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Grand Canyon Education Inc (NASDAQ:LOPE)
Q2 2019 Earnings Call
Aug 6, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter Grand Canyon Education Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time.

[Operator Instructions]

At this time, I'd like to turn the call over to your host to Dan Bachus, CFO. Please go ahead.

Daniel Bachus -- Chief Financial Officer

Thank you. 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 position in GCE.

And with that I will turn the call over to Brian.

Brian Mueller -- Chairman & Chief Executive Officer

Good afternoon and welcome to the Grand Canyon Education's second quarter fiscal year 2019 conference call. During the second quarter of 2019 enrollment in the programs at our partner universities for which we provide services increased to 11.4% to 90,906. This increase includes 3,316 enrollments in programs serviced by Orbis Education as of June 30, 2019. New working adult students attending our partner institutions grew in the low teens year-over-year. On a comparable basis, total enrollment grew 8.1% and new enrollments grew in the high single digits.

I want to begin by addressing the issues regarding to you. There have been leaders in the OPM space and we wish them nothing but the best going forward. However, I want to be clear about how the GCE strategy is different and why we believe we will be successful. Number one, the Grand Canyon University online strategy is the strategy being replicated throughout the country, namely taking academic programs that have been designed to teach traditional students in a face to face environment on a campus and redesigning them to be delivered online to working adult students. This is the quickest and least expensive way to begin operating in this space. Although this space is very competitive, Grand Canyon Education has some significant advantages.

Number one; it has the world's largest and most comprehensive platform to deliver both academic and operational services to GCU and other partners going forward. For the same or very similar revenue arrangements, GCE will offer over twice as many services including operational services that most OPMs don't offer, but will allow programs to be offered at scale. These are fully automated services that include the following; program and curriculum design, the learning management system, faculty services, including recruitment training and assessment, admissions intake including transcript evaluation, comprehensive financial aid services, automated class scheduling, fully develop academic and counseling services including course reminder calls, practitioner or licensure follow-ups, schedules built or changed in technical support. These services will be offered in addition to the advertising and enrollment services which are common in the space.

Number two; GCE is already the biggest player in this space with 2,600 very experienced staff members serving over 80,000 students on a $200 million platform producing very favorable outcomes. Those outcomes include high graduation rates, lower average debt amounts, low cohort default rates, good and still improving 90-10 rates, as well as GCU's programs meeting the formal gainful employment guidelines. Adding additional partners into this already large proven model will put a minimum of initial strain on the GCE operations and it's financials.

The next point is very important. GCE is not looking for many new partners with a lot of very small programs, we are looking for three or four partners that want to scale to approximately 5,000 students over a five to seven year period, we want to make sure that our partners are differentiated based on either brand, geography or program mix. We also want to avoid partners and programs with extremely high price points resulting in $80,000 plus masters degrees. These factors will produce good results for students, GCE, the partner institutions, and our investors.

Number two; Grand Canyon Education is providing services to Grand Canyon University's traditional ground campus, which has become a very unique asset. The GCU traditional campus is going to grow to over 30,000 students in the next five years. This growth is happening at very low tuition rates, has become profitable, and GCU will continue to reinvest it's profits to build out it's campus. The competitive advantage GCU ground enjoys is unique and transformative in higher education. $1.5 billion has been invested into the campus in the last eight years and it has been ranked the 16th best campus in the country. GCU has built out nine colleges with over 230 academic programs and continues to grow with very high quality students.

Number three; the Orbis acquisition is a second very unique asset. While the rest of the country is rushing into the GCU online very crowded space, Orbis is uniquely differentiated. It involves ground classroom and laboratory infrastructure located in strategic markets combined with online delivery. There is a huge need for the healthcare professionals they've produced and there is a significant positive value proposition for graduates. These locations, programs and students don't cannibalize any other GCE University partner students. GCE is in a strong position to support the rapid expansion of Orbis. Orbis had 19 partner schools under contract at the close of quarter two and expects to sign either two or three new partners by the end of 2019. This will bring the total number of Orbis partner schools to either 21 or 22 by year-end. 12 of Orbis's 19 partners are currently enrolling students across 19 sites with four new sites set to open by year-end.

