Grand Canyon Education Inc (LOPE) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Grand Canyon Education second-quarter 2015 earnings call. (Operator Instructions) As a reminder, this conference is being recorded.

Now I'd like to welcome our host for today's conference, Mr. Brian Roberts, General Counsel. Please go ahead.

Thank you, operator. Good afternoon and thank you for joining us today on this conference call to discuss Grand Canyon's 2015 second-quarter results. Speaking on today's call is our President and CEO Brian Mueller and our CFO Dan Bachus.

This call is scheduled to last one hour. During the Q&A period, we will try to answer all of your questions. We apologize in advance if there are questions that we are unable to address due to time constraints.

I would like to remind you that many of our comments today will contain forward-looking statements with respect to GCU's future performance that involve risks and uncertainties. Various factors could cause GCU's actual results to be materially different from any future results expressed or implied by such forward-looking statements.

These factors are discussed in GCU's SEC filings, including our annual report on Form 10-K for the fiscal year ended December 31, 2014, our quarterly reports on Form 10-Q, and our current reports on Form 8-K. We recommend that all investors thoroughly review these reports before taking a financial position in GCU. And we do not undertake any obligation to update any one with regard to the forward-looking statements made during this conference call.

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

Good afternoon and thank you for joining Grand Canyon University's second-quarter fiscal-year 2015 conference call. In the second quarter of 2015, enrollments grew by 9.1% and net revenues grew by 10.2%. New enrollments grew in the low single-digits. I will explain why later in the call. And operating margins are at 24.2% for the quarter. I again want to thank our faculty and staff for the hard work they continue to put in to produce these results.

We are now less than 3 weeks from starting the fall semester on our traditional campus. We are expecting approximately 16,000 ground students, which is a combined traditional and cohort number. That is a 24% increase over prior year.

The average incoming GPA of the traditional students admitted based on GPA will be greater than 3.5 and 60% will be studying in science, technology, engineering, or math. In our Honors College, the average incoming GPA will be greater than 4.0 and the college will have grown in a 2-year time period to over 760 students.

We are starting the year with 35 new academic programs, including electrical, mechanical, and biomechanical engineering. We have added 130,000 square feet of new classroom and laboratory space, 4 new residence halls with 3,200 new beds, 10 new restaurants, and we'll finish a new soccer stadium in October. We are excited about the new theater, music, dance, debate, and athletic seasons, which start in just a few weeks.

The number of returning students for the fall semester appears as if it will exceed our expectations, which is very important. Graduation rates of our most recent large incoming classes is moving in a very positive direction, especially given the rigorous academic programs the students are studying.

We anticipate that we will miss our new student enrollment number on our traditional campus by about 250 campus students and 250 cohort nursing students. The new enrollment goal was very aggressive and we are still perfecting the ground campus growth strategy. We learned a lot this year and we'll make some small tweaks to our advertising strategy, number of counselors, territory assignments, etc., for next year and believe we will meet or exceed our goals.

In spite of missing the new student start number, we will hit the tuition revenue goal on the ground campus because of a higher tuition revenue per student number. Our online campus of working adult students grew by 8.9% to 57,000 students at June 30, 2015. The students in the highest retention categories grew again slightly, from 63.3% to 63.6% of the total.

Our long-term goal is to make the online campus primarily a graduate campus. In order to continue to move in that direction, we plan to add 20 new graduate programs in the 2015 calendar year.

Another differentiating feature of our online delivery model is that 97% of the first 6 undergraduate classes in each program are taught by full-time faculty and 100% of the first graduate courses in each program are being taught by full-time faculty. This is a quality feature built into our online delivery model, as is building the brand of the University, increasing student satisfaction levels, and contributing to high graduation rates.

The approximate 250 new student shortfall on the traditional campus and 250 shortfall of new nursing cohort students will put some pressure on our third- and fourth-quarter overall goals. We have made some adjustments in our online strategy to cover the shortfall and feel good about the initial results.

In the first month of the third quarter -- July -- our online new student growth was up in the teens over the same period in the prior year and total student growth -- enrollment growth was 8% over prior year. These numbers exceeded our expectations.

