Earnings Call Transcript - LOPE Q4 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the Grand Canyon Education's Fourth Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Dan Bachus, CFO. Please go ahead.

Daniel 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 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 GCE. And with that, I'll turn the call over to Brian.

Brian Mueller, CEO

Good afternoon, and thank you for joining Grand Canyon Education's fourth quarter fiscal year 2023 conference call. GCE had another strong quarter, exceeding enrollment expectations with online new starts up in the mid-teens over the previous year and achieving better-than-expected retention rates. We exceeded revenue guidance estimates at midpoint by $3.3 million, delivering a $0.05 beat in adjusted diluted earnings per share compared to consensus, all while heavily investing in initiatives for our university partners. Given these results and the current organic lead flow, there has never been more interest in what Grand Canyon Education and its 25 partner institutions are doing. There is a significant amount of untapped potential in the American labor force today. Some universities still focus on U.S. News & World Report rankings, but such rankings do not address the unmet potential in areas like nursing and teaching, which suffer from shortages due to misplaced priorities. Our success stems from understanding students' life situations and their educational needs. The mix of relevant programs and innovative delivery models drives interest in our offerings. GCU's traditional ground campus caters to 18-year-old high school graduates who can spend three to four years on campus, while the online campus is designed for working adults who can complete programs entirely online. Additionally, we are developing hybrid locations for students who can't commit to full-time campus learning but need some in-person instruction for certain content. Currently, nursing programs are provided in those hybrid settings. We are also creating a new platform for recent high school graduates seeking a distance college experience. I discussed this overview because there are discussions regarding the reasons behind our success in a challenging industry. Higher education must evolve beyond the basic choice of campus or online learning. We face significant shortages in fields like education and nursing due to a lack of innovative delivery models that align with students' life circumstances and educational needs instead of chasing outdated rankings. Scaling these programs and ensuring quality delivery require substantial investments in personnel, technology, and processes, and we remain committed to these investments. Now, let me review the results from our four delivery platforms. First, our online campus saw new starts increase in the mid-teens compared to last year's fourth quarter, with total enrollment growth surpassing our expectations at 10% year-over-year. There are several reasons for this, including our focused approach to current labor market opportunities, with GCU introducing 135 new programs since the pandemic that directly tie to student career opportunities, accounting for 6.7% of new student starts in the fourth quarter. While many universities cut programs amid declining enrollments during the pandemic, we have continued to engage with employers directly to resolve workforce shortages in various industries, resulting in an 18.6% increase in new starts from this effort. Our fourth-quarter student retention improved by 120 basis points, likely due to the relevance of the programs to students' career goals. Importantly, we have maintained modest tuition increases, averaging about 1% per year since 2018, anticipating year-over-year growth in new enrollments of mid to high single digits in 2024. This anticipated growth isn’t due to decreased interest in GCU online but rather the normalization after a surge of online starts in 2023. Second, for GCU's ground campus, we expect enrollment for fall 2024 to return to its regular growth trajectory, with discovered GCU visits up 43% year-to-date. The demand for online attendance remains high among traditional-age students. Given GCU's advantages, including low price points and low average debt levels, we believe we will benefit from both trends. We remain focused on meeting growth targets for traditional on-campus students while also attracting those wishing to learn from home. We are addressing FAFSA delays alongside other institutions. Third, we reported a 3.3% year-over-year decline in our hybrid campus enrollment in the fourth quarter, but we believe this platform has turned around. New fall enrollments were up in the high single digits year-over-year, and we expect over 20% growth in both spring and summer 2024. This shift is largely due to our ABSN partners admitting advanced standing students. GCU has developed online science courses that students can complete in eight weeks, allowing them to become eligible for entry into ABSN programs. Since implementation, approximately 6,816 students have enrolled in these courses. The success rate for students moving into ABSN programs is 90%, with a similar pass rate on the NCLEX exam. There is heightened interest from potential students entering health care fields, especially nursing, and many of our partners have adapted to support advanced standing students. While two partners have not made necessary changes, we will be closing two sites, reducing future losses. For a third site, a partner has decided to terminate the agreement due to underperformance, leading to lower anticipated revenue in the future while also reducing expenses. These site closures do not diminish our enthusiasm for this platform. Our goal remains to operate 80 locations with around 25 partners, with 40 being GCU locations. Fourth, the Center for Workforce Development at GCU recently started 80 students in an electricians pre-apprenticeship program, with positive outcomes. This year, we plan to start 230 students, building on the successful completion of 74 students last year. Additionally, we began a manufacturing certificate program, allowing students to gain practical experience while studying. These initiatives exemplify the relevant programs and innovative delivery methods GCE has implemented. In the past five years, GCE has successfully supported Grand Canyon University in graduating over 154,000 students, including substantial numbers in education and nursing, amidst national shortages. Service revenue for the fourth quarter of 2023 was $278.3 million, marking a $19.6 million or 7.6% rise compared to the same quarter last year. This increase was primarily driven by an 8% rise in GCU enrollments and higher revenue per student. Our operating income reached $97.8 million, up from $90.7 million a year ago, maintaining a consistent operating margin of 35.1%. Net income rose by 13.6% to $80.7 million for the fourth quarter of 2023 compared to the previous year. The GAAP diluted income per share for this period is $2.71, while the adjusted non-GAAP diluted income per share stands at $2.77. With that, I will hand it over to Dan Bachus, our CFO, to provide further insights into our fourth-quarter performance and discuss changes in the income statement, balance sheet, and our guidance for 2024.

