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..

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..

number one, the country needs 1.3 million additional nurses in the next five years alone. Nursing programs are very expensive to operate and given the financial pressures facing many universities, they will be unable to invest the dollars it will take to scale the programs.

Number two, GCE has the capital to invest in the continued build-out to eventually 80 locations. Number three, in addition to the runway of 80 locations, up from 35 locations currently, our enrollment budget for this coming year is only 50% of the actual spots that exist today.

The 50% shortfall is partly due to the lack of efficient and highly supportive prerequisite course environments. Regulatory issues creating slowdowns in opening of planned locations and lack of clinical placements due to COVID issues.

However, there are now over 800 students in GCU’s accelerated online science courses, preparing to earn spots in one of our 35 locations. We expect that number to grow and be a leading indicator of our ability to reestablish growth on the hybrid campuses.

GCE is working hard in investing in new enrollment, simulation, virtual reality and prerequisite strategies to, in the future, fill all the spots that are available. This is a transitional year for the health care partnerships. However, there’s a 10-year runway that is very promising.

It creates a winning scenario for students that want into a promising career, health care providers desperately needing professional nurses and universities who want a low-risk way to help solve the nursing shortage, while at the same time, creating additional revenue streams.

Last, as we discussed on last quarter’s call, we continue to work on a new pillar. We are extremely excited because this is desperately needed in higher ed to date. In collaboration with our largest partner, GCU, we are developing accelerated certificate programs.

Two of the certificate programs are for students who want an efficient way to get into nursing school. We believe there’s a big opportunity here. Getting prepared academically to apply a nursing school can be a daunting and confusing process.

The first, a pre-nursing certificate program allows recent high school graduates to stay home and take the first 60 credits of their bachelor’s degree completely online. GCU has worked with GCE to design state-of-the-art science courses that prepare students to apply for a spot and eventually one of our GCE’s 80 locations.

These courses are taught mainly by full-time faculty with a tremendous amount of academic support for the students. The second certificate program is designed for students who have completed a college degree in another academic area or have a partially completed degree.

The students take mainly the science courses necessary to produce to apply to one of our partners in one of our 80 locations. The first certificate has a synchronous component, while the second certificate is being taught completely asynchronously.

Given that eventually GCE will have approximately 24,000 ABSN slots to our partners across 80 locations, we will need more than 24,000 students in certificate programs preparing for those opportunities. As I said earlier, over 800 students are taking these pre-nursing courses currently.

The third certificate program began in September and comes out of GCU’s newly formed Institute of Workforce Development. This certificate is preparing students for a professional electrician apprenticeship program.

This is a 16 credit, one semester program heavily focused on the mathematical concepts necessary to prepare for a career as an electrician. This program has been designed with a major industry partner who will offer apprenticeships to the students successfully completing the program.

This partner needs 1,000 electricians for their business in Arizona alone. This partner also indicates that the country is short of minimum 100,000 electricians necessary to complete the building projects currently underway. This fall, 300 students applied for this program, and we accepted 40 into the program.

39 of the 40 graduated in our apprenticeships making between $50,000 and $65,000 currently. An additional 200 submitted applications for the spring semester and we accepted another 40 in the spring. Once the concept is proven, there is a potential to scale this program in a significant way.

Service revenue was $258.7 million for the fourth quarter of 2022, an increase of $7.3 million or 2.9% as compared to the $251.4 million for the fourth quarter of 2021.

The increase year-over-year in service revenue was primarily due to an increase in GCU’s traditional campus enrollments of 8% and increases in revenue per student year-over-year partially offset by a decrease in online enrollments at GCU of 1.6% and to a lesser extent, students in our university partner’s Occupational Therapy Assistants program of 11.3%.

Operating income for the three months ended December 31, 2022, was $90.7 million, a decrease of $11.7 million as compared to $102.4 million for the same period in 2021. The operating margin for the three months ended December 31, 2022, was 35.1% compared to the 40.7% for the same period in 2021.

The operating margin was negatively impacted by the investments that are being made to grow our partners’ enrollments and the year-over-year decline in online enrollments. Net income decreased 16.5% to $71 million for the fourth quarter of 2022 compared to $85.1 million for the same period in 2021.

Decline in net income was partially due to a significant reduction in interest income between years due to GCU paying off the secured note in the fourth quarter of 2021. GAAP diluted income per share for the three months ended December 31, 2022, is $2.30.

As adjusted, non-GAAP diluted income per share for the three months ended December 31, 2022, is $2.36 and $0.11 over consensus estimates.

With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our 2022 fourth quarter, talk about changes in the income statement, balance sheet and other items as well as to discuss the updated 2022 guidance..