Net revenues were $174.7 million in the second quarter of 2015, an increase of $16.1 million or 10.2% from $158.6 million in the prior-year period. Operating margin for quarter 2 2015 was 24.2% compared to 23.9% for the same period in 2014. It is important to note that tuition and housing has been frozen for seven years on our ground traditional campus and there was no increase in tuition for the online campus the past three years.

Net income was $25.8 million for the second quarter of 2015 compared to $23.1 million in the prior-year period. After-tax margins were 14.8% compared to 14.5% in the same period in 2014. Instructional costs and services grew from $67.8 million in the second quarter of 2014 to $75.4 million in the second quarter of 2015, an increase of $7.6 million or 11.1%. This increase was primarily due to the increase in the number of faculty and staff to support the increasing number of students attending the University as well as increases in occupancy expenses and depreciation expense due to the additional ground campus buildings and higher instructional supplies and related expenses.

As a percent of revenue, IC&S increased 0.3% to 43.1%. Admissions advisory and related expenses decreased 0.8% to 15.7%, primarily due to our ability to leverage our admissions and advisory personnel across an increasing revenue base.

Advising expense as a percent of net revenue increased 60 basis points, from 9.9% in Q2 of 2014 to 10.5% in Q2 of 2015. The slight increase is a result of continued focus on digital media and brand advertising in the Southwestern United States region. Marketing and promotional expenses as a percent of net revenue decreased 20 basis points, from 1.2% in quarter 2 2014 to 1% in quarter 2 of 2015.

We continue to explore a transaction that would result in converting Grand Canyon University back to its original not-for-profit status, which was the structure it held from its inception in 1949 until financial distress forced it to seek outside investment in 2004. We believe we have identified a potential structure that would accomplish this conversion and allow the University to operate in a manner that's consistent with the hundreds of other public and private universities with which it competes.

However, given the University's strong financial position and record of regulatory compliance, it is imperative that any conversion transaction not jeopardize the University's long-term viability and all regulatory bodies that oversee the University provide a degree of comfort that any chosen structure will meet with their approval moving forward. This is a complex process and we remain at the very early stages of it. Accordingly, we are unable to provide additional information at this point in time, as we work with these regulatory bodies on the structure of the transaction, which is currently a very fluid process.

Please keep in mind that there is a great deal of work yet to be done and no assurance can be given that the transaction will be completed. I also want to emphasize that whether the transaction is completed or not, there will be no change in the University's strategy.

As we have previously disclosed, the Board of Grand Canyon Education has established an independent committee to oversee this process and to ensure that this transaction would be in the best interest of our shareholders. We'll provide updates if and when material developments occur.

With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2015 [second] (corrected by company after the call) quarter, talk about changes in the income statement, balance sheet, and other items.

Thanks, Brian. Revenue per student was up slightly year over year due to us earning one month of revenue from the spring semester for our residential traditional campus in the second quarter. When factoring in room, board, and fees, the revenue per student is higher for these students than for our working adult students.

Online revenue per student was down again this quarter due to the continued mix shift to programs that earn less revenue per student per day. We believe this trend of lower online revenue per student will continue. Although, as I will discuss later in this call, this will be partially offset by a slight online tuition increase that will occur late in the third quarter.

The traditional ground campus summer school enrollment was higher than we anticipated, but the revenue earned per student was down year over year as the number of credits being taken by these students was much lower than in previous years, as expected, as the vast majority of these students took only one or two courses this summer.

Scholarships as a percentage of revenue increased from 14% in quarter 2 2014 to 14.9% in quarter 2 2015 due primarily to the growth in our ground traditional student enrollment between years. Online scholarships as a percentage of related tuition revenue was up slightly year over year.

Bad debt expense as a percentage of revenue decreased to 2% in quarter 2 2015 as compared to 2.1% in quarter 2 2014. This decrease is primarily the result of continued improvements in processes and the quality of our student body as well as the change in the accounting for withdrawn students made in the third quarter of 2014, which has had the effect of reducing our bad debt expense and revenue. Our effective tax rate for the second quarter of 2015 was 39% as compared to 38.9% in the second quarter of 2014.