Daniel 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 December 31, 2023 and 2022. Non-GAAP amounts exclude the tax-affected amount of the amortization of intangible assets of $2.1 million in the fourth quarters of both 2023 and 2022 and the tax-affected amount of the losses on fixed asset disposals of $0.2 million and $0.1 million for the three months ended December 31, 2023 and 2022, respectively. We believe that 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 December 31, 2023 and 2022 is $2.77 and $2.36, respectively. Service revenue was higher than our expectations in the fourth quarter of 2023 due to higher than expected enrollments at GCU and some of our other university partners. Revenue per student continues to grow on a year-over-year basis, primarily due to the service revenue impact of the growth in the GCU traditional campus enrollments between years, which has a higher revenue per student and the higher revenue per student at off-campus classroom and laboratory sites. Service revenue per student for hybrid ABSN students generates a significantly higher revenue per student than we earn on the other students as these agreements generally provide us with a higher revenue share percentage, partners have higher tuition rates and the majority of their students take more credits on average per semester as they are in accelerated programs. The increase in revenue per student was negatively impacted in the fourth quarter of 2023 by year-over-year differences in the timing of the GCU traditional campus fall semester such that $1.2 million shifted from the fourth quarter of 2023 to the third quarter in 2023 as compared to last year. Our operating margin was slightly lower than our expectations, primarily due to higher than expected investments, including higher Discover visitors and increased headcount and higher technology costs. As I discussed on prior quarter's earnings calls, we have been aggressively hiring in which headcount had been mostly flat since March of 2020 to meet our partners' expected future growth which is driving increased compensation costs, primarily in counseling services and support costs. We also plan for and have incurred significant increases year-over-year in travel primarily related to Discover. We also planned and have incurred increased clinical costs at off-campus classroom and laboratory sites due to the nursing shortage. We also continue to spend more in technology services both in headcount and licensing fees, as a result of new technology requests by our partners, and we are incurring costs related to new hybrid locations that have opened in the last six months or will open in 2024. And the shift of $1.2 million of revenue from the fourth quarter to the third quarter as compared to the prior year negatively impacts the fourth quarter margin. Our effective tax rate for the fourth quarter of 2023 was 19.9% compared to 22.8% in the fourth quarter of 2022 and our guidance of 20.3%. The decrease in our effective tax rate between periods was primarily driven by other discrete tax items recorded in the respective periods. We repurchased 134,747 shares of our common stock in the fourth quarter of 2023 at a cost of approximately $16.8 million. And another 50,703 shares were repurchased since December 31, 2023. We have $258.6 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 its shares. Turning to the balance sheet and cash flows, total unrestricted cash and short-term investments as of December 31, 2023, were $244.5 million. GCE CapEx in the fourth quarter of 2023, including CapEx for new off-campus classroom and laboratory sites was approximately $10.4 million or 3.7% of service revenue. We expect CapEx for 2024 to be between $30 million and $40 million. The slightly higher CapEx expectations are due to higher spend on internal IT projects and due to a couple of the new off-site locations incurring slightly higher-than-expected tenant improvement and equipment costs. Last, I would 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 amounts to non-GAAP as adjusted net income and non-GAAP as adjusted diluted income per share. Consistent with the prior year, we have provided ranges for revenue, operating margin, and earnings per share for each of the four quarters of 2024. We do this because our financial results are seasonal. The revenue range assumes the following: GCU ground enrollment will grow to 22,900 in the spring, 7,800 in the summer, and between 25,800 and 27,100 in the fall. The ground number continues to include GCU hybrid and professional study students. Residential students are projected to grow to 16,000 in the spring and between 17,500 and 18,500 in the fall. Timing differences in the fall and timing differences in the start and end of the traditional campus semester are pushing $2.1 million from Q2 2024 to Q1 2024 in comparison to 2023, $0.2 million from Q3 2024 to Q2 2024 and $2.7 million from Q4 2024 to Q3 2024 in comparison to 2023. We anticipate that new online enrollments will be up year-over-year in the mid to high single digits in each quarter during 2024 and that total online enrollment will continue to grow in the high single digits over the prior year throughout 2024. As Brian has discussed, the online enrollment results were outstanding in 2023. Not only did new enrollment grow at a much higher rate than we expected and in the second half, these growth rates were coming off a very difficult year-over-year comp, but retention rates significantly improved over