Earnings Call Transcript - LOPE Q3 2021

Operator, Operator

Good day. And thank you for standing by. Welcome to the Q3 2021 Grand Canyon Education Earnings Conference Call. At this time, all participants are in a listen-only mode. And after the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Dan Bachus, Chief Financial Officer. 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 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 third quarter fiscal year 2021 conference call. I want to again begin and again by listing the major challenges facing higher education because so much of our strategy is meant to directly address those challenges. I believe those issues continue to be one, the out-of-control rising cost of university education. From the early 1980s to the late 2010s, the price of college increased eight times the increase in wages. Number two, the increasing student debt levels that will seriously hinder graduates as they begin their adult lives. Three, as tuition levels go up, diversity on college campuses goes down. Four, Bachelor's degrees should not take four to six years to complete. Five, programs and delivery models lack the creativity and flexibility necessary to address critical shortages in some very important industries. Six, there are inadequate counseling and support services, especially for first-generation students or those studying at a distance. Seven, three-fifths of college graduates would change majors if they were starting over, with 30% citing better job opportunities. And eight, prior to the pandemic, 43% of college graduates were underemployed in their first job, and two-thirds remained in jobs that don't require college degrees five years later. In addition to these challenges that have been building up for decades, I want to read from an article that came out on October 26 regarding enrollment at U.S. colleges and universities being on track to fall by nearly 500,000 undergraduate students this fall, continuing a historic decline that began with the start of the coronavirus pandemic. According to new data out Tuesday, the decline of 3.2% in undergraduate enrollment this fall follows a similar drop of 3.3% the previous year, the first fall of the pandemic. According to research from the National Student Clearinghouse Research Center, these numbers are from a preliminary data set representing 8.4 million undergrad and graduate students from about 50% of U.S. colleges. The data shows that there are now 240,000 fewer undergrads enrolled this fall compared with the same time last year. If this rate of decline holds up for the rest of the colleges, that could translate to almost 500,000 fewer undergraduate students. If these preliminary numbers hold up, Shapiro says the last two years of undergrad decline, totaling more than 6%, would be the largest two-year decrease in at least half a century. This fall, the drop in undergraduate enrollment is spread across all sectors, but the numbers are worse at community colleges, public four-year colleges, and private for-profit schools. While schools that are primarily online saw gains last year during the height of the pandemic, those positives turned to negatives this fall with enrollment dropping by 5.4% for undergrad programs and 13.6% for graduate programs. In the context of these negative trends, we believe Grand Canyon Education is doing well and is very well positioned going forward. Grand Canyon Education's business is comprised of three pillars. I want to review the performance of each pillar beginning with the GCU traditional campus. In spite of the significant obstacles presented by the COVID-19 pandemic and the challenges we just reviewed, GCU’s traditional campuses had a remarkably successful fall semester. The university's goal this year was 8,800 new students, and they started the fall semester with 8,911, up from 8,402 in the fall of 2020. The average incoming GPA of this year's record-breaking class was 3.6. The prestigious honors college at GCU has grown to approximately 2,800 students with average incoming GPAs of 4.1. The number of students housed on campus has grown to 15,570, up from 11,441 the prior year. The university built three additional residence halls thinking it had built one year out in advance, however, all 100 beds are filled. The total number of graduate students on campus is 23,628. Investment in GCU's traditional campus has not been raised in 13 years. The average GCU student takes out less debt than heavily subsidized state university students. Parent loan amounts are 50% of the average parent loan amounts at the three state universities in Arizona. The traditional campus is becoming a national institution. 