In 2020, we plan to open between six and nine new sites, which is higher than the four to eight new sites that we originally projected. Six of the possible nine new sites will represent partners who are opening their first sites, with the remaining three with partners who have a site already open but who are adding additional sites. This represents more than the necessary amount of activity to achieve a greater than 35% enrollment growth rate in programs serviced by Orbis Education in 2020.

In summary, the OPM space is still a relatively new and evolving space and GCE has a unique and differentiated strategy, it is one, unlike any that currently exists.

Now turning to the results of operations. As a reminder, beginning July 1, 2018, the results of our operations do not include the university operations of GCU but rather reflect the operations of GCE as a service technology provider. Therefore for comparability purposes, we will discuss amounts on an as adjusted basis as is discussed in a minute. Additionally, on January 22, 2019, GCE completed the acquisition of Orbis, therefore the results for the second quarter of 2019 include Orbis's financial results for the entire quarter.

Service revenues were $174.8 million in the second quarter of 2018, compared to $236.8 million of university-related revenue in the prior year. Had the GCE-GCU transaction occurred on January 1, 2018, comparable service fee revenue would have been $142.1 million in the second quarter of 2018; this represents an increase of 23% between second quarter of 2018 and second quarter of 2019 on a comparable basis. The increase year-over-year in comparable as adjusted revenue was primarily due to our Orbis acquisition on January 22, 2019, and the increase in GCU enrollments between years. The partnership agreements that were acquired as part of the Orbis acquisition generally generate a higher revenue per student than our partnership with GCU as these agreements generally have higher revenue. The Orbis partners have higher tuition rates than GCU and the majority of these students are studying in the accelerated Bachelor of Science in Nursing Program; so these students take on average more credits per semester.

End of the period enrollments increased 11.4% quarter-over-quarter to 90,906 from 81,620. As adjusted operating income and as adjusted operating margin for the three months ended June 30, 2019 for $53.1 million and 30.3% respectively. As adjusted operating income and as adjusted operating margin for the three months ended June 30, 2018 were $44.7 million and 31.5% respectively; GCE will continue to invest profits to create additional educational infrastructure for our partner institutions that will create more opportunities for students and families.

Technology and academic services grew from $10.7 million in the second quarter of 2018 to $22.5 million in second quarter of 2019, an increase of $11.8 million or 111%. This increase was primarily attributable to the partner agreements acquired in the Orbis acquisition which requires certain technology and academic services including headcount, classroom facilities and equipment to be provided to each university partner. These costs along with the increased cost to service our existing client GCU's increased enrollment resulted in the increase. As a percent of comparable revenue, these costs increased by 140 basis points to 12.9% from 7.5%, primarily due to the partner agreements acquired requiring a higher level of technology and academic services in our partner agreement with GCU.

Counseling services and support expenses grew from $50.8 million in the second quarter of 2018 to $54.3 million in the second quarter of 2019, an increase of $3.5 million or 6.8%. This increase was primarily attributable to the partner agreements acquired in the acquisition which requires certain counseling services and support; principally, headcount to be provided to each university partner. These costs along with the increased cost to service our primary university partner, GCU's increased enrollment resulted in the increase. As a percentage of comparable revenue these costs decreased 470 basis points to 31.1% from 35.8%, primarily due to the counseling services and support cost to service the acquired partner agreements. Being less as a percentage of revenues than the cost to service GCU, and due to our ability to leverage our counseling services and support expenses across an increasing revenue base.

Marketing and communication expenses as a percent of comparable revenue increased 20 basis points from Q2 2018 to Q2 2019. This increase is primarily due to the advertising cost associated with marketing our new university partners programs. General and administrative expenses increased $3.4 million between years, and as a percentage of comparable revenue increased 120 basis points to 5.3% in Q2 2019 from 4.1% in Q2 2018. This increase was primarily due to increases in employee compensation and benefit cost between years and other administrative expenses in occupancy and depreciation, and in professional fees including audit and legal expenses. Our increases in employee compensation occupancy and depreciation and other general and administrative costs are primarily related to the acquisition including additional headcount and office space in Indiana.

