learning Commission is going to do that and we want to see what those rules are, what that language is, and if that makes sense for us then we would possibly move forward, but we need to wait until that comes out.

Peter P. Appert - Piper Jaffray & Co.

Got it. And then one last thing for Dan, in terms of preliminary thoughts on CapEx for next year, it sounded like perhaps the building program steps up again is that correct or not?

Daniel E. Bachus - Grand Canyon Education, Inc.

It's consistent with what we've been saying, we want to average about $100 million a year excluding the potentially land purchases. This year will be, a little bit below the $100 million. Next year, we expect it to be a little bit above the $100 million, as high as maybe $120 million, next year and so. But over the five-year period as we've been saying, we continue to believe that we'll average about $100 million.

Peter P. Appert - Piper Jaffray & Co.

Understood. Okay. Thanks very much.

Brian E. Mueller - Grand Canyon Education, Inc.

Thank you.

Operator

Our next question comes from Jeff Silber of BMO Capital Markets. Your line is open.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Thank you so much. Just going back to the online growth, and forgive me, I think, you just spoke a little bit too quickly for my pen, can you just give us a little bit more color with, was it spending more? I mean, you mentioned the strength of the brand, but I'm just curious if there were any changes in the rate of spend that you did.

Brian E. Mueller - Grand Canyon Education, Inc.

No. We're spending what we anticipated spending. We're within budget with regards to the advertising budget. It's just the messaging is becoming more effective. It's becoming much more efficient. And we generate far fewer leads and convert them at a much higher rate. And so we attribute that to the efficiency and effectiveness of the messaging, but also the strength of the brand.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Okay, great. And I know, everybody asked it this quarter, so it will be my turn this time. From a competitive perspective, I know, it's obviously a competitive area, any change over the past few months, any new competitors coming in, going out, et cetera?

Brian E. Mueller - Grand Canyon Education, Inc.

Not really. And we talk to our people every two weeks in a major meeting, and no, we have not noticed any significant difference in the last couple months.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Okay. Fantastic. Thanks so much.

Brian E. Mueller - Grand Canyon Education, Inc.

Yeah.

Operator

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

Chris Howe - Barrington Research Associates, Inc.

Good afternoon. This is Chris Howe sitting in for Alex Paris. Just in relation to some of the previous comments that were made by Peter. Could you perhaps provide some general commentary on some of the improvements to this advertising strategy? And as I was thinking about some of your competitors and how they did it in the past, do you use third-party lead generation?

Brian E. Mueller - Grand Canyon Education, Inc.

Well, that's the big change, we've been be able to move away from that to a large extent and that's a major shift. We're getting a high-quality messaging out there with television campaigns, social media campaigns and that messaging builds the brand, drives a lot higher quality of person who is interested in your program. We need fewer of those people to be interested and we put them into class at a higher rate. So, and that's been going on for a couple years now.

Chris Howe - Barrington Research Associates, Inc.

Okay. And then you had commented about CapEx expectations for this year and also next. Would you be able to provide any commentary on depreciation and amortization and/or stock compensation expense?

Daniel E. Bachus - Grand Canyon Education, Inc.

Yeah, sure. So, we have seen a pretty significant year-over-year increase in depreciation and amortization as a percentage of revenue, this year and the year before because of the huge CapEx billings in the years prior to that. Given that this year has ticked down, we expect depreciation and amortization maybe to be up 10 basis points or 20 basis points year-over-year. Next year could be flat to up 10 basis points to 20 basis points. So, that will be slowing on a year-over-year basis as a percentage of revenue as will stock-based comp.

So, stock-based comp could be up, it could be flat to as much as 10 basis points or 20 basis points up year-over-year. But you won't see big year-over-year increases in those amounts as a percentage of revenue going forward.

Chris Howe - Barrington Research Associates, Inc.

Okay. And then one last question if I may. You had previously made some comments about the success and the acceleration in enrollments that you're seeing from the Midwest and from states like California. Has the message started to resonate even further outside of these success areas, perhaps into new hidden gems within the geography?

Brian E. Mueller - Grand Canyon Education, Inc.