the prior year. These factors will impact the total enrollment growth rate in 2024. The new enrollment growth is a deceleration from 2023 in the growth rate, but not in the overall new students being added and the total online growth rates are expected to remain over our long-term objectives of mid-single-digit growth throughout the year. There could be some upside to these projections given the strong lead trends, but given the very significant growth in 2023 and thus the difficult comps, we believe these estimates are appropriate. We also anticipate seeing a decline in the growth rate of re-entries, students returning to school after a break due to 2023 retention rates and a significant year-over-year increase in graduates both of which will put pressure on the total enrollment growth rate. As Brian discussed earlier, the new student growth rate in the hybrid pillar is predicted to grow on a year-over-year basis greater than 20% in each of the next two start periods during 2024 and the total hybrid enrollment will return to growth in the first quarter, which is much sooner than we had previously predicted. The revenue growth rate for the hybrid pillar as a result of the enrollment growth will be partially offset by changes made to the contracts for the university partners that are no longer being reimbursed for faculty costs and the site closures discussed earlier. We estimate that this will lower revenue approximately $6.1 million during 2024. On the expense side, as you'll recall, we made significant investments in the past few years, primarily in headcount and travel expenses to meet the growth goals of our partners. Our headcount growth will slow in 2024, which will allow us to return to margin expansion, but there are still expense categories that we anticipate will see year-over-year increases greater than revenue growth. As Brian mentioned earlier, beginning this past fall and continuing in the spring, we have seen a significant increase in the demand for GCU's traditional campus discovery events and thus, we anticipate a continued increase year-over-year in travel expenses. This is a significant expense we believe we need to incur to meet GCU's desired traditional campus growth rate. We also anticipate increases in technology and academic services costs as we spend more in technology services both in headcount and licensing fees as a result of new technology requests by our partners, and we will incur costs for the new hybrid locations that have opened in the last six months or will open in 2024-’25. We do anticipate that the hybrid pillar will continue to lose money in 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 back to growing at rates more similar to what we experienced pre-COVID. But to get back to profitability, the mature sites need to get back to pre-COVID enrollment levels. Those are now admitting advanced standing students are generally back to growth. Those that have not generally continue to see enrollment challenges. We are also continuing to observe that our cost to service students in the licensure online programs that GCU is seeing significant growth in is higher than other programs. We anticipate that this will continue to put pressure on long-term margins as these programs continue to grow. Last, we anticipate an increase in legal fees in 2024 over prior years as we have a couple of lawsuits filed in prior years that are expected to go into the discovery phase and/or into trial during 2024. Litigation fees and regulatory reserves are included as a component of our non-GAAP measure adjusted EBITDA. With all that said, we anticipate returning to long-term margin growth. In estimating interest income for 2024, we assume similar cash balances to 2023 and a similar interest rate environment in the first half of 2024. So we projected similar interest income in the first half but are conservatively projecting a decline in interest rates in the second half of 2024 and thus slightly lower interest income. We believe the effective tax rate for the fourth quarters of 2024 will be 23.4%, 24.9%, 24.9% and 22.8%. The effective tax rate will be higher in 2024 than 2023 because of the impact of state income taxes as revenues continue to grow at the offsite locations outside of Arizona, driving our tax rate increase and the first quarter effective tax rate is much higher than in 2023 as in 2023, we received a large one-time Arizona state income tax refund. These estimates do not assume a contribution in lieu of state income taxes, but if one is made, that will increase G&A expense in the third quarter and decrease the effective tax rate in the second half of the year. Our weighted average shares guidance assumes that we purchased most of the remaining amount authorized by our Board over the rest of the year, although given the rise in the stock price, we anticipate purchasing less stock in 2024 than in 2023. The Board continues to authorize the repurchase of shares as it believes 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 multiples of other education companies as although we can be viewed as being in the same sector, there are few, if any, appropriate comps. On an enterprise value to adjusted EBITDA basis, the stock is currently trading at roughly 11.8 which is less than the recent S&P average of 17. The average free cash flow yield for the S&P 500 is 2.8%, whereas the company's free cash flow yield is approximately 5.7%. I will now turn the call over to the moderator so that we can answer questions.

