Earnings Transcript for LOPE - Q4 Fiscal Year 2022

Operator: Hello, and thank you for standing by. Welcome to Grand Canyon Education Inc. Fourth Quarter 2022 Earnings 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. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to CFO, Dan Bachus. Sir, you may begin.

Dan Bachus: 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 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: Good afternoon, and thank you for joining Grand Canyon Education’s fourth quarter fiscal year 2022 conference call. GCE had a very good quarter, exceeding enrollment expectations, exceeding revenue guidance at mid-point by $2.7 million and producing an $0.11 beat in adjusted diluted earnings per share to consensus. Given how most of higher education is coming out of the COVID years, these are excellent results. Most importantly, GCU online new enrollment growth for the second consecutive quarter in the mid-teens, over fourth quarter prior year, and that momentum is expected to continue into the first quarter of 2023. I want to begin by – again by taking a step back and explaining why this is happening and briefly review what has happened since the GCE-GCU transaction took place 4.5 years ago. I have said often that in the past, small and elite has won a day in higher education, especially in areas like U.S. News and World Report rankings. In the future, it will be institutions who are large, scalable and flexible in how they offer higher education. We expect to impact young people and adults across the lifespan, using technology to build platforms that take into account the life situation of the student and the nature of the content and skills that need to be learned. GCE has invested approximately $300 million, producing its own learning management and administrative system that allows it and its partners to manage over 7,000 full-time and adjunct faculty, 113,000 students and over 315 academic programs, emphases and certificates across four delivery platforms. This system has automated processes, including admissions, transcript collection and evaluation scheduled building, financial aid processing, faculty recruitment, faculty assignment and payroll, content acquisition, assessing learning outcomes, student teacher placement, counseling and social work internships and the list goes on. The administrative capability of the system allows faculty and students to focus on the learning, which is still in a small group instructor-led process that is highly interpersonal, collaborative, focused on writing, critical thinking and problem-solving and produces outstanding outcomes. GCE currently employs approximately 4,000 full-time professionals and approximately 1,500 student workers as it continues to build out its capabilities to grow faculty, students, programs and delivery platforms for its university partners. Leveraging this infrastructure has allowed GCE’s partners to expand programs that are critical to the economy, maintain tuition levels in a period of rapid tuition increases across the country and make access to higher education affordable to all socioeconomic classes of Americans without any burden on the taxpayer. In the 4.5 years since GCE has become a service provider has helped its partners accomplish the following