We did not repurchase any shares of our common stock during the second quarter of 2015. We have $25.9 million available under our share repurchase authorization as of June 30, 2015. The expiration date on the repurchase authorization has been extended to September 30, 2016.

Turning to the balance sheet and cash flows, total cash, unrestricted, restricted, and short-term investments at June 30, 2015, was $197.9 million. Accounts receivable, net of the allowance for capital accounts, is $8.2 million at June 30, 2015, which represents 4.1 days sales outstanding compared to $8.5 million or 4.8 days sales outstanding at the end of the second quarter of 2014.

CapEx in the second quarter of 2015 was approximately $66.2 million or 37.9% of net revenue. This was consistent with our expectations. All of the major construction occurring on campus is currently on time and on budget.

Last, I would like to provide some color on the updated guidance we have provided for 2015. We have lowered revenue and our margin expectation slightly due to the continuing decline in our online revenue per student due to a mix shift to programs that generate less revenue per student per day due to either lower tuition rates or longer program length. We will be increasing our online tuition rates effective September 7 by 1%, which will help offset that.

In addition, we made approximately $3 million of contribution in lieu of state income taxes in the third quarter of 2015, which will be reflected in general and administrative expenses in the third quarter. The offset to this payment is a reduction in our effective tax rate in both the third and fourth quarters.

We now anticipate that our effective tax rate will be 34.6% in the third quarter and 37.5% in the fourth quarter. These changes result in no net change to our expected EPS in the third quarter and a $0.01 increase in expected EPS in the fourth quarter.

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

(Operator Instructions)

Peter Appert, Piper Jaffray.

So Brian, can you give us any additional color on the slight miss in the enrollments? And in particular, I'm wondering on the nursing side, do you think the more intense competitive environment might be part of the issue?

No, I don't think so. The ground campus students -- we had a very aggressive number. And so missing it by just a little bit is not a big deal for us from a long-term perspective. We're still trying to figure out exactly how many people we need out there -- the right markets to put them in so that we can maximize the output that we are getting.

This is kind of a work in progress. You're not really seeing this anywhere else in the country -- this kind of explosive growth on a ground campus. And so we're kind of blazing a new trail here, but if you look at percent increases as we move from one year to the next, they keep going up. So the momentum is very strong, but the slight miss does have a little bit of impact in the third quarter simply because the revenue per student with our ground campus students compared to our online students is greater.

So there will be a little impact in the third quarter. We'll recover from it in the fourth quarter and we'll be fine.

And then I don't think there's anything -- we're going to make a little bit of an advertising adjustment in terms of the cohort program for nurses, but we're not -- we don't see any long-term problem there.

Okay. Thank you. And then I know you can't provide a lot of details on the exploration around the conversion to not-for-profit, but can you give us any sort of time frame in terms of how long you are going to continue to pursue this before you decide if it's a go or no go?

I think another 3 months, another 90 days, and we'll be very close to understanding whether we are going to go or not. I would tell you that the majority of the feedback that we get is positive, but it is complex. And so we want to take our time and make sure that we're doing the right thing.

If we can make this thing work for our investors, it's going to be so positive for our students. Because when you cut that effective tax rate in half or more, it puts us even in a stronger position from a tuition standpoint.

Now if we -- if for some reason this doesn't turn out to be the right time in the next 90 days, the model is very, very stable and we feel very good about it. We haven't raised tuition on our ground campus for 7 years and the margin on those students continues to go up. It will get better if it works, but we feel very good about the model if it doesn't work. So we don't really -- we're not in a position to lose here.

When you say feedback positive, are you meaning from a regulatory standpoint or in terms of financing?

Regulatory -- and from a financing aspect as well. Although that is the complex part of it is to work through all that. But from a regulatory standpoint, we've gotten very favorable feedback.

Okay. Thanks, Brian.

Jeff Silber, BMO Capital Markets.

Thanks so much. Wanted to focus on your decision to raise online tuition. I know you haven't done it in a while and I know it's small, but I'm going to ask a stupid question here. Are you doing this just to make sure that you didn't have to reduce your revenue guidance? Did you study the impact or potential impact on enrollments, etc.?