35.8% of the students are from Arizona, 22.7% from California, and there is significant growth in the Northeast, Midwest, and Southeastern parts of the country. The first set of the student body is very encouraging, as 28% of our students are Hispanic, 6% African American, and 46% are students of color. To prepare for the students this year, GCU invested almost 140 million to add three new residence halls, a huge parking garage, three new restaurants, and 55,000 square feet of additional classroom and laboratory space. GCU made this investment with its own cash reserves and has accumulated $407.4 million in cash. The university after the transaction continues to be in a very strong financial position with two additional residence halls, additional classroom and laboratory space, and two new restaurants being added for next year, as next year's incoming class is expected to exceed 9,600 students. The campus is completely open with no vaccine mandates, and active positive cases on campus are now less than 15 total students. Participation rates in campus activities are at an all-time high. I would also like to note that the school's sports cumulative winning percentage leads the nation with men's soccer at 85%, women's soccer at 76%, and women's volleyball at 78%. We believe this momentum will take GCU to 40,000 students on the Phoenix campus, but the demand for what is offered is much higher than that. Further building out the current campus to greater than 40,000 students and evaluating additional campus locations continues to be evaluated. We estimate that the service fees we earn in this pillar will be 25% of GCE’s total 2021 revenues and we estimate that they will grow to just under 30% of total revenues in the next four years. Our strategic advantages in this segment of the market are very significant. The second GCE platform I want to discuss is Orbis. Dealing with the COVID-19 pandemic across many academic institutions, geographies, and hospital studies has not been easy. We have had to be extremely creative and flexible to keep this moving. We have developed technology solutions with our university partners, including virtual simulations and virtual reality projects that have replicated and replaced some of the clinical experiences. Enrollments have grown to 5,652 across all existing sites, which is a 12.1% increase. Nursing enrollments have actually grown 70%, but we have had a reduction in occupational therapy enrollments due to a backlog in clinical placements directly related to the pandemic. Year-to-date revenue from Orbis partners has grown over 17%. That is not the 20% that we initially projected, but given the significant COVID challenges, we are extremely happy with the performance. The new enrollments for the fall semester exceeded our expectations. We have also exceeded our expectations in terms of the number of partners and the number of locations. There are still regulatory bottlenecks in certain markets, and we still plan to have approximately 40 locations opened by the end of 2022 and will eventually grow to 80 locations. We estimate that service fee revenues earned from Orbis partners will continue to grow in the mid to high teens year-over-year in 2022. We estimate that these service fees will be 15% of GCE’s total revenues and will grow to greater than 20% of total revenue in the next four years. The third pillar, Grand Canyon University online, is the pillar currently being hit the hardest by the pandemic. The working adult online space is very crowded, and GCU has a very large student body. GCU online has 89,838 students as of September 1, 2021, which is flat year-over-year, but new enrollments have plunged into the low teens this past quarter. To combat a very crowded space with most players using the same advertising, enrollment, and programmatic strategies, we have created a very successful B2B model. GCU has over 4,000 partners with over 17,000 locations in the healthcare, education, counseling, business, and technology industries. Over 30% of the new starts are coming from those partnerships. When the pandemic hit, it shut down our access to those partners, and new numbers eventually took a hit. The opening up of the country, including schools, businesses, hospitals, counseling centers, etc., has been an uneven process, and our new start numbers have reflected that on a year-over-year basis. New enrollments improved in August and September as schools reopened. However, comparisons are very difficult in October, November, and December, and we anticipate new starts to continue to be down year-over-year. Meetings with many of the over 4,000 partners are now being scheduled at historic pre-COVID rates. In addition to the B2B strategy, GCU online is well positioned because it has done the difficult work of providing academic programs that lead to professional licensure in a fully online environment. While working adult online enrollments are declining in generic programs whose value is currently being questioned, the licensure programs that GCU offers in education, healthcare, counseling, social work, etc., continue to be in high demand. To work in