Operator, Operator

Thank you. Our first question comes from Jeff Silber with BMO Capital Markets. Your line is now open.

Ryan Griffin, Analyst

Hey good afternoon. This is Ryan on for Jeff. Just a question on some of the FAFSA delays. Have you seen any impact there in Orbis or GCU and just anything related to call out there?

Brian Mueller, CEO

We expect to see changes primarily on the ground campus. It's crucial for us to maintain contact with interested students and provide them with as much information as possible about our programs, including costs. We invite them to our campus through "discover GCU." We trust that eventually the site will be operational, allowing us to provide the FAFSA information they need to make informed decisions. Our ability to stay engaged with students and keep them motivated is essential, and this applies to every university. Last fall, we noticed that enrollments in four-year institutions declined, while community colleges experienced an increase, which is significant considering the previous drops during the pandemic. We believe this trend reflects reality for middle-class Americans facing inflation, leading to ongoing questions regarding the return on investment for higher education. Those questioning the return may seek more affordable alternatives, which temporarily benefits community colleges. However, we are optimistic that we will also see benefits in the long run. One of the reasons we are investing heavily in campus visits this year and are 43% ahead is because I, as President of the University, believe we offer an exceptional value that remains largely unknown to many Americans. We are thrilled about what we have to offer and the success of our graduates. Despite some FAFSA-related challenges, we plan to continue investing in this process and feel well-equipped to face these challenges. We are looking forward to a successful fall semester.

Ryan Griffin, Analyst

That's great. And sorry, just one more clarifying one. Can you go over the $6.1 million you called out? And when is that expected to be phased out? I'm assuming that's just the two partners and the other one closing down.