Dan Bachus: 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, 2022 and 2021. The non-GAAP amounts exclude the tax-affected amount of the amortization of intangible assets of $2.1 million in the fourth quarters of both 2022 and 2021. The tax effective amount of the loss on fixed asset disposals of $0.1 million for the three months ended December 31, 2022, and both the tax effective amount of the reversal of the $5 million credit loss and the tax effective amount of the write-off of the deferred loan costs of $1.1 million upon repayment of the credit facility recorded during the fourth quarter of 2021. 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, as Brian just mentioned, for the three months ended December 31, 2022 and 2021 is $2.36 and $2.11, respectively. Service revenue was higher than our expectations in the fourth quarter of 2022 as online enrollments exceeded our projections due to the higher-than-expected new student starts and due to higher-than-expected ancillary revenues at GCE. Hybrid revenues were in line with our expectations. The hybrid enrollment growth rate is being impacted on a year-over-year basis due to the timing of site openings and 11.3% year-over-year decline in OTA enrollments, the closing of sites and a decline year-over-year in the enrollment at some of the mature sites due to the challenges previously discussed. Excluding enrollments from closed sites, ABSN enrollments grew 3.6% year-over-year. 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 due to room board and other ancillary revenues 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, the partners have higher tuition rates and the majority of their students take more credits on average per semester as they are in accelerated programs. Our operating margin was higher than our expectations, primarily due to higher-than-expected revenue. As I discussed on prior quarter’s earnings calls, we have been aggressively hiring in which headcount had mostly been flat since March of 2020 to meet our partners’ expected future growth, which is driving increased compensation costs in technology and academic services and counting services and support costs. At the end of the third quarter of 2022, we remain below our headcount plan, but are at head count plan today. We also plan for a significant increase year-over-year in travel and employee benefits as those amounts were significantly lower than pre-COVID levels in the prior year. We also plan for increased clinical costs at off-campus classroom and laboratory sites due to the nursing shortage. The spending has generally remained in line with our expectations, and the year-over-year difference in the timing of new site openings impacts year-over-year cost comparisons. Our effective tax rate for the fourth quarter of 2022 was 22.8% compared to 21.8% in the fourth quarter of 2021 and our guidance of 23.0%. The increase year-over-year is due to higher state income taxes. We repurchased 318,935 shares of our common stock in the fourth quarter of 2022 at a cost of approximately $28 million and another 154,098 shares since December 31, 2022. We have $178.4 million remaining available as of today under our share repurchase authorization. The Board and the company intends to continue using a significant portion of its free cash flows from operations to repurchase its shares, but share repurchases in future years will be less than in 2021 and 2022 as we have utilized all of the proceeds from the repayment of the secured note during the past two years. Turning to the balance sheet and cash flows. Total unrestricted cash and short-term investments on December 31, 2022, were $181.7 million. GCE CapEx in the fourth quarter of 2022, including CapEx for new off-site classroom, campus classroom and laboratory sites was approximately $8.9 million or 3.5% of service revenue with total CapEx for 2022 of $35 million. We expect CapEx for 2023 to be similar to 2022 at between $30 million and $35 million. Last, I’d like to provide color on the updated 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 components to adjust the GAAP amounts to non-GAAP as adjusted net income and non-GAAP as adjusted diluted income per share, and we will continue to provide both GAAP net income and diluted income per share and the non-GAAP amounts with a reconciliation between the two when we report actual results. Consistent with the prior year, we have provided ranges for revenue, operating margin and earnings per share for each of the four quarters of 2023. We do this because our financial results are seasonal. The revenue range assumes the following

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Jeff Meuler with Baird. Your line is open.

Jeff Meuler: Yes, thank you. How is demand trending lately for the hybrid programs? And you gave us the number on the 800 students, I don’t know if this is too soon, but can you give us any sort of metrics on the success those students are seeing going through the accelerated online pre-reqs.

Brian Mueller: Yes. The demand is changing because of the employment situation. The employment situation is so strong, there are so many jobs out there that people are – people with bachelor’s degrees in their 20s are not really willing to give up a $60,000 a year job to invest $50,000 or $60,000 to make $70,000 or $80,000. The – at the same return isn’t there currently. And so people are being more cautious about re-careering. However, the demand is still very strong and increasing for those students that are younger and have it – already invested in higher ed and don’t have any debt or have very little debt. And so there is significant demand. And what’s very interesting and very encouraging is that when we can get students to the ABSN start – get them to the front door, we have a 90% success rate getting them through in a greater than 90% first-time pass rate on the NCLEX exam. The challenge is getting them so that they have the course work necessary to get into the ABSN program. People were referring them to community colleges and they won’t hear from them for a year two or three, if at all. And in other places, the programs were not delivered online or they were extremely expensive. And so we worked very hard at creating first to science courses. And those science courses – that’s what I was referring to in terms of the 800 students and growing pretty rapidly. And we have between 75% and 80% success rate, meaning the students got to see or better in those courses. And therefore, they can use them to get into an ABSN program. So we’re really happy with that success rate because studying science online is not easy. Our courses are rigorous. But the demand is still very strong, and we think we’re going to be in a very strong position in somewhere between six and 12 months because we’ve – I think we’ve figured out, it doesn’t matter where in the country a student is. Our programs are delivered online. So they can be entered into the program. We’ve got start times every couple of weeks. And as opposed to once fall or just spring semester and what time was being offered in person, all those things were really difficult to navigate. And so I think the most important challenge is that one. And between that, and we think we’ll get some traction with high school graduates who want to stay home, do the first two years of a pre-nursing program in 18 months, do it completely online and then qualify to be in an ABSN program in one of our locations throughout the country. Between those two things, we’re hoping to address that challenge and then reaccelerate the enrollments.