these professional areas, academic degrees will always be required. Currently, 36,167 GCU online students are in licensure programs, and that number continues to grow as a percent of the total. We expect momentum to return next year and eventually return to mid-single-digit new and total enrollment growth at GCU online. GCE is in a very strong position. Long-term, we are set up to be a mid to high single-digit revenue growth company with margin expansion on a yearly basis. The ground campus has considerable strategic advantages in the marketplace and will grow revenues in the high single digits and become larger as a percent of total revenues. GCE Orbis is in a very high demand base. The country will need an additional 1.3 million nurses in the next five years alone. The path is clear to 80 locations, and additional programs will be rolled out over time. This pillar will produce mid to high teen revenue growth and will also become larger as a percent of total revenues. GCU online continues to add a minimum of 20 new academic programs on an annual basis. As the country continues to open up and outside activity resumes to normal levels, we believe revenue will again grow in the mid-single digits. Having three differentiated platforms to grow with high-quality students is important because we want to continue to produce quality outcomes. Even in this pandemic-induced transitional period, we continue to produce good graduation rates, a very low 5% cohort default rate, and low student debt amounts. We are doing this while, at the same time, GCE continues to invest in Orbis infrastructure, new online learning and technical administrative infrastructure. And GCU continues to invest in building out the traditional campus, all of which will create growth opportunities for students. With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2021 third quarter, talk about changes in the income statement, balance sheet, and other items, as well as to provide 2021 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, 2021, and 2020. The non-GAAP amounts exclude the tax affected amount of the amortization of intangible assets. Their amortizable intangible assets acquired in the Orbis acquisition totaled $210.3 million, and amortization expense in both the third quarters of 2021 and 2020 was $2.1 million. 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, 2021, and 2020 is $1.11 and $1.14 respectively. We typically file our 10-Q alongside our 8-K the first week of November each year. We plan to file our 10-Q when it normally is filed, so that will be next week. Service revenue was slightly below our expectations in the third quarter of 2021. As expected, the GCU online enrollment growth rates slowed in the quarter due to the items we have discussed previously. Ground traditional summer and fall semester enrollments and Orbis enrollments were in line or exceeded our expectations. Revenue per student continues to grow on a year-over-year basis primarily due to increased room, board, and other ancillary revenues from GCU when compared to the prior year, as well as the growth in enrollment for students at off-campus classroom and laboratory sites. Service revenue per student for off-campus classroom and laboratory sites generates significantly higher revenue per student than we earn under our agreement with GCU, as these agreements generally provide us with a higher revenue share percentage. The partners have higher tuition rates than GCU, and the majority of their students take more credits on average per semester, as they're in accelerated programs. However, revenue per student continues to be negatively impacted by a number of factors. Revenue per student associated with the GCU contract is being negatively impacted by a decline year-over-year in days in class for its online students. As we have discussed previously, we saw a significant increase in days in class during the last nine months of 2020 and the first few months of 2021, as students took far fewer breaks between courses than previous years. Beginning at the tail end of the second quarter and continuing into the third quarter of 2021, days in class returned to pre-COVID levels as students decided to take breaks between classes. Second, GCU continues to see a mix shift to less accelerated programs that generate less revenue on a daily basis. Additionally, beginning with the summer 2021 semester and continuing into the fall 2021 semester, Orbis partners have experienced a decline in revenue per student caused by some students delaying their scheduled clinical courses due primarily to vaccine mandates at hospital partners. It’s important to note that none of these items reduce the amount of revenue that will ultimately be earned from the student, but it extends the time it takes to complete the program. Included in both our 8-K filed today is a detailed explanation of the actual and anticipated impact of