Yes, we study that all the time. We look at it every week. We look at it by every single one of our programs and if we are competitively priced or not. One way to go would have been to take a look at the programs that are growing -- that have a different revenue per student per day model that don't produce as much revenue -- and raise them.

We thought it would be better to raise across all programs by 1% so that the impact would be very negligible to any particular student or program. And so from an overall standpoint, that would put us in a stronger position.

Okay. Fair enough. And just a quick numbers question. Can you just give us what you are budgeting for capital expenditures for this year? And if you have any insight into next year, that would be helpful as well. Thanks.

Sure. We still believe that we'll be in that same $192 million, $193 million range for 2015. For 2016, we have not finished our forecast for the fall 2016 building year, and so we haven't finalized that. But I think it will be an amount that is lower than what we spent this year, but will that number be $100 million or will it be $150 million? It will probably be somewhere in that range, but we haven't finalized that.

Okay, great. Thank you so much.

Sara Gubins, Merrill Lynch.

Hi, this is David Chu for Sara Gubins. So you mentioned that you made some changes to drive online start growth in the third quarter. What changes did you make?

Where we are putting some advertising dollars -- putting advertising dollars behind some programs that have better potential to grow. And we got some really good result from that already in July. So we feel like we can make up for what we've missed on the ground in the third quarter and be in a good position for the fourth quarter.

So do you expect to kind of maintain that level of spend to drive growth like in the second half?

Yes.

Okay. And then in terms of margins, is the additional costs in lieu of taxes a reason why you lowered margin expectations for the year?

The biggest impact obviously on margin is in the third quarter. And that is the contribution made in lieu, which is approximately $3 million. And so the best way to look at it is to pull that $3 million out and in effect put it back in in taxes. And you will see that we lowered margin a little bit, but we didn't lower it a lot.

Yet in terms of why we lowered margin a little bit, when you take that out, advertising is a small piece, legal and tax and other related expenses is a small piece. So there's nothing really I would say significant. But given that our margins have significantly exceeded our expectations even for this year, we thought it was appropriate to invest the money in places that needed investment.

Okay. Got it. And lastly, Brian, you mentioned that you had identified a potential structure to convert to nonprofit. And I know you can't discuss it in too much detail, but is the structure similar to what you discussed last quarter, where it's a nonprofit campus and maybe a for-profit management team?

Yes, a university that has a not-for-profit status and a service company that has a for-profit status, which is very common in the higher-ed industry -- very, very common. In fact, things are moving that way in a big way, so this kind of just fits into where the momentum is going anyway.

Okay. Great. Thanks, guys.

Jeff Meuler, Baird.

Yes, thank you. On the low single-digit starts growth -- I'm assuming that's online only. Brian, I didn't catch the reason for the slower growth, if that was online only?

Yes, that was online only, because we really didn't have starts -- we had starts, but they aren't very significant. In terms of -- I think it was more timing probably than anything else. April and May were up at levels that were consistent with our expectation. June was a little bit slower than we expected, but July, as Brian said, was over our expectation. So if you look at kind of the four-month period in totality, I think we are equal to, if not slightly ahead, of expectations.

Okay. And then in terms of the quality of the ground student and I know you gave some metrics in terms of the intake. But the overall kind of cut-offs at the low end for GPA and overall quality, is it a similar standard that you use this year to what you've used in past years?

Yes, at one point, we were at 2.75 and you could get into the University, where our admission standards to get in fully admitted now are 3.0. The average incoming GPA for students admitted based upon GPA has gone from under 3.4 to now almost 3.6, so it continues to go up, which is an exciting thing.

But the other reason that it's exciting is because literally 60% of the kids are studying in very, very difficult rigorous academic areas that lead to very good paying jobs. And that is a very exciting thing -- not just for us, but it's a really exciting thing for the state of Arizona to have now a fourth university that will be producing engineering students and computer science students and information technology students; biology majors.

That's what we feel best about. In fact next year, we are adding another four programs in our engineering school. So we are going to more than double the size of that in a one-year time frame.