With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2019 second quarter, talk about changes in the income statement, balance sheet and other items, as well as to provide 2019 guidance.

Daniel Bachus -- Chief Financial Officer

Thanks, Brian. Included in our Form 8-K filed with the SEC we haven't included non-GAAP net income and non-GAAP diluted income per share for the three months ended June 30, 2019. The non-GAAP amounts exclude the tax-affected amount of the amortization of intangible assets and the loss on transaction amounts included in our consolidated income statement. The amortizable intangible assets acquired in the Orbis acquisition totaled $210.3 million and amortization expense in the second quarter of 2019 was $2.2 million. We believe the non-GAAP financial information allows investors to develop a more meaningful understanding of the Company's performance overtime.

As adjusted non-GAAP diluted income per share for the three months ended June 30, 2019 is $1.9. Service revenue exceeded our expectations in the second quarter of 2019 due to slightly higher revenue per student. GCU and Orbis enrollments were generally in line with our expectations. Included in the investment, interest and other is a one-time gain of $2.1 million. This resulted in $0.03 of the earnings beat [Phonetic].

Our effective tax rate for the second quarter of 2019 was 21.7% compared to 23.3% in the second quarter of 2018, and our guidance of 24.5%. The lower than expected effective tax rate is due to a recent law change with respect to Arizona State taxes and higher than expected excess tax benefits to $2.2 million in Q2 2019 from $1.2 million in Q2 2018. The lower-than-expected tax rate resulted in $0.04 of the earnings beat. We repurchased 3,000 shares of our common stock in the second quarter of 2019 in the cost of $0.3 million, and another 10,000 shares at a cost of $1.2 million in July. We had $77.8 million available under our share repurchase authorization as of June 30, 2019.

Turning to the balance sheet and cash flow; total unrestricted cash and short-term investments at June 30, 2019 were $80 million. Restricted cash and cash equivalents were 300,000 as of June 30, 2019 and represents pledged collateral for newly acquired lease site. GCE CapEx in the second quarter of 2019 including CapEx for new Orbis partner sites was approximately $5.1 million or 2.9% of net revenue. We continue to believe that GCE's 2019 Capex should range between $20 million and $25 million, consisting primarily of software development and the build-out of Orbis partner location.

We funded Capex on behalf of GCU through the secured note of approximately $139.9 million in the second quarter of 2019, which includes an advance of $99 million for estimated capital expenditures through the end of 2019. Some amounts may be repaid during the six months remaining in the year ended December 31, 2019. This funding is to finish the 2018-19 school year projects and for the initial cost to build three additional apartment-style residence halls, a classroom building, and a parking garage for the 2019-2020 school year. Based on recent conversations with GCU, it continues to be likely that the university will not request us to continue to fund it's Capex after this year as the university anticipates they will be able to fund it's own Capex moving forward.

Last, I would like to provide color on the guidance we have provided for the rest of 2019. 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 of acquired intangible assets and the loss on transaction. We have increased revenue guidance for the full year due to the second quarter beat. We have non-adjusted revenue for the second half of 2019 but have increased revenue guidance for the third quarter and lowered it by the same amount in the fourth quarter as Orbis revenue will be slightly higher than initially predicted in the third quarter but less in the fourth quarter, due primarily to timing differences in the cohort start dates.

Excluding the effect of the contribution made in lieu of state income taxes that we'll discuss in a second, we have raised operating margin for the third quarter from 31.1% to 31.8%, and lowered in the fourth quarter due to the Orbis revenue shift and due to slightly higher projected Orbis spend in the fourth quarter on new site openings. All other expense assumptions remain the same for the second half of the year.