COVID-19 on all of our university partners. Our effective tax rate for the third quarter of 2021 was 20.3%, compared to 20.2% in the third quarter of 2020 and our guidance of 20.7%. We did make $5 million of contributions in lieu of state income taxes in July 2021, which resulted in an increase in general and administrative expenses in the third quarter of 2021. These contributions are for dollar reduction in our state income taxes, three quarters of which is recorded as a rejection in our effective tax rate in the third quarter when the payment was made in that quarter and in the fourth quarter. A number of months ago, GCU engaged a firm to assist them in refinancing a secured note. Today, October 28, 2021, we were formally provided notice by GCU that it will be repaying $500 million on the secured note and have also been informed that they are optimistic that they will be refinancing the rest of the secured note by the end of November, based on the ultimate success of marketing the new bonds. This will eliminate or reduce the interest income earned by us. As a result of the refinancing, our credit agreement, which consisted of a term loan facility and a revolving credit facility, will be terminated. The remaining term loan amount of $83.7 million along with the $30 million that was outstanding on our line of credit will be repaid. As we discussed last quarter’s call in anticipation of the possible repayment, the Board of Directors increased the authorization under our stock repurchase plan by $970 million and approved a plan to repurchase stock using the expected net proceeds from the refinance. We repurchased 2,324,316 shares of our common stock in the quarter of 2021 at a cost of approximately $202.5 million, and 978,779 shares at a cost of $85.6 million subsequent to September 30, 2021. As of today, including the increased authorization, we have $778.4 million available under our share repurchase authorization. We plan to buy at a minimum an additional $250 million of our common stock with proceeds to be received on the refinance, and any additional funds received above the $500 million will also be used to repurchase our common stock. We have considered a number of different options to repurchase stock. In the near term, we will continue to repurchase in the open market rather than through a tender or a large ASR. As a result, we have slightly changed our weighted average share assumptions for the fourth quarter of 2021. Turning to balance sheet and cash flows, total unrestricted cash and short-term investments at September 30, 2021, were $61 million. GCE CapEx in the third quarter of 2021, including CapEx for our new off-campus classroom and laboratory sites, was approximately $5.6 million or 2.7% of net revenue. We continue to anticipate CapEx for 2021 will be between $30 million and $35 million. Lastly, I would like to provide color on the guidance we have provided for the fourth quarter of 2021. The guidance that we have provided continues to be non-GAAP as adjusted net income and as adjusted diluted income per share, as we exclude amortization acquired intangible assets. Consistent with last quarter due to the uncertainties discussed previously, we have provided ranges for revenue operating margin and earnings per share for the fourth quarter of 2021. We have tightened up the ranges previously provided based on current trends, which Brian spoke about a few minutes ago. On the expense side, we have lowered expenses for the last three months of 2021 based on current expense trends. Additionally, we will realize a $2.5 million reduction in technology and academic services expenses related to the reduction in the CECL reserve previously recorded on the secured note. We estimate interest expense will be $1.4 million in the fourth quarter, as although interest expense paid will decline due to the repayment of our credit facility, we anticipate writing off $1.1 million of deferred loan costs. We believe the effective tax rate for the fourth quarter will be 21.2%, which is slightly lower than our previous guidance. We have adjusted the interest income estimate to $9.5 million for the fourth quarter based on the timing of the repayment of the $500 million on the secured note. As mentioned earlier, we have increased the weighted average shares outstanding slightly due to the estimated timing of the repurchase of the additional $250 million of stock by the end of the year. If the university refinances an additional amount by the end of the year, we will reduce the remaining $2.5 million of CECL reserve while interest income will be lower than what is in current guidance. The weighted average shares will also most likely be lower but not materially, as though we will further increase our buybacks the impact on the fourth quarter weighted average share count will be minimal. I will now turn the call over to the moderators so that we can answer questions.

