Earnings Call Transcript - LOPE Q2 2023

Operator, Operator

Good day, and thank you for being here. Welcome to the Second Quarter 2023 Grand Canyon Education Earnings Conference Call. Please note that today's call is being recorded. I will now turn the conference over to Dan Bachus, Chief Financial Officer. Please proceed.

Daniel Bachus, Chief Financial Officer

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 will turn the call over to Brian.

Brian Mueller, Chief Executive Officer

Good afternoon, and thank you for joining Grand Canyon Education's Second Quarter Fiscal Year 2023 Conference Call. GCE had a very good quarter, exceeding enrollment expectations by producing new starts that were approximately 20% over prior year and also producing greater-than-expected retention numbers, exceeding revenue guidance estimates at midpoint by $3.1 million and producing an $0.11 beat in adjusted diluted earnings per share to consensus. An article that recently appeared in Fortune Magazine titled the labor shortage is pushing American colleges into crisis, with the plunge in enrollments the worst ever recorded. Author Collin Binkley says the following, "Nationwide undergraduate college enrollments dropped 8% from 2019 to 2022, with declines even after returning to in-person classes, according to data from the National Student Clearinghouse. The slide in the college going rate since 2018 is the steepest on record, according to U.S. Bureau of Labor Statistics. Economists say the impact could be dire. Fewer college graduates could worsen labor shortages in fields from health care to information technology." Grand Canyon Education and its 25 university partners are experiencing significant growth in spite of declines in the overall market, and that growth will continue for the reasons I will explain as I review the four platforms we use to deliver higher education. First, the online campus at Grand Canyon University. New starts were up approximately 20% over the second quarter of the prior year and total enrollment has returned to positive growth again at 4.1%. There are many reasons for this, but I want to highlight four. Number one, we have stayed hyper-focused on opportunities that exist in today's labor market and since the beginning of the pandemic have rolled out 66 new programs, emphases, and certificates across the nine colleges at GCU. These programs are tied directly to labor market opportunities for students and accounted for 10.8% of the new students that started in the second quarter. One of the responses of universities to the declining enrollments during the pandemic was to reduce the number of programs they offered. Number two, we continue to work with employers directly to address their workforce shortages. This effort has focused on the industries of education, health care, technology, public safety, and the military. In the second quarter, 31% of the new starts came from that work. Number three, the retention of students in the second quarter went up 20 basis points, which we believe continues to improve because of the relevancy of the programs that students are entering. Number four, GCU has resisted responding to the soaring growth during the pandemic by raising tuition, which many institutions have done. Online net tuition increases since 2018 have averaged approximately 1% per year. Second platform, the GCU ground campus for traditional students. There is a clear trend here that we are uniquely positioned to respond to. Working adult students post-pandemic are more inclined to work from home and to do higher education from home. This is now becoming a trend for traditional-aged students as well. We have been projecting between 10,000 and 11,000 new students for the GCU ground campus for the fall of 2023. It will be greater than the 11,000 number, but with approximately 9,000 new students coming to campus and greater than 2,000 traditional-aged students starting GCU programs online between April and September. These students may come to campus eventually or may do the entire program from home. The greater than 2,000 students are traditional-aged students, but we are currently counting them in our online campus numbers. They accounted for about 6% of our approximately 20% increase in new starts in the second quarter at the online campus. This will slightly impact our room, board, and other auxiliary revenue attributed to ground students, but be offset by increased revenue due to higher-than-expected overall student counts. Third, Grand Canyon Education's hybrid campus had a decline in enrollment year-over-year of 5.2% in the second quarter. However, the