Daniel Bachus, CFO

Yes, the $6.1 million is the net impact of changing the contract with some of the hybrid partners, who are now covering their own faculty costs, meaning we are no longer reimbursing them. This change reduces both our revenue and expenses, effectively netting to zero. A significant part of that $6.1 million comes from this adjustment, and some of this impact was also felt last year. The remainder is due to the closing of the sites, which contributes a minimal amount compared to the overall $6.1 million, with most of that impact occurring in the second half of the year.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Jeff Meuler with Baird. Your line is now open.

Unidentified Analyst, Analyst

Yeah, thank you. It's Stephen Pollock on for Jeff. Just on the GCU Discover strength, obviously, good numbers there. But just maybe some more detail. Are you seeing that you have better reach or better conversion of students? I guess just kind of what are some of the driving forces behind some of those strong numbers?

Brian Mueller, CEO

The number of visitors is strong, and so is the number of students applying to the institution. However, the commitment level, indicated by down payments, is lagging because many students are waiting for FAFSA information. I want to emphasize, as President of the University, that I am very optimistic about our current situation. There is still a lack of awareness about the value we offer across much of the country, but we are becoming better known. Currently, 25% of our ground students come from Arizona, about 20% from California, and we are rapidly growing in the Midwest, Northwest, and Southeast. Our goal is to keep these students informed and ready to commit once they receive the FAFSA information, and we believe we are in a favorable position to convert these students compared to our competitors. Our aim is to reach 50,000 students on campus, and we are committed to achieving this goal, especially with the exciting developments for students in Arizona and the greater Southwest, including job opportunities. We have 25 advisory boards with over 600 companies represented, many seeking access to our graduates who are making a significant impact in the workforce. While we are investing heavily to attract students, we have learned from last year when more opted to study from home. We believe that now, one year removed from COVID, both students and their parents are more comfortable with the idea of moving away from home. We are optimistic about the potential return on our investment this fall, despite some risks involved, and we are very positive about the outcomes for students, families, and the overall economy.

Daniel Bachus, CFO

Do you have any thoughts on why Discover visits are up so much? Is the university brand growing nationally?

Brian Mueller, CEO

Yes, absolutely. People are responding to our value proposition given the current inflation. If you are unsure about the return on investment of attending college, it's becoming widely recognized that you can graduate in three years with less debt than the average state university students. Our parent loan amounts are half of what in-state institutions charge. So if you're questioning the value of incurring $100,000 or $150,000 in debt for college, you don't have to face that here. This is primarily what drives interest and motivates people to visit.

Unidentified Analyst, Analyst

No, that makes sense. I appreciate the information. Brian, I believe you mentioned starting a fifth pillar focusing on traditional age students through an online program. Did I understand that correctly? Also, how would that differ from your GCU Online program?

Brian Mueller, CEO

Currently, the students who are 18 or 19 years old and wish to earn a degree in business or education from home are placed in the same program as our 35-year-old working adult students. There isn't much difference between these groups at this point. We are working towards developing a fifth platform that will take into account the younger students, who have less work experience and contribute less in terms of that experience in the classroom. Over time, we may distinguish between these two groups more than we do now. Presently, we enroll them in the same program as, for example, a 32-year-old returning to college seeking a degree in those fields. Today, the distinction is minimal. However, our ability to provide this option sets us apart. If someone is considering college, is comfortable staying home, has a network of friends, and is working part-time earning $20 an hour, they can pursue their education from home for at least a year or longer. Few institutions offer this flexibility. As we aim to grow our ground campus to 50,000 students, we also see the opportunity to serve those younger students who prefer to stay home, a need that most institutions are not addressing. We will pursue both of these avenues.

Unidentified Analyst, Analyst

Thank you very much.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Alex Paris with Barrington Research. Your line is now open.

Alex Paris, Analyst

Thank you for taking my question. I just had a follow-up on the hybrid campus, a lot of information. I was writing as fast as I could. So hybrid, you had a 3.3% decline in total enrollment during the fourth quarter but fall, new student was up in the high single digits. You're expecting, and I'm just trying to get some clarification. New student enrollment growth in the spring and the summer are expected to be up over 20% and you expect total student enrollment to inflect positive in the first quarter among the hybrid campus.