Operator, Operator

[Operator Instructions] And our first question is from Jeff Silber of BMO Capital Markets. Your line is open.

Jeff Silber, Analyst

Thanks so much. Wanted to first focus on GCU online. I know you guys usually have pretty good visibility. Have things worsened since we last talked three months ago and specifically what has changed, if anything?

Brian Mueller, CEO

Yes, I think versus three months ago, things are not as good currently today as they were three months ago. And what's changed is the uneven opening of the country. Three months ago, schools were opening in August and September. Hospitals were a lot more accessible because, in some cases, there were decreased nurse demands in hospitals, counseling centers, etc., and in certain cases, it's just gotten harder. September and October are opening as fast as we were hoping. That 30-plus percent that we get from that outside activity didn't pick up as fast as we were hoping. But it's important to note that the 65% to 70% of GCU online new starts that we get as a result of the traditional advertising mechanisms are strong. We're not seeing a deterioration in our investment in those advertising strategies. We do believe we've seen investment if we went above the current amounts that we are spending. So, that 30% to 35% which eventually in the GCU online business is going to be 50%. That stuff is coming back a little bit more slowly, but it’s coming back, and we think next year we're going to be in a very strong position. The students that we give as a result of that activity are really weighted heavily in the graduate area. Our decline in GCU online has been primarily a decline in graduate students. And so, not only do we have a significant amount of new student starts and enrollments from those activities, it's a high-quality way to do this business. We get really good students. As that thing comes back and as our graduate student number grows, I think we will be back to normal levels; we're not saying online will be high single digits. We're saying mid-single digits above our currently 90,000 students, but as the ground campus grows in the high single digits and the Orbis campus grows in the mid-double digits that overall we're going to be back to an 80% enrollment growth company.

Jeff Silber, Analyst

And probably forgive me, when you were talking about the traditional advertising channels, which still remain strong, did you comment on the cost? Is it getting more expensive to find those students?

Brian Mueller, CEO

No, maybe just a little bit, but it would be much worse. We believe it would be worse if we all of a sudden would spend an additional 30%. If we would spend an additional 30% in our advertising budget, we believe we would see a decline in return on that both in the quality of the students and in the cost per lead and cost per start. We anticipated this a few years ago, not only because we now have a significant number of students at 90,000, but because 90% of what’s going on in this industry is not different than the strategies employed by the University of Phoenix years back. It’s the most inexpensive way to get into this business when you don't have a lot of capital to deploy; that's why we pivoted into the B2B part of what we're doing, in addition to pivoting to licensure programs. If you're going to prepare teachers at a distance, you have to set up their observation hours and all that work. The same is true in counseling, social work, and in certain technical areas. The investment in that infrastructure is going to pay off long-term dividends because, right now, with so many jobs being available, if you're a 28-year-old with job choices, does it pay to go back and earn an undergraduate degree in business administration? That question is currently very serious. But if people aren't getting counseling, they cannot provide counseling without a license, the same in social work and nursing. Those two pivots we made months ago are going to help us recover from this transitional period. I feel very optimistic about how we're going to come out.

Jeff Silber, Analyst

And if I could just ask Dan a quick question, I just want to make sure I understand what's embedded in your guidance in terms of the share purchase. So I think you said in the third quarter, and so far this quarter to date, you've repurchased, I think about $288 million worth of stock. And you're expecting to purchase at least another 250 million, is that what's embedded in the guidance for this year?

Dan Bachus, CFO

Yes, but it's pretty evenly spread over the rest of the calendar year. As you get out towards the end of the year, it has a pretty low effect on the weighted average shares outstanding.

Jeff Silber, Analyst

It'll carry over into next year. Okay, great. Just wanted to check the numbers. Thanks so much. I'll get back in the queue.

Operator, Operator

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

Jeff Meuler, Analyst

Yes. Just trying to connect the pieces on what you've given us and make sure I'm understanding the magnitude. So the roughly 70% channel, new enrollments from that channel are actually growing year-over-year. And the decline from the 30% or so channel is causing the low teens total decline in terms of online starts for GCU.

Brian Mueller, CEO

Yes. Again, the return we're getting on the traditional investment is not in decline. We're getting good returns similar to what we've gotten, but I'd also add that if we had to increase spending, I think we'd see a deterioration at that point.

Jeff Meuler, Analyst

And then if you could just help me, you gave us a statistic about the number of partners or number of locations, and you were kind of giving us some month by month, so what I'm wondering is how much this looks Delta wave driven? And I know it's impossible to predict if there will be future waves, so maybe it will remain uneven. I don't know if you can tie it to that and it's since been getting better. Can you tell us how many of the over 4,000 partners are you back live with, and how broadly does that statement about the number of meetings that you're setting up looking like pre-pandemic levels? How broadly does that apply across the partner network?