hybrid campus is definitely turning the corner. We are now projecting new fall enrollments to be up in the mid- to high-single digits year-over-year, and we expect the growth rate in Spring 2024 to be even higher. There are two main reasons for this. Number one, all but one of our active ABSN partners have responded to the younger students interested in ABSN programs by admitting advanced standing students this fall or are in the process of making that change. This is up from only 11, one year ago. Students with partially completed degrees, having accumulated a great deal of debt, and are very interested in nursing careers but didn't have an efficient way to earn the prerequisite science coursework. GCU created the science courses and some other general education courses so they could be delivered online in eight weeks. Students can access these courses from anywhere in the world or 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 going live in September that will provide students 24/7 access to tutoring. Since we implemented these courses, we have already enrolled 3,068 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 enter our ABSN programs is 90%, and the first-time pass rate on the NCLEX exam remains approximately 90%. We now have an extremely efficient way to get students academically eligible and prepared to enter the programs. We are seeing positive results as we look at third quarter enrollments and believe it will get better from there. Fourth platform, the Center for Workforce Development at Grand Canyon University. In the 2022-2023 school year, we started 80 students in an electrician pre-apprenticeship program in partnership with companies that are experiencing labor shortages in that area and are excited about hiring our graduates. The program consists of 4.4 credit courses and runs one semester. 74 students successfully completed the program. This upcoming school year, we will start 220 students in the program and expect the same results. This fall, we also start 20 students in a manufacturing certificate program. GCU is running a small parts manufacturing business on campus that is doing work for some of the major companies in Arizona. These students will go to 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 will receive a manufacturing certificate and be eligible for employment in Arizona's fast-growing manufacturing industry. GCU's growing engineering college will also have students assisting with this project. I started out talking about the fear that exists around future labor shortages in key industries as a result of declining enrollments in higher education across the country. In the five years since GCE has become a service provider, it has helped its partners accomplish the following: In that time, GCE has helped Grand Canyon University graduate 140,331 students. 38,722 in education, including 19,042 first-time teachers at a time when teacher shortages have created a national crisis. 39,590 in nursing and health care professions, including 1,939 pre-licensure nurses at a time when there is a huge shortage of nurses. 26,905 in the College of Humanities and Social Sciences, including thousands in counseling and social work, where there are also huge shortages. The College of Business has become one of the largest business schools in America and has produced 24,179 graduates. The College of Science, Engineering and Technology has grown by 187% and provided 5,291 graduates. The Doctoral College, Honors College, and College of Theology also continued to grow. The numbers that I have just cited have all happened in the five years since GCU has become a nonprofit institution and GCE has become an education services provider. Service revenue was $210.6 million for the second quarter of 2023, an increase of $10.8 million, or 5.4%, compared to $199.8 million for the second quarter of 2022. The increase year-over-year in service revenue was primarily due to an increase in GCU enrollments of 4.1% and an increase in revenue per student year-over-year. Operating income for the three months ended June 30, 2023, was $35.4 million, an increase of $1.6 million compared to $33.8 million for the same period in 2022. The operating margin for the three months ended June 30, 2023, was 16.8% compared to 16.9% for the same period in 2022. Net income increased 13.3% to $29 million for the second quarter of 2023 compared to $25.6 million for the same period in 2022. GAAP diluted income per share for the three months ended June 30, 2023, is $0.96. As adjusted, non-GAAP diluted income per share for the three months ended June 30, 2023, is $1.01.

