Earnings Call Transcript - LOPE Q3 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q3 2024 Grand Canyon Education Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Dan Bachus, CFO. Please go ahead.

Dan Bachus, CFO

Joining me on today's call is our Chairman and CEO, Brian Mueller. Please note that many of our comments today will contain forward-looking statements that involve risks and uncertainties. Various factors could cause our actual results to be materially different from any 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 position in GCE. And with that, I will turn the call over to Brian.

Brian Mueller, CEO

Good afternoon, and thank you for joining Grand Canyon Education's Third Quarter 2024 Conference Call. GCE had another solid quarter, producing online enrollment growth of 5.8%, and hybrid growth excluding the closed site and those in teach-out, 12.6%. Although we are disappointed that ground enrollment is down slightly year-over-year, this was not unexpected given the widely reported challenges faced industry-wide. We also continue to produce strong retention rates, while investing heavily in initiatives for our university partners. The investment GCE and its 22 partner institutions are making are based on the belief that there is a vast amount of untapped potential in today's workforce. Many recent high school graduates did not go to college this year because of exorbitant tuition rates, potentially exorbitant debt levels and difficulty managing their financial situations. Many older students who could benefit from higher education are not attending because of the lack of creative delivery models that do not take into account their life situations. Grand Canyon Education will continue to grow at our stated goals over the long run because we are addressing those challenges in ways that work for students and employers. With that, I would like to review the results of the four delivery platforms at GCE. First, the online campus at Grand Canyon University. New starts were up again in the third quarter of 2024, and total enrollment growth met our long objectives, up 5.8% over the prior year. The new start growth rate in the low single digits in the third quarter was slightly lower than we had expected. But as we have discussed previously, the year-over-year comparison was extremely tough, given that growth in the third quarter of 2023 significantly exceeded our long-term objectives and which was made more difficult given the third quarter is the largest start quarter of the year. We still anticipate starts for the fourth quarter to be up in the mid-single digits even with what continues to be challenging comparisons. There are many reasons for this, but I want to highlight four. First, we continue to stay hyper-focused on opportunities that exist in today's labor market. Since the beginning of the pandemic, GCU has rolled out 148 new programs, emphases, and certificates across the ten colleges. These programs are tied directly to delivering market opportunities for students. One of the responses of universities to the declining enrollments during the pandemic was to reduce the number of programs they offer. Secondly, we continue to work with employers directly to address their workforce shortages. This effort is focused on the industries of education, health care, technology, public safety, and the military. In the third quarter, new starts from this work increased 7.5% year-over-year. Thirdly, student retention in the third quarter remained strong, which we believe continues because of the relevancy of the programs that students are entering and their direct tie to the student's career aspirations. Lastly, GCU has resisted responding to the slower growth during the pandemic by raising tuition significantly, which many institutions have done. Online net tuition increases since 2018 have averaged approximately 1% per year. The recent partnership between Grand Canyon Education and its largest partner, Grand Canyon University, has produced consistent results over the last 16 years as we stay focused on programs that are a real benefit to students and employers. I want to reiterate that the low single-digit new online start number was due to the above-average growth rates one year ago. Again, we will continue to stay focused on our stated growth plan and believe new start growth will return to mid-single digit rates in the fourth quarter and continue at that level into next year. Second, regarding the GCU ground campus for traditional students, new and total traditional campus enrollment was down slightly year-over-year. Although this is a disappointing result, this is equal to or better than what is occurring nationwide. Department of Education's FAFSA issues caused significant delays in universities receiving the FAFSA data from eligible students. Once they did, millions of forms were found to have errors and needed to be reprocessed, forcing many universities to push back deadlines. As a result of these delays, the number of FAFSA completions among high school seniors is down significantly, including at GCU. According to preliminary data released recently by the National Student Clearinghouse Research Center, freshmen enrollment dropped more than 5% from last year at colleges and universities, including public and private four-year schools that admit the largest share of students receiving Cal Grants with freshmen enrollment dropping by more than 10% from 2023 levels. Our percentage of ground traditional students that receive Cal Grants is comparable to state universities. GCU ended its recruiting cycle up year-over-year as was expected in applications and registrations with students that did not complete the FAFSA, but was down in applications and registrations with students that completed the FAFSA. GCU will be able to re-accelerate growth on the ground campus because of GCU's significant advantages, including a very low price point, very low average debt levels, the percentage of students completing in less than four years, and the relevancy of GCU academic programs. We anticipate that GCU will benefit from both trends. We will continue to focus on meeting GCU's growth goals for traditional students attending on GCU's campus, with a goal still being 50,000 and focusing on traditional-aged students across the country who want to do their academic work from home. It is our understanding that the Department of Education continues to work on fixes to the FAFSA issues and that the initial results have been positive. We believe that this, along with a number of strategic changes we have made to address this specific challenge for 2025-2026, will help us meet