Okay. And what was the overall acceptance rate for on-ground new applications?

I don't have that number. The number of applications that we are getting runs about -- we've got over 25,000 applications for this year. And so the number of applications that we're getting on an annual basis is going up exponentially.

Some of the students are not going to meet the admissions requirements. Some of the students will not have a good enough GPA to get the academic scholarship that they want. 90%-plus -- almost 90% of scholarships that we give out at Grand Canyon are based upon grade-point average.

It's academic standard. If students don't start here, typically it's because they can't get in -- they are not admittable. Or secondly, they can't get the scholarship they were expecting because their grade-point average is not going to be good enough.

The phenomenal thing -- we started an Honors College two years ago and the thing is just blowing up. I mean, we are almost 800 students in that Honors College. And we've got a separate residential place where they are living and some of the work that they are putting out already is really, really exciting work.

Okay. Thank you.

Adrienne Colby, Deutsche Bank.

Hi, thanks for taking my question. I was wondering if you could comment on how many students you had to turn away this fall due to capacity constraints? So you talked about a 250 miss in terms of your new enrollment goals, but is there something else that we should think about? Again, because you didn't have the capacity on campus for them?

There were certain programs that we don't have capacity for. And so for example, the hit on our nursing program was not for our pre-licensure nurses; it was for our RN to BSN nurses, which doesn't have much of a limit to it. But the pre-licensure for nursing program, for example, is an area that we couldn't take all the demand that existed.

We're out in front of it now from a residential standpoint. That was a big problem for us the previous two years. We built way out in advance this year and so we aren't going to have a capacity problem from that standpoint.

Okay. And can you comment at all about what your expectations are then for fall 2016? Again, in terms of if you are thinking again in terms of how many new students -- if it's 7,000 again that you will be targeting. And in terms of capacity, if you are expecting a similar percent of students will look to live on campus and where you are at in terms of construction for capacity?

Yes. The percent increase will go up again. We are not ready to give you an exact number as we sit here today. We will next quarter, but the percent increase will go up again.

The percent of those living on campus will stay about the same. But if we have a -- we don't expect to have a capacity issue from a residential standpoint next year because we built out in advance this year. If we have any capacity issues, it will be program related, like the pre-licensure program, for example.

Great. And if I can just sneak in one more. In terms of the tuition increase for your online students, will that be for just new students coming in or will it be for all students already enrolled and new students?

It will be for everybody.

Thank you.

Phil Stiller, Citi.

Hi, guys. Thanks. I guess you talked about getting the Phoenix campus up to 25,000 ground students. Just wondering if that's still a target for you guys and what the time frame is for that?

Four years, and that's a minimum number. We still expect at some point we will go past that.

Okay. So that's unchanged.

Yes.

And then the online growth dipped back into the single digits for the first time in a while. I know you talk about July improving in terms of starts, but what's the longer-term outlook for that?

We're still very confident about 6 or 7 percentage points on an annual basis. And then you combine that with our ground campus and we are 8% to 10% enrollment growth on an annual basis, so that hasn't changed at all.

We've been predicting this decline in terms of year-over-year total enrollment growth. And it's really being caused by two things. One, graduation. We're seeing 20%-plus year-over-year graduation increases.

And then secondarily, our retention rate. Although it continues to improve year over year, the rate of improvement is slowing. Where we saw for probably a 3-year period 150 to 250 basis point improvement in that metric, we're now seeing 50 basis points or less.

And so your new starts and your total enrollment growth rates are getting more in line, whereas for a period of three or four years, you saw significant differences between your new start growth rate and your total enrollment growth rate.

Okay. And then lastly on advertising, it sounds like you are increasing it for the remainder of the year. Is this something that we should view as permanent? And what's the target for, I guess, advertising as a percent of revenue?

We were running as low as 9.5%. I would tell you probably 10.5% -- between 10% and 10.5% is where we will be on an annual basis.

Okay. Great. Thank you.

And I am not showing any further questions, sir.

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 either myself, Dan Bachus, or Bob Romantic. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful day, everyone.