Daniel Bachus, Chief Financial Officer

Thank you, Brian. In our Form 8-K filed with the SEC, we provided non-GAAP net income and non-GAAP diluted income per share for the three months ending June 30, 2023, and 2022. The non-GAAP numbers exclude the tax-affected amortization of intangible assets totaling $2.1 million in both second quarters and the tax-affected fixed asset disposal losses of $0.1 million for the three months ending June 30, 2023. We believe the non-GAAP financial data offers investors a clearer understanding of the company's performance over time. For the three months ending June 30, 2023, and 2022, adjusted non-GAAP diluted income per share is $1.01 and $0.85, respectively. Service revenue exceeded our expectations in the second quarter of 2023, driven by increased GCU enrollments and higher-than-anticipated ancillary revenues at GCU. Hybrid revenues were as expected. The growth rate in hybrid enrollment is currently affected year-over-year by the timing of site openings and a decline in enrollment at some established sites due to previously discussed challenges. Revenue per student is consistently increasing year-over-year, mainly because of the service revenue impact from growth in GCU traditional campus enrollments, which yield higher revenue per student due to room, board, and other ancillary revenues, as well as higher revenue per student at off-campus classroom and laboratory sites. Service revenue per student for hybrid ABSN students is significantly higher compared to other students because these agreements generally provide a greater revenue share percentage, the partners charge higher tuition rates, and their students typically take more credits per semester in accelerated programs. The growth in revenue per student also benefited in the second quarter of 2023 from the shift of $4.5 million from the first quarter to the second quarter, which was due to differences in the timing of the GCU traditional campus' Spring semester compared to last year. Our operating margin was better than expected, largely due to higher-than-forecasted revenue. As mentioned in earlier earnings calls, we have been actively hiring since headcount has remained mostly flat since March 2020, in anticipation of our partners' expected future growth, which is increasing compensation costs, especially in counseling services and support. We also expect a significant year-over-year increase in travel and employee benefits since those amounts were significantly lower than pre-COVID levels last year. Furthermore, we predict increased clinical costs at off-campus classroom and laboratory sites due to the nursing shortage. Our spending has generally aligned with our expectations. The effective tax rate for the second quarter of 2023 was 23.8% compared to 25.2% in the second quarter of 2022 and our guidance of 24.9%. This effective tax rate for the second quarter of 2023 benefited from the resolution of some state income tax audits. We have repurchased 418,432 shares of our common stock in the second quarter of 2023 for about $45.3 million, and we have repurchased another 128,013 shares since June 30, 2023. We have $102 million remaining under our share repurchase authorization. Both the Board and the company plan to continue utilizing a significant portion of our cash flows from operations to repurchase shares, but future share repurchases will be less than in 2021 and 2022 since we have used all the proceeds from the repayment of the secured note over the past two years. Regarding the balance sheet and cash flows, total unrestricted cash and short-term investments as of June 30, 2023, amounted to $233.4 million. GCE CapEx in the second quarter of 2023 was approximately $9 million or 4.3% of service revenue, including CapEx for new off-campus classroom and laboratory sites. We still anticipate CapEx for 2023 to be similar to 2022, estimated between $30 million and $35 million. I’d like to highlight the updated guidance in our 8-K filed today. The guidance provided in our outlook section includes GAAP net income and diluted income per share, along with adjustments from GAAP to non-GAAP for as adjusted net income and as adjusted diluted income per share. Additionally, at the request of several investors, we included non-GAAP as adjusted diluted income per share estimates in our guidance section. We have updated full-year 2023 guidance to reflect the revenue and earnings surpasses in the second quarter. We narrowed the revenue and operating margin ranges for the third and fourth quarters and raised the revenue guidance midpoint for the third quarter while slightly lowering it for the fourth quarter. Excluding the contribution in lieu of state income taxes paid in July, we have reduced expenses for the last two quarters and updated estimates for other income, tax rates, and the weighted average shares outstanding for the second half of the year. This resulted in an $0.11 increase in EPS estimates for the second half of 2023 at midpoint, a $0.22 increase in full-year EPS estimates at midpoint from last quarter's estimates, and a $0.30 increase in full-year EPS estimates at midpoint from the original 2023 estimates. As Brian mentioned, we expect total enrollment in the second half to exceed our original forecasts, leading to higher-than-expected tuition revenue in both the third and fourth quarters. However, the second half revenue will face slight declines in ancillary revenues at GCU, as Brian noted, and slightly lower hybrid revenues associated with contract changes that we discussed in previous calls, which will mean we no longer reimburse some clients for specific costs and have agreed to lower the contractual revenue share percentage. Delays in opening the Southern California location will also impact hybrid revenues in the second half of 2023, but we expect to surpass our revenue goals at the GCU location and with some of our other partners, which should help offset the reductions in hybrid revenues. These factors will affect both the third and fourth quarters, but their impact will be more pronounced in the fourth quarter due to the timing of the fall term. Online new enrollment growth is expected to stay above our long-term targets in the second half of 2023, but the growth rate will decrease from the first half of the year due to more challenging comparisons. As Brian mentioned, new hybrid enrollment growth is expected to be in the mid- to high single digits for the fall semester and should gain momentum in the Spring semester. Apart from the expense reductions tied to contract changes, the delayed Southern California opening, and the contributions in lieu of state income taxes of $3.5 million paid in July 2023, there have been no significant changes in our expense forecasts for the second half of 2023. Contributions in lieu of state income taxes are a tax credit, which does not affect the net income for the second half but will raise G&A expenses in the third quarter and lower the effective tax rate in the latter half of the year, approximately 75% in the third quarter and 25% in the fourth quarter. Consequently, due to these factors and a tax refund received in the third quarter of 2023, we have revised our effective tax rate for the last two quarters of 2023 down to 18.6% for the third quarter and 21.3% for the fourth quarter. Our guidance for weighted average shares assumes we will buy back most of the remaining authorized amount evenly throughout the year. The Board continues to approve share repurchases as it views the stock as undervalued based on our evaluation metrics, including the enterprise value to adjusted EBITDA and the free cash flow yield, since while we may be classified in the same sector, there are hardly any relevant comparisons. On an enterprise value to adjusted EBITDA basis, the stock is currently trading at around 11, less than the recent S&P average of 16.4%, and the average free cash flow yield for the S&P 500 at 2.8%, whereas our company's free cash flow yield stands at about 6.1%. I will now hand the call over to the moderator for questions.