the university's new enrollment growth goals of a 15% increase in new enrollments over 2024-2025. Third, Grand Canyon Education's hybrid campus had an increase in enrollment year-over-year, up 8.1% in the third quarter. Excluding the closed site and those that are on teach-out, enrollment increased 12.6% year-over-year. New fall enrollments, excluding the closed site and those that are on teach-out, were up approximately 10% year-over-year, slightly better than our projected mid to high single-digit growth year-over-year expectation. We expect the new enrollment growth rate in the spring of 2025 to show similar growth on a year-over-year basis. There are two main reasons for this continued growth. Firstly, almost all our active ABSN partners have responded to the younger students interested in ABSN programs by admitting advanced standing students or are in the process of making the change. Students with partially completed degrees haven't accumulated a great deal of debt and are very interested in nursing careers, but didn't have an efficient way to earn prerequisite science coursework. GCU created the science courses and some other GenEd courses so they can be delivered online in eight weeks. Students can access these courses from anywhere in the world. There are start opportunities almost every week. These courses have been made very affordable, are taught by experienced faculty, class sizes are low, and there's a tremendous amount of academic support, including an artificial intelligence project that went live in October 2023, providing students 24/7 access to tutoring. Since implementing these courses, we have already enrolled approximately 11,522 students. We have a waterfall report that allows us to know how students are progressing through their prerequisite courses and when they will be eligible to start at one of our ABSN sites. The success rate of students who successfully entered the ABSN program is in the high 80s, and the first-time pass rate on the NCLEX exam is approximately 90%. We now have an extremely efficient way to get students academically eligible and prepared to enter the program. These positive results, we anticipate will continue. There has never been greater interest among potential students for entering the healthcare professions and specifically nursing. Because of the low unemployment rate, the interest has shifted to these younger students who haven't accumulated a great deal of debt, are completing their Bachelor's degree in another area, and are currently underemployed. Nearly all our partners have responded positively to the changes needed to serve the advanced standing students. Our goal is to still have 80 locations with our partners, with 40 of those locations being GCU locations. Fourth, the Center for Workforce Development at Grand Canyon University. In the 2022-2023 school year, we started 80 students in GCU's electricians pre-apprenticeship program, in partnership with companies experiencing labor shortages in that area and who are excited about hiring these graduates. The program consists of four credit courses and runs for one semester. 74 students successfully completed the program in the first year. This past school year, we started 233 students in the program. 123 students completed this program in the fall and 82 in the spring of 2024. GCU has 164 students enrolled in this program in the fall of 2024, including 23 in Austin, Texas. A year ago, GCU also started 19 students in the manufacturing certificate program and has 23 students in that program this fall. GCU is running a small parts manufacturing business on campus that is doing work for some of the major companies in Arizona. These students attend school for 20 hours a week and then work in the facility as paid employees for 20 hours. At the end of the semester, they receive a manufacturing certificate and become eligible for employment in Arizona's fast-growing manufacturing industry. GCU's growing engineering college also has students assisting with this project. Once this concept has been successfully proved out, we expect to work with GCU to scale this program and then add others. I started out talking about the relevant programs and creative delivery models that GCE has implemented with its 22 partner institutions. In the past six-plus years since GCE has become a service provider, it has helped its partners accomplish significant achievements: GCE has helped Grand Canyon University graduate 175,209 students, 47,419 in education, including 22,492 first-time teachers at a time when teacher shortages have created a national crisis. 47,615 in nursing and healthcare professions, including 2,594 pre-licensure nurses at a time when there is a significant shortage of nurses. 35,211 in the College of Humanities and Social Sciences, including thousands in counseling and social work, where there are also major shortages. The College of Business has become one of the largest business schools in America, producing 30,577 graduates. The College of Science, Engineering, and Technology has grown by 218% and provided 7,127 graduates. The Doctoral College, Honors College, and College of Theology also continue to grow. Additionally, GCE has helped its other partners graduate 17,644 pre-licensure nurses and occupational therapist assistants. The numbers that I've just cited have all happened in the past six-plus years since the GCE-GCU transaction and since GCE has become an education services provider. Service revenue was $238.3 million for the third quarter of 2024, an increase of $16.4 million or 7.4% compared to $221.9 million for the third quarter of 2023. The year-over-year increase in service revenue was primarily due to an increase in GCU enrollments of 4%, an increase at our off-campus classroom and laboratory sites of 8.1%, and an increase in revenue per student year-over-year. Operating income for the three months that ended September 30, 2024, was $48.2 million, an increase of $6.7 million compared to $41.5 million for the same period in 2023. The operating margin for the three months ended September 30, 2024, was 20.2% compared to 18.7% for the same period in 2023. Net income increased 16% to $41.5 million for the third quarter of 2024 compared to $35.7 million for the same period in 2023. GAAP diluted income per share for the three months that ended September 30, 2024, is $1.42. As adjusted, non-GAAP diluted income per share for the three months ended September 30, 2023, is $1.48. With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2024 third quarter, talk about changes in the income statement, balance sheet, and other items as well as to discuss the updated 2024 guidance.