In July, we made $4 million of contributions made in lieu of state income taxes, which has the effect of increasing general and administrative expenses, and decreasing income tax expense. The entire $4 million of expense is recorded in G&A expense in the third quarter, while three quarters or $3 million of this amount is recorded as lower state income tax in the third quarter and a quarter or $1 million is included as lower state income tax in the fourth quarter. This along with us revising our excess tax benefit estimates result in our revised effective tax rate of 21% in Q3 and 22.6% in Q4. We have also revised our net interest income projections for the second half of the year based on the borrowings that took place in June and our assumptions that no additional borrowings will take place the rest of 2019 but that some repayments might be made.

We project net interest income in the third and fourth quarter of 2019 will be $13.0 million and $12.5 million respectively. Although we might repurchase additional shares during 2019, these estimates do not assume repurchases other than those made today.

I will now turn the call over to the moderator, so we can answer questions.

Question-and-Answer Session

Questions and Answers:

Operator

[Operator Instructions]

I'd show our first question comes from Jeff Silber from BMO Capital Markets. Please go ahead.

Jeff Silber -- BMO Capital Markets -- Analyst

Thank you so much. I wanted to start with Orbis; you've been putting up some really good numbers in those programs since you purchased the company. I'm just curious what has gone better than your expectations? Why does it seem to be growing faster than you might have thought?

Brian Mueller -- Chairman & Chief Executive Officer

I would say that the success levels of the initial partners have given a lot of confidence to the whole organization. We have been making the rounds and meeting with some of the universities and every single institution not only wants to build their current location to larger amounts but they want additional locations. And so it's the success -- we happen to buy it at a time when they were really starting to turn the corner. The end collect results are consistently high and they are consistently hitting their enrollment numbers, and so the confidence levels of the model are growing and people are very excited about expansion.

Jeff Silber -- BMO Capital Markets -- Analyst

Okay, that's great to hear. I appreciate the color you gave on the overall OPM or managed services market. I'm just curious, is there any update in terms of potential timing on any announcements of any new partnerships from your perspective?

Brian Mueller -- Chairman & Chief Executive Officer

Yes. We are working hard, we have been on the road for two months now and we're going back on the road next week for additional meetings with three potential partners which will be -- we're down the road with all three. Some of the meetings will include as many as 100 people from those partner institutions. And so I think it's a long kind of process, the way it's been traditionally done in this OPM industry; but this is a little bit longer because we're not looking to pick off a program and prove we can do it well with 100 students or 200 students or 300 students. We really are looking for institutions -- three or four institutions like I said, whose President is behind this and is wholeheartedly behind it, and who has their entire academic infrastructure behind it and excited about it. So that when we hit the ground running that we can produce not results that are nice but not really -- they don't really change anything.

Grand Canyon University and Grand Canyon Education has fundamentally altered the economic structure of higher education. Our students now and our traditional campus here are on average going for less room board -- tuition room board fees than our average state university student in this country, probably two-thirds under the private universities average students. And so, if we can find the right -- and it's probably going to be private university partners in the Midwest or Northeast that one-off scale to 5,000 -- between 5,000 and 7,000 students over a five to seven year time period. It won't have a dramatic effect on their institution as this had on ours but it will have a significant effect, and it will be transformative in a sense. And so making sure that we've got an entire institution versus just a couple of small programs is why it's taking a little longer but we think that in the next -- for certain, before the end of the year we will have partners in place and start working toward starting students in the fall.

Jeff Silber -- BMO Capital Markets -- Analyst

Okay. I appreciate the color. If I could just sneak one more in. Over the past few weeks, there has been some noise in the market about changes to state authorization rules in California and potentially limiting their residents from getting Title 4 Financial Aid to go to -- on online non-profit institution out of their state. Hopefully this has been resolved, but do you think there was any impact on your upcoming enrollments for the next few quarters or so because of this issue?

Brian Mueller -- Chairman & Chief Executive Officer

No, no. We will be fine.

Jeff Silber -- BMO Capital Markets -- Analyst

All right, that's good to hear. All right, I'll get back in the queue. Thanks so much.

Operator

Thank you. Our next question comes from Jeff Meuler [Phonetic] from Baird. Please go ahead.