Operator, Operator

Our first question comes from Jeffrey Meuler with Baird.

Jeffrey Meuler, Analyst

Yes, thank you. To clarify the guidance for easier comparison before we evaluate other changes, could you explain the adjustments in the contract structure regarding reimbursed costs and provide an estimate of the impact?

Daniel Bachus, Chief Financial Officer

Yes. The unexpected impacts, including the change in the contract and the delayed opening in Southern California, result in an approximate $2 million reduction in both revenue and expense.

Jeffrey Meuler, Analyst

Okay. Brian, can you share some insights about the trend of traditional-aged students choosing to start their studies online instead of on campus? Is this primarily affecting students from outside Arizona, or is that not the case? Also, how does this influence the university's plans for campus expansion in the coming years?

Brian Mueller, Chief Executive Officer

It's going to be intriguing to observe how America is evolving, particularly with people wanting to work from home, educate their children locally, and attend college nearby. Many high school students have part-time jobs, earning around $20 to $22 per hour, and inflation has certainly affected middle-class families. Therefore, the chance to complete their degree from home in 2 to 3 years while keeping their jobs and maintaining local relationships becomes appealing. There's also noticeable anxiety among universities, leading them to provide attractive offers to students. However, these deals might not be sustainable without changing their financial structures, and it will be interesting to see the reactions of students halfway through their second year when these offers may no longer be available. We chose not to partake in that approach and remain transparent, providing offers based on students' academic performance. This may have resulted in us missing out on some potential students. The situation is dynamic; Arizona's economy is expanding rapidly, and our programs are highly relevant, with nearly 50% of our students graduating in 3 years with less debt. Once the current panic subsides, we will assess the landscape for next year. The good news is our unique position allows us to continue offering students the chance to study from home. Regarding our campus impact, we have been constructing two residence halls each year, and we will begin building one next year. We have the capacity to support around 50,000 students, and our approach allows for timely expansions. This strategy will relieve some of the capital expenditure pressures, enabling GCU to accumulate more cash. Whatever direction trends may take, we believe we are well-positioned to adapt. Additionally, we are thrilled about the development of our hybrid campuses. We launched prerequisite courses about a year ago and currently have 3,000 students enrolled, with room for growth in our existing facilities. As enrollment increases, we will better understand how quickly we can fill these spots, while also planning for new locations. Graduates from these programs are in high demand and our success rate is impressive, resulting in higher revenue per student compared to online or ground campus students. Therefore, we're confident in our position for the upcoming years, regardless of how these trends evolve.

