Grand Canyon Education Inc (LOPE) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Grand Canyon Education's third quarter 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. If anyone should require operator assistance during the conference, please press * and then 0 on your telephone keypad. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Brian Roberts, General Counsel. Sir, you may begin.

Thank you, operator. Good afternoon and thank you for joining us today on this conference call to discuss Grand Canyon's 2015 third 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 and 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 that 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 anyone with regard to forward-looking statements made during this conference call.

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

Good afternoon, and thank you for joining Grand Canyon University's third quarter fiscal year 2015 conference call. In the third quarter of 2015, enrollments grew by 10.2%, and net revenues grew by 10.5%. New online enrollments grew in the mid single digits. Total new enrollments grew in the high single digits. Operating margins are at 25.3% for the quarter. The leadership team, the faculty and staff continue to work hard to produce these results, and I again want to thank them for their efforts.

This is our 20th consecutive quarter of beating consensus and raising expectations, and I want to briefly review the differentiated strategies that have led to this success and will guide us going forward. Most important is the commitment to building a high quality student body. Our traditional campus admissions requirement is a high school GPA of 3.0, and our institutional scholarships start at that level. Over 90% of our traditional students are on institutional aid. The scholarship program is weighted toward the highest GPA students, and is helping produce an average incoming GPA of approximately 3.5. Almost 70% of the students are studying in a very rigorous science, technology, engineering, math or business areas.

We started the semester with about 15,500 students attending the Phoenix campus. Our target next fall is 7,200 new traditional students, with the average incoming GPAs again being approximately 3.5. That would bring total enrollment on campus to somewhere between 17,500 and 18,000. Our goal in four years is to have 25,000 students on the campus.

Our online student body continues to grow from a quality perspective as well. 47.5% of our working adults are studying at the graduate level, which is 230 basis points up from a year ago. 67.7% of our students are studying in areas that produce the highest graduation rates. That is a 170 basis point improvement from one year ago. Our third quarter online student persistence rate was 91.9%, which is up 40 basis points from the third quarter prior year. We will continue to grow the online campus at between 6% and 8% per year with high quality students.

Second, we remain committed to a very traditional educational model. The average class size on our Phoenix campus is 25, and online it is 13. In addition, we continue to increase the number of sections taught by full-time faculty, both on ground and online. On our ground campus, our students have over 50% of their classes taught by full-time faculty. Our goal is to grow that to 65% in the next three years. The first six courses in every online bachelor's program are now taught by full-time faculty.

Third, we continue to invest in counselling services for students, and continue to invest in technology to track their performance. President Obama has indicated a significant deficiency that exists in higher education today is the lack of adequate counselling services provided for students. Every student at GCU is assigned a counsellor before they begin their program. Our online students speak to their counsellor a number of times before they start the program, and continue to communicate with them as they move through their program, discussing various topics including course schedule, academic performance, use of library and other academic support services, financial aid, et cetera. On ground, each student has one required appointment per semester, but the majority of our students meet multiple times with their counsellor to discuss similar issues.

Fourth critical quality strategy is the commitment to building new academic programs that are relevant to today's economy and lead to good paying jobs. On our Phoenix campus we have rolled out 17 new programs in the last 12 months, with many of them being in the stem categories. In order to accommodate these stem programs we are building a second engineering building that will have 170,000 square feet of new high tech classrooms and laboratories. The building will be completed by August of next year. We will implement 20 new programs on ground in the next 12 months. We have rolled out 26 new programs online in the previous 12 months. And we'll roll out an additional 31 in the next 12 months.

A fifth critical strategy, quality strategy, is the commitment to invest in educational infrastructure. In the last six years, we have invested hundreds of millions of dollars in classrooms, laboratories, residence halls, eating facilities, fitness and recreational areas, and athletic facilities. We anticipate continuing to invest hundreds of millions of dollars in the next four years. This has become important to Arizona's future because the demand for highly skilled college graduates is increasing. We are proud of the fact that we have made these investments while freezing tuition for our traditional students for the eighth consecutive year.

We continue to pursue a return to a not-for-profit status for the university. I think it's important to note that when the university was on the verge of bankruptcy, going to a for-profit status in order to get access to capital from the public markets was the best thing for our students, faculty and staff, and the community, and has worked out well for investors. We now have an organization, an economic model that is sustainable for years into the future. We don't have a need for a secondary offering.

We now believe that it is in the best interests of our students, faculty and staff, the community and our investors that we pursue a not-for-profit model. I also think it is important to note that all universities who look like us, having a large and vibrant traditional campus as well as having online students, have a not-for-profit status. It is also true that hundreds of not-for-profit universities are outsourcing services, like residence halls, online delivery, food services, et cetera, to service companies, many of whom are for-profit and publicly traded. We believe that 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.

The university has a strong financial position and a strong record of regulatory compliance. The university has no problem with any of the current or proposed regulations placed on for-profit universities by the Department of Education. This includes the 90/10 rule, the gainful employment rule, and cohort default rate limits.

With regards to the 90/10 rule, we are at 76.5% and continue to decline, and this is without any state subsidies. With regards to the loan defaults, our three-year rate for the 2013 cohort will be under 10% when the maximum allowable rate is 40%. Because of our low tuition rate, especially the actual tuition paid by students after scholarships, we do not anticipate any material issues with the gainful employment rule. 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 that all regulatory bodies that oversee the university provide a degree of comfort to any chosen structure will meet with their approval before moving forward.

We have provided extensive information to the IRS and to the HLC. HLC will be performing a site visit in November as required by its change of control regulations. We will continue to work with these regulatory bodies on the structure of the transaction, which is currently a very fluid process. Please keep in mind that there's 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 interests of our shareholders. We will provide updates if and when material developments occur, although it is likely that it will not be until early 2016.

Net revenues were $193.4 million in the third quarter of 2015, an increase of $18.3 million, or 10.5%, from $175.1 million in the prior year period. Operating margin for quarter three 2015 was 25.3% compared to 26.3% for the same period in 2014. Excluding contributions made in lieu of state income taxes in 2015 and 2014, operating margin for Q3 2015 was 26.8% compared to 27.8% for the same period in 2014. It is important to note that tuition and housing has been frozen for eight years on our ground traditional campus and there was no increase in tuition for the online campus for the past three years until the university made a slight increase starting in September 2015 for online tuition, which averaged approximately 1% for online programs.

Net income was $33.3 million for the third quarter of 2015 compared to $29 million in the prior year period. After tax margin was 17.2% compared to 16.6% for the same period in 2014. Instructional costs and services grew from $71.7 million in the third quarter of 2014 to $83.2 million in the third quarter of 2015, an increase of $11.5 million, or 16%. This increase is 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 the occupancy expenses and depreciation expense due to the additional ground campus buildings and higher instructional supplies, licensing costs, food costs and related expenses.

As a percent of revenue, IC&S increased 2% to 43%. Admissions advisory and related expenses decreased 1.4% to 14.2% primarily due to our ability to leverage our admissions advisory personnel across an increasing revenue base.

Advertising expenses as a percent of net revenue increased 60 basis points from 9.4% in Q3 2014 to 10% in Q3 2015. The slight increase is the result of continued focus on digital media and brand advertising in the Southwestern United States region. Marketing and promotional expense as a percent of net revenue decreased 20 basis points from 1.1% in Q3 2014 to 0.9% in Q3 of 2015.

With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2015 third 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 the 19.9% student growth in our ground traditional campus, although we only generated a little over one month of revenue from the fall semester in the third 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 slightly lower online revenue per student will continue.

Scholarships as a percentage of revenue increased from 15.7% in Q3 2014 to 16.3% in Q3 2015, due primarily to the growth in our ground traditional student enrollment between years. Online scholarships as a percentage of related revenue were up slightly year-over-year.

Bad debt expense as a percentage of revenue decreased to 2.1% in Q3 2015 as compared to 2.2% in Q3 2014. This decrease is primarily the result of continued improvements in processes and the quality of our student body.

Our effective tax rate for the third quarter 2015 was 31.8% as compared to 36.1% in the third quarter of 2014. Both quarters had favorable tax effect as a result of the $2.8 million of contributions made in lieu of state income taxes. And the third quarter of 2015 additionally benefited from some favorable non-recurring items as compared to the prior year tax rate. We did not repurchase any shares of our common stock during the third quarter 2015 although it is our intention to put a 10b5-1 plan in place this quarter. We have $25.9 million available under our share repurchase authorization.

Turning to the balance sheet and cash flows, total cash, unrestricted and restricted and short-term investments, at September 30th, 2015 was $226.9 million. Accounts receivable net of the allowance for doubtful accounts is $9.5 million at September 30th, 2015, which represents 4.6 day sales outstanding compared to $8.3 million or 4.6 day sales outstanding at the end of the third quarter of 2014.

CapEx in the third quarter of 2015 was approximately $57.8 million, or 29.9% of net revenue. This was consistent with our expectations. All the major construction for the 2015/2016 school year was completed on time and on budget. Construction will begin in the next 60 days on a 170,000 square foot engineering and technology building, three apartment style dorms, and an additional parking garage for the fall 2016/2017 school year. We currently estimate the 2016 CapEx will be approximately $150 million.

Last, I would like to provide some color on the guidance we have provided for the fourth quarter of 2015. We have reaffirmed our revenue, operating margin and tax rate up 37.5% for the fourth quarter. We now anticipate that our weighted average shares outstanding will be 47.6 million shares.

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

Thank you. (Operator instructions). And our first question comes from the line of Paul Ginocchio with Deutsche Bank. Your line is now open.

Thanks. Brian, you piqued my interest with the commentary around you kind of identified a structure and you're moving through it for early 2016. Is it too much to ask for some color? And maybe is there a -- could you comment on any share price you think you could do that transaction? And thanks.

Yeah, we really can't comment on the structure at this point. We have a very important visit from HLC in two weeks and we're working hard to get ready for that visit. And we think that's going to go well. If that goes well, that will set in motion some other things, and we think we'll know more early in 2016, but we don't want to comment any further publicly on that until we've got some good advice from HLC.

Maybe ask it another way. Will all the share -- all the public shareholders be bought out in this -- in a new structure? Is that always the case or is there some situation where there would be publicly traded shares still out there?

Yes. The second is true. The structure that we're pursuing would allow for people to be invested in the -- in existing structure.

Great. Thanks for that. Dan, just on that slight decline in the online revenue per student, can you just talk about what are the programs that you're seeing the mid shift towards? Thanks.

Yeah, so we're seeing mid shift to a number of programs that just generate, in most cases, more revenue over the lifetime of the program but slightly less revenue on a daily basis. So we're seeing that with some of our new counselling programs that have been rolled out over the last year or two. Those are mostly eight-week three credit programs versus a lot of our other programs that are eight-week four credit or even five-week three credit. We're seeing really good growth in Masters in nursing, which is a slightly lower revenue per student per day program. I think that -- it's really the counselling programs and the Masters in nursing that are driving that.

(multiple speakers).

The mid shift is deliberate on our part. I mean we are working hard to get more students involved in those programs because the retention and graduation rates are high and revenue over the lifetime of student is higher.

And one other -- and we've seen this, but doctoral too. Doctoral, although, you know it has slightly higher tuition rates and a long program, on a day's revenue approach it's actually slightly below average. And we're obviously seeing significant growth in that program.

Great. And Dan, if I could just follow up one more. It looks like you slightly tweaked down enrollment growth for the fourth quarter. Is that correct? And is that related to the slightly fewer nurses that we talked about last quarter or is it something else? Thanks.

Yeah, as we talked about last quarter, we thought that ground enrollment would be about 500 less than what we had projected, and that's what that slight tick down is because of that played out as we expected.

Thank you.

Thank you. And our next question comes from the line of Sara Gubins with Bank of America. Your line is now open.

Hey, this is David Chu for Sara. Correct me if I'm wrong, but you guys revised the ground enrollment to 16,000 from 16,500, and it came in at 15,500. Is that correct?

Yes. About 500 students were the students that we talked about in the last conference call, which is a shortfall on our ground traditional campus, mainly nursing students. And then our cohort students on our campus, that's down a little bit, but a lot of those students have decided to go online. And so the total number is up and good in terms of working adult students, it's just that there's a little bit of a shift away from those that are attending on campus versus those that are attending online. So it didn't affect us from the standpoint of our overall enrollment or our revenue growth.

Yes, but again the reduction -- and I want to make this point very clear -- the reduction in the fourth quarter enrollment number was related to what we talked about last quarter as being a strong likelihood not this other thing that Brian just talked about. That was just a shift between ground and online for some of our cohort students.

Understood. And so last quarter you guys mentioned that, you know, you guys were making some changes to drive online (inaudible). Just wanted to see how these efforts have been going.

They're going good. October is a good month from both a new enrollment standpoint online and a total enrollment growth online. So we're off to a good start for the fourth quarter.

And can you just remind me like what are some of these initiatives in place?

We just moved some enrollment counsellors around. We moved into more productive programs where we're getting a higher level of interest. We had a little bit of a decline in the RN and BSN program and that's now accelerating again. So that's one of them.

Okay. And lastly, just I know it might be a little bit early, but just any initial thoughts on 2016 margin profile?

Yeah, it is too early. We haven't done our budget. You know Brian's talked about trying to raise margins 50 basis points a year, operating margins 50 basis points a year. That will be our goal but we have not started the budget process for next year, so once we do we'll set a goal.

Okay, great. Thanks, guys.

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

Thank you so much. A few weeks ago there was some press reports that the company had decided not to open the campus in Mesa for next year. I just wondering if you can comment about that.

Yes, that decision was made a while back and we were a little bit surprised that it resurfaced, which was fine. And again, it's the same thing. We just -- the growth that we are having on our ground campus, and keeping up with that growth, is consuming. And every dollar that we invest right now on this campus is going to return a lot more to investors than starting new at another location. So we're not ruling out additional locations at some point in the future, but right now to invest dollars on this campus and grow it out to 25,000 will be the best return -- the best not only just for students, but be the best return for investors.

And can you quantify how much was spent on that effort?

No, but it was [not] material. It was minimal. We didn't -- yeah, we put a down payment in some land but that was it.

Yeah. And those costs were written off back a year plus ago when that decision was made.

Okay. Great. I just wanted to clarify that. Thank you so much.

Yeah.

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

Yeah, thanks. Could you give the investors some sense of what the financial implications of the model you're exploring would be? Meaning, you know, will the service (inaudible) likely preserve or retain the vast majority of the company's current EBIT streams? Or if not, you know is there a cash payment for monetization of real estate and it becomes a more capital efficient or CapEx light business? Or just anything that you can say to help investors understand the financial implications of what you're currently exploring, I guess that now we're a year into it? Thank you.

Well I think, you know the goal would be to make sure that this is a deal that's good for investors. And so I think it will be a combination of what you just talked about. I think there would be a return of capital to investors as part of any transaction, and then there would be the ability to participate in the remaining entity on a go forward basis, with the hope that the, you know, ROIC on that business would be equal to if not greater than the ROIC as it currently stands.

Okay. That's helpful. And then I just -- to circle back to this, and I know you said that you want to make it perfectly clear. But yes, it's not perfectly clear yet for me, so maybe I'm just slow today. On the Q4 enrollment guidance being reduced, if that's a result of, you know, the 500 students that you talked about last quarter, why is the Q4 guidance being reduced now if it's based upon something that was known as of the time of the last call?

Well we didn't know at the last call. We gave a good sense at the last call of where we thought that we were going to end up from a ground enrollment standpoint. You're right, you know we could have, and maybe should have brought down that enrollment number guidance for the fourth quarter at that time. But, you know, we didn't know exactly where the ground campus was going to end up and so we didn't. And so, you know, we could take some criticism for not bringing down that enrollment guidance at that time, but that's where we're at.

Okay. And then just finally, what's the total growth CapEx to build out the ground campus to get to the 25,000 student capacity? And now that it looks like you're inflecting it should start throwing off some good free cash flow, what's the plan for the free cash flow in the meantime?

Well I think the question -- the first question is hundreds of millions. We don't know exactly what that number is. You know, it will continue to decline on a raw dollar basis and as a percentage of revenue basis as we go out because the net increase in enrollment year to year won't be as high as it was this year or as high as it will be next year in the future. So that's that first question. The second one, you know we'll explore avenues for our free cash flow as we go.

Okay. Thank you.

Well I think 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.

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