Jeff Meuler -- Baird -- Analyst

Dan, thanks for the detailed guidance. I just want to make sure that I have it right because there is a lot of timing factors and moving around in terms of geography on the P&L with the contribution in lieu for the income taxes. So, I just -- in terms of underlying if I adjust for the timing and that movement are the only two real underlying changes here flowing the upside from Q2 in? And then a little bit of incremental expense for Orbis in Q4 like-for-like given that you're opening a greater number of locations than previously contemplated, are those the only underlying changes other than the timing and P&L movement?

Daniel Bachus -- Chief Financial Officer

Yes, you've hit it on the head. We are -- we'll have a little bit of additional expense in the fourth quarter related to Orbis, and we're making up for that with slightly higher interest income and slightly lower effective tax rate on a combined basis. Everything else is basically nets out, the revenue shift nets out, and the other expenses other than the slightly higher Orbis expenses in the fourth quarter all net out. So, you -- what you said is exactly correct.

Jeff Meuler -- Baird -- Analyst

Okay. And then, Brian, is there interest on your part that you would potentially do three OPM partnerships to sign them all at once? And is there any framework for what like 2020 margin implications could look like -- just thinking if you would potentially do three OPMs plus you're stepping up the pace of Orbis launches; is there any sort of -- like mid-year [Phonetic] term margin framework you could provide?

Brian Mueller -- Chairman & Chief Executive Officer

I don't think that we would sign three at the same time. I think it is likely that we'll probably sign two within a reasonable amount of time. And, the -- but if we do that in the next 60 to 90 days, we wouldn't actually be starting students until the fall. And so there would be some expense that would be incurred but it would not be an extreme amount of success that would have hugely material impact on the financials.

Daniel Bachus -- Chief Financial Officer

And the only thing I would add is, I think there is still a lot of things that have to be resolved. As we've mentioned before; how the material -- the upfront expenses are, has -- significantly, the biggest factor in that is how fast the partner wants to scale; and so coming to agreement on that or then telling GCE how fast they want to scale is a critical component. So as soon as we have a partner in place and we have those plans finalized we'll be able to give you a lot more detail on the impact it will have both, on the expense side but then on the revenue side.

Jeff Meuler -- Baird -- Analyst

And are you saying fall 2019 you could have students starting at these programs or you're saying fall 2020?

Daniel Bachus -- Chief Financial Officer

Fall 2020. That's why we're not -- we might sign an agreement in the next 60 to 90 days so we wouldn't park students for nine months after-tax [Phonetic]. So it's not like we're going to be throwing a bunch of expense in the first 30 days, no. And it could be those programs don't roll out even until January of 2021; so fall 2020 or spring of 2021 I think is as early -- fall 2020 is the earliest.

Jeff Meuler -- Baird -- Analyst

Yes. Got it. And then just as a follow-up to the other just question, the -- around kind of the California and state reciprocity areas, the -- so I guess you're saying you'd be in good shape, it sounds like Ed is going to accommodate the California proposal but maybe it didn't tick off all of the boxes. Just -- if there continues to be future noise about this, so I'm thinking like -- if there would -- if the judge in the original court ruling would chime -in or something, even if there would be a period where California students were not eligible for Title IV did the University or GCE have some sort of stop-gap financing plan or did you not even go that far down the path given that it was so short-lived?

Brian Mueller -- Chairman & Chief Executive Officer

You know, what GCE was told by GCU is to continue to do the right thing for the students in terms of enrolling new students and retain the students that it add. And it took the risk on it's own balance sheet that the Department of Ed and the State of California would come to a reasonable conclusion on this, and that financial aid would be disbursed. And so that's why there is really no impact on GCE, and frankly, other than a short-term cash impact on GCU there was no impact on GCU. And if something happens in the future, I would assume that the same would occur.

Jeff Meuler -- Baird -- Analyst

Helpful. Thank you.

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.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Daniel Bachus -- Chief Financial Officer

Brian Mueller -- Chairman & Chief Executive Officer

Jeff Silber -- BMO Capital Markets -- Analyst

Jeff Meuler -- Baird -- Analyst

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