Jeffrey Meuler, Analyst

And on the hybrid, is the expected acceleration in starts this fall and next Spring entirely about the pre-req program? I don't think that was a same-store sales number. So do the new campus launches play into that as well? And any sort of change in trends in the traditional career change or student demand?

Brian Mueller, Chief Executive Officer

It's really three things. First, it took some time for our partners to recognize the market had shifted. With unemployment being so low, individuals who have completed degrees are reluctant to leave their $60,000 or $70,000-a-year jobs to invest $50,000 or $60,000 for a marginally higher salary. However, there's a rising number of enthusiastic recent high school graduates or those with some community college experience who now see a clear path into an ABSN program. Our partner institutions are beginning to realize that’s where the market is and there are excellent students in that area. Currently, we only have one partner resisting what we call advanced standard students, which has contributed to the growth we expect to see in the third and fourth quarters. Secondly, the prerequisites were a significant obstacle. Students would often seek advice, only to be directed to community colleges or state universities where they would have to wait several months before they could start classes. We now offer courses specifically designed to cover what nurses need to know about biology, chemistry, anatomy, physiology, and so on, in 8-week formats. These courses are very affordable and accessible from anywhere in the world. This has drastically improved the situation for students since most of them are not incurring debt for these initial courses without knowing if they will gain admission into the program. Once they realize they can complete their courses, the decision to borrow money becomes much easier, especially since they are only 12 to 16 months away from their Bachelor of Science in Nursing program, considering the job opportunities and salaries available. I believe we have removed a significant bottleneck. Our counselors are very optimistic because when they refer students to these courses, they can track their progress throughout. They know exactly where a student stands in completing their courses, which means that students will be eligible for the fall semester at one of our partner institutions. This is the second major factor that leads to a much more promising outlook, and I expect things to accelerate from here, returning to the levels we initially anticipated when we acquired the company.

Operator, Operator

Our last question comes from Jeff Silber with BMO.

Ryan Griffin, Analyst

Hey, this is Ryan on for Jeff. Last quarter, you had called out some issues with conversion in the funnel for the ground campus. And given your outlook, it looks like that had improved a lot during the quarter. Can you just explain what drove some of the upside from the last time we spoke?

Daniel Bachus, Chief Financial Officer

On the ground side or the online side?

Ryan Griffin, Analyst

On the ground campus.

Brian Mueller, Chief Executive Officer

Since the last time we spoke, the only real difference is that we had a certain percentage of students who want to come to Grand Canyon that want to do it online. And so we're going to exceed the number of students in each category that we thought we would put into our program. But it's the continued inflationary pressures that families are experiencing that has caused certain students to say, would love to have that experience about being on your campus. But I'm going to hold off and I'm going to go online. So they begin their coursework, and they may come in second semester or they may come at the first of the year. So unlike what's going on in a lot of universities, where they just have a declining enrollment because they don't have the flexibility to give people options, when changes like this happen, and there's a lot of things changing in America right now with people becoming comfortable working from home, educating their kids from home, going to college from home. I mean that's definitely changed things. People are getting more comfortable with that. But then, inflation. Inflation is very real for middle-class families and our ground campus is a big middle-class play. We have upper-class students and upper-middle-class students, and because of the work we're doing in our neighborhood, we have significant numbers of students that come from the lower socioeconomic strata, but we're mainly a middle-class play. And there's a significant amount of inflationary pressure on those families. And so they're taking more conservative approaches and they're holding off. Now the other thing that's changed, as I said since the last time we talked, is that we didn't anticipate schools making the kind of deals they're making. One of our issues is that we're extremely transparent and very objective. We don't change criteria. It's very specific around what your GPA is and there are other criteria, and that determines your scholarship amount and what you owe. And that amount historically has been really, really good. Still is, as compared to private universities. State universities have really started to make deals that don't make any sense to me. We know that they're getting declining subsidies from their state governments, that's happening all over the country. And so unless they can change their expense structure significantly, I don't know they can make those deals in years 2, 3, and 4, we'll see. Either way, we've got the ability because of our flexibility to offer students a lot of different options, which I think puts us in a great place.