Jeff Meuler: Got it. And then GCU looks like it’s tough to get back to growth. On margins, I understand the annualization effect of the headcount ramp. I understand the trade-off to the benefit of the university of the current financial model in a lower demand and higher inflation environment. But to the extent to which the university may be getting back to enrollment on a sustained basis and since you’re caught up on head count, just any comment on what you’d expect on a multiyear basis in terms of margins while still probably balancing not taking tuition pricing increases?

Brian Mueller: Yes. We believe that once we can get back to mid-teen total enrollment growth online, that, that core GCE contract margins can expand on an annual basis year-over-year. Somewhere between 30 and 100 basis points where we were pre-COVID. And we believe that because, one, we’ve done it in the past, two mid-teens, online enrollment and the growth of the ground campus and the revenue per student from that can help drive that margin expansion. And when you look at – if you look at the high end of our guidance, which is – if everything goes perfectly as we hope this year, you will see margin – you do see margin expansion on the GCU core in the second half of the year. If we hit the midpoint of our guidance, we gave today from a revenue standpoint; it would be fairly flat the second half of the year on the GCE contract from a margin standpoint. So that gives us confidence we can do it.

Dan Bachus: The other thing is – the other thing that impacts that, because you follow this thing historically, we’ve gotten margin gains by cost to acquire a student going down. And when we mentioned in the fourth quarter that 27% of our new enrollments or we were 20% - 7% higher this fourth quarter than prior year’s fourth quarter in new enrollments that were coming from our outside people. And those were basically working with school districts and others, and we don’t pay for those leads. And so we’re hoping that number continues to grow because that is where, historically, we’ve gotten margin expansion by reducing the cost to acquire a student. And if that work continues to go as it does, that will help.

Jeff Meuler: And I may not have heard correctly. I think you said mid-teens, you mean mid-single-digit growth for online, correct?

Brian Mueller: Yes. Dan is sitting next to me and he punched me on that. So yes.

Jeff Meuler: I’ll take the mid teen, but just making sure.

Brian Mueller: You’re correct.

Jeff Meuler: And then just last, I know you talked about the former Dear Colleague Letter. There was another Dear Colleague Letter last night regarding third-party services and Title IV. When you list out the services, Brian, you talk about financial aid processing being one of them. So is the GCE-GCU contract, are you already I guess, subject to these types of regulations and oversight, so no impact on you? And then just on the hybrid contract, is it a different setup? And just if there’s any sort of like qualification of how burdensome that may or may not be for you?

Brian Mueller: Yes, you’re right about the financial. We provide – GCE provides that service for GCU, which is the bulk currently of the business. And so yes, we’re already subject – GCE is subject to an audit as a result of doing that financial aid work and GCE does really, really well in that audit process. So we feel very good about that. The other 26 partners...

Dan Bachus: Yes. I think a couple of points to expand on what Brian just said. I mean I think it’s important for people to know that as part of the audit that Brian talked about, they not only look at the financial processing and compliance but they do testing – payroll testing, including an in-depth review of incentive compensation plans and payments, fiscal testing, including program reconciliation, bank statements, contract testing, including division of services and responsibilities. So as it relates to GCU, I think we’re already a third-party servicer and go through a full audit similar to what I think the Department of Ed is pushing for on the Dear colleague. As it relates, as Brian said, to the other 26 partners, they don’t do that audit currently for those. But for us to add that testing for our other 26 partners would not be a problem at all. The compensation plan is very similar and the other controls and processes are very similar to – so for us, not a concern at all to have that expanded to our other 26 partners.

Jeff Meuler: Okay. That’s it for me. Great to see GCU doing so well. Thanks guys.

Brian Mueller: Thanks.

Dan Bachus: 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 very much.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.