Yes, really on both sides of it. We were moving in a direction of being a more Southwest play for a number of years and then because of national TV, cable exposure and other things we have become again, a very national university. And so that would – and so I'm talking about from an online student perspective. From a ground based perspective we have, we were at – 60% of our students were from Arizona at one time, that's down to 50% now. We expect that to be significantly under 50% next year as the campus grows. And so for a number of years this was primarily on a ground campus, was Arizona and California. But it – we are expanding our reach into different parts of the country now and getting very high quality students and are very excited about that.

Chris Howe - Barrington Research Associates, Inc.

Thank you for taking my questions.

Brian E. Mueller - Grand Canyon Education, Inc.

Yeah.

Operator

Our next question comes from Jeff Meuler of Baird. Your line is open.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Yeah. Thank you. Hey, Brian, if you do decide to pursue the for-profit service or strategy and not-for-profit university, what will the plan be for the dorm ownership? Like, will that be with the not-for-profit university or will the dorms be owned and serviced by the for-profit service or co.?

Brian E. Mueller - Grand Canyon Education, Inc.

If you go back two years to what we talked about two years ago, the plan was for the not-for- profit university to acquire the dorms and there's been no discussion of doing something different than that. So, I would assume that if we did move forward, it would be the not-for-profit would own those dorms.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Okay. And then on the guidance assumption in terms of the mid-single-digit online enrollment growth in Q4, you just sustained high-single digits into a meaningfully tougher year-over-year comp. So on the Q4 assumption, are you seeing the deceleration and to the extent to which you are at this point can you call out, I guess, any color in terms of geographies, programs, et cetera where deceleration maybe occurring?

Brian E. Mueller - Grand Canyon Education, Inc.

No. Not really, not in terms of geography or really in terms of programs. It's just a slight deceleration based upon really the law of large numbers. We have 90,000 students now. So, we've tried to be very careful in saying that over the last couple years, we expect this to eventually slow down and it to become a normalized rate. And, we just expect that to start fairly soon.

Daniel E. Bachus - Grand Canyon Education, Inc.

We did our budgets for the beginning of the year or at the beginning of the year that the assumption that within there is, because of how – what the numbers were a year ago. Just as Brian said, the law of large numbers in a – in a period of time that's not your typical back-to-school time. And so, that's still our expectation at this point.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Okay. But are you like seeing it in October to starts and lead flow or is it more the guidance assumption?

Brian E. Mueller - Grand Canyon Education, Inc.

Yeah, the assumption.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Okay. And then can you just help me on the – the cyber security warfare facility? I – I – what kind of programs are these? Are these online programs, are they on ground programs, are they traditional aged students, are they degreed, what types of offerings are you envisioning there?

Brian E. Mueller - Grand Canyon Education, Inc.

All of what you just said, we – we have – we have formed a partnership with organization called ACTRA, which has some very high profile players in it around a national movement to – to part – to strengthen everything around cyber security. And – and so we – and in Arizona, we have a warfare range in the East Valley. They came to us and asked if we would work with them on – on warfare range in the West Valley, which we have, and we've now completed that.

And we're bringing in some pretty high-profile people for training. We'll turn all of that into the degree programs and certificate programs for students. There are depending upon who you believe, 500,000 jobs available right now in cyber security positions, and so I think, the opportunity is tremendous, and we would like to be a – a big part of that.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Okay. And then can you just give us some general sense of what the annual revenue is at this point for the ancillary, I'm not talking the room and board, I'm more thinking the coffee and golf and spirit were in all of those things and so what's the rough annual revenue run rate for them and what's the margin profile on it?

Brian E. Mueller - Grand Canyon Education, Inc.

Off the top of my head, I don't remember the exact number, once you take out food and that sort of thing, but it's clearly less than $100 million, it's probably less than $50 million. And the margins on that are less than our margins for the core business. So, they're somewhere between 5% and 15% margins.

Jeff P. Meuler - Robert W. Baird & Co., Inc.

Okay. Thank you.

Brian E. Mueller - Grand Canyon Education, Inc.

With that we've reached the end of our third 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 for your time.

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.