GCU ground enrollment will grow to 23,200 in the spring, 7,800 in the summer and be between 26,250 and 27,750 in the fall. The ground number continues to include GCU hybrid and professional study students. Residential students are projected to grow to 15,700 in the spring and between 17,900 and 18,900 in the fall.

Timing differences in the start and end of the traditional campus semester is pushing $4.5 million from Q1 2023 to Q2 2023 in comparison to 2022. And $1.3 million from Q4 2023 to Q3 2023 in comparison to 2022. We anticipate that new online enrollments will be up year-over-year in the high-single digits to low-teens in the first and second quarters.

As a reminder, the comps get much more difficult in the second half as new enrollments were up year-over-year in the mid-teens in both the third and fourth quarters of 2022. Thus, our guidance provides a wide range of potential outcomes in the second half of between low and high single-digit growth.

Given that our long-term objectives are to grow new enrollments in the mid-single digits, the midpoint of this range would meet our long-term objectives.

Based on this, we anticipate that total online enrollment will return to year-over-year growth in the first quarter of 2023, and we’ll end the year with a low to mid-single-digit year-over-year growth rate.

As Brian discussed earlier, hybrid growth will remain below our long-term objectives during the first half of 2023, but we are hopeful that we will see acceleration beginning in the fall semester due to new site openings, and the impact of the prerequisite initiative on the number of eligible students that could start in our partners’ programs.

Our guidance assumes flat to slightly down year-over-year total enrollment in the spring semester, flat to low single-digit enrollment growth in the summer and flat to mid-single-digit growth in the fall semester.

On the expense side, as you’ll recall, we made significant investments in 2022 for expected future growth, which given the timing of that spend will have a negative impact on margins in the first half of 2023.

Headcount, which had been mostly flat since March of 2020 was increased over the course of 2022 with the most significant gains being made in the fourth quarter of 2022 and early 2023.

This will drive year-over-year increases in compensation costs in technology and academic services and counseling services and support costs in the first nine months of the year, but that growth will slow in the fourth quarter.

We are also continuing to budget for increased clinical sites at off-site locations, good clinical costs at offsite locations due to the nursing shortage and new site openings will have a negative impact on expense.

We do anticipate that the hybrid pillar will continue to lose money in 2023 given that a number of mature sites are currently below pre-COVID counts. To get back to profitability, these sites need to get back to pre-COVID enrollment levels and the newer sites need to grow at rates more similar to what we experienced pre-COVID.

We are hopeful the initiatives that Brian discussed earlier in the call will allow that to happen even if the job market remains tight. We do not plan to have any material interest income or expense. We believe the effective tax rate for the fourth quarter of 2023 will be 22.3%, 24.9%, 24.9% and 24.0%.

The effective tax rate will be higher in 2023 than 2022 because of the impact of state taxes as revenues continue to grow at the offsite locations outside of Arizona, driving our tax rate increase.

These estimates do not assume a contribution in lieu of state income taxes, but if one is made, that will increase G&A expense in the third quarter and decrease the effective tax rate in the second half of the year.

Our weighted average shares guidance assumes that we purchased most of the remaining amount authorized by our Board evenly over the rest of the year.

The Board continues to authorize the repurchase of shares as it believes the stock remains undervalued based on the metrics that it uses to evaluate, including the ratio of enterprise value to adjusted EBITDA and the free cash flow yield rather than multiples of other education companies, as although we can be viewed as being in that same sector, there are a few, if any, appropriate comps.

On an enterprise value to adjusted EBITDA basis, the stock is currently trading at roughly 12.2%, which is less than the recent S&P average of 16.4%. The average free cash flow yield for the S&P 500 of 2.8%, whereas the company’s free cash flow yield is approximately 5.5%.

Last, the guidance provided does not include any reduction in revenue or expenses associated with the Dear Colleague Letter issued last year that I discussed last quarter.

As a reminder, the Dear Colleague Letter does not impact our relationship with GCU as GCU provides all faculty for their courses, pays them and receives little and no reimbursement from us or any other outside sources for the faculty costs.

But we are still working with our other university partners to assess the impact of the Dear Colleague Letter, if any, of the programs we partner with them on. We will provide updates to our outlook if contractual changes are needed, but it is important to note that any changes made would have an immaterial impact on revenue and operating profit.

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

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

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. .

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. .

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?.

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. .

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. .

And I may not have heard correctly.

I think you said mid-teens, you mean mid-single-digit growth for online, correct?.

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

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

You’re correct. .

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?.

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....

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. .

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

Thanks..

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. .

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