Brian Mueller, CEO

Correct.

Daniel Bachus, CFO

You got it right, Alex.

Alex Paris, Analyst

All right. Thank you. And then with regard to the site closures. Of your 24 partnerships, only two have not responded to the advanced standing students' proposition, and that led to the closure of these two sites and the discontinuing of business with these two institutions, right?

Brian Mueller, CEO

That's correct.

Alex Paris, Analyst

And then you had one other that you were closing just because it was below expectations, which then led to you discontinuing business with that. So you've gone from 24 partners to 21 partners within the hybrid pillar.

Daniel Bachus, CFO

One point of clarification. The last one is a partner that had multiple locations, and the decision was made this quarter to close one of their locations. So we are only decreasing the number of partners by two.

Alex Paris, Analyst

Okay. Good. Thank you for that. Now your goal is to have 80 site locations, 40 of which will be GCE locations with 25 partners. So you expect to add based on that target, three net new university partners in the hybrid pillar.

Brian Mueller, CEO

That's an approximate number. Some areas in the country are easier for us to operate with existing institutions than for GCU to enter. In those states, we will bring on an additional partner. This time, we will ensure that any new partners understand that our main focus is on 19-, 20-, and 21-year-old students who have earned 30 college credits. These students typically don’t have significant debt from previous degree programs. Therefore, they are quite willing to complete their prerequisite work online and pay for what they need to obtain their nursing degree. We will not partner with anyone who does not agree to admit these students. Regarding the 20% increase, it may seem significant compared to last year, but we started over 6,000 students in these prerequisites. This accessibility allows students to take courses from anywhere in the country, primarily without relying on financial aid or loans, which is a major advancement. If we can encourage 19, 20, and 21-year-olds to recognize that they can complete the necessary academic work without incurring debt, especially if they haven't already accumulated it from a prior degree, investing in the ABSN program makes a lot of sense considering the earning potential in nursing and the ongoing shortages. We believe we have made progress with our hybrid programs, and we are very optimistic about the future.

Alex Paris, Analyst

That's great. And then, obviously, there's a lag between new student enrollment and total student enrollment, although we expect total enrollment to be up in the first quarter. Yet, Dan, I think you said that you expect the hybrid pillar to still lose money in 2024. What level of revenue do we need or what level of enrollment do we need for it to break even? And do you expect it to be breakeven or better in 2025?

Daniel Bachus, CFO

We're hopeful. I mean, we expect a significant decrease in the loss between '23 and '24, and we're hopeful it will get back to profitability in '25. The key, as I mentioned earlier, is to get these mature locations that were at capacity pre-COVID and have seen significant declines in their enrollments back to or close to capacity. And so we're obviously very focused on that, working along with our university partners and the things that Brian talked about. We're on our way, but we have work to do to get those mature locations back to capacity.

Alex Paris, Analyst

Great. And then last question, unrelated. FAFSA. Brian, I think you said that you're watching it most closely for the ground campus. Why is it less of a concern for the online students or the hybrid students?

Brian Mueller, CEO

I wouldn't say it's less of a concern, but our ability to work with online students regarding the delays in FAFSA is smoother compared to ground students who are first-time college entrants from backgrounds where their parents haven't attended college and may not fully understand the process. There is a greater degree of uncertainty with traditional ground students compared to online students. Additionally, it's worth noting that 50% of our online students are graduate students and are not eligible for grants.

Alex Paris, Analyst

Got it. That's helpful. Is it also easier with online students because of the frequent starts? If a student misses a start, they don't have to wait an entire semester to enroll and risk losing that student in the meantime?

Brian Mueller, CEO

That's part of it, too. Yes, that is part of it.

Alex Paris, Analyst

Great. Well, thanks for the color, guys. Appreciate it.

Daniel Bachus, CFO

Yes. Thank you. We've reached the end of our fourth 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.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.