Ryan Griffin, Analyst

Okay. And then just on the last pillar, some of those apprenticeship and the workforce development. Just thinking longer term, how big do you think those could be and how meaningful down the line do you think they are? And maybe additionally, what other corporates might make sense to partner with? I think you highlighted electricians before.

Brian Mueller, Chief Executive Officer

It's very significant. The impact on our financials remains to be seen, but it's incredibly meaningful in terms of our efforts. We are now the 16th ranked campus in the country, with brand-new classrooms and laboratories. We're expanding to accommodate 50,000 people, yet we still have 300,000 square feet of unoccupied engineering space during late afternoons and evenings. This presents us with an opportunity to create programs for employers in the Southwest. I was surprised by the pre-apprenticeship program for electricians since we didn't need to invest heavily in capital expenditures to implement it. We simply needed to teach students math using whiteboards, which is highly scalable. The machinist program is equally thrilling as manufacturing is returning to the U.S., particularly to Arizona, offering significant business growth potential. Some former students approached me with the idea, and I provided them with free space and covered their utilities. They initially bought five machines, and after a successful first year, we loaned them $1.5 million to purchase 15 more machines. We're running a business that sells parts to clients like Honeywell. It's a fantastic opportunity for recent high school graduates to learn while they study, with financial backing from future profits. We're still in the early stages of this initiative. It could potentially become a significant financial aspect of our business, but for now, it's exceptionally valuable in providing opportunities for young people from lower-income households to secure middle-class jobs. The Maricopa County in Arizona learned about our program and awarded us a $750,000 grant, which we didn't necessarily need, but we accepted. We managed to conserve $380,000 of that grant for the next year. Their response was indicative of our approach, as they were surprised that we didn't use all the funds immediately. This initiative is closely integrated with local companies that inform us of their needs for electricians and machinists, enabling us to create a process that allows students to transition directly into jobs after just one semester. We're excited about the graduations, where students come with their families to celebrate. It's an incredible project in its early stages, and we will continue to provide updates as it develops.

Ryan Griffin, Analyst

That's great to hear. And then just last one for me. Anything to call out on the regulatory front, whether it's gainful employment or otherwise? And then any color on talks you might be having with the Department of Ed or any other commentary there?

Brian Mueller, Chief Executive Officer

No, not really. It's the same for us. Our metrics are strong, with very good graduation rates and low cohort default rates. The 90/10 calculation continues to improve. We might face some challenges with our education programs related to gainful employment, especially regarding first-time teachers, and we're collaborating with our local state representatives on that. I don't think it would be unreasonable to halt such initiatives. We've produced 19,000 first-time teachers in the last five years. They're considering reinstating some previous rules, but we generally have no issues with that. Our metrics are very good. I hope to resolve this with the Department of Education soon, but in the meantime, it absolutely does not affect our growth. 99.5% of our students are unaware of these developments; they are simply enjoying their programs. So, there's really no update from that perspective.

Daniel Bachus, Chief Financial Officer

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 myself, Dan Bachus. Thank you very much for your time.

Operator, Operator

Thank you. This concludes the conference call. Thank you for participating, and you may now disconnect.