Brian Mueller, CEO

It applies very broadly across the partner network. I don't give a lot of details on that in terms of a lot of the work we’re doing; it’s extremely high-quality work. I'll give you one example: Schools are under immense pressure to find teachers, counselors, and social workers. A lot of industries when you can come in with a strategy to help them grow their own professionals. They are incredibly receptive to that and grateful for it. There are districts where we will put together cohorts of professionals—those people with usually associate degrees who want to become licensed teachers. It’s a fantastic way for schools, and it’s scalable. That’s an example of how we work inside school districts to put together custom programs that help meet their human resource needs. We do the same in counseling. A lot of people with bachelor’s degrees in counseling want to enter master’s degree programs that lead to licensure to move up significantly. There’s a lot of work in that area. Bases have a very difficult time developing cybersecurity specialists. They can't get them from outside—we have great programs at both the undergraduate and graduate level that can help current military members grow into those positions. That work is really high quality and leads to a high-quality student for GCU. It satisfies the human resource needs, but it's a trailing effort to get back in and do the meetings. The reason we didn’t go away from that is the momentum from before the pandemic is just too strong. We didn’t switch strategies during the pandemic. We took a hit, but this won't last forever, and the outcomes we're producing are excellent, keeping us in a very strong position.

Jeff Meuler, Analyst

Okay. And then on just expense planning and budgeting for 2022, especially with how the recovery sounds like it's been pretty uneven for a while now. You obviously have a unique model in terms of this provider model, but just trying to understand where you need to preserve investment, where you can flex spending, just given that we've had a couple quarters now of new enrollment declines, and we're also in a high inflation environment generally. So can you just help with a framework for how you think about managing expenses through an environment such as this, or where you can cut or how aggressively you would look to make adjustments?

Brian Mueller, CEO

The positive side is that the ground campus is growing in high single digits. It has a significant pathway to growth for a long time, and is going to become a higher percent of overall revenue. The same is true for Orbis, which can grow in the high teens from a revenue perspective. This helps mitigate the pressures of GCU online, which has a crowded space. We've had to thank goodness we've been differentiating our strategy for years now. The positive side is that by the middle of next year, we believe that student numbers at GCU, number one in ground and Orbis, will continue to operate at a high level. The online campus will get back towards the middle of the year to a point where we’re operating on all cylinders, and I think capable of being back to 4% or 5% revenue growth. Together, by the end of the year, we’re looking at 8%. However, it’s going to take six to 12 months for that to happen.

Dan Bachus, CFO

We should remember what 2020 was for GCU online. It was basically a 10% total enrollment growth year. Given our size, we never dreamed we'd be there, but it was the perfect storm for new reentries and drop and graduation percentage. This year has unfortunately been the perfect negative storm where new enrollments have been under pressure, and we still have reentries and drops. So, I think next year things will normalize. We're optimistic about our ability to grow new enrollments next year, especially after we get through the first quarter. Starting in the second quarter, we feel very good about our ability to grow, and we expect reentries and drops to normalize. This quarter, total enrollment growth rate was basically flat, but graduates were up almost 15% year-over-year in the quarter, so we have those challenges as well. From an expense standpoint, we're not planning on changing anything materially. This company makes a lot of money and feels very good about the long-term here, and we’re not going to start cutting a bunch of things. Travel expenses will take another step up next year as the world opens up more because that's a big part of our strategy.

Brian Mueller, CEO

During the works of the pandemic, we didn’t lay off anyone. There were no layoffs, no furloughs, and no pay reductions. We maintained our staffing levels with less than 1.5% faculty turnover which is quite unheard of. We continued to invest and provide salary increases, which we believe we’ll benefit from in the long run. We could have done some of those layoffs, but we have a very strong culture. Our people know that we are loyal to them. I believe that long-term loyalty and keeping our staff employed and happy are crucial to our success. Therefore, we avoided making cuts. The repayment of the secured note is timely and will allow us to buy back stock, increasing our EPS next year.

Dan Bachus, CFO

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 me, Dan Bachus. Thank you for your time.

Operator, Operator

And this concludes today’s conference call. Thank you for participating. You may now disconnect.