Dan Bachus, CFO

Thanks, Brian. Included in our Form 8-K filed with the SEC, we have included non-GAAP net income and non-GAAP diluted income per share for the three months ended September 30, 2024, and 2023. The non-GAAP amounts exclude the tax-affected amount of the amortization of intangible assets of $2.1 million in the third quarters of both 2024 and 2023, and the tax-affected amount of the losses on fixed asset disposals of $0.4 million for the three months ended September 30, 2023. We believe the non-GAAP financial information allows investors to develop a more meaningful understanding of the company's performance over time. As adjusted, non-GAAP diluted income per share for the three months ended September 30, 2024, and 2023 is $1.48 and $1.26, respectively. Service revenue was slightly lower than our expectations in the third quarter of 2024, primarily due to lower-than-expected revenue per student and slightly lower-than-expected enrollments. As Brian discussed earlier, online and ground traditional enrollments were slightly less than expected, while hybrid was slightly higher than we expected. We continue to see a decline in professional study students, working adult students attending GCU's ground traditional campus in the evening. These enrollments are included in the ground enrollment number reported in our filings. Although revenue per student continues to grow on a year-over-year basis, primarily due to the growth in hybrid ABSN students, which generate significantly higher revenue per student than we earn on the other students, the growth was slightly less than we expected in the third quarter for two primary reasons. First, the net tuition rate for GCU's ground traditional campus was slightly less than we expected as scholarships were higher than expected. Secondly, ancillary revenues were less than expected. Residential enrollment was slightly less than expected. However, we also saw a decline in student spend, which we believe is the result of inflationary pressures. As expected, the increase in revenue per student was also due to the timing of the fall semester for the ground traditional campus. The fall semester started two days earlier in 2024 than in 2023, which shifted $2.2 million in service revenue from the fourth quarter of 2024 to the third quarter of 2024. Additionally, contract modifications for some of our university partners, in which the revenue share percentage was reduced in exchange for us no longer reimbursing the partner for certain faculty costs, had the effect of reducing revenue per student. Our operating margin in the third quarter of 2024 was higher than our expectations, primarily due to lower spending than expected. Although we continue to invest to meet our clients' growth goals, headcount, and certain other spending were less than projected. The third quarter operating margin was also positively impacted on a year-over-year basis due to the timing of the fall semester start and contract modifications. Our effective tax rate for the third quarter of 2024 was 20.8% compared to 19.3% in the third quarter of 2023 and our guidance of 20.8%. The effective tax rate increased year-over-year due to higher state income taxes, partially offset by higher contributions in lieu of state income taxes year-over-year. Contributions in lieu of state income taxes of $4.5 million were made in July 2024. These contributions have the effect of increasing G&A expenses in the third quarter by this amount and decreasing the effective tax rate in the third and fourth quarters by this amount, roughly three-quarters in the third quarter and one-quarter in the fourth quarter. Excluding the impact of the contributions in lieu of state income taxes, our effective tax rate would have been 24.9% in the third quarter of 2024 and 23% in the third quarter of 2023. We repurchased 272,497 shares of our common stock in the third quarter of 2024 at a cost of approximately $39.3 million, and another 133,792 shares were repurchased since September 30, 2024. We have $146.4 million remaining available as of today under our share repurchase authorization. The Board and the company intend to continue using a significant portion of its cash flows from operations to repurchase shares, and we anticipate daily purchases during the rest of 2024 and early 2025 will be accelerated from what was purchased year-to-date. Turning to the balance sheet and cash flows. Total unrestricted cash and short-term investments as of September 30, 2024, were $263.6 million. GCE CapEx in the third quarter of 2024, including CapEx for new off-campus classroom and laboratory sites, was approximately $9.6 million or 4% of service revenue. We still anticipate CapEx for 2024 to be between $30 million and $40 million. Last, I'd like to provide color on the guidance we have provided in our 8-K filed today. As a reminder, the guidance that we have provided in the outlook section of our 8-K filed today is GAAP net income and diluted income per share with a component to adjust the GAAP amount to non-GAAP as adjusted net income and non-GAAP as adjusted diluted income per share. We have updated full-year 2024 guidance to include the third quarter revenue and earnings results. We have narrowed the fourth quarter revenue range using actual fall semester ground traditional campus and hybrid enrollment and current revenue per student trends. We continue to anticipate that new online enrollments will be up year-over-year in the mid-single digits in the fourth quarter of 2024, although the comparisons remain difficult. We have slightly increased the midpoint of our revenue guidance from previous estimates as we estimate that higher hybrid and online revenues will offset the lower ground campus revenue. On the expense side, we have adjusted our assumptions for current spending trends and for the investments that are planned during the rest of the year, primarily in headcount to meet our clients' growth expectations in 2025, resulting in a slight increase in operating income for the quarter. We anticipate the hybrid pillar will continue to lose money during the remainder of 2024, given that a number of mature sites remain significantly below pre-COVID student counts. The newer sites are generally back to historical margin profiles as they are growing at rates more similar to what we experienced pre-COVID. But to return to profitability, the mature sites need to achieve pre-COVID enrollment levels. Those that are now admitting advanced standards are generally back to growth, while those that are not generally continue to see enrollment challenges. In estimating interest income for the fourth quarter of 2024, we assume cash balances will decline as we use more of our excess cash to buy back stock. We have reduced the effective tax rate for the fourth quarter of 2024 to 21.2%. Our weighted average shares guidance assumes the increased buyback activity. The Board continues to authorize the repurchase of shares, as we believe the stock remains undervalued based on the metrics that it uses to evaluate, including the ratio of enterprise value to adjusted EBITDA and the free cash flow yield rather than the multiples of other education companies, as although we can be viewed as being in the same sector, there are few, if any, appropriate comparables. Although we do not give 2025 financial guidance until our next quarter's earnings call, as we have just recently kicked off our 2025 budget process, given the significant changes that have occurred with some of our hybrid contracts during 2024, I thought it would be helpful to provide some color on the impact these changes will have on 2025 revenues and on our preliminary expectations for 2025 revenues. We estimate that the contract modifications and site closings will lower revenue by $8.9 million in comparison to 2024, but this reduction will have only a minimal impact on operating income. Excluding these items, we currently anticipate hybrid revenues will be up year-over-year in the high single-digit low teens, and we are hopeful that our hybrid pillar will come close to breaking even. This growth rate is impacted by the fact that we have 10 locations that are at or near full capacity, and thus, we will have little to no growth year-over-year in total enrollments at those locations. We are hopeful that many of these locations will get approval to grow in the future as they currently have waitlists. Excluding the impact of leap year in 2024, which we estimate to be $1.6 million, online enrollments and revenue should continue to grow in the mid-to-high single digits year-over-year, while ground revenues will be relatively flat year-over-year in the first eight months of the year and up in the mid-to-high single digits in the last four months as new enrollment growth will be partially offset by the increasing percentage of graduates. I will now turn the call over to the moderator so we can answer questions.

Operator, Operator

Our first question comes from Ryan Griffin with BMO Capital Markets.

Jeff Silber, Analyst

It's actually Jeff Silber with BMO. Had a few questions. In your prepared remarks, you talked about the lower student spend. I think it was at the ground that is specifically because of higher inflation. Can we get a little bit more color on that, is that something new? I mean, inflation has been around for a few years. I'm just curious why it's impacting you now?

Brian Mueller, CEO

Inflation is probably a little delayed in its impact because higher education is such a big picture item, and there was a strong mandate to go to college if you're going to be successful. I think it took people a while to catch up to the fact that some very hard realities middle-class families had to face. But we think we're through that. We're very excited about what's going to happen on our ground campus next year for three reasons. First, we have plans in place to deal with the FAFSA problem. We have strategies that we believe are going to be very successful, and a lot of schools in the state are excited about what we can provide for students, even if there are delays from FAFSA’s perspective. So we're prepared for that now, and our percentage of those students is going to go up. Secondly, middle-class students, whom we lost some of those because parents were very nervous about sending them away from campus and incurring debt, we’re seeing some of that subsiding. Most of our programs now allow students to graduate in three years, and the word about the ability to come here, graduate in three years, and with a minimum amount of debt is starting to circulate in a way that we think will increase the number of out-of-state students willing to come because of low debt levels. And thirdly, many of the offers being made to students, especially by some of our in-state universities, are no longer there. Both the University of Arizona and Arizona State University recently announced a $350 surcharge on every one of their students in the middle of the semester due to a $25 million shortfall. The University of Arizona has significant financial issues. To keep their growth goals, they might have made offers to students that haven't worked out financially. We didn't do that; we have stayed very true to our scholarship program, and we believe this will help our percentage of in-state students go up. Some of the shortfall this year from a revenue standpoint is due to extra spending; students didn’t spend as much money in our bookstore during welcome weeks. Ancillary revenues were down, just as they are down almost everywhere in the country. These factors did impact us, but we believe we're through that to a large extent. The results of the election will likely give middle-class families more confidence that their financial situations will improve, and that they will be doing their children a disservice by not supporting them in going to college. We’re ready to have a big year on our ground campus this year and rebound significantly.

Dan Bachus, CFO

The only thing I would add is that we benefited in previous years from the fact that GCU's ancillary revenues grew at a faster pace than overall revenues. Surprisingly, this year, for reasons like Brian explained, ancillary revenues have actually grown at a slightly lower pace than other revenues. It was just a weird anomaly that we believe, as Brian mentioned, was tied to inflationary pressures families are experiencing.

Jeff Silber, Analyst

Brian, you mentioned the elections, so that's a good segue to my next question. Obviously, it should benefit or hopefully will benefit the parents as you had mentioned. But I'm just curious from you as a company, what do you think the potential changes in funding could be under a Trump administration?

Brian Mueller, CEO

Well, I think it has to do with what the future is as much as what the past has been. There are a lot of rules being discussed for future implementation in higher education that are not going to be helpful to students and are not going to be helpful to the economy. What I stated earlier in my remarks is that there is a vast amount of untapped potential in today's workforce. We had six online graduations a couple of weeks ago. We had a lady who is 60 years old and attended our ABSN site, graduating nursing and now she is going to make a 15-year career in one of our hospitals. We had a lady who gave a graduation speech who's 42 years old, becoming a math teacher in the Newark public school districts and is set for a 20-year career. Some of the restrictions being discussed, like the gainful employment restriction on teachers, are counterproductive to what we are doing here and what is necessary to produce more teachers. We believe we have a voice in what’s important for the future of higher education under this administration. The creative delivery models we have developed allow people in the workforce to transition into crucial areas that other universities are not addressing due to their lack of creativity. An economic development report recently revealed how much we contribute to the economy compared to many state institutions. This new administration will likely be interested in understanding why we're succeeding, and we are excited about the next few years ahead.

Operator, Operator

Our next question comes from the line of Steven Pawlak with Robert W. Baird.

Steven Pawlak, Analyst

Brian, there’s softness in new online enrollment. Could you help us understand what might be driving that? Is it the labor market or demand for certain programs? Any details regarding some of the softness there?

Brian Mueller, CEO

No, we’re trying to grow our new online enrollments by 5% to 6% per year. We want total enrollments to grow at 7% per year, focusing on high-quality students. We want to produce great graduation rates. We're committed to ensuring that the students we admit can graduate and contribute positively to the economy. In this quarter, we staffed and spent the same amount but over produced a year ago, so it doesn’t appear that we had a good quarter. The raw numbers are very good; it’s just that the year-over-year comparisons don’t look favorable, but we're on target for the fourth quarter to again grow in the mid-single digits for new enrollment. We're actively planning for next year and believe it will sustain that level going forward. Additionally, we’re very excited about recent progress in our hybrid programs. The revenue per student in those programs is significantly high, and our retention and completion rates are strong. As this initiative progresses, we’re very optimistic about the next four years.

Steven Pawlak, Analyst

And then Dan, just to clarify, the 225 framework. Is the hybrid breakeven for the full year, or is that a comment on some crossover at some point during the year?

Dan Bachus, CFO

Well, we haven’t finalized our budget yet, but the goal is to get as close to breakeven for the full year as possible. However, I believe we might start out in the spring with a small loss, and that will improve as the year progresses. We have 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 myself, Dan